If You Believe in China, Buy This Stock

Guangshen Railway (NYSE: GSH), the dominant provider of passenger and freight rail services in China's populous Pearl River Delta, quietly released excellent results earlier this week that, had you been following the monthly volumes data the company posts on its website, should have come as no surprise. Revenues overall were up almost 8% thanks to a better than 20% rebound in the company's freight transportation business that the company attributed to a recovering global economy as well as to a revitalized Chinese economy.

The reason why Guangshen's results will track those two broader benchmarks is because the Pearl River Delta is the heart of China's manufacturing shelter. As demand for hard goods ebbs and flows in China and around the world, so too will the number of people and things Guangshen's trains are tasked with shipping in and out of the region.

Will this trend continue?
At a little more than $17 per ADR, the market is claiming that it doesn't expect Guanghen's passenger and freight volume growth to continue. In fact, the current valuation is pricing in little more than zero growth for the next decade according to my estimates. Personally, I don't think that's realistic, but what is realistic is that there will be near-term volatility in the Chinese economy due to the uncertain after-effects of the Chinese government's ongoing efforts to rein in rapidly rising housing prices. Should these issues spill into the banking sector in any significant way, then economic activity in China could suffer quite dramatically.

That appears to be the source of the market's skepticism when it comes to Guangshen, but if you're willing to take a longer-term view of the Chinese economy and expect that, despite volatility, it will continue growing for the next decade or more, then Guangshen shares look like a real bargain today. Just take a look at how the company's valuation compares to some of its peers in the railroad industry:

Data from Capital IQ.

Although these aren't perfect comparisons given the geographic comparisons and Guangshen's somewhat smaller size, the fact remains that its valuation sticks out like a sore thumb among this peer group. To put it all in further context, Berkshire Hathaway paid 9x EBITDA when it acquired Burlington Northern. And while investments in rail networks in Canada and the U.S. aren't without their merits, China is a market with much higher potential despite its potential for greater near-term volatility. That's particularly true when you consider government initiatives to spur domestic consumption, which would be a boon for the growth of the transportation and logistics industries within China.

All told, if you believe in the long-term potential of China's economy, then Guangshen is a buy at these prices. What's more, if the Chinese economy is able to sustain itself for the next six months and Guangshen's freight volumes continue to recover, then the market might reassess its valuation of Guangshen much sooner.