Cheap China Stocks That Defy Downturns

NEW YORK (TheStreet) -- With growth in China slowing, the country's stocks have been pummeled. For the year so far, China region mutual funds have dropped 22.0%, lagging the S&P 500 by more than 20 percentage points and ranking as the worst performing category tracked by Morningstar.

Now some portfolio managers argue that the stocks have gotten cheap. Steve Cao, portfolio manager of Invesco Asia Pacific Growth ( ASIAX), says that he was underweight China in 2010. But lately he has been scooping up bargains. "Since the correction, things have become attractive," he says.

The markets are pricing stocks as if China may be on the verge of a big downturn, says Jasmine Huang, portfolio manager of Columbia Greater China Fund ( NGCAX). She says that at the trough of the markets in 2008, Chinese stocks traded at 7.3 times forward earnings. Now the multiple is 8 times earnings.

Financial and property stocks trade at a discount to their prices of 2008. Huang argues that the concerns about China are overdone.

Huang concedes that the economy is slowing. After hitting an annual growth rate of 11.9% in the first quarter of 2010, the Chinese GDP expanded 9.7% in the first quarter of 2011 and 9.5% in the second quarter. Analysts say the current rate is around 9.0%.

While the trend has been down, Huang says that the slowdown has been stage-managed by the government. During the financial crisis, the country spent more than $500 billion on economic stimulus. The medicine worked, and the economy grew. Now the government is unwinding the stimulus.

To prevent the economy from overheating, the central bank has raised interest rates. The authorities required banks to hold more reserves, a step that reduces lending activity. All the moves are slowing growth. But if the drop becomes too steep, the government will again begin stimulating demand, says Huang.

"The government will do what it takes to avoid a hard landing," she says.

To own a China fund that does relatively well in downturns, consider Columbia Greater China. The fund has outdone its peers by 3 percentage points this year. During the past five years, Columbia returned 7.8% annually, surpassing 54% of its competitors.

To limit risks, portfolio manager Jasmine Huang looks for companies with little debt and high returns on equity. She wants market leaders that benefit from government policy and can grow consistently for several years.

A favorite holding is ENN Energy Holdings ( XNGSF.PK), a producer of natural gas. The government is encouraging increased reliance on gas because it is a relatively clean fuel. As a result, the gas company's sales increased 42% in the last quarter.

"The gas penetration in China is still very low, and there is a lot of room for growth," says Huang.

She also likes Belle International ( BELLY.PK), a dominant seller of shoes in China. Besides producing its own brands, the company operates 10,000 retail outlets. With the government encouraging consumers to shop, Belle has been growing at an annual rate of more than 20%.

Another solid fund is Invesco Asia Pacific Growth, which has 18% of its assets in China. During the past five years, the fund has returned 9.1% annually, outdoing 80% of its peers. While portfolio manager Steve Cao seeks growth, he steers away from expensive shares. Many of his holdings have price/earnings ratios of less than 10.

A favorite holding is the Industrial and Commercial Bank of China, which has a P/E multiple of 6. Chinese bank shares have been slumping as investors worry that hot property markets could turn cold. But Cao says that Industrial and Commercial Bank has little exposure to real estate. A dominant commercial bank, it has high returns on equity and a strong balance sheet. "The bank has enough capital to cope with a downturn," Cao says.

Another holding is ANTA Sports ( ANPDF.PK), which operates 2,400 sporting goods stores. The company focuses on second-tier cities, where it faces limited competition from Western brands. In the last quarter, sales increased 28%.

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Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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