Bargains Made in China

06/30/2010 3:08 pm EST

Focus: STOCKS

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, editor of China Stock Digest, sees better days ahead for two heavily discounted China plays.

Changyou (Nasdaq: CYOU) [recently] delivered record financial returns, but shares suffered in extremely volatile markets.

The company reported total revenues reached a record $72.1 million, an increase of 2% quarter-over-quarter and 17% year-over-year. Net income hit a record $39.7 million. Net income increased by 2% quarter-over-quarter. The number of registered accounts for the company's games grew 8% quarter-over- quarter and 38% year-over-year to 87.4 million.

Gross margin in the first quarter of 2010 was 93%, which was roughly inline with 92% in the fourth quarter of 2009. Operating profit for the first quarter of 2010 increased 19% year-over-year to $45.3 million.

At this point Changyou is seriously undervalued. The company’s return on equity exceeds 78%. Its operating margin exceeds 60%. Yet Changyou trades with a price/earnings multiple of only 4.78. The company has maintained a gross profit margin in excess of 90% over the past five years, and has a free cash flow yield of 5.76% with $226 million in the bank.

Changyou operates one of the most popular massively multi-player online games (MMORPGs) in China, and has enjoyed strong growth in user data and revenue per user for its games. It is now beta testing a new game. One analyst explained the extreme expectations of some investors, saying to Investors Business Daily, “Next year, you will see online gaming (revenues) growing 30% or 25%, which is down from 50% to 70%.” Changyou actually met analysts’ earnings expectations but suffered from falling short of exaggerated expectations for annual growth.

CYOU was added to our buy list with a 5% allocation at a buy up to price of $35 a share. We have a target sell price of $50 a share, and our stop loss price is $25.

Zhongpin (Nasdaq: HOGS) shares were also not rewarded in this chaotic month despite a positive earnings report. Zhongpin Inc. reported that its first-quarter net income increased to $13.25 million from $9.74 million prior year. Earnings per share were $0.38 compared to $0.33 a year ago. Net sales revenues increased 32.8%. Net income increased 37.1%. Sales revenues were $204.28 million compared to $153.85 million last year. Analysts had expected revenue of $219.20 million for the quarter.

Zhongpin maintained its guidance for the year 2010. The company continues to believe that sales revenues should be within a range of $900 million to $940 million, and net income within the range of $52 million to $57 million. The earnings per share for the year 2010 are currently expected to be within the range of $1.49 to $1.64 per share.

Zhongpin remains one of the cheapest stocks relative to its earnings growth on the NASDAQ. It continues with expansion plans throughout the country. Zhongpin remains a buy, with a buy-up-to-price of $14 and a target of $20. Zhongpin has a forward price/earnings multiple of only 7.6. We have a price target of $20 and a stop sell price of $11.

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