Sector Rotation Opportunities Arise
Timothy Fung, Head of Equity Advisory, Asia
After a strong tech rally in the first two months in 2021, opportunities emerge in the more traditional sectors.
Sector rotation opportunities emerge - After a strong rally in the first two months in 2021, China tech stocks are taking a much-needed breather. We have been expecting this healthy consolidation to happen, and continue to believe this offers a good long-term re-entry opportunity. Meanwhile, sector rotation opportunities emerge in the more traditional sectors.
Macau gaming: Near-term good news are priced in - Macau gaming stocks on average have rallied ~30% in February 2021 at the back of the market optimism about the gradual border reopening with China. However, it seems that the lift of travel restrictions only has minor positive impact to the sector. We expect the industry to remain challenged at 4Q20 levels until non-Mainland China quarantine measures are also removed or there is a reactivation of electronic Individual Visit Scheme issuance in China. We would not be surprised to see some Macau gaming companies conducting fund raising, as they need to replenish their cash after more than a year of cash burn.
Metals & mining: Vulnerable to a pullback - Chinese miners and copper plays have rallied more than 50% in a month as copper price hits a 10-year high. 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.
Property: Still a value play - The Chinese property sector is trading at 4x forward P/E and 54% discount to NAV, which are still at historical trough levels.
News on more land supply could potentially work to calm property prices and translate into decreasing policy risk, which has been a key overhang for the sector. 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.
China Auto: A profit margin widening year: We expect auto makers’ margins 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. We prefer stocks with strong research and development (R&D) capability in NEV and trading at reasonable valuations.
We have locked in some profits from select Macau gaming stocks, and reduced exposure on utilities and consumer staple in line with our CIO downgrade. Meanwhile, we have taken the recent correction to add exposure to select tech and property stocks.
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.
Chart 1. Macau daily visitation: 2021 CNY vs. 2020 Oct Golden Week – visitation has been weaker than expected
Source: Morgan Stanley, February 2021
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.
Chart 2. Total copper inventory at futures exchanges at 6-year low
Source: Bloomberg, JP Morgan, February 2021
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.
Chart 3. Cities under potential concentrated land supply reform
Source: Sina Finance, Jefferies, as at February 2021
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.
Chart 4. Chinese property sector trades at 54% discount to NAV
Source: Bloomberg, Jefferies, as at February 2021 Past performance is not indicative of current or future performance
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)
Chart 5. China NEV sales projections
Source: CEIC, DBS Research, as at January 2021 Past performance is not indicative of current or future performance