China Infrastructure Plays

by Zack Buckley, GeoTeam Contributor

The greatest advantage investing has over baseball is that you get to choose the pitches you swing at. In baseball, you only get a few pitches in order to get a hit. In investing, I have sifted through thousands of companies in order to choose only the obvious picks. If I don’t like a company, I don’t have to buy it! Imagine only having to swing at the perfect pitch, you could hit a lot of home runs!

When I traveled in China last year I was amazed with the growth in infrastructure. There was construction everywhere cranes building new skylines, brand new large toll roads being built to support the over 100% growth in automobile sales, and rapid construction in general in order to achieve modernity. Compare that with extremely undervalued companies and you have a great industry for a value investor. That’s why I am traveling to China this summer, to find those special companies that will turn into home runs.

China is the largest developing nation in the world with an 8+% growth rate for the last 30 years. Steel production from 2000-2010 has increased from approximately 100 million tons to 500 million tons. In response to the economic crisis, the Chinese government pledged a 586 billion dollar package to help the economy. As a result, massive investments by both the national and local governments were made in infrastructure. Projects include expansions to the nation's international airports, road and rail networks, energy production capacity, and buildings and other large public works projects. Here are two infrastructure companies I think will get knocked out of the park.

China Armco (NYSE AMEX:CNAM) specializes in importing and distributing metal ore. CNAM recently has completed its scrap metal recycling facility and has already received a 100 million contract. The company expects the factory to be at full capacity by fourth quarter 2010, which should generate 400 million in revenues with 8-12% margins, giving it a net income of about 40 million and a forward p/e of 2.5. While it was a nonsensical 35 million dollar company a little over a month ago, at the current market cap of 97 million it will still be trading at a P/S of .25.

The cement industry is currently growing at an annual rate of 6%. The industry is composed of many small players, with few larger, developed companies. The Chinese government is trying to clean up the environmentally costly industry; as a result, they are closing the smaller and less eco-friendly plants. This will lead to the closing of close to 300 factories in Shandong province alone in 2010, which will create additional demand for the larger consolidated companies. In general, the cement industry has recently experienced restricted supply, this should lead to cement companies increasing cement prices, while also being able to operate at full capacity.

China Shuangji (OTC BB:CSGJ) appointed a US based CFO, a reputable auditor, and a New York based legal firm that all specialize in handling Chinese companies that want to up-list to larger exchanges. Up-listing means higher share prices! Generally much higher! Just look at CNAM in the past month. These are all extremely exciting developments for a company currently trading at an adjusted P/E ratio of about 5 excluding onetime gains. The company is currently running at full capacity and has the lowest P/E ratio and the highest expected growth rate compared to its peers China Runji Cement and West China Cement.

China Shuangji's shares have fallen for a reason, but we believe the problem is only a short term hiccup in the company's operating cycle. In late 2009, the company closed down one of its 500,000 ton manufacturing facilities in order to relocate. The company is planning on reopening the facility in a nearby location by the summer of 2010. This presents the one risk present in the company; they must secure 5 million to reopen the factory. We believe this is why current prices in the company's shares are so depressed. However, it seems very likely the company will raise the 5 million dollars necessary to get the relocated plant running. Once running, they expect to increase revenues and net income by 70% through the expansion of capacity from 500,000 to 1,000,000 tons at the new factory.

With the factory closed down, they are operating at a capacity of 1.5 million tons of cement annually. By the end of 2010, if they are able to secure their revenue, they will expand capacity to almost 3 million tons per year. In future years, they have a two prong growth strategy, they will continue to create organic growth through the expansion of capacity at their current facilities and pursue strategic acquisitions using their financial resources.

I would not miss these home run pitches; they should be easy to knock out of the park.

Disclosure: At time of this article, Zack was long CNAM & CSGJ

Profile