March 27, 2010
Zack Buckley is CEO of Uncoveringalpha.com. He developed his investing methodology by synthesizing the ideas from the best investors of all time, based on their track record. This led him to closely follow Warren Buffett, Peter Lynch, George Soros, Seth Klarman and Benjamin Graham. Using a value approach, he pursued the most undervalued companies he could find, which led primarily to companies in China. Buckley will be spending three months this year in China visiting companies that are exciting investment opportunities. Follow him on his blog, Uncoveringalpha.com, as he travels across China touring factories and interviewing management.
PART I
When shopping in the supermarket, shoppers always flock to the half off sales. In the stock market, a half off sale creates worldwide panic. Although these circumstances are actually exceptional for long term investors, most people fear the world is ending. I welcome half off sales in the stock market because they are a great way to build long term wealth.
The Chinese pharmaceutical industry presents multiple bargains for value investors. Pharmaceuticals sales in China have been growing at a rate of 15.5% annually from 2005-2010. There is a strong demand for pharmaceutical products in China due to growing income, a larger middle class, and a rapidly aging population. The elderly population in China grew from 130 million in 2000 to 171 million in 2010. Healthcare spending by the elderly is 5 times higher.
In addition the government has made healthcare one of its primary initiatives; as a result, a Universal Health plan package geared to deliver $123 billion in the next three years has been issued.
The industry is rapidly consolidating, where the market leaders are rapidly growing in value. Characteristics of future markets leaders are
1. A strong nationwide sales and distribution network
2. Strong research and development capabilities
3. Access to capital in order to expand
While some companies trade with P/E ratios as high as 63, Lotus pharmaceuticals has a P/E of only 5.12. You would expect a low P/E to be indicative of a stalwart company. However, Lotus Pharmaceuticals grew revenues at 59% from 2005-2008 and has net income up 700% since 2005. Lotus Pharmaceuticals revenue streams are a combination of pharmaceuticals wholesaling and the development and sale of proprietary drugs. Their primary growth strategies are expanding their distribution sales channels in order to increase sales, expanding production capacity through the building of a large factory, and bringing new drugs to the market by partnering with top R&D institutions. We believe a company this cheap should not be overlooked. In summary, lotus is a comprehensive company with both strong manufacturing capability and a nationwide distribution network, great R&D capabilities with a new drug pipeline including a Class I drug, and a very attractive valuation.
China Medicine Corporation (CHME) has a current P/E ratio of 5.91 and P/S of .69. The company is rapidly growing and has developed a proprietary product rADTZ, which is made to decrease animal mortality rates by fighting Aflatoxins, should substantially enhance revenues. They estimate the addressable market for rADTZ is up to $4 billion and that the successful commercialization and licensing of rADTZ has the potential to substantially improve revenue and profit picture in the years to come. Their distribution consists of 300 hospitals and 500 other medical companies, which leads to 2000 drug stores. Revenues are up to 53 million in 2008 from 15 million in 2005. A company like this is extremely cheap. A comparable company is 3sBio, which has a P/E of 22 and a P/S of 3.96. China medicine is much cheaper than 3sBio with better return on equity and profit margins.
China Yongxin CYXN has a current P/E ratio of 4.9 and a P/S ratio of .25. The company has three divisions, they run 93 retail drugstores in China, similar to Walgreens, they are a distributor of pharmaceutical products, and they have their own proprietary ginseng products. The company’s products are Chinese traditional medicines, chemical pharmaceuticals preparations, flower teas, natural health products, healthy food, cosmetics, and medical equipment. CYXN will focus on expanding its retail chain across China. The company has continued to grow its wholesale business and is moving to expand the higher margin retail and manufacturing activities in the pharmaceutical business. Management also plans to eventually uplist, once the company qualifies.
| Symbol | Mkt Cap | P/E | Price/Sales | Rev growth CAGR % 2007-08 | Net income CAGR Growth %, 2007-08 |
| CYXN | 20.20 | 5.00 | .33 | 23% | 13% |
| NPD | 705.60 | 25.00 | 2.00 | 22% | 30% |
| LTUS | 65.58 | 5.12 | .96 | 51% | 11% |
| CHME | 53.93 | 5.91 | 1.00 | 27% | 33% |
| SSRX | 239.94 | 24.03 | .99 | 35% | -23% |
It is clear that these are three great bargains in the Chinese pharmaceuticals industry. I have a hard time believing markets are efficient when I look at these companies. These companies seem to be trading well below their intrinsic values, although I reserve the right to be wrong. In fact, I have founds tons of undervalued Chinese ADRs. That is why I am going to China this summer to visit as many publicly traded companies as I can fit into two and a half months. In the past three years on their trips to China, The Motley Fool researchers have identified companies that are now all up between 100-500% since their recommendations, I hope to do the same.
