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In our everlasting quest to find true secular growth stories, we keep finding stories outside the US. All 3 companies mentioned at the beginning of this Investors’s Business Daily story have interesting opportunities ahead of them, but let’s focus on SmartHeat (HEAT) for today. While there is nothing groundbreaking about the company, as we often say – you are getting a second chance to buy in the type of companies that prospered in the US in the 1950s/1960s as the world modernizes.

As you can see this $500M market cap company has caught the attention of some portion of the investment world since its most recent earnings release on the 16th of November.

Apparently the market opportunity is quite large

China’s heat transfer market is currently estimated at approximately $2.4 billion with double-digit annual growth according to China Heating Association.

Let’s see what IBD has to say

Among other things, 2009 may be remembered as the year China’s pollution-control industry came of age. Back in May, SmartHeat (HEAT) migrated to the Nasdaq from a lesser exchange, followed a few months later by Rino International (RINO), which makes pollution control equipment. At the same time, water treatment equipment maker Duoyuan Global Water (DGW) pulled off a successful IPO.

The market for such firms is huge, said Rodman & Renshaw research director Joe Giamichael in an e-mail to IBD from China. “The energy-conservation, pollution-reduction opportunity in China is tremendous,” he wrote. “As I speed through Qingdao in a cab writing this I am in my fifth major city in two weeks, all equally gray-skied with extremely poor air quality.”

SmartHeat is attacking one aspect of the problem: heating systems. Most of China’s buildings currently house coal-burning boiler systems using shell-and-tube heat exchangers that were “state of the art in 1930,” says analyst Greg Garner of Singular Research.

SmartHeat’s plate heat exchangers, standard in the West but new to China, are more than twice as efficient as the old technology. They transfer heat between fluids without allowing the fluids to mix. Individual PHEs are sold to power utilities and certain industries such as chemical processing. Entire PHE systems, involving pumps, valves and control systems, are installed in buildings for climate control.

The China District Heating Association estimates that Chinese PHE sales are growing 30% a year, while PHE system sales are gaining 70% annually. Analyst Garner admits to some skepticism that the numbers are really that high, but he agrees the market is growing rapidly. He points to the lack of price competition, even though there are so many rivals that SmartHeat leads the field with just 9% market share. “(SmartHeat) prices the end product based on the raw-material costs,” he said. “Any pricing pressures are minimal.”

Government policy is a key factor in that growth. China’s $586 billion economic stimulus package, passed late last year, includes $31 billion for energy efficiency. On Nov. 25, the government doubled its planned investment in environmental protection to $454 billion by 2015.

New regulations are also mandating another piece of equipment that Americans take for granted: heat meters. Traditionally, when businesses and residents leased buildings owned by the government, which is a lot of them, the heat was simply included in the rent. The government eventually realized how wasteful this was and in 2003 mandated that all new buildings include heat meters. Last year, it expanded the law to retrofit older buildings.

The market is so new there is data on its growth. But analysts agree it’s a big opportunity for SmartHeat. Garner points out that in the most recent quarter the firm reported $7.8 million in heat-meter sales, while all of 2008 brought in only about $500,000.

Now typically I prefer investing in something with a much wider moat around its business… there is nothing proprietary here. But with anything in China you basically are buying a market opportunity.

So far, these are the seven-year-old company’s only product lines. Analysts say there isn’t much to differentiate its products from other firms’ since PHEs and heat meters are fairly uniform.

Giamichael says SmartHeat stands out for its speed and flexibility of service. “The success is largely service-oriented,” he wrote in his e-mail. “They have developed a proprietary software that allows them to identify PHE needs for proposed structures in real time and can provide a contractor with an on-the-spot quote, rather than the multiweek quote process that peers require.” (while nice… that doesn’t seem like an innovation that competitors could not copy relatively easily)

SmartHeat has some 250 customers in all, none providing more than 8% of sales.

Vertical integration, on the other hand, is more promising

SmartHeat is also moving to vertically integrate. Since 2004, it’s been getting the plates for its PHEs from Denmark’s Sondex, making it one of Sondex’s three distributors in China. But last June, it bought Siping Beifang Heat Exchanger Manufacture Co., which can make the plates for SmartHeat in-house.

“In our view, SmartHeat’s plan to vertically integrate is a wise business decision, reducing lead time and manufacturing costs, and seems inevitable,” he wrote.