Chinese A-shares offer a new frontier

Peter Garnry

Head of Equity Strategy, Saxo Bank Group
Peter Garnry joined Saxo in 2010 and is Head of Equity Strategy. In 2016, he became responsible for the quantitative strategies team, which focuses on how to apply computer models to financial markets. He develops trading strategies and analyses of the equity markets as well as individual company stocks applying statistics and models.

The Shanghai-Hong Kong Stock Connect programme launched on November 17, 2014, as the first direct channel for foreign investors to invest in mainland China  A-shares, but only eligible stocks under the programme. Later, on December 5, 2016, the Shenzhen-Hong Kong Stock Connect was launched, expanding the A-shares offering to international investors.

The two Stock Connect lines to mainland China through Hong Kong were part of an orchestrated effort by the Chinese government to open up their capital markets. The main goal for China is to become the world’s new superpower with corresponding global influence. This can only be achieved if the world can invest in the country and the currency is free-floating. The Stock Connect programmes were a direct requirement for MSCI to include Chinese A-shares into the MSCI Emerging Markets Index. Following years of debate between MSCI Inc and Chinese regulators, including capital market reforms, 233 A-shares were included into the MSCI Emerging Market Index on June 1 of this year, increasing the need for global investors to hold Chinese A-shares.

Saxo Bank will offer access to Chinese A-shares on June 19, 2018, helping investors to get access to the Chinese equity market (now the world's second-largest equity market, eclipsing Japan). The Chinese A-shares segment is a new frontier for many global investors been used to the listed Chinese stocks in Hong Kong and New York, and to help navigate this new territory we will highlight five A-shares (only listed in mainland China) based on their good total score in our global equity factor model (Equity Radar).

Five high-ranked A-shares

The mainland China equity market is more expensive than the global equity market, trading at a 10% premium. On the surface it would seem that this should scare away global investors as the opportunity set in China is much larger and interesting than most of the developed world. The A-shares will give investors access to companies that have not listed in Hong Kong or the US.

The majority of A-shares available through the two Stock Connect programmes are financials. Indeed, many of the top rated mainland Chinese stocks in Equity Radar are financials driven by very low valuation multiples. Given that China’s credit markets have been a bit more shaky lately and new loans activity has deteriorated, we have chosen five A-shares that are not financials and have high ROIC combined with low leverage on the balance sheet, meaning the companies will have low interest rate sensitivity.

All the A-shares highlighted below have also been included in the MSCI Emerging Markets Index. Given Trump’s latest tariffs against China, it is relevant to ask how these five shares are exposed to a potential trade war. All five companies have the majority of their revenue exposure from the Chinese market making them less vulnerable to Trump’s trade policy against China. Only one company has meaningful revenue exposure outside China, and that is Hangzhou HikVision with around 29% of its revenue coming from outside China.

Focus Media (002027:xsec)

This is a fast_growing company operating the country’s largest out-of-home advertising network with revenue of $1.83 billion and net income of $853 million in the past 12 months. The company has a market value of €20.3bn causing the value factor to be very negative (expensive stock), but this factor is offset by very high ROIC (almost the highest in our entire global stock universe) and very low debt leverage. Overall, the Equity Radar score is 0.32. Of the five stocks highlighted, Focus Media has performed the best (see price chart below), delivering 906% total return in USD over the past five years. 20 sell-side analysts are following the stock with all having a buy recommendation. The shares are listed on the Shenzhen Stock Exchange.

Kweichow Moutai (600519:xssc)

Kweichow Moutai is China’s largest beverage company and the world’s third largest beverage company measured by market value at around €130.3bn. The company produces and sells Maotai liquor and other beverages and foods. Revenue is $8.6bn with net income of $4.4bn in the past 12 months. The stock is significantly more expensive (value factor) than the average stock but the quality, leverage, and momentum factors are all very positive leading to an overall score of 0.38. Thirty-two sell-side analysts are following the stock and 30 analysts have a buy recommendation with none having a sell on the stock. The firm's recent strong stock performance has been driven by margin expansion fueling profit growth. The stock is up 411% in USD over the past five years. The shares are listed on the Shanghai Stock Exchange.

Hangzhou HikVision Digital Technology (002415:xsec)

Hangzhou HikVision Digital Technology is the country's largest manufacturer and supplier of video surveillance products with revenue of $6.6bn, net income of $1.5bn in the last 12 months, and a market value of €47.1bn. The company is growing very fast with +25% growth rates over the past eight years. It is therefore no surprise that the stock is expensive (the value factor is -1.32) but again the quality and leverage factors are very strong, translating into an overall score of 0.20. Of the 29 sell-side analysts following the stock, 28 have a buy recommendation with consensus price target currently 30% below the latest price. Based on our review into the company, it seems that it has a competitive advantage in customisation of solutions to clients; its AI solutions also set them apart from the competition. The shares are listed on the Shenzhen Stock Exchange.

Yunnan Baiyao (000538:xsec)

A large pharmaceutical company with revenue of $3.7bn, net income of $473m, and a market value of €14.7bn. The company manufactures and sells traditional Chinese medicine to the domestic market and has maintained an organic growth rate of 10% per annum for many years. The stock is more expensive than the global equity market but this is offset by above average quality and good leverage factor translating into an overall score of 0.39; the best factor right now is the reversal factor (1.86) as the stock has underperformed recently as investors have begun worrying about the valuation relative to the growth outlook. There are 17 sell-side analysts covering the stock with 16 having a buy recommendation. The shares are listed on Shenzhen Stock Exchange.

Foshan Haitian Flavouring & Food (603288:xssc)

The world’s largest soy sauce manufacturer with revenue of $2.3bn, net income of $547m, and a market value of €28.2bn. Like the four others, the stock is expensive compared to global equities but with a high quality and leverage factors, the overall score is 0.31. The company has maintained an almost 15% annualised growth rate for the past eight years. There are 25 sell-side analysts covering the stock with 21 buy recommendations. The shares are listed on the Shanghai Stock Exchange.

Key risks

The five companies mentioned have the majority of their revenue from mainland China so they are obviously exposed to a decline in economic activity in that country. A potential escalation on trade policy between China and the US could severely impact sentiment and investments in China. All companies mentioned also have above average valuation metrics which means that they are vulnerable if investors suddenly reprice Chinese companies due to changed growth outlook. It also makes them more volatile over earnings releases because high growth companies are often priced for perfection and the slightest miss means a volatile response from investors.

Five-year price chart (Source: Bloomberg)

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