Check on China: Sutor Technology Group

Shannon Roxborough | Mar 06, 2008 6:20am EST | 1 Comment

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China is attracting Wall Street's attention like never before. And with good reason: after all, a country that dominates the low-end consumer market in everything from clothing to toys to consumer electronics simply can't be ignored. The nation of 1.3 billion has become an economic juggernaut that has propelled Chinese companies onto the world stage and made China an integral part of the global economy.

China's economy grew 11.4% in 2007, the fastest in 13 years, and that type of growth requires an enormous amount of raw materials to fuel the country's rapid industrialization and urbanization. In fact, China now consumes roughly 50% of the world’s cement, about 25% of all aluminum and copper and nearly 40% of the steel supply. Which brings us to Sutor Technology Group, Ltd. (Nasdaq: SUTR).

Founded in 2003, Changshu-based Sutor is one of China's leading private manufacturers of steel finishing fabrication products for a wide range of industrial uses. Sutor uses a number of processes to convert steel supplied by third parties into products including hot-dipped galvanized steel, pre-painted galvanized steel, acid-pickled steel and hard cold-rolled steel for use in automobiles, seagoing vessels, household appliance parts and outer casings, electronics, construction materials and large industrial equipment. Roughly 90% of the company's products are supplied to the Chinese market, while the remainder is exported to the United States, Europe, Asia and South Africa.

Last year, the company introduced a new antistatic color coating technology engineered for its steel strips. It also secured a contract to supply 10,000 tons of hot-dip galvanized steel to Anhui Water Resources Development Co., Ltd., a company engaged in various commercial building and infrastructure development projects. The pursuit of new technologies, expansion of production lines and increased market penetration has already begun to pay off for Sutor.

Second-quarter results, reported on Feb. 14, exceeded all expectations. Net income surged close to 50% to $6.7 million, or $0.18 a share, from $4.5 million, or $0.14 a share, in the same period a year earlier. Sales increased 46% to $114.9 million from $78.6 million in the same period last year. Gross profit leaped 67% to $11.41 million from $6.82 million, while gross margin as a percentage of sales advanced to 9.93% from 8.67%.

Sutor's good fortunes may have only just begun. It has recently completed the vertical integration process for making its zinc and aluminum hot-dipped galvanized steel production system operational. And its stepped up production efforts haven't gone unnoticed by the Street.

In a Feb. 15 report, analysts at Roth Capital Partners were bullish on the steel product maker’s future, noting: "we anticipate incremental revenue contribution starting Q1 FY09. We expect HDG capacity will double by December 2008, which will increase total capacity by 30%+, to 1.7 million tons. Except the AP line, all the other three lines are running at full capacity. That said, we believe the company is planning to add additional lines, which could provide upside to our FY 09 estimates. With increasing capacity and strong pricing trends, we expect a 3-year revenue growth CAGR of 19% and gross margin expansion to 11.9% by the end of FY09 from 9.9% this quarter."

On a cautionary note, the analysts added: "In January 2008, China experienced the most severe weather in decades. Unusually heavy snowfall stopped major transport arteries in the central and southern parts of China. Power outages rolled across 17 provinces, forcing manufacturers to close. While we believe the impact is temporary, as steel manufacturing is highly energy and logistic dependent, we expect SUTR to face headwinds in Q3 FY08 due to power supply shortage and delayed shipping."

According to China's National Bureau of Statistics, China consumed a record 520 million tons of steel products in 2007, up 17.4% from the previous year. And despite the rising costs of raw materials like iron ore, the Chinese steel industry as a whole generated record profits of about $26 billion last year, a 45% jump from 2006.

While the China Iron and Steel Association, a quasi-governmental organization that oversees the majority of China's steel mills, has expressed concerns that rising raw materials prices will push up steel product prices in 2008, Sutor appears well positioned for continued growth, due largely to its capacity expansion efforts and continued strong demand for steel products in China and globally.

Investors should bear in mind that the steel industry is cyclical and pricing can be volatile, subject to whims of global economic conditions. A variety of factors — including commodity prices, labor costs, competition in a highly fragmented market and currency fluctuations in China or abroad — could decrease the demand for steel products or increase steel imports into China, which could, in turn, negatively impact Sutor's business.

Sutor began trading on the Nasdaq Capital Market on Feb. 11. Shares closed on Wednesday at $5.10. Sutor’s (SUTR) stock is undervalued, trading at a heavy discount to both its Chinese and American peers.