Profit warnings shall cap any significant near-term rebound in Chinese stocks
Despite our constructive view on Chinese equities in the H2, we have previously pointed out that a dramatic decline in corporate earnings is one of the major fundamental overhang to the stock market, and we are beginning to see the impacts now. Over the past two weeks, many Chinese companies have issued profits warnings on their 2008 profits. Not surprisingly, airlines such as China Southern Airline and Cathay Pacific may report significant losses from oil hedging and tariff drop, while Chinese property companies (e.g. Zhongan Real Estate) are also expected to suffer from a major profit decline on sharply lower development margin and revaluation losses on their inventories/ land bank. Weakening global and domestic economies also make industrial and export-driven companies like Weiqiao Textile and Nine Dragon Paper vulnerable. Even consumer-related (Parkson Retail, Lenovo) and infrastructure (Shanghai Electric) companies, which are “stimulus package beneficiaries” and are perceived to be more defensive, are no exceptions.
We expect more profit warnings will be issued in the next few months. Sectors that face biggest earnings decline pressure include such cyclical sectors as steel, copper, cement, shipping, airlines, autos and power plants. We expect investment sentiment will be dampened during the upcoming reporting earnings in April. Investors would be once again reminded of the growth risk faced by Chinese companies, and may begin to question the effectiveness of government’s pump-priming measures. This will be a major drag to cap any major upside to this round of bear market rally in our view. This also reinforces our view to stay defensive and avoid cyclical sectors for now.
On the macroeconomics front, although Premier Wen has recently said that Q4 2008 growth is “not as bad as expected”, we forecast that the real economic impact of government’s fiscal and monetary expansion could only be felt in Q2 2009. Thus more disappointing economic data should be expected for the next few months. We currently project HSCEI 2009E EPS to mildly increase by approximately 5%, with the biggest downside risk hinging on the earnings of banks (i.e. extent of margin contraction and asset write-off) and oil companies (i.e. crude oil prices). Despite this near term overhang, we stay constructive of a higher year-end index target of 11,000 for HSCEI, backed by our base-case GDP growth of 8% in 2009. Thus we would regard any major weakness in the H1 as good long-term accumulation opportunity.
Currently our top SELL include such cyclical stocks as China COSCO-H (1919 HK), Chalco-H (2600 HK) and CCCC (1800 HK). We do not recommend to bargain hunt our HOLD-rated stocks such as CSCL-H (2866 HK), China Shipping Development-H (1138 HK), Angang-H (347 HK), Magang-H (323 HK), Jiangxi Copper-H (358 HK), Hopson (754 HK) and Guangzhou R&F (2777 HK). China Mobile (941 HK, BUY), China Railway Construction-H (1186 HK, BUY) are our top picks which offers good long-term value. Within the banking sector, we also prefer BOC-H (3988 HK, BUY) on current attractive valuation as the overhang on strategic shareholders’ disposal has been recently removed.
With regards. Timothy Fung, CFA Global Research - China Equity Strategist CREDIT SUISSE
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China Equity Strategy Views
Profit warnings shall cap any significant near-term rebound in Chinese stocks
Despite our constructive view on Chinese equities in the H2, we have previously pointed out that a dramatic decline in corporate earnings is one of the major fundamental overhang to the stock market, and we are beginning to see the impacts now. Over the past two weeks, many Chinese companies have issued profits warnings on their 2008 profits. Not surprisingly, airlines such as China Southern Airline and Cathay Pacific may report significant losses from oil hedging and tariff drop, while Chinese property companies (e.g. Zhongan Real Estate) are also expected to suffer from a major profit decline on sharply lower development margin and revaluation losses on their inventories/ land bank. Weakening global and domestic economies also make industrial and export-driven companies like Weiqiao Textile and Nine Dragon Paper vulnerable. Even consumer-related (Parkson Retail, Lenovo) and infrastructure (Shanghai Electric) companies, which are “stimulus package beneficiaries” and are perceived to be more defensive, are no exceptions.
We expect more profit warnings will be issued in the next few months. Sectors that face biggest earnings decline pressure include such cyclical sectors as steel, copper, cement, shipping, airlines, autos and power plants. We expect investment sentiment will be dampened during the upcoming reporting earnings in April. Investors would be once again reminded of the growth risk faced by Chinese companies, and may begin to question the effectiveness of government’s pump-priming measures. This will be a major drag to cap any major upside to this round of bear market rally in our view. This also reinforces our view to stay defensive and avoid cyclical sectors for now.
On the macroeconomics front, although Premier Wen has recently said that Q4 2008 growth is “not as bad as expected”, we forecast that the real economic impact of government’s fiscal and monetary expansion could only be felt in Q2 2009. Thus more disappointing economic data should be expected for the next few months. We currently project HSCEI 2009E EPS to mildly increase by approximately 5%, with the biggest downside risk hinging on the earnings of banks (i.e. extent of margin contraction and asset write-off) and oil companies (i.e. crude oil prices). Despite this near term overhang, we stay constructive of a higher year-end index target of 11,000 for HSCEI, backed by our base-case GDP growth of 8% in 2009. Thus we would regard any major weakness in the H1 as good long-term accumulation opportunity.
Currently our top SELL include such cyclical stocks as China COSCO-H (1919 HK), Chalco-H (2600 HK) and CCCC (1800 HK). We do not recommend to bargain hunt our HOLD-rated stocks such as CSCL-H (2866 HK), China Shipping Development-H (1138 HK), Angang-H (347 HK), Magang-H (323 HK), Jiangxi Copper-H (358 HK), Hopson (754 HK) and Guangzhou R&F (2777 HK). China Mobile (941 HK, BUY), China Railway Construction-H (1186 HK, BUY) are our top picks which offers good long-term value. Within the banking sector, we also prefer BOC-H (3988 HK, BUY) on current attractive valuation as the overhang on strategic shareholders’ disposal has been recently removed.
With regards.
Timothy Fung, CFA
Global Research - China Equity Strategist
CREDIT SUISSE
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