Time once again, dear children, for a tale from the Middle Kingdom.
Once upon a time, there was a nation so vast and populous that investors got dollar signs in their eyes just gazing upon the smoggy mega-cities that grew like weeds in that distant land. And lo, it was told that it was just the beginning, that verily, small upstarts in this giant land would become like the giants who roam the rest of the world.
Well, that’s basically the idea — when you’re looking at investments in emerging markets, one of the more tempting (and reasonable) strategies is the “what works in the West” idea … if a strategy, store, or business model worked in the United States to build an empire 20 or 50 years ago, will it work in China, or Brazil today as they grow to become the next great world-leading countries?
And it’s especially tempting because it gives you the feeling of getting in on the ground floor — which is the pitch that underlies the latest ad from the Motley Fool for their Global Gains newsletter from Tim Hanson: their “No. 1 China Stock for 2011” is not just “the Chipotle of China,” bringing to mind the huge gains that stock has made in the last five years, but … “McDonald’s may be the better comparison … in the 1950s!”
Tempting, right? Not just the quick gains of a fad eatery, but perhaps the early days of a megacorporation that will make our grandchildren wealthy? Sign me up!
So what, then, is it? Well, the Foolies are telling us that we should buy their top four favorite Chinese stocks that are on the table after their analysts’ tour of the country — all are apparently consumer-focused and should profit from the rise of Chinese consumers (ok, if you insist, the “Chinese consumer revolution”). So that’s an admirable note of caution and diversification — better, at least, than the “buy just this one stock of the decade” pitches we see so often.
And they spill the beans on one of their picks right up front, telling us that the most important thing we can do, and probably the most solid pick, is to buy the US company Yum Brands (YUM) — something they’ve said many times before, both in teasers and in outright recommendations, and something that certainly any Chinese-focused investor is aware of. KFC and Pizza Hut are hugely popular in China — especially KFC — and are supplying much of the growth for Yum Brands as they continue to expand aggressively in that country, with blue skies ahead thanks to the still extremely underserved (by global food chains, at least) population.
Add in that it still gets more than half of its revenue from more “established” economies, largely the US but also Europe, and that they pay a decent dividend and are still putting up solid earnings growth numbers, and you can see why folks still love YUM as a China play with some safety — or perceived safety, at least. It’s not cheap, but the valuation and growth — at least in the last quarter — are comparable to the much large McDonald’s (MCD), and certainly folks perceive that YUM has a stronger growth platform in China than McDonald’s does.
So yes, YUM is a fine company and is probably the most China-focused large cap consumer stock in the US markets. I’ve been tempted by the shares but have never bought them, for whatever that’s worth. But the big headline pitch here is not for YUM, it’s for Tim Hanson’s “No. 1 China Stock for 2011” …. which is a much smaller company aiming at the same market.
So what is it?
Here’s how Hanson introduces the idea:
“Yum! Brands is a relatively mature $26 billion multinational corporation. Now imagine the transformative power this same insatiable consumer demand could have on a company a fraction the size.
“You don’t have to imagine. We’ve seen it with our own eyes!
“Frankly, it’s hard to miss. In fact, the venture capitalists that first “discovered” this phenomenon were in town scouting another restaurant concept when they were ensnarled in the snaking lines of customers waiting to get in.
“How excited were they? The VCs spent six months hounding the company’s founders before they were even granted a meeting. One hundred locations and millions of satisfied customers later, I imagine they’re thrilled the founders relented.
“We certainly are. This is a once-in-a-generation opportunity to invest in what can realistically be called ‘The Chipotle of China’ — and even that may be an understatement.”
And then, in addition to a somewhat blurry and lacking-identifying-signage photo of customers lined up at the store, we get some more clues:
“‘The Chipotle of China’ opened its first location in 1996 and operated just 9 restaurants as recently as 2008. In the short time since, that number has blossomed to over 100 locations — but here’s the difference…
“Now that the expansion is on, the company conservatively targets an additional 700 units in the provinces of Chongquing and Sichuan alone. By my calculations, that number could EASILY explode to 2,500 locations — even if the company never ventures beyond its core markets in western China….
“I can tell you that I couldn’t be more impressed with the company’s novel, measured approach to dealing with the overwhelming consumer demand for its concept.
“I can also tell you that at current valuations the market is pricing in expansion to just 500 stores over the next 10 years — a number that in my view doesn’t do justice to the opportunity in Chongquing and Sichuan alone.
