4 Chinese Stocks Positioned for the Rebound

by: China Stock Guru

Last week I wrote about “Irrational Despair” causing panic in the markets. Stocks had been beaten mercilessly, regardless of the fundamentals. Maybe they were too high to begin with? Or maybe not. The point is that many stocks had declined precipitously on the back of unrelated negativity. They have since fallen further. And, as a result of the recent dramatic declines, there are amazing buying opportunities.

Let’s face it; there is plenty to be worried about. The US financial system is in turmoil. Credit markets are frozen solid and leveraged companies are justifiably panicked. However, the central banks are coming to the rescue and, while business will not return to prior levels for many years, liquidity will return to the marketplace. When it does, it will be too late; stocks will rally before things get better.

The question is how to position one's self for the inevitable rebound. The market will find stable footing, but it is doubtful that it will return to the highs for some time. The US is entering recession…tread lightly on anything exposed to the American consumer. Financial stocks will be a minefield and best to avoid the group unless you have insight into credit default swap exposure that I don’t have. Meanwhile, the US government is printing cash like there’s no tomorrow. The dollar will fall (maybe not against the Euro, but that’s another story).

My solution is simple: instead of placing bets in large cap US companies, look abroad for the next generation of leaders. I continue to believe that China has the cash, the people and the political motivation to remain the best investment opportunity for years to come. Companies with exposure to insulated areas such as the Chinese consumer and energy production will be the first to rebound when the market has ceased its decline.

In the past few months I have written about four companies: A-Power Energy (NASDAQ:APWR), Zhongpin (NASDAQ:HOGS), Jingwei (NASDAQ:JNGW) and China Precision Steel (NASDAQ:CPSL). From August 1st through October 9th these stocks have declined respectively; 82%, 41%, 38% and 50%. On the surface, this type of performance would lead one to believe these companies are on their way out of business. Nothing could be farther from the truth. Quite to the contrary, all of these companies have come out with positive news regarding earnings and state of their business. Nobody cares…Irrational Despair has taken over the trading in these stocks.

A-Power appears to be the best candidate for a tremendous rebound in this group. The stock’s decline borders on insane. The likely cause of the drop is found in the ownership filings: JLF Asset Management has a 10% position. Purely based on speculation, it seems quite possible they have been selling as this is a huge position for them and must be weighing on performance. Judging from the stock, it is certain that someone has been selling, and hard.

And that selling has created quite an opportunity. While APWR has trended down, business has remained strong. Last week the company announced a major contract and on October 10, management reiterated guidance. Guidance is for earnings of over $2 per share in 2009, making the forward P/E a meager 2.2x. I’m betting this stock hits $20 again sometime in 2009. Ten times earnings for a clean energy company focused on smog filled yet power hungry China seems very reasonable.

Zhongpin is another example of a stock going south while business keeps chugging along. With the Chinese consumer’s demand for pork ever increasing, and being a consolidator in the highly fragmented industry, HOGS is perfectly positioned. Don’t listen to me, however: management raised guidance last week. Zhongpin trades at around 6x 2008 estimates now but won’t for long.

Similarly beaten up is Jingwei. Like HOGS, Jingwei is a direct play on the increased strength of the Chinese consumer. The middle class in China numbers around 200 million and growing. Accessing this group is key for global consumer focused firms and Jingwei is the premier firm for this. While recent news for Jingwei has been lacking, recent insider buying suggests that business remains on pace. The P/E based on 2009 estimates is 3. Don’t expect to buy it at these levels for long.

Along with the rest of the market, steel stocks have been traded dramatically lower recently. Steel pricing has started a rapid decline, putting earnings at risk for the group. A global slowdown in demand is lurking and sellers have leaned all over the steel stocks, CPSL included. The selling of steel stocks is probably justified. The selling in CPSL is definitely not.

CPSL is a steel processor, not manufacturer. As a cold rolling processor, steel is the major component in their Cost of Goods. In other words, lower steel prices are positive for their margins! On their mid-September earnings conference call, after reporting record earnings, the company hinted towards better margins going forward. They also said that business was booked out three months in advance; the most in company’s history. CPSL is focused on import replacement and its final products are benefiting from the surge in the Chinese consumer. Yet, the stock continues to decline. Irrational Despair has taken over and, at 5 times trailing earnings, it has created a buying opportunity .

There are two common threads between the four stocks mentioned here: incredibly low valuations and zero correlation in their business to the US or European consumer. Markets always bottom and this current selloff, scary as it is, will end. When it does, the world will look different from before. Yesterday’s leaders might not regain that status for a long time, if ever. There is real and possibly permanent damage to the US financial system, real estate market, and consumer. Panic has overtaken rational thinking in the stock markets of the world. Do not let Irrational Despair drive your actions. Instead, look among the carnage for the few stocks whose fundamentals remain intact and where the best chance at upside resides. For those of us smart enough to play contrarian, a very profitable future awaits.

Disclosure: I own all four stocks mentioned in this article, and I am a "non-executive director" for China Precision Steel.