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A Positive Earnings Surprise

This name reported strong revenue and earnings results, a trend we expect to continue over the next 12 months.
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Model portfolio holding China Direct (CDS) posted its fourth-quarter and full-year 2007 results this morning, and we want to update readers. We are not taking any action in this Alert. Shares were recently trading up 10%, to $7.90.

China Direct's fourth-quarter results were strong, with revenue of $58.3 million and net income of 23 cents a share both coming in ahead of consensus estimates for $56.7 million in revenue and 18 cents a share in earnings for the quarter. In addition, these results show the surprisingly strong business momentum that China Direct is experiencing, as net income was up 59% vs. the third quarter. Operating margins came in at a healthy 8.8% for the quarter.

Full-year 2007 numbers include revenue of $174.2 million, net income of $11.8 million and fully diluted earnings per share of 67 cents. These numbers are a major increase from 2006 revenue and earnings of $14.0 million and a penny per share, respectively. Considering that China Direct's business model focuses on acquiring fast-growing Chinese businesses that are often in the early stages of ramping production, these outsized growth rates are not surprising. We believe 2007 results are most important as a benchmark to compare 2008 results. We expect the company to continue posting strong revenue and earnings over the next 12 months, proving the viability of its acquisition-based strategy.

Other catalysts that could help push shares higher this year include increased coverage from Wall Street analysts and the possibility that shares of China Direct gain a listing on the Nasdaq.

This morning's earnings announcement came as a bit of a surprise to us because the company had scheduled the release for after the close today. But considering that the results were so positive, we view the early announcement as a pleasant surprise. In this morning's press release, the company said it would update its 2008 guidance during this afternoon's conference call, scheduled for 4:30 p.m. EDT. We will provide an update for subscribers regarding additional information provided on the call, as we believe 2008 guidance is a major catalyst for investors.

We remain bullish on China Direct based on the significant potential we see over the next 12 months. However, the stock is extremely volatile and has jumped more than 35% in the past two weeks. Therefore we would wait for a pullback before adding to our position.

Frank Curzio is a research associate at TheStreet.com.

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