A Play on China’s Security

09/02/2008 12:00 am EST

Focus: STOCKS

Robert Hsu

Editor, China Strategy and Asia Edge

Robert Hsu, editor of China Strategy, says a Chinese provider of security services is growing rapidly and the stock is cheap.

If you watched the Beijing Olympics, then you've probably heard about one of the hot topics of this year's Games—security. The Chinese government spent an estimated $10 billion in security infrastructure. That's nearly a quarter of the total $40 billion that China spent on the Games!

Aside from the Olympics, security technology is a huge and fast-growing business in China. While the government is increasing its security measures, many private businesses are installing security technology, and businesses currently being constructed are increasing the demand for security and surveillance equipment. So, as China's economy grows rapidly, so does the vast need for security measures.

In fact, the Chinese security and surveillance industry will grow by over 20% annually in the next several years, [and] China's security market will grow tenfold from just $4 billion in 2004 to over $40 billion by 2010!

This new trend is an excellent investment opportunity. My new recommendation is a domestic leader in the Chinese security and surveillance industry. It has consistent annual earnings growth of 30% or higher, it was started by private entrepreneurs, and it is trading at a bargain-basement price-to-earnings ratio of only nine times this year's earnings.

The stock is China Security & Surveillance Technology (NYSE: CSR). Based in Shenzhen, CSR manufactures, distributes, installs, and maintains security and surveillance systems throughout China. It provides many surveillance products including hardware, software, design, implementation, and technical support.

Looking ahead, I think China Security has a lot of potential for growth and profits. From 2002 to 2007, CSR achieved strong top-line growth: revenue jumped to $240 million in 2007 from $16 million in 2004, and net income soared to $46.6 million in 2007 from $5.9 million in 2004. That's an average of more than 100% growth a year!

And in early August, China Security posted strong second-quarter earnings. Net income soared 81% year-over-year to 17 cents per share, [while] revenue increased 78% from the second quarter of 2007. Gross margin—one of my favorite indicators of a company's operating performance–improved to 32.8% from 28.6% in the same period last year.

Looking ahead, the company expects its strong growth to continue. It raised its adjusted 2008 net income forecast to $1.60 to $1.77 per share—a year-over-year growth of more than 60%!

This largely undiscovered stock was unfairly beaten down in the recent Chinese stock sell-off since October, but this created the most attractive combination of strong growth and attractive valuation right now. The stock is growing its earnings six times faster than the nonfinancial portion of the S&P 500, and yet it is 50% cheaper than these companies.

Buy CSR under $19. (It closed below $18 Friday—Editor.) This is a rare stock that I believe has the potential to make a huge move up before year-end. I'm targeting $27 by the end of this year, which would give us over a 40% gain.

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