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Ethan Backus
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Ethan Backus currently lives in Guangzhou, China and is interested in the Chinese economy. The Chinese financial system is still very early in its development stage. This presents many risks and opportunities for investors. Being fluent in Mandarin and having spent several years living in China... More
  • Short These 3 Chinese Stocks Before they Implode! 1 comment
    May 11, 2010 11:26 AM | about stocks: ZNH, EJ, CRIC, FXI

    People are getting more and more bearish on China these days. Some people want to cash in on a possible real estate bubble, while others just want to hedge the exposure they have to higher quality Chinese stocks currently in their portfolio. Here are three stocks that have had a considerable run up over the past year and seem overvalued on several metrics. The last two have significant exposure to Chinese real estate. These Chinese growth stocks are sure to implode if there is a slow down in China as surely as the internet bubble popped.

    Moreover, Chinese ADRs (American depository receipts) are great to short because they have a natural speculative run-up caused by the fact that they are the only choice for small investors looking for China exposure.

    1) China Southern Airlines (NYSE:ZNH) is set to crash and burn. Recently it has skyrocketed out of control up to $24 a share from it’s March 2009 low of $5.50 . However, it lost $6.30 a share over the past 12 months, and for the past five years the stock has made only pennies per share of earnings during the years it actually turned a profit. It is a great example of the speculative mania that has accompanied China's rise. Writes: “China Southern Airlines is one of the three largest airlines in China. The firm operates a highly leveraged business, both financially and operationally, in a cyclical industry. We believe investing in its shares entails very high uncertainty.”

    Recently, I flew on a short flight from Kunming to Canton on China Southern. After waiting in line an hour at their ticket counter I got to my gate, boarded the plane, where I was rudely told there was a mechanical problem with plane. We passengers all got off the plane and had to wait two hours for our luggage. The incompetence continued another 24 hours until I finally reached my destination. Additionally, China Southern’s food sucks.

    Warren Buffett doesn’t touch airline stocks, so I advise you not to touch this one. There are so many things that could crash this stock: higher oil prices, increased domestic competition, a recession that would slow business and tourist travel. There is little reason to expect a turnaround. The company's debt levels are out of control and set to get worse.

    2) E-House (China) Holdings Limited (NYSE:EJ) is a real estate services company. From 2005 through 2009 its revenue is up 700%. Although the stock has a solid P/E of 12, if there is a major disruption in housing activity in China, its revenues could easily shrink. It works through a number of subsidiaries, and doing this in China is notoriously hard because the hectic nature of the legal system and fraud at all levels of society. Also, this is one of the most overvalues Chinese ADRs in the housing sector.

    3) China Real Estate Information Company (NASDAQ:CRIC) is a subsidiary of E-House. It runs a database used in 56 cities all over China for finding information on parcels of land and existing developments. The stock trades at about $8 with 2009 earnings of .63 cents a share. However, in 2006 and 2007 the earnings per share were each only .03 cents! What is truly amazing about this stock is how gigantic the revenue growth has been in the past few years, from 2006 to 2009 revenue grew 1700%. If and when the Chinese real estate bubble does burst, its profits should really be eroded and its current earnings multiple of 14 be turned into 140. In case of a slow down, all the investments the corporation has made in anticipation of its next leap of 1700% will turn awry.

     BONUS: If you think that China real estate will go bust, short FXI, a China ETF. It is full of Chinese banks and financial institutions. It is the best way I have found to get access to Chinese banks, and on the reverse side, the best way to short them without flying to Hong Kong and opening a brokerage account!

    Disclosure: I am currently short ZNH, EJ, CRIC and FXI.
    Themes: China, Real Estate Stocks: ZNH, EJ, CRIC, FXI
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  • nicholas_du
    , contributor
    Comments (2) | Send Message
    I agree to some extent, ZNH is a risky stock if we take into account the high leverage of the business and vulnerability to the rising fuel costs etc. However, it's still very cheap from the valuation perspective. Their fwd P/E for 2010 in US market is around 11 while the fwd P/E ratios in China market and HK market are around 29 and 16 respectively. Plus the huge demand in China airline industry is expected to continue in next 3-5 yrs.
    8 Nov 2010, 10:09 AM Reply Like
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