This Chinese Small Cap Should Be On Your Radar

For investors who don't get to spend all day doing research on stocks, it can be hard to do the homework required to find the next big international stock. Allow me to introduce you to one that should be on your radar: Zhongpin (Nasdaq: HOGS  ) , a Chinese pork processor and packager.

What they do
The Chinese consume roughly 50% of the world's pork. Traditionally, Chinese pork has been sold in wet, or open-air, markets. It is kept at the ambient temperature for the consumer to buy, instead of being frozen, as we're used to in the United States. Quite simply, the process of freezing and ensuring sanitization is too expensive for the average vendor.

That's where Zhongpin comes in; you could think of Zhongpin as the Chinese version of Hormel. They package and either chill or freeze pork products to be distributed to vendors throughout eastern China.

An enormous opportunity
Long considered a sleeping giant, the rise of the Chinese middle class has been well-documented. In 2007, Euromonitor reported that the Chinese middle class had grown to 80 million people. What's their prediction for the year 2020? It's 700 million! Yep, you read that right, 700 million. That's an increase of 775% in just 13 years. Even if this prediction overshoots by 100 million, the increase is still astounding.

Zhongpin will profit from this trend for two reasons.

  1. As people move into the middle class with full-time jobs, time will be a more valuable commodity. The ability to have pork, because it's frozen, available at a moment's notice, will help save time.
  2. With the means to obtain food that is certified to be free from diseases, consumers will pay for the added peace of mind.

Why so cheap
Though it's had a recent run-up in price because of diplomatic spats between the U.S. and China, Zhongpin is still cheap. It currently trades for 13 times its trailing earnings, only 9.6 time future earnings, and has a measly PEG ratio of 0.69. Those are minuscule numbers for a company with Zhongpin's potential.

This is due, in large part, to the dangerous nature of small-cap Chinese stocks. It isn't like your average investor can hop in the car and check out the company's factory, or test their products. Allegations of financial dishonesty from companies such as China Marine Food (NYSE: CMFO  ) and -- just this week -- China Green Agriculture (NYSE: CGA  ) make it hard for investors to pay any premium for growth.

Though there's no foolproof way to ensure the same won't happen to Zhongpin, there are signs that the company could be cut from a different cloth. One of the key criticisms of Chinese small caps is the inadequacy of their auditing firms. Though Zhongpin doesn't have a Big Four auditor yet, their investors are pushing in that direction; and RiskMetrics currently identifies Zhongpin's auditing as a low-risk situation.

In the end, no Chinese small cap should garner a large part of your portfolio, but by picking out a solid few, your returns could get supercharged. Zhongpin could be the stock that helps you get there.

For more on Zhongpin:

Fool contributor Brian Stoffel owns shares in China Green Agriculture and Zhongpin. China Green Agriculture is a Motley Fool Global Gains recommendation. The Fool owns shares of China Green Agriculture. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 29, 2010, at 2:50 PM, Gonzhouse wrote:

    I had HOGS during the 2006-2008 timeframe. The same great expectations noted above were present then. The stock didn't do squat: every quarter was a new disappointment.

    How a hog producer in the world's largest hog-consuming nation, both per capita and in total, can continue to underperform is beyond me.

    You have been warned.

  • Report this Comment On October 29, 2010, at 4:02 PM, brewersfan81 wrote:

    @Gonzhouse-

    I don't think the fear from Chinese small caps can be emphasized enough. IMO, time will be the variable that will reveal who the really profitable companies are from those who are just a smoke screen.

    Also, HOGS has had to pay a lot of money to get their business started. Though I'm not worried too much about the debt load that they carry, it can easily scare off a number of investors.

  • Report this Comment On October 30, 2010, at 10:06 PM, 153fish wrote:

    <Though it's had a recent run-up in price because of diplomatic spats between the U.S. and China>

    You are kidding, right? How on earth did you reach that conclusion? China imports basically no pork from the US and Hogs exports very very little. I see no relationship whatsoever there.

    <Also, HOGS has had to pay a lot of money to get their business started> They have been in business a long time, there are no start up costs on their recent income statements. It is capital intensive, but their margins are in line with the industry

  • Report this Comment On November 02, 2010, at 10:29 AM, masokotanga wrote:

    @ Gonzhouse,

    It's too bad that you threw in the towel on an excellent company. I've been a shareholder in HOGS for 3 years now. It's been my best performing holding over the past year, and is the company that I have the most confidence in to continue to execute in the long-term.

    I don't know what sort of underperformance you speak of. In terms of share price alone, HOGS has massively outperformed all the major indexes over the past two years. In terms of fundamentals, earnings per share were $.80 in 2007 and will come in at a minimum of $1.50 this year, and likely around $2.00 next year. These are also high quality earnings backed by good operating cash flow and low DSO.

    The company is growing aggressively, but is managing their balance sheet well. They have issued shares from time to time, but never abused shareholders with massive dilution like many Chinese small caps. Unless something terrible happens, I see HOGS above $30 within the next few years.

  • Report this Comment On November 02, 2010, at 5:05 PM, brewersfan81 wrote:

    @153fish-

    In evaluating the recent leap in price, the two events (the trade disputes and price jump) are correlated. They may not be causational, but the market (especially the Chinese small-cap market) isn't always completely efficient.

    And on the second point, you're right, they didn't just get started. I was instead referencing the high infrastructure costs associated with what they do, as well as the debt load they carry. I should have been more clear.

    Brian Stoffel

  • Report this Comment On November 17, 2010, at 2:52 PM, 153fish wrote:

    <In evaluating the recent leap in price, the two events (the trade disputes and price jump) are correlated. They may not be causational, but...>

    <Though it's had a recent run-up in price because of........>

    So in your world, "because of" means something is correlated to something else, not that it caused it?

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