FSIN: Wired for success or a short circuit for investors?

    Monday, 11/9/09, Fushi Copperweld, Inc. (FSIN:NASDAQ) surged 13% on a mediocre quarterly earnings report. Trading activity in this Chinese wire producer may represent an optimistic outlook for the telecommunications and electrical grid infrastructure stimulus in China and emerging economies. Is this company really supercharged or is this just the trading static of an over-hyped stock?

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Fushi Copperweld is a Nevada holding company for Dalian Fushi Bimetallics Manufacturing Co. in China and Copperweld Bimetallics in Fayetteville, Tennessee and Telford, England. These facilities produce copper clad aluminum and steel wire for end-user markets in the telecommunications, electrical transmission, and mass transit and automotive industries. Copper clad aluminum and steel provide the excellent conductivity and anti-corrosive advantages of copper with greater pliability and strength and the reduced weights and costs of aluminum and steel. Although FSIN’s primary market is China, its micro strand to 19 filament macro strand wires have markets in greater Asia, the Americas, the Mid-East, and Africa.

            3G growth of mobile and broadband and governmental stimulus for electrical grid infrastructure in China, Africa, and the Mid-East as well as the automotive electrical harness and battery cable markets bode well for worldwide consumption of FSIN’s patented wire technology. FSIN’s stunning ROIC of 42% is testimony to the significant competitive barrier to entry that its proprietary processing procedure represents.

            The mixed performance of other ratios, however, exposes the weakness in FSIN’s business model. Gross and operating margins of 24% and 16% respectively eclipse industry standards. Low P/E, P/B and P/S ratios also make this company attractive to value investors. However a ROE of 9.4, P/FCF of 125 and D/E of 31 attest to FSIN’s dependence on debt for operations. Closer examination of its business model further diminishes the luster of this stock.

            FSIN maintains an asset backed line of credit to purchase copper, aluminum, and steel on the spot markets. Payment is due in 30 days while receipt of shipment is 30-60 days. Order contracts for customers are 30 days to 1 year with pricing open in order to pass changes in spot market prices to the customer. The inherent weakness in this model is obvious. Purchasing on the spot market prevents hedging when commodity prices are favorable thus guaranteeing variable operating and net margins. This procurement method also limits the ability to respond to favorable increases of demand in good times and decreases access to raw materials in bad times when assets are diminished, limiting future sales potential.  Operating cash flow is tied up prior to revenue flow increasing vulnerability for cancelled contracts.  Leaving pricing open-ended allows for competition from producers that can offer fixed pricing, giving customers a chance to hedge in favorable environments.

            Despite these flaws, the model has worked for FSIN due to the lack of significant competition. By their own admission, competition is expanding rapidly in localized markets and infringement of patents are eroding FSIN’s existing business moat. With 5 suppliers providing 65% of raw materials and 10 customers accounting for 30% of sales, FSIN may find increasing competition will challenge the present business model.

            FSIN will most certainly benefit from the telecommunications and electrical grid build out of emerging markets, but the significant down side risk if management clings to its present business model may shock even the most intrepid investor. Personally, I wouldn’t touch this “hot wire” until it was trading at half of its present $7.48/share price.

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