We’ve been saying much the same thing. These things are cheap, and we don’t think they’ll remain cheap forever…
Short-Term Opportunity in U.S. Quoted Chinese Stocks
Atticvs Research

Investment opportunities and risks are changing constantly. Consequently, investors must periodically adapt their investing activities in order to safeguard portfolios and boost long term performance.

Whilst this maxim may seem obvious to short-term traders it is equally valid for long-term investors. For them too it can be both wise and profitable to selectively allocate an amount of resources towards attractive short term opportunities which the market periodically throws up.

One such short-term opportunity exists today. It has evolved via the confluence of several factors and resulted in stocks of small US-quoted Chinese companies becoming compellingly cheap ahead of their 4Q 2009 reports. These stocks have been buffeted by a barrage of negative factors including;

• Small companies, by their very nature, do not have broad analyst coverage and stock prices often suffer from a lack of media support caused by infrequent news publications. This leads to stock prices sinking during times when positive news is scarce i.e. typically between earnings release dates.
• Global issues such as sovereign debt default concerns are shaking markets everywhere and again small/mid-cap stocks with high betas tend to experience more than their fair share of the downdraught.
• US investors are increasingly ethnocentric during worrying times, leaving stocks of many foreign US-quoted companies to languish at a discount to their US peers.
• In the face of accelerating economic growth, and in order to guard against the emergence of an asset bubble, China is starting to curtail new bank lending and tighten existing criteria. Such news stories often lead to negative over-reaction by individual investors who then sell indiscriminately.

Behind these headlines lies the reality that the Chinese economy is growing at over 10% per annum and, with its tremendous competitive advantages, will surely continue to grow strongly for the foreseeable future.

Moreover, because China’s economy experienced accelerated growth in late 2009, it seems inevitable that many Chinese companies will report better-than-expected earnings for 4Q 2009. In the circumstances one could reasonably expect share prices for a number of carefully chosen US quoted Chinese companies to have performed well lately.

Instead, the opposite has happened – almost all have pulled back sharply since mid January, even where the underlying business is booming and profits soaring.

Thus, the current plethora of negative news items has thrown up an attractive short-term trading opportunity: US quoted Chinese companies with low valuations that report good results are well positioned to experience upward share price moves into and on earnings release day. This short term opportunity may well transmute into a long term buying opportunity but this note concentrates simply on the immediate picture.

Some early reporting Chinese companies are already verifying the validity of this thesis.

• On February 8, China Fire & Security Group (Nasdaq: CFSG) issued preliminary but slightly disappointing 2009 results together with improved 2010 guidance. The stock rose from $12.06 to close at $14.47, a 20% gain on a day the Dow Jones lost 104 points.
• On February 10, Baidu Inc (Nasdaq: BIDU) jumped 10% on its solid 4Q earnings release.
• On February 11, Xinuan Real Estate Company (NYSE: XIN) reported strong 4Q results and issued in-line outlook – its stock rose over 12% in two days into and during earnings release.
• Also on February 11, J.A. Solar Inc (Nasdaq: JASO) stock rose almost 15% in the two days into and during earnings release on better than expected results.

Reassuringly, since reporting, and without any exception, these stocks have held on the gains achieved at earnings release.

A common theme is emerging: In today’s difficult markets, beaten-down Chinese stocks are experiencing lively gains at reporting time, provided that; (a) 4Q results are in line or better than expectations, and; (b) the company is able to confirm via its forward 2010 guidance that the underlying business remains in decent shape.

This second point is particularly important in allaying investors’ overdone concerns about a possible slowing of the Chinese juggernaut.

From over 200 Chinese stocks quoted on US markets, I extracted the following list of six which I consider to have the best criteria: cheap stock with good upside potential, healthy continuing business into 2010 and beyond, likely to meet or beat 4Q 2009 earnings estimates, and good stock trading liquidity. Observe that all companies have single digit 2010 p/e ratios and all are forecast to experience 2009-2010 sales growth of greater than 30%.

Notes: All data from Yahoo Finance except CSR 2010 p/e which is based on company guidance. Stock prices are market close February16, 2010.

