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Newsletter: Earnings season is on. Investor, how are you doing?

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questionmark November, 2010 (Chinavestor) October was a banner month for Chinese stocks on the Mainland, sending the Shanghai Composite Index (SHA:000001) 12.7% higher for the month. The index is still in the red for the year as policy makers keep fiscal tightening measures and property curbs on the table to fight inflation and cool off the construction sector. The Hang Seng Index (INDEXHANGSENG:.HSI) advanced 3.3% in October, its second best performance for the year after a 6.4% surge in August.

Western investors with a China focus had a reason to cheer as well for the China ADR Index (CAI), compiled by Chinavestor, rose 3.6% in October. This gain for the month was the third best for the year after a strong March and April performance earlier this year. All this was supported by a sound performance of the Dow Jones Industrial Average (INDEXDJX:.DJI), recording a 2.6% rise at the same time.

Key stocks mentioned in this report include China Mobile (NYSE:CHL), China Telecom (NYSE:CHA) and China Unicom (NYSE:CHU) from the telecom sector. Internet stocks include Baidu.com Inc. (NASDAQ:BIDU) and Google Inc. (NASDAQ:GOOG) from the search engine part plus  Sohu.com Inc. (NASDAQ:SOHU) and Changyou.com (NASDAQ:CYOU). Key energy stocks are Petrochina Co. Ltd. (NYSEPOTR), CNOOC Ltd. (NYSE:CEO) and Sinopec (NYSE:SNP). Financial / insurance stocks include Wells Fargo (NYSE:WFC), Goldman Sachs (NYSE:GS) and China Life Insurance (NYSE:LFC). 

NSL_Nov2010_1

But investors are baffled going forward. Weak economic data in the U.S. on one hand and sound corporate earnings on the other. Key earnings from the tech sector, like Google Inc. (NASDAQA:GOOD) and Intel Corp. (NASDAQ:INTC), sent the NASDAQ on fire but the Dow Jones Industrial Average (INDEXDJX:.DJI) was kept at bay by lackluster performance of the financial sector.

China in no different either. Sound earnings can’t lift stocks while the government keeps rising interest rates and clamps down on the property market. Nevertheless the Shanghai Composite Index (SHA:000001) is now officially in bull territory after rallying 26.6% since July 3, 2010.

While there was not much support from the economic front, corporate news continues to shine for the most part from both sides of the Pacific. Large cap, major Chinese corporations have already reported for the third quarter in October, leaving room for smaller NASDAQ listings to follow in November. Strong GDP growth has been trickling down to the corporate level in China. Industrial and Commercial Bank of China (HKG:1398), the world’s largest lender by market cap, reported record quarterly profits of $6.27 billion for the quarter or $18.719 for the first three months. The company is on track to surpass record earning from last year. Bank of China (HKG:3988) is in a distant second position behind its domestic competitor but way ahead of Wells Fargo & Company (NYSE:WFC), the most profitable U.S. commercial bank.

NSL_Nov2010_2

Strong earnings growth is not limited to financials alone. Energy, transportation, internet and the telecom sectors all impressed investors. China’s oil triumvirate has already reported earnings, meeting or exceeding expectations. Petrochina Co. Ltd. (NYSEPTR), the largest Chinese oil producer with a significant oil refining capacity as well, beat expectations as oil prices for the quarter rose. The company reported net income of RMB37.4 billion ($5.1 billion), slightly above consensus estimates of RMB34.6 billion. Most of the increase is due to higher oil price, averaging $71.76/barrel from $49.15 same period last year. Considering that China’s economy is humming along at a comfortable 9.3% rate for the year, demand for energy remains solid, putting Petrochina Co. Ltd. (NYSE:PTR) in a comfortable position.

CNOOC Ltd. (NYSE:CEO), China’s off-shore oil specialist, reported strong revenue growth due to increase in production but provided no information on net income yet. Total production of oil and equivalents (mainly gas) reached 88.7 million barrels of oil equivalents (BOE), up 48.8% YoY. Most of the growth came from existing fields such as Bohai Bay, suggesting the company is well on target to reach production targets for FY2010. China Petroleum & Chemical Corp. (NYSE:SNP) or Sinopec, Asia’s largest refiner, reported sound results as well. The company reported net income of RMB19.621 billion ($2.67 billion), an increase of 14.8% YoY as refined gas output increased.

