HK/China Equity Perspectives [August 2019]: After the Hype - Not Too Cold
- HK/China equity market remained range-bound in July as excitement from resumption of trade dialogue between China and the US has proven short-lived, as investors are waiting for new data points, in particular 2Q19 results, for future directions.
- Although a rate cut by the US Fed should have been fully priced-in, we believe it will create additional room for the Chinese government to launch more supportive measures, such as reserve requirement ratio (RRR) cuts and further relaxation on Local Government Financing Vehicles loans issuance to support additional infrastructure spending.
Thus, there could be short-term support to Bank sector sentiment.
What’s next? Looking for directions from 1H19 results
Macro data from China remains mixed at best, if not deteriorating. The latest data from Industrial sector profit growth dipped to -3.1% year-on-year in June from +1.1% in May.
From the valuation perspective, MSCI China is trading at around 11.5x 12-month forward P/E (according to Bloomberg consensus estimates as of 29 July), which is slightly above its long-term average of 11.1x since 2010.
In our view, without a clear significant breakthrough in trade negotiation between China and the US, it would be difficult for HK/ China markets to experience any meaningful valuation re-rating in the near-term.
Investors’ expectations on Chinese corporate earnings growth in 2019 remain low, which consensus estimates have been revised down by 2 percentage point since 1Q19 results.
Based on Bloomberg consensus estimates, investors are expecting 2Q19 earnings growth to slow moderately from 1Q19, with overall 1H19 earnings growth estimated at 11.9% year-on-year.
Among the key sectors, Consumer Discretionary (mostly from e-Commerce), Insurance and Real Estates are expected to contribute the lion’s share of earnings growth in 2019, whereas the Material sector is expected to report earnings decline.
What to lookout for from 1H19 results in some sectors in onshore?
UNDERWEIGHT - BANKS
We expect large state-owned banks to report stable 2Q19 earnings growth in August, underpinned by:
i) Manageable net interest margin downward pressure;
ii) Sustained fee income growth;
iii) Benign asset quality trend.
Potential RRR cuts should provide supports to the already low valuations.
UNDERWEIGHT - INSURANCE
We expect sector earnings to grow by a solid >50% YoY for life and >25% YoY for non-life.
Key earnings drivers are:
i) Stellar equity market performance. CSI300 gained 29% YoY;
ii) Lower effective tax rate under new tax regime;
iii) Favorable direction of the benchmark 750-day moving average of the 10-year government bond yield.
UNDERWEIGHT - TECHNOLOGY HARDWARE
Despite the better-than-expected results reported by global leading semiconductor companies, such stellar performance is unlikely to be extended to Chinese companies given their higher exposure to the saturated smartphone industry.
However, there is demand stabilisation in selected segments outside of the smartphone space.
OVERWEIGHT - REAL ESTATE
Overall earnings growth is expected to decelerate from about 20% in 1H18 to low-to-mid-teens on the back of moderated profit margin.
Earnings growth of mid-cap developers to continue to outpace that of large-cap developers due to relatively lower-based comparison of market share gain.
NEUTRAL - MATERIALS
Drastic difference between Cement and Steel sectors, despite both having benefitted from the robust real estates and infrastructure activities in 1H19.
For cement, positive earnings alert were issued by major players, thanks to the stable pricing.
On the other hand, surging input price is expected to weigh down steel mills’ profitability.
MIXED RESULTS - INTERNET
A mixed set of results is expected with e-Commerce continuing to lead the sector performance on the back of steady revenue growth and cost reduction.
The gaming sector should record some improvement along the normalisation of new games approval.
However, cautious about the advertising segments on the back of severe competitions for the diminishing advertising budget, while we observe tightening of regulatory control.
Why we favour Auto, Healthcare and Cement sectors?
- The worst looks to be over. Industry inventory levels have returned to more normalised levels, while the sector is entering into a lower-based comparison with wholesale sales growth which started to turn negative in July 2018.
- Sector valuation is cheap, trading at 1 standard deviation below 5 year average P/E, implying downside risks are mostly priced in.
- Recently announced revised drug purchase policy only expands the geographical coverage but not the list of drugs covered by the policy.
- The market has priced in a much worse scenario, and therefore, earnings expectation as well as valuation is likely to gradually improve.
- On the back of the strong 1H19 earnings performance
- Looking into 2H19, although real estates related fixed asset investment (FAI) may slow down due to policy tightening, infrastructure related FAI is likely to remain robust which support steady demand for cement.
Although we maintain a positive view on sectors such as Real Estate and Consumer Staples, we have become more cautious. For Real Estate, for example, as policy has become less accommodative, we believe Privately-owned Enterprises (PoEs) has become less favorable than State-owned Enterprises (SoEs) .