Three Chinese Firms Poised for Long-Term Success

Investors who follow international markets have found it impossible to ignore China in recent years; the country has grabbed headlines around the world with double-digit economic expansion rates, large-scale urban construction, and a rising influence on global trade. It's no surprise to us that more investors outside of China have started to look closely at opportunities that would enable them to participate in this boom.

Although China's manufacturing industry has attracted the most limelight, it is the service industry that has recently caught our attention. In this article, we outline the two key reasons why investors might find investing in this area an appealing option, and we discuss a handful of Chinese service firms that we like. Currently, none of these firms is a 5-star stock, which means our Morningstar analysts don't think these companies are screaming buys at current stock prices. But we think it's worthwhile to keep them on your radar screen, in case short-term concerns push these stocks to levels near our Consider Buying prices.

Chinese Economy Benefiting Service Providers
As the Chinese economy races ahead on all cylinders, Chinese consumers, especially those in the more-developed coastal areas, have seen their wages double and even triple along the way. Like everyone else, when their wallets start to bulge, these consumers are more willing to splurge a little bit, treating themselves and their loved ones to services such as leisure, travel, and entertainment that they could not have afforded before. This release of pent-up demand has created enormous opportunities for service providers, and those that serve such needs well have been rewarded with impressive revenue and profit growth.

 Ctrip.com International (CTRP)
Moat: Narrow | Price/Fair Value Estimate Ratio*: 1.12 | 2 Stars
Ctrip is the dominant player in the Chinese online travel market. The company differentiates itself by targeting midtier business and frequent leisure travelers, groups that are expanding rapidly but have been traditionally underserved in China. Morningstar analyst Iris Tan believes that impressive execution records, an extensive supplier network, and strong brand recognition should enable Ctrip to further gain from the rapid expansion of China's travel industry.

 Home Inns & Hotels Management 
Moat: None | Price/Fair Value Estimate Ratio*: 0.95 | 3 Stars
Home Inns is an operator of Chinese economy hotels. Catering to middle-class travelers in China, the hotel chain provides comfortable, standardized rooms with amenities such as high-speed Internet access and business centers. The concept has been very successful; the firm's hotels are 95% occupied, and new properties are opening at a rapid rate. Although competition has been heating up, Morningstar analyst Jeremy Glaser thinks the Chinese market is big enough to accommodate several major hotel chains and that Home Inns will be one of them.

 Sina Corporation 
Moat: Narrow | Price/Fair Value Estimate Ratio*: 0.82 | 3 Stars
Sina is one of the most influential Internet media companies in China because of its large user base and substantial Web traffic. The company earns about 70% of its revenue from online advertising, while the rest mainly comes from wireless value-added services. Having earned its reputation as the most attractive online brand advertising destination in China, Sina is well on its way for robust profit growth, according to Tan.

These are just a few examples of service providers that we believe have benefited from wage increases and lifestyle changes of Chinese consumers, and we expect more to emerge as wealth creation spreads to more inland and rural areas, where China has invested billions to foster local industries and create new jobs. As these firms have become indispensable for millions of Chinese seeking a more enjoyable life, their prospects should look attractive for years to come, in our opinion.

Yuan Appreciation Could Help Returns
It's no secret that the Chinese currency, the yuan, has been on the way up. Since the Chinese government depegged the currency against the U.S. dollar in 2005, the yuan has already gained 15%, and we think this upward trend should continue for some time.

We think China needs a stronger yuan to offset the rapid increase in commodity prices in order to tame inflation, which was at a high of 7.1% in January 2008. This was confirmed by a recent monetary report issued by China's central bank on its Web site, which said China will likely accelerate the yuan appreciation to help slow price increases.

Unlike manufactured goods that are traded globally, services are mostly local, so the revenue and profits of Chinese service providers are denominated in the yuan. If the yuan strengthens as we expect, profits from those firms will become more valuable when translated into U.S. dollars. This is how investments in such firms may yield extra returns for our investors.

There's no doubt that many risks and uncertainties still exist when investing in China, a country still transitioning into a vibrant market economy. However, we believe investors can uncover attractive opportunities by sticking to areas that stand to benefit from China's economic transformation for decades. For investors whose time horizon extends past the next quarter, we think Chinese service providers have the potential to deliver solid returns for patient, long-term investors.

*Price/fair value ratios calculated using fair value estimates and closing prices as of Wednesday, Feb. 27, 2008.