This is a re-print from my column on "TheStreet".com (TheStreet)
Finding Gold in Cash-Rich China StocksRick Pearson
BEIJING My "target" for a good opportunity in a cash-rich China stock is where cash is at least 40% of market cap. This will clearly be a moving target as prices change every day.
There are two reasons why cash-rich China stocks can be the source of significant hidden value. First, headline P/E numbers provided by the financial media do not back out cash. For companies with a low to moderate amount of cash, this doesn't change the picture much. However, for companies with a large cash balance, the "true" economic P/E is actually much lower than what many people may realize.
Second, many people (myself included), view the Chinese yuan as a fundamentally undervalued currency that will inevitably appreciate as the Chinese government reduces intervention in response to growing international pressure. Although this appreciation is expected to be a slow, gradual process, large cash balances can be seen as a large undervalued asset on the books.
One great example of this type of stock is Shenzhen-based Cogo Group(COGO Quote), which provides module and subsystem designs to mobile phone and telecom equipment manufacturers in China.
At a price of $6.14, COGO is trading at a market cap of $221 million, a multiple of 35 times trailing 12-month earnings. However, in a recent 10-Q released on Aug. 6, COGO maintains a balance of $118 million in cash and pledged bank deposits, 53% of its market cap. Backing out the cash results in a "cash-adjusted" P/E of only 16 times trailing 12-month earnings.
Looking at COGO's fundamentals, the stock is moderately attractive at these levels. Gross margins have held consistently at 14% over the past four quarters, and second-quarter sales rebounded 16% to $74 million after dropping 22% from the fourth quarter in 2008 to the first quarter of 2009, during the worst of the financial crisis. COGO has been profitable every quarter, and has had annual profits ranging from $14 to $21 million over the past 3 years.
In its recent 10-Q and conference call, management stated, "Based on current visibility and new business in the pipeline, management is providing 2009 Q3 guidance of $79 milllion to $80 million in revenue." This represents an expectation of about 8% quarterly growth, and puts revenue near the $81 million level in the fourth quarter of 2008.
On July 13, the stock hit a recent low of $5.02, implying a market cap of $181 million and a cash-adjusted P/E of less than 10 times trailing 12 months. Since July 16, the stock has not closed below $6, but last Thursday, it dipped intraday to as low as $5.93.
Based on the strong balance sheet and the potential for reasonable growth and sustainable margins, COGO looks promising at current stock prices. However, for investors who feel that the overall market is due for a pullback, it looks like it is still possible to pick up shares occasionally at just below $6.
If the market should happen to pull COGO back to the low $5's, it will represent a cash-adjusted P/E in the single digits and will begin to represent a significant bargain. It's definitely one to keep on the watch list.