Heating Equipment Maker Benefits As China Spends To Clean Its Air
December 3, 2009
Among other things, 2009 may be remembered as the year China's pollution-control industry came of age.
Back in May, SmartHeat migrated to the Nasdaq from a lesser exchange, followed a few months later by Rino International , which makes pollution control equipment.
At the same time, water treatment equipment maker Duoyuan Global Water pulled off a successful IPO.
The market for such firms is huge, said Rodman & Renshaw research director Joe Giamichael in an e-mail to IBD from China.
The energy-conservation, pollution-reduction opportunity in China is tremendous," he wrote. "As I speed through Qingdao in a cab writing this I am in my fifth major city in two weeks, all equally grayskied with extremely poor air quality."
Replacing Old Technology
SmartHeat is attacking one aspect of the problem: heating systems. Most of China's buildings currently house coal-burning boiler systems using shell-and-tube heat exchangers that were "state of the art in 1930," says analyst Greg Garner of Singular Research.
SmartHeat's plate heat exchangers, standard in the West but new to China, are more than twice as efficient as the old technology. They transfer heat between fluids without allowing the fluids to mix. Individual PHEs are sold to power utilities and certain industries such as chemical processing. Entire PHE systems, involving pumps, valves and control systems, are installed in buildings for climate control.
The China District Heating Association estimates that Chinese PHE sales are growing 30% a year, while PHE system sales are gaining 70% annually. Analyst Garner admits to some skepticism that the numbers are really that high, but he agrees the market is growing rapidly. He points to the lack of price competition, even though there are so many rivals that SmartHeat leads the field with just 9% market share.
"(SmartHeat) prices the end product based on the raw-material costs," he said. "Any pricing pressures are minimal."
Government policy is a key factor in that growth. China's $586 billion economic stimulus package, passed late last year, includes $31 billion for energy efficiency. On Nov. 25, the government doubled its planned investment in environmental protection to $454 billion by 2015.
New regulations are also mandating another piece of equipment that Americans take for granted: heat meters. Traditionally, when businesses and residents leased buildings owned by the government, which is a lot of them, the heat was simply included in the rent.
The government eventually realized how wasteful this was and in 2003 mandated that all new buildings include heat meters. Last year, it expanded the law to retrofit older buildings.
The market is so new there are no data on its growth. But analysts agree it's a big opportunity for SmartHeat. Garner points out that in the most recent quarter the firm reported $7.8 million in heat-meter sales, while all of 2008 brought in only about $500,000.
Total sales in the third quarter jumped 83% over the prior year to $37.8 million. Profit doubled to 36 cents a share.
Its Edge Is Service
So far, these are the seven-yearold company's only product lines. Analysts say there isn't much to differentiate its products from other firms' since PHEs and heat meters are fairly uniform. Giamichael says SmartHeat stands out for its speed and flexibility of service.
"The success is largely service-oriented," he wrote in his e-mail. "They have developed a proprietary software that allows them to identify PHE needs for proposed structures in real time and can provide a contractor with an on-the-spot quote, rather than the multiweek quote process that peers require."
This has helped SmartHeat develop long-term relationships with some large customers. The client list includes Motorola, Beijing International Airport, Dalkia and Sinopec. Earlier this year, it signed a contract with the Chinese arm of Fluor, a huge construction firm. It has some 250 customers in all, none providing more than 8% of sales.
SmartHeat is also moving to vertically integrate. Since 2004, it's been getting the plates for its PHEs from Denmark's Sondex, making it one of Sondex's three distributors in China. But last June, it bought Siping Beifang Heat Exchanger Manufacture Co., which can make the plates for SmartHeat in-house.
In his Sept. 28 initiation report on SmartHeat, William Blair analyst Brian Drab wrote that this purchase strained the firm's relationship with Sondex. This creates the risk that Sondex will end the partnership, depriving SmartHeat of a significant chunk of revenue.
But Drab also points out that SmartHeat accounts for only a small percentage of Sondex's total sales, so it might not be worth the fuss. And it would be tough for Sondex to replace the Chinese distribution network.
Drab believes the buyout was worth the risk.
"In our view, SmartHeat's plan to vertically integrate is a wise business decision, reducing lead time and manufacturing costs, and seems inevitable," he wrote.
Analysts polled by Thomson Reuters remain upbeat about Smart-Heat's outlook, though they do see the ramp-up reaching maturity. For the full year, they expect EPS to jump 117% to 63 cents. In 2010 they see growth slowing to 17%, but picking up again in 2011 to 42%.