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The Giant Inefficiency

There was an article recently published in the NY Times China's new "Growth Enterprise Market"- China's new version of our NASDAQ, which just began operations last week. Click Here to read the article in its entirety.

Currently, there are only 28 companies listed on this exchange, and Chinese investors have gone absolutely bonkers bidding up stocks on this exchange.

Chinese citizens are not yet allowed to invest outside their own exchanges, and there's a lot of money chasing a very few stocks. The Shanghai Exchange- more akin to our NYSE, is the home of the larger, all or partially government owned companies. The Growth Enterprise Market (GEM for short) is the home of smaller, faster growing companies. The combined market value of these 28 companies alreadyexceeds $2 billion, and a number of billionaire entrepreuer CEOs have already been created.

On average, the China based companies trading on this exchange are already valued at about 100 times trailing earnings- or PE ratios of 100. These are not sustainable valuations, but don't reach the kinds of extreme bubble valuations we experienced in the Dot-Com bubble where companies achieved absurd valuations based on EPS (eyeballs per share) instead of EPS (earnings per share).

Here's the estimated PEs for my most active followings right now:

• CEU- about 7x'09 estimates
• CREG- about 7.3x'09 estimate
• NFEC- about 6x'09 estimate
• TPI- about 5.8x FY '10 estimate
• UTA- about 8x'09 estimate

Clearly there's a disconnect here. China is booming, and its citizens know it. The US is in a recession despite the GDP number for Q3 last week, and capital is not as easy to come by as it once was. We have 200 million stock market investors chasing thousands of ideas. China has 1.3 billion chasing a very small number of ideas. True, the amount of per capita investable money is far smaller in China, but there's so many more individuals to make up the difference.

Also, China investors aren't handicapped by the doom and gloom surrounding the US at present. They know their country is booming, and believe in their future. Hence, the major disconnect between the valuations in the China markets vs the valuations for the roughly 400 China based companies that trade on a variety of US exchanges.

So-what's going to happen? Eventually, the gap in these valuations will close, and the end result will be somewhere in the middle. I suspect a number of these China companies are could legitimately trade at 50 PE multiples- it's far from unheard of. Currently, they are not even eking out EPS valuations in line with the S&P 500 where growth is a much scarcer commodity.

If these China stocks don't start trading at higher multiples, dynamic China based companies will simply go public on the Shanghai or GEM exchanges, and cut our markets out of the picture. We still dominate the world in two categories- Innovation and Finance. As far as China is concerned, we could lose the finance edge if these stocks don't start trading with better valuations.
 

Tianyin Pharma (AMEX: TPI): Antibiotics Will Be A Cure For Growth

TPI is one of a number of growing companies in the China Pharma industry. TPI delivered about $43 million in revenues and $8 million in profits in FY '09 ($.41 in EPS). Therefore, the next quarterly numbers will represent FYQ1 for the company. As of last week, TPI's formal forecast for FY'10 is  $63.3 million in revs, and $11.3 million net- about $.60 in EPS. These numbers represent between 40% and 50% annual growth rates.

TPI also pays a $.10 cash dividend to shareholders. Only 3% at the current price, but better than a CD at the bank. I believe this stock will trade at $8 to $10 over the next year or two.

TPI is a manufacturer of traditional Chinese medicines. Here's the big development. Last week the company announced it had entered into a joint venture with Sichuan Mingxin Pharmaceutical Co to manufacture and market the ingredients used to make Western style antibiotics.

China's Rural Reform Initiative comes into play here. If you haven't heard of it, it's another long term plan provide affordable health care to Chinese citizens- a mere $124 billion has been earmarked for the first three years. China is going to help its citizens with their health care, and most experts expect the market to develop on both the Western Medicine side and the traditional Chinese herbal medicine side.

In conjunction with the announcement of the new JV, TPI also announced it had completed a nearly $5 million round of financing. The proceeds will be used to purchase a $4.5 million land parcel and build the new manufacturing facility. This new facility is expected to be fully operational by July of 2010, and immediately start making a top and bottom line contribution to TPI's corporate performance.

In Phase I of this JV antibiotic ingredients will be manufactured. In Phase II of the JV, antibiotics themselves will be manufactured, resulting in a major acceleration of both the top and bottom line.

On the slightly negative side, the company did pump another 1.5 million free trading shares out to investors at $3.33 per share, with a $4.50 warrant. Technically, this caused a temporary drop in the stock, and represents a technical negative on a go forward basis that can only be cured by a whole bunch of volume.

I think TPI could make net profits approaching $20 million in FY 2011 (starts next July 1). This would equate to a fully diluted EPS of roughly $.75. Hence my belief this stock could trade to $8 to $10 over the next one to two years. 

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