Is SmartHeat's Growth Sustainable?

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus. In this series, we'll take a closer look at many of the market's great growth stocks, to see which of them show real, numerically relevant signs of sustainability.

This time, we're tackling SmartHeat (Nasdaq: HEAT  ) , a manufacturer of plate heat exchangers, pipes, and related equipment for customers in China. The company says it's aiming to create a system that captures and passes along energy efficiently, thereby lowering costs for a nation badly in need of cheap oil.

Sound enticing? It should. In January, Beijing's mayor said that China's capital city faces an "extremely serious" pollution problem, and announced plans to increase public transportation and green energy, Reuters reports. This is why four of the 10 highest-rated solar power stocks in Motley Fool CAPS hail from the Sino superpower: ReneSola (NYSE: SOL  ) , JA Solar (Nasdaq: JASO  ) , Suntech Power (NYSE: STP  ) , and Yingli Green Energy (NYSE: YGE  ) . SmartHeat's in good company, to be sure.

Foolish facts

Metric

SmartHeat

CAPS stars (out of 5)

*****

Total ratings

473

Percent bulls

97.3%

Percent bears

2.7%

Bullish pitches

56 out of 56

Highest rated peers

Hubbell, SL Industries (NYSE: SLI  ) , BTU International (Nasdaq: BTUI  )

Data current as of Aug. 30.

China's glaring need for efficient heat transfer could explain why there isn't a single bearish take on SmartHeat. While too much optimism can lead to an overheated stock price, that doesn't seem to be the case here.

SmartHeat entered the week trading for just 14 times trailing earnings, and 7.1 times its projected 2011 profit. In the long term, analysts see SmartHeat improving per-share earnings by more than 30% annually.

The elements of growth

Metric

Last 12 Months

2009

2008

Normalized net income growth

90.9%

139.5%

237.6%

Revenue growth

124.6%

152.7%

146.2%

Gross margin

34.7%

35.2%

33.5%

Receivables growth

178.1%

180.6%

130.3%

Shares outstanding

32.8 mil.

32.8 mil.

24.2 mil.

Source: Capital IQ, a division of Standard & Poor's.

There's good news in this table:

  • As the bold text shows, the gap between revenue growth and net income growth is narrowing. We like seeing this, because it suggests that earnings growth is being driven by demand, rather than share buybacks or some other gimmick.
  • Stable gross margins further suggest that demand isn't being driven by massive price cuts, another good sign.
  • Receivables have grown faster than revenue recently, but not at a worrisome pace. We'd only fret if receivables started to grow twice or three times as fast as sales. At that point, we'd have to wonder whether the company were making deals it couldn't collect on.

Competitor checkup

Competitor

Normalized Net Income Growth (3 years)

Alfa Laval AB

8.7%

GEA Group

(4.6%)

SmartHeat

Not applicable

THT Heat Transfer

Not applicable

Source: Capital IQ, a division of Standard & Poor's. Data current as of Aug. 26.

SmartHeat doesn't have three full years of net income growth records in Capital IQ. Interestingly, neither does THT. Although both companies tripled earnings in 2008, THT's bottom line is up just 30% over the past year, while SmartHeat's earnings improved more than 90% during the same period.

Grade = sustainable
SmartHeat has several attributes we look for at Rule Breakers: high levels of organic growth, stable margins, and evidence of market leadership, to name three. I like the stock as a sound market-beater over the next three years, and I've rated it accordingly in my CAPS portfolio.

Now it's your turn to weigh in. Do you like SmartHeat at these levels? Would you make it one of our 11 O'Clock stocks? Let the debate begin in the comments box below, and when you're done, click here to get today's 11 o'clock portfolio pick.

You can also ask Tim to evaluate a favorite growth story by sending him an email, or replying to him on Twitter.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Suntech Power is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


Read/Post Comments (2) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 03, 2010, at 9:24 PM, stugotz143 wrote:

    yes smart heat should be an 11 oclock stock for sure!!!!

  • Report this Comment On September 07, 2010, at 9:25 AM, RHinCT wrote:

    "While too much optimism can lead to an overheated stock price, that doesn't seem to be the case here."

    Do I detect a note of irony there? Compare the current price to the 52 week range and it is about 10% from the bottom. Well chilled might be an appropriate description.

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