What's the worst feeling in the world for a stock analyst? To watch a stock you were about to tell people to buy rise 25% before you had a chance to tell anybody to buy it.
But that was precisely what happened to our team last week as we were picking stocks for a recent issue of Motley Fool Global Gains. Here's how it went down ...
Your behind-the-scenes look
Although my job is to know China stocks cold, Winner Medical was never one I paid too much attention to. It's an export-oriented manufacturer of medical cloths (used in gauze, gowns, and the like), and I assumed it was a low-margin commodity business that would see its cost advantages erode as the Chinese renminbi, or yuan, inevitably strengthened against other world currencies.
Johnson & Johnson, after all, has the Band-Aid brand locked up, and you as a consumer don't much care about who supplies the materials for generic products as long as the price is right. In other words, we're talking narrow margins, limited growth opportunities, high capital requirements, and no moat. That's any investor's definition of a bad business.
A better idea
What we prefer instead at Global Gains when it comes to China are companies that are serving China's fast-growing domestic market and developing brands along the way that will give them long-term pricing power. Why? Well, just think about how much brand matters in a burgeoning consumer market. Coca-Cola (NYSE: KO) makes sugar water and can still charge more than $1 per can of it, even in some poor parts of China.
Which Chinese companies have learned that lesson well? Success stories in this regard are Chinese travel company Ctrip.com (Nasdaq: CTRP) and China Mobile (NYSE: CHL). Both of these companies are serving fast-growing markets in China, are among the country's best-known brands, and have more than tripled since 2005.
At first glance, Winner Medical doesn't have anything in common with these companies. But as we discovered in investigating the company further, it may soon.
Winner is no loser
To understand Winner's opportunity, you need a little bit of background about recent developments in China's health-care sector. The Chinese government is executing a three-year, $124 billion plan to improve and expand basic health care.
Action items include basic health insurance for 90% of the population by 2011, a nearly $20-per-person annual health subsidy for rural Chinese, 29,000 new rural health clinics, 5,000 rural health centers, 3,700 urban health centers, and 2,000 new county hospitals.
These measures are expected to dramatically increase the demand for health care, and health-care consulting firm Scientia Advisors estimates that China's annual spending on health care will more than triple to $600 billion by 2015.
What this all adds up to is massive increased demand for basic health-care supplies such as sterile gauze and dressing pads, hospital gowns, and doctor facemasks -- all items Winner manufactures and distributes through hospitals, clinics, and retail drug stores in China.
Further, Winner is investing heavily in promoting its brand to Chinese consumers. Finally, the company has patented a new material called PurCotton that not only delivers higher gross margins to the company but also combines the functional benefits of synthetic materials with the lower cost of cotton.
Given these traits, we expect Winner's domestic China business to take off over the next few years, resulting in rapidly rising sales and profits, and we were prepared to recommend the stock to our Global Gains members. Unfortunately, it rose 25% before we were able to do so.
Why not buy it anyway?
While we expect Winner's growth to be impressive, we also expect that it will consume significant amounts of capital -- a suspicion confirmed by the company's recent filing of a $50 million shelf registration.
Further, competition should cause some margin erosion over the long term. As a result, there are limits to what we'll pay to own the stock, and today's price has exceeded that limit.
Finally, there's still a lack of clarity surrounding just how China's health care reform will play out. While pharmaceutical companies such as American Oriental Bioengineering (NYSE: AOB) are betting that hospitals will remain important purchasing points for consumers, for example, companies such as China Nepstar (NYSE: NPD) have been suggesting that the government will revise regulations to give retail drug stores an important new presence in the market.
All in all, there's too much uncertainty here to justify paying a premium price. That's the bad news. The good news is that we now have a promising candidate on our watch list (and one you should add to your list as well). If you're looking for more emerging markets ideas, click here to get a free Global Gains guest membership. There's no obligation to subscribe.
This article was originally published March 11, 2010. It has been updated.
Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of American Oriental Bioengineering. Ctrip.com International is a Motley Fool Hidden Gems recommendation. Coca-Cola is an Inside Value recommendation. Johnson & Johnson and Coca-Cola are Income Investor recommendations. The Fool owns shares of China Mobile and Johnson & Johnson. The Fool's disclosure policy is also a winner.
