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Chinese investors target cyclicals to ride on improved first-half earnings

Raw material companies are reporting improved earnings as China reports that it is ahead of schedule to cut excess supply

PUBLISHED : Tuesday, 18 July, 2017, 1:21pm
UPDATED : Tuesday, 18 July, 2017, 10:39pm

Chinese traders are snapping up cyclical stocks as favourite bets to speculate on interim earnings season that kicked off last week.

A gauge of raw material companies had climbed 5.3 per cent through last week this month as the best-performing industry group on the CSI 300 Index.

Coal, cement, steel and commodity producers that rely on the economic strength as main revenues, from Shaanxi Coal Industry to Huaxin Cement, have all rallied, as they forecast profit jumps or returns to profitability for the first half, thanks to strained supply amid a government-led drive to eliminate unneeded capacity.

While futures contracts spanning from hot-rolled bars used for building houses to coal have risen more than 20 per cent over the past month in Shanghai and Dalian futures exchanges, Zheshang Securities and Shanghai Jingxi Investment Management say raw-material prices may have further legs to go, and the strength of corporate profitability is likely to persist into the third quarter.

“Investors are expecting good results from these companies’ interim reports,” said Wang Zheng, chief investment officer at Shanghai Jingxi Investment Management in Shanghai.

“There will be more buying interest until they are done with the release of first-half reports. Such a good momentum on earnings will carry on at least into the third quarter.”

He predicts that the commodity stocks will rise a further 10 per cent from the current level.

Profitability for China’s old-economy companies grappling with excessive output has been improving, as the world’s second-largest economy enters a second year of a campaign initiated by President Xi Jinping to cut unneeded capacity in traditional industries from coal and steel to cement and commodities to bolster growth.

Such a good momentum on earnings will carry on at least into the third quarter
Wang Zheng, Shanghai Jingxi Investment Management

China is already ahead of its schedule in removing excessive output this year.

The nation completed 85 per cent of its annual goal of curtailing steel capacity in 2017 by the end of May, and 65 per cent of the target for cutback in coal output, according to the statistics bureau.

Last year, the nation reduced coal output by 290 million tonnes and steel capacity by 65 million tonnes.

“The administrative means has caused a strain in supply due to the capacity reduction,” said Dai Ming, a fund manager at Hengsheng Asset Management in Shanghai. “They are price-sensitive sectors and once prices are up and steady, profitability returns to these companies.”

Gross profits for coal companies surged 88 folds from a year earlier in the January–May period, and those for commodity producers surged 58 per cent in the period, the statistics bureau said.

Still, brokerages including Shenwan Hongyuan Group and BOC International say the rally on cyclicals may be ending soon as economic growth is likely to slow and tight liquidity weighs on equities.

“It’s a rebound and the nature of it is a recovery from pessimistic expectations,” said Chen Letian, an analyst at BOC International. “The rebound is ending soon and we recommend taking profits out of it. There will be better performances among new-economy stocks in the second half.”

Data from the central bank showed the nation’s broadest measure of money supply grew at the slowest pace in June as financial deleveraging curbed inter-banking activities.

Shares of Shaanxi Coal have advanced 12 per cent in July in Shanghai, extending the stock’s gain to 63 per cent this year. The coal producer said this month that first-half profit probably jumped 22 fold from a year earlier on increased prices on the fuel and improving management.

Huaxin Cement has climbed 12 per cent this month after the maker of building materials forecast more than 50 per cent increase in profits for the six-month period ended in June. The stock has advanced 38 per cent in Shanghai this year.

There will be better performances among new-economy stocks in the second half
Chen Letian, BOC International

Animal feed company Fujian Tianma Science and Technology and Angel Yeast kicked off the first-half earnings season for mainland-listed companies last Thursday, reporting increases of at least 31 per cent in earnings. The companies on the Shanghai and Shenzhen exchanges are required to release interim reports between July and August.

Zheshang Securities says steel, coal and commodity companies have not risen to expensive levels yet, as their metrics of price-to-earnings and price-to-book value are still below the five-year average.

Gains in producer prices in June’s official purchasing manager’s index indicated that industrial good prices might have already bottomed out, said Zhan Shihua and Jin Yongbin, analysts at the brokerage.

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