“Bargain Buys as China Turns” Robert Hsu

By Travis Johnson, Stock Gumshoe, September 19, 2008

I haven’t written much about Robert Hsu and his China Strategy newsletter lately, but back when China’s markets were shooting out the lights last year he was probably the most popular newsletter editor out there. This year has seen a reversal of so many different Chinese stocks, and a loss of faith in the China growth story among many investors, so I thought we might take another look at some of his favorites now that he says the China market is full of bargains.

I can certainly sympathize with the general feeling of any China-focused investor — two of the stocks I’ve written about as “Ideas of the Month” over at the Irregulars site are Chinese companies, and though I still like them and think they have bright futures, they’re both down at least 40% since I first wrote about them. China’s not going away, and its economy is not going to stop growing — if it does and they stop coming up with jobs for those millions of people who move to their cities every year, they’ll have a revolution on their hands. But that doesn’t mean that Chinese companies are good investments, or well-timed investments — that’s a much tougher question.

Robert Hsu, who has generally been much more momentum focused in his picks (or maybe it just feels that way, since most of his stocks were in incredible uptrends all of last year), thinks that the market is going to come around and embrace Chinese stocks again. Here’s an excerpt:

“… indiscriminate selling by mutual funds, hedge funds and investment banks are creating attractive valuation opportunities in Chinese stocks for long-term investors. Notoriously overpriced Chinese domestic A-Share stocks in Shanghai are now trading at its cheapest level ever—14.4 times 2008 estimated earnings, down from 50 times last October and cheaper than S&P 500 stocks. So at these record-low levels, Chinese stocks are ready for a run-up.

“In addition, I believe the Chinese economy is strong enough to continue growing during this global economic slowdown. I think this is especially the case because Beijing policy makers have shifted their focus from battling inflation to more to stimulating the economy. Earlier this week, China cut lending rate by 27 basis points to 7.2% and lowered bank reserve requirement for mid-sized and small banks by 1% to 16.5%., reversing a tightening policy that started in July of 2006.

“Because of these factors, I am optimistic about Chinese stocks. I expect them to be the first to have a meaningful recovery and actually lead other emerging markets to an uptrend as well.”

I can’t tell you what the Chinese stock market sentiment is going to be for the year ahead, but I can explore the picks that Robert Hsu is featuring now. He says that there are three stocks that you should buy now, while they are still bargains — here’s what we hear about them, and the Thinkolator’s best cogitating on their likely solutions:

“Bargain Stock #1: As my newest addition to the China Strategy portfolio, this company has a lot of promise. It is China’s leader in the security and surveillance sector, and it is profiting from the Chinese government’s requirement of security technology in public places, as well as increased demand for surveillance systems in private businesses. This company is perfectly positioned to profit—learn more now.”

We actually looked at this one, before — though not as a Hsu pick. I wrote about the same company a few weeks ago, back when Bill Mann at the Motley Fool was touting it as a “Billion Dollar SSE” — you can see that writeup here if you like (along with a spirited debate among my readers).

If you don’t want to go into the details of that firm, the answer is: China Security and Surveillance Technology (CSR). Depending on how you feel about China, video cameras, and the influence of the State, you probably either think of this as profiting from an increased need for security, or as profiting from the intrusive police state. That feeling will probably color how you feel about the company — on the pure financials it looks fairly reasonable, if growth continues as expected it’s priced pretty cheaply on next year’s earnings (estimated forward PE of about 8). The shares have come down dramatically from their highs of a couple weeks ago, highs that may have been caused in part by Mann and Hsu’s picking of these shares, since both of them have a lot of subscribers.

And on a day when we are close to having legislated that all stocks must go up, this one is down 10%. It’s going to be a wild ride, most likely, but I don’t know what direction that ride will move in next.

“Bargain Stock #2: This company has survived the Chinese stock market turmoil with impressive strength. The company is a leading insurance provider in China, and as the Chinese stock market firms up, I expect its shares to improve as well. Learn more.”

This one I can’t be absolutely certain of, but in all likelihood it’s China Life Insurance (LFC). And saying it survived with impressive strength is certainly relative, it’s down 50% from its highs of a year or so ago, but it has certainly been reasonably stable for the past six months. They certainly have a huge market to address, and the Chinese should be interested in life insurance and related products given the disappearing promise of the “iron rice bowl” safety net and the growth of a middle class. The shares are fairly comparably priced in many ways to the big US life insurance companies like Metlife — something on the order of 1.5X book value. LFC has a lower trailing PE than the average big US life insurer, but you would have to assume that a LFC buyer would demand a larger margin of safety than an investor in a US company (maybe not given the recent news, but I’d still be more confident in the books of MetLife or Prudential than China Life).

This is a very large company, $40 billion+ market cap, and my guess is that it will probably trade largely as a proxy for the Chinese economy, good or bad. Your call.

Moving on.

“Bargain Stock #3: This company is the number-one medical device manufacturer in China, and because it operates in a booming market, it consistently delivers strong earnings growth. As China’s middle class grows, so does the demand for high-quality medical care, and this company is a top beneficiary of this trend. My China Strategy subscribers are already sitting on 115% gains, and there’s more to come. Learn more.”

This one has also been featured by other investment newsletters many times in the past year or so — I know it was a pick of the Rule Breakers service at the Motley Fool at one point (and probably still is). This must be Mindray Medical (MR), a company that makes many common pieces of medical equipment but that does so cheaply because it’s based in China. This is a different animal than China Medical (CMED), which is really focused on ultrasound therapy and is looking for a breakthrough in fighting cancer. Mindray makes all kinds of stuff that is competitive, but it has to be because it’s a very competitive industry — they make patient monitoring equipment, imaging ultrasounds of various types, and diagnostic machinery, so they’re competing with the likes of Siemens, GE, and the dozens of other powerful medical equipment manufacturers.

That doesn’t mean there’s anything wrong with Mindray — to begin with, it has a really cool name, so that’s something. And they’re doing something right and taking customers, as evidenced by some really impressive sales growth. Earnings growth in this past quarter disappointed a bit, but if sales growth continues at this kind of pace (70%+ last quarter), earnings should follow eventually. Clearly the shares are priced for growth, with a trailing PE in the 40s, but they do have an inside track on a big medical market in China, and they do also export a lot of lower cost medical equipment. It’s a real company with real products, and sales growth, whether you’re interested really depends on how much you’re willing to pay for that growth — and how fast you think the growth will be for the next several years.

So there you have it — three “bargains” in China. The market is like a Mexican jumping bean today so they could be wildly differently priced by the time you read this, as I type both LFC and MR are up big, and CSR (which, not coincidentally, is far smaller than the other two) is getting clobbered. If you like any of these stories, or have an opinion about what to think about the bipolar Chinese market, feel free to share — me, I’m getting a little nauseous watching all these stocks move up and down by 20% a day, but it is nice to see some of them making those moves in a Northward direction today. I don’t own any shares mentioned above.

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