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My Top 10 List

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To OTC Journal Members: 

Well, May has turned out to be an atrocious month for the bulls in the markets. All the major indexes were down about 8%- the worst May since 1962. The 2010 gains have been given back, and then some. The headline risk remains massive everyday between the European "Austerity" programs and the free fall of the Euro, oil spilling into the Gulf Of Mexico a mile below the surface, and North and South Korea pointing guns at each other. It's been rough.

This environment is especially tough on the high Beta stocks- my focus. Beta is a measure of volatility. A stock with a Beta of 1 has the same volatility as the S&P 500. If the S&P goes up 5%, it is likely to have moved 5% over the same time frame. A beta measure of 5 would be 5 times the volatility of the big boys. Therefore, if the S&P moves 5%, a stock with a Beta of 5 would likely move 25%. My ideas are all high beta stocks that will go up considerably higher than the large cap stocks when the market is strong, but get clobbered when the market is weak.

China stocks out performed the market by 30% in 2009, but have been decimated in 2010. The meteoric rise in real estate values in China has the markets concerned about inflation, while at the same time the Europe situation has investors concerned about a China slow down.

The world can't decide. It sees the Chinese economy standing half way in a freezer door in the Sahara desert. Some believe their economy is too hot. Others said Europe will make it too cold. No one believes it's just right. When in doubt turn to history. The South American Debt Crises and the "Asian Contagion" both worked themselves out. The Europe recession and the overheated Chinese real estate market will both resolve with less damage than the market is pricing in right now.

Somehow China managed to keep it's economy growing at over 9% in 2008, the year of the US's worst recession since the great depression. Somehow, China will muddle through a real estate boom. The really smart guys say to stay away from the high end China real estate developers, but focus on companies who are working on lower to middle income housing.

If we don't learn from mistakes of the past, we are doomed to repeat them. I have learned, from as recently as March of '08, that when stocks get blown up and are super cheap, it's time to take a hard look. When the CNBC rhetoric would have everyone believing China is going to implode in a circular motion and disappear into the ground like the house in the last scene of the movie Poltergeist, it's time to buy. When retail investors are pulling their money out of funds, petrified of the markets, that's the time to buy. Sounds like now.

Here's some thoughts I pulled out of a couple of recent articles: Sadiq Currimbhoy, head of Merrill Lynch Asia Pacific strategies, recently stated "“We should start nibbling at Chinese stocks", “Given the concerns on growth and risk aversion in Europe, China will end up pushing back tightening measures. There's a chance for a bounce as things get oversold.” Reported by Bloomberg on May 20th. Jing Ulrich of JPMorgan Chase states "China’s Shanghai Composite Index may rise to 3,800 in the next 12 months, driven by “strong” earnings growth and “reasonable” valuations," That's 35% above current levels. I don't want you to think I take all my cues from JPMorgan or Merrill Lynch, but it's worth noting the big boys are starting to believe the over reaction in valuation is going to reverse course, and I don't want you to be left without some really good, undervalued ideas in small cap stocks.

I've put together a list of 10 stocks. These are all China based companies trading with US listings I believe are absurdly undervalued and represent an opportunity to take advantage of the recent blow offs in the markets. Perhaps you want to nibble. Perhaps you want to be a shark and attack.  Perhaps you think there will be more blood before the patient can get healthy, and want to stay on the sidelines.

When there's blood in the water, the most efficient predators on Earth- the sharks, are circling. The list below is easy prey for sharks looking for a meal of profits between now and year's end.
 

My Top 10 Undervalued China Ideas

I've called all my contacts and reached out to numerous resources in the China investing world. I'm not going to miss the opportunity to go bargain hunting while the investment community believes China is about to implode from high real estate prices. I believe we have Post Traumatic Real Estate Bubble Syndrome. Even the slightest hint of a bubble brings back memories of 2008 when our largest financial institutions nearly collapsed.

