China Drug Stocks Offer Value Remedy

Chinese pharmaceutical stocks are offering great bargains for value investors.

Pharmaceutical sales in China have been growing at an average annual rate of 15.5% since 2005. This growth is being fueled by rising incomes, a growing middle class and a rapidly aging population. The elderly population in China has grown from 171 million from 130 million over the past decade, and health care spending by the elderly is five times higher than it was in 2000.

In addition, Beijing has made health care one of its primary initiatives and plans to spend $123 billion on a universal health care in the next three years.

China's pharmaceutical industry is rapidly consolidating, and the market leaders are growing in value.

These leaders have several things in common: a strong nationwide sales and distribution network, strong research and development capabilities and access to capital.

Although some Chinese pharmaceutical companies trade with price-to-earnings ratios as high as 63, Lotus Pharmaceuticals ( LTUS.OB) 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 revenue at 59% from 2005 to 2008, and net income is up 700% since 2005.

The company's revenue comees from a combination of pharmaceuticals wholesaling and the development and sale of proprietary drugs. It plans to continue to grow by expanding distribution channels, expanding production capacity through the building of a large factory and bringing new drugs to the market by partnering with top research 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 research-and-development capabilities with a new drug pipeline and a very attractive valuation.

China Medicine ( CHME.OB) has a P/E of 5.91 and a price-to-sales ratio of .69.

The company is rapidly growing and has developed a proprietary product called rADTZ, which was designed to decrease animal mortality rates by fighting Aflatoxins. China Medicine estimates that the addressable market for rADTZ is as large as $4 billion.

The company's distribution network includes 300 hospitals and 500 other medical companies. Revenue rose dramatically from 2005 to 2008.

A company like this is extremely cheap. A comparable company is 3sBio ( SSRX), which has a P/E of 22 and a price-to-sales ratio of 3.96. 3sBio shares were recently trading at $11.91. China Medicine is much cheaper, with a better return on equity and profits.

China Yongxin ( CYXN) has a current P/E of 4.9 and a price-to-sales ratio of 0.25.

The company runs 93 retail drugstores, distributes pharmaceutical products and makes its own proprietary ginseng products. It distributes products including Chinese traditional medicines, chemical pharmaceuticals preparations, flower teas, natural health products, health food, cosmetics and medical equipment.

The company plans to expand its retail chain across China. It 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.

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.

I have found lots of other undervalued American depositary receipts of Chinese companies. That is why I am going to China this summer to visit as many publicly traded companies as I can.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Lotus Pharmaceuticals, China Medicine, China Yongxin and 3sBIO to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Buckley had positions in Lotus Pharmaceuticals, China Medicine and China Yongxin.

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.

More from Opinion

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Red Hat CFO Tells TheStreet: Tech Trends Are Still in Our Favor

Throwback Thursday: Intel Edition

Throwback Thursday: Intel Edition

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

Intel's Next CEO Should Try Harder to Protect Its Flanks Against AMD and Others

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

3 Warren Buffett Stock Picks That Could Be Perfect for Your Retirement Portfolio

Wednesday Wrap-Up: GE and Facebook

Wednesday Wrap-Up: GE and Facebook