Sector Rotation Opportunities Arise

Macau Gaming – staying selective after the recent rally

Macau gaming stocks on average have rallied ~30% in February 2021 at the back of market optimism about the gradual border reopening with China, particularly around Macau's government announcement that it lifted quarantine requirements for all Mainland Chinese, given all cities were removed from the COVID-19 high risk list.

It seems that the lift of travel restrictions only has minor positive impact to the sector, given that in 4Q20, when there was no quarantine rule for most Chinese visitation, gross gaming revenue (GGR) was only tracking at 30% of 2019 level. We expect the industry to remain challenged at 4Q20 levels (MOP 237m/day GGR and 20,000/day visitation) until non-Mainland China quarantine measures are also removed or there is a reactivation of electronic IVS (individual visit scheme) issuance in China.

Other than the re-opening optimism, we believe the recent rally has been driven partially by the cyclical rotation trade, as well as investors’ light positioning in the sector. Having said that, we think that much positivity is priced in already.

At this point, we continue to see uncertainty for economic recovery and maintain our preference for the lower risk plays which have stronger balance sheet and cheaper valuation. We would not be surprised to see some Macau gaming company coming out for fund raising, as they need to replenish their cash.

Chinese metals & mining – copper hits a 10-year high, what’s next?

The macro backdrop remains supportive for the commodity trade:

1) China’s stance remains accommodative, with the People's Bank of China clarifying their stance, in what remains a still uneven recovery in China;

2) fiscal spending has yet to be materialised in the West, while China’s Five Year Plan is to be released in early March 2021;

3) commodity inventories are still lean, with recycling still lagging in line with manufacturing;

4) ESG constraints are adding more barriers to entry (water access, clean power, cultural heritage) and reinforcing the sector’s pricing power effectively;

5) more investors are now discussing a certain degree of inflation returning from H2 onwards this year and are looking to implement the reflation trade in their portfolios. 

After a strong rally in 2H20 during which copper price rose by ~70%, copper has risen by another ~10% in February 2021 and reached US$9,000/ton level, a 10-year high. Other industrial metals also jumped, with aluminum at its highest since 2018, and nickel at its strongest since 2014. Underpinning the rally is a strong demand recovery in China post COVID-19 as the government rolled out infrastructure-driven stimulus, followed by market expectations of a similar stimulus in the US.

On the supply side, copper inventories in LME (London Metal Exchange)-registered warehouses are near 6-year low (Chart 2) and the premium for cash copper over the three month metal is rising, suggesting tight nearby supply. These micro dynamics are reinforcing the macro reflation trade that is lifting prices across the commodity complex.

Accordingly, Chinese miners and copper plays have rallied more than 50% in February 2021. In the near-term, Chinese miners and copper plays could be vulnerable to a pullback on concerns that the share prices have moved too fast, and we suggest investors to lock in some profit. 

Chinese property – is potential land supply reform a game changer?

In late February, there were media reports that the Central government of China was asking the local governments of 22 major Tier 1 and 2 cities to focus their public land sales on three auctions a year (Chart 3). While at the time of writing, there is no official confirmation from the Central government, it is noted that the Qingdao government announced a similar policy overnight. Based on estimates, the 22 major Tier1 and 2 cities account for ~40% of national property sales value, ~30%+ of national land sales and ~35%-40% of the new starts.

On the back of this news, the Chinese property sector has a strong rally, with a somewhat uniform performance across the board. We see the outperformance as a continued rotation into value, low investor positioning, and expectations that the land supply news could potentially work to calm property prices finally and translate into decreasing policy risk, which has been a key overhang for the sector.

A more concentrated land sales program could suggest crowded new project launches that may add pressure to developers’ sell-through rates, average selling prices, cash collection and asset turnover. However, we view this as a measure by the authorities to control property prices by controlling land cost itself. This would be an overall net positive for the sector, given market concerns on margin erosion on the back of the Central government’s tightening policy stance.  

Typically, large developers are likely to bid for land given their strong cash flow, but historically their bids are relatively less aggressive, especially compared with those smaller or unlisted developers, who tend to drive up land cost and hence property prices. Additionally, given a smaller probability to bid for land, the smaller developers could resort to partnerships or joint-ventures that would lead to further consolidation in Chinese property sector.

The Chinese property sector is trading at 4x forward P/E and 54% discount to NAV (Chart 4), which are still at historical trough levels. Moving

forward, we expect more divergent performance based on each developer’s balance sheet, cash management capabilities, capital access, execution and product quality/brand name.

For large developers, this news is positive as they will be able to leverage on their stronger balance sheet to take advantage of lower land cost to gain market share. Developers with strong balance sheets also have the flexibility to better time their project launches to avoid peak supply period. Developers that are higher geared could face challenge in managing their cash to short-term debt coverage ratio.

China Auto – a profit margin widening year

As the demand has continued to decline in the past three years, most auto makers suffer from notable drop in profit or even incur losses. Given this backdrop, auto makers and industry associations are relatively conservative on the 2021 sector outlook which leads to a more disciplined supply. This is likely to reduce the cash support manufacturers provide to dealers, and therefore ex-factory prices would be more stable. Auto makers will continue their cost cutting efforts under the impact of COVID-19, such as shutting down idle capacities, laying off excess employees, reducing marketing/ advertisement expenses, etc. Thus auto makers’ margins are likely to increase due to stable retail prices, ongoing cost cutting efforts, and lower per-unit fixed cost on operating leverage from double-digit volume growth.

Meanwhile, new-energy vehicle (NEV) continues to receive positive policy support. The promotion of NEV to rural areas since July has also delivered decent results. From July-November 2020, NEV sales in rural areas reached about 180,000 units. Stronger rural area penetration, alongside Beijing’s supportive 2021-2035 NEV development plan, reinforces our view that China’s NEV sales could reach 30% Compound Annual Growth Rate from 2021-2025E, translating into potentially 5.3m units by 2025 (up from 1.3m units in 2020). (Chart 5)