A major real estate collapse in China would not be good for consumers over there, but the circumstances aren't even remotely close to the US in 2008. 40% of the property being bought in China today is being paid for in cash. That's hardly leveraged. Property prices have appreciated at an unreasonable clip, but leave it to the Chinese Government to engineer a soft landing on this issue. Didn't China still have 9% GDP growth in 2008 while the US economy was mired in a recession/near depression state? If the high end real estate market collapses, there will certainly be some NPLs (non performing loans around), but better a government with $3 trillion in cash (China) vs a government with $30 trillion in debt (US) will handle it. Look for the Government to tighten slightly and slow things down a bit.

The growth over there is happening, and no matter how many analysts that haven't been to China get on CNBC and predict an implosion, there are still 1 billion people waiting in the wings to be the next generation of consumers. 
I would challenge you to simply look at some of the numbers these companies are cranking out. There's no way these stocks can stay this cheap.

We'll consider this portfolio of 10 ideas to take life on June 1 based on the closing prices of the stocks, and see where we are at the end of 2010. I'll bet it will be enlightening for all. In order to make this list, the stocks had to be trading at far less than 10x 2010 EPS, have at least a 30% growth rate, and have a very strong balance sheet.

On this list of 10 stocks, I believe there are at least 3 or 4 that will double before the end of the year, 4 to 5 that will be up at least 50%, and one or two that will be down slightly. Of course, this assumes the financial world will not come to an end, so call me an optimist.

If you like to bottom fish for value and growth, you might find this list useful. The first two are my top two picks, but there's a good chance others might do even better than the top two. After the first two, they are listeded in random order.
 

China Media Express Holdings: (AMEX: CCME)- Switches To NASDAQ Next Week

• Recent price: $13.25
• 52 week range: $7.35 to $14.82
• ’09 performance: $95.9 million revs- $56.6 million net profits
• Market Cap: $400 million
• Q1 Financials: $44.5 million in revs (137% growth from Q1 ’09), Net: $18.1 million after subtracting one stupid GAAP non cash charge
• 2010 Estimated EPS: $1.75 to $2- company expects to earn about $70 million with an estimated 36 million shares I&O
• Overview: In 2008 Vision Media (VISN) was one of the hottest stocks around. It was $6 in March of ’08, and ran to $26 by the end of July. The company was deploying flat panel displays all over China at high traffic points and making the screens available to advertisers. The business model was flawed as the advertisers came to understand people really didn't see the ads as they moved around rather busily on their way to wherever they were going. CCME has taken a different approach, and advertisers love it. There are 21,500 mass transit buses in China’s 5 most prosperous municipalities sporting CCME’s advertorial flat panel displays. The audience is captive on the bus, and the advertising is far more effective. If the company can deliver $2 in EPS this year, I cant see the stock trading much under $25 to $30 as interest comes back to China stocks.  Amazingly, there is not one analyst covering the stock yet, which is another reason to own it now.
 

Longwei Petroleum: (OTC BB: LPIH)

• Recent Price: $2.15
• 52 Week Range: $.74 to $3.28
• ’09 Revenues (FY June of ’09) $200 million- $22 million net profits
• Market Cap: $194 million
• Rev calendar Q1 ’10: $97 million up from $50 million Q1 ’09 (94% growth).
• Net profits over last 3 quarters- their FY ’10 (ends June): $30 million after you add back in another one time, non cash, BS GAAP charge for “derivative dividend”.  Will deliver at least $.45 in EPS for FY’10 in non GAAP numbers. Cash flow is excellent.
• The company has publicly stated it expects to deliver nearly $1/2 billion in revs in FY ’11 (July 1), and $73 million in net profits (non GAAP)- According to company, this equates to $.71 in EPS.
• Overview: Longwei is an oil and gas operation. The company stores, transports, and sells finished petroleum products. It purchases finished product from refineries and moves to its large scale storage facilities. There's no reason why the company, based on its track record, shouldn't be able to deliver $.71 in EPS non GAAP, and I cant see this stock trading at less than $5 in any sort of rational market.
 

