6 Stocks to Capitalize on China Trade Worries

by: Erik Wright

Yesterday the market was taken by surprise when China announced a trade deficit of $7.3B in comparison with analyst expectations of a $4.95B surplus.

This was the first time since March 2010 that China had a trade deficit. In March 2010 the deficit was of $7.24B. Both in the 2010 deficit and in the recently announced trade data, the numbers were skewed due to the Chinese Lunar New Year. Last year, the Lunar holiday was later on in February (14), which affected March trade data; this year it fell on February 3, affecting February data.

The holiday usually lasts around 15 days, which typically leads to a slump in exports since the country's factories shut down or run at half speed for the whole holiday period.

Some analysts expect that this deficit is temporary and that China's trade data will return to the norm with a surplus next month. A chief China economist for UBS was quoted as saying:

We look at January and February together. On that basis, growth is still quite healthy. We were expecting exports and imports to slow this year due to weak external demand, so this is in line with that.

As seen above, this is simply a seasonality due to the Chinese New Year; it may be a little slower than normal, but this may very well be what China needs to ease into a sustainable growth rate. People always expect so much from China in terms of growth. The expectations are always so high that when China misses growth estimates, the country is always punished and criticized -- even though its economy is growing much faster than the norm.

China achieved an average annual growth of 11.2 percent in the last five years and now is targeting GDP growth of 7 percent from 2011 to 2015. If achieved, China will still be growing at a very reasonable rate; this slower growth rate will ease fears of inflation and the nation will still be among the higher growth countries.

When the trade deficit was announced with a combination of other worldwide factors, markets sold off sharply. The Dow Jones Industrial Average dove 1.87 percent and the Nasdaq 1.84 percent.

The effect on some U.S.-listed small-cap Chinese stocks was even more drastic -- and presents some opportunities. For those afraid of China's exports slowing, all of the following companies are self-contained in China and all of their products are consumed domestically.

The following stocks have also been drastically out of favor and are at very convincing valuations, which may signify a compelling opportunity for a sentiment that is due for a change in direction.

Gulf Resources Inc. (GFRE)

Has lost 24.8% year to date and is currently trading at a forward P/E of around 4.70 with a cash value per share of over $2.10 with no debt. It is the largest bromine company in China and also specializes in crude salt, specialty chemicals and waste water treatment. The demand for bromine is in excess of the supply available in China, which demonstrates that the company's sales will not be affected even if the economy does slow. Potential catalysts include the company's earnings due out in the next week. For more information on the rise of bromine prices, Gulf Resources and its industry refer to my last article.

China MediaExpress Holdings (OTCPK:CCME)

Has lost 21.65% year to date and is currently trading at a forward P/E of 3.9 and a cash value per share of near $5 with no debt. CCME has a very high margin business trough, operating the largest television advertising network on inter-city and airport express buses in China. CCME has undergone a lot of controversy recently, since many fraudulent claims have been brought up against the company by research companies such as Muddy Waters and Citron Research. The fraudulent claims have been refuted by the CEO, but there is still a pending class-action lawsuit against CCME, as well as lawsuits against the research companies involved for fraud. The company has a very simple business model which does not require exports. Catalysts for CCME also involve the company's soon releasing its year-end results, signed by Deloitte, which if correct will send the stock much higher.

China Gerui Advanced Materials Group Ltd. (NASDAQ:CHOP)

Has lost 8.67% year to date and is trading at a current P/E of 4.90. CHOP is a leading niche and high value-added steel processing company. China Gerui has over 200 domestic Chinese customers, and the largest market share (12.5%) in China for specialty steel. It will soon be finishing an expansion that is expected to almost double the company's production by mid-2011. The company has been under pressure due to its financing and the warrant overhang on the company that was used to fund the expansion. Warrants will be expiring March 19, which should eliminate the overhang on the stock. Earnings for CHOP should also be released soon, and investors should look for guidance and earnings improving as they will ramp up production on the new production lines.

L & L Energy Inc. (NASDAQ:LLEN)

Has lost 30.46% year to date and has a 3.8 forward P/E. LLEN is in the businesses of coal mining, coal washing, coal coking and coal wholesaling. As we all know, coal is China's main source of energy and heating; therefore, the coal industry continues to have high demand in China, and companies such as L & L have no trouble selling all of their supply domestically. Even if China has been moving towards cleaner sources of energy, coal still remains dominant, and coal companies have been finding cleaner techniques of using coal -- such as coal washing, which involves removing the impurities of the coal before it is burned to lower the environmental effect. L & L has had strong growth by expanding in terms of coal mines and production, and has drastically grown its sales while maintaining relatively high margins. L & L, like many Chinese stocks, has had some negatives. It was criticized by CNBC's Herb Greenberg for being a reverse merger, which sent investors fleeing. The company will be announcing its earnings March 14, which could help stimulate some positive movement if management provides a good outlook in its conference call, as well as better-than-expected results. Coal prices have been rising, which should prove to be good for the company's future outlook.

China Information Technology (NASDAQ:CNIT)

Has lost 29.17% year to date and has a forward P/E of 5.3. CNIT specializes in Geographic Information Systems (GIS), digital public security and hospital information systems, as well as selling other software and electronic products. CNIT has been consistently growing in the Chinese market since the demand for information technology infrastructure has been drastically growing in China. CNIT has also been recognized through various awards such as the "Most Promising Companies" by Forbes and the "Fast 50 China" in 2009 by Deloitte. CNIT's earnings were recently announced, which made the company sell off well over 10% in the past two days. The company's earnings showed growth in revenue as well as adjusted bottom line net income and EPS, but net margins dropped and unadjusted net income attributable to the company for the fourth quarter showed negative growth, mostly due to a higher tax rate than the prior year's. The company is clearly oversold at the moment and could be an opportunity to pick up cheap shares for a short-term run back up, or for a longer-term growth play if margins show signs of improving or stabilizing.

Longwei Petroleum (LPH)

Has lost 18.15% year to date and has a P/E of 3.91. Longwei engages in transporting, marketing, and selling finished petroleum products such as diesel, gasoline, fuel oil, and kerosene. LPH has been expanding and experiencing drastic growth in earnings through gas station distribution as well as an increase in storage facilities. The company appears to be planning to acquire new facilities in new areas of the PRC. It is expected that this acquisition would be funded through the shelf registration for $50M in securities and $26M of current warrants, which is why the stock has been recently dropping. The stock appears to be currently oversold, but investors should wait until after the acquisition to consider buying back in after the dilution has been taken into account. LPH appears to be an appealing way to take advantage of the rising use of vehicles in China.

Closing Thoughts

As seen above, due to fears of China's slowing growth and trade deficits, there appears to be an abundance of oversold opportunities, many of which are awaiting catalysts that should help the companies' stocks bounce back upwards. All of the companies listed above do not rely on exporting internationally to sell their products; after a more lengthy due diligence process, you may find that many are well deserving of a higher valuation. With time, and when the pendulum decides to swing back China's way, some of these deeply undervalued stocks will make a comeback and will reward patient investors with a handsome return.

Disclosure: I am long GFRE.