Shutterstock photo

3 Plays on the Fastest Growing Industry in China

Shutterstock photo

Shutterstock photo

The health care industry has been on a steady growth path for nearly two decades. That's been good news for investors who have enjoyed almost non-stop gains from the sector. But now, cost pressures are now putting heat on the sector and gains have been much harder to come by. In contrast, the party's just beginning for China...

Chinese health care is far earlier on the growth curve and appears to have a long growth path ahead of itself. Chinese per-capita spending on health care is the lowest of any of the 20 largest global economies. Off that low base, key companies look set to grow at a double-digit clip for a number of years to come and offer investors the same consistent gains once offered by American healthcare stocks.

Here are three companies I've found that appear nicely positioned to capitalize on that trend.

1. American Oriental Bioengineering (AMEX: AOB )

Growing through acquisitions can be winning strategy if it helps a company develop a broad and compelling set of products. That was the plan for this purveyor of plant-based drugs and neutraceuticals. Chinese consumers greatly prefer traditional organic remedies, some of which go back more than one thousand years. AOB hoped to become the leading seller of these traditional remedies. Sales grew from just $32 million in 2004 to more than $250 million by 2008. That helped pushshares above $10 a few years ago.

But as the company grew, a major flaw appeared: ABO's acquisition spree was taking it into ever-lowerprofit margin niches. EBITDA margins that had been around 35% likely fell down to 20% in 2010.Earnings per share ( EPS ) looks to have fallen by half in 2010 to around $0.26. Roughly half of the company's deals have worked out well, and the other half have been disappointing. Sensing the company had been pursuing "growth for growth's sake," investors have fled and shares now trade for around $2.40. The luster of this high-growthbusiness model has surely dimmed, but shares now look quite oversold.

Chastened from its buying spree, management now plans to generate organic growth by expanding its national footprint and improving theproductivity of its distribution network. Those efforts are starting tobear fruit. In the third quarter of 2010, sales rose 16%, the highest organic growth rate in several years. In fact, all three operating divisions (pharmaceuticals, nutraceuticals and distribution) saw sales rise at least 10% from a year earlier. But profit margins are lower than a year earlier, which explains the downturn in profits. Margins now appear to have stabilized, soEPS is expected to rise roughly 20% in 2011 (to $0.31) on a projected 12% increase in sales. Current R&D efforts are focusing on improving the efficacy of AOB's existing products -- money likely better spent than yet another acquisition.

Meanwhile, $92 million in cash holdings accounts for more than half of the company'smarket value , and shares trade at about 60% of tangiblebook value . Back out that cash, and shares trade for less than five times projected 2011cash flow . Shares look capable of rising roughly 40% to the $3.50-$4 range, assuming AOB can continue to generate the more stable results in posted in the third quarter of 2010. (Fourth quarter results will likely be released in about a month.)

2. Concord Medical (NYSE: CCM )

Here's a sobering stat: Nearly 3 million people in China are diagnosed with cancer every year, and nearly 2 million people die from the disease annually. Early detection remains the key factor behind whether someone can survive cancer and this company aims to play a big role.

Concord operates more than 100 radiotherapy and diagnostic centers throughout China, with plans to open another 100 during the next five years. Analysts at Brean Murray expect the diagnostic industry to double in size by 2015, driven by wider medical insurance coverage for many middle-class Chinese citizens.

Shares look to have 15% to 20% upside if you look at current trends. But shares likely have significantly more upside for patient investors wanting to ride out the company's five-year growth plan. This $7.50 stock could hit $9 in a year, but I look for it to move past $12 in a few years as EPS rises up to $1 by 2013.

3. China Jo-Jo Drugstores (Nasdaq: CJJD )

This is a micro-cap stock and may not appeal to everyone. China Jo-Jo aims to become the "CVS of China," though it currently operates less than 50 retail pharmacies, with plans to grow the base to 75 by 2012. The company sells both traditional herbal remedies and modern pharmaceuticals, along with other wares typically found at a drug store. Each store has a licensed physician on-site, paving the way for China Jo-Jo to start bolting urgent care facilities onto each of its drug stores.

Despite high levels of staffing, it's a very profitable business, with gross margins exceeding 50% and operating margins exceeding 20%. Each of those metrics is roughly twice as high as what U.S.-based drug stores typically post. That said, as the company grows, margins are likely to come down to a moderate extent as the company opens stores in more competitive areas. Shares, which trade for less than half of the 52-week high, look quite cheap at around four times projected fiscal (March) 2012 profit forecasts.

Action to Take --> Each of these three stocks represents a unique growth and risk profile, so the most appealing name for you depends on your risk tolerance. Concord Medical appears to be the most solid business model , though it will likely take several years for shares to rise by a significant amount. American Oriental Bioengineering and China Jo-Jo Drugs are more speculative, but look significantly undervalued.

-- David Sterman

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story


Other Topics