Net income growth for most Chinese energy firms suggests that the current pricing formula, determining gas prices at the pump, ensures fair profit for both oil producers and refiners at the same time. This is a fundamental change from the previous year when the high oil price helped oil producers but sent refiners way in the red or vice versa. Price and profit stability in the sector sends bullish signals for market participants for the sector.

The Chinese telecom sector is another place that has upside potential. Part of it is coming from lackluster stock price performance since early 2009, making select companies attractive on valuation. While U.S. and global indices recovered in 2009 and 2010, Chinese telecoms barely moved, except for China Telecom (NYSE:CHA). Investors should not miss that market leader China Mobile (NYSE:CHL) is trading about the same price as it was back in February 2009, while the company kept growing—albeit at a slow pace. Still the company has been the most profitable Chinese telecommunications firm, boasting more mobile subscribers than the sector combined. The company lined up more 3G users than either China Telecom (NYSE:CHA) or China Unicom (NYSE:CHU) did. Despite all the homework, investors shun China Mobile (NYSE:CHL) on slow earnings growth. The world’s largest mobile carrier reported net income of $13.89 billion for the first nine months of 2010, an increase of 3.9% YoY. This is slow compared to that of China Telecom (NYSE:CHA), a company that delivered 10.5% bottom line growth. But that’s from a much smaller base, as the top chart on the page testifies. China Unicom (NYSE:CHU) has just reported but fell short of expectations. Net income for the first nine months declined to $520 million from $1.48 billion a year ago.

NSL_Nov2010_3

Yet China Mobile (NYSE:CHL) and China Unicom (NYSE:CHU) are treated as equal, when it comes to stock price appreciation for the past 21 months. While I’m all for revenue and earnings growth, I think China Mobile (NYSE:CHL) deserves much better than the current stock price of $51/share. The company has an extremely healthy balance sheet, strong free cash flow and sound subscriber growth. Given that China has 1.3 billion inhabitants while total mobile subscribers are 815 million, there is room left for growth.

NSL_Nov2010_4

Disposable income is on the rise in China, evidenced by spurring transportation activity both in the air and on wheels. Both NYSE listed Chinese airliners reported extremely strong profit growth, but most of the gains are already incorporated in their prices. Consider this: earnings for China Southern Airlines (NYSE:ZNH), the largest carrier in China, grew tenfold! We’re well aware that some of it is due to a low base but when an industry leader surges, the rest follows.

When it comes to transportation, we like the following stock on valuation and growth. Guangshen Rail (NYSE:GSH), a railway company operating in the Pearl River delta region, reported 9.5% top line and 23.2% bottom line growth. With a high speed rail connecting Guangzhou to Wuhan, the company has the upper hand against domestic airliners like China Southern Airlines (NYSE:ZNH).

Yanzhou Coal Mining Co. (NYSE:YZC) reported blockbuster earnings growth topping forecast but most of the gains are already incorporated in the stock price. China Life Insurance (NYSE:LFC) lacked bottom line growth nevertheless the company is well positioned to churn out more profits from its substantial bond holdings should interest rates raise.

Most companies from the Chinese internet sector are going to report earnings in November, but what we’ve seen so far is very encouraging. Baidu.com Inc. (NASDAQ:BIDU) reported “triple play”, beating revenue and earnings estimates while guiding higher for the next quarter. The revenue & earnings growth chart above is here to justify that China’s search engine company is trading at over 100 times earnings.

BIDU_2010Q3_revearnings

Sohu.com Inc. (NASDAQ:SOHU) and its former online game unit, now independent, Changyou.com (NASDAQ:CYOU) reported in October. Both companies beat estimates and guided higher for the rest of the year. But here is the trick. While stock price of Sohu.com Inc. (NASDAQ:SOHU) has been following its earnings growth closely, there is a yawning gap between the two for Changyou.com (NASDAQ:CYOU). See widening gap between the red and yellow lines in the last chart of this page.

SOHU_2010Q3_revearnings

CYOU_2010Q3_revearnings

Arguing that Sohu.com Inc. (NASDAQ:SOHU) is more than just consolidating earnings from Changyouc.om (NASDAQ:CYOU) doesn’t make sense either for two reasons. For one, net income form online games grew faster than brand advertising and for two, online game was twice as profitable than brand advertising. Considering that Changyou.com (NASDAQ:CYOU) is trading half the valuation of Sohu.com (NASDAQ:SOHU), I think we have a gem here.

Blaze Fabry



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