China Information Security: (NASDAQ: CPBY)

• Recent Price: $5.32
• 52 Week Range: $2.50 to $7.97
• ’09 Financials: $100 million in revs; $30 million net profits
• Market Cap: $250 million
• Financials Q1 ’10: $25.3 million (68% higher than Q1 ’09)
• EPS estimate for 2011: $.73 on $142 million in revs (42% top line growth)
• Overview: This Company provides integrated solutions for information security. It sells computer hardware and software. It has a first responder coordination platform. It sells products and services to both the government and private enterprise. It has an entire information platform for health care/hospital/patient information as well. If you think the world is getting to be a safer place to live, you don't want to own this stock. If you think $.73 in EPS should put a company with a 40% plus growth rate over $7.50, there's 60% return from current levels.
 

China Integrated Energy: (NASDAQ: CBEH)

• Recent Price: $9.43
• 52 Week Range: $3.95 to $12.31
• ’09 Financials: $290 million revs, $38 million net profits (36% growth rate)
• Market Cap: $314 million
• Q1 ’10 financials: $110 in revs, $11.4 million net profits (18% growth)
• Consensus Estimate for ’10: $411 million revs, $1.15 in EPS (41% growth yty)
• Overview: CBEH is an integrated energy company- they engage in wholesale distribution of oil products and own retail gas stations as well. The company produces and sells Bio diesel as well. No reason they can't deliver $1.15 in EPS this year, which would put the price of the stock at no less than $12. Since they are in bio diesel, the stock may command a higher multiple. Perhaps $15 is a good target for this particular stock.
 

China Cast: (NASDAQ: CAST)

• Recent Price: $6.63
• 52 Week Range: $5.08 to $8.50
• ’09 Financials: $50.7 million revs; $13.5 million net profits (21% growth rate)
• Q1 ’10 financials: $15.8 million revs; $4.559 million net profits- $.10 in EPS (47% top line growth)
• ’10 financial forecast: $78.5 million revs; EPS of $.42 (54% growth)
• Overview: This is the one stock I'm highlighting that doesn't trade at less than 10x ’10 EPS. The EPS number on this company is really skewed by the property they own. This is an education company. CAST provides eLearning, vocational training, and multi media education services. The company also owns a University, and the depreciation of the physical property really skews their bottom line. However, real estate is the one asset that is more likely to appreciate than depreciate, so their real financial performance is a bit hidden. Education in all forms is growing like crazy in China. Stock could see $10 over the remainder of the year.
 

China Education Alliance: (NYSE: CEU)

• Recent price: $4.37
• 52 Week Range: $3 to $7.50
• ’09 Financials: $37 million; Net Profits: $15.2 million (48% growth)
• Q1 ’10 $8.2 million revs; $3.66 net- $.12 in EPS (only 5% growth)
• 2010 Financial Estimates: $.62 in EPS- on $58 million in revs (56% growth)
• Market Cap: $140 million
• Overview: CEU is another education company. This company specializes in three areas: specialized training for high school students to do well on standardized tests (like our SAT), online vocational training, and class room vocational training for post high school level. The stock is cheap because the company only delivered 5% top line growth in Q1. However, the CEO pledges the company will deliver no less than 30% in ’10 over ’09. If he's right, the next 3 quarters have to be over $40 million, and show very strong year over year comparisons. This is credible as the company did this in ’08 as well. Also, CEU has over $2 per share in cash with no debt of any kind, so you are really only paying $2.4 per share for the business. I could easily see this one trading to $8 in the next China rally.
 

SinoHub: (AMEX: SIHI)

• Current Price: $2.74
• 52 Week Range: $2.05 to $5.70
• ’09 Financials: $128.4 million in revs; $12.4 million net profits- $.48 in EPS
• Q1 ’10 financials: $38.6 million (113.4% increase); $3.5 million net
• Market Cap: $77 million
• ’10 Estimated Financials: $180 million in revs (40% growth); $.56 in EPS
• Overview: SIHI is an electronics component sales and supply chain management company.  Since SIHI sells lots of stuff to exporting manufacturers, the market is pricing the stock as if the European slow down is a death knell. Of course, it's ridiculously overdone, and there's lots of evidence the US consumer is coming back. Perhaps they wont grow as much as they thought, but there will still be substantial growth, and I fully expect the company to come close to their ’10 forecast. With EPS around $.56, there's no rational way on earth this stock trades much below $5, and likely a lot more. Very cheap right now thanks to Europe fears.
 

