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Best & Worst Chinese Internet Stocks

Five long-term winners & 2 set to crash and burn

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As the volatility in global markets continues — and the price of oil spikes higher — it’s been quite interesting to watch many emerging markets actually rebound.

This was certainly the case with China, as stocks in the FTSE China 25 Index have gained more than 7% in the past two weeks. This resurgence of China stocks off their February lows tells me we may already have seen a short-term bottom in the space. Against this backdrop, several Chinese Internet stocks are exhibiting great relative strength.

As you may know, the Chinese Internet market is the world’s largest — surpassing the U.S. in Internet users in 2008, and now China has a whopping 457 million users — nearly double the U.S. Internet-using population. And the China Internet market has largely been dominated by local Chinese companies.

So why have homegrown Chinese Internet companies beaten global giants such as Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Yahoo (NASDAQ:YHOO)? Well, more than anything else, these incredibly successful U.S. companies failed miserably in China because they tried to replicate their U.S. business model in China — but without tweaking their model to account for local customs and culture.

Looking forward into the near term, I continue to believe that Chinese Internet companies will maintain their lead. Here are five hot Chinese Internet stocks where your research into the sector should begin — and two stocks to avoid.

Chinese Internet Stock #1 – Baidu

Baidu Inc. (NASDAQ: BIDU)

You can’t talk about the Internet in China without mentioning Baidu (NASDAQ:BIDU), a well-known domestic Chinese company that simply dominates the local search market, leaving Google a very distant second player. Baidu recently bought a stake in a real estate listing website to expand (just like Google did in the U.S.) in the country’s rapidly growing real estate sector.

This is a change of strategy for Baidu, which had been focusing on its core business until recently due to the very rapid growth. But, as growth slows due to the law of large numbers, the next five years may look very different on the acquisition front according to management.

The profitability is staggering with operating margins of 50% and returns on equity of 53.3% on a trailing twelve-month basis. The company grew revenue at 94% in the latest quarter, handily beating analyst estimates and sending the share price 10% higher.

Chinese Internet Stock #2 – (NASDAQ:CTRP) is the leading travel service provider for hotel accommodations, airline tickets and tours and corporate travel management in China.

Similar to Baidu, the company is expanding into different ventures. Management just made an investment in Dining Secretary China, a leading provider of free online and offline restaurant reservations.

The company grew revenues 44.4% in 2010 and 33.6% in 2009. Profits grew 57.7% in 2010, after climbing 48.38% in 2009. Those are staggering numbers and yet the stock has done little in the way of market performance. However, CTRP is still the number-one player in the very fragmented Chinese travel market — a market that is seeing absolutely huge growth. For example, according to a recent New York Times story:

  • On average, China’s 1.3 billion people each take just 1.3 trips a year. By 2015 the figure is projected to rise to 3.3.
  • The World Travel and Tourism Council expects the sector in China to expand by an inflation-adjusted 9% a year between 2010 and 2020, the fastest rate in the world.
  • Mainland Chinese made 47 million trips overseas in 2009, a figure that is expected to rise to 54 million this year. By 2015, the government expects 100 million people to venture abroad, making China the world’s biggest outbound tourism market.

So I think that investors fear a slowdown in the Chinese economy driven by policy measures, and they think that CTRP is a cyclical company. However, the slowdown never came in 2010, and growth actually accelerated. At 25 times forward earnings I think the risk of a slowdown in operational performance is more than priced in. Pullbacks here are strong entry points to initiate a position.

Chinese Internet Stock #3 – NetEase (NASDAQ:NTES) is one of China’s leading online gaming companies and web portals. NetEase was established by founder William Ding in 1997 during the dot-com boom as one of China’s early web communities and portals. The company was a pioneer in many web applications such as online auction, portal and email in China.

In recent years, the company has built up a well-rounded online game portfolio and the most comprehensive online community with a leading market share in services such as email, blogs and community portals — not to mention an expansion into microblogging, a product that displays dual characteristics as a media and as a social network — such as the well-known Twitter in the U.S.

These social networks and online communities are hot areas that Wall Street likes right now, and because of all of these catalysts, I believe this company is the best U.S.-listed investment opportunity right now in the Chinese Internet sphere.

The company recently reported a nice beat to expectations for the latest quarter, and the stock popped nicely following the earnings beat. And finally, the company has a very healthy balance sheet with net cash of $1.2 billion exceeding a full quarter of NetEase’s market valuation, making it one of the top-three cash-rich Chinese Internet companies.

Article printed from InvestorPlace Media,

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