By Sonali Verma
Globe Investor Magazine Online, June 17, 2008
Chinese stocks dropped half their value between November 2007 and March 2008. They have since rebounded, but still fell sharply again last week.
Is it wise to dance with the dragon now?
They may well be playing your song, say the experts, citing strong earnings and steady economic growth. But move in slowly because there are concerns over rising interest rates and energy prices – and China still isn’t cheap.
Despite the recent plunge that ended in March, Chinese share prices are still twice as high as they were two years ago. The price-to-earnings ratio for the Hang Seng China Enterprises index was 18.2 in May, compared to 10.2 three years earlier – and a peak of 36.2 in October, 2007.
“I’m less concerned about overvaluation now than I was nine months ago – clearly, Chinese stocks are not as overvalued as they once were,” said Morningstar analyst William Rocco. That said, he adds a note of caution. If you’re relatively new to investing, now might not be the best time to plow money into China, given the volatility. Look instead for a less risky international fund, which is diversified across emerging markets rather than focused on a single country or sector.
Investors who already have well-diversified portfolios should consider investing in China, with a 10- to 15-year horizon, Mr. Rocco added. “Sophisticated investors should dollar-cost average. Put in some minimum amount, do a bit at a time, and move in slowly.”
Patrick Ho, who heads corporate research for UBS Wealth Management in the Asia Pacific, is also concerned about stock prices rising faster than profits.
“One risk factor is valuations, which have continued to increase over the recent weeks but are still substantially more attractive than at the beginning of the year,” he said. “Nonetheless, China is among the more expensive markets in Asia.”
That may mean more rocky times for Chinese stocks. Although the long-term earning outlook for Chinese companies is “solid,” Mr. Ho expects earnings to be revised downward in coming months.
High inflation could mute earnings. China’s May consumer price inflation was 7.7 per cent – well above the government target rate of 4.8 per cent. Prices rose 8.5 per cent in April.
Utilities and retailers should fare well this year because the labour market and consumer sentiment remain strong. China is the world’s fastest-growing economy and home to more than 1.3 billion consumers. Bank earnings rose more than 70 per cent in the first quarter of 2008, when North American banks were hit hard. China recently lowered the corporate tax rate to help domestic companies compete. Infrastructure stocks are bound to prosper as urbanization spreads.
Some strategists are expecting the latter half of the year to be better than the first for Chinese stocks. For instance, Steven Sun of HSBC expects Chinese equities to rise 15 to 18 per cent by the end of the year, while reasonable share valuations and a strong economy will help them even further in the longer term.
What investors should be wary of is oil-sensitive sectors, which are at the mercy of rising energy prices. Earnings per share for the benchmark Morgan Stanley Capital International China index could drop as much as 8 or 9 per cent for every $10 (U.S.)-a-barrel increase in the price of crude oil, HSBC estimates. HSBC lists independent power producers, toll roads and car makers as the most oil-sensitive.
About half of the world’s additional oil demand in 2008 compared with a year ago will come from China, according to the International Energy Agency. Chinese companies are partly cushioned against any oil shock because the government subsidizes prices at the pump by as much as $40 a barrel. The domestic fuel price is one of the world’s lowest, but Beijing will need to raise or deregulate prices soon.
One stock to take a closer look at is China Mobile, the world’s biggest phone company with more than 400 million subscribers. Buy the stock whenever it falls, both HSBC and UBS say, because the Chinese telephone industry is still growing rapidly, and China Mobile controls a market share of more than 70 per cent.
The phone company was the focal point of an industry-wide restructuring plan announced last month. Concerned, many investors switched from China Mobile to smaller phone service providers and equipment manufacturers. China Mobile shares fell 13 per cent after the announcement.
Fair value for China Mobile’s American depositary receipts is $77, according to Morningstar. They traded Tuesday at about $69.
“China Mobile is the market-share king of China’s telecom industry, which gives the firm economy of scale and funding advantages over the competition,” Morningstar analyst Lun Lu said. “The firm operates the country’s most extensive network, covering more than 95 per cent of China’s population, and is known for its high quality of service.”
Special to The Globe and Mail
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