Were clearly in a boom period for Chinese stocks right now, and there will be a bust as surely as day follows night. But no one can tell you with any accuracy when it will begin.
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You need to invest in China, but how?
The market du jour is hardly a slam-dunk for investors. To understand the risks, lets compare the stocks of two well-known brewers: Anheuser-Busch and Tsingtao.
By Jim Jubak
China undoubtedly is the investment story of our time, and every portfolio should have some exposure to it. The challenge is how to participate in the goliaths growth yet avoid the inevitable stock market meltdown -- a China Syndrome, so to speak.
Its not an easy task, and it certainly isnt without its risks. But by poring over a couple of beer stocks, we can get a better idea of the challenges China presents.
First on tap, the Chinese beer company Tsingtao Brewery (TSGTY, news, msgs). (Tsingtao Brewery trades as H-shares on the Hong Kong market under the symbol TSGTF and in the U.S. over-the-counter pink sheets under the symbol TSGTY.)
Tsingtao Brewery trades at 48 times its earnings per share over the last 12 months and at 32 times J.P. Morgans projected 2004 earnings per share. Although sales grew by 16% in 2003 and J.P. Morgan projects them to grow by 17% in 2004, the company missed its sales projections for 2003 by about 11%. J.P. Morgan projects that earnings per share will grow at a compounded annual rate of 30% from 2002 through 2005. Morgan notes, however, that Tsingtao projects a very modest 4.8% net profit margin in 2004.
Second, the global beer power Anheuser-Busch (BUD, news, msgs). Anheuser-Busch trades at 21 times trailing 12-month earnings per share and at 19 times the Wall Street consensus projection for 2004 earnings. The companys sales volume climbed about 2% in the last quarter of 2003, pretty good considering that volume growth in the mature U.S. beer market is about 1% annually.
Anheuser-Busch almost never misses Wall Street estimates; it has reported earnings at or slightly above the Wall Street consensus for the last five quarters. The company projects 2004 earnings will be up 12%. But J.P. Morgan thinks the number through 2005 will be closer to 11%.
The company sure knows how to wring a profit out of sales, however: Anheuser-Buschs net profit margin is projected at 15% in 2004, about three times the net margin at Tsingtao.
So how do you decide which of these stocks is a better buy on the information that Ive just given you?
More investing news and commentary on MSN Money
Check those PEGs
Start by comparing PEG (price/earnings to growth) ratios. The PEG ratio helps you understand what it is that you are buying. Tsingtao is selling for 32 times projected 2004 earnings per share (the PE part of the PEG ratio) and shows projected long-term growth of 30% for a PEG ratio of about 1.1.
Anheuser-Busch, on the other hand, is selling at just 19 times projected 2004 earnings per share but sports a much lower projected long-term growth rate of just 11% for a PEG ratio of 1.7.
With PEG ratios, lower is better, so why is the market willing to pay so much more for Anheuser-Buschs lower rate of earnings growth? The market is telling us with these numbers that it thinks that the projections for 30% growth at Tsingtao are a whole lot riskier than the projections for 11% growth at Anheuser-Busch. (Remember, Tsingtao is a company that missed its own projections for sales volumes in 2003.)
To decide if youre getting your moneys worth in buying shares of Tsingtao (versus shares of Anheuser-Busch), you have to decide if that discount for risk is too large, too small, or just right.
China has its own special risks
Thats exactly the approach that youd take with any stock, Chinese brewing company or U.S. chip maker or Canadian natural gas producer. But the risk factors you have to throw into the equation are a tad different for China:
- Accounting: Chinese accounting can be a joke.
Even in comparison with all-to-often shoddy U.S. accounting. Chinese companies do not have to adhere to either U.S. or international accounting standards. And Chinese accounting is particularly murky when it comes to dealing with cash flow among the different large investment vehicles that often own big chunks of Chinese companies.
- Industry or sector data: Forget it.
There are very few industrywide organizations in China putting together the kinds of surveys of their members to generate the numbers on sales and sales trends that were used to in the U.S. And the Chinese government hasnt filled the gap.
- Ownership: Who owns the company and whats their agenda?
Something called the Qingdao State-owned Assets Bureau owns 31% of Tsingtao Brewery. Its clearly a governmental investment entity, but that doesnt tell an investor much about what the bureaus goal is in owning a stake in the company. Investors shouldnt assume that these state-owned investment entities are out to maximize profit at the company. Often providing jobs is a more important purpose. According to J.P. Morgan Asia, only about 50% of Tsingtaos 48 breweries turn a profit.
- Management: Whos running the company and how good are they?
I know that the chairman of Tsingtao is Li Gui-Rong, but does an investor know if hes the Andy Grove (or fill in your favorite U.S. CEO) or a bureaucrat who got to run this company because of who he is rather than what he knows?
- Chinas financial markets: Do they work?
