“Only ONE China Stock — Before Tuesday”

By Travis Johnson, Stock Gumshoe, July 18, 2007

A quickie here from Robert Hsu — he just sent an email out telling us (after an exhaustive recounting of his successful China calls, including the Chalco play that Skousen has also been touting), that there will be a big pop in one of his favorite China stocks next Tuesday.

Well, that sounds pretty precise and actionable, eh? He said that his “on the ground” research allowed him to foresee that demand for aluminum in China was dramatically higher than most analysts predicted … can he also foresee a beat on earnings for this other company?

Well, I suppose it’s worth finding out. I’ve seen a few positive mentions of Hsu’s services over at the Gumshoe Forum, where folks often comment about newsletters they’ve tried and like or don’t like, and while I think it would have been difficult to be a bad China advisor over the past two years it’s certainly true that he’s got a repository of winners.

So what is the ONE stock we need to buy before Tuesday, according to Hsu?

Turns out, it’s one we’ve looked at before.

It’s a play on what he calls “Sea Turtles”, the Chinese students who were taught English after class in the 1980s, then went to the West for University degrees, and now are the business barons of the new China. This is fomenting a huge desire for English classes in China because that appears to be the path to riches, and this company is a leading provider thereof.

In Hsu’s words, “China’s top English-language trainer is reporting earnings Tuesday. I expect a quick 25% – 35% gain as a result of the company’s great earnings … Earnings … will show expanding margins for the company and the reason is: when you are the top brand, you can put up your prices.”

Thankfully, though he does say he thinks this stock will give you a double this year, he also specifically says, “no guarantees.” So cool your jets a little.

Then again, he is standing behind a pretty rapid advance: ” Indeed, if this stock doesn’t jump on earnings and make a dash for another double in the next 90 days—I’ll refund every penny of your subscription fee.” Maybe he’s been actually doing some channel watching and checking on the prices for EDU’s classes.

The Gumshoe, of course, will refund you none of the time you’ve wasted in reading this writeup. It’s lost forever, I’m afraid.

And in it’s place, all you’re left with is the name of this firm … which is …

New Oriental Education (EDU)

This is a stock that Hsu has been recommending for a while — and we even sleuthed it out back in March on a prior teaser. It’s up about 30% since that teaser, so if it’s going to go up another 30% after earnings, and double by the end of the year, we’re talking about one hell of a stock.

And, arguably, that’s what EDU is. Analysts are pegging this one with a forward PE of 46, so I really hope that Hsu is right and they’re going to blow out earnings. Any disappointment in earnings or outlook might really whale on these shares, and I of course have no real idea of exactly how much of a “beat” is priced in.

Then again, the August call options pricing right now is pretty modest, given Hsu’s certainty — some people think the shares are going to go up by 8 or 9% in the next month. Not too outrageous for a fast-growing China company ($55 calls, which are right about at the money with the share price of $54.60, are going for roughly $3.50 at the moment).

As a play on the Chinese demand for education, and on upwardly mobile citizens who want to be part of the global economy (a goal which is certainly lubricated by a knowledge of English), the company is compelling.

But it is kind of funny to look at a company that runs decidedly low-tech English classes trading at a much higher forward PE than Google (to be fair, in the same vein their PE is still smaller than BIDU’s suddenly huge forward number of 64). Either growth is huge and the barriers to entry are higher than I think, and the brand more important, or the analysts are lowballing the numbers like crazy out of fear. I wouldn’t be surprised if both were true to some extent, but I also know there are plenty of cheaper ways to play China if all you’re looking for is exposure to the Middle Kingdom and you’re not particularly focused on the private education sector.

I don’t have a fundamental argument with EDU’s business, margins are already reasonable for the education sector and if they improve, as Hsu believes, that will undoubtedly help (though I don’t have any idea how scaleable this is — when you get more students, don’t you need to hire more teachers and rent more rooms in roughly equal proportion? … but the thing that has kept me from buying it in the past — sky high valuation on a business, with many smaller competitors, that doesn’t seem to me to offer any big barriers to entry — remains in my mind. It would behoove you, however, to remember that I’ve been wrong before. Often.

Best of luck, everyone.

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July 19, 2007 3:59 pm

Once again, your analysis is spot on. It is important to be somewhat skeptical of the “hype” we often see to get into stocks prior to earnings. EDU might report solid earnings, however I listened to an analyst on CNBC who suggested waiting until AFTER earnings to buy the stock because there were going to be “charges” reported that would affect earnings this quarter. He went on to say that the company has been spending lots of their treasure on ramping up the company, and therefore will not have the kind of bottom line number that will please Wall Street this quarter. Further, he suggested that the Fall/Winter quarters are more important to EDU as they bring in most of their revenue at that time.
This is definitely one to watch. It may be that individual investors and fund managers, hungry to get into this stock, may hold up the price by entering now and through earnings. It was selling off until today, (7/19) so technically it might rebound here going into earnings. If the stock analyst is correct, be sure to keep a tight stop on EDU, unless you want to buy more on weakness.
Good Luck!

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