China brokerages look like good bets amid mounting signs that mainland shares have stabilised, analysts say
Macquarie, among other analysts, point to better days ahead for mainland securities brokerages
It’s been a choppy year for China’s stock market, and for the stock brokers, whose fortunes rise and fall with the equities tide, not to mention the shifting policy backdrop that seems to wobble according to the whims of authorities.
China’s securities brokerages, operating in a highly competitive environment, earned handsome profits in the bull market that began late last year, thanks to commission fees and interest income on margin financing.
They have also been among the biggest casualties from the summer crash, with revenues squeezed, their own stock prices pounded, and in some cases, top management being probed as part of an anti-corruption drive.
The top 50 brokers each put 20 per cent of their net assets into the government-mandated market stability fund. Total contribution was estimated at 200 billion yuan (HK$242.6 billion), although that figure was never validated by the authorities, nor has there been a detailed disclosure of where the money has been invested or how well its has performed.
These are among the reasons that brokerages’ share prices are lagging even as China stocks have staged an impressive rally. The Shanghai Composite Index has gained more than 25 per cent from its trough in late August.
The ongoing anti-corruption investigation that has brought down several powerful government officials and executives in securities firms, underscoring the changing and unpredictable regulatory environment.
“In short, this is not a sector that will cure investors’ insomnia,” said Macquarie analysts Matthew Smith and Steve Zeng.
Still, Macquarie recently issued a “cautiously optimistic” view on the sector, noting that it has a high correlation to Chinese equities.
“We are making a call that the third quarter 2015 sell-off has bottomed and further downside is limited given that turnover and margin lending – the bread and butter of the brokers’ core business – remain at elevated levels versus history. Moreover, the brokers offer upside optionality on financial reform,” Smith and Zeng wrote in a report titled “China Brokers: Boom, bust and back”.
After the exponential four-fold earnings growth year-on-year seen in the first half, mainland Chinese brokers’ profit trajectory will likely face challenges in 2016. Still, the sector will be able to deliver double-digit return on equity, assuming the Shanghai Composite averages around 3,800 in 2016, margin financing balance at 1 trillion yuan and average daily turnover of 600 billion yuan.
In addition, the resumption of initial public offerings means brokerages should reap the benefits of pent-up demand for stock listings. Future revenue streams such as asset management will add to the long-term attractiveness of the sector.
Among them, Haitong Securities is a favourite pick, owing to its “business diversity and broad global scope” that “should enable the company to navigate through stormy market seas and capture long-term opportunities once China gets back on track for financial market reform”, Smith and Zeng said.
There is roughly a 44 per cent premium of Haitong’s A share price over that of H share, the largest among the dual-listed brokers.
Likewise, Leon Qi Steve Xu, analysts at Daiwa Capital Markets, also find the sector and its current valuation fundamentally attractive.
“We maintain our neutral rating on the sector and recommend companies with solid fundamentals, such as Haitong Securities (for its good track record in underwriting business and non-cyclical growth in financial leasing and margin lending) and Huatai Securities (for structurally gaining market share in margin lending and low valuation),” they said in a report.