To OTC Journal Members: 

Now that you've seen the movie, it's time to read the book. If you haven't been to www.otcjournal.com, and watched the 12 minute China Energy video, please do so now. Then, read on.
 

Twin Turbo Growth Drivers Fuel China Energy Recovery (OTC BB: CGYV)

I think we can all agree- the recent Beijing Summer Olympic games were an overwhelming success. I had a rough time getting out of bed the second half of August after staying up so late to watch Michael Phelps ring up all those gold medals and world records, along with a myriad of other absolutely fantastic and memorable athletic performances.

Coverage of the air pollution in Beijing was a media favorite prior to the start of the games. The Chinese government was highly sensitive to this issue. In fact, all factories in the Beijing area were forced to shut down 30 days prior to the start of and during the games. It probably cost the Chinese economy billions in lost revenue.

If those factories had installed China Energy Recovery heat and waste recovery systems, none of those factories would have shut down. CGYV is no start up- boasting 100 installations world wide  (click here to see a pictorial of their systems), the company is sporting a 200% annual growth rate thanks to two mega growth drivers- the need for energy efficiency, and the need to eradicate air pollution- and not just in China.

Here's A Few Facts Driving Energy Demand and Creating Shortages in China as depicted in the chart:

• The World Energy Outlook report predicts that China will overtake the US in its energy use by 2010.
• The Chinese economy expanded by 11.4% over the past year (2007), reaching its fastest growth rate in 13 years. China is highly energy inefficient. It takes more than four times as much energy to generate a unit of GNP in China than in does in the U.S. according to a recent study published by Gordon Feller.
• China's crude oil imports rose 12.4 percent in 2007 to a new record. Crude oil imports for 2006 increased 16.9 percent from the previous year.
• China is facing widespread, temporary electric power shortages that could affect global energy markets if they aren't resolved soon. The distribution system is having trouble keeping up with the country's rising demand for electricity according to the Wall Street Journal.  13 provinces including the industrial-and-export hub of Guangdong in the south will experience a total shortfall of about 70 gigawatts of electricity - about a 10% shortfall.

Mr. Wu Qinghuan: A Great American Success Story- In China

Known simply as Mr. Wu by those who know him, this man is the Chinese version of a great American success story. 35 years ago, Mr. Wu was the head engineer in the People's Republic of China for a government agency responsible for creating industrial efficiency technologies.

15 years ago Mr. Wu's agency was converted into a government owned business developing waste/heat recovery systems.

In the 90's the Chinese government began to allow the privatization of government owned businesses, and in 1995 Mr. Wu privatized China Energy Recovery, which he financed with a $5,000 charge on his credit card. At the time he had 12 engineers and a COO, all of whom still work at the company.

Despite being the CEO of a company on track to generate over $20 million in revenues this year, Mr. Wu still lives in a modest middle class apartment in Beijing and takes an annual salary of about $5,000- 20% more than the mean white collar annual salary of about $4,000 in Beijing.

Today, CGYV has 80 full time engineers on staff, and will be expanding that number to 120 to 150 full time engineers by the end of 2009 to meet the accelerating demand for their systems.
 

How The Technology Works

Here's the simplified description of what they do- Visualize a factory that is belching heat and energy into the atmosphere. In fact, about 67% of the energy used by Chinese factories is wasted as heat in the form of high temperature steam that simply pours out of the smoke stacks.

Now, imagine a technology where you place a cap over the wasted energy, capture it, and filter out the pollutants. Then you use the steam to drive a turbine that creates energy to run the factory. That's it:the China Energy Recovery system.

Net result - the factory now becomes 90% efficient- only 10% of the energy escapes into the atmosphere.

Due to skyrocketing energy costs, factories who have installed the CGYV systems are recouping 100% of their investment through lower energy costs in 9 to 18 months.

Higher energy costs and the need to reduce pollution are both turbo growth drivers for CGYV. Hence, the extraordinary growth rate of 200% plus last quarter. You need to look at the shear scope of the installations. This company is real "old economy" combined with new technology. To view a series of pictorials click here.

On a number of their projects, CGYV has teamed up with Monsanto EnvironChem, a division of the $11 billion behemoth Monsanto (NYSE: MON). In projects that call for a heat/waste recovery system, Monsanto frequently outsources the design, manufacture, and installation of the systems to CGYV.
 

Financial Performance

Let's look at the hard growth numbers. Revenues for the first half of 2008 were $9.8 million, up from $3.6 million the previous year. That's an annualized growth rate of 172% for the first half of 2008.

Taking out the one time expenses in Q2, you can make the assumption CGYV earned about $800,000 in the first half of 2008, up from a loss of $150k in the first six months of 2007.

This past Spring, CGYV raised $8.5 million in cash before expenses. Shares were priced at $2.12, with a 1/2 warrant convertible at $2.80. The shares and the shares underlying the warrants became free trading recently by virtue of an effective registration statement with the SEC. Most of the shares issued in the financing were purchased by institutional financiers- there were a combination of domestic and overseas institutional investors with a "green" theme in their strategy.

There was virtually no public float prior to these shares becoming free trading. As a result, the real public float at this time is about 7 million shares of the 30 million I&O. Mr. Wu personally retains about 70% ownership in the company.

Here's my first thought about this chart- everything before this past Tuesday is basically meaningless. The little blips to $15 per share are nice, but they don't mean much. Tuesday was the first trading day after the registration statement was effective, meaning it was the first time there were any shares publicly traded.

Since Tuesday, the volume has averaged in excess of 100,000 shares daily, and the stock has been trending up nicely from just under $3 to about $3.50. There's a nice little incline, but it's too early to call it a trend. The volume is more telling. Clearly, there is early interest in this relatively unknown issue.
 

Energy Recovery  Inc (NASDAQ: ERII)- the Best Comp

There's one very good comparable company trading in the US markets. Take a look at Energy Recovery Systems (NASDAQ: ERII)- ERII came public in July of this year and it was one of the few successful IPOs in 2008.

Priced by Credit Suisse at $8.50, ERII traded up to $13.50 in a couple of days. The recent market turmoil has the stock trading back down to about the $7.25 level, one of the last IPOs to finally trade below its IPO price.

ERII is a Bay Area company that has similar technology to China Energy Recovery with one major exception- ERII's technology is designed specifically for desalinization plants only. CGYV's technology can be applied to a far bigger market.

Here's a table comparing the two companies performances:
 

The above table is based on a combination of historical fact and future assumptions. Revenue and earnings estimates for ERII are extracted from a recent report published by Citi Group analyst Leone Young. Citigroup rates the stock a "hold" with an $11 price target. Credit Suisse has them an "Outperform" with a $12 price target.

The estimates for China Energy are based on my own personal assumptions. These are derived from historical growth and the company estimates for the second half of the year based on CGYV's current $40 million back log of orders and recent capital injection.

On Friday, after the market closed, CGYV announced a backlog of $16 million in contracts expected to complete over the remainder of 2008- coupled with the $9.7 million it has already delivered, we should see $25.7 million in revenues this year- more than double 2007. Click here to read the press release.

One comment on Q2 numbers: CGYV delivered $5.6 million in revenues for the quarter. This was up from $1.6 million the previous year (250% growth), and 36% higher than the previous quarter. CGYV lost $173k for the quarter (eps: -$.006), but also raised $8.5 million in equity capital during the quarter. One time expenses included huge legal and accounting for two annual audits, the filing of a registration statement, and the fees and commissions associated with the capital raise. I believe the one time costs ran somewhere in the range of $1 million. Without the one time expenses, CGYV would have delivered another profitable quarter.

Furthermore, CGYV should be able to deliver margin expansion in the back half of 2008. Until Q3, they had little cash, so clients were required to pay in advance for large installations. Armed with $6.6 million in cash at the end of Q2, I would expect margins to improve considerably over the course of the year as their pricing power improves.

My take- CGYV is worth at least 70% of the value of ERII. The market says ERII is worth $330 million- CGYV would be worth $231 million- divided by 30 million I&O- you have a stock in theory worth $7.70 per share. ERII is a little bigger, but CGYV is growing about 4 times as fast and has 36% fewer shares I&O.

If CGYV attains a 70% value ratio to ERII, it will provide a 126% return from Friday's closing level.
 

Conclusion: Suggested Trading Strategies

In this case, you have the competitive investing advantage. This publication is the first real coverage of China Energy offered by anyone, and you have the first look opportunity. 

If you like this company and you want to invest, consider the following strategies. You need to figure out the best one for you, and stick with your discipline. Here are several options to consider:

• Identify how much capital you are willing to invest in this idea, and divide it into 3 equal amounts. Invest the initial 1/3 of your capital on Monday up to $4.  If the market offers you better pricing later, invest the next 1/3, keeping the last one third ready for another time. If you end up accumulating at a higher price, your average cost will still be below the market.
• Put in the whole amount you are willing to invest for the long term, and forget about it
• Regardless of how you get it, set your stop loss at $3, or even tighter. To preserve capital, be disciplined and sell if it trades to your SSL. Don't think about it. Just do it. As the stock moves up, move up your SSL.

Inital positions should be taken right up to $4 immediately. 

Current Price: $3.40
Market Cap: $102 million
Short Term Target (six months or less): $6 to $7
Long Term Target: $25 ( two to five years)
SSL: $3

References:

Corporate Web Site: www.chinaenergyrecovery.com
Pictorial of Systems: http://www.chinaenergyrecovery.com/i/pdf/CER_Pictorial_Book.pdf
SEC Filings: Click Here
Questions and/or comments: editor@otcjournal.com

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