What's NEXT For China Equities Market as at 01 Sept 2009

Broke 2700 Points!!! …

China's benchmark Shanghai Composite Index may stabilise at around 2,700 points as valuations become more compelling, with any further drop seen prompting officials to take action to prop up the market.
· The 2,700 level is seen as key because it marks the 125-day moving average, the Chinese market definition of a bear market. A fall below that could spur further panic selling after the more than 20% slide in Aug 2009.
· While investors believe the bull run is over in Shanghai, few expect a sustained fall in shares because corporate profits have rebounded this year (2009) along with the surprisingly strong bounce in economic growth.
· Combined Shanghai and Shenzhen A-listed shares are trading at about 25 times forecast earnings for this year (2009) -- a high level but one that is seen as compelling given China's turbo-charged economic growth.
· Forecasts are for Chinese earnings-per-share growth of 22% to 23% this year (2009) and in 2010 compared with historical EPS growth of 35.2%.
· The official Shanghai Securities News reported on Aug 2009 that about half of China's more than 1,600 listed companies that have reported results have seen net profit soar 70% in the second quarter 2009 from the first three months of the year.
· The fall in the stock market is not seen tied to any change of opinion on the economic recovery that saw growth accelerate to a 7.9 percent annual pace in the second quarter 2009, with the latest data prompting economists to upgrade economic forecasts.
· Officials are concerned about the market's sharp retreat. China's three most influential official securities newspapers published bullish comments on Aug 19 2009 and sought to talk up the mood, which is typical in the market's 18-year history.
· Authorities will probably be reluctant to intervene unless the Shanghai Composite falls sharply below 2,500 points in coming weeks (Aug 2009 & Beyond) and they believe panic is starting to grip the market.
· As a first measure, officials would likely try to talk up the economy's strength and the health of corporate profits.
· More serious intervention could involve an announced slowdown in the number of initial public offerings that have started to hit the market in the past month (July 2009) and have been cited as one factor sparking the retreat from a 14-month high earlier in the month (Aug 2009)
· Other intervention could involve China's US$200 billion sovereign fund, China Investment Corp, saying saying it would start buying shares in big state-owned banks, such as Industrial and Commercial Bank of China and Bank of China.
· CIC bought bank shares several times last year (2008) when the market tumbled 65 percent, its biggest yearly drop on record.

Fear of Shanghai Crash Unfounded …

Concerns that the China stock market will crash appear to be unfounded. Why should it? There is ample liquidity in the mainland.

Although the Chinese government is beginning to tighten lending, the republic’s banking sector has lent much more money than projected, with new loans totaling RMB7.73trillion in the first seven months of the year (2009).

Meanwhile, funds keep pouring into China in the form of foreign direct investments. And the fact remains that funds do not flow out of China easily due to strict capital control.

Also, after a 20% fall since Aug 3 2009, China’s stock markets is not that excessively expensive anymore.

For instance, take the valuation figures of the widely used benchmark CSI 300 Index, which tracks the 300 key component stocks listed on Shanghai and Shenzhen stock exchanges. It is trading 30.3 times 2008 earnings, ww.2 times current year (2009) estimated earnings and 18.4 times 2010 earnings.

In comparison, the broader S&P 500 index in the US currently (late Aug 2009) trades at 18.4 times historical earnings, 16.7 times current year (2009) estimated earnings and 13.4 times 2010 earnings.

But given the high expectations of China’s high GDP growth that is projected to hit between 9% and 10% in 2009 and next, the CSI 300’s premium relative to other major intl markets is acceptable.

Taking a deeper look at the CSI 300 index, its top 20 constituent stocks, which have a combined market value of RMB7.2 trillion as at late Aug 2009 and account for over 43.4% weightage of the index, are not excessively priced.

In the top five, BOC (9.23%), China Merchant Bank Co Ltd (3.24%), Ping An Insurance Group Co of China Ltd (3.14%), Citi Securities Co Ltd (2.45%) and China Petroleum & Chemical Corp (2.34%).

