“No. 1 China Stock for 2010… textbook (though exceedingly rare) opportunity to profit from the rise of the Chinese consumer”

By Travis Johnson, Stock Gumshoe, July 29, 2010

Today we again visit our friends from the Motley Fool, and they transport us to the Middle Kingdom with a teaser chock full of Chinese stock ideas. The teaser comes in an ad for the Fool’s Global Gains newsletter from Tim Hanson, and it’s all about the Chinese consumer. They’ll send you a special report if you pony up the $149 … but of course, they also provide some clues about their favorite picks, so your friendly neighborhood Stock Gumshoe is ready to dig in and reveal what they are.

Tim tells us that he’s got four picks, and he wants you to buy all of them today — one of them is revealed in the letter, a stock that the Global Gains folks and several other newsletters have been recommending for years as a “safer” China play, and I can’t argue with that one: Yum Brands (YUM) and their hugely popular KFC and Pizza Hut chains in China that are supplying much of their global growth. But you’ve probably heard of that one before, it’s huge, and it’s easy to research and buy, so we’ll just leave that on the table.

There are three other stocks teased in the article, and I may follow up and get to the other two sometime soon, but when someone teases that they’ve got a “Number 1” stock idea … well, that’s naturally the one I most want do uncover for you, the finest and most gracious readers in cyberspace. So what is the number one Chinese stock idea from the Motley Fool today?

First, they explain why they’re looking at this particular sector — television advertising in China (and no, this isn’t the same stock that Robert Hsu was touting last week) … here’s their pitch on that:

“Global consultant McKinsey & Company has studied the Chinese consumer as thoroughly as anyone I know. Among McKinsey’s top takeaways is that the Chinese consumer is fiercely loyal and extremely brand-conscious.

“And this goes beyond a notorious infatuation with luxury brands like Gucci, Louis Vuitton, and Coach. Even when shopping for routine daily items, the McKinsey survey reports that ‘63% of shoppers enter a store with a shortlist of favorite brands and don’t stray from it when making purchases.’ ….

“‘Television advertising remains the bedrock of Chinese marketing’ — The McKinsey Quarterly

“What’s a Chinese consumer company to do? Simple. Establish a BRAND consumers can trust. And given that ‘41% of Chinese consumers say they must see a new product advertised on TV before they’ll buy it,’ it’s easy to understand why China television is the place to do it.”

Then we finally get into a few specifics about this favorite company … the clues, please!

“… multinationals Nokia and Kraft, too. Both are among the company’s numerous deep-pocket global partners….

“… this is no ordinary ad agency. In addition to designing, producing, and packaging TV advertisements, the company also buys and sells valuable time slots on national television channels to its high-profile clients. Wherein lies the double-edged sword that makes investing now such a golden opportunity…

“… my No. 1 idea is the brainchild of an anointed “insider” — a distinguished alumnus of China Central Television (CCTV). As a result, the company once enjoyed a monopoly on a valuable CCTV property, but no more.

“In response to the temporary setback as this exclusive arrangement was unwound, the company took a 60% hit to first-quarter revenue. Lost amid the handwringing, however, are two important facts that stand testament to the company’s superior management: Through it all, the company remained both profitable AND cash flow positive.”

OK, so that’s intriguing — bad news, a drop in earnings, but still profitable. How about a few more clues?

“Despite sitting on $3 per ADS (essentially a U.S. share) in cash and investments — nearly twice the current market price — the stock trades at less than 1 times sales and 6 times earnings…”

And a cautionary note, with also a wee bit of a clue hidden inside:

“… while you can buy it easily through your current broker, the company we’re discussing today is small — with a market cap just shy of $50 million — and relatively thinly traded.

“Frankly, I’m reluctant to forward it on to so many investors, some of whom may simply be unqualified to invest.”

OK, so I’m a bit reluctant to forward it on to so many Stock Gumshoe readers, too, since he’s right about it being tiny and somewhat illiquid — but I can count on my readers (usually) to be grown-ups who take a sober look at stocks, not folks who are going to climb out on a limb and get a second mortgage when a stock I write about goes up 10% following the “reveal.”

So yes, be careful … but this stock is China Mass Media (CMM)

I’ve written about thousands of stocks over the years, and, frankly, it’s enough that I’m starting to forget about some of them, but it’s a refreshing reminder that at least a few times a month I get to write about a stock that I had never heard of. I didn’t even realize that any “traditional” Chinese advertising agencies were publicly traded in the US, though it turns out that there’s more than one to choose from — not just the somewhat oddball advertising names like Focus Media (FMCN — LCD ads in building lobbies and convenience stores), AirMedia (AMCN — a network of advertising for airplane passengers), China MediaExpress (CCME — tv ads on intercity buses) and VIsionChina Media (VISN — tv ads in city buses and subways), but actual ad agencies and TV time buyers. The other one that caught my eye as a TV advertising agency in China is far bigger (though still very small, under $200 million market cap), Charm Communications (CHRM) — also trades at a very low forward PE of about 5.

But it’s China Mass Media we’re looking at today — so who are they?

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China Mass Media is the largest advertising agency on CCTV, and they did indeed take a 60% hit to their ad agency sales in the last quarter — you can read the press release here, but they attribute the hit to CCTV’s decision to handle advertising sales for their China New Years Gala in-house instead of contracting out to CMM as they had in the past (the gala is, as I interpret it, comparable to the Super Bowl for US advertisers — at least half of all Chinese see the program, so losing that exclusive is a big deal). The earnings hit was far greater, since this cut in sales also took a big bite out of their margins, so earnings were actually down more on the order of 80% year over year, and 68% sequentially from the fourth quarter of last year.

There are only a couple analysts issuing estimates for CMM, but they have been cutting earnings expectations — the estimate for this calendar year is that they’ll earn 27 cents per share, which seems to be more or less in line with the tepid guidance offered by the company, and estimates for 2011 are at 20 cents per share, with the expected continued decline in sales. The trailing PE is about 8, the estimated forward PE is 11.

So that’s why the stock is cheap — they’ve been doing badly, though you can argue that much of that bad news is “priced in” now, though with their weak guidance and declining sales you’d have to have a strong faith in the company and in the power of the Chinese TV advertising market to see growth in earnings anytime soon.

But I should probably be more careful with that word “cheap” — I would hesitate to say that a forward PE of 11 for a stock with declining earnings and sales is “cheap,” but if you look at other metrics they are undoubtedly super-cheap: A quick look at their latest (unaudited) earnings press release indicates that they have about $55 million in net cash even after you back out the short-term investments to cover their accounts payable stuff, and that’s roughly the market cap — there’s no guarantee that they’ll do what you want with that cash, but it looks like they are still generating positive cash flow so you can effectively buy the company’s cash pile and get their operations for nothing.

Not that they’ll give you the cash o