Paper and cardboard maker, Orient Paper Inc.’s (OPAI.OB:OTC) CEO is so confident in the future of this small cap, he recently purchased approximately 5 million shares at market price to bring his ownership to almost 50%. The election of 3 independent board members prompted him to declare “we believe we now meet the corporate governance requirements to list on a senior US stock market”. In anticipation of a 4-to-1 reverse stock split and big board exposure is this a real roar or the purr of a paper tiger?

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OPAI is a Nevada holding company for wholly owned Hebei Baoding Oriental Paper Milling Co. (HBOP) located near Beijing, China. HBOP annually produces 170,000 tons of corrugated, high and medium grade offset, printing, blueprint, and thermal paper stock that are made from recycled waste paper products. 60% of production is corrugated product, 22% is offset printing stock, and 18% is a mix of other products, including custom print and patented thermal products. In development are digital photographic and security or anti-counterfeit papers.

            3,500 Chinese paper and board manufacturers produce 73.5 million tons of paper products annually. China consumes 72.9 million tons annually. According to the China Paper Association this mild oversupply of paper products will not last and China will be the world’s largest producer and consumer of paper products, requiring at least 90 million tons annually by 2015. Greater consumer demand for news, educational materials and retail containers and packaging are sighted for the increased need.

            OPAI competes indirectly with 5 major manufacturers that produce 500,000 to 4 million tons of corrugated and offset printing stock, 3-25 times OPAI’s output. All are publicly traded on Chinese exchanges and two have prominent national recognition. OPAI sees major competitive advantages in its niche product lines and strategic proximity to Beijing and Tianjin. Located just 75 miles from these major publishing centers reduces shipping costs and eliminates warehouse costs. Access to massive raw waste material from these megalopolises reduces input costs. OPAI can offer its products cheaper than larger competitors, all distant from these important cities. 

OPAI also feels its long standing environmental permits offer a strong competitive advantage. Paper production requires large water resources and heavily pollutes air and water. The PRC’s environmental initiatives seek to consolidate the industry by eliminating or merging facilities with annual production less than 50,000 tons of paper products. Remaining facilities must meet higher pollution standards. Fewer mills, lacking comparable environmental records, reduce OPAI’s competition. Little wonder the CEO is roaring about this rag maker.

Here, kitty, kitty.  OPAI’s low cost business model does not appear to be working well. Despite a P/E under 7, P/S < 1, and 24% earnings growth, other ratios expose its massive debt. Its ROE of 30% is primarily comprised of debt, with only half showing on the balance sheets. The company owes the CEO and other board members an additional 8 million dollars in undeclared, non-interest bearing loans. High inventory with subpar asset turnover weighs heavily on OPAI’s already industry-low 13% net profit margin. OPAI also relies on 3 major sources for 80% of its raw materials. Any change in loyalties could increase input costs and drive margins even lower.

So what’s the play for OPAI? The CEO’s actions make this stock tempting. Investors with a taste for risk may want to nibble at the present $1.48/ share and evaluate its earnings and big board performance before digging in.

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