Investing in undervalued Chinese Stocks while avoiding landmines

US-listed Chinese stocks have seen strong momentum in recent weeks — but investors are still at risk of the many landmines.

One of the top-performing hedge fund managers shares his strategies for avoiding these landmines.

Investing like a local

Liao Maolin returned 30x over the past 5-years in his local Chinese hedge fund (BBG). Now he’s raising more money as valuations of Chinese stocks look increasingly attractive.

• Strategy: Picking undervalued Chinese stocks and avoiding industries targeted by regulators (i.e., internet stocks and real estate developers).
• Stance: Liao is bullish — thinks negative news has been priced in, and policymakers will be less likely to pop bubbles given global uncertainties.

Liao prefers companies in industries like new energy infrastructure (i.e., charging stations), database construction, information security and environmental protection.

Today’s focus: Renewables. China has twice the solar and wind capacity compared to the US — with plans to significantly expand its capacity (BBG). Forecasts also imply a more bullish outlook for Chinese renewables.

China’s big focus on renewables

Allegations of forced labor and human rights abuse in the Xinjiang region hit the Chinese solar industry hard in 2021. This region made ~45% of global polysilicon — a key material in solar panels.

• Biden banned solar imports from 5 Chinese companies, including Daqo New Energy (NYSE:DQ) — a polysilicon producer.
• $DQ fell 62% from its 2021 top alongside other Chinese renewable stocks trading at a fraction from their peaks.

To appeal to the US, Daqo opened up its facility to outside visitors and announced plans to build a second facility in Inner Mongolia. So far, little luck.

After falling 63% from its peak, Daqo is looking undervalued on various metrics with zero debt, strong cash flows and expected 2022 first-quarter sales growth of 75% — along with a 2.5x forward price-to-earnings multiple.

Investors: Performance issues

Contrary to its falling stock price in the past year, Daqo’s earnings have soared from rising polysilicon prices — up 4x in the past two years. But this is likely to reverse over the next two years, with industry experts expecting prices to fall back to historical averages, lowering DQ’s profitability.

Like other Chinese stocks, Daqo was hit by delisting fears — worsened by its US ban.

• A reversal in either of these roadblocks could reverse Daqo’s downward trend.
• China is reportedly making progress in keeping Chinese stocks from being delisted from US exchanges — but it’s far from certain.