China Recycling Energy (OTC BB: CREG): The Annuity Model That Keeps on Giving

There's a lot to go over with earnings season for the small companies getting into full swing over the next two weeks. A few will file between now and the 15th, and then there will be a barrage of reports to go over right around the 15th.

In my last edition we discussed strategy for the long awaited market correction. If there was any doubt there's a sentiment shift and a downside bias, it was erased on Friday. Last Wednesday, the market sold off. Thursday, it rebounded on the 3% GDP news, then Friday it tanked, making a lower low.

I believe this correction is welcome, long overdue, and resets the bar to allow the trillions of dollars on the sidelines get into the market with some reasonable upside.

Earnings season for large caps is over. About 75% of companies that have reported beat expectations. As usual, the analysts swung too far, and the market continued chugging higher as we all learned corporate America is in pretty good shape. Earnings are now fully priced in, and the market will have to hang its hat on economic news for the foreseeable future- a bit of a murky picture.

I suggested getting some capital ready to go bargain hunting for the right companies after we see their numbers. Two OTC Journal followings have delivered outstanding developments in the past two days- Tianyan Pharma (AMEX: TPI), and China Recycling Energy (OTC BB: CREG).

Of the two, CREG is the one I'll cover today- TPI will follow tomorrow. This is great stuff, and CREG might not want to wait for the correction to run its course to start climbing again.

Today, CREG reported it has completed a major installation at Shenmu County Jiujiang Trading Co., Ltd. The installation will result in reduced annual coal consumption of 52,000 tons, equivalent of 130,000 tons of CO2 emissions. This is a protype of the BOT (Build, Operate, and Transfer) model I covered in the original presentation.

The completion of the project is of interest to shareholders. However, the way they are going to collect the money over the next 10 years is of far greater interest to shareholders, and suggests this stock is absurdly undervalued.

Here's the facts as discussed in today's release: CREG will recognize revenue of $18.3 million in the upcoming Q3 report from this installation. In the June quarter, CREG reported $11.1 million in revenues of which $9.5 million was product sales. Therefore, we are assured of about a double in product sales over the last quarterly report.

CREG also disclosed COG was $14.1 million, leaving $4.2 million in gross profits to be reported. That's great, but it's one project. Now they have to do it again this quarter or they become another short story - Or do they?

Read on. Here's why I believe this is the stock to own in this sector, and why I believe this company will be generating huge profits for years to come. As it turns out, CREG still owns the system, and will operate for the next ten years. Shenmu has the obligation to provide its industrial coke production to the system, and CREG then uses it to generate recycled power. Shenmu then has to buy the recycled power from CREG for the next 10 years for about $500,000 per month- yes- that's $500,000 per month in revenues - $1.5 million per quarter- $6 million per year in recurring revenues.

So, what's CREG's cost to collect this $6 million in annual revenues? Glad you asked- CREG has to pay rent for the space the system takes up of $7,300 per year, and about $438,000 in annual management costs. Nice- in all, this adds up to $38.4 million in interest income over the next 10 years with about 10% annual costs. They need to pay the staff to collect the money. At the end of the 10 year lease, Shenmu takes ownership. Until that time, CREG owns the asset.

Imagine a company with about 10 of these installations? It would equate to $60 million per year in recurring revenues that would be about 90% pure profit. What a business model. CREG makes money on the design, manufacture, and installation of the project, then collects big money for 10 years. I love it.

The coming quarterly report will be interesting in light of today's news. We know they're going to report a strong quarter, but I can't gauge what the rental/lease revenue side of the quarter will look like. We now know the project side will be a double over the June quarter, which should be enough to send this stock higher.

There's 38.8 million shares I&O- about a $78 million market valuation. The annual revenue run rate is likely in the $60 million range at this point in time, and we know the company will now have earnings of about $.14 per share just on the rental/lease recurring revenues from this installation alone - and for the next ten years.

Nine more just like it would equate to $1.40 in EPS annually in recurring revenues. It could happen in the next 3 years. No wonder Carlyle Group owns 31% of the company- they know a good investment.

Long term this could be a $20 stock if they keep completing projects of this nature. The stock has already started rebounding today.

Is it worth thinking a little more long term with these smaller stocks? It's the only way you're going to make any real money. One of my business associated can attest that thinking a little longer term could pay off.

Last March he picked up a rather sizable position in Ford (NYSE: F) at $1.75 when it looked like the Auto Industry was about to shut down. He sold it at $2.75, and thought he was a trading genius for the moment. Today, he doesn't feel that smart watching it trade through $7.50 just six months later.

CREG has the killer business model, and this stock is destined for much higher levels in my view.