Two Picks From China’s Bargain Basement

01/19/2011 11:54 am EST


Jim Trippon

Editor-in-Chief, China Stock Digest

Power producer Huaneng and nutrients maker Yongye boast big growth rates and attractive valuations, writes James Trippon in China Stock Digest.

Huaneng Power International (NYSE: HNP) shares came under pressure in December as worries about inflation fanned concerns about the company’s near-term profits. Beijing has suggested that it may consider price caps on some items such as coal, but for the time being rising coal prices are seen as a possible threat to Huaneng’s bottom line. There is also concern that the huge power generator could face price controls of its own as Beijing struggles to bring inflation under control at the consumer level.

Despite those concerns, Huaneng said it is securing its coal supply and expanding its nuclear energy business by buying stakes in companies from its state parent, the China Huaneng Group, for $184 million. In addition to stabilizing the price that Huaneng will pay for coal, the purchase commits the company to a future in the atomic energy business with two new pressurized water reactors under construction.

Huaneng is also buying a 50% stake in Massachusetts-based power utility InterGen for $1.23 billion. With this purchase, Huaneng will gain access to 12 power plants in the UK, Netherlands, Mexico, Australia, and the Philippines in its biggest overseas acquisition in two years.

Huaneng sells at a cash flow multiple of just 8.5, and offers a robust dividend of 5.7%. The stock remains a buy up to $27, with a price target of $35. The stop/sell price is $20. [Shares traded just below $22 Tuesday—Editor.]

Downgrade a Speed Bump for Yongye
Yongye International (Nasdaq: YONG) slumped during the middle of December after an analyst downgrade, but bounced back on cheap valuation and earnings momentum.

Yongye is a leading developer, manufacturer, and distributor of plant and animal nutrient products in the People’s Republic of China.

Taking lignite coal as the raw material and applying modern extraction technologies, the company produces a highly pure and natural liquid nutrient. Yongye’s plant nutrient product can significantly increase a plant’s output and nutritional value.

Oppenheimer & Co. analyst Katherine Lu downgraded the stock to “Perform” from “Outperform.” She said Yongye’s expenses have increased because of its aggressive store opening strategy and its geographic expansion plans. She said the company’s sales will keep growing rapidly, but the company’s leverage will be limited, and that will curb share price gains.

Yongye turned a profit in its most recent quarter after losing money in the year-ago period. Its revenue more than doubled, but its cost of sales also increased.

As the late December rally showed, the company’s valuation is attractive with a bargain basement PEG ratio of only 0.15. [The PEG ratio divides the company’s price/earnings multiple by its projected earnings growth rate—Editor.] Yongye has impressive financials with gross margins above 57% and a profit margin of nearly 25%. Earnings per share are expected to climb 43% next year.

We believe that Oppenheimer’s fears are overstated and believe that the company will achieve its growth targets.

Buy YONG up to $10. We maintain a target sell price of $19 and a stop/sell price of $5. [Shares traded a bit above $8 Tuesday—Editor.]

[Another Chinese small-cap recently recommended by Nicholas Vardy is showing even stronger price momentum. Trippon recently highlighted China’s new focus on efficiency, transport links, and high technology—Editor.]

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