Buy These Three Stocks During the Dip in Highly Valued China

Chinese stocks have pulled back massively in recent days, after valuations climbed rapidly to highly optimistic levels and questions about the sustainability of stimulated growth in China finally entered the psyche of the investing public. Right now, buying shares of Chinese companies traded on American exchanges resembles attempting to catch a falling knife by its blade. This pullback, however, hardly implicates the resumption of a bear market in China.

China has been the story of the last several years, confidently dubbed the world's economic superpower of the 21st century by legendary investors Jim Rogers and Warren Buffett, among countless others. Output and consumption there have grown at world-leading rates in the last decade and continued, albeit more slowly, during a global recession. The national one child policy has reduced crowding in major cities and ultimately encourages individual consumption, education and responsibility. The same policy combined with a high savings rate and strong work ethic is very conducive to maintaining a rich commodities stockpile and consistent surpluses in output.

So, if you believe in the China story but can't convince yourself to buy a stock with a 30+ P/E, how can you invest in China today? An ETF like PGJ or FXI would provide broad exposure to Chinese industries and ensure more liquidity than a relatively thinly traded individual stock, but far better value is almost always out there for a patient investor who can handle some volatility. Outside of less transparent and reliable OTC (over the counter) stocks, Chinese stocks generally trade at a significant premium. IPOs for Chinese companies, like Changyou (CYOU) and Duoyuan Global Water (DGW), inspire buying frenzies that have pushed those stocks to valuations ahead of worldwide leaders.

Three Chinese companies I followed on the OTC market recently earned NASDAQ or AMEX listings, making them more visible, transparent and appealing as investments. Each is growing, profitable and highly discounted relative to peers. Also important is that none of these stocks received the same IPO hype that comes with initially being listed on a major exchange. All of the following are thinly traded, but each represents a value opportunity in pricey China.

1. CBEH China Bio Energy Holding Group (CBEH): If anything is certain, China's oil consumption will continue to rise. Year over year national car sales in May were up nearly 50% and, thus far in 2009, China has surpassed the USA as the leading purchaser of automobiles. From the prospectus:

The Company is currently engaged in the development, exploration, production and distribution of bio-diesel and wholesale and processing of heavy oil and finished oil products, and the sale of gasoline and diesel at retail gas stations, through its indirect wholly owned operating subsidiary in China, Redsky Industrial (Xi'an) Co., Ltd. (Redsky Industrial), and Xi'an Baorun Industrial Development Co., Ltd. (Baorun Industrial).

CBEH recently reported revenue growth and a $42.5M cash position (market cap is $160M) through Q2 FY2009. Since then it has purchased its seventh gas station in the Shaanxi province and gives a positive outlook for the remainder of the fiscal year.

2. NEP China Northeast Petroleum (NEP): My favorite thing about CBEH is that it only relies on consumption of refined oil products in China and adds value to the underlying commodity regardless of raw prices. NEP, on the other hand, is involved in exploration and production, making its profits perfectly correlated to crude prices. The Company has over 250 producing wells and low extraction costs. Furthermore, all production is guaranteed to be purchased by Petrochina (PTR). NEP trades near 6 times earnings and has given a strong outlook for the rest of FY2009.

3. SKBI Skystar Bio-Pharma (SKBI): This maker and distributor of veterinary medicine trades under 5X trailing earnings (@$12.45/share) and has reported growth in H1 FY2009. The second half has historically been stronger for SKBI and management has predicted a continuation of that trend for this year. $20M was raised with the public offering that accompanied being listed on the NASDAQ. Much of that cash will be used for R & D of new products and the expansion of production capacity (by 2300% according to reports). The stock hit $22.49 less than six weeks ago and since then has pulled back almost 50%.

Besides conducting business in China, the aforementioned stocks have a lot in common. Each has lost 25%+ shortly after achieving 52-week highs, pulling back with Asian markets. This is panic selling, and just a little of it can really hurt a thinly traded stock. With single digit P/Es and in tact growth stories, the companies described are rare investment opportunities in an economy almost everyone wants a piece of.

Disclosure: Long CBEH, Considering Long Positions in NEP & SKBI

Comments

[Jordan Lindsey:]

You mean highly overvalued China who's bubble is about to burst!

Aug 20 11:44 AM

[turb0kat:]

Thanks for the ideas Danny - I agree with the thesis and have been adding to my NEP prior to reading this article. Will check out the others!

