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Longwei Petroleum Holdings Inc. (LPH) has gained the market's attention lately, and so many investors are learning more about this company. Still, many American investors probably do not know what Longwei means in Chinese-dragon power. Being a fundamentally focused analyst, I try most of the time not to be technical and certainly not to be superstitious. However, I cannot help noticing the matching of the company's name and the arrival of the dragon year on the Chinese calendar. The year so far has shown quite some dragon power, boosting stock prices in China and all over the world in the first six weeks of trading. Longwei Petroleum's dragon is still dormant, though, because its current stock price is still nowhere close to its fair value. In my opinion, the stock's advance so far this year is only a fraction of its potential multi-fold appreciation this year. Before I discuss its fair value, let me review its recently released financial results for the second quarter of fiscal 2012, ended December 31, 2011.

The company reported financial results for second quarter of fiscal 2012 on February 9, 2010 and hosted a conference call with investors and analysts on February 10. My reviews of key financial numbers for the quarter are as follows:

Revenue: Revenue came in at $126.4 million, or 1.25% lower than the low end of my forecast ($128 million). I overestimated the positive effects of increased inventory and advanced the level a little bit. Still, this is a satisfactory sequential and year-over-year increase under the temporary tight situation for the company.

Going forward, the sequential revenue growth rates for existing operations in mid and southern Shanxi should accelerate gradually each quarter for two reasons: (1) domestic consumption will likely increase at a much faster clip than in 2011 due to the China central government's mandate to boost consumption and (2) wholesalers' and retailers' gasoline/diesel prices will likely increase at faster speed, too, because the Chinese government is easing control of gas/diesel prices to allow them to increase in tandem with international crude oil prices (rather than waiting for 22-day, look-back period), which in all likelihood will keep on marching upward this year due to supply shortages and stronger demand under easing monetary policies worldwide. LPH's revenue and net profit will increase when oil prices increase because oil consumption is inelastic to changes in prices. In plain English, when the oil price increases 30%, the total quantity consumed by consumers and industrial buyers only decrease 10%, making total revenue for the oil providers rise 17% (1.3 * 0.9 - 1). Readers who have a hard time understanding this concept can think about the movement in crude and gasoline prices and the changes in revenue and net profits for all oil giants over the past several years.

Part of the temporary slowdown in the company's sequential revenue growth over the last two quarters could be attributed to the fact that it sold a significant amount of inventory to fund a major acquisition that the U.S. equity market refused to contribute additional capital to at a reasonable cost. Going forward, either one of two things should happen. If the acquisition is closed soon as the management plans, the new storage site alone should give the company 30% more revenue ($150 million or more) in the first 12 months of operation because it is servicing an area that does not overlap the company's existing operations and covers the super-sized Beijing metropolitan area. Thereafter, the facility's revenue could contribute 30% to the company's top-line growth for a couple more years because the total market in Beijing metro is so huge and the Huajie facility has a high storage capacity for inventory growth. In the unlikely scenario that the deal is canceled at the last minute due to some unusual circumstances - such as the provincial government blocking the deal for anti-trust reasons due to the fact that LPH's scale has grown considerably over the past two years and the company is now a dominant wholesaler in Shanxi Province - the company will have $86 million free cash. The company can then use the additional capital to significantly raise inventory levels in its two remaining sites to boost annual revenue growth from these two sites back to 15% to 20%. In the latter case, the company will likely have some reserve cash to immediately pay dividends or buyback shares.

Gross Margin and Gross Profit: Gross margin came in at about 18%, a little bit lower than my estimate. Gross margin got squeezed a bit due to a temporary mismatch between increases in international crude prices (which are tied to the price refiners charge) and retail gasoline prices (the prices Longwei gets from its customers).

I apparently missed this part in my calculations. As the management team said, retail prices increased on February 8, and will likely be increased several times more this year. I am not sure it will be increased by five times as the head of energy research said. I think an increase of four times or 12% is more likely. Regardless, the China central government is trying to shorten the time lapse between the movements of international crude prices and domestic gasoline prices. Therefore, the company's gross and operation margins, already stable compared with those of most other industries, should become even more stable. I think it is likely that the company can maintain an average gross margin of 19.5%-20.0% over the next 12 months.

Net Income and EPS: Net income came in at $15.2 million, with EPS at ￠15.2 per share. The numbers were moderately lower than my forecast, again due to less-than-forecasted gross profit. There were no surprises in operation and miscellaneous expenses.

Overall, this earning release is clear evidence that the business is real and its financial results are normal for an oil wholesaler/distributor. It is apparent that management is honest and straightforward and is interested in only presenting a true financial picture each quarter and not in cooking the books.