How much can an overseas investor understand about the buying and selling trends that periodically roil the prices of stocks that trade on one of Chinas exchanges? For example, someone shorted 50,000 shares of Tsingtao in Hong Kong on the morning of Feb. 3. What did that move mean? Its important too to have at least some understanding of the complex current state of the Chinese equity markets in which shares can be offered as A and B shares in the Shanghai and Shenzhen exchanges, on the Hong Kong Exchange, or as American Depositary Receipts (ADRs) or shares traded in U.S. equity markets.
- The New York factor: How much of China is just Wall Street hype?
How much of the price of any China stock these days is being set by the New York investment banks who know a hot market when they see one? Merrill Lynch estimates that Chinese initial public offerings will raise $15 billion this year. Pricing for some of these issues, driven by overheated demand and a shortage of offerings, has reached levels that should remind investors of the U.S. Internet bubble. Chinese Green, for example, a small Fujian-based vegetable producer, set out to raise $24.8 million in a Hong Kong offering that was so oversubscribed that the company could have raised $4 billion if it had sold shares to meet the total demand.
Given the risks of China in general, the average Chinese stock should sell at a discount to the stock of a well-run, established company such as Anheuser-Busch. Thats the historical relationship between equities in developed and emerging markets, and its still true for most emerging markets, where the average trailing 12-month price-to-earnings ratio is just 15.
How much of a discount depends on how many of these risk factors apply to a specific stock.
A risk reducer for Tsingtao: Anheuser-Busch buys in
Anheuser-Busch has bought what will be by 2010 a 27% ownership position in Tsingtao Brewery. That deal gives Anheuser-Busch representation on the Tsingtao board and on key board committees including Strategy and Investment, Audit and Finance, Human Resources, and Corporate Governance.
Does that guarantee that Tsingtao will shut unprofitable breweries as quickly as an investor with an eye on the bottom line would like? Absolutely not. One shouldnt underestimate the importance that the Chinese government puts on keeping its people working. But it certainly does mean that someone at Tsingtao will be keeping track of the same profit and loss numbers that are of critical interest to outside investors.
Anheuser-Busch has put real money into Tsingtao. Its stake in the company that was started in 1903 by German business interests operating in eastern Chinese city of Qingdao will cost it about $180 million in all. That should give an individual investor some faith that the U.S. company has done its due diligence. (It also doesnt hurt to know that U.S. mutual fund giants Franklin Resources and Templeton Asset Management owned 2.4% and 2.3% of Tsingtao shares as of Jan. 31, 2003. The company has passed their due diligence tests.)
A final bit of risk reduction may come later this year if, as rumored, Tsingtao lists ADRs on the New York Stock Exchange. That would mark a big step up in disclosure from that now provided by the companys ADRs that trade on the over-the-counter market. ADRS listed on a U.S. exchange provide financials that have been reconciled to U.S. Generally Accepted Accounting Principles (GAAP) and the U.S. Securities and Exchange Commission regulates the companys disclosure of investor information. (OTC-traded ADRs do not require accounting conformity to U.S. standards, and the SEC does not mandate regular communication with shareholders.)
Details like these help reduce the risk gap. But, in the case of Tsingtao, they dont close it enough for me to make up for the stocks current high price to earnings ratio. Id rather wait for the inevitable bust that regularly follows the boom cycle in an emerging market. Were clearly in a boom period for Chinese stocks right now, and there will be a bust as surely as day follows night. But no one can tell you with any accuracy when it will begin. Given the risks that I cant eliminate, Id simply like Tsingtao to be cheaper.
Invest in China at the edges
In cases where you cant reduce the risk gap to acceptable levels, you dont have to give up on China entirely. Instead you can adopt a strategy of investing from the edges by buying U.S. or other established companies that are doing business with China or selling into the Chinese market. For example, you could decide to buy shares in iron-ore producers Rio Tinto (RTP, news, msgs) or Companhia Vale do Rio Doce (RIO, news, msgs) as a way to profit from Chinas growing demand for iron and steel without exposing yourself to the risks that Ive laid out.
Theres no hard and fast rule, and no quick and easy way to make investment decisions like this. Case by case is the way to go if you want to profit from the rise of China but dont want to simply throw your money at todays hot story.
If you have trouble sticking to that kind of discipline in this very volatile merging market, just remind yourself that on Feb. 3, shares of Chinese Internet company Sohu.com (SOHU, news, msgs) dropped 20% when the company missed revenue projections by a mere 4%.
That example should be enough to keep any investor focused.
New developments on past columns
10 stocks for a changed planet
SanDisk (SNDK, news, msgs) fell to support on Feb. 2 and then just kept on going down on Feb. 3, falling almost 10% that day. The catalyst was news that South Koreans Hynix Semiconductor would start mass production of flash memory chips. That news had been expected since the company had signed a joint venture agreement late last year with STMicroelectronics (STM, news, msgs) to develop flash memory. But with the sector already in retreat on announcements from SanDisk and Lexar Media (LEXR, news, msgs) warning Wall Street to expect lower margins in the first quarter of 2004, this news was all it took. Im still looking to buy SanDisk, but the stock now has the potential to become a falling knife, and Id like to see some signs that the shares have found support before I add it to Jubaks Picks.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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