To see how the CSI 300 is composed, it is worth nothing that seven of the top 20 weightage stocks are commercial banks. Besides BOC and China Merchants, the other five are Shanghai Pudong Development Bank, Bank Of Communications Industrial Bank Co, China Minsheng Banking, and Industrial and Commercial Bank of China.

Besides the seven commercial banks, two of the top 20 CSI 300 components are in financial services (Ping An and Citic), with three in the steel , aluminium and petroleum sectors. There are two power generation companies, two real estate players, two beverage producers, one railroad operator and a telecommunications company.

While some among the top 20 constituents have high PERs of more than 25 times, it is worth that an average, the seven commercial banks, which collectively command 21.5% of the CSI 300 weightage, are trading 15.46 times of 2008 and 14.43 times current year estimated earnings (2009).

Valuations of banks are considered moderate, given their high loans growth versus the risks in asset quality.

In general, the fact that the composition of CSI 300 is well represented across different sectors and that it is trading at about 22 times 2009 estimated earnings. Shows that its downside is fairly contained from this point (late Aug 2009).

Recent moves by China to open the floodgates for IPOs and its plans to invite foreign listings tend to improve the breath and depth of the stock market, thereby diverting hot money circulating mostly at overpriced lower liners counters and new IPOs.

If the China government is not inclined do divert part of the massive liquidity abroad by relaxing capital control rules, it has to create a bigger pool within with more stock offerings. This will improve the breadth and depth of its stock markets, and enhance their ability to absorb shocks and waves.

Xingquan/MSports … Why Trading Below Their IPO Prices

The two Chinese companies listed in Bursa Malaysia have been trading below their IPO prices, although both recently reported improved earnings.

The entry of both companies into Bursa Malaysia garnered much attention as they provide an avenue for local investors to tap the Chinese market, but investors have yet to respond with confidence to the stocks.

There are many views on why the share price performance and trading volume of the Chinese counters are poor.

One is that their IPOs were overpriced. Industry players familiar with the listing process point out that the pricing was done through a market mechanism and that it is unlikely the stocks were mispriced at the time of the IPO.

Industry observers attributing the poor performance of the counters to a lack of understanding of the Chinese market among local investors.

Malaysian investors do not understand the Chinese market yet. That is why they are still staying on the sidelines.

Their IPO prices were not too high. At a PER of around five times, their IPO prices were quite low compared to the PERs of Malaysian manufacturing companies of about seven to eight times. In Malaysia, we only have a population of 27 million, so our market is quite limited. But in China, the market is much larger for the same manufacturing company. Despite this, the pricing of the Chinese companies were lower than that of Malaysian manufacturers … the investment bankers had no choice because Chinese stocks are new to the market here.

It is not surprising that investors are cautious when it comes to investing in Chinese companies, given reports of fraud at some of those listed Singapore, ranging from missing cash to management using company cash to secure personal credit facilities from Chinese banks.

The rational is that Chinese companies are quite difference from Malaysian companies. The SGX bourse has developed due diligence guidelines through experience. These evolved over time and have been significantly enhanced following reports of fraud in a few Chinese companies.

It is understood that while Malaysia does not have guidelines for foreign listing, the due diligence undertaken by the advisers here is thorough.

Moreover, the drop in the share prices op the two Chinese companies happened at the same time as a correction on the Shanghai Stock market. The fall in the prices of the two shoemakers was likely due to recent (Aug 2009) poor marker sentiment. Their performance of the Chinese market, which has been on a downtrend since early August 2009. If you track back, the price patterns of both these counters have a correlation with trading on the Shnaghai market.

When market improves in China, these two counters should rise in tandem. Both are trading at a PER of four times at the present time (Aug 2009), which is half the PERs of shoemakers listed on the Singapore and HKSEX.

These could be local investors have adopted a cautious stance on the Chinese counters. The two companies may have cheap PERs – way below the market’s PER of 20 times – but investors may still adopt for a cautious approach when it comes to investing in them. This is not because the companies are not good per se … it is believed that it has more to do with the industry they are in. These are challenging times and the industry is facing declining margins and is not monopolistic or oligopolistic in nature. The barriers to entry are also very low.