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Monday, March 27, 2006

All China Stocks (China theme / China) 8 comments

Final Poll Results: 5:4

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.Evolution from quality to speculative

2.High valuations, with single-digit PE becoming a rarity

This is an irresistable situation and hence I will break from my tradition and highlight a sector/theme instead of an individual stock. The China rally that has started since Dec 2005 has lasted all of three months and has passed through different phases, with various market leaders emerging at each phase.

My opinion is that timing of the market, of a sector and of a stock are three completely different things. For the first, it is usually futile since macroeconomics is such a complex mix of various geographical, functional and political factors; economists have tried and failed for centuries, so why do we try? For the third, it is usually a matter of valuation and watching for turning points in the company's fortunes through news developments. However, for the second, the development of the theme through various phases, with a gradual decline in quality of market leaders, usually provides one with a good feel for when to exit.

And since there is no price/price index associated with China stocks, how will one be able to track my hot-stock-not call as opposed to previous stock calls which had prices that could allow yardstick comparison? Well, I believe it'll be obvious to all when the China play ends.

Let's watch the development of the China theme from December 2005, in roughly chronological order.

Stocks with strong newsflow: Celestial, Fung Choi
Given that confidence in China stocks have been low since the CAO scandal and a series of China IPOs that have turned out poor results post-IPO, it was natural that any interest had to start from stocks where newsflow was highly favourable and corroborated by institutional interest. Fung Choi's dynamic dealmaking (display advertising JV with leading PRC company, acquisitions of Flying Media and Rainbow China, tie-ups to print media for 2008 Olympic Games) gave a favourable impression of an expanding media company, further corroborated by its director taking Fung Choi shares in payment for Rainbow China which was previously under her --- that is a sign of confidence by insiders. As for Celestial, the turning point must be Mark Mobius of the renowned Templeton Funds taking a huge stake in the company at ~40-50 cents -- a sign that its huge soybean zone project holds huge promise in the long-term.

China domestic consumption: China Hongxing, Beauty China, Sunray, Hongguo
China Hongxing has not taken a breather in its upward rise since its IPO at 40 cents in Nov 05; it is now at three times that price. Beauty China has rallied to near 90 cents, Sunray and Hongguo have doubled from their price in December. These key representative stocks of the domestic consumption theme have strong niches, branding and substantial revenue base, hence when interest began shifting from China outsourcing plays to China domestic consumption plays, they became key beneficiaries.

Bargains by comparative valuations: China Sun, China Paper
In a bull market, people become receptive to the idea that valuations for stocks should somehow approximately arbitrage across borders; thus it helps SGX stocks especially if they have counterparts in the more highly valued Hong Kong market. Hence China Sun has been re-rated closer to corn starch processor counterparts on the Hong Kong market, as has China Paper (in response to a strong Nine Dragons IPO on the HKEx). China Hongxing, of course, also benefits from this due to its favourable comparison valuation-wise with the exorbitant (30X PE) Li Ning on the HKEx.

IPOs: China Fishery, Luzhou Biochem, China Milk
When IPOs gap up on the first day of trading, it is time to set off alarm bells inside the investor's head. Most well-known of course is China Fishery, but the latter two have also exhibited >70-100% price gains within one week of their IPO (believe Luzhou doubled over its IPO price on its first day of trading). If the owners have spent their lives building up the company, they would have ensured fair IPO valuations because effectively they are selling away part of their company; so is there any fundamental justification for the price doubling over what the owners considered fair value??

Inferiors/Laggards: Zhongguo Jilong, China Infrastructure, China Great Land
Recently in these two weeks, we are seeing the emergence of China laggards. I choose to highlight three stocks that have come into prominence today: Zhongguo Jilong, which saw FY05 profit fall 40-50% over FY04; China Infrastructure, a micro-cap stock; China Great Land, whose CEO resigned recently on a staggering 90% collapse in profits. The previous week saw rotational play in Hongwei and CG Tech (laggards to China Sky & Fibrechem), Star Pharmaceuticals (micro-revenues), China Fashion (FY05 profits dropped >30%).

