Following months of intense pandemic restrictions, China’s “zero COVID” policy forced residents to isolate themselves at home, the masses were quarantined, and business operations halted.
The sacrifices made by residents and businesses in some of the world’s biggest hubs like Shanghai and Beijing are finally seeing some reprieve.
As we look at the decline in international markets like China, investors willing to take some risks when others are fearful may see the benefits. As I recently wrote in Diamonds In The Rough: 3 Top Emerging Market Stocks, international stocks have been struggling under inflationary and recessionary pressures. Over the last year, Chinese markets have sold off by more than 27%. These selloffs have created labor shortages throughout the nation and affected global shipping and supply chains around the globe. Finding good stocks in emerging markets can require some digging. Seeking Alpha offers tools to create your own stock screeners to deliver investors’ the names of fundamentally sound companies in some of the biggest developing nations. I used these screens to identify these stocks. Based on our quant ratings, I have selected three Chinese companies with Buy recommendations to consider diversifying a portfolio.
Investing In The China Reopening
Any company domiciled in China has sustaining political risks. One of the biggest risks involved China’s poor healthcare system – the Achilles heel for reopening – forcing China to have multiple countrywide shutdowns given the lack of access to adequate healthcare to fight the pandemic. These impacts were felt around the globe, given the shortages in the Chinese labor market, demand, and global supply chains.
Politics, government regulations, and transparency are other concerns for investors. China has a reputation for falsifying data reports that call into question the integrity of company financials. In addition, the government-imposed restrictions, censorship, etc., have all posed challenges and concerns for investors. Take, for instance, Alibaba’s (BABA) intended IPO of Ant Group was held up by Chinese regulators. Or the gaming limitations and pandemic controls placed on Tencent Holdings Limited (OTCPK:TCEHY) and other institutions pose risks to investors investing in any Chinese company. Now my point is not to discourage investors from considering companies in China. I merely want to outline some potential risks and emphasize that the key is performing due diligence and looking for companies with strong fundamentals.
Chinese markets have been down more than 27% over the last year compared to the S&P 500, which was down more than 10%. Many of the risks and concerns highlighted above have been discounted, as seen by China’s equity market underperforming the U.S. benchmark over this 52-week period. However, more recently, as the government’s easing rears its head in China, its markets have rallied. This trend started in mid-June as reported by SA News, Alibaba, JD.com rise as sentiment towards Chinese tech begins to steady. As evidenced in the below chart, the MCHI is now outperforming the SPY on a year-to-date basis.
MCHI Vs. SPY Year-To-Date Performance
Following last week’s news that China is considering a $220B stimulus to boost its economy, several Chinese stocks performed favorably, including two of our picks, JD.com (NASDAQ:JD) and Baidu (NASDAQ:BIDU). China would allow local governments to sell up to $220B in bonds, the first time bonds would be sold before the start of the year. I see this as an opportunity that could prove favorable. For now, I believe looking into sectors that rallied during the last several weeks in the U.S. post-stimulus, like growth and some cyclical consumer-driven sectors post-COVID – and some tech – at their current valuations could prove beneficial. JD and BIDU are well off of their 52-week highs. The tide could be turning for these stocks as all three have outperformed the S&P 500 over the last 4 weeks. With a focus on core metrics, fundamentals, and solid balance sheets, my three stock picks experience some great returns for portfolios.
3 Chinese Stocks To Buy
China is known for its advanced tech industries and varying products and services. As its economy begins to recover from strict lockdowns, we believe three Chinese stocks stand to benefit from the nation’s reopening that may be worth considering for a portfolio. Check out these three stock picks.