PART II
There has been much debate recently as to the future of the Chinese economy. Famous hedge fund manager Jim Chanos has publicly come out saying he will short the Chinese economy. While I believe the Chinese real estate market and domestic stock market are overvalued, I think the Chinese companies trading on the U.S. exchanges are screaming buys! Buffett talked about feeling like “an oversexed man in a brothel” in the mid 1970’s because he was so excited about the cheap prices in U.S. stocks, I feel the same about stocks in China right now. No one can predict market fluctuations; I just buy when stocks are trading at a huge discount to their intrinsic value. While I am not sure of the future in the markets in the next year or even two years, I am certain that these companies are exceptional buys for the long term investor.
As I discussed in my previous article, leaders in the pharmaceutical industry have a similar winning business model: a strong nationwide sales and distribution network, strong research and development capabilities and access to capital.
Skystar Biopharmaceuticals appears to be the perfect Buffett-like company. They have a sustainable competitive advantage with little competition in the veterinary health industry. They are currently the only large corporation in this field that is not a state owned enterprise. Skystar also has two important Buffett traits, a high Return on equity and high profit margins of 55% and 42% respectively. This shows that they are not in a heavily competitive industry; profit margins and ROE are low in competitive industries. Skystar has a P/E of 5.96 while it has grown revenue from 6 million in 2005 to 26 million in 2008, and will have substantial revenue growth in fiscal 2009, with estimates between 44-46 million. Skystar also has a strong balance sheet with no long term debt.
Biostar pharmaceuticals is poised for exceptionally strong growth over the next year. They are expanding their sales outlets from 3,512 to 10,000 sales outlets by the end of 2010!! If they reach their estimates, they will have net income growth of at least 100% in fiscal 2009. Biostar’s most important drug, the Xin Aoxing Capsule, used for the treatment of Hepatitis B, has a near monopoly. The drug is the only OTC approved drug of its kind in China, and has 93% efficacy with a cost of pennies on the dollar in comparison to other global competitors. There may be as many as 130 million people in China with hepatitis B, so the target market for this product is huge. They could as much as triple revenues in 2010, and are trading at a p/e of only 8.
Biopharm Asia is involved in the planting, manufacturing, distribution, and retail sale of a large line of health care products. It is trading at a p/e of only 4.42, and grew net income from 5.5 million to 14.4 million from 2007-2008. This company is expanding rapidly and priced as if it was going nowhere, in these situations, it does not make sense not to buy.
Weikang Bio-technology group (WKBT) is another Chinese pharmaceutical company that appears extremely undervalued. They engage in the research, development, manufacturing, marketing, and sales of Traditional Chinese Medicine in China. We believe that a lack of investor awareness is one of the primary reasons for this substantial undervaluation.
A valuation comparison of these Chinese companies to their US counterparts is shocking. Pfizer has not grown since 2006, and is trading at a p/e of 13. Walgreens is at a p/e of 16, and has grown revenues from 47 to 63 billion. Sanofi Aventis has had no substantial revenue growth from 2006-2009, yet is trading at a p/e of 14. In China we have companies growing at 30% or greater growth rates, and trading for p/e ratios of less than 8, while in the U.S. we have companies with 0-5% growth rates trading at p/e ratios of 13-16.
The Chinese companies clearly present better value for the intelligent investor. There are a few reasons why this undervaluation happens. Two primary reasons are that these companies are unknown to investors and that they are in China. Investors are afraid of Chinese stocks. They are worried about companies in China because of conflicting opinions about the future of the Chinese economy. This creates an incredible financial opportunity for those who do their research. While I agree that the real estate market and domestic Chinese stock markets are overvalued, many of the Chinese companies trading on US markets or the OTC exchange are extremely undervalued.
Other companies in the Chinese pharmaceutical industry worth watching are CKGT, CSKI, RHGP, and CPHI. This industry is exploding with undervalued companies; investors would be well served to do some serious research.
Zack Buckley
CEO
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