Drawing parallels between my observations in early 2004 and the current situation, I would feel really cautious about putting any new money in China stocks. I struggled to find single-digit (trailing) PE stocks in early 2004; it seemed that all such stocks had been bid up. In this current market, I am finding a similar situation for China-themed stocks, even IPOs which I have always believed should be accorded risk premiums given their lack of a track record. You will find that most of the stocks in the first few categories above are above 10X, or even 15X trailing PE, and that is based on the latest FY05 results just recently, in Feb/Mar 06! If the brokers want to extend this rally, they will base target prices based on projected FY07 earnings which is so far away.

You may want to note that despite all my talk above, I still have some money in China stocks in my portfolio. Obviously, one has to manage potential returns with perceived risk, and the uptrend for China stocks has been so strong that one should capitalise on it rather than just quit because of principles or doubts about general valuations. What I feel is that one should be more selective and exercise prudence in asset allocation, as the abovementioned China theme play seems to be developing into lower quality rotational plays.

(1) Share Investment: Mar 2006




Anonymous Anonymous said...

i agree.

very hot!!!

4/01/2006 8:14 PM  
Blogger Gallen said...

Hi Daniel, very insightful summary, cheers! Enjoy your sunday

4/02/2006 1:21 PM  
Anonymous Anonymous said...

Mr XX - on the other channel you said "may as well run with these and see how high they go"

What is your real position?


4/04/2006 2:00 PM  
Blogger DanielXX said...

Very simple: if you are vested, let the profits run. If you are not, don't buy in blindly because sentiment towards this sector has been bubbling. Position a portion of your assets in these stocks --- you never know where the turning point is --- but don't throw everything and the kitchen sink into China stocks. The keyword (or rather, keyphrase) here is "asset allocation".

4/04/2006 10:14 PM  
Anonymous Anonymous said...

Thanks for your comments - but I've always had a bit of a problem with the notion that you should let your profits run if you are vested, but not get in otherwise. The cost of one set of commissions does not seem really to justify this stance. If stocks are in a general way too highly priced, then sell, if too lowly priced then buy, regardless of whether one is vested or not.

Lastly, your point about asset allocation. Yes ... true ... but despite such received wisdom all my stocks are China stocks right now. If they drop again as in the past, well I can stomach that, but who is to say how high is up. I was so close to buying Celestial at 18c (foolishly wanted it to drop to 16c) - look at it now!

4/05/2006 6:57 PM  
Blogger DanielXX said...

Hi anonymous,
I know what you mean on the first point. It is analogous to saying that if a stock that you hold wouldn't be one that you would buy if you were not vested, then logically you should sell. Frankly, there is no right answer. It's just that a buyer tends to be brimming with enthusiasm, and will have to tune himself to enough pessimism to make a sell --- that may be psychologically difficult to do. I may perhaps not have reached that stage where my psychological makeup can treat a buy and a hold the same way emotionally. And indeed, in this period of increasing volatility in China stocks, that may be an important quality many (including me) may not have. Hence the circumstances play a part.

If you keep all China stocks in your portfolio, then good luck. It is akin to the punter who throws his whole fortune at one turn of the roulette wheel --- you either hit it big, or you lose without any chance to recover. That is about as blunt as I can get.

4/05/2006 11:39 PM  
Anonymous Anonymous said...

"If you keep all China stocks in your portfolio, then good luck. It is akin to the punter who throws his whole fortune at one turn of the roulette wheel --- you either hit it big, or you lose without any chance to recover. That is about as blunt as I can get".

Well of course I can't deny the commonsense of this - but I am a foreign investor who is specifically trying to ride the China boom over the next 10 or more years. I am presently too scared to invest in the China stockmarkets themselves, but the Singapore and Hong Kong markets seem to give one the opportunity to get a degree of "insider running". Added to that the valuations in many cases are cheap. If one can find companies with competitive advantage, I think the profits could be large. I note Jim Rogers likens China to the US at the start of the last century. To have invested in the Dow at the start of the last century was a recipe for handsome profits. Sure there is risk, but life is risk. I am happy with my choice (although the last two or three years have been quite a hard haul).

4/06/2006 11:58 AM  
Blogger DanielXX said...

Yes, you would have made good money. :-) Extending on my analogy of the roulette wheel, some also say that the best way to play the casino is actually to stake all the money in one bet, because that eliminates the house odds (in the long term, the punter always loses). So there's a flip side to everything.

Good luck and great discussion!


4/06/2006 12:36 PM  

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