1. JD.com, Inc. (JD)
- Market Capitalization: $98.90B
- Quant Rating: Buy
- Quant Sector Ranking (as of 7/8): 67 out of 527
- Quant Industry Ranking (as of 7/8): 1 out of 61
Headquartered in Beijing, China, JD.com, Inc. is the must-needed supply chain-based technology and logistics company offering various products and marketplace services. It develops, owns, and manages logistics facilities. The company has a healthy balance sheet with more than $7.3B cash on hand and significant year-over-year cash flow growth. Compared to other big-name Chinese companies like Alibaba and Tencent Holdings, its business outperforms. Following signs of increasing revenue last Thursday, JD stock rallied as much as 3%. Despite a less than ideal D Valuation grade, some of the underlying valuation metrics coupled with stellar momentum grades indicate this stock is a solid buy.
JD Valuation & Momentum
Like many Chinese companies, JD.com felt the effects of extended lockdowns and negative sentiments surrounding companies abroad. While JD’s stock price comes at a premium, forward EV/Sales of 0.52x indicate a -50.89% discount compared to its peers. Its B- forward Price/Sales are also solid, with a near 30% difference to the sector.
As we look at the stock’s momentum grade and quarterly price performance, JD outperforms peers quarterly, with six- and nine-month price-performance nearly 4x and 2x (respectively) better than the sector median. Although the stock’s price is -6.47% YTD and JD.com is likely to continue facing headwinds given geopolitical factors, the company continues to increase its customer base, sales, and thus revenue year-over-year. Based on the most recent earnings report and potential business ramp-up amid China’s reopening, JD could see tremendous growth and profitability.
JD Growth & Profitability
The May kickoff of JD.com’s annual shopping festival known as 618 Grand Promotion proved successful. Although industry trends indicate that retail e-commerce sales in China have flattened over the last few years, JD continues to experience high growth, including JD’s logistics CAGR of 6% forecasted from 2021 to 2026.
JD possesses diversified income streams that include e-commerce, logistics, and technology.
- JD E-commerce – The largest online retailer in China and leading one-stop e-commerce platform, JD is a Fortune Global 500 company.
- JD Logistics – As of March 31, 2022, JD.com operates more than 40 of Asia’s largest and most automated smart fulfillment logistics centers. Using advanced technologies, JD has achieved top rates of fulfillment of nearly 90%.
- JD Technology – Through industry-leading innovative retail supply chain technologies, JD.com is at the forefront of robotics and automation, offering the first drone commercial deliveries and unmanned vehicles. AI and machine learning tools are at the forefront of their desire to bring smart logistics to customers.
As showcased in the recent earnings report, JD beat both top-and bottom-line results. With an EPS of $0.38 beating by $0.13 and revenue of $35.58B beating by $850.74M (12.69% YoY), these figures indicate that JD customers are using the platform, and the firm is experiencing higher user growth.
“China’s Internet industry is entering a more mature development stage going forward as we optimize and expand our omnichannel ecosystem and we continue to expand and meet the diversity of our users, creating long-term user value…We are proud that JD’s supply chain capabilities and the business model have proven themselves valuable in the fight against the epidemic…In the future, we will continue to optimize overall operating efficiency and drive a sustainable high-quality growth with healthy cash flow and profitability” –Lei Xu, JD.com CEO.
In addition to steady profits for Q1 2022, JD’s executive team plans to focus on optimizing operations and creating a better customer structure.
Regarding profitability, some of the conventional metrics for the twelve-month trailing are underwhelming compared to the sector. With this in mind, as mentioned above, the company possesses $7.31 Billion in Cash from Operations. In this environment, ‘Cash is King’. Given the chip shortages and price increases that have affected some of their tech categories, the reopening of warehouses and fulfillment facilities, and the success of the 618 Grade Promotion, JD stands to see improving results, which is why the Seeking Alpha quant ratings support this stock as a buy.
2. Baidu (BIDU)
- Market Capitalization: $51.55B
- Quant Rating: Buy
- Quant Sector Ranking (as of 7/8): 18 out of 248
- Quant Industry Ranking (as of 7/8): 4 out of 60
Stringent regulations and policies have created hurdles to limit the number of Chinese stocks, particularly those in the tech sector like Baidu. Those limitations have caused their stocks to fall, and now with reopening and other tailwinds, I believe these stocks may be positioned to gain.
