American Oriental A Play On China

American Oriental Bioengineering, Inc’s (AOB) second-quarter financials were strong and exceeded our expectations. We expect the company to continue to deliver strong performance in the coming quarters due to relatively high growth in the Traditional Chinese Medicine (TCM) market in China. We maintain our Buy rating on the shares.

The company targets two rather large markets in China: the TCM pharmaceutical market and nutraceutical market. We view AOB as a China play stock and growth story. In the past few years from 2003 and 2007, the company achieved more than impressive top line CAGR of 66.6%. EPS grew from $0.15 in 2003 to $0.60 in 2007, a CAGR of 42.7 percent. Both topline and bottomline continued to grow in the first quarter of 2008.

We believe the company will ride the wave of Chinese economic growth and increased healthcare spending in the next few years. We think American Oriental will also continue to manage its growth through both organically and through acquisition. Although growth in the plant-based nutraceutical sector may level off in the next few years, we believe the company will achieve high growth in the plant-based pharmaceutical sector going forward.

Specifically, we model top line growth (CAGR) of 32.5% from 2008 to 2011, EPS growth will reach 29.7% CAGR. Our price target is $16. The price target corresponds to a P/E ratio of 17.4 x, 11.9x and 11x of our estimated EPS of $0.92, $1.35, and $1.46 for 2008, 2009, and 2010 respectively.

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