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No. of Recommendations: 29
With the official annual review and earnings season now behind us, I thought we could take a look at our China Rural Boom Basket -- a collection of stocks that has proved to be both popular and successful. I hope you find this helpful, and enjoy.

China Rural Boom Basket: Review

Portfolio and performance
If you acted on our report when it was released, then you took a 5% position in 5 different stocks in the following amounts:

Yongye International (YONG): 2%
China Green Agriculture (CGA): 1%
China Marine Food (CMGO): 0.5%
Coca-Cola (KO): 0.75%
China Mobile (CHL): 0.75%

The good news is that the basket has worked out very well. Here are the returns through COB 11/18/09:
Yongye International (YONG): +93.5%
China Green Agriculture (CGA): +106.1%
China Marine Food (CMGO): +13.3%
Coca-Cola (KO): +15.0%
China Mobile (CHL): -2.4%

Overall, the weighted basket is +61.8%. That puts it 47.9 points ahead of the S&P 500 and 53.4 points ahead of China’s Xinhua 25 Index.

That’s all good news. The only bad news now is that due to recent returns, your boom basket is now overweight in YONG and CGA and underweight in CMFO, KO, and CHL. Here’s how the basket weighting looks today:

Yongye International (YONG): 2.39%
China Green Agriculture (CGA): 1.27%
China Marine Food (CMGO): 0.35%
Coca-Cola (KO): 0.53%
China Mobile (CHL): 0.45%

Looking at those numbers and comparing them to the relative valuations of the stocks and our desire to stay diversified in this segment of the market, I would probably take this opportunity at the end of the year to rebalance the boom basket back into its original weightings with one exception (which I’ll get to below). That’s particularly true for CMFO and CHL, which are now the smallest parts of the basket, but which offer the most compelling valuations. For more on that, see the stock by stock reviews below.

Yongye International
Yongye recently reported strong Q3 results that put them in great shape to achieve their FY09 goal of $95mm in sales. And while non-cash derivative losses on previously granted warrants sunk net income, the company’s stated operating income remained strong. One problem the company continues to have is in its accounts receivable, so its sales have not yet shown up on the cash flow statement. To the company’s credit, they have long held they do most of their collecting in Q4, so this is not something we can check on until they release full year results in Feb. 2010 or so.

Overall, the stock continues to look cheap, and I put fair value at $11 or so using their near-term guidance, a 16% discount rate, and forecasting at 10% of sales based on their plans to expand manufacturing capacity and vertically integrate by acquiring a coal mine and distribution capacity. Please note that this valuation would be revised downward if we begin to see the company’s allowance for doubtful accounts on its receivables creep up. That is a real-risk, which is why rebalancing is a prudent move here. That said, given the valuation and the opportunity, I am more than happy to keep YONG as the largest position within the basket and the fact that we'd rebalance it within the basket doesn't mean it's not a buy if you don't own it.

For more on YONG’s recent earnings report see this thread:

China Green Agriculture
China Green Agriculture also reported a strong quarter (Q1 of FY10) and announced that it had received a VAT exemption on its organic fertilizer. This should add 300 to 500 basis points to operating margins. As I noted in our review issue, I have increased our buy below to $13.50 and have since revised that up to $14 after incorporating the VAT news. That said, the stock is over $15 today, so I would not consider it a buy here. Rather, I would rebalance this back into the original position.

For more on CGA’s recent earnings, see this thread:

China Marine Food
As you probably are aware, China Marine Food was my re-recommendation in our recent review issue, and I continue to consider it the most undervalued stock in this group. That is why I don’t like that it is now the smallest position within the basket. In fact, if the company delivers on its recent 2010 guidance, the stock is worth about $9 per share in my estimate (which makes buying below $6 or even $6.50 look pretty darn appealing). Further, the company continues to execute on its stated goals, recently purchasing the property near Shishi port where they will build a new cold storage facility. Thus, I’d take advantage of this opportunity to not only bring CMFO back to 0.5% of the basket, but ratchet it all the way up to 0.75%.

See the CMFO re-rec here:

For more on the 2010 guidance see here:

Coke has delivered a healthy 15% return since it joined the basket and delivered strong international sales and volume growth in its third quarter -- including 15% growth in China. That said, the stock is not as cheap as it once was and is now trading for 14x EBITDA with a less than 3% dividend yield.

As a result, while we continue to like Coca-Cola as a key part of our rural China thesis, I wouldn’t increase exposure to the stock at this time. Rather, keep it at its current 0.5% weighting.

To read about Coke’s Q3 earnings see here:

China Mobile
China Mobile is down since its inclusion in the boom basket due to market fears that China Unicom and its new iPhone offering will steal market share in major markets such as Beijing and Shanghai. I, however, believe these fears are overblown for two reasons. First, there are already many iPhones in China that have been brought in from Hong Kong and unlocked to run on CHL’s network. Second, the iPhone is selling for more than $1,000 with no service contract in China, which is cost prohibitive for most Chinese consumers and particularly prohibitive for the rural consumers that CHL continues to sign up in droves and that we citied as the reason for CHL’s inclusion in this basket. Thus, our thesis remains well intact and with more than $30b in net cash, a greater than 3% yield, and at less than 5x EBITDA this looks like a pretty good deal. Further, the company’s recent earnings report showed that it continues to hold onto its market share in rural even areas even as competition in urban areas heats up.

So bring this back up to 0.75% of the basket.

For more on CHL’s recent results see here:

The new weightings
All that said, going forward I believe the Boom Basket should look like this:

Yongye International (YONG): 2.0 %
China Green Agriculture (CGA): 1.0%
China Marine Food (CMFO): 0.75%
Coca-Cola (KO): 0.5%
China Mobile (CHL): 0.75%

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