Fool Radio Interview: China Stocks on our Radar

On this week's Motley Fool Money radio show, Chris Hill talked all things China with Motley Fool Global Gains Advisor Tim Hanson, fresh back from a trip to China. Below is an edited transcript of that interview.  

Chris Hill: You went to China for a couple of weeks with the other members of the Motley Fool Global Gains team. Give me the headline of your trip, from an investor's standpoint.

Tim Hanson: There were a few questions that we had going into the trip that we were seeking to get answered. The first one was just about the Chinese real estate sector and whether or not that is a bubble or not. I will say our thesis going in was that there were still pockets of opportunity in the real estate sector for going long. The stocks have been crushed by the belief that this housing market is going to come down. Our thought was as you move out into the smaller cities, the less-developed cities, like Xian, Shenzhen, the tier two cities, you can still find some reasonable deals, and that might create opportunity. The consensus though was that even in tier two, tier three, tier nine --- Housing is very expensive in China. So we are still a little bit skeptical of that sector.

Chris: So in terms of Chinese real estate, is there a ripple effect for U.S. investors, other than investing in the stocks themselves?

Tim: Basically what it comes down to is a lot like here in the United States. Any problems in the housing market, because it is so fueled by loans, are going to end up showing up in the banking sector. And when you have problems in the banking sector, you have problems in a lot of other sectors. And so people start defaulting on those loans and you start seeing loans on the banks' books going bad. Banks have capital requirements; they have to have a certain amount of money reserved when banks go bad. It just creates a whole knock-down effect; this is the whole problem we just tried to solve in the United States.

Now it is different in China because all the banks in China are already state-owned and state-operated and so they have some things at their disposal. For example, not too long ago, China Mobile (NYSE: CHL  ) , another state-run corporation, sort of mysteriously bought a $6 billion stake in the Shanghai Pudong Development Bank, and this is a company that had many billions of dollars of cash and it looked like, to our eyes, from the outside, that this was one state-run company being asked by the government to help subsidize another state-run company.

So they have little tricks like that. China's agricultural bank just IPO'd and raised some money to try to recapitalize their balance sheet, so they are trying to head off this problem. China can have a lot of controls over the housing sector. For example, they can dictate what type of housing is allowed to be built on any land that is being developed. So they can say we want you to build affordable housing, and that lowers the cost and maybe they think they can bring the bubble down more slowly. So I think for the Chinese economy overall, it actually may continue to outperform expectations, even if the housing prices decline, but in terms of the housing and building stocks specifically, we are still steering clear of those.

Chris: One of the companies you visited, and this is a stock you have recommended in the past, is China Green Agriculture (NYSE: CGA  ) , and the stock has done really well since you recommended it. Give me a snapshot of that company.

Tim: Well, it is a small fertilizer manufacturer based in Shaanxi province in Xian, central China. They make green fertilizer, compound organic fertilizer, which are sold to small farmers. The reason this is in sort of a sweet spot for China, is because the Chinese government is at the same time, trying to accomplish two things. One, raise rural incomes -- largely farmer incomes -- and they can do that by subsidizing their purchase of food and fertilizer and seeds and that sort of thing. So that is good for sales. The second thing is that China wants to increase its own domestic food production, become food independent, without putting a huge, further tax on the water supply; they have already got a massive pollution problem. So that is China Green's operating sweet spot.

This is another company that suffers from a little bit of credibility gap, even though it has done well since we bought it. We bought it very, very cheap a long time ago, but they have a very questionable auditor that they are saying they are going to improve in the coming year. That was one of the insights we learned during the trip. So that is their opportunity. They have got some problems to solve for, but we continue to be impressed by how they are running their business. And again, if you can find these pockets of opportunity in China, the valuations now are so low that there is a place for them in a diversified portfolio.

Chris: Give me just a couple more stocks that are on your radar as a result of the trip that you took.

Tim: Sure. One of the things that we learned is the economy is reaching a transition point. It has had a great record for 20 years, doing better than 10% GDP growth, but that is built largely on export manufacturing, all the "Made in China" things that Americans and Europeans have purchased. That is changing now as demand for those goods in Europe and the United States has declined, given our sort of economic malaise that we find ourselves in. And China, frankly, doesn't want to be reliant on the rest of the world to fuel its growth anymore.

So what it is trying to do is transition into more of a consumer-driven culture. Chinese people are sitting on a lot of savings. They are hoarders, they have been so for the past five to 10 years, and they are sitting on a lot of money. The Chinese government has done some things to try to make them spend more. They have some new health-care regulations, sort of a new social safety net to make people feel more comfortable about being able to spend. So we think that is going to create an opportunity in the consumer space, particularly with companies that are branding themselves.

An interesting one in that regard is a small Shenzhen-based company called Winner Medical (Nasdaq: WWIN  ) , which previously exported gauze and cotton products to medical suppliers in the United States and Europe and is increasingly trying to transition their business around this brand, Pur-Cotton, which is going to sell cotton products in China and Pure Cotton brand in stores and on the Internet. It is an interesting company and we think it is in an interesting position to play off that move to national branding in China.

Baboons, monkeys, and exports, oh my!
Chris: And one of the things that you wrote about on your trip, you actually constructed a metaphor involving baboons, monkeys and the Chinese economy. Could you explain the connection for the benefit of our listeners who may be skeptical that you could actually pull this one off?

Tim: Sure. I am reading this book about evolutionary biology right now and they were just talking about the way different species evolve, and the author, Melvin Conner, was comparing the vervet monkey to the yellow baboon, and the vervet monkey does very well when things are good because it grows up very fast and it learns just one or two things. If it does those one or two things exceptionally well and learns to feed on just one or two things, it gets big fast. But then when those one or two food sources disappear, as naturally happens in the environment, it gets totally wiped out.

The yellow baboon, on the other hand, takes much longer to grow up, but in doing so learns a lot more about its environment, becomes much more diversified. It learns to feed off of 15 to 20 things, so its population is much more stable, even as the external conditions change.

China over the last 20 years has been more like the vervet monkey than the yellow baboon. It has feasted at the trough of export manufacturing. Going forward, it would much more like to be like the yellow baboon. It would like to have a much more diversified source, or base for its economic growth, so China formerly the vervet monkey, now the yellow baboon. That is the headline.

Get more stock ideas and read more on Tim's trip to China at www.China2010.fool.com

Neither Mac nor Chris nor Tim owns any of the stocks discussed.  Tim Hanson is co-advisor of Motley Fool Global Gains. China Green Agriculture and Winner Medical Group are Motley Fool Global Gains recommendations. The Fool owns shares of China Green Agriculture and China Mobile. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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