China Nepstar

***********READ THIS WARNING!**************
This is a post I wrote this morning, before listening to the first quarter's conference call and reading the quarter's financial report. I now take back what I am about to say. I think it's important to post this for everyone to see, because I was wrong. I was blinded by what I thought was a sure thing, but I want everyone to search for where I went wrong. Feel free to post a comment if you figure it out.
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China Nepstar Chain Drugstore, Ltd. (NYSE:NPD) is trading at $4.45 a share and, in my most humble of opinions, that's cheap.

China Nepstar is the CVS of China. They operate 2,907 of China's 315,000 drugstores (as of December 31, 2008) and that makes them the largest direct operator in China. So just like hog producers, pharmacies operate in an extremely fragmented market. The largest chain of drugstores is just 0.8% of the market. Not 8%, but 0.8%.

I'm not actually recommending China Nepstar, because I would feel terrible if I told anyone to buy a stock and it lost money. All I'm saying is that when Monday comes, I'm probably going to buy a bunch of it.

I have a legal pad in front of me and I just made a long list of reasons why I like this stock and a list of questions I have about the future. I'll get to that in a minute, but here's what is most important:

This is a chart of Nepstar's sales in the past 3 years. Sales growth in 2007 was 12.8%, and in 2008 it was 22.6%. Now, China won't grow in 2009 like it did in 2008 or 2007, but it's NOT shrinking. The economies of the US and the rest of the industrialized world are shrinking, China's is not. I don't know what revenues will look like in 2009, but my instinct is that they'll be higher than 2008's. So consider this:

This is a graph of Nepstar's net income for the same years. Net Income as a percentage of revenue was 0.8% in 2006, 7.6% in 2007, and 8.1% in 2008. Net income as a percentage of revenue is increasing. Even if you assume Nepstar will be no more profitable in 2009 than it was in 2008, income will still rise if revenue does. Nepstar's shares are currently trading at $4.45, implying a market cap of $463.45 million. According to Google Finance, the P/E ratio is 19.72. If you divide the market cap by the P/E ratio, you get expected earnings for 2009. The implied earnings are then $23.5 million (159 million CNY) . I included this number in the graph above as 2009's net income. Now, (as Barack Obama likes to say) let me be clear: the stock market currently thinks income in 2009 is going to be that much lower than 2008's. China is projected to grow at 7.2% this year. Nepstar has no debt, $175 million in cash and equivalents, plenty of growth opportunities, and it's revenues and net income are rising. The stock market is projecting a reduction in net income by 17%. If you think Nepstar WON'T shrink by that much, then the stock is currently cheap and you just have to wait for everyone else to figure that out.

I think this will jump 30% in the immediate future (it was trading at $5.81 a month ago), but then go much higher as we get some sense of what revenue and income look like. Obviously we're talking about a Chinese company though, so the risks are redonkeylips. I can't even imagine what could go wrong with this company in the next year.

Again, anyone who buys a stock on someone else's recommendation without even reading the 10-K (or 20-F in this case) is a buffoon.