Investor's Champion Blog
Provides refreshingly forthright, independent comment on predominantly small cap companies and specialist investment funds. Informed opinion, based on first-hand research, but pulls no punches in exposing management weaknesses.

China Shoto - Electric growth and an appealing valuation-so why the share price fall!

I recently met with the management of China Shoto, the Chinese producer of industrial batteries and power supply systems which announced its year end results last week.

Although the group appeared to come out with some great numbers the market (or rather a small number of shareholders) was clearly unimpressed pulling the shares down c8% on the day.

For the year to end December 2006

- Revenue increased by 134% to £66.45 million (2005: £28.41 million)
- Net profit increased by 29% to £4.0 million (2005: £3.11 million)

…and this is the big one:

- Debtor days fell from 121 days in 2005 to 75 days in 2006-now that looks quite good for a Chinese business.

- An interim dividend for 2006 of 1.5 pence per share can be added to a final dividend for 2006 of 3 pence per share to give 4.5p for the year. Also very encouraging.

If a British company had come out with these sorts of numbers the shares would have soared. Furthermore, China Shoto has, in quick time, managed not only get its new plant up but also running at near to full capacity.

Admittedly there no growth in eps but none was really expected with the business having gone through a metamorphosis in the year, with fund raisings, acquisitions, new factories etc.

After all China, much like Rome (or Microsoft for that matter), wasn’t built in a day!

The core back up battery business grew by 38% with sales to China Mobile, the largest network operator, doubling and now representing c25% of group sales.

We acknowledge that earnings per share of 19.5p was slightly below the house broker’s estimate of 20p but given all the activity in the year and the work involved in getting the factory up and running we shouldn’t be too concerned at the current valuation.

The industrial back up power supply business should be flying with 3G being rolled out.

The new line supports the manufacture of batteries for electric bicycles and with bicycle production increasing by 78% in 2006 and c25m electric bikes forecast to be produced this year there is no problem with demand! The group has also expanded its sales network in order to address the replacement market as this develops and has opened 43 sales offices. This is essentially a commitment for the future which is clearly going to have an impact in margins in the short term, as evidenced by the operating margin falling from 16% to 9%. With regard to these falling margins, other factors include the increase in lead prices over the year (lead represents c55% of cost of sales) and the lower gross margins from the electric bicycle battery business.

Year end stock levels have obviously shot up but this is a very different business one year on.

I agree with the house broker (that’s a first) that a UK stock experiencing such positive conditions would trade at c13x to 15x next years estimates. Coslight, a Hong Kong listed peer trades on a calendar year 2007 PER of 19x. I wouldn’t be surprised if China Shoto is having regrets about coming to London!

The house broker estimates 15% earnings growth in 2007 and a yield of 3%. The stock currently trades on a calendar year 2007 PER of 7.3x falling to 6.5x for 2008.
The PEG is therefore just under 0.5-there aren’t many out there in the UK market on these sort of valuations at the moment!

Even if one takes a hatchet to the numbers and pulls back the earnings the shares still seem to look reasonable value. The debtor days (75 days average, but a big spread) still remain quite high as do year end stock levels (60 days) but this is a business that is expanding at the sort of rate of most of us have never seen from a UK operation so perhaps allowances should be made.

It should also be remembered that this is a Chinese business whose principal customers are big telcos and who is well supported by major Chinese banks.

Let’s see what happens!


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