With recessionary fears and geopolitical uncertainty surrounding China, the announcement of a potential $220B stimulus came right on time, prompting Baidu’s stock to jump for joy last Thursday. The downturn experienced by many tech giants due to a crackdown on Chinese technology has created some concerns for investors. Baidu is a tech giant whose core online advertising business (79%) generates the bulk of its revenue. Baidu offers internet search services and an online community via Baidu Core and iQIYI segments. Experiencing a one-year price decline of more than 13%, Baidu has recently undergone an up-trend. Heavily investing in Ai and autonomous vehicles, Baidu may be a stock for the future.
BIDU Valuation & Momentum
Although BIDU’s C- valuation is not ideal and underlying metrics come at a bit of a premium, the stock is still trading well below its 52-week high and possesses tailwinds for upside potential in line with A+ momentum.
As you can see from the momentum grades, BIDU’s price performance significantly outperforms its peers on a quarterly basis. As Seeking Alpha contributor Chen Yang writes:
“Baidu’s valuation multiple is low. However, in the next three years, I estimate that both AI Cloud and autonomous driving business will grow exponentially. In 2024, non-ad business could take 50% of total core revenue. Cloud business could take ~28% (46% CAGR), the rest (Apollo, Jidu, Xiaodu, Kunlun) could provide the remaining 22%…By that time, Baidu will have a higher valuation multiple due to more tech components. The best trading strategy is to hold it.”
In addition to diversified revenue streams, this stock showcases a solid growth and profitability outlook.
BIDU Growth & Profitability
With a fast-growing cloud business and digital advertising segment, BIDU has continued to beat earnings estimates, despite a slowdown attributed to the pandemic, regulatory concerns, and its streaming video service iQIYI, which Baidu is rumored to be sold for $7B. Baidu holds a majority share of iQIYI that amounts to 53%, which it says is no longer part of its core business.
For 2022 Q1, the Baidu App MAU grew 13%, substantially higher than the 2% growth of mobile users. Beating top-and bottom-line earnings, EPS of $1.67 beat by $0.83, and revenue of $4.22B beat by $58.95M.
With substantial dry powder ($2.82B) to invest in Ai and technology, Baidu’s cloud technology has grown 45% year-over-year plus seen a 35% increase in non-online marketing revenue +850M for Q1.
“We see great opportunities to use technology to accelerate the development of the real economy. Organizations in various sectors, such as energy and utilities, manufacturing, finance, and the public sector, have come to realize that not only they need digitize what they do, they can also use all kinds of AI technologies to enhance their competitiveness through cost reduction and efficiency improvement. So the demand for digitization and AI come at the same time. That presents a unique opportunity for us to deliver Baidu AI Cloud solutions in a seamless way” –Robin Li, Co-Founder & CEO of Baidu.
Baidu is in a growing sector that looks to the future and is attempting to scale while cutting costs successfully. Although uncertainty surrounds this tech leader, given regulatory headwinds and competitors like Alibaba and Tencent in its space, BIDU’s R&D, dominant user base, and ecosystem successfully focused on mobile applications should serve as a moat. We believe this technology behemoth and our next smaller-scale tech company will be Chinese stocks worth investing in.
3. Daqo New Energy Corp. (NYSE:DQ)
- Market Capitalization: $5.29B
- Quant Rating: Strong Buy
- Quant Sector Ranking (as of 7/8): 1 out of 630
- Quant Industry Ranking (as of 7/8): 1 out of 30
Headquartered in Shanghai, China, and in the business of one of my favorite tech sectors, semiconductors, I’ve written about Daqo New Energy Corp. as a strong Stock For a Terrible Market. The stock is up 90% since the writing of the May 12th article. Still, from a valuation perspective on forward P/E, it remains at a significant 82% discount to the IT sector and a 31% discount to its 5-Year historical average. Daqo is a leading manufacturer and seller of low-cost semiconductor equipment for high-purity solar power solutions. Using polysilicon material, a popular and primary conducting component required by solar products, DQ should stand to benefit from its renewable business, as the company continues to be a leading clean energy company with high record sales, revenue, and earnings. In addition to its industry-leading track record, Daqo’s subsidiary Xinjiang Daqo received approval from the China Securities Regulatory Commission for a private A-share offering to be used for expansion. If that’s not an indicator of potential growth and profits, let’s dive into those metrics.
