Bull Market Starts in China Small Caps: Stock Picker

Investors can get exposure to the Chinese economy with fast growing, small-cap companies with strong balance sheets such as China Metal Recycle and Sinoref Holdings, Brook Mcconnell, president of South Ocean Management, told CNBC.

Photo by: Cory Doctorow

"In the (Chinese) smaller-cap sector we think we’re in the beginning of a multi-year bull market," Mcconnell said.

There are several companies in the steel industry that are very interesting and offer investors a way in to the Chinese market, according to Mcconnell.

China Metal Recycle is one such small-cap, owned by Mcconnell. The company specializes in recycling scrap metal such as used automobiles, which is an industry of growing importance, he said.

Mcconnell points out that the company's first-half 2010 revenue grew 228 percent, while net profit grew 215 percent. China Metal Recycle also has practically no debt and is expanding rapidly, he said.

Sinoref Holdings, a supplier of steel flow control components to steel makers in China, is also on Mcconnell's buy list. The company is newly listed in Hong Kong, he said.

One of South Ocean Management's key holdings is Chaoda Modern Agriculture, which specializes in vegetable production, he said.

"It is growing faster than 20 percent, with 25-30 percent annual compound growth rates, top and bottom line, since its public offering in 2001," Mcconnell said in an email to CNBC.

"Agriculture to me is a huge beneficiary of all the policies in the rural area that the state council is going after," he said.

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MY Medicare is one of the few medical companies selling diagnostic cancer testing in China that owns the intellectual property rights, according to Mcconnell. The company's stock is currently depressed due to a one-off, hit to last year's earnings, he said.

In the consumer sector, Mcconnell owns shares of Oriental Watch, which he thinks offers exposure to the growing consumer market in China.

"There's plenty of purchase power, the Chinese want luxury items," he said.

In the alternative energy sector, Mcconnell is positive on solar-panel and wind-turbine manufacturers in China. He said that if the current level of commitment from the Chinese government toward the sector remains, it will allow the sector to grow strongly.

However, stocks in the sector are currently too high since there is still a question mark over whether government support will remain as strong, he said.

Min Li, head of alternative energy at Yuanta Securities, warned that China's alternative energy plays have already seen an upswing, but said there could still be opportunities.

Even though there may be good growth opportunities in lesser-known Chinese stocks, investors are liable to pay brokerage fees and stamp duties, Mcconnell told CNBC.com. Different U.S. brokerages have different policies on buying Chinese stocks, he said.

Interactive Brokers charges 50 Hong Kong dollars for trading 1,000 shares at 50 Hong Kong dollars per share. That includes exchange and clearing fees, as well as the government stamp duty. Investors would have to take into account the additional cost when calculating profit or loss on any Chinese shares.


- South Ocean Management and Brook Mcconnell own shares in: China Metal Recycle (0773.hk); Sinoref Holdings (1020.hk); MY Medicare (0233.hk); Chaoda Modern Agriculture (0682.hk) and Oriental Watch.