By Mike Kobal
Follow news flow around south China-based rechargeable battery maker Highpower International (NASDAQ: HPJ) and you might think earnings performance is driven by battery sales for electric vehicles, initial sales to Costco, and the growing adoption of ‘wearable’ electronics.
These are all appetizing aspects to the drivers behind the rechargeable battery business, and they’ve helped boost HPJ’s shares almost 300% over the last twelve months. At the same time these are very prospective, rendering any forecasts based on them highly speculative.
Recently we took our skepticism on a visit to the company, meeting with senior management and touring each of the company’s subsidiaries in Shenzhen and Huizhou. (We were also invited to the company’s new battery recycling company in Ganzhou, Jiangxi Province, but elected to save that for another time.) Electric vehicles, mass retailers, and wearable electronics are all mouth-watering stories, and we get the appeal.
The company is selling into these segments, and each provides exciting prospects. Still, we were surprised to find a much more promising, near-term earnings driver –meat amid the side dishes.
Highpower is, at its core, a manufacturing company. It develops products that feeds these emerging markets with power. The company is largely industry-trend agnostic, with flexibility to go in a number of different directions / applications depending on what customers require of it. Hence, the focus on new applications of their battery products. However, for the company to grow it needed to expand and was at the forefront of our initial hesitancy in visiting their facilities.
Since 2010 HPJ has been investing about US$30 million to build and equip a new facility that, with some additional production lines added in phases, is poised to enable double-digit revenue and earnings growth over the next several years.
In 2013 the company’s original Shenzhen facilities ran at near capacity, so the capacity addition is overdue. But that isn’t the exciting part: the facility is part of an effort, already visibly underway, to scale up for larger customers and production runs, and focused on higher-margin lithium polymer batteries.
For this the company has also been investing in recruitment of experienced leadership and technicians for the plant, R&D, sales and marketing. These operating expenses, more accurately thought of as investment in the new capacity launch, have weighed on profitability over the past few years. Since 2009 HPJ’s profits have actually fallen at a double digit rate even as revenues grew at a 17% CAGR. This trend is poised to reverse as HPJ leverages this investment.
We see revenues continuing to grow at double digit rates, but for earnings to accelerate and grow over 40% per annum from their current low base as they rebound with force from depressed levels.
Rising above the U.S. Listed, Small-Cap Fray
That HPJ has been able to bring this capacity online this year is no small feat. The last several years have not been easy for growing small-cap Chinese companies, and particularly for those listed in the US. Not only has the Chinese government kept a tight lid on lending to the private sector, but reputable and legitimate Chinese companies have found it increasingly difficult if not impossible to raise capital in the US, where investors have been burned by a succession of fraudulent listings.
Like the Energizer Bunny, HPJ invested in Huizhou by bootstrapping internal cash flow and inexpensive short-term lending, only recently (April ’14) selling about 1.0mil in shares for $5.05 in order to help finance operating needs as production ramps at the new plant.
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Our tour started early in the day at Shenzhen Highpower, the company’s original Ni-MH rechargeable battery plant. This plant has capacity to produce batteries for what seems to be every company in the space including Energizer, Rayovac, and … well, you can fill in the blanks. It would likely be more challenging to find a rechargeable battery brand NOT being produced at Shenzhen Highpower. These are the rechargeable batteries one is likely to find on sale at every North American retailer. This plant runs at near capacity, currently generating gross margins just shy of 19%.
Nearby we visited Springpower Technology, which was the company’s first foray into offering Lithium batteries. Here the company can produce up to 2.5-mil batteries per month, including both cylindrical and polymer types. This facility has also been running near full capacity for almost two years.
Lithium-based batteries, used in both portable electronic devices and electric vehicles among other applications, is where the most promising growth opportunities exist. Lithium-polymer is particularly suited for the demands of smaller, lighter, portable consumer electronics. Not only do the batteries pack increased energy density, but their form factor is malleable to the particular needs of the product in which they are encased. It is in lithium-polymer that the new Huizhou facility is focused.
In Shenzhen we also visited subsidiary ICON Energy System which develops more complete battery systems for new products. Here we saw a number of products from well-known brands – including some battery powered gloves meant for very cold weather conditions, various hand-held communication devices – simply a wide assortment of products requiring portable battery power.
In Huizhou, which only launched production in 1Q14, manufacturing was much more highly automated, the clean-room spec significantly more stringent. Here we met key leadership with experience designing batteries for many of the world’s leading portable device manufacturers.
A key requirement for winning large orders for tablet and handset batteries is obviously scale, something HPJ has lacked until this point. During our visit the company’s first production line in Huizhou was churning out mobile device batteries in high volume.
Personnel at the plant related how many of the largest Taiwan-based electronics manufacturers, some of whom manufacture on an OEM basis for the world’s most highly regarded electronics brands, had all recently visit the Huizhou facility and explored a new or growing relationship. Amid booming demand for portable devices, naturally OEMs will seek to diversify their supply of key components.
Having spent several years in Taiwan following local electronics manufacturers, we have a fair sense for how they think about bringing on a new supplier like HPJ: ‘Yes!’
For investors, getting caught up in ‘sexy’ ideas can be exciting, but it is also dangerous. In HPJ we found the buzz around recent hot sectors like electronic vehicles has overshadowed something more fundamentally important for investment performance: the meat is cooked, and it is about to hit the table.
Mike Kobal is a Chartered Financial Analyst who has spent over a decade in China, Taiwan, and SE Asia conducting bottom-up fundamental research on companies in the region. He has worked both independently and for well-known sell side research teams including Jardine Fleming, JPMorgan (Taiwan), and Arete Research (Asia). He speaks fluent Mandarin, and currently splits his time between China and the US Pacific Northwest.
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For more information about Highpower International, click here: www.Highpowertech.com
The company paid consideration to SNN or its affiliates for this article.
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