Gene Marcial's Stock Picks

Marcial: Hollysys Is on the Express Track in China


China's robust economic growth, which is fueling much of the fiery advance in its stock markets, is becoming increasingly enticing to U.S. investors. But for the most part investors are scouting for Chinese companies with solid business fundamentals and attractive valuations whose shares trade on the New York Stock Exchange or Nasdaq.

Already, several of China's widely known publicly-traded enterprises have found their way into some U.S. investors' portfolios, including Baidu.com (BIDU), the Chinese-language Web search engine; Shanda Interactive Entertainment (SNDA), which operates online games in China; and Sohu.com (SOHU), a provider of Internet content, advertising, and search services,

But one Chinese company yet to catch the eye of many U.S. investors is Hollysys Automation Technologies (formerly named Holi Systems International) (HOLI), which trades on Nasdaq.

The company "provides investors with exposure to China's rapidly growing nuclear and rail sectors," says Mark Tobin, senior research analyst at Roth Capital Partners (it owns shares), who rates the stock a buy.

The stock has been on fire, more than tripling in value, to 7 on Aug. 4 from a low of 2 on Nov. 12, 2008. It has since eased a bit to 6.70 on Aug. 28. But Tobin figures it will go even higher, to 10, in 12 months, based on his earnings estimates of 57¢ a share for fiscal year 2010 (ending June 30) on revenues of $186.8 million, and 77" for fiscal 2011 on revenues of $225.5 million.

nuclear safety systemsHollysys' main business is providing automation services to Chinese industrial companies, which, Tobin notes, are recovering from the impact of the global economic downturn. But the nuclear and rail industries, which so far account for only 30% of Hollysys' total revenues, appear to be the most promising for the company because of their rapid growth.

Specifically, Hollysys develops and operates automation and safety control systems for China's sensitive nuclear installations and vast high-speed railway system. Revenues from the combined nuclear and rail operations are growing at a yearly pace of 63.2%, vs. 16% for the company's industrial automation business.

Margins from the nuclear and rail automation segments are also a standout: 40% to 50% for the railroads and 50% to 60% for nuclear. Industrial automation clocks in at 30% to 35%.

What makes Hollysys a distinct part in China's economic engine is that it's the "only certified domestic automation control systems provider to China's nuclear industry," according to Dr. Changli Wang, the company's CEO. Plus, it is one of only two automation control systems and product providers approved by China's Ministry of Railways for the 300-350km high-speed railway segment. And it is only one of five approved for the shorter 200km to 250km high-speed sector.

China's high-speed railway system is expected to grow at more than 148% a year in kilometer-tracks through 2012, according to Peter Li, Hollysys' chief financial officer. He says China's $586 billion stimulus spending plan favors the nuclear and rail industries, and Hollysys, he notes, would be a direct beneficiary. Li says revenues from the company's rail and nuclear segments combined grew 63.2% from 2006 to 2008.

subway surveillanceA U.S. investment manager (who prefers not to be named), whose company owns a stake of just under 5%, says Hollysys is a "one-of-a-kind" investment opportunity in China as it is "well-positioned to participate in China's nuclear build-out." The company, he says, has a joint venture with government-owned China Guangdon Nuclear Power Holdings, the nation's largest nuclear power operator, There is talk, he adds, that Hollysys plans to buy 25% of the government's 50% stake in the joint venture.

That's not all this pro considers exciting about Hollysys. The company, which already provides surveillance and signaling services for China's vast subway system, expects its participation in that market to jump as the government rapidly expands the nation's subway services. Right now, Hollysys has a 60% share of the surveillance market in the subways.

According to China's State Council on Urban Rail Transit, a total of 125 additional subway lines, or 2,600km of tracks, will be completed by the year 2050. By 2013, the government estimates over 35 lines will be in operation. Right now, China operates 29 subway lines with 770km of tracks.

The surveillance system for the new subway tracks, according to Hollysys' CFO Li, will cost about $260 million. The signaling business, which is currently controlled by foreign companies Siemens (SI) and Bombardier (BBDB), will cost about $1.1 million per kilometer. The additional subway tracks the government is building "will significantly improve our margins," says Li.

Roth Capital's Tobin expects the additional subway lines to result in booking of new contracts in fiscal 2010 and accelerating revenue growth. "We are becoming more optimistic about the subway segment for Hollysys," he says. The company has "made progress with its introduction of higher-margin subway products," he says,

Few U.S. institutional investors have discovered the potential of Hollysys' businesses in China. Heartland Advisors is the largest U.S. shareholder, with an 8.8% stake (as of Mar. 31, 2009). Other U.S. investment companies that have bought shares include Sherleigh Associates with 6.8%, Whitebox Advisors with 3.6%, and Royce and Associates with 1.2% (as of Mar. 31).

With China currently leading the way out of the global economic slump, Hollysys may start to garner more attention as it rides the fast track of growth.
Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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