Newsletter April 2005

Earnings Season is Over in China, too   Most Chinese companies, that are listed in the U.S. stock markets as American Depositary Receipts (ADR), reported 2004 fourth quarter and yearly results so far. To be actual, out of those thirty ADR that are listed either on the NYSE or NASDAQ  at present, twenty three reported earnings with mixed results. Investors have to realize though that good earnings are just half the success in emerging markets. The other half lies in market timing, as investors’ sentiment is very volatile. Concerns about inflation, high oil prices and interest rates contributed to significant outflows from emerging markets, lately. The Morgan Stanley Capital International emerging-markets index, which has been up 8% for the year three weeks ago, finished the quarter down 0.4%. Hardest hit were the internet and telecommunications-equipment sector. Still, short-term fluctuations should not deter intelligent investors from capitalizing on outstanding opportunities from the fastest-growing economy on the world. The wireless-internet sector in China has been extremely risky, and some investors still don’t touch it. However our finding is that three out of those four “strong buy” rated stocks we identified, are within the hard hit internet sector. Companies that processed natural resources seemed to enjoy a rally so far however mediocre operational efficiency coupled with increased competition is starting to dent into profits. What drives these stock still is that supply can hardly catch up with demand as China’s economy was growing at a robust 9.5% last year. And there are not much signs to slow despite efforts by the central government. After carefully analyzing and comparing stocks within the heavy industry, one petrochemical company sticks out. This petroleum and natural gas related company (name intentionally missing, please buy the Report separately) not only boosted its top line remarkably but, thanks to excellent internal measures, the bottom line looks even better. But the real bargain lies within the hard hit  internet sector. It was frustrating to see  Shanda or Ctrip to report great results only  to see their hefty gains in after-hours trading disintegrate on  the next day. Investors simply lost confidence in the sector in general after 51jobs mislead the investors community in January. Well, the good news is that it is paying for it dearly making other companies to think about it twice before attempting to do something similar. (see February Newsletter, article “Jobs Effect”) We believe that as soon as investors reverse course and start pumping money back to emerging markets, fund inflows will change trends very rapidly and those four letter names will be golden to hold. Not only are those high growth-rate companies poised to grow just because they operate in China where internet penetration is still low and raising, but on their own merit, too. Their operational efficiency is on he heels of the western counterparts as they are getting increasingly cash rich and ready to take over the smaller fish. For our biggest surprise we found that net income/employee or sales/employee ratios of the best Chinese internet firms are comparable to their western rivals in dollars, despite the existing huge purchasing power difference between the U.S. and China. We think that these well managed companies are remaining compelling growing leaders in the world’s most populous nation and the long term will reward the nimble grower. But make no mistake. Investing in China carries immense risk and investors should exercise extreme caution before doing so. Loss of principal is possible.     Full Throttle from Asia   I think we all got accustomed to reports like China’s GDP is growing at 9.5%, or that thanks to the central government’s efforts now it’s just 8.8%. But did we really thought about what does it mean? Mathematically speaking, China will double its GDP within ten years and will fourfold it within 17 years. And we could play with numbers more however the underlying point is that China is flexing its economic muscle and despite efforts to cool down the economy, there are no such signs. Couple of important facts. Shipping from Asia is expected to cost more thanks to the ever growing U.S. demand for manufactured goods and a shortage of containerships for the busy trans-Pacific lanes. In addition, many in the shipping industry expect a repeat of the congestion problems that delayed shipments through the busy Southern California ports for as much as a week last year. The Asia-to-U.S. trade represents the world’s biggest container-shipping market, carrying Asia-made goods such as fashion apparel, footwear, electronics and toys to American retailers. Based on current estimates, the Asia-to-U.S. container volumes will increase between 10% and 12% in 2005 from the previous year’s