IB Net Payout Yields Model

Dr. Copper and Lihua International

As the US markets sell off back into a technically negative levels below the 200ma, Dr. Copper continues to suggest that the panic over a slowdown in China and weak jobs reports in the US are very much overdone.

The below real time 24hr price chart of Copper shows little additional impact from the US selloff today and in fact Copper continues to hold up at a very strong $3.26. Not very indicative of a weak China or a slowing US.

Lihua International (LIWA) has become one of our favorite copper plays beyond the big play of Freeport-McMoRan (FCX). LIWA reported Q2 earnings of $.34 that easily surpassed the estimate of $.28. More importantly though (because analyst estimates shouldn't rule valuations) the stock trades at only 4x the EV of roughly $160M. LIWA has $85 in net cash on its balance sheet and generated a whopping $9M in cash for Q2.

Why then is the stock trading so cheaply? Really why do all the small cap Chinese stocks trade at amazing discounts to growth rate? Possibly the market lacks knowledge of the companies or its more of a trust issue. After the financial crisis do you really trust US companies any more? In the last decade the US has already proven that auditors and rating agencies can become complicit with management to avert the rules in place to prevent fraud.

Another possible concern is that a lot of companies like LIWA are expanding at fast clips and the market is likely concerned about over expansion. LIWA just doubled its smelting capacity in July and is looking to double again in 2011. That is a natural concern for any business but that are amazingly profitable is a solid balance sheet. The concern should only come if they were piling on high debt levels. The exact opposite is happening though. LIWA is generating piles of cash and the market for recycled and refined copper in China is expected to continue growing. Where else can you buy a company if an Enterprise Value of $160M that expects to make $40M in net income this year and then double and quadruple capacity in the next 12-15 months?

Highlights of Q2 results:

-- Sales increased 55% year-over-year to $75.5 million.
-- Gross profit increased 49% year-over-year to $14.5 million.
-- Net income increased 48% to $9.9 million, or $0.34 per diluted share,
compared with $6.7 million, or $0.31 per diluted share in the second
quarter of 2009.
-- EBITDA increased 45% year-over-year to $13.0 million.(2)
-- Strong balance sheet with $87.6 million in cash and cash equivalents as
of June 30, 2010.
"We are operating near full capacity while trying to keep pace with demand and continuing to expand our business," said Mr. Zhu. "We remain on track to initiate construction on our planned new copper recycling facility in the fourth quarter of 2010, which we expect to come online in the second half of 2011. This new plant and additional smelting capacity will increase our annual refined copper output to 100,000 tons from our current capacity of 50,000 tons per annum (just doubled to 50K so thats not even in the numbers yet). We also plan to expand our copper and CCA wire drawing capacity by the end of this year through the addition of new high-speed production lines. We believe these key initiatives will enable us to better address the growing customer demand for pure copper replacement products."

Disclosure: Long LIWA, FCX


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