DQ Growth & Profitability
Considered a hot stock on a solar stocks rally, DQ advancing almost 15% last Thursday and as the frontrunner as solar and clean energy news loved the reports of a China stimulus package. DQ has been operationally sound and one of the top gainers in the semiconductor equipment industry.
With revenue growth of +254% year-over-year, and experiencing an increase in gross margins, the company is poised to continue outperforming the market.
As the push for green energy grows and DQ takes advantage of its low production costs for polysilicon, it can maintain its competitive advantage. Over the last 90 days, seven analysts provided FY1 Up revisions, and record revenues were recorded for Q1 2022.
“We recorded $1.3 billion in revenue, also more than 3x of the revenue for the fourth quarter of 2021, and we recorded operating income of $797 million, net income attributable to Daqo New Energy shareholders of $536 million, earnings per share of $7.17 per share and EBITDA of $827 million, all representing substantial sequential and year-over-year growth,” said Daqo CEO Longgen Zhang
DQ’s high purity polysilicon material is essential in producing solar photovoltaic (PV) technology which converts light into electricity. This genius conversion of light into electricity has enabled Daqo to experience high demand and sales volumes, prompting a ramp-up in production.
Not only has 2022 Q1 resulted in gross profits of $813.6M compared to 2021 Q4 of $118.9M, the gross margins also saw increases attributed to decreased production costs for raw materials and higher demand. With strong free cash flow and cash from operations, it’s no surprise that DQ has plans for continued expansion in various business lines.
“Last year, Daqo set up a roadmap to increase production capacity to 270,000 metric tons MT by the end of 2024, representing a 50% annual growth rate. In Q1, the new Phase 4B production facility was completed. The new facility increased total polysilicon capacity by 35,000 MT. Slight increases in production volume are visible each quarter, which are caused by the ramp-up phase in the latest facility” –Friso Alenus, Seeking Alpha Contributor.
Although the company faces similar risks, including geopolitical and lockdown-related, the overall outlook remains strong for DQ at the current price point.
DQ Valuation & Momentum
Year-to-date, DQ is +75%, and over the last year, +7%. DQ’s collective factor grades are impressive. With A’s nearly all across the board and a valuation severely discounted relative to its peers, this stock is undervalued.
Possessing a forward P/E ratio of 3.69x, DQ trades at more than 82% discount and maintains a PEG (TTM) of -98.18% difference to the sector.
Quarterly, DQ’s price performance outperforms sector peers significantly. Although the risks associated with this company can be a bit off-putting for investors, the stock’s bullish momentum, discounted price, tremendous growth, and profitability are key considerations when investing in this stock. Although these stock picks could face some headwinds, I believe that JD, BIDU, and DQ are 3 Chinese stocks whose buy ratings are justified based on their quant ratings and solid underlying metrics.
Investing In Chinese Stocks
For a number of years, on a political level, tensions between the United States and China have remained heightened. China is a very competitive economic partner to the United States – the key word here being a partner. The depth of the relationship between both countries can be found in trade data from The US-China Business Council. As of 2020, the trade relationship accounts for more than one million American jobs. Accordingly, American companies exported $188 billion in Goods and Services Exports to China. This is a competitive relationship, but it is mutually beneficial to both countries in many ways.
While a bit scary, global market conditions can prove favorable, especially in the three different sectors I’ve chosen. Although YTD the MSCI China is down 11%, it’s begun a rally, outperforming the S&P 500 by more than 7% for the same period. As such, there is an opportunity to capitalize. No risk. No reward! If you’re willing to focus on stocks with solid earnings and growth potential, in times when fear is moving markets, owning stocks with strong investment characteristics and Quant buy recommendations could see the possibility for a strong rebound.