There are two stand-out prospects on the list:

1. China Security & Surveillance Inc (NYSE: CSR) is a $502m market cap company in the nascent Chinese surveillance and security industry. In order to carefully monitor its vast population in an age of growing disparity between the rich and poor, and thereby try to minimize social discord in the country, the Chinese Government will rely more and more on surveillance technology. This provides companies such as CSR with a long term business platform. At earnings time CSR is expected to announce new business wins of potentially up to $1.8 billion since the beginning of September 2009 thus suggesting that 2010 sales estimates of $812m and CSR’s EPS guidance of $1.20 approx should be within grasp. CSR is expected to report on March 4.
2. China Housing and Land Development Inc (Nasdaq: CHLN) is a real estate developer in Xi’an city (pop 8.5m). Whilst there is a serious property bubble threat in eastern seaboard cities such as Beijing where the average property prices per Sq meter in December 2009 was Rmb 13,000 ($177/Sq ft), the picture is very different for tier 2 inland cities such as Xi’an – its average pricing in December 2009 was a mere Rmb 5,000 ($68/Sq ft). CHLN is set to report 4Q’09 figures best described as blowout. Sales, for example, will be about 130% greater than broker estimates. Further, due to a burgeoning projects pipeline in the second half of 2010 the company is likely to beat brokers’ 2010 EPS estimates by a wide margin. But what makes CHLN stand out is that, beyond its existing and planned construction projects, it owns a prized 390 acre tract of development land in Baqiao, a mid to upper income suburb of Xi’an, that is valued at over $1million per acre (CHLN sold an 18 acre parcel for $24.4 million cash in 2007). Even ignoring CHLN’s strong earnings cycle for 2010 and beyond, the value of the Baqiao land alone is worth over $400 million. Yet, the total market cap of CHLN is a mere $131 million (enterprise value $165m). CHLN is a company with an unusual amount of hidden value. Expected reporting date is March 25.

The other four companies on the list also have great stories to tell and they too should be examined:

1. Advanced Battery Technologies Inc (Nasdaq: ABAT) designs, manufactures and sells rechargeable lithium-ion batteries in China, the USA and Europe. It also owns a small but growing electronic scooter and vehicle business. On February 3, 2010 ABAT announced it had won orders to deliver significant numbers of scooters to distributors in both Turkey and The Netherlands. It is on a 2010 p/e of 8.6, anticipates sales growth of over 50% in 2010 with further strong growth expected in future years. ABAT is expected to report earnings on March 15.
2. China Information Security Technology Inc (Nasdaq: CPBY) is a provider of digital security, geographic information and hospital management solutions. On January 14 CPBY announced that it had signed a record $36.7 million of new contracts in 4Q’09. The company has a 2010 p/e of 7.6 and expects 2010 sales to be about 40% above 2009. CPBY is anticipated to report 4Q on March 16.
3. Zhongpin Inc (Nasdaq: HOGS) processes and distributes pork and food products in China and some export markets. It has a strong record of sales and EPS growth. Sales increased in 2009 by nearly 50% and are expected to increase in 2010 and future years by about 30% annually. On January 11 HOGS released favorable preliminary results for 2009 and on February 8 announced the successful opening and initial production at a new large processing plant. HOGS trades on a 2010 p/e of 7.1. Expected 4Q earnings release date is March 16.
4. China North East Petroleum Holdings Ltd (NYSE: NEP) is an ultra-low cost oil producer and driller in North East China. It sells all its oil to PetroChina on the open Singapore market. NEP owns a well drilling company and in the past 2 months the company announced 2 significant well drilling contracts. NEP’s consensus estimates for 4Q 2009 were built using an average oil price of $65 per barrel. Since the true average oil price in 4Q 2009 was greater than $65 we can expect NEP to beat brokers’ estimates. 4Q earnings should be released on about March 29.

Caveats:

The 4Q 2009 reporting dates used are provisional – they have been estimated with reference to previous earnings announcements. Hence, investors/traders must keep an eye on the companies in question for news of the official earnings dates.

After earnings release, there is a risk that some share prices may drift lower if the reporting company does not follow-up with good PR and if the stock does not get broker upgrades but all this very much depends on the specific results and on other external factors.

Being a long term investor, I won’t attempt to offer expert advice as to the best timing for entering these short-term opportunities. Best time may be immediately before earnings or it could be several days ahead of earnings. Time will tell.

Disclosure: Within a wider portfolio I hold core long positions in CSR, NEP and CHLN. Additionally, I have already taken short-term trading positions in some of the mentioned stocks. I intend to do further short-term trades with all of them by the time they report their 4Q earnings.