“China’s Screwed” … how to profit from the “tiny company [that] solves the #1 threat to China’s economy.”

Sleuthing out a teaser pick from Jeff Opdyke's Emerging Market Strategist

By Travis Johnson, Stock Gumshoe, April 16, 2012

For as long as there’s been a Stock Gumshoe (that’s since 2007, in case anyone’s askin’), there’s been an easy pitch to be made that goes like this:

  1. China is polluting it’s water like crazy.
  2. China has a godawful number of people.
  3. China needs to spend a helluva lot of money on cleaning up their water.
  4. This water stock (enter name here) will make you rich as a result.

And there’s a reason why the pitch is easy to make — it’s because it’s true (well, 1 through 3 are true … 4 is “to be determined”). China is indeed a disaster many years in the making when it comes to water, whether it be water for agriculture, industry, or human consumption … as befits a newly industrialized nation, the environmental standards have been horrid over the years, or overridden by corrupt local governments. Nothing unique there — but as with everything else, when China does it they do it bigger than anyone else.

Of course, a lot of the investments that have been teased as China plays have not worked out for a variety of reasons — whether because the company wasn’t enough of a direct “China water” play, or it got snagged in the accounting shenanigans of so many US-listed small China stocks, or whatever else. That doesn’t stop the urge to find them, water is an easy to understand basic commodity and China is the source of most of the world’s marginal commodity demand and long-term strategic investment in commodities … so really, companies that can capitalize on connections or assets or technologies to sell water-related services or build water and wastewater projects in China should be in a profitable niche, and the search for the best ones continues.

Which leads us to today’s tease from Jeff Opdyke, a former Wall Street Journal reporter who turned into a newsletter guy when he joined up with the Sovereign Society a couple years ago. He’s pitched a few interesting ideas in his ads over the years, largely for smallish, often hard to trade foreign securities that are “under the radar” for mainstream US investors. And I’ll admit to having a soft spot for those kinds of investments myself, so I thought I’d try to sniff this one out for you.

Here’s the intro from his latest ad to get us revved up:

“China’s screwed!

“If its government doesn’t act fast, 30 years of massive economic growth could crumble in an instant…

“Hurling China back to the days of bicycles and pushcarts.

“London’s Guardian newspaper reports that, ‘China is resorting to desperate and expensive measures to head off this crisis.’

“So what exactly could throw China into a depression… and how could this create an opportunity that could double your money by July 2012?

“The crisis at hand is China’s water supply.

“In short, China’s drinking water is filthy, polluted and often undrinkable.

“The water in China is so bad that legendary investor Jim Rogers – a long time pro-China investor – went on record saying… ‘I don’t mind if China has a civil war, epidemics, panics, depression, all of that. You can recover from that. The only thing you cannot recover from is water… If China doesn’t solve its water problems, then there is no China Story.’

“China’s State Environmental Protection Agency already confirms, ‘90% of the water under China’s major cities is polluted to some extent'”

So that’s the copywriter’s version of “why the problem is so bad.” What’s the stock that Opdyke is pitching as a way to profit from the solution?

“I’ve uncovered an incredible water-treatment company.

“It has already secured 21 government contracts to help Chinese communities manage their water woes, and I’m confident more contracts are in the pipeline.

“It’s one of China’s premier water engineering firms and is set to bank more than $225 million in new revenue directly from the Chinese government.”

Then we get into the more detailed spiel about this stock, with a lot more clues — here’s that:

“Right now China’s funnelling millions of dollars into the coffers of a small government-backed water treatment company…

“It’s a tiny company with an $845 million market cap. But over the last 7 years its net profits have increased 34% annually. And its stock, which could double by July 2012, trades well below $5.

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“Already a leader in the water-treatment industry, this company ranks among the top 10 outstanding water and engineering firms in China, and just signed a slew of government contracts, including:

  • Contracts to build 18 waste-water treatment plants in Changsha county in Hunan Province.
  • An $18 million contract to build a waste-water project in Shaanxi Province.
  • A winning bid worth $13.2 million for a waste-water project in Liaoning Province.
  • And it’s the leading contender to win a $210 million contract to build a 300,000 ton waste-water treatment plant in Jiangsu Province, north of Shanghai.

“These contracts alone could boost its stock 100% or more. But there’s more good news that could move the shares even higher.

“This company is expanding beyond China’s borders.

“In fact, it’s making a splash internationally by winning contracts well outside its home market. For instance, just recently the company:

  • Won an $86.8 million contract to reconstruct a waste-water treatment plant in Saudi Arabia.
  • And trumped 20 competing bids to win a $50 million contract to build a water supply plant in Bangladesh.”

So who, then, is our little Chinese water engineering company? Well, we toss all those clues into the Mighty, Mighty Thinkolator, throw in a few gallons of H20 from the Gumshoe well just to be sure, and we get our answer right quick, a bit damp but on target: Sound Global.

Which, as you might guess from past Opdyke teaser picks, is a bit tough to buy for US investors — it trades in Hong Kong at 967 and in Singapore (which is a hub for water stocks) at E6E (or SGL, if you’re looking at Bloomberg), and, very lightly, on the pink sheets at SGXXF.

And it’s not particularly expensive — according to Bloomberg, it’s trading at about 8 times earnings, and about 1.6X book value. The company is primarily dependent for revenue on significant projects to design and build new water and water treatment plants, largely in China (though they are looking outside for deals and growth, particularly because competition for Chinese projects is apparently very intense and cutthroat, including that contract in Bangladesh that they won last Spring, and one in Saudi Arabia that they won in 2009). The clues about the various plants and contracts are all a match, so I’m confident that the Thinkolator is right this time around.

And there is plenty of business — China is spending hundreds of billions of dollars on water over the next few decades, including some truly massive projects to reroute water from the southern rivers to the northern, arid cities. Sound Global and other Asian water companies are all fighting for the contracts in the rest of Asia as well, as India and the countries throughout Southeast Asia upgrade their water facilities for growing populations and improving environmental standards.

You can see Sound Global’s latest investor presentation here — sounds fairly compelling from this quick snapshot, the stock is not particularly expensive, they’ve been growing margins and revenues nicely, and they don’t carry much debt. They are, however, very much an engineering and construction company at this point, they depend heavily on new contracts to design and build water plants, so I would presume that their revenues and earnings will be pretty lumpy going forward since those contracts don’t necessarily roll in on a regular basis. It seems like they’re building the other segments of their business, including contracts to build and operate these plants, sort of like a utility, or to operate and maintain existing plants, and those should enable them to build a steadier “utility-like” stream of revenue if they’re successful … and they also have a small business building and selling water treatment equipment … but those are still only about 20% of revenues, for now growth is really all about new contracts to build plants.

And that’s about all I know on Sound Global … your turn! Have an opinion, or another favorite water stock (Chinese or otherwise?), just shout it out with a comment below.

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