Investing in H-share firms a wary process
INVESTING in China-related equities has become a much more discriminating process with the euphoria over China investment having dissipated, according to a report.
Salomon Brothers' latest H-share review said sector cycles of H-share companies played a key role in making China-related investment decisions.
The investment bank highlighted four sectors and forecast their performances.
It said the investment outlook for the capital goods sector was 'poor but improving' this year but would rebound next year.
The chemical sector was 'exceptionally good' this year, although its prospects would be 'neutral' next year. The outlook for light industry was 'moderate' this year and 'neutral'.
Prospects for the steel sector was 'exceptionally poor' this year, although it would be 'poised for a rebound in the longer term'.
'Operational and financial gearing are key factors in determining when the turnaround point will be for some of these H-share companies,' Salomon said.
'A highly geared company should benefit from a moderate improvement in revenue when there is an upturn in the operating cycle.
'Other factors, such as the liquidity of the stock and management quality, can also be useful when making investment decisions.' According to the report, it was important to understand some of the uncertainties of H-share companies.
These include the timing of a turnaround, which can be delayed for some companies if easing of credit does not materialise in the next year.
There are also potential fund-raisings, spurred by expansion programmes resulting from China's Ninth Five-Year Plan and the consolidation in industry sectors, which may lead to falling prices and stronger competition.
'Given the H-share sector's discounts to the Hang Seng Index - about 15 per cent this year and 24 per cent next - we look for the Hang Seng China Enterprises Index to gain about 20 per cent on the back of a stronger performance from the Hang Seng Index in the fourth quarter,' the report said.
On stock recommendations, Salomon preferred the petrochemical sector, which it sees offering strong earnings growth on undemanding multiples.
It said the capital goods sector has probably reached the bottom of its operating cycle although the sector's recovery might be a long-term process given the lengthy production cycles involved.
Salomon sees Maanshan Iron & Steel Co and Shanghai Hai Xing Shipping Co as potential recovery plays, but believes their performances will depend on a cyclical upturn of the economy.