Sometimes stock markets don’t like to look beyond the obvious. After China announced that it will try to buck the global slowdown by pumping money into building work, local infrastructure shares leapt. China Railway Group and China Railway Construction Corporation, the usual suspects whenever investors turn to this sector, posted 20% gains in Hong Kong on the Monday after the news broke.
As often happens, much of the news wasn’t actually that new – China had already committed to spending RMB2trn ($290bn) on railway building over the next few years. What’s more, the firms involved looked fairly expensive already: CRCC is on a forward price/earnings ratio of 25 times and CRG is at 34 times.
Yet it’s easy to see why investors latched on to them. With precious little good news at the moment, a Chinese infrastructure boom is an attractive place to park your money.
I’ve been hunting for a good play on this for a while. But I’d prefer something a little less pricey and where there isn’t so much potential for national interests to clash with shareholder interests. So let’s take a look at one promising contender …
For MoneyWeek Asia stocks, I’m looking for firms that have the potential to be long-term investments. Yes, it’s good if they can get a boost in the short-term from something like a government spending splurge, but they also need to be compelling on their own merits: a company with a good product, a growth market and ideally the possibility of expanding abroad or moving into new sectors.
One small, obscure firm that I like on this score is a US-listed, China-based manufacturer called Jinpan International (NASDAQ:JST). Jinpan makes cast resin transformers. Sounds dull – but its results have been anything but. As you can see in the table below, profits have soared over the last five years.
| 03 | 04 | 05 | 06 | 07 | 08E | |
| Rev ($m) | 33.43 | 42.25 | 53.61 | 82.27 | 119.62 | 155 |
| 26% | 27% | 53% | 45% | 30% | ||
| Net profit ($m) | 3.25 | 3.49 | 4.54 | 7.51 | 16.39 | 20 |
| 7% | 30% | 65% | 118% | 22% | ||
| EPS (c) | 0.5 | 0.53 | 0.68 | 1.12 | 2.03 | 2.45 |
| 6% | 28% | 65 | 81 | 21 |
Clearly cast resin transformers has been a growth industry. But unless you’re an engineer, your first thoughts are likely to be: “Great, but what are they? And why are they making money?”
Jinpan makes a crucial part of the power grid
When power goes from the power station to the end user across the grid, it travels at a number of different voltages. Transformers step the voltage up and down as it moves between the different parts of the network. Jinpan makes medium voltage transformers, which are used to step down power at facilities such as factories and subway stations. The ‘cast resin’ part refers to the way that the transformers are made: it has some safety and maintenance advantages over the older, more widely-used oil-filled technology.
As China has industrialised, electricity demand has exploded and so has the need to build up the country’s power infrastructure. Jinpan’s profits testify to that. But a lot remains to be done. China has six, patchy, fragmented regional grids and the government hopes to unify them into one national grid by 2020. Well before any talk of a stimulus package, the 2006 five-year plan called for RMB1trn ($145bn) investment in the network over the next five years alone.
What’s more, many other parts of the infrastructure programme are highly dependent on electricity – subways, airports and water treatment plants will all need local transformer stations. All told, demand for products like Jinpan’s should remain very strong, especially given Chinese laws that require transformers in many public access buildings to be cast resin types.
But the firm’s not just a China play. While its home market accounts for 85%-90% of sales, it’s expanding rapidly in America, where sales rose 145% in 2007 and should beat that this year. A deal last year to supply the World Trade Center rebuilding project and a recent $6.6m (5% of 2007 sales) order from industrial giant Siemens suggest that it’s beginning to build a solid reputation. Making the Forbes Asia ‘200 best under a billion’ list two years in succession won’t have hurt its international profile either.
With a huge US infrastructure stimulus package looking ever more likely, Jinpan should benefit from two streams of government spending over the next few years. On top of this, there’s the global push for alternative energy and wind power, which should also receive plenty of government funding in years to come. While wind is still a small part of Jinpan’s business, the firm is building a new factory near Shanghai which will focus on producing transformers and reactors for wind power projects, as well as other equipment that it can cross-sell with its transformers.
