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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