By Ephraim Fields

China Clean Energy  (CCGY) is a small, rapidly growing, undervalued and poorly named Chinese manufacturer and distributer  of specialty chemical and biodiesel products located in Fujian Province.  The company is benefitting from increasing demand and improved pricing for its products as well as significantly increased production capacity that has already been funded and is already up and running (in other words, they don’t need to raise equity nor is there much execution risk regarding the new facility).  Based on the company’s current guidance of $8.2 mm of EBIT for 2010 (which we consider conservative), the company is trading at only 3.9x EBIT and 4.6x Adj. EPS (based on our derived Adjusted EPS of 23c, which excludes warrant and stock comp charges).  EBIT last quarter (q2) was $2.1mm up from $1.0 million in Q1.  More importantly, next year the company should experience significant growth in profitability as a result of increased revenue and improved margins.  The company has not yet provided 2011 guidance however they have stated that by the end of this year they expect to be running their new facility at full capacity, which based on last quarter’s selling prices (which have since increased) would imply $90.0mm of revenue for 2011, up 58% from 2010E.  Assuming $90mm of revenue and flat EBIT margins, that would imply 2011 EBIT of $12.9mm and an approximate 2.5x EBIT multiple.  While this basic math assumes flat margins, 2011 margins might increase due to increased demand and improved operating leverage.  On the other hand, if 2011 profitability does not reach those levels, the stock is still very cheap.  While no one likes “paying up”  we have done so because even at $2 per share (up 100% from here) the stock is only at 4.8x our 2011E EBIT.  We believe this stock should appeal to value, growth and momentum buyers.  Also note that all EBIT figures here are after about $400k of annual non-cash stock comp which some may exclude from their valuations.

For a small, Chinese company, CCGY has a well-written 10k and recent investor presentation available at http://www.chinacleanenergyinc.com/ .  These are very helpful in understanding the company (especially the new capacity expansion) so I won’t waste time describing the business in detail.

So why is the stock so cheap?

1)      The stock is small and illiquid.  Furthermore, the company’s IR efforts could be improved, although they are actively attempting to improve them.  Two easy things they could do would be to (1) begin giving adjusted eps guidance, rather than just ebit guidance and (2) change their name to better reflect their actual business.

2)      There has been some confusion regarding the company’s need to raise equity.  Our recent and repeated conversations with management (and their public statements) indicate CCGY does not need to raise equity for its current business but could raise equity (but only at significantly higher prices) to finance acquisitions of feedstock suppliers (that would enable the company to have greater control over its cogs).  

3)      The stock is currently traded on the OTCBB, but is actively working to uplist, which we expect will happen next year.  In the near term, however, we expect to see the announcement of new, independent board members necessary to qualify for the uplisting.

4)      In Jan 2008 the company did a PIPE, selling 10mm shares at $1.50 with 5mm warrants at $2.00.  The company failed to commence production of its facility on time and the CEO had to issue some of his personal shares to PIPE investors.  As a result, the company has a tarnished reputation among some investors.  We believe some of these PIPE investors are fatigued and thus are sellers of stock which creates an opportunity for new investors to buy this illiquid stock.

5)      The company records non-cash stock comp every quarter.  Also, although the warrants our out of the money ($2.00 strike price) the company still records a non-cash item on its income statement every quarter.  The company reports an “adjusted” eps figure though but gaap eps is often ugly and confusing.

6)      CFO is based in NYC and is very user friendly.  He has been responsive to all our questions although some investors have complained that his CV is not up to par.

7)      The stock has no analyst coverage and minimal institutional ownership, except for existing PIPE investors.

Catalysts:

1)      Improved quarterly results

2)      Issuance of 2011 guidance – likely when they report q4

3)      Signs of progress with uplisting

4)      Improved and increased IR

5)      Clarification of no equity raise message to investors

6)      Increased interest from investors as stock trades above $1 and at 52 week high