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September 2009 Newsletter: Earnings Season is Over, New Opportunities Lay Ahead

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cash2(Sept. 1, 2009 - Chinavestor) What a difference a month makes! The previous issue just said: “July turned out to be the best month of 2009 for investors globally”. Looking at Chinese stocks in August, this was the simple worst month in 2009. And while Chinese shares spilled blood, the DJIA advanced to 2009 highs contradicting previous trends that these markets move in tandem, or show at least some sort of correlation.

So what happened? Strong corporate earnings and better then expected housing reports continued to fuel American stocks to new highs in 2009. The DJIA advanced 3.5% in August and is now up 8.2% for the year.


But China was remarkably different. Weak corporate earnings, or at least not as strong as the market anticipated, put pressure on stocks in the first place. Disappointing earnings growth came at a time of a market peak, a time when the Shanghai Composite advanced well over 80% for the year, earlier in August. The Shanghai Composite was the best performing major global index in 2009, ready for a correction. With an over 20% drop in August, the index entered a bear market, something that skeptics like to point out. But we’ve been around long enough to know that a healthy market correction is beneficial and necessary. There is nothing wrong with a 46.5% performance YTD.



Unfortunate for the Chinese,  a large number of retail investors, e.g. individuals, flocked the market in June-July on hopes of easy profits. The number of new brokerage accounts grew five fold during that period compared to January 2009. But uneducated investors are prone to follow the crowd and this herd behavior is partially to blame for such a swift correction. The sad thing is that retail investors came at the worst possible time: at the height of the rally and right before earnings season.

Ultimately, it was earnings that moved stocks the most. All NYSE listed China heavy weight stocks reported earnings with some notable disappointments.

Take a look at Aluminum Corp. of China (NYSE:ACH) for example. The largest alumina and aluminum maker in China reported further deterioration in revenues and earnings despite a pick up in economic activity in China. Another bellwether company for the non-ferrous metal sector, Jiangxi Copper reported dismal 2009 second quarter earnings, raising doubts about the profitability of the sector. But this is what creates opportunity for the seasoned investor. As the Primary Aluminum Price Graph testifies, the price of aluminum has picked up 45% since hitting bottom earlier in February. This in turn means higher profitability for aluminum makers, something that I expect to materialize in the upcoming quarters.


I called Aluminum Corp. of China (NYSE:ACH) a “steal”  last October when shares of the company were trading below $10. Now that ACH is trading below $30 the “steal” argument is not valid but I see further upside potential for the stock. But this is contingent upon global economic recovery. If recovery, even gradual, will continue, commodity prices are expected to firm up, keeping Aluminum Corp. of China’s profit margins high. Another factor that is overlooked is the unfortunate disaster at the Sayano-Shushenskaya hydropower station in Russia in August. Since this is the largest Russian hydroelectric station right next to a major aluminum smelter, the impact on production will be substantial.

Moving on to the solar sector, I see some companies presenting excellent bottom fishing opportunities. Remember, Chinese solar stocks reported disastrous revenues and earnings, sending the sector tumbling, again. But outlook is not as bad when the price of oil keeps hovering around $70/barrel. In a distressed industry like this, I like to stick with industry leaders like Suntech Power (NYSE:STP) and LDK Solar (NYSE:LDK). It looks like that Suntech (NYSE:STP) under $15 and LDK Solar (NYSE:LDK) under $10 are steals.

Solarfun Holdings (NASDAQ:SOLF) has been on the top of the most oversold stock list for weeks, but I don’t think it qualifies the stock to be a buy. I see this company instead  as a possible victim of a consolidation within the industry.

Another field that moves investors is the Chinese online game industry. This industry generates the most revenue and profit online, surpassing that of online advertizing in China. Inc. (NASDAQ:NTES), one of the industry leaders, fell 10% on August 12 following not strong enough quarterly earnings. The stock fell despite record revenues and improved profits. But the stock became too expensive after its price ran up over 100% in 2009 before earnings. Looking at NetEase’s archrival, Shanda Interactive (NASDAQ:SNDA), I see some upside potential here. Shanda Interactive (NASDAQ:SNDA) is up 51% YTD compared to NetEase’s 90% gain. If Shanda can report something similar to that of NetEase, e.g. strong revenues and improved profits, a 10%-20% upside is certainly in the cards. Shanda will report on September 3.

Another important field that investors pay attention to is the Chinese telecom sector. All three major carriers reported 2009 first six month interim results at the end of August, making a case for a transparent comparison.

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China Telecom (NYSE:CHA) reported the highest percentage growth in subscriber numbers, but the company started out from a low basis. Yet its net addition of 11.37 million new subscribers in the first six months of 2009 surpasses China Unicom’s (NYSE:CHU) 7.01 million. But China Mobile (NYSE:CHL) strengthened its position by adding 35.87 million new subscribers.

China Mobile (CHL) and China Telecom (CHA) reported total revenue growth but slower growth took a toll on China Unicom.

But when it comes to earnings, China Mobile (CHL) is the only one that reported net income growth while her smaller rivals struggled with high operating costs and lower consumer spending.

This is a strong case for China Mobile (NYSE:CHL) and despite current weaknesses, China Mobile is expected to outperform smaller rivals in the long run. There is some  merit to the strength of China Telecom‘s (CHA)  3G business but that segment alone can’t make up for other deficiencies of the company.

I see some opportunities by moving over to the Chinese oil industry. I say this being fully aware that this industry is difficult to time right due to two major factors: the fluctuation of crude oil price and the changes in the regulatory environment in China.

But despite all challenges, CNOOC Ltd. (NYSE:CEO) looks to be a good company to invest in at this moment for the following reasons. CNOOC Ltd. (NYSE:CEO) is the only Chinese oil major that could increase oil production in the first six months of 2009. More importantly, the increase in production looks sustainable since most of he increase came from underdeveloped foreign fields in Nigeria and Indonesia.


The other upshot for CNOOC Ltd. is that is has negligible refining capacity, an industry whose profitability is subject to wide fluctuations.

Chinese regulators are constantly updating the formula calculating domestic gasoline prices with focus on domestic price stability. This in turn leaves Chinese refiners in the cold when the price of oil hits highs, see 2008, but showers them with profits when price of oil is low.  So record profit growth of 338% for Sinopec (NYSE:SNP) is not a result of more efficient operation but rather a result of a low crude price in 2009 H1. This in turn throws sustainable profit growth out the window for Sinopec.

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But as long as oil stays around $70/barrel, expect CNOOC Ltd. (CEO) to report a blockbuster 2009 Q3.

Blaze Fabry

PS I: October Newsletter will be posted on the website on October 1st.

PS II: For updates to the Conservative and Growth Portfolios, you have to become aSubscriber. Hint: Chinavestor Conservative portfolios are up 46.4% YTD followed by a 44.5% performance by our Growth portfolios.

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