Aug 20 12:47 PM

[China Expert:]

Jordan....while the Chinese stocks trading oversease and on the big board trade at crazy multiple there are many smaller China stocks trading at "value" multiples under 5x, growing fast, debt free and generating attractive FCF. SKBI is in this category along with a small handful of others.

Aug 21 09:17 AM

[Alphameister:]

Excellent ideas, Danny. I would suggest that "pricey China" is more popular perception than reality ("anything that goes up by 100% in six months must be overvalued"). The description certainly does not apply to your selections, nor does it apply to my holdings of Chinese growth ADRs which trade at earnings multiples ranging from 2 to 12, mostly below sales per share and some below book value. Chinese stocks are not nearly as fully valued relative to growth potential as are most U.S. stocks.

Aug 21 09:18 AM

[Danny Furman:]

Thanks for the feedback. The "priceyness" I was referring to relates more to large cap Chinese solar, financial and internet companies, many of which carry 30+ forward P/Es and have already grown close to capacity (in valuation and operation). There is still a selection of good value in Chinese ADRs, but investors should hardly be buying expensive "leaders" or playing momentum in volatile China. China is easy to hype and many companies/PR firms take advantage of that. What matter are results and projections based on contracts or production. There are a limited number of companies that will profit from Chinese growth, but they will make a killing.
Alphameister, as a side note I'd like to point out that I see more high quality undervalued companies based in Hong Kong than I do in China, and consider TSTC, AFOP, CTEL, ALIF.... another breed.

Aug 21 01:06 PM

[collins:]

Danny,

Thanks a lot for your article. I already own a hefty amount of NEP, but hadn't heard of CBEH and SKBI. This latter one seems great, but I'm concerned about their legitimacy and was wondering if you could vouch for them in some way. I feel uneasy when I read in their 10Q report 8/14/09 that they were:

"formerly known as The Cyber Group Network Corporation, (which) was incorporated in Nevada on September 24, 1998."

Along with this further string of ownership claims:

"All of the Company's operations are carried out by Xian Tianxing, a PRC company, which the Company controls through contractual arrangements originally between Xian Tianxing and Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. ("Skystar Cayman"), a Cayman Islands company that became the Company's wholly-owned subsidiary subsequent to a share exchange transaction on November 7, 2005. On March 10, 2008, all of the rights and obligations of Skystar Cayman under the contractual arrangements were transferred to Sida Biotechnology (Xian) Co., Ltd. ("Sida"), a PRC company and wholly-owned subsidiary of Fortunate Time International Limited, a Hong Kong company and wholly-owned subsidiary of Skystar Cayman. Xian Tianxing also has a wholly-owned subsidiary, Shanghai Siqiang Biotechnological Co., Ltd., a PRC company."

This might be a "common" practice, but I'd really appreciate it if you could elaborate on what assuaged any doubts you might have had along these lines.

Moreover, I also found their website rather suspect since their homepage uses a "drawing" of their facilities and not a real picture. Why pay someone to do a drawing for you with fake people walking around your "facilities" when you could just take a picture of it with real people walking around? Likewise, when you go to their page outlining their "operations" there's strange close up picture of a huge industrial drill-bit like device that would seem to have absolutely nothing to do with a plant that manufactures vaccines for animals. Presumably you've seen what I'm talking about. But here's the link:

www.skystarbio-pharmac.../

I bring these points up because I am genuinely interested in this company. I'm not at all bashing it. I'm just stating some initial concerns and assume you can clear them up as I wouldn't think you'd want to put your name behind this companies without having done a fair amount of research on them.

Again, I think very highly of NEP, and this in turn made me feel your other do picks deserve serious consideration. I hope you will have time to respond.

Thanks for the article.

Collins

Aug 21 07:06 PM

[Danny Furman:]

Collins,
Thanks for the thoughtful response and questions.
I don't know much about taking a company public, but the process for SKBI looks far from unusual. Many Chinese companies were initially taken public by small (sometimes unscrupulous) firms with promises of a NASDAQ listing (etc), only to be listed on the OTC market with minimal exposure to raise capital. The drawing on SKBI's website is a planned facility (www.skystarbio-pharmac...), not a random cartoon :). SKBI has grown rapidly since 2007 and doesn't have much operating history, so continuing to grow profitably may be a challenge. Still, the company is cheap by almost every valuation metric and has a diverse pipeline of existing and developing products.

Aug 22 01:27 AM

[collins:]

Danny,

Thank you very much for your prompt reply. I started a 2.5% position yesterday--shoot first ask later! I came to the same conclusion you did about SKBI's Nevada-Cayman Island corporate history: it's done a lot. Likewise, a friend noted that the institutional investors in this company most likely did a fair amount of DD and evidently didn't find this issue inherently problematic.