Biostar Pharma (NASDAQ: BSPM)

• Current Price: $3.41
• 52 Week Range: $1.75 to $5.50
• ’09 Financials- $53.3 million revs, $7.8 million net (non GAAP)
• Q1 ’10 financials- $12.3 million; net profits $2.26- $.09 in EPS
• Market Cap: $85.1 million
• 2010 Forecast: $80 million revs, $18 million net profits (likely about $.50 in EPS)
• Overview: Biostar is a pharmaceutical company engaged in prescription medicines, OTC therapies, and traditional Chinese medicines. The company generates over 50% of its sales from one blockbuster product- an OTC therapy for HepB- a big problem in China. They have the only approved OTC treatment for HepB, and it is estimated 10% of the Chinese population is infected. The other treatment is a very costly prescription product. As the Chinese health care system grows, it will be a big positive for BSPM. The stock is very cheap thanks to a bottom line disappointment in Q1. The company spent a lot of marketing money in Q1, but the CEO says it will pay off big time later in the year. If they do deliver $.50, I don't see the stock trading less than $5.00 to $7.00 in a reasonable world.
 

China Recycling Energy (NASDAQ: CREG)

• Recent Price: $3.57
• 52 Week range: $.50 to $6.40
• ’09 Financial Performance: $44.23 million in revs; $9.7 million net (105% growth rate)
• Q1 ’10 financial performance: $10.1 million in revs; $2.1 million net- 134% top line growth
• ’10 forecast: $70 million in revs; $18 million net (about 100% growth of ’09)
• Market Cap: $126 million
• Overview: CREG is an energy savings company that operates with a unique business model. The use a “BOT” strategy – Build, Operate, Transfer. They install energy savings systems on factories. The installations are financed by an off balance sheet owned entity. The factory owners pay a monthly fee which is less than the energy savings, and come out ahead. They generally pay monthly for 10 years plus.  The financial are a little complex to understand. Last year they called the monthly payment rent, this year they are calling it Interest Income, and therefore it's not included in the revenues, but it does come to the company in cash every month with zero cost of goods once an installation is complete. Filtering out all the quarter to quarter weird ways the accountants categorize this stuff, the company should deliver $18 million net this year- one analyst has them at $.27 in EPS, and a $6 price target. I believe $6 is low thanks to the recurring nature of their revenue stream. The more systems they install, the more “Interest Income” hits the bottom line for 10 years. At the end of the term, the system transfers ownership to the factory owner. Hence the acronym BOT- Build, Operate, Transfer. With the recurring revenues building, this one should trade at a higher multiple.  Slightly illiquid, so not for short term trading. Carlyle Group, the largest private equity fund in the world, is a shareholder in this one, and I believe has a seat on the board.
 

NF Energy: (OTC BB: NFEC)

• Recent Price: $3
• 52 Week range: $1.80 to $6
• ’09 Financials: $20.3 million revs; $4.776 net
• Q1 ’10 $2.9 million revs; $370k net - $.03 in EPS
• ’10 forecast: $30 million in revs; $6.3 net profits- likely about $.50 in EPS
• Market Cap: Only $40 million
• Overview: NF Energy is a pet favorite of mine as I have personally been an investor in this one for nearly a year now. The company is in the energy saving space, and is a “jack of all trades” for their local government. However, they really specialize in gigantic hydraulic systems for hydro electric projects. Their water valves can run up to 20 feet in diameter, and they control the water flow in a hydro power project to maximize the turbine yield. It's a very project driven company, so quarter to quarter numbers can be herky jerky depending on where they are in the delivery cycle. The year is going to be very back end loaded. Q1 numbers were very light, and only represented 10% of the revenues they expect to do. They still have 90% to go. The stock is pretty illiquid, so this is another one you can't trade in and out of. The stock should easily return to its high of $6 once we get past this big sell off and we have a quarter or two more in the rearview mirror. The company is getting some major international recognition for its flow control systems, so I believe you'll see new contracts coming in from global customers.
 

Disclosure: I'm long CCME, LPIH, CEU, BSPM, CREG, NFEC

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