“Assuming even measured expansion into neighboring provinces — which seems almost a lock at this point — the return profile skyrockets. In short, the sky is the limit!”
So … who is it? We shovel that pile of squirmly little clues into the Thinkolator, flip the switch, let it churn for just a few moments… and find that we’re looking at Country Style Cooking Restaurant Chain (CCSC)
Which has indeed been around for about 15 years and were started as a tiny chain run by a husband and wife team, but just really started growing, as the tease notes, in 2008, when they had nine stores — after a couple years of venture backing for growth they have 133 as of the end of last year, and had just over 100 when they went public back in September of 2010. They operate quick service restaurants with fresh food prep (cooked to order to some degree, apparently, but made in 60 seconds), serving traditional Chinese-style food at low prices (average around $2 a meal, it appears — still a lot for many Chinese, but affordable for millions).
I have never had my “boots on the ground” in Chongqing or Sichuan, where most of their restaurants are located, so I can’t vouch for the “lines out the door” stories — but like most Motley Fool picks they tend to write about this one quite a bit on their free site as well, so you can see some additional commentary from their visit here and an older, pre-visit note from Tim Hanson about the stock here.
And after the hot IPO back in September, which priced “above the range” around $16 and shot up into the mid-$30s within a month, the stock has fallen apart — like many recent Chinese IPOs. After two disappointing quarters (disappointing to analysts, at least — they came in short of expectations on earnings per share) the stock bottomed out near $10 a few weeks back and has since seen some recovery, trading now at around $13. That’s right around where the average analyst target price is, so it shouldn’t be surprising that the stock has a very weak average rating that falls somewhere between “sell” and “underperform.”
To add to the recent woes, the company said they got an unfavorable tax surprise and owe another $2.7 million on their 2008-2010 tax bills — which wouldn’t faze YUM brands but is a big dent for CCSC, which earned about $7 million over the last twelve months (they’ve got plenty of cash, however, thanks to that IPO — more than $90 million, so they can certainly pay the bill).
So what does Tim Hanson see in the shares? I don’t know his full opinion, of course, I just read the tease and interpret the clues for you — but it sounds like he’s relying to a substantial degree on his meetings with management and his visits to the stores, since he was more cautious before. I suppose he’s probably betting on blowout consumer popularity driving much faster expansion than analysts expect, and that the company will prove to have standout management and won’t fall prey to the short-sellers who sniff out accounting irregularities or operational problems in Chinese companies. This is not, to be clear, one of those sneaky “reverse merger” stocks that was able to come public without full scrutiny — they did a “real” IPO on the New York Stock Exchange … doesn’t mean they’re perfect, but at least they didn’t sneak in the back door.
It’s an ambitious little company, though so far very much a regional brand — and it does report that they are profitable and expect to grow revenues by better than 35% in the current quarter, so that’s interesting (though also down, quarter over quarter — they hit 40% revenue growth last quarter). There are plenty of competing chains in China that we’ve never heard of before and that aren’t publicly traded, I’m sure, since to a great degree this is a nation of copycat entrepreneurs, but CCSC is at least valued roughly in line with the other small restaurant chain that has been in the China news lately — that’s the Little Sheep hot pot chain (968 in Hong Kong) that’s partly owned by YUM, and which bounced recently on an offer from YUM to buy the rest of the company. That chain is a couple times larger in terms of number of locations and is a different type of restaurant, but also trades near 30X trailing earnings. CCSC trades at a trailing PE of 35 right now, with earnings having dropped year over year in the last quarter, and at an estimated forward PE of about 22.
So what we seem to have is a company with disappointing numbers, but possibly a great story and huge future growth potential — maybe I should have bolded that “possibly.” That’s about all I know about the firm — they did present at several investor conferences in June, but all were in China and they haven’t made the presentation materials widely available, so you can start with their filings if you want to dig in, which along with their other basic info and press releases are available on the investor relations page here.
What do you think? Underestimated growth potential that might be the Chinese Chipotle, or overpriced regional fast food chain? Let us know with a comment below.
Personal Capital is an advertiser with Stock Gumshoe, but Travis also uses it every day for his personal accounts and finds it invaluable. Here's what he said: "They offer a great (and genuinely FREE) 'second opinion' for your financial plan, but what I love most is their automated financial dashboard -- it will look at all your assets and debts, tally up your asset allocation, project where you'll be at retirement, and suggest ways to manage risk or improve returns. It's free, I think their free tools are great, and I think it's worth checking out -- you can do so here.