Thanks for clarifying my concern about the website. The picture indeed looked like the very type of drawing companies use to portray a project they envision for the future. Perhaps they mentioned this on the website as I did not examine it closely.

The more I think about SKBI and the niche it's working in, the more I like it. Thanks a lot for calling this one to our attention. I will have to look more closely at your other suggestion CBEH.

Also, do you post your ideas elsewhere on a frequent basis? If so, I'd appreciate hearing where. Your three ideas here so closely match up with my own inclinations that I'd like to hear what you're discovering on a regular basis.

Again, thanks a lot for taking the time to respond to my inquiries.

Collins


On Aug 22 01:27 AM Danny Furman wrote:

> Collins,
> Thanks for the thoughtful response and questions.
> I don't know much about taking a company public, but the process
> for SKBI looks far from unusual. Many Chinese companies were initially
> taken public by small (sometimes unscrupulous) firms with promises
> of a NASDAQ listing (etc), only to be listed on the OTC market with
> minimal exposure to raise capital. The drawing on SKBI's website
> is a planned facility (www.skystarbio-pharmac...),
> not a random cartoon :). SKBI has grown rapidly since 2007 and doesn't
> have much operating history, so continuing to grow profitably may
> be a challenge. Still, the company is cheap by almost every valuation
> metric and has a diverse pipeline of existing and developing products.

Aug 22 01:17 PM

[Danny Furman:]

Collins,
I've been posting my ideas here at Seeking Alpha since the beginning of May, not long after buying my first stock. I analyze every publicly traded company I can find in sectors I believe are fundamentally very strong (non-export China, Brazil, mobile internet, biotech...) and frugally look for value, growth and positive technicals. Many foreign companies trade for less in NY than they do domestically, which is another reason I focus on foreign ADRs. Stocks I write about are very volatile, should be researched thoroughly and belong in a diversified portfolio.
My Seeking Alpha Instablog is where all the magic happens (no website etc.)!
Thanks for the vote of confidence and best of luck.

Aug 22 08:35 PM

[collins:]

Danny,

Thanks for the further details on your investing focus. I clicked on "following" next to your name. I'm not sure what that means. What I wanted to have happen by doing that is to be notified via email when one of your pieces makes it to the internet. But perhaps that's not what clicking that button does. I never even knew it was an option till this morning.

Also, I'd be very interested to hear what companies you've singled out in Brazil and was wondering if you could pass their ticker symbols along so I can more quickly find your blogs on them. I suspect there's only a couple at this point. But I'm sure you're busy so I understand if you want to let this request slip by.

Thanks again. Looks like you picked an excellent time to start investing.

Collins

Aug 23 10:38 AM

[The GeoTeam:]

Collins, if you have an RSS reader you can follow any particular author by subscribing to his/her feed. I use Mozilla Thunderbird for its amazing filtering capabilities.

Zou
GeoTeam


On Aug 23 10:38 AM collins wrote:

> Danny,
>
> Thanks for the further details on your investing focus. I clicked
> on "following" next to your name. I'm not sure what that means. What
> I wanted to have happen by doing that is to be notified via email
> when one of your pieces makes it to the internet. But perhaps that's
> not what clicking that button does. I never even knew it was an option
> till this morning.
>
> Also, I'd be very interested to hear what companies you've singled
> out in Brazil and was wondering if you could pass their ticker symbols
> along so I can more quickly find your blogs on them. I suspect there's
> only a couple at this point. But I'm sure you're busy so I understand
> if you want to let this request slip by.
>
> Thanks again. Looks like you picked an excellent time to start investing.
>
>
> Collins

Aug 23 08:35 PM

[Danny Furman:]

Collins,
By "following" me, like you suspected, you get e-mail notifications for my articles. Here's a list of some of my favorite Brazil stocks (a month ago the list would be endless, but many (GOL, CZZ...) have "popped" lately and are hardly still cheap):
SBS, TNE, BAK, PZE, BOBS.OB, BTM, NMM

Aug 23 10:35 PM

[Ramesh:]

This is a general question about migration of stocks from pink sheets or other OTC to an exchange. What happens to the shares held? Do they get migrated? Do you have to sell them and purchase the exchange version?

for example, what happened to CNEH.OB holders when NEP was listed in amex?

thanks.

Oct 06 11:50 AM

[Danny Furman:]

As you put it, Ramesh, the shares "migrate."

Oct 15 07:40 PM