S&P gauges outlook for listed firms
(China Daily)
Updated: 2005-01-14 14:20

Editor's note: Standard & Poor's Asia-Pacific Equity Research Services published the Select S&P Greater China Picks Portfolio on December 31, 2004, which recommended 25 listed companies in Hong Kong and the Chinese mainland and gave a strategic outlook of the Chinese market in 2005.

The following is a list of the portfolio and the main parts of the report.

Introduction:

The report takes the 25 picks as the best positioned for outperformance in their respective sectors in 2005.

All 25 stock picks are listed in Hong Kong and consist of Hong Kong companies, H shares and red chips from nine economic sectors.

The median capitalization of the Select S&P China Picks Portfolio is approximately US$3.9 billion, ranging from a high of US$64.8 billion for China Mobile to a low of US$300 million for Singamas Container Holdings.

The portfolio is comprised of eight stocks considered to be large capitalization issues (market cap above US$5 billion), while there are five small cap issues (market cap below US$1 billion) and the remaining 12 are mid-cap issues.

Strategic outlook for China:

Moving from the Monkey to the Rooster

In true Year of the Monkey fashion, the markets started 2004 with much optimism but proved tricky thereafter.

China shares fell sharply in April after the government's introduction of measures to curb overheating sectors in the economy. Although rebounding off its lows, year-to-date (December 14) performance indicates a 6 per cent loss as measured by the Hang Seng China Enterprise Index.

The previous Year of the Rooster in 1993 was buoyant for Asia but we believe the outlook in 2005 will be complicated, so sticking to fundamentals appears to be the safest option.

What will complicate matters in 2005?

Slowing global economic growth with signs that the US consumer may be tiring, coupled with the potential for continued US dollar weakness points to rising risks for China's external sectors in 2005.

In addition, there is the possibility of excess capacity in certain industries given, in our opinion, the likelihood for a number of non-central government approved capacity expansions and illegal "back-yard" operations that set up in 2004.

Measures implemented to prevent overheating in May 2004 are also having an impact, with the rate of investment easing to a projected level of less than 20 per cent in 2005 from an estimated 28 per cent in 2004.

What about positive drivers?

On the bright side, domestic consumption remains strong and industries catering to the domestic market are likely to continue to benefit.

Also, with global crude prices expected to ease down to US$39 per barrel in 2005, we anticipate reducing inflationary pressures should provide margin pressure relief to companies not engaged in the energy or materials sectors.

Rising interest rates may also haunt the market. Although we believe that the fall of recent inflation figures to the 2.8 per cent level from above 5 per cent in the summer should help contain any aggressive rate rising.

Micro-economic factors may also loom with reorganizations and mergers and acquisitions likely to keep the spotlight on China, particularly its State-owned enterprises.

These will range from ongoing internal adjustments to simplifying corporate structures, to a continuation of acquisitions such as the recent high profile bids for global entities such as Noranda and IBM's PC manufacturing business by Chinese companies Minmetals and Lenovo.

Where is China's GDP likely headed?

China's GDP growth is projected to ease from more than 9 per cent in 2003 and 2004 (estimated) to around 8 per cent in 2005. This remains relatively robust and among the strongest in Asia.

We predict a soft landing thanks to the government's tightening measures. The positive growth should continue to boost domestic consumption.

Where is earnings growth coming from?

The 25 companies in the Select S&P China Picks portfolio have a median 2005 EPS (earnings per share) growth of 21 per cent and are trading on a PEG of 0.8x.

The PEG ratio is calculated by dividing a stock's forward P/E by its projected three-to-five year annual EPS growth rate. A PEG ratio of less than one is considered a sign that the stock is good value.

While the overall Hong Kong-mainland market is likely to see moderating earnings growth estimated at 11 per cent in the absence of the jumps from the energy and materials sectors in 2005, favourable pockets remain especially for those in the real estate, consumer discretionary and industrial sectors.

The former two are benefiting from increased spending while the latter from our expectation for cost pressures to ease as crude prices back off.

What is the recommended strategy?

With a number of factors clouding the global economic outlook in 2005, we are of the view that a slightly more defensive stance is warranted. We are concerned that risk: reward profiles are moderating with the promise of continued fiscal and monetary prudence in China and a tired US consumer.

Our stock picks therefore reflect issues where we believe there is relatively less downside risk and margin erosion. This may be due either to positive demand outlooks for the products enabling sustained high or improving capacity utilization rates and/or a relative underperformance in 2004 resulting in compelling valuation discounts.

We also have a sizable representation of Hong Kong owned and managed companies, which we believe generally have a better track record in terms of corporate governance.

The five-year average beta of the Select S&P China Picks is 0.9x indicating a relatively defensive stance.

Mainland shares

Shares listed on the Chinese mainland's domestic bourses are tagged as either A or B shares and some companies may have both. In the past, A-share ownership was restricted to citizens on the mainland while B-shares were available only to foreigners.

However, China has been opening up its domestic market and a number of A-share funds have now been set up for foreign investors. Likewise, B-share access has been opened up to approved investors on the mainland.

However, the choice is lacking with mainland's larger companies listed elsewhere and as A shares are trading at relatively high valuations and have lower trading liquidity compared to China issues listed elsewhere.

We therefore recommend mainland companies quoted on the Hong Kong Stock Exchange, known either as red-chips, which are Hong Kong registered listed vehicles of mainland companies, or as H-shares mainland registered companies listed in Hong Kong.

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