volume of 5.2 million 40-foot containers. Volume rose 14.4% in 2004 from 2003. There are other signs, too. The Wall Street Journal reports that Asian oil refiners are near full tilt as region hits 90% capacity utilization, adding likely strain on the world energy market. The oil-thirsty Asian nations are rapidly using up the excess refining capacity they built in the 1990s. Asia’s roughly 200 oil refineries now are operating at more than 90% of capacity, the first time the region hit that threshold since at least the 1980s, according to UBS AG analysts in Hong-Kong. Meanwhile, a new study by energy-consulting firm Wood Mackenzie of Scotland projects that a “significant deficit” of refined products will emerge in Asia in a few years if substantial new investments aren’t made soon. Our analysis supports the same findings, namely that Chinese petrochemicals like PetroChina (PTR) or Sinopec (SNP) and integrated oil companies like CNOOC (CEO), all reported record year in sales volume and profits. Besides oil related stocks, Chinese energy giant Huaneng Power Intl. (HNP) and Yanzhou Coal Mining (YZC) reported record financials, too. Investors have to look beyond internet portals in China. The internet sector have been extremely risky and some investors still don’t touch it. The main damper has been a crackdown by the Chinese governments on some of the industry’s less savory marketing and billing practices. This has dented profits at several mobile-content companies. And if it wasn’t enough, investors became extremely cautious after 51jobs Inc. (JOBS) mislead the investors community by misrepresenting financials. The loss of confidence took heavy toll on other internet stocks like Shanda Interative (SNDA) and Ctrip.com (CTRP) whose financials are very sound. Still, stock prices remain short-term disappointments and I recall it was frustrating to see Shanda to report great results only to see its hefty gains in after-hours trading disintegrate on the next day. But we don’t give up a dream that big. We believe the long-term will reward the nimble growers and intelligent investors will be able to benefit from the world’s most populous nation’s boom.   Who will fix the broken wings?   In our previous Newsletter in March, we highlighted two sectors to watch closely. First, the pharmaceutical sector is of our interest since we recommended than badly hurt Merck Co. (MRK) last December. We successfully estimated market turnaround was around the corner and those who followed our advice and bought it at $26-$28, are sitting on a 15%-20% gain since then. We are still bullish on Merck Co. and keep our price target somewhere the low $40s, based on valuation. But this time I want to spend more time on the other sector we recommended a month ago, the airlines industry. We all know that September 11 devastated the industry. Major carriers filed for bankruptcy and they are still on the brink. However, troubles can be good for smart investors. First of all, we don’t see much downside potential now that valuation is way down. United Airlines (UALAQ) is a penny stock now while Delta (DAL) is around $4 as we speak. Current market cap is about 1/100th of enterprise value. Second, recent reports showed that flight travel is back to prior 9/11 levels, causing travel delays and congestions. Airline service in general is getting worse because more people are flying at a time when carriers have slashed their workforces. We all can recall last year’s Christmas disaster when delays and cancellations inconvenienced more than 500,000 passengers. Regional carrier Comair cancelled all its flights during the holiday weekend while US Air’s baggage handling systems failed. Third, as airliners were chasing customers by cutting prices, increased price competition further deteriorated the battled industry. However, the ice is breaking as two major carriers, Continental (CAL) and Northwest Airlines (NWAC) announced price increase this year other expected to follow suit. And fourth, high crude prices resulted increased cost for the carriers. When Delta Airlines calculated that current kerosene prices will wipe out $3 billion from the books this year, bears took over and Delta lost 20% of its share price the same day. But as soon as nerves calmed down next day, the stock re-bounced ten percent and is still extremely volatile. At this point we see how sensitive the industry is to oil prices. Soon as futures spike, investors loose confidence and carriers fell. However this is the time to accumulate undervalued flagship carriers. We think Delta Airlines (DAL) and United Airlines (UALAQ) offers unparalleled opportunities for long-time investors. For medium-term investors JetBlue (JBLU) may suit better after it was once again ranked as offering the best service in an annual survey. To access latest Newsletter and other research content, please register!