Fushi International, Inc. (“Fushi” or “FSIN”) is a US-domiciled, China-based producer of bimetallic composite wire products, primarily copper clad aluminum wire (“CCA”). The company currently trades for 10.5x 2007E EPS, and roughly 8x what I believe will be year-end 2007 run-rate EPS.  The only material limit on the company’s potential top-line, and bottom line, growth going forward will be the rate at which it can increase production capacity for its product.  I believe that FSIN can reasonably grow its volumes and top line at 20-30% for the foreseeable future, leading to rapid earnings growth and 4-6X multiple of earnings several years out.  Moreover, the company recently completed a financing with Citadel that will provide it with the necessary capital to grow both production and the balance sheet to support these rapidly increasing volumes for the next several years.

 

CCA is a substitute for copper wire, which is constructed of an outer layer of copper that is bonded to an inner core of aluminum.  It provides conductivity properties similar to pure copper wire, with a dramatically superior price:performance profile given the relatively lower cost of aluminum.  A ton of CCA generally costs 15-20% less than a ton of pure copper wire, and delivers 2.7x the amount of wire per ton.  CCA can be used in numerous signal transmission applications such as cable television, telecom network transmission lines, electrical distribution, and electrical/electronic product wire components.  As infrastructure growth in China has taken off, and copper prices have increased, the demand for CCA has exploded.  CCA production in China grew 7-fold between 2004 and 2006, yet CCA still has only an estimated 1.5% market share.  Even small additional market share shifts will drive huge incremental demand for CCA.  Various independent estimates place growth potential for CCA anywhere from 25% annually, to a total market share of 10% within the next several years (i.e. 6x the current demand).

 

FSIN is the leading domestic producer of bimetallic wire in China.  It has multiple patents covering its production processes, and is currently pursuing patent infringement suits against several of its smaller competitors.  To the extent it prevails in these suits, demand for its product would receive an additional boost; however, intellectual property protection being what it is (or isn’t, rather) in China, the investment thesis is not predicated on this happening.  FSIN’s domestic production base provides it with cost advantages over the largest supplier to the Chinese bimetallic wire market, Dofasco.

 

At year-end 2006, FSIN had 20 production lines.  With proceeds from the Citadel financing ($40mm debt + $20mm convertible preferred), the company plans to add another 20-30 addl production lines, thereby more than doubling its capacity this year alone.  FSIN quite simply cannot keep up with demand at this point.  During 1Q 2007, it ran its plant at 114% capacity and received a 10,000 ton order from a single customer.  To put this in perspective, 10,000 tons represents roughly 80% of the company’s entire output for 2006.  Concurrent with the announcement of the new order, FSIN raised its EPS guidance for the year just one quarter after providing initial guidance.

 

Copper pricing is a double-edged sword for FSIN.  As copper prices rise, the cost advantage of bimetallic wire increases, thereby spurring further demand.  However, given that copper is a major input to the production process, copper cost increases also tend to squeeze the gross margin.  Despite copper cost fluctuations over the last several years, FSIN has maintained a relatively consistent 30% operating margin.  While a long-term decline in copper prices poses a risk to bimetallic wire demand, it is instructive to note that demand has increased markedly as copper has moved above $1.50/lb.  This leaves a lot of room for decline from the current prices in excess of $3.25/lb.  As an aside, FSIN tends to trade in the short-term with copper prices, which leads to some decent trading opportunities.

 

Revenue and earnings over the next several years will be driven by a combination of  production expansion and copper pricing.  Company guidance for 2007 EPS is $1.03-$1.13/shr.  I estimate that FSIN will add 20-30 addl production lines in each of the next three years (a line costs roughly $660k), which will take capacity to over 50k tons annually.  The company will be able to finance this expansion entirely from a combination of cash on hand and cash generated from operations.  Assuming that copper prices drop to $1.50/lb by 2009 (a decline of over 50%), I believe that company will exit 2009 with EPS power in excess of $2.00/shr.  If copper prices remain high, EPS power will be substantially higher.  For instance, at $2.75/lb, the company could exit 2009 with EPS power of roughly $3.00/shr, implying a current multiple of 4x EPS.  My estimates assume that operating margins compress by 400bp over the next three years, and that tax rates rise from the current 2.5% level (FSIN has a tax holiday in its manufacturing locale) to 15% by 2009.

 

FSIN is currently way off the radar screen, as it trades OTC and is covered (from a research standpoint) by only one firm, issuer-paid Dutton Associates.  Dutton’s initial research report (available free at www.jmdutton.com) provides decent background information on the company.  FSIN is in the process of obtaining an exchange listing, which should markedly improve its liquidity and raise its profile.

 

To summarize, FSIN provides an opportunity to invest in a company that I believe will grow its top line by at least 20-30% for the foreseeable future, with a strong market position, enviable operating margins, and good returns on invested capital, for a mid-single digit multiple of earning two years out.

 

Disclosure: We and our affiliates are long shares of Fushi and may either buy additional shares or sell our position at any time without notice.  We undertake no obligation to update information provided above or to inform you of any changes in our views.  This is not a recommendation to buy or sell shares.