Chinese Pharma Stocks Shine

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.

Warren Buffett talked about feeling like "an oversexed man in a brothel" in the mid-1970' 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 Biopharmaceutical ( SKBI) appears to be the perfect Buffett-like company. It enjoys a sustainable competitive advantage with little competition in the veterinary health industry. It is 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 it is 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 million to $46 million. The company also has a strong balance sheet with no long- term debt.

Biostar Pharmaceuticals ( BSPM) is poised for exceptionally strong growth over the next year. It is expanding sales outlets from 3,512 to 10,000 sales outlets by the end of 2010.

If it reaches its estimates, it will have net income growth of at least 100% in fiscal 2009. Biostar's most important drug, the Xin Aoxing Capsule which is used for the treatment of hepatitis B, has a near monopoly. The drug, the only OTC-approved drug of its kind in China, has 93% efficacy with a cost of pennies on the dollar in comparison to other global competitors. With 130 million people in China with hepatitis B, the target market for this product is huge. Trading at a P/E of only 8, Biostar could as much as triple revenue in 2010.

Weikang Bio-Technology Group ( WKBT) is another Chinese pharmaceutical company that appears extremely undervalued. It engages 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 U.S. counterparts is shocking. Pfizer ( PFE) has not grown since 2006 and is trading at a P/E of 13. Walgreen ( WAG) is at a P/E of 16 and has grown revenue from $47 billion to $63 billion. Sanofi Aventis ( SNY) has had no substantial revenue growth from 2006 to 2009, yet is trading at a P/E of 14.

In China, we have companies with 30% or morer growth rates, and trading for P/E ratios of less than 8, while in the U.S. we have companies with 0% to 5% growth rates trading at P/E ratios of 13 to 16.

The Chinese companies clearly present better value for the intelligent investor. There are a few reasons why this undervaluation happens. These companies are unknown to investors because they are in China. Investors also are afraid of Chinese stocks 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 U.S. markets or OTC are extremely undervalued.

Other companies in the Chinese pharmaceutical industry worth watching are China Kangtai Cactus Biotech ( CKGT), China Sky One Medical ( CSKI), Renhuang Pharmaceuticals ( RHGP) and China Pharma Holdings ( CPHI). This industry is exploding with undervalued companies.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Skystar Pharmaceuticals, China Pharma Holdings and China Sky One Medical to be small-cap stocks. Market-cap information on the other stocks mentioned were not available. 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 was long CKGT, RHGP, WKBT, SKBI, BSPM.

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.

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