Smartheat Inc (NASDAQOTH:HEAT)

CAPS Rating: 1 out of 5

Engaged in the manufacturing and sale of plate heat exchangers (PHEs) and various packages, thermometer testing devices and heat usage calculators through its wholly owned operating subsidiary in China.


Player Avatar BuffettJunior1 (97.69) Submitted: 4/11/2011 9:11:43 PM : Underperform Start Price: $30.70 HEAT Score: +85.25

Another Chinese company that employs aggressive accounting to make its stock look cheap. Its reporting positive net income, but in actuality is losing money. Don't believe me? Then take one quick look at the cash flow statement and you will see that I am right.One thing I've noticed over the years is that the P/E ratio has helped investors lose more money than any other piece of information about a company. People need to learn how to do proper fundamental analysis so they don't buy stocks such as this.

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Member Avatar Slider08 (< 20) Submitted: 4/13/2011 1:34:28 PM
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I don't think "one quick look at the cash flow statement" counts as proper fundamental analysis.

From their 10k:

"Our accounts receivables remain outstanding for a significant period of time, which has a negative impact on our cash flow and liquidity.

Our agreements with our customers generally provide that 30% of the purchase price is due upon the placement of an order, 30% upon delivery and 30% upon installation and acceptance of the equipment after customer testing. As a common practice in the heating manufacturing business in China, payment of the final 10% of the purchase price is due no later than the termination date of the standard warranty period, which ranges from 3 to 24 months from the acceptance date. We may experience payment delays from time to time, which range from 1 to 3 months from the due date. While these payment delays are very common in the heating manufacturing industry in China and historically our collections have been reasonably assured, such delays cause capital to be tied up in inventories, which may result in pressure on our cash flows and liquidity. In 2010, we had accounts receivable turnover of 2.98 on an annualized basis, with days sales outstanding of 123 and inventory turnover of 4.26 on an annualized basis. In 2009, we had accounts receivable turnover of 3.6 on an annualized basis, with days sales outstanding of 146 and inventory turnover of 6.2 on an annualized basis. The low accounts receivable turnover and high days outstanding is due to the seasonality of our sales and postponement of payments from certain customers. The low inventory turnover in 2010 compared to 2009 was due to increased inventory on hand for the readiness of the high production season with an increased number of large orders in 2010. Approximately 74% of our revenue is generated in the third and fourth quarters."

In short, they have poor cash flow because they're growing by leaps and bounds (upwards of 50% revenue growth for the TTM), and their number of days outstanding for AR is actually among the best in their industry. The poor cash flow may indicate that their growth is unsustainable (without some dilution), but it doesn't mean HEAT should be trading at a trailing P/E of 4.5, a PEG of .18, and a price/book of .89.

Member Avatar BuffettJunior1 (97.69) Submitted: 4/13/2011 1:59:31 PM
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In the long run its cash that matters. I don't care how much a company can increase its accounts receivable if it doesn't collect that cash in time it wont be able to pay its expenses.

Increasing accounts receivable is a trick some companies use to make their stock look cheap because it increases net income. Now, I understand there will be years where you cant collect your receivables in time and your cash flow will suffer because of it. However, if it happens year after year then we got a problem.

The P/E ratio is an inferior valuation measurement. Price to Free Cash Flow is the best and most conservative measurement of a stocks value.

Member Avatar Slider08 (< 20) Submitted: 4/13/2011 3:36:22 PM
Recs: 0

I like FCF. However, HEAT hasn't even reached a stable growth phase yet. If you think they're playing with AR, that's fine, but I don't think it's fair to try to value HEAT by FCF until their growth tapers off, which should lead to a more stable AR and inventory.

Member Avatar BuffettJunior1 (97.69) Submitted: 4/13/2011 3:51:12 PM
Recs: 1

I must agree with you there. A young company is not going to have very good cash flow. That's why I only invest in business that have been publicly trading for a minimum of 8 years. HEAT went public in 2008 so its only been around for 3 years.

Cash flow problems aside, I still don't like the overall business. The company is a designer, manufacturer and seller of clean technology plate heat exchangers and related systems in China. There is lots of competition in this industry, and its not the type of business you want to invest in for the long term. Even if the fundamentals were excellent, this business is very unpredictable. Maybe 10 years from now this will be an excellent stock to buy, but currently I'm giving it a thumbs down.

Member Avatar Slider08 (< 20) Submitted: 4/13/2011 4:16:11 PM
Recs: 0

Fair enough. This is certainly a high risk stock. Thanks for explaining your rationale a bit further.

Member Avatar BrianBristow (54.05) Submitted: 6/7/2011 8:29:46 PM
Recs: 0

Awww. You guys make me proud, with your civil discussion and thoughtful responses, all that correct spelling...

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