All China Stocks (China theme / China) 8 comments
Final Poll Results: 5:4
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1.Evolution from quality to speculative
2.High valuations, with single-digit PE becoming a rarity
This is an irresistable situation and hence I will break from my tradition and highlight a sector/theme instead of an individual stock. The China rally that has started since Dec 2005 has lasted all of three months and has passed through different phases, with various market leaders emerging at each phase.
My opinion is that timing of the market, of a sector and of a stock are three completely different things. For the first, it is usually futile since macroeconomics is such a complex mix of various geographical, functional and political factors; economists have tried and failed for centuries, so why do we try? For the third, it is usually a matter of valuation and watching for turning points in the company's fortunes through news developments. However, for the second, the development of the theme through various phases, with a gradual decline in quality of market leaders, usually provides one with a good feel for when to exit.
And since there is no price/price index associated with China stocks, how will one be able to track my hot-stock-not call as opposed to previous stock calls which had prices that could allow yardstick comparison? Well, I believe it'll be obvious to all when the China play ends.
Let's watch the development of the China theme from December 2005, in roughly chronological order.
Stocks with strong newsflow: Celestial, Fung Choi
Given that confidence in China stocks have been low since the CAO scandal and a series of China IPOs that have turned out poor results post-IPO, it was natural that any interest had to start from stocks where newsflow was highly favourable and corroborated by institutional interest. Fung Choi's dynamic dealmaking (display advertising JV with leading PRC company, acquisitions of Flying Media and Rainbow China, tie-ups to print media for 2008 Olympic Games) gave a favourable impression of an expanding media company, further corroborated by its director taking Fung Choi shares in payment for Rainbow China which was previously under her --- that is a sign of confidence by insiders. As for Celestial, the turning point must be Mark Mobius of the renowned Templeton Funds taking a huge stake in the company at ~40-50 cents -- a sign that its huge soybean zone project holds huge promise in the long-term.
China domestic consumption: China Hongxing, Beauty China, Sunray, Hongguo
China Hongxing has not taken a breather in its upward rise since its IPO at 40 cents in Nov 05; it is now at three times that price. Beauty China has rallied to near 90 cents, Sunray and Hongguo have doubled from their price in December. These key representative stocks of the domestic consumption theme have strong niches, branding and substantial revenue base, hence when interest began shifting from China outsourcing plays to China domestic consumption plays, they became key beneficiaries.
Bargains by comparative valuations: China Sun, China Paper
In a bull market, people become receptive to the idea that valuations for stocks should somehow approximately arbitrage across borders; thus it helps SGX stocks especially if they have counterparts in the more highly valued Hong Kong market. Hence China Sun has been re-rated closer to corn starch processor counterparts on the Hong Kong market, as has China Paper (in response to a strong Nine Dragons IPO on the HKEx). China Hongxing, of course, also benefits from this due to its favourable comparison valuation-wise with the exorbitant (30X PE) Li Ning on the HKEx.
IPOs: China Fishery, Luzhou Biochem, China Milk
When IPOs gap up on the first day of trading, it is time to set off alarm bells inside the investor's head. Most well-known of course is China Fishery, but the latter two have also exhibited >70-100% price gains within one week of their IPO (believe Luzhou doubled over its IPO price on its first day of trading). If the owners have spent their lives building up the company, they would have ensured fair IPO valuations because effectively they are selling away part of their company; so is there any fundamental justification for the price doubling over what the owners considered fair value??
Inferiors/Laggards: Zhongguo Jilong, China Infrastructure, China Great Land
Recently in these two weeks, we are seeing the emergence of China laggards. I choose to highlight three stocks that have come into prominence today: Zhongguo Jilong, which saw FY05 profit fall 40-50% over FY04; China Infrastructure, a micro-cap stock; China Great Land, whose CEO resigned recently on a staggering 90% collapse in profits. The previous week saw rotational play in Hongwei and CG Tech (laggards to China Sky & Fibrechem), Star Pharmaceuticals (micro-revenues), China Fashion (FY05 profits dropped >30%).
Drawing parallels between my observations in early 2004 and the current situation, I would feel really cautious about putting any new money in China stocks. I struggled to find single-digit (trailing) PE stocks in early 2004; it seemed that all such stocks had been bid up. In this current market, I am finding a similar situation for China-themed stocks, even IPOs which I have always believed should be accorded risk premiums given their lack of a track record. You will find that most of the stocks in the first few categories above are above 10X, or even 15X trailing PE, and that is based on the latest FY05 results just recently, in Feb/Mar 06! If the brokers want to extend this rally, they will base target prices based on projected FY07 earnings which is so far away.
You may want to note that despite all my talk above, I still have some money in China stocks in my portfolio. Obviously, one has to manage potential returns with perceived risk, and the uptrend for China stocks has been so strong that one should capitalise on it rather than just quit because of principles or doubts about general valuations. What I feel is that one should be more selective and exercise prudence in asset allocation, as the abovementioned China theme play seems to be developing into lower quality rotational plays.
(1) Share Investment: Mar 2006