Investing in China has not been for the faint of heart. Shares of major companies have surged and fallen in repeating cycles during the past few years. But take a step back and note that China's economic growth has only been going one way — up. China has had a remarkable run and years of robust economic growth have enabled it to move into the top tier of global economies in terms of GDP.
Thanks to the laws of bigness, China's future economic growth is unlikely to be as impressive. But thanks to very heavy investments in infrastructure, China is now well-equipped to handle a sustained period of solid economic growth — perhaps in the +4% to +5% range. That's a rate that we here in the United States can only envy.
The key then is to not simply focus on Chinese stocks that are doing great right now, but instead look for Chinese companies that stand to do well over time — that means companies focused on China's emerging middle class. As the ranks of the Chinese middle class swell, look for growing spending on health care, retail goods and tourism, along with sustained advances in agricultural yields and energy efficiency.
Ctrip.com (Nasdaq: CTRP)
With rising disposable income comes the urge to travel, and Chinese citizens are increasingly venturing out, either elsewhere in China or throughout Asia. And they're increasingly using the Internet to research and book flights and hotels. But this is not yet a mature business. Less than 30% of the Chinese population is currently online, compared to more than 70% in countries such as Korea, Japan and Singapore, according to global communications firm Fleishmann-Hillard.
How large is the potential travel market? During the late September/early October holidays, roughly 200 million Chinese are expected to hit the road (mostly to go back to their home region). That's nearly the entire population of the United States. And according to analysts at Brean Murray, 10% of Chinese travelers now use the Internet to arrange travel plans — roughly 20 million people. That figure is expected to rise to 60 million in 10 years.
Ctrip.com is seen as the best pure play in the online booking space (along the lines of Expedia (Nasdaq: EXPE)), and has considerable brand recognition in this fast-growing area. Web portal Taobao.com has vowed to overtake Ctrip.com eventually, but there's ample room for both of these firms to flourish.
As for major hotel chains, Home Inns & Hotels (Nasdaq: HMIN) has established a national network of lodgings, along the lines of Holiday Inn or Best Western. China Lodging (Nasdaq: HTHT) has similarly built an impressive national footprint. However, both of these stocks are awfully expensive based on trailing and current earnings. This is a case where it may be wise to wait for a pullback, so you may want to put these names on your watch list.
The ad market builds
Chinese consumers are bombarded with advertising pitches at every turn. But companies are realizing that the scatter-shot approach isn't helping to truly establish brands in consumers' minds, so they are turning to specialized agencies that have more targeted ad campaigns tied in across several types of media. Sina.com (Nasdaq: SINA) has emerged as a leader in the space. The company's range of tools, both offline and offline, are considered to be very innovative, which has enabled Sina.com to quickly build a large base of Chinese and foreign clients that are looking to get a foothold in China.
The market for Sina.com's services slowed earlier this year, and sales growth is expected to cool to about +10% in 2010. But recent results have been much more encouraging, leading analysts to expect a +20% rebound in sales next year. Over the long haul, investors should expect solid +10% top-line growth and more impressive bottom-line results.
Deer Consumer Products (Nasdaq: DEER)
I've written about this company several times before, noting that it is morphing from a supplier of global kitchen appliance firms into a solid brand in its own right in China. Growth has ranged from steady to spectacular: sales are likely to double this year and grow another +25% in 2011. Longer-term, sales growth is likely to moderate in step with China's decelerating GDP growth.
Shares of Deer hit almost $18 last fall and can now be had for less than $10, even as earnings per share (EPS) estimates have steadily risen during that time frame. The company's balance sheet is helping to support shares, as management has recently announced a series of stock buybacks. This is a solid, unsexy play on the Chinese consumer.
Cars, cars and more cars
Chinese consumers have quickly grown to love their cars. And the nascent Chinese auto industry aims to capitalize on that demand and also eventually export to other markets — if quality standards can be boosted. It's hard to find U.S.-traded shares of any Chinese auto makers, but Wonder Auto Group (Nasdaq: WATG) is a backdoor play, providing a wide range of auto parts to the big auto makers. The company makes everything from alternators to seat belts to airbags. And as is the case with Deer Consumer Products, exports are also part of the picture, which explains why the auto parts sector has been growing even faster than the auto sector itself.
China's water woes have been widely chronicled. The country's pro-industrial policies led to epidemic levels of pollutants being dumped into the country's major waterways. Regulatory efforts are finally starting to take root, but it will be many years before the water from major rivers is truly potable. But China is aggressively building filtration plants to at least clean up the dirty water so it is fit for consumption. The Chinese government is increasingly turning to companies like Duoyuan Global Water (NYSE: DGW). This company makes a range of filtration products, water softeners and ultra-violet sterilization equipment.
Shares plunged more than -40% on September 13 when Duoyuan Printing (NYSE: DYP) owned up to some accounting problems. The two companies are unrelated except that they have the same Chairman. As of now, Duoyuan Global Water simply looks guilty by association. If the company can avoid accounting troubles in coming months and auditors continue to give it a clean bill of health, shares should move back up off current lows. More importantly, the company's products should see considerable demand for the foreseeable future.
Action to Take –> These are just a few of the stocks that investors looking at China should be researching. In many respects, the theme is even more important than specific stock selection. China's economy has become too large to ignore, and many China-focused companies will see a very long period of sales and profit growth.
– David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…
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5 Chinese Stocks with Unlimited Potential