Two China Small-Cap Opportunities

08/12/2015 9:00 am EST

Focus: STOCKS

Matt McCall

Founder and President, Penn Financial Group

Given the recent volatility in the Chinese market, global investors are starting to question the legitimacy of the world's second largest economy, but as Matt McCall of Penn Financial Group points out, there's still money to be made in the country with the right stocks.

The volatility in the Chinese market has been well documented over the last few weeks as investors begin to question the legitimacy of the world’s second largest economy. This week the Chinese government announced it would devalue its currency in an effort to help increase exports to compensate for slowing growth.

Although growth may be slowing for the Chinese economy, it remains one of the fastest growing in the world. From an investor’s viewpoint, there is money to be made in the country with the right stocks.

The Chinese small-cap asset class, as measured by the Guggenheim China Small-Cap ETF (HAO), has had a wild year. From mid-March through mid-May, the ETF was up over 40%; in the next month the ETF gave back all the gains. Based on the recent pullback in the small-cap stocks, it has opened up an opportunity for two flying under-the-radar companies.

Movies

Bona Film Group (BONA) is one of the biggest players in the film industry in China. Founded in 2003, the company operates through four segments: film distribution, film investment and production, talent agency, and movie theaters. As of the end of April, the company owned 25 movie theaters. While the growth potential for the movie industry in China is difficult to quantify, in February of this year the total box office revenue surpassed that of the US for the first time ever.

BONA is in a unique situation because in June the company received an offer to take the company private from its founder and CEO, Yu Dong. The price of the offer is $13.70 per American depositary share (ADS), which trades in the US on the NASDAQ. Based on the current price of BONA, the $13.70 takeover price represents a 15.5% premium.

Even if the company does not ultimately go private at $13.70 per share, there is still big upside to the stock. With a PEG ratio of 0.50 and revenue growth of 70% last year, the stock could continue the current rally. If the stock were to double and trade with a PEG ratio of 1.0, it would still not be considered overvalued based on traditional metrics.

E-Commerce

Baozun, Inc. (BZUN) provides e-commerce solutions for its clients in China and is also traded in the US on the NASDAQ. The company has partnered with nearly 100 international brands such as Nike and Pepsi to help them with e-commerce in China. It is estimated that the company controls 20% of the massive e-commerce space in China and it continues to expand.

From a valuation view, the stock trades with a ridiculously low PEG ratio of 0.35 and it has the growth to back it up. Revenues are projected to increase by 49% in 2015 to $382 million before jumping to $608 million in 2016. Earnings per share are expected to come in at 13 cents this year before increasing by 269% to 48 cents in 2016.

Both stocks have been trading within narrow ranges over the last couple of weeks and considering the volatility in the Chinese market, this action is bullish. All it will take is one catalyst for either stock to create a breakout and a new leg higher.

Matt McCall, Founder and President, Penn Financial Group

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