Tuesday, May 20, 2008

One to ponder - apwr

A-Power is an under-the-radar name in the alternative energy space that I believe has potential for explosive earnings growth. Many stocks in this space have been rallying sharply in recent months, and shares of A-Power have followed suit. Although the stock has been trading near a 52-week high, I believe investors will see major additional upside over the next few years given that the company is rather well positioned in the Chinese energy market.

A-Power designs, builds and installs distributed energy facilities, which provide power separate from traditional massive grid-based supplies. Demand has been strong in China and recent announcements indicate additional potential to expand into other countries in Southeast Asia.

In addition, A-Power has plans to enter the wind energy business, with its new production facility in Shenyang that is scheduled to begin churning out 2.5 MW (megawatt) turbines later this year. The combination of an entrenched distributed energy business and a move into wind turbine manufacturing has the potential to turn the company into one of the fastest-growing alternative energy players in Southeast Asia.

I expect A-Power to win additional distributed energy projects in 2008, as well as continue its progress in the construction of the Shenyang plant. Updates on both of these fronts should help drive shares higher.

China's wind energy industry remains in the early stages of development, and government commentary has prioritized making renewable energy a much larger contributor to the power supply in China. It's no secret that the country suffers from power outages and brownouts caused by the overburdened national energy grid. I believe that the construction of distributed energy systems (including wind energy facilities) in China has the potential to undergo a rapid multiyear growth spurt as the country looks to solve problems stemming from the combination of skyrocketing national energy consumption and an unreliable energy infrastructure.

In addition, China's mounting pollution problems create an added incentive for government support in getting alternative energy projects up and running quickly. Recent laws provide evidence of this favorable government view: The 2007 Energy Conservation Law and the 2005 Renewable Energy Law provide a strong framework for ongoing support of the renewable energy industry in China.

China's NDRC (National Development and Reform Commission) has taken an aggressive stance toward expanding the nation's wind power capacity over the next 12 years, and has set specific long-term targets. In 2010, installed wind power capacity is expected to hit 5 GW (gigawatts), and by 2020 it is estimated that total capacity will reach 30 GW. Based on these expectations (which could prove conservative), the wind power industry is poised to benefit from a period of rapid and sizable investment, likely totaling more than $20 billion over the next 10 years.

China's electric utility industry is highly regulated, giving China-based companies an edge over foreign players looking to secure lucrative deals. Currently, companies such as Denmark's Ventas, Spain's Gamesa and General Electric have double-digit percentage shares of the Chinese market. However, China-based companies are likely to see domestic-friendly government incentives that will help solidify and possibly expand their market share.

A-Power's GaoKe Energy Group is the company's main operating unit that focuses on securing new projects, handling design and subcontracting of most preparatory activities, and overseeing the facility construction. The company also engages in the development and commercialization of renewable energy technologies through its relationships with Tsinghua University and the China Sciences Academy in Guangzhou.

GaoKe has a corps of over 100 engineers, and specializes in projects for distributed energy systems ranging from 5 MW to 25 MW in size. The company also recently acquired a construction company that was previously run by the Chinese government. The key to this acquisition was that it came with a class A license, which is needed in order to work independently on projects larger than 25 MW. In effect, A- Power's potential for large projects within China is just beginning.

However, the company has plans to expand its operations outside of China, where it already has the ability to ink larger deals. Just last month, the company announced it had received a $150 million contract in Thailand to develop a 300 MW system fueled by 50% coal and 50% biomass.

In addition to its attractive distributed energy business, A-Power is poised to accelerate its long-term growth by becoming a full-scale producer of wind turbines. In January, the company signed license agreements with two major European turbine makers, Fuhrlander AG and Norwin A/S, and expects to begin production later this year upon the completion of a new production facility in Shenyang. By producing its own turbines, the company faces less potential for pricing pressure from manufacturers, and benefits from more favorable labor costs in China. In addition, A-Power qualifies for a 17% value-added tax rebate (from the Chinese government) on exported equipment, making the exporting of wind turbines even more profitable.

A-Power announced full-year 2007 results March 31, posting net income of $15.2 million on revenue of $152.5 million. More importantly, management confirmed 2008 full-year guidance for earnings in the range of $35 million to $45 million, or $1.05 to $1.35 in earnings per share. Also of note was the large jump in the company's backlog, which increased to $550 million as of March 31 from $398 million at the end of 2007.

The company's growing backlog makes sense when you consider the rapid growth in energy demand from Chinese businesses. Also, it's understandable that businesses would choose to build a new distributed energy facility rather than rely on the nation's overtaxed grid system. This is certainly true for businesses that operate in remote parts of China, where energy infrastructure is almost nonexistent. It's no wonder that A-Power's GaoKe subsidiary is seeing such acceleration in its business, as building new energy facilities is essentially a necessity for the many of the new businesses that are springing up (or simply expanding) across China.

In addition, investors should not discount the advantage of A-Power being the first established company in a growing area. GaoKe already has completed nine projects that now serve as a major marketing tool for securing new contracts.

The April 15 announcement of a $150 million distributed power generation contract in Thailand marked A-Power's first major international deal. We believe international opportunities will be a huge driver for the company, as many nations in Southeast Asia also suffer from limited or unreliable energy infrastructure.

Although shares of A-Power are trading close to their 52- week high -- set earlier this week -- I believe that there is much more room for appreciation as the company's potential becomes clear to institutional investors and Wall Street researchers. Consensus estimates from the two research firms that currently cover A-Power indicate that expectations are for net income to grow 145% in 2008. Revenue for the year is expected to jump 155%. These numbers could potentially prove very conservative, especially considering that A-Power's guidance released at the end of March was for an earnings-per-share range of $1.05 to $1.35, the midpoint of which is 4 cents greater than the analysts' $1.16 consensus earnings estimate for 2008.

Based on the $1.20 midpoint of management's 2008 earnings guidance, shares of A-Power are currently trading at about 17 times earnings -- a number that is downright cheap considering the company's growth profile. Using the existing analyst estimates for 2009 (consisting of two data points), shares are trading around 15 times earnings expectations. I believe the modest valuation is a result of the company's under-the-radar status and lack of major institutional support.

Other positive factors for A-Power include a solid balance sheet with zero debt and a cash balance of $97 million as of March 31. The company's GaoKe unit qualified as a foreign investment enterprise under Chinese regulations in 2006, entitling it to a full exemption from Chinese income tax through 2008, and a 50% exemption for three years starting in 2009.

A-Power's small size (it has a market cap of less than $300 million), short track record of results and limited analyst coverage all contribute to the speculative nature of this investment. However, I believe that a discretionary investment portfolio needs a few highly speculative positions, and in this case I see a favorable risk/reward profile. A-Power is an unproven company with a story that is just beginning to take shape. As such, it's a high-risk name that could see large swings in its stock price even without major news.

Disclosure: None; but seriously looking

No comments: