To OTC Journal Members: 
 

China Energy Recycling (OTC BB: CREG): The Perfect Model For Maximum Profits

I was planning on introducing this idea last week, but the stock got on a roll, and I was hoping for a bit of of a pullback. I don't think we're going to get any major pullback on this particular idea since it would appear the company could earn perhaps $.25 in EPS this year, and the stock is only trading at $2.50 (about 10 times this year). With a 500% growth rate (unsustainable) this year, it's unlikely this valuation will hold much longer, so I'm not going to wait any longer. If the stock decides to take a breather, so much the better.

When I published my October 8 article on Carlyle Group - the largest private equity firm in the world, I was planning on doing a follow presentation on CREG- why? because Carlyle owns 32% of the company and has invested about $25 million. Carlyle can make mistakes, but you don't get to be an $80 billion private equity fund without making some astute growth investments.

Let's cut right to one of the difficult admissions as it relates to CREG- many of you read my recent treatment of CGYV where I expressed my disappointment in their relatively weak performance in 2009. There's no way to sugar coat this- the CREG has the superior model where projects are designed to generate recurring revenues for anywhere from one year out on an unlimited basis. Bad quarters are replaced with recurring revenue cash flows, and analysts love a predictable revenue and profit model.

Read on:
 

What CREG Does

CREG builds, own, operates, leases, rents, and charges interest on energy recycling systems for Mining, Steel, and Cement factories. China currently produces 33% of the world's steel and 45% of the world's cement. With massive construction and $600 billion earmarked for roads just in the next two years, the steel and cement factories are staying busy.

Here's a schematic of a TRT system- Top Pressure Recovery Turbine- commonly used in Steel mills and coal mining facilities. On your right is a picture of a working version of the TRT system at an intensive industrial plant in China.

CREG has the next three years of business pretty well locked down- doing business with some of the largest heavy manufacturing names in China including Sino-Steel, Erdos Metallurgy, and Shengwei Cement.

CREG has unique technology very well suited for heavy manufacturing, but of far greater interest to myself as an investor is the powerful recurring revenue business model- a model I believe individual investors, fund managers, and analysts will embrace.
 

The BOT Model

The BOT Model- Build, Operate, and Transfer.

CREG actually has 3 different revenue models, which is why you see several categories of sales on their income statement. CREG reports product sales, rental revenues, and interest revenues.

Through the first six months of 2009, CREG has generated product sales of $9.5 million, rental income of $6 million, and interest income from leases of $2.3 million. In total- $17.8 million with $4.3 million in net income.

CREG actually has three different revenues models for projects. The first is the BOT model previously mentioned. Build-Operate-Transfer. In the BOT model, the customer pays up front fees for the design, build, and installation of the project. CREG still holds title to the system, operates it, and participates in the energy cost savings for 5 to 20 years. At the end of the holding period, the factory takes ownership of the system. There are recurring revenues generated over the life of the BOT.

CREG also uses a leasing model in some of their installations. In this case, CREG will build the system with its own capital, and lease it to the manufacturer. The can create recurring revenues for many years. In the end, the system transfers to the manufacturer for either a buy out fee or no fee depending on structure.

The third model is a straight investment model wherein the manufacturer and CREG jointly invest in and finance the system. They then share in the energy cost savings for anywhere from 5 years out to forever.
 

Outlook

CREG is building out three major projects for the second half of 2009, and has substantial future business in their pipeline. 

The company estimates it has the next three years of projects either under contract or at the MOU stage (memo of understanding). Their current projects represent 64 megawatts of power generation. One project has a 4 year term, another a 4 year, and a third a 3 year term.

These projects represent 11 years of recurring revenues, and about 175 MW of power.

6 more projects being contemplated, if they all come to fruition, would generate 135 years of recurring revenues in total.
 

Conclusion and Upside

CREG has been a very quiet and under followed stock until the past two weeks. All of a sudden, the stock has gotten red hot. The company presented at the Roth China conference in Miami last week, which might account for the emerging interest.

There's nothing to really say about the chart besides wow- this stock has broken out of late on both price and volume, and investors are starting to figure out the value.

I'd like to see the stock cool off a bit since I'm hoping for a more favorable entry level, but it didn't happen at the end of last week, so there's no reason to wait. Ideally, I'd like to see the stock pull back to the $2.25 range, but it might just keep streaking.

The recurring revenue model lends itself to a stock that might trade with a much higher multiple than simply a project driven model- earnings become more predictable and less subject to the whims of projects- analysts and institutional investors love that in a company.

CREG could end up generating over $40 million in '09 revs and over $10 million net- with 38 million I&O, a range of $.25 to $.30 in EPS seems reasonable. I also believe $.45 to $.55 EPS is possible in 2010.

The profits and corresponding Earnings Per Share can accelerate quite dramatically as more projects with recurring revenues are installed and start generating cash flow. This makes the model more valuable as we move through time.

I see this stock as an easy double over the next 6 months and perhaps stronger. Much more on this company as numbers come out over the next couple of quarters.

Today, I would take my initial position immediately, leaving some capital in reserve in case it pulls back. I'd get in right up to $2.75, and be very aggressive if we're lucky enough to see the stock head back towards $2. SSL in my view is $1.75. Six month price target is $5. 

Q3 numbers will be very interesting on this one. 

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