If there is one thing investors hate more than uncertainty, it’s negative surprises. And Bio-Treat Technology is guilty of creating both. At issue is the surprise fourth quarter loss the company announced yesterday, which caused the stock to plummet 31.1% to a 10-month low in the Wednesday session. The loss was caused by, among other things, a RMB 36 mln cost overrun at its RMB 288 mln Xianyang waste water treatment project. That’s a blowout of 12.5%. The cost overrun contributed to a 42.3% drop in FY2006 net profit to RMB 189 mln. Other factors were higher finance costs, taxes and operating expenses. But already at the operating level, where you subtract the cost of sales from revenue, Bio-Treat registered a decline in eanings.

The Xianyang project was unveiled in October 2004, and was divided into two stages. The 200,000 cubic metre build-operate-transfer wastewater treatment project was going to be half completed by the end of 2005 and the other half by the end of 2006. It was Bio-Treat’s first, and marked the start of a long list of contract announcements. It is difficult to believe that the RMB 36 mln cost blow-out was itself a surprise to the company. Whether it was or not, the company should have warned investors before releasing its results. Instead, these were the announcements posted on the SGXNet website since the end of the financial year:

Jul 26 2006 MISCELLANEOUS :: BIO-TREAT SECURES NEW TURNKEY PROJECT IN SHENZHEN CITY WITH CONTRACT VALUE OF RMB270,000,000
Jul 25 2006 MISCELLANEOUS :: BIO-TREAT SECURES TWO TRANSFER-OPERATE-TRANSFER ("TOT") PROJECTS WITH CONTRACT VALUES TOTALLING RMB376,000,000
Jul 10 2006 MISCELLANEOUS :: BIO-TREAT CLINCHES FIRST LARGE-SCALE UNDERGROUND WASTEWATER TREATMENT PROJECT IN BEIJING

No mention of any problems with the accounts here. Building up investors’ expectations before letting them down so badly is, at best, poor form. Are we now to believe that its other projects are going to cost more than budgeted? And we are still no closer to understanding what caused the cost overrun in the first place.

Bio-Treat has a lot going for it. It has an orderbook of more than RMB 1 bln and its services are in demand from the increasingly environmentally-aware Chinese authorities. The business generated RMB 114.4 mln in cash from operations. Trading at three times book value, investors are placing a lot of confidence in it, confidence which has been damaged by this affair.

Execution risk is now the name of the game, and management will have to work specially hard to convince investors once more that they can pull this off.