A strong record, but there are risks
Jinpan has a solid track record, growing earnings every year since it floated in 1998. The balance sheet looks fairly solid, with a bank debt/equity ratio of 23% as of September 2008. You don’t buy a small, fast-growing company for dividends at this stage, but Jinpan has been paying one since 2003 (it yields 1.35% on its current share price), which is encouraging for the long run.
However, while Jinpan looks very promising, it’s clearly a high-risk investment. With a market cap of just $145m, all the usual dangers of investing in small firms apply. Regardless of how good they are, small businesses are often outmuscled by bigger competitors or have difficulty raising cash to expand or get through tough times.
Cashflow can also be a problem, as can making customers pay up. For example, in its third-quarter results, Jinpan reported net profits of $5.2m, but operating cashflow was $0.8m and accounts receivable expanded by $13.5m to $60.3m. There’s nothing surprising about this – small firms with rapidly rising new orders often have to plough all their cashflow into meeting the next set of deliveries – but it’s always important to watch receivables and check that bad debts aren’t ticking up (there are no signs of trouble so far in Jinpan’s case).
Since Jinpan operates in China, there’s political risk as well. Jinpan says it has around 17% of the Chinese cast resin transformer market, making it the second-largest producer. However, many local rivals are state-owned, including both the other big players in the market, and could be favoured for political reasons. That said, Jinpan has won plenty of business from state agencies, doesn’t operate in a politically-sensitive field and seems to be well-regarded in its home province.
Finally, there’s the competition. The transformer market is a tough one and intellectual property advantages are relatively few. Jinpan is clearly competing well on quality and price and beginning to build a good brand, but with industries like this there is an ever-present risk of being undercut, either by local rivals or foreign firms setting up factories in low-cost China. Management will have to execute their marketing, expansion and research and development plans well to stay ahead of the field – so far their performance has been very good.
As you can see from the chart below, Jinpan’s strong results have attracted some attention in the last couple of years and it rose as far $45 a share earlier last year, before tumbling along with anything small or China-related.
The stock now looks very good value: it trades on a forward p/e ratio of just 7.3 times, based on fairly conservative-looking management guidance (no analysts cover this stock at present). While there are certainly risks, at that price the potential returns are equally high – so I rate it a buy.
Jinpan International
Exchange: Nasdaq
Ticker: JST
Price: $18
Market cap: $145m
Turning to the markets…
| Market | Close | 5-day change |
| China (CSI 300) | 1944 | +15.8% |
| Hong Kong (Hang Seng) | 13543 | -4.9% |
| India (sensex) | 9385 | -3.6% |
| Indonesia (JCI) | 1264 | -5.5% |
| Japan (Topix) | 847 | -3.7% |
| Malaysia (KLCI) | 882 | -1.4% |
| Philippines(PSEi) | 1978 | +3.0% |
| Singapore (Straits Times) | 1759 | -5.6% |
| South Korea (KOSPI) | 1088 | -4.1% |
| Taiwan (Taiex) | 430 | -7.3% |
| Thailand (SET) | 352 | -3.8% |
| Vietnam (VN Index) | 352 | -3.8% |
| MSCI Asia | 75 | -4.5% |
| MSCI Asia ex-Japan | 264 | -6.9% |
Asian markets managed small gains on Thursday and Friday, but only China finished the week in the black, buoyed by speculation that the government would set up an RMB800bn ($120bn) fund to buy shares if the Shanghai index fell below 1,500.
Elsewhere, news was generally poor. Fear seemed to be rising in currency markets again, with most Asian currencies falling over the week. Contracts betting on the value of the Indonesian rupiah are again pricing in a substantial devaluation over the next twelve months: they rose to 15,000 IDR/USD, the highest since the crisis began. The rupiah currently trades at 11,850 IDR/USD.
Progress in credit markets also halted during the week. Interbank lending rates remained largely flat after falling steadily for a couple of weeks, while broader measures of credit risk, such as the cost of insuring corporate bonds against default, ticked up slightly.