Three Plays on China

11/25/2005 12:00 am EST

Focus:

Paul Tracy

Editor, The StreetAuthority Market Advisor

"Imagine the gains you'd have earned if you had invested in the US or UK early in their development," ponders Paul Tracy. "But investors don't have to just imagine that scenario. Just look at China." Here, he offers he favorite plays on the region.

"China is far and away one of today's most exciting growth markets. One way for US investors to capitalize on China's booming economy is with a Chinese-focused mutual fund. Funds offer broad diversification and access to a host of companies that would be difficult for individual US investors to buy directly. For example, many of China's best placed companies trade in Hong Kong but do not trade in the US as ADRs. What's more, it's extremely expensive for individuals to trade stocks listed in Hong Kong; funds can, however, offer easy access to this market. One of my favorite funds is the iShares FTSE/Xinhua China 25 Index Fund (FXI NYSE), an exchange traded fund concentrated in China's largest and most liquid stocks.

"But there's even better news for US investors. Over the past five years we've seen an explosion in the number of Chinese and Hong-Kong based companies that have listed on the US exchanges as ADRs. Here are two of my favorites:

"Ctrip (CTRP NASDAQ) is China's leading hotel and airline travel consolidator, controlling roughly half the market. Like Expedia or Travelocity in the US, Ctrip acts as a middleman between consumers and travel service providers like hotels and airlines. Its main competitive advantage comes from its enormous network of hotels. Unlike most developed countries, China's hotel market is still mainly served by independent chains, not global powerhouse brands like Holiday Inn or Hilton. That enhances the value of travel agents who can search through a plethora of independent hotels to find the best deals.

"Ctrip's growth is being fueled by the recent explosion in Chinese travel demand. The Chinese government has relaxed restrictions on travel in recent years, and as a result, the Chinese are increasingly taking advantage of the more liberalized market. As consumers become wealthier, they will have more time and money for leisure pursuits. As a result, the Chinese travel industry is expected to roughly triple in size over the next decade. What's more, right now only 2% of Chinese have traveled outside the country. Due to easing travel restrictions and visa requirements, however, by 2020 the World Tourism Organization projects that China will become the world's fourth-largest source of overseas tourists.

"Analysts peg Ctrip's long-term earnings growth at roughly +35%. With a forward P/E of less than 30, that puts the company's price to earnings growth (PEG) ratio under 1.0, which is a very reasonable level. Even better yet, Ctrip's recent growth has been far higher than those long-term estimates suggest. Over the past year the company has delivered revenue growth in excess of 60% and earnings growth of nearly 80%. And there's a kicker: the potential for a takeover bid. Expedia already owns China's #2 travel consolidator. Ctrip has an enterprise value of only $850 million which would make the company an easy acquisition target for a company that wanted to expand its footprint in China.

"China National Offshore Oil Company (CEO NYSE), popularly dubbed CNOOC, is engaged in the exploration and production (E&P) of oil and natural gas. CNOOC has more than 2.2 billion barrels of oil equivalents in total reserves, most located inside China. In addition to its internal exploration and production program, the company has partnered with foreign firms to explore for oil and gas both inside and outside of China. By working closely with foreign firms, CNOOC has already gained significant expertise and is now considered a world-class energy firm. In addition, the company is very familiar with China's geology, which will keep it a partner of choice for foreigners.

"Going forward, CNOOC's growth will be fueled by two main factors- rising energy prices and developing new reserves. China's tremendous demand for energy is being driven by increased car ownership and general economic growth and development. And CNOOC is also looking to expand its reserves portfolio abroad. Although the company's deal to buy US-based Unocal fell through under political pressure, more deals are sure to be in the pipeline and CNOOC will likely grow via acquisitions in the coming years.

"CNOOC trades at roughly 7.5 times 2006 earnings, which is one of the lowest valuation levels of any major independent producer anywhere in the world. Meanwhile, the company's long-term growth rate is estimated at more than 23% annualized, or nearly three times its growth rate. That gives the stock an enticing PEG ratio of just 0.32. Given that most international oil companies trade at a PEG of roughly 0.70 to 1.0, this stock could see a great deal of appreciation as its valuation level catches up to global norms."

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