Sunday, October 26, 2014

Highpower International ( Nasdaq - HPJ ) -- Charges Ahead

Highpower International (HPJ $6.25) is a leading manufacturer of plastic lithium ion batteries used in consumer electronic devices.  The basic technology is similar to the batteries made popular by Tesla Motors.  Those are produced by Panasonic.  Unlike Tesla's which are all identical cylinders, Highpower makes batteries in whatever shape and size is required to fit a particular device.  The company has been producing batteries for two decades.  It still relies on nickel cadmium batteries, an older technology, for 40% of sales.  That line has price-performance advantages for numerous applications and is likely to remain viable into the next decade.  But lithium ion is the company's principal source of growth at this point.

Competition is intense.  Low cost producers are springing up in China.  Established Japanese manufacturers already have solid connections in the consumer elections area.  Many now are moving into electric vehicles and solar back-up, as well.  And while the Americans aren't directly involved, they are devising ways to improve the batteries and make them efficient with better software.  But Highpower is remaining ahead of the pack.  The company upgraded its existing facilities in 2012.  A new plant was constructed last year, potentially doubling capacity.  About one third of that was activated this year.  More equipment and personnel will be added as order volume expands.

Highpower already supplies Sony and several other major Japanese consumer electronics producers.  This year it began working with Qualcomm to develop batteries for next generation products like smart watches.  R&D collaborations are underway with American scientists to improve the lithium ion technology, particularly to make it less prone to fire.  Highpower also is moving into the electric vehicle market with batteries aimed at buses.  The Chinese government has made it a priority to reduce air pollution with cleaner public transportation systems.  The company also is working with an American company to develop a line of solar powered back-up energy systems, to replace diesel units.

Consumer electronics will drive the boat in the near term.  Margins have been impacted by the capacity expansion.  Non cash depreciation charges on the entire new facility have overwhelmed the incremental revenue to date.  Sequential improvement is likely to reverse that equation as volume builds during the second half of 2014.  Gross margins promise to widen further in 2015 as depreciation expense remains fixed and revenue continues to climb.

We estimate 2015 earnings will double to $.60 a share.  Sales are poised to advance 22% to $195 a share.  Further margin improvement should accompany rising sales volume in subsequent periods.  Margins also may benefit from Highpower's battery recycling unit.  That operation is losing money presently, having just opened last year.  But a swing to profitability is likely as volume improves.  The facility also enhances sales activity, because customers know they won't have any environmental liability down the road.

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Saturday, October 25, 2014

Pure Technologies ( Toronto - PUR ) -- Runs a Tight Ship

Pure Technologies ( $7.50) is the leading provider of monitoring technologies used by water utilities to identify leaks.  The company makes several devices that travel through pipes of all sizes without getting stuck behind valves or other obstacles.  The systems rely on several methods to pinpoint weak spots in the network.  Utilities apply that information to fix short lengths of pipe, where the problem resides.  Traditional methods applied corrective action after a leak occurred.  Those approaches were less accurate, moreover.  So repair work often spanned miles of pipe, causing much greater expense levels.  Most customers still hire Pure on a one-off basis to assess an entire network and plan how to make to repairs.  A growing number use the company to provide full-time monitoring services, to ensure major problems never arise.

The company completed a significant acquisition in September.  Up until then Pure had conducted similar monitoring services for oil and gas pipelines, on a limited scale.  That unit comprised about 7% of sales.  The acquisition tripled that revenue run rate, expanded the customer base, and provided key technologies and services.  Oil and gas pipeline construction is surging to accommodate the fracking revolution.  Older pipelines are running at capacity, moreover, making preventative maintenance more essential.  Only a small percentage of the leak detection market has been penetrated to date.  The combined unit could grow 25% annually or more well into the decade.

Meantime, demand for water monitoring is accelerating, too.  The threat of droughts is causing utilities to manage their systems more efficiently.  But many are close to 100 years old.  Upgrades certainly have been made over the years.  Still, a lot of systems are aging and require close attention to prevent major breaks.  International business offers additional opportunity.  Many systems are groaning under the weight of expanding populations and modernized economies.  Water use tends to correlate with GDP growth.  To date international revenue has been modest.  But marketing efforts are being ramped up to make a deeper penetration over the coming years.

We estimate 2014 earnings will advance 82% to $.20 a share (Canadian).  Sales tend to be stronger in the second half as utilities implement their annual plans.  That sequential improvement could propel full year sales to $78 million (+28%).  Next year, bolstered by the acquisition, sales could rise 35% to $105 million to support a 50% increase in earnings ($.30 a share).  Pure faces lots of indirect competition in the water area from engineering companies, which specialize in replacing big sections of pipe.  Patents and experience provide a competitive barrier in the company's niche.  Technologies exist to monitor oil and gas pipelines (so-called "pigs").  Pure's work with those and provide an overall improvement in performance and lower cost.

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