Monday, November 5, 2007

Two New Foreign Positions Added Today

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Well it was quite a hectic day today, and the way the indexes ended did obviously not tell the whole story. In continuing the theme of finding global growth stories, I added 2 brand new names to the fund today, one inside China and one outside.

#1) I mentioned Mechel (MTL) this weekend, as one of the stocks with the most prodigious moves of the past quarter. I wrote:

Running over to Yahoo Finance I find a Russian company that "through its subsidiaries, operates as a mining and steel company. The company engages in the production and sale of coking and steam coal concentrate, steam coal, iron ore concentrate, and ferronickel that are used in the production of steel."

If you've been reading the blog for any period of time, you know coal is a big favorite and iron is at a premium and has some pricing security due to 1 year contracts - so it offers more stability than other base metals. And here we have both these in 1 company? As Paris would say: "That's hot." Too bad I missed the last 105% run. But one to put on the radar, further analyze, and look for a pullback. While there is some political risk in investing in anything Russian, it's an interesting play. With estimates of $6.32 for 07 and $7.70 in 08, at $83 it trades at 13x this year's earnings and 11x next year's. Still dirt cheap in comparison to some of the better known mining companies trading at 14-15x this year's earnings. Granted there is some premium associated with being in more stable areas such as Australia or dare I say it "Brazil", but even after this amazing run the stock seems "cheap"? So while many investors love chasing these stories at 52 week highs, I would prefer to enter at a pullback level. On Thursday's severe market drop, Mechel pulled back to its 20 day moving average of $76, only to rebound by Friday to $83, so there was a nice opportunity for a quick 9% pop.

So today the stock pulled back a bit, to $80. Not the perfect entry point and I hope for a larger pullback to $76 (20 day moving average) to get more exposure to the name. But the valuation is solid, and Russia has a good relationship with China so as the need to import coal only grows (energy might become one of the major limiting effects on Chinese growth), Mechel looks to be well positioned. It also gives iron ore exposure which I have been lacking.

Since the stock has run up so much so quickly and I'd prefer a lower entry point, I started with a simple $6K position (75 shares) bought in the $80s. This is a 0.5% position, and I am hoping to see some pullback to add lower. With that said, the valuation (even after this run) is very solid so it is hard to count on a huge pullback.

#2) While the large cap Chinese names (the 'household names' if you will) have run up to valuations and market caps I just cannot get behind, I have been trying to scour the massive list of smaller Chinese stocks (see '51 Other Ways to Invest in China') for companies that have something unique. I have considered a few of the new names on that list in the past (more for personal account than this fund), but have not pulled the trigger. While you could throw ANY Chinese stock out there and say "it will grow, it has to just by demographics alone" - and to some degree that will be true, I'm trying to find names which fill more long lasting niches, especially in the business to business end. After seeing WuXi Pharmatech (WX) on Zach's blog in the past few weeks, this one really struck a chord with me. WuXi is a contract research organization (CRO) for pharma companies - think outsourcing. I have invested for my own personal account in a similar company in Ireland called ICON (ICLR), which if you pull up a 2 year chart only continues to perform year in and year out. There are also a few slower growing US competitors to compare WuXi against.

Instead of reinventing the wheel let me copy over some comments from Zach on this company:
  • Large pharmaceutical companies are facing challenges as the rate of new discoveries has declined and margin pressures are forcing them to reduce costs. As these pressures create headaches for the large producers, they also open opportunities for the young thriving CRO (Contract Research Organization) sector. While many CRO firms operate in the traditional US and European markets, large companies have increasingly been turning to India and China to outsource their research projects. While China is playing catch up to its Indian counterparts, the large supply of labor and lower costs are driving more business to China.
  • Among the handful of CRO firms operating in China, WuXI PharmaTech (WX) is becoming known for its strict compliance to research standards and its high quality work. While the company does not participate directly in official clinical trials, WX completes Research and Development projects and pre-clinical evaluations of drugs and compounds for the major pharma firms. While the company is not the cheapest of the Chinese CRO providers, outsourcing firms still typically save up to 50% of the traditional costs if they had done the same research in western facilities.
  • WX has been successful in landing quality clients, boasting that its client roster includes 19 of the top pharmaceutical and 8 of the top 10 biopharmaceutical companies in the world.
  • WuXi breaks its business down into two divisions. Laboratory services include the research and development on new and developing compounds, and pre-clinical trials on discovered drugs. The second division is manufacturing which makes up a small but rapidly growing portion of revenues. In this division, the company produces drugs that have already been designed and tested.
  • The manufacturing division carries higher margins than the Laboratory Services and is growing at a more rapid rate. At the same time, analysts caution that manufacturing revenue may experience lumpy growth as major orders are filled and delivered and those contracts may not be spread evenly throughout the next several quarters.
So Zach did the heavy lifting and I'd also point readers to a series of solid articles on SeekingAlpha. After IPOing in the upper teens the stock of WuXi has been on a tear with a spike to the $45s in mid October; another spike to $42 just last week, and in the recent pullback in the market, a drop down to its 20 day moving average of $37. This constitutes a 19% pullback from where the stock sat 3 weeks ago, and 12% lower than where it sat last week.

While I'd love to see a price of $32 (50 day moving average), I am sure current shareholders would not :) So I started a position of $12.9K (350 shares) in the $36s. This constitutes a 1.1% position. If the market were to sell off further and WX were to drop to lower $30s this would be an even more interesting opportunity but in general stocks in strong uptrends don't pull back much past their 20 day moving average. So I started a position here.

Wuxi is very expensive at 52x 2008 estimates of $0.71, but it is growing at a 50-70% pace. As Zach said, it has some lumpy revenue growth so the infatuation with 90 day periods on Wall Street could lead to a disappointment (I use that word facetiously) and we might get an even better buying opportunity in an earnings report down the road. But this company hits my sweet spot - it has something going for it above and beyond simple demographics - much like the Indian business outsource companies, it has access to a cheap, educated labor force that Western pharma companies would love to take advantage of in terms of cutting costs.

Long Mechel, WuXi PharmaTech in fund; no personal positions




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