Stock freebies boost A-shares

PUBLISHED : Sunday, 14 August, 2005, 12:00am
UPDATED : Sunday, 14 August, 2005, 12:00am

A strong rally in Shanghai-listed shares in the past three weeks may be evidence the mainland bourse has turned the corner, some fund managers say.

The shift is a dramatic reversal in fortune for a market that twice saw the government intervene to prop up shares on the Shanghai Stock Exchange in July. Only last month, business columnists said the dismal price action reflected the market's collective unconscious at work, revealing the ill-health of the Chinese corporate sector hit by shrinking margins and declining profitability.

So what has happened to change the dire outlook? Of course, the yuan revaluation has been a magnet for foreign money betting the initial move is the first of many to come.

But aside from what were widely expected changes to the currency regime, fund managers say there are several pieces of good news that add up to a bullish outlook.

'Our view is that the A-share markets have become more attractive now,' said Samantha Ho, co-manager of Invesco's US$507 million GT PRC Fund. 'The direction is up.'

Ms Ho said an important catalyst is assurances the government's share sale plans will not cause a slump in the stock markets. Earlier this year, analysts were worried the conversion of non-tradeable state-held shares into common shares would soak up liquidity and dampen prices. The issue was widely cited as a reason to avoid mainland-listed equities.

Under the government's pilot scheme currently under way, approvals have been given to compensate current investors with free shares. The giveaway ranges from two to three shares for every 10 owned by investors.

By the end of August, the boards of 46 companies are expected to approve share-reform plans. The move was designed to compensate investors for falling share prices when the free float is enlarged, and is seen as an important pillar in shoring up confidence. A-shares listed in Shanghai and Shenzhen trade at a premium to Hong Kong listed H shares, and are generally viewed as overvalued by international standards.

'In terms of company earnings there is no dilution whatsoever,' Ms Ho said of the bonus scheme.

The Shanghai Composite Index, which covers A and B shares, has soared 14.43 per cent since July 21, the day China announced it was revaluing the yuan by 2.1 per cent against the dollar and pegging it to a basket of currencies.

One of the first state companies to approve a share reform, Bao Shan Steel, surprised the market with a compensation ratio of 2.2 free shares for every 10 owned by investors. The company also committed 4 billion yuan to prop up the share price and promised to pay a cash divided for each of the next three years equivalent to 7.6 per cent.

The plan beat fund manager expectations who had forecast the board would approve just 1.5 to 2 shares in compensation.

'For investors who make investment decisions based on fundamentals, this should make A-shares extremely attractive because it represents a 23 per cent price discount and a potential of 30 per cent-plus gains based on the price level prior to the announcement of the share reform programme,' said Lipper analyst Linbo Fan, commenting on the overall reform plan.

The government may announce rules as early as August 20 to expand the programme to all domestically listed companies, according to state media reports last week.

The disposal of state shareholdings has a phased schedule. No sales are permitted in the first year, 5 per cent in the second, and 10 per cent in the third.

Aaron Boesky, director of the Cayman Islands-registered Marco Polo Investments, estimates that when the effects of the bonus-share scheme are factored in across the exchange, the average price/earnings will fall from 16 to 13.

'All the reform is doing is giving away, in some cases 20 to 40 per cent of their shares, to the current shareholders in exchange for the right to dispose of their remaining holdings in the future to parties that we don't know yet,' he said.

He added the bonus shares will be paid out to investors shortly after board approval and is not tied to the disposal schedule of the state company.

The share reform programme began in April and so far 12 companies have approved reform packages. Another 33 companies are expected to complete their approvals in the next two weeks.

'Before the pilot programme, we knew there was going to be a disposal of government-owned shares at some point, but no one was expecting the windfall of these bonus shares,' Mr Boesky said.

Only one company, Tsinghua Tongfang, has had its reform plan rejected.

Mr Boesky said an increase in the A-share quota allocated to qualified foreign institutional investors (QFFIIs) to US$10 billion from US$4 billion, should bolster the market. At the end of March, QFFIIs had invested 4.48 billion yuan in A shares, less than 0.5 per cent of total market capitalisation, and less than 10 per cent of their quota.