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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Highpower International ( Nasdaq - HPJ ) -- Takes Shape

Highpower International (HPJ $2.65) is a niche manufacturer of lithium-ion and nickel metal hydride batteries. The nickel line accounted for a majority of sales in the past (59% through the first nine months of 2013) but that technology has reached maturity.  Faster gains are being achieved by the higher performance lithium products.  Those are used in laptops, phones, cameras, and a wide range of other portable electronics.  The company is the technology leader in lithium polymer batteries than can be produced in virtually any shape.  Demand is rising as more mobile devices go into service, the devices become smaller, and consumers demand longer up times between recharging.  Highpower recently began supplying lithium batteries to the electric vehicle industry, as well.

Highpower's lithium batteries are distinguished by their flexible form factor.  The company is able to produce high levels of electrical energy while configuring the battery to fit almost any space.  Most competitors provide standard shapes that product designers need to adapt to.  Chinese competitors have recently entered the lithium polymer space.  But they generally are unable to match Highpower's performance level. In spite of the new entrants production capacity within the lithium battery industry has been unable to keep pace with demand.  Highpower is benefiting from that trend.  Existing customers are expanding purchase commitments.  New customers are being added.  And margins are improving as a result of better pricing and longer production runs.

New capacity is coming on line.  A large expansion was completed in 2013.  Depreciation charges will moderate earnings growth over the next few quarters as a result.  But the available capacity combined with Highpower's superior quality is helping the company gain market share.  Margins are poised to improve significantly over the next 2-3 years as the new plant fills up.

The electric vehicle market could yield substantial leverage.  Lithium batteries were considered uncompetitive by most EV producers until Tesla Motors adopted the technology.  While energy output is lower than for more exotic batteries, overall price-performance has proven far superior due to lower cost.  Tesla presently buys all its batteries from Panasonic.  Those are standard cylinders that Tesla packs together underneath the floor of the car's cabin.  Panasonic is expanding its dedicated manufacturing facilities to support Tesla's next car, the Model X high end crossover.  If that car meets its sales targets pressure will intensify on Panasonic despite the current ramp up.  Tesla has a third car in the pipeline, moreover, aimed at the mass market.  If that model connects capacity could become seriously constrained.  If other car makers adopt lithium batteries the problem could be magnified.  Tesla is contemplating construction of an in house battery manufacturing facility to help meet demand.  It's existing business already is being limited by battery shortages and it wants to avoid further limitations in the future.  Highpower could wind up selling significant quantities into the EV industry as the number of cars sold takes off.  Conceivably, it also might consult or partner with Tesla on its internal project if the car maker diversifies away from its complete dependence on Panasonic.

Meantime, consumer electronics demand promises to accelerate growth.  We estimate 2014 sales will advance 23% to $160 million to provide income of $.40 a share (+471%).  Margins are poised to widen in 2015 and beyond, enabling earnings to keep climbing faster than sales.  In 2-3 years sales could reach $200-$250 million to provide earnings of $.75-$1.00 a share.  Those figures assume the sale of 4 million and 7 million shares, respectively, to reduce debt and finance expansion.

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