China Fire Incurs 4Q Loss - Analyst Blog

China Fire & Security Group Inc. (CFSG) reported a loss per share of 8 cents in its fourth quarter, way short of the Zacks Consensus Estimate of positive 23 cents and EPS of 10 cents in the year-ago quarter. Reported quarter EPS was hurt by lower-than-expected revenues and gross margins.

Revenues

Total revenue plunged 32.5% year over year to $11.4 million, failing to meet the Zacks Consensus Estimate of $26 million. Revenue from China Fire's product sales exhibited a growth in the quarter driven by the company's business expansion in its OEM product supply of linear heat detectors as well as the its successful execution of product sales contracts in India.

However, the increase was offset by a 53% decline in revenue from system contracting projects due to slow construction progress in the large-scale Wuhan Iron and Steel retrofitting project, where a mere $2.4 million was recognized as revenue during this quarter.

Margin Performance 

The gross margin during the quarter was 41.4%, a substantial drop of 740 basis points year over year. The plunge was due to declining gross margins across all business segments. Gross margin at the system contracting projects segment was 29.8% compared with 42.7% last year.

The segment was affected by a negative $1.1 million in gross profit due to increased installation costs and other expenses incurred to meet a customer's stricter requirements for the final acceptance of the $32 million Capital Iron and Steel's Caofeidian Project.

The gross margin of the product sales segment dipped to 58.3% from 72.4% in the year-ago quarter as a lower percentage of self-manufactured, higher-margin proprietary products were sold. Increase in unit labor costs pulled down the gross margin of maintenance contracts to 28.9% from 43.6% last year.

China Fire reported an operating loss of $2.3 million in the quarter compared with a gain of $3.3 million in the year-ago quarter.

Fiscal 2010 Performance

China Fire reported EPS of 52 cents in fiscal 2010, below the 86 cents in the prior year and the Zacks Consensus Estimate of 84 cents. Revenues dipped 1.5% to $80.0 million, pulled down by lower revenues from system contracting projects, which was somewhat offset by increased sales in its product sales and maintenance services segments.

Business at systems contracting projects has been under pressure due to the slower execution of projects in the iron and steel industry. Revenues during the year missed the Zacks Consensus Estimate of $94 million.

Backlog

As of 2010 end, China Fire's backlog was $151.3 million, with the iron and steel industry hogging the lion's share of 51.8%, while traditional power generation and nuclear power contributed a respective 4.7% and 18.7%. The international market contributed 14.6% while the petrochemical and other sectors together represented the balance of 10.2%.

Financial Position

As of December 31, 2010, China Fire had cash and cash equivalents of $28.1 million, down from $35 million as of December 31, 2009. The company currently has no bank loans or long-term debt.

Contracts

In February lat year, China Fire signed a $92 million contract with Wuhan Iron and Steel and, in July, the company won a $10 million contract with China Nuclear Power.

In December, the company received preliminary contract win notice of $8.2 million from Beijing Infrastructure Investment Co. -- the company's first contract win in China's Subway industry. Taken together, in 2010, China Fire signed over $170 million worth of new contracts, a record in the company's history.

Our Take

China's Iron & Steel Industry's Revitalization Scheme promotes total production control, encourages industry consolidations and emphasizes the development of new technologies.

This stimulus plan provides financial subsidies and loan discounts to leading iron & steel companies, thereby enabling advanced steel producers to upgrade existing plants and build new ground-breaking facilities. Given that China Fire derives a dominant portion of its total revenue from the iron and steel industry, it stands to benefit from such upgrades.

A major amendment of the Fire Prevention Law issued on May 1, 2009, requires all fire protection products to comply with national standards. Nearly 80% of steel plants are not fully compliant with new mandatory fire safety requirements.

Given the strong support from the government, China's massive iron and steel industry will likely accelerate the process of upgrading their outdated fire safety systems. As China Fire occupies a dominant brand position, it is strategically positioned to capitalize on the emerging growth opportunities in this market.

China Fire primarily serves the iron and steel, power and petrochemical industries, and relies heavily on the iron and steel industries for its revenues. Though the company is now exploring other industrial sectors, we believe its inability to successfully expand the market for its products and services in these industries will limit its long-term growth potential. Thus, we maintain our long-term Neutral recommendation on China Fire.

China Fire & Security Group, through its wholly owned subsidiary, Sureland Industrial Fire Safety Limited, is engaged primarily in the design, manufacturing, sales and maintenance services of a broad product portfolio including detectors, controllers and fire extinguishers. China Fire's clientele comprise major companies in iron and steel, power, petrochemical and transportation industries. It competes with privately held COSCO Fire Protection Inc., UTC Fire & Security and Western States Fire Protection Company.