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Migao CEO Guocai Liu
Migao CEO Guocai Liu

Emerging Markets

Looking for bargains in Sino-Forest's shadow Add to ...

Practically every Chinese stock listed in Canada has suffered collateral damage from the recent implosion in the shares of Sino-Forest Corp.

As often happens when an entire market segment takes a drubbing, investors might be unfairly clobbering some companies with promising futures.

As a possible entrant into the latter category, consider the case of Zungui Haixi Corp., a Venture Exchange-listed manufacturer and retailer in China of athletic footwear. It's recently been trading around $2, has about $1 a share in cash on its books, and could earn 43 cents a share this year and 61 cents next, according to an estimate at Mackie Research Capital Corp.

And in a rarity among junior companies, it's even had enough spare cash to finance a modest stock buyback program.

Yet the shares have fallen as much as 25 per cent from their early June reading, even though the shoe maker has little in common with tree company Sino-Forest, except the China factor.

"They're well-placed in a fast-growing industry," contends Robert Cavallo, an analyst at Mackie Research who believes the stock is a steal. In his estimation, Zungui trades at only 3.5 times next year's share profit, an inexpensive price-to-earnings level for a cash-laden company.

But given investor fear over Chinese listings, he doesn't know when the stock might recover. "They're all trading down on the [Sino-Forest]news and they're probably all going to stay in the penalty box for a while," he says of the sector.

In an effort to allay investor suspicions about the company, Mackie has published pictures in a recent report on Zungui showing its Chinese manufacturing plant and retail locations. Mr. Cavallo says he's seen the operations and has a high degree of confidence that its affairs are in order.

Another analyst whose picks have been caught up in the Sino-Forest swoon is Steve Hansen at Raymond James Ltd., a bull on a pair of Chinese agricultural stocks: low calorie sweetener distributor GLG Life Tech Corp., and corn starch manufacturer Asia Bio-Chem Group Corp. They've fallen 36 per cent and 28 per cent respectively since a "buy" recommendation in late April.

Investors may be unfairly punishing the companies. GLG has a major contract to provide sweeteners for Cargill, the U.S.-based agricultural-trading powerhouse. Asia Bio-Chem's starch operations provide ease of due diligence because they're relatively uncomplicated.

"I've been to the different plants in these cases and seen the assets and the product coming in and out," he says, adding that such direct observation "gives us a degree of comfort."

China-phobia has also engulfed fertilizer distributor Migao Corp. Its share price has tanked by nearly half following the announcement in March of a contract to buy Russian potash that involved a $100-million (U.S.) prepayment to receive the crop nutrient over a 10-year period at a discounted price.

Migao says a confidentiality agreement with the supplier, Potash Export Co., prevents it from disclosing more details about the transaction, including Potash Export's ownership structure and resources.

Regaining Investor Confidence

Such non-disclosure doesn't pass the smell test for most investors, and sellers have pummelled the stock for one of the biggest losses in the sector after the approximately 80-per-cent shellacking at Sino-Forest.

Yet the company is trying to win back investor confidence in ways that could ultimately boost the stock. CEO Guocai Liu has pledged his entire holding of about 20 million shares as security to protect the company from losses in the event the potash deal turns out to be dubious. To make doubly sure it's a convincing move, he's deposited his shares at the Toronto office of law firm Goodmans LLP.

Migao has also started a share buyback program for up to 5 per cent of its stock because the selloff is unwarranted, says Jay Hussey, Migao's vice-president of corporate finance. By June 22 the company had picked up 76,900 shares.

In a sign that company insiders think the shares have fallen to inexpensive levels, five officials have recently been picking up stock on the open market, according to INK Research, which tracks such activity. "We're hoping that that shows a strong level of confidence in our operations," says Mr. Hussey, one of the buyers. He picked up 5,000 shares at $4.06.

How to Play China

Not everyone thinks the best approach to China's growth story is trying to figure out which companies might have the best prospects among Canadian-listed stocks.

Jiang Zhang, a former equity research analyst at First Capital Securities Ltd. in Beijing and an investor in Chinese securities, says the Canadian companies are generally small and hard to do due diligence on. His approach: buy shares in big Chinese companies with consumer brand names, or for the more risk-averse, stock in the public floats of Chinese state-controlled enterprises. Both also trade in North America, alongside the more speculative listings common in Canada.

He says investors should stick to such well recognized companies as Baidu, the Chinese version of Google; Sina Corp., a major Web portal firm, and PetroChina, the country's major oil firm.

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