The Chinese Contagion - A New Flash Crash
Here's a revelation you probably never saw coming (notice I'm starting with the sarcasm early here...)...
I have a tendency to not only be a realist in my views but to do the exact opposite of what the majority of traders are doing. Notice I didn't say investors there? That's because people who are investing for the long-term aren't going to be swayed by garbage momentum plays, or bail from a company just because a competitor huffed and puffed and blew someone's house down within a sector.
Lately, there is absolutely nothing that a small or mid-cap Chinese company listed on the New York or Nasdaq stock exchanges can do to stabilize their stock price from hoardes and I mean hoardes of panic sellers. Short interest has been drastically climbing on these issues and in a few isolated cases we've seen press releases that have been so misconstrued or distorted that some of these companies have lost more than half of their value in the past three months. It doesn't matter what the underlying balance sheets or growth prospects are for these companies, or that the Chinese economic indicators are predicting 8.0%-8.4% growth in Chinese GDP in 2010 - traders (not investors) are out to get these Chinese issues and drive them down in a much more drawn out version of what I'd like to call, "The Chinese Flash Crash."
Now immediately I'm going to be slammed with the bad apples of the bunch that have caused some of this panic selling. Companies like Duoyuan Printing (DYP) today announced that it fired its independent auditor, Deloitte Touche and is practically doing a dice-game rearranging of its board of directors after speculation of possible misappropriation of third-party transactions. China Sky One Medical (CSKI) failed to provide any evidence last quarter that it's sales were slowing due to speculation that its over-the-counter herbal products could cause health hazards. Orient Paper (ONP) as well has been at the head of all speculation with a group of essentially college kids from Muddy Waters Inc. putting out a report "poo-pooing" Orient's cash flow stream and business model.
Well I have two revelations to make of this... 1) Boy have I been dead wrong about the entry prices of a few of these Chinese companies and 2) I don't care. Why? Because I make a living doing exactly the opposite of what traders do - it works for me and it CAN work for those of you who can see the logic and growth behind the panic. Am I saying that greed and corruption do not exist on some of these boards of directors? Not at all, in fact I mentioned in my "Time to Buy C.H.I.N.A." article that you have to be willing to accept these corporate hiccups now and then from Chinese companies, but you also have to be able to look past the panic and see the underlying value. I mean if someone would step in and save Sirius Satellite Radio it either proves the man upstairs hates me or there are some really terrible evaluators of business value out there (hooray sarcasm!).
So how do you approach investing in China? Well mainly by walking on water and dipping your toe in every now and then. Keep in mind that the majority of these companies, especially the one's which are already down 60% or more off of their highs have very limited downside left largely because of their amazingly cash-rich balance sheets. The huge profits made during the collapse in March of 2009 were made by taking bets on companies with a far, FAR greater chance of insolvency than I am seeing from these Chinese small and mid-cap stocks. Despite these scandals the prospects for solid growth remain and until proven otherwise you have to take the information from these balance sheets as accurate representations of the company, or you could even do what I do which is take those numbers, discount them slightly and run with that valuation (sort of a worst-case scenario).
Chinese companies are absolutely swimming in cash and they will either put that money to work in the form of stock buybacks or simply get taken out by larger competitors who value cash-rich, high growth entries into the Chinese market. Take for example the list below which lists the current price per share of a select group of Chinese companies in comparison to their net cash per share on hand. It's astounding just how much cash is sitting out there in the market right now.
Duoyuan Printing (DYP): Current price $2.99 / Net cash per share $2.51
HQ Sustainable Maritime (HQS): Current price $2.80 / Net cash per share $2.99
China Sky One Medical (CSKI): Current price $6.33 / Net cash per share $3.85
A-Power Generation Systems (APWR): Current price $6.59 / Net cash per share $1.35
SmartHeat (HEAT): Current price $6.35 / Net cash per share $0.95
Jiangbo Pharmaceuticals (JGBO): Current price $8.98 / Net cash per share $6.01
Fuqi International (FUQI): Current price $5.15 / Net cash per share $4.52
KongZhong Inc. (KONG): Current price $6.20 / Net cash per share $3.58
Lihua International (LIWA): Current price $8.05 / Net cash per share $2.95
That's just a small sample of the amount of cash outstanding out there. Now let's look at the projected three-year growth rates for a "few" Chinese small and mid caps...
Orient Paper (ONP): 37% 3-year growth rate / forward PE of appx. 4
SmartHeat (HEAT): 29% 3-year growth rate / forward PE of 7.16
Lihua International (LIWA): 47% 3-year growth rate / forward PE of 4.45
A-Power Generation (APWR): 34% 3-year growth rate / forward PE of 5.76
Harbin Electric (HRBN): 26% 3-year growth rate / forward PE of 5.12
Xinyuan Real Estate (XIN): 22% 3-year growth rate / forward PE of 2.82
Duoyuan Printing (DYP): 12% 3-year growth rate / forward PE of 2.40
China Security & Surveillance (CSR): 17% 3-year growth rate / forward PE of 4.57
China Sky One Medical (CSKI): 12% 3-year growth rate / forward PE of 2.34
China Valves Technology (CVVT): 23% 3-year growth rate / forward PE of 6.08
Advanced Battery Technologies (ABAT): 39% 3-year growth rate / forward PE of appx. 5.5
Andatee China Marine Fuel (AMCF): 10% 3-year growth rate / forward PE of 3.64
AgFeed Industries (FEED): 25% 3-year growth rate / forward PE of 7.27
Zhongpin Inc. (HOGS): 19% 3-year growth rate / forward PE of 7.46
China Fire & Security (CFSG): 20% 3-year growth rate / forward PE of 5.15
Telestone Technologies (TSTC): 40% 3-year growth rate / forward PE of 4.12
Biostar Pharmaceuticals (BSPM): 24% 3-year growth rate / forward PE of appx 4.5
CDC Software (CDCS): 9% 3-year growth rate / forward PE of 4.63
NIVs Intellimedia (NIV): 11% 3-year growth rate / forward PE of 3.00
China Marine Food Group (CMFO): 34% 3-year growth rate / forward PE of 5.15
HQ Sustainable Maritime (HQS): 13% 3-year growth rate / forward PE of 3.15
So again... with very low single digit forward price to earnings ratios, generally mid to high double digit 3-year growth rates, and boatloads of cash, why wouldn't you consider taking a risk in this area of growth and dabble a bit. I mean the probability that every single Chinese company is a fraud is infinitesimally small, so there are some clear winners in that group of companies above along with probably a loser or two. Dabble a bit here and there and you may have a shot to pick up Chinese companies at levels you thought you wouldn't see again after March 2009. You're getting a second chance at catching the panic selling knife in less than two years, don't mess it up!