Here at StreetAuthority, we don't talk about Chinese stocks very
much. They've proven too risky, and more than a few have blown up
in the face of major
scandals. In short,
the risk usually seems to outweigh the reward
when it comes to investing in the world's fastest-growing major
Yet I've been watching one stock, quarter after quarter, and I'm
now increasingly convinced that it's not just another Chinese house
of cards waiting to topple over. It has solid auditors that have
been in place for quite some time, has been steadily growing for
many years, and just as important, is now quite inexpensive.
I'm talking about
7 Days Group (NYSE:
, which is one of the leading hotel brands in mainland China.
Chinese tourism has exploded during the past five years, and this
company has the numbers to prove it. And though Chinese domestic
tourism is booming, it's still in the early innings. Consider that
there are currently 0.5 hotel rooms per 1,000 people in China,
compared with 2.5 rooms per citizen in the United States.
The industry is led by
Home Inns & Hotels Management (Nasdaq:
with roughly 16%
. 7 Days is the second-largest player with 9%, and Jin Jiang
China Lodging (Nasdaq:
and Motai round out the top five. The industry is heavily
concentrated in the Beijing and Shanghai regions, and further
expansion is expected to come from major cities in the country's
interior. 7 Days has rapidly expanded during the past five years,
and now owns, leases or manages 2,000 hotels in roughly 150 cities.
7 Days focuses on the economy end of the lodging
, catering to Chinese consumers that have only recently entered the
middle class and are just beginning to travel, primarily to
domestic destinations. It's also become an increasingly popular
choice for other travelers as the Chinese economy has slowed.
"Business and leisure travelers with increasingly tight budgets
have switched out from 3- and 4-star hotels. This makes the
[economy segment] particularly more attractive than the general
lodging industry," note analysts at Brean Murray.
7 Days differentiates itself by seeking out locations close to --
but not inside -- the prime
of a particular city. That lowers development and operating costs,
enabling it to pursue aggressive pricing. It also spends less than
others on advertising or travel agents, instead capturing consumers
through its website, which is the leading hotel site in China.
The company's growth has mirrored the expansion of the Chinese
tourism sector, as sales grew from $40 million in 2007 to more than
$300 million in 2011. Yet, as that sales base expands, robust
growth will be harder to achieve. Analysts expect sales to grow 30%
in 2012 to above $400 million, and less than 25% in 2013 to just
above $500 million. That slowing growth may be what scared off
have fallen from the low $20s in early 2011 to around $8.50.
Management now appears more committed to expanding the
than before, slowly migrating the base of hotels from company-owned
to franchises. This "
light" approach is expected to boost
margins from the historical rate in the high teens to the low 20s
this year, and perhaps the mid-20s by mid-decade. Looking ahead to
2013, analysts expect operating profits to expand roughly 45%, or
nearly twice the rate of sales growth.
The move to a franchising model should also free up cash, which
management intends to use in a share buyback. The current $25
million buyback authorization should shrink the share count by
around 5%, though management may expand that program when
second-quarter results are released in early August.
The buyback comes at a good time. Shares are trading for less than
five times projected 2012 EBITDA and less than four times projected
2013 EBITDA, according to Brean Murray. The firm stands by its $25
, representing nearly 200% upside, even as other investors have
cooled on Chinese stocks in general, and lodging stocks in
Risks to Consider:
Chinese stocks like this have been slumping badly in
anticipation of further economic weakness in China in the quarters
ahead. Recent stimulus moves by the government may blunt those
Action to Take -->
Brean Murray's $25 price target reflects a world where investors
embrace Chinese stocks and few are concerned about the possible
fallout from a slowing Chinese economy. Still, this stock looks
quite undervalued, and a move back to the upper teens seems quite
realistic once 7 Day's transition to more franchised hotels starts
to boost its
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.