Thoughts on Chinese Pharma Stocks

by: Jason Tillberg

Around 2005, I read Jeremy Siegal's book "The Future for Investors." In it he provided a lot of good research on what worked over the previous 50 years for investors to help give us an idea of using the same principles to use to make investments for the "future" that have a greater chance of working.

One of my favorite pages in the book is the one where he tells of the top 20 US stocks from the long period of 1957-2003. Please see this link.

What should jump out at you is that just about every stock on this list has "franchise value" or brand name recognition. Also, what should jump out at you are all the Pharmaceutical companies that made the list.

Pharmaceutical companies can have incredible franchises. When you have a headache and there is a brand that you know will help relieve the pain, you will surely be willing to not only buy that brand but pay a little more than another brand for the brand you know will work for you.

America surely had a wonderful run in the latter half of the 20th century as we levered up in debt and lived well beyond our means. Although we should now be living within our means in our nation, we're not. We've proven to be dependent on deficit spending and dependent on imports for our society to run. This could end tomorrow as far as I'm concerned, so I'm very wary of investing in US stocks, bonds and holding US$.

However, I should add, I am very bullish in the American spirit of creativity and innovation, regardless of the obstacles that face us today.

After reading The Great Inflation, which I wrote about here, I learned that as the German Government gave the license to print money (A deal with the devil) to the central bank and the currency got debased/hyperinflated away, the German people didn't realize their currency was a lie due to having that "deal with the devil" until the last stage of the hyperinflation. Only Germans with access to foreign currencies, owners of agricultural and industrial premises were able to keep from going broke or even starving. It was the pension earners and holders of the domestic currency, the German Mark, who so their wealth evaporate.

You debase a nation's currency, you debase the country itself and eliminate the middle class.

Are we doing this in America today? Actions speak louder than words.

Lastly, the book called "The Theory of Investment Value" by John Burr Williams, written in 1938, best described in my judgment, the basic underlying investment value theory in that the value of an asset is worth what can be derived from that asset over its life discounted at a rate equal to a high quality bond.

Taking lessons from all 3 of these books, leads me to my thoughts on Chinese Pharma/Traditional Chinese Medicine or TCM Stocks as potentially great long term investments. Of course, I'd rather be certain of a good investment than hopeful for a great one. So I do my best to be as certain as my knowledge and logic allows.

I think it's safe to say, China is a growing economic super power that has played its economic planning cards very well over the last 30 years. China is now the world's 2nd largest economy. Jim Rogers suggests that if you want your family to be rich, move to China. Byron Wien, recently on Bloomberg Radio, said, "You go to China, I just was in China in July, and when I come back from China I wonder whether I've left a third world country or come back to one."

I personally have spent a total of 4 months in Shanghai and can attest that China has a very bright future ahead of themselves.

This leads me to believe that the healthcare category in China may prove, just as it did in the US, to provide some outstanding long-term investments. Investing in Chinese stocks also provides a hedge against a continually debased US$ backed by an ever weakening US economy as well. The lesson learned from "The Great Inflation"; (Note: this book pretty much can only be found in your local library or used book store.)

If the Fed continues to make deals with the devil and does more QE, it should prove to take the RMB exchange down with the US$ more rapidly.

From the Chart of the RMB to US$ exchange rate below, you can see the potential for the dollar to fall much further and revert much of the gain. You can also appreciate that it's this currency exchange rate that was so favorable to global international corporations to outsource manufacturing from the US to China. Hence the destruction of our manufacturing base and high paying jobs. What did we get in return? Sneakers at Wal-Mart (NYSE:WMT) for $12 that literally rip apart after 3 months of wearing.

I believe this is now set to reverse and as China's RMB gets stronger, the living standards of the Chinese people will rise, thus allowing them to purchase more commodities per capita. This includes medicines and healthcare products.

click to enlarge

Owning shares of Chinese stocks that do business in China and earn their money in RMB should prove a good hedge against US/Fed dollar policy as well as general participation of a growing healthcare industry in China.

The Chinese have already announced their intentions of allowing the RMB to appreciate against the dollar in June. Currently, the move has been from 6.83 to 6.725 RMB for 1 US$.

Investing in Chinese Stocks, you have to do two things:

A. Pick the right companies with strong management and strong franchises

B. Pay a fair price.

You could do lots of homework and pick a particular company, or simply buy a bunch of the names you think are good candidates for 10, 20, even 50 years of growth ahead of them. Like finding Pfizer (NYSE:PFE) or Johnson and Johnson (NYSE:JNJ) in 1957. Perhaps you couldn't decide which one to buy in 1957, so just buying them both is the idea.

These are not stocks you buy when Jr. is going off to college in 2 years. (I know, tuition is going up 4.5% a year and the 2 year CD at the bank is only paying 0.75%, and you now realize the consequences of Ben monetizing the deficits: you debase the dollar, you debase America.) These stocks may see substantial gains, or may remain down and even go lower in 2 years' time.

However, these are stocks you might consider buying as a way to both preserve and build wealth over long periods of time. Say if you are in your 20's to 40's and want to save for retirement. Owning shares of Chinese Pharma/TCM may prove good allocation in your overall estate. It's a risk you have to decide for yourself if you're willing to take.

I believe owning long term bonds at current yields will prove disastrous under current monetary policy. I wrote about that being disastrous here, which is yet another reason to look to perhaps Chinese Pharma/TCM as an alternative asset allocation.

In the end, I could be very wrong because I really don't know what the Fed is going to do with respect to the Dollar as it's in their power to hyperinflate or allow massive defaults to preserve dollar value. My bias is they resume QE because it's the perceived benevolent thing to do or the lesser of two evils and what they have been doing all along.

When I look today at the Chinese Pharma stocks that trade in the US, I see beaten down names. One reason for this could be the healthcare reforms going on in China that not only are bringing uncertainty to the industry, but price caps are being put on the drugs in the national insurance catalog thus hurting profit margins on many of the companies that are selling drugs/medicines in China. Another reason could be that simply not enough investors are paying attention. Also, fear of fraudulent activity may play a role. But I've seen far more fraud in US stocks over the years than in Chinese names. I notice that institutional ownership is very low in some of these names as well.

The underlying dynamics of the general growth of China's economy, the energy flux increases happening due to massive investments in infrastructure; I.E. A very enviable high speed rail system that will be completed by 2020 (why we are not building such a system in America today is baffling as we pay millions not to work when there is clearly so much work to be done) and higher spending on healthcare as a % of GDP should prove to offer tremendous growth opportunities for many years ahead for Chinese healthcare companies.

The US spends 14.6% of its GDP on healthcare while China only spends 5.8%. (see link above)

Without going into detail on any particular names in this article, below are 5 names in the Chinese Pharma/TCM industry that trade in US markets where you could be part owner of.

American Oriental Bioengineering (AOB)
Tianyin Pharmaceutical Co,. Inc. (NYSEMKT:TPI)
Tongjitang Chinese Medicines Co (NYSE:TCM)
Simcere Pharmaceutical Group (NYSE:SCR)
Tiens Biotech Group (NYSEMKT:TBV)

Disclosure: Long AOB for myself and clients