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Internet stocks brighten earnings season

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NASDAQ_1 March 2011 (Chinavestor) We said last month that the central theme for 2011 is going to be economic growth and inflation. “This is my story and I’m sticking to it” as the saying goes. We have no reason to alter our opinion going forward.

Feateured Chinese stocks in this Newsletter include search engine giant Inc. ((NASDAQ:BIDU), online gamer Inc. (NASDAQ:NTES) and Shanda InteractiveWebportal Sina Corp. (NASDAQ:SINA) and 51job Inc. (NASDAQ:JOBS) complete the NASDAQ list this time. China Life Insurance (NYSE:LFC) and Mindray Medical (MR) are the most important NYSE listing in this issue. (NASDAQ:SNDA).

The Shanghai Composite Index (SHA:000001) advanced 4.1% in February but it is still in the red for the past 52 weeks. This is in sharp contrast to the Dow Jones Industrial Average (INDEXDJX:.DJI), the most followed U.S. index, which advanced 16% for the same period and has outperformed every major Chinese index for the year.

Investors in Hong Kong got spooked by the unrest in the Middle East and sold off Chinese shares for most of the month, sending the Hang Seng Index (INDEXHANGSENG:.HSI) 0.5 percent lower in February. While corporate earnings suggest Chinese H-shares, equities listed in Hong Kong, are trading at a discount, investors have little appetite for downside risk. This is evidenced by a record gold prices, a metal seen as a safe haven in times of uncertainty.


Sluggish investor sentiment in Hong Kong hurt Chinese ADR trading as well. Most U.S. listed large cap Chinese ADRs look at Hong Kong for direction. The China ADR Index, a market cap weighted proxy measuring the performance of Chinese ADRs on the NYSE and NASDAQ, fell 1.0 percent in February, a clear reflection of weak market sentiment in Hong Kong.

Another worrisome development is the high price of oil, reaching $100/barrel by the end of the month. High oil prices may hurt economic growth FED Chairman Ben Bernanke told the lawmakers on the Capitol Hill just yesterday.

A high oil price may hurt growth in developed countries but there is more damage that it can do in the rest of the world. High gasoline prices are certainly fueling inflation in China where the food price increase is one of the biggest challenges policy makers have to overcome. As the following chart reflects, the food price increase has been the major cause of inflation in China since measurements began in 2005.


Increasing food prices have been a two edged sword in China in the past. Higher food prices meant more disposable income for farmers, a development Chinese policy makers welcome. This is perfectly in line with spreading wealth to the rural west, another top priority for Chinese policy makers.

But too much of a good thing can be a curse, as high food prices may ferment social unrest. This is something Beijing can’t tolerate on the eve of Mid-Eastern developments. For this reason fiscal tightening is the more likely scenario going forward. This in turn suggests that Chinese equities will be under pressure. Financial and related stocks are expected to be hit the hardest.

With no Chinese financial institution listed on the NYSE or NASDAQ, U.S. investors don’t have to be stock specific. But the iShares FTSE/Xinhua China 25 Index (NYSE:FXI), the most liquid Chinese ETF, is financial heavy weighted as the chart on the bottom of the page testifies. This in turn suggests upside potential is going to be limited for the most popular Chinese ETF going forward.


China Life Insurance Co. (NYSE:LFC), the largest Chinese life insurer, is another investment opportunity we suggest to shun in 2011. China Life Insurance (NYSE:LFC) derives approximately 16% of its net income from investment related activities, tied to the performance of the Shanghai Composite Index (SHA:000001). For this reason China Life Insurance (NYSE:LFC) is going to feel the pinch directly from the monetary tightening.

But opportunities always exist and we’re here to find them.

Anyone who has recently come back from China knows that there are no signs of global recession or economic slowdown there. With an over 10% GDP growth over the past two years, the time developed economies were hit the hardest, economic activity is as buoyant as ever.

Chinese internet stocks remain prime investment targets for western investors for a good reason. Besides stable revenue and earnings growth, these companies bring to the table what most small cap Chinese stocks can’t: corporate governance. Large internet stocks have long stock market histories and are transparent thanks to big four quality auditors. Growth potential remains lucrative. With over 500 million internet users, China is the largest market in the world, yet there is room left for growth thanks to the population of over 1.3 billion.

We detailed our assessment of Inc. (NASDAQ:SOHU) and her former online game unit, now independent Inc. (NASDAQ:CYOU).

This time we highlight Inc., China’s dominant search engine company along with Sina Corp. (NASDAQ:SINA), Shanda Interactive (NASDAQ:SNDA) and Inc. (NASDAQ:NTES).

BIDU_revearnings_2010Q4 Inc. (NASDAQ:BIDU) is not only the largest Chinese search engine company but one of the best run Chinese company as well. The company has been delivering constant revenue and earnings growth for over 5 years, increasing its market share in all internet searches to over 75% in 2011.



Another company we liked and continue to promote is Inc. (NASDAQ:NTES). The company has been a frequent name in the weekly stock recommendation list as well as in the growth portfolio. The company reported a record fourth quarter and issued guidance above analyst estimates, jumping to an all time high of $48 at the open. Inc. (NASDAQ:NTES) has become the largest and most profitable online game developer and operator since 2008, dethroning Shanda Interactive (NASDAQ:SNDA).


Continuing the line of thought, Sina Corp. (NASDAQ:SINA) is another stock we’ve been following very closely. The problem is that 2010 Q4 numbers are awful at the first sight and our assessment doesn’t improve much after giving this company a second look. Sina’s numbers were spiked in the fourth quarter in 2009 on a one-time gain following the sale of its real estate unit. This time of the year it just wrote off a real estate company related investment of $100 million, sending its bottom line to the red. But what’s really troublesome besides this one time gain in 2009 and write-off in 2010 is the lack of earnings growth while the stock price has substantially appreciated over the last six months. This in turn suggests that Sina cORP. (NASDAQ:SINA) is about to face a correction more than just the 5% loss it suffered following the earnings announcement.


51job Inc. (NASDAQ:JOBS) is another highly liquid internet stock that reported earnings in February. Investors have to remember that this stock, along with Spreadtrum Communications (NASDAQ:SPRD), were the best performing Chinese ADRs in 2010, delivering over a 200% return! So the stakes were high for the online recruiter and the company didn’t disappoint. Revenues and earnings all came out to a record and 51job Inc. (NASDAQ:JOBS) issued a bullish outlook on top of sound results. But the stock price didn’t budge, which many attribute to the already high stock price. Nevertheless this company has more upside potential for the online recruiting arm has been growing steadily, overtaking print advertisement.


Another stock we keep a close eye on is Mindray Medical (NYSE:MR). We have been following this Chinese medical equipment maker for a long time and added it to the Conservative portfolio for February. The company reported a record year with a strong fourth quarter, yet its stock price failed to gain much traction. The good news is that this just creates an opportunity for the intelligent value investor. As the bottom chart on this page testifies, the current stock price of $27.18 is essentially the same as it was 5 years ago. Yet revenues and net income more than tripled during the same time.

It is too early to tell if Mindray Medical (NYSE:MR) is going to play catch up with earnings like 51job Inc. (NASDAQ:JOBS) did, but one thing is for sure: this company is offering long term potential.

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