Drill, Comrade, Drill

02/08/2011 12:33 pm EST

Focus: GLOBAL

Robert Hsu

Editor, China Strategy and Asia Edge

SinoTech Energy is capitalizing on China’s mounting oil thirst and its inventory of aging wells, writes Robert Hsu in China Strategy.

China has had an insatiable demand for oil since the Asian giant's economy started accelerating ten years ago. And as we stepped into the 21st century, China's oil self-sufficiency has been left in the past. Nearly 50% of China's current oil consumption is imported from other countries.

In order to satisfy its rapidly rising demand for oil, large state-owned oil giants such as PetroChina (NYSE: PTR) and CNOOC (NYSE: CEO) are looking for oil assets globally. In addition, they also try to improve the output from the aging oil fields within China. For example, China's largest and one of its oldest oilfields, Daqing, has been producing oil since 1959.

However, as the wells in these older oilfields have matured, the productivity has been declining. Oil drillers now need advanced technologies to increase exploration efficiency and produce more oil from those old oil wells.

Profits Flow as Wells Age

As of now, CNPC and Sinopec (NYSE: SHI)—China's two largest oil producers accounting for more than 80% its oil output—have increased their oil recovery spending from $1.5 billion in 2004 to about $3.5 billion in 2009. Their spending is expected to rise to $5.3 billion by 2014.

To benefit from this trend, buy SinoTech Energy (Nasdaq: CTE), which provides oil recovery services in China.

The company's financials are in great shape. It used the proceeds from its IPO in November to pay off debt and it is now debt-free.

The company also has very strong track record. In the fourth quarter of 2010 (CTE's fiscal year ends on September 30), revenue reached $19.8 million, a 113.4% gain compared year-on-year and up 102.7% from the previous quarter. Gross margin increased from 45% to more than 60%.

SinoTech's service also generates strong operating cash flow ($17.2 million in the fourth fiscal quarter). I expect the company to accumulate a large cash position that could help it boost growth.

Top Banks on Board

SinoTech’s IPO was underwritten by top global investment banks Deutsche Bank (NYSE: DB), UBS (NYSE: UBS) and Citigroup (NYSE: C), with venture capital investors Sequoia Capital. This is good company to place ourselves in, and I believe CTE will benefit from an oil price run-up and the huge demand for oil recovery services in China.

The share price dropped below $5 after the IPO, but has since turned around. After watching this stock for almost three months, I believe the market has started to understand the business and financials of this company and show interest in this very promising investment opportunity.

Begin accumulating shares of CTE under $9. [Shares closed at $8.60 Monday—Editor.] I expect the share price climb above $10 within three to six months, and my long-term price target is $12, for gains of about 40% from current levels.

[James Trippon recently recommended two Chinese stocks he calls cheap. Chinese Internet pacesetter Baidu.com (Nasdaq: BIDU) looks attractive as well, according to Jim Jubak —Editor.]

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