Marcial: Jeweler Fuqi, a Gem from China

Jewelry is an ancient piece of Chinese culture, so despite the recent economic downturn, sales in China of such precious items as gold rings, precious stone gems, necklaces, and bracelets have remained robust. Analysts say that last year's strong sales growth of 18% was supported by China's fast economic expansion, which has driven up levels of personal disposable income and increased spending among the growing middle-class population.

Chris Haroun, CEO of Haroun Capital Management, which invests in publicly traded companies in China and other emerging countries, notes that discretionary income in that country grew more than 13% last year, a trend he expects will continue. Jewelry sales should rise by at least 20% annually over the next five years, predicts Haroun.

So how do investors participate in China's thriving $14.9 billion jewelry industry?

One way, says Haroun, is through Fuqi International, China's leading jewelry designer, manufacturer, and wholesaler/retailer, with roughly 2.5% market share. Its stock trades in China as well as on the Nasdaq with the ticker symbol FUQI.

Fuqi went public in the U.S. on Oct. 23, 2007, at 9 a share, and since then has sizzled, rocketing to a 52-week high of 32.68 a share on Sept. 15, 2009. The stock eased to 27 by Oct. 9. Even with such a dramatic rise, Fuqi, figures Haroun, who owns shares, is still way undervalued.

Highly Favored on the Street Fuqi's valuation is "extremely compelling," figures Haroun, as the stock trades at only 11 times his 2010 earnings estimate of $2.50 a share on revenues of $700 million, and $3 for 2011 on sales of $835 million. For 2009, Haroun expects $1.94 a share on sales of $527 million, vs. 2008's $1.32 on $367.6 million.

Other jewelry players, including Tiffany (TIF), Movado Group (MOV), and Blue Nile (NILE), trade at an average price-earnings ratio of 21, notes Haroun. He says Fuqi deserves a higher multiple since its sales grew 150% in 2008. His 12-month price objective: 52 a share.

Based in Shenzhen, China, Fuqi is already highly favored on Wall Street, with five analysts who track it recommending buying the stock. Two rate it a hold, and none rate it a sell.

Fuqi's "strong competence in design, manufacturing, sales, and distribution has enabled it to outperform in good and bad economies, fending off thousands of small competitors," says analyst Echo He of Oppenheimer Holdings (OPY) (it has done banking for Fuqi), who rates the stock outperform. Fuqi is likely to gain further market share and grow faster than the industry over the foreseeable future, says He.

Acquisitions at Attractive Prices Moreover, Fuqi has demonstrated "consistent attractive returns" on invested capital, according to He, who expects high returns to continue because of favorable business trends, an established wholesale business that generates the bulk of sales, and expansion in the retail market. The new focus on retail, says He, should provide potential upside in improved returns, higher profit margins, and brand development.

Equally important in Fuqi's fundamentals, says He, is its strong balance sheet and dedicated management team. Fuqi has about $140 million in cash and $87 million worth of inventory as of June 30. Its healthy balance sheet, argues He, allows the company to take advantage of market downturns to make acquisitions of other jewelers at attractive prices.

With regard to Fuqi's management, He figures its interest is well aligned with investors, as officers and directors own about 48% of the total outstanding shares, including 42% owned by chairman, CEO, and founder Yu Kwai Chong.

China, notes He, is the world's largest market for platinum jewelry, No. 2 in gold jewelry, and one of the biggest in the diamond consumer market along with the U.S. and Japan. Fuqi's core capability in gold products, which account for about 70% to 80% of the company's revenues, says He, is fueled by the Chinese preference for gold as a primary gift of choice in key life events, such as birthdays, weddings, graduations, and anniversaries. Fuqi's competence in the jewelry wholesale business, He says, has enabled it to grow sales despite the economic slowdown, rising 147% in 2008 and 32% in 2009's first half.

Accelerated Counter and Store Openings The retailing of jewelry is expected to significantly boost sales. Fuqi expects to have 100 retail locations by the end of 2009, notes Chenyi Lu, analyst at investment firm Cowen Group (COWN) (it has done banking for Fuqi), who rates the stock outperform. As of June 30, Fuqi has 64 retail counters located in various shops and seven company-owned stores. Lu expects Fuqi to accelerate counter and store openings in the fourth quarter to capture holiday sales at yearend and in the first quarter of 2010. "We visited Fuqi's retail stores in Beijing, and we saw solid traffic and strong business momentum," reports Lu, especially in its gold product lines.

As Fuji expands its retail footprint, "we expect rapid sales growth in the higher-margin retail channel over the next several years," says Jack Murphy, analyst at investment firm William Blair, which has done banking for Fuqi.

In August 2008, Fuqi acquired Temix, an upscale jewelry maker that has 50 retail locations. The purchase of Temix, says Murphy, accelerated the entry of Fuqi into the important tier-one cities of Beijing and Shanghai, expanding its market in those areas.

Large investors in the U.S. are only starting to take notice of Fuqi, but a number of the big institutional investors have started to nibble. Top Fuqi shareholders, according to Bloomberg, include State Street (STT), which owns 102,512 shares; Oak Ridge Investments, with 101,215 shares; Fidelity Management, with 91,400 shares; and Goldman Sachs (GS), with 82,851 shares.

Investors who continue to flock to markets in emerging countries, as well as U.S. investment funds seeking to catch fast-growing companies worldwide, are likely to discover the allure of Fuqi.

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