Profit from China's Terrible Problem

Wednesday, December 9, 2009 - 4:35pm

by Tom Hutchinson

An unprecedented level of industrial expansion during the past two decades has not only made China wealthy. It's made the country really dirty.

Now comes the clean up.

Years of industrial growth, largely powered by coal, have left China choking in smog. Cities smolder in grey skies and many rivers have become too dirty to even use for irrigation. Earlier this decade, the World Bank estimated that of the world's 20 most polluted cities, 16 were in China.

The Chinese government has made some attempts to clean up the pollution in the past. But now, they're getting serious.

During the boom years of last decade, with industries firing on all cylinders, the government was reluctant to interrupt production for environmental upgrades. But excess industry capacity in the recession combined with massive stimulus spending on infrastructure has provided a perfect catalyst for the Chinese to unleash a serious effort to tackle the problem.

How serious?

Late last month the Chinese government announced that it will spend $454 billion on environmental protection in the five-year period through 2015, more than double what's being spent in the current five-year period. That's a lot of money, even for the Chinese. To put it in perspective, China's $586 billion stimulus package was regarded as massive and is often credited with revitalizing its economy as well as the rest of Asia. Now, $454 billion will be spent on pollution alone.

One of the main targets is the Chinese steel industry. In 1996, China became the world's largest steel producer and today accounts for one third of the world's steel production. Steel manufacturing is also a major polluter. In 2007, the industry accounted for 10% of the nation's industrial wastewater, 15% of industrial dust and 10% of sulfur dioxide emissions. And, steel plants tend to be located near densely populated areas.

RINO International Corporation (Nasdaq: RINO, $28.01) provides pollution control equipment for the iron and steel industry in China. RINO designs, manufactures, install and services wastewater treatment and exhaust emissions desulphurization equipment principally for use in iron and steel plants. The company also makes anti-oxidation products and equipment designed for use in the manufacture of hot rolled steel plate products.

Business is booming.

In 2008, revenues rose +119% from the year before to $139 million. For the first nine months of 2009, revenues have risen +42% from the year-ago period. Net income rose +111% between 2007 and 2008 to $21.3 million, and is up +94% for the first nine months of this year.

As for the stock price, RINO has soared a mind-boggling +690% year-to-date. The stock moved from the pink sheets to a Nasdaq listing on July 31. Since then, shares have almost doubled. Even after this year's performance, RINO is still selling at just more than 14 times 2009 projected earnings, a cheap price for this level of growth.

Through the haze, RINO's outlook is bright. On July 21, the Chinese Ministry of Industry and Information Technology published a formal plan in which it prioritized flue gas desulphurization (FGD) installation and set specific guidelines and targets for companies while offering government funding. Flue gas desulphurization screens the sulfur pollutants from industrial smoke stacks. RINO called this the single most important regulatory event in the company's history, and said the new mandates should double the number of FGD systems installed annually through 2011. This will significantly help RINO, as FGD systems have accounted for 63.8% of company sales so far in 2009.

In order to keep up with the rising pace of business, RINO just completed a $100 million capital raise, offering 3.25 million shares at $30.75. The offering will not be significantly dilutive as the company already has more than 25 million shares outstanding. With $167 million in total assets as of September 30, the additional $100 million will give the company a huge funding boost and enable it to expand to meet the escalating demand. This represents a low cost of funding for a company that is virtually debt free already.

Clearly pollution control is not going away in China. The country desperately needs to clean up and become more energy efficient. RINO is in an ideal situation to benefit.

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Tom Hutchinson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.