The Straits Times / The Business Times News on AsiaPharm

Analysts relook China stocks - and like what they see

Fallen valuation and decent earnings growth are a recipe for good returns, they say

'That's a bet I dare to make,' says Gabriel Yap, a senior dealing director with Phillip Securities, when asked if he sees interest in China stocks returning any time soon.

He says the catalysts for a rerating will come from at least three fronts. One is the macro policy of the central Chinese government, which is favourable to the market. Two, the economy is expected to continue growing at a steady clip and three, the government is implementing various measures to boost interest in the flagging A-shares market in China.

Till now, these A-shares issued by Chinese companies are available only to domestic investors and qualified foreign buyers, but Beijing earlier this month announced a relaxation that will open the market wider to foreign investors. Mr Yap sees the interest in A-shares eventually filtering through to H-shares - the Hong Kong-listed shares of mainland companies - and to China stocks listed in Singapore.

The view that China A-shares is bound for a revival is shared by David Cheung, investment director of Prudential Portfolio Managers Asia.

'We are looking at the beginning of a multi-year rally,' he says. Decent valuation, along with good growth and improving corporate governance, are the basic ingredients. The government's move to increase the quota of foreign investments in the A-share markets and their inclusion in major global indices will be the ultimate trigger for the markets' turnaround, he says.

Meanwhile, for Singapore-listed Chinese companies, many have turned in better-than-expected results in the current reporting season. For example, soy products manufacturer Celestial Nutrifoods posted a 290 per cent jump in its third-quarter results to 200.9 million renminbi ($42.3 million).

Finally, valuation of these companies is attractive - more so than those listed in Shanghai, Shenzhen or Hong Kong.

According to independent equities research company Riedel Research Group, Singapore's China stocks are trading at an estimated range of four to 10 times their forecast earnings. This compares with the Singapore market average price-earnings ratio of 14.5 times and the Hang Seng China Enterprises Index's PE of about 10 times.

'Good earnings growth and poor valuations are perfect recipes for a bull run,' says Phillip's Mr Yap.

Riedel, in a 29-page report recently, says that careful stock selection can uncover potential gems among China companies listed on the Singapore Exchange. 'We believe that the gap in valuation between small and medium-cap stocks listed in Singapore and large-cap stocks listed in Hong Kong will narrow as the former expand through organic growth or mergers and acquisitions.

'Given the rapid growth in China's economy, we expect many of these companies to realise their growth potential over the next two to three years,' says its analyst Chew Boon Leong.

Kevin Scully, managing director of independent equities research firm Netresearch-Asia, also emphasises the importance of picking the right stocks now that the Singapore bourse is going into its third year of gains.

'At this point of the market, investors have to do bottom-up stock picking,' he says. When some of the corporate scandals emerged last year, investors flocked to blue chips. And now the blue chips are trading at some 14 times their forecast earnings.

'For the next run, investors should be looking at laggard sectors. The moment there is a delivery in earnings or signs of a turnaround, the stocks will move.'

Mr Scully says the risks of investing in China stocks are mitigated by the fact that many of them are trading at single-digit PEs now. 'That's the discount for the uncertainty on the earnings front. Once there is delivery, the discount is going to narrow.'

Riedel's top picks are stocks from sectors that are expected to benefit from China's rapid economic growth. Its list of nine stocks hails from three sectors: the consumer sector (China Dairy, China Sun, Beauty China, Fung Choi and Hongguo), the pharmaceutical sector (AsiaPharm), and the water treatment sector (Asia Water, Biotreat, and Sinomem).

However, investing in China stocks has more than its fair share of risks. For one, the business environment in the country is notoriously competitive.

Prudential's Mr Cheung warns investors to watch out for stocks with rapidly declining margins, for example those in the auto and low-end manufacturing sectors. One company which has seen its margins collapse is Junma Tyre Cord. Its gross profit margins halved to 3.4 per cent in the three months to Sept 30, 2005, compared with the same period a year ago. Consequently, its share price has plunged by some 70 per cent this year since it hit its peak of 62.5 cents in January.