China Gerui Advanced Materials Group Earnings Call Nuggets: Shrinking Market Demand and Prepaid Purchases

China Gerui Advanced Materials Group (NASDAQ:CHOP) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Shrinking Market Demand

Echo He – Maxim Group: First one, I want to ask on, Ed you mentioned in your prepared remarks that the demand of your products boosted during the quarter, I just wonder could you – whether you could give some reasons and what’s the consideration? The second question I would like to know more details about ASP changes on your raw material, and also your product during the first quarter and also currently and this configuration during the first quarter of 2013? The third question and you talk about the acquisition rationale, just want to know whether you could talk more about what the major changes in your balance sheet? That will be it.

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Edward Meng – CFO: Let me take the – I mean first of your question about the shrinking or weaker market demand and why that happened. As I said, actually 2012 as the worst year since the beginning – since the very first year of the century, we as a long-term player in this market, we really haven’t seen this market the way – as bad as it was. Now, look at it from two perspectives. One, if you look at the overall our upper stream the crude steel producers the market demand was weak too and then the margin was even worst. In our sector of the market for cold-rolled steel products, first of all especially in the construction and decoration material sector our end applications, the demand was weak, but we hope that with the new government coming on board with this I mean urbanization initiative hopefully that’s going to come back gradually. And then the overall reaction from the customer or the market as since the beginning of this, I mean last year starting from actually January, February and March, the market was very weak and then April, May and June it hesitated and then all of a sudden starting from July, the overall I mean prices really went like fell like a rock into the historical low level of September. Because of that I mean on one hand we try to maintain the operation of all production lines. On the other hand, we don’t release that capacity only to see us engaging in pricing what was competitors, which are going to hurt our reputation of the premium precision cold-rolled steel producer and also going to get us to the point of no return where we can charge I mean no longer charge premium compared to our competitors. So, that’s our strategy, but I mean as I see whatever I mean pricing concession to give to the customers, it’s very difficult to get it back within a short timeframe, but we do expect that as I talked already in the call, when the market comes – it now comes backs, will come back to the position where we are able to charge premium compared to the competitors based on our cost plus method of pricing and we are going to see gradual improvement of the margin going to – getting to 2013, especially in the second half of the year. Now the second part of your question about the average cost of the – the average selling price and also the average cost of the raw materials is a very detailed but I can show that offline. I talked about – I want to mention that the thing is, probably people say I can actually done a lot of questions from very enthusiastic and caring, I mean investors asking hey, we see the iron ore cost really going up. I mean the price goes up so you can translate that into a higher price average selling price for China Gerui, but in this case the (Indiscernible) works that way, first of all you see the iron ore cost really goes up but that just squeeze without the meager profits of the crude steel producers in office stream of the value chain. They have to check up their average selling price, but they are not really making profits, that’s why I’m saying I mean across the board the overall China steel industry was actually incurring losses in lion share for our sector of the market which is stream in the value chain, we see first of all the raw material cost that really goes up that the average selling price in the recovery is not moving in tandem. For easy reference I recommend if you go to mysteel.com you see the composite, I mean steel price indicate that for cold rolled and hot rolled, you will see they are not really moving in the same fashion. So, this is primarily because of the resistance from the customer whom we used to serve, who are used to the – from January to February last year they kind of liking the price concession. As I said it’s going to take a lot of patients and time for that to recover. Now we just now mentioned about trying to, asking for some indications about what happening in fiscal of 2013 if we look at the overall price movement which is probably (indiscernible) upon in the Internet you see that actually in the first quarter of 2013 the overall steel price actually comes down. So I want to be very cautious about, in the first quarter we haven’t announced that yet, but given the calendar New Year in January and then the Chinese spring festival, for the country it’s going to be a low season historically low but despite that I mean we are very opportunistic about the guidance we provided on the full year basis, because we are very optimistic about the especially the second half of the year. We are going to have some new and introduced laminated steel products as well as the expected recovery of the average selling price starting for the second half. Now third question you asked about the how the acquisition of Zhengzhou No. 2 Iron and Steel Works is going to help solidify the balance sheet. First of all how that’s going to impact the balance sheet, first of all you are going to see that actually look at the financial statement we just release early today. We have actually deposited only certain amount about $24 million for the acquisition of that company, so that is down and then the balance between purchase price versus 24 already deposited. We have that cash reserved for that earmarked for that purpose. So it’s not going to hurt out our cash position on impact our operations going forward no its going to happen. But once we are done with that acquisition we are going to see – primarily you see the land use right is going to be – the balance of account is going to be increased and then on the income statement going forward you will see probably added the amortization cost of the land from that newly acquired business. But after this acquisition when you do the recent analysis of our balance sheet, our income statement I personally, I do think that it is going to be more meaningful than what it used to be when we are just leasing that land from the company paying a symbolic lease payment to the company over the last four years and then when our investors or bankers comes in, do analysis on the company say hey, the denominator of the recent analysis is actually understated. So I think that’s going to be an income. For this acquisition I want to make further comment is that our relationship with Zhengzhou No. 2 Iron and Steel has been fully disclosed through our SEC filing. This acquisition is based on a fair appraisal of the target company and being went through the solid review by the Board, so we believe this is an arms-length transaction. Going forward will be have fully successfully initiated risk associated, risk financed usage. I hope that answers your question.

Prepaid Purchases

Yang Zhu: Just looking at the rising prepaid fixtures, actually had contributed negative operating cash flow for 2012, so I think my question is that why are we seeing $76 million of prepaid purchase in the current environment, and if so many Chinese companies are having to extend more generous payment terms, you know this is a case for other companies that incurred high DSO, then why this trough is prepaying more for the raw material than the years ago, while the balance was actually a decline.

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Edward Meng – CFO: With the timing in mind, we have skipped the translation if you don’t mind. So, I’ll take your question. I mean first of all, yes I mean I think at the third quarter earnings call we discussed about this issue and at that time I just say that by the end of the fourth quarter we’re going to settle accounts with the supplier for the prepayments, prepaid purchases. So, that’s happening, but just unfortunately because the balance sheet is going to snapshot on what all – what is the situation as of December 31, 2012. Probably here we haven’t seen what’s really happening, because once we close the book, we close our book and we sit down and kind of settle the prepayment on our account. So, it’s happening as we speak right now, but this is just because of the cut-off I mean of the balance sheet. You didn’t see that moving down significantly. It is coming though, and then as a second part of the answer to your question why we have those prepayments to the supplier. Now, historically before 2011 the Company’s products have been just narrow-strip cold-rolled steel. So, I mean we have four or five suppliers basically providing us the narrow hot-rolled (coil) for us I mean as raw material. So, the type of product is relatively different simple, but once we get into 2012, we are offering both wide and narrow-strip and starting from 2012, we anticipated we will be moving towards further optimizing our product mix by offering wide-strip, narrow-strip, chromium plated, laminated, so that means for example that probably means we are going to, given the newly added chromium plating capacity, for example, that means going forward we may not have to take the half-finished products from our own cold-rolled steel mills and then put them through that chromium-plating or laminating process. We can actually go to the market and purchase finished cold-rolled steel and for further processing. So, that is in our initial assumptions, so that’s why our strategy as part of the supply chain management is we try to comb and combing are kind of like a grooming one to two suppliers who can offer us the kind of like flexibility when we do our production scheduling. So, it can happen that we come back with them very but we have to be, I guess, we see the pros and cons of this approach and also the pros and cons plays out differently at different market situation. So, I guess we really need to be very careful this time. But this is a good reminder and good question.