HK still offers reasonably priced pickings

PUBLISHED : Sunday, 17 September, 2006, 12:00am
UPDATED : Sunday, 17 September, 2006, 12:00am

The 34-member Hang Seng Index hovering above 17,000 tends to arouse trepidation in investors who equate that figure with an expensive equity market.

In fact, it does not. Of the more than 1,100 companies listed on the HK bourse, there are many that are still valued affordably.

Let me go over several sectors.

Among the local banks and developers, majors such as BOCHK and Henderson Land and many of their second-tier peers can be had for a good price. Despite possible moderation next year, the Hong Kong economy should continue to grow at 4 to 5 per cent, a key driver of demand for properties, loans and other financial services. Peaking of interest rates will also help a lot.

Do not overlook the power of accelerating inflation. It serves to reduce the real cost of capital, and to stimulate demand for property and loans, as well as equity investment to combat falling purchasing power. I believe the consumer price index will grow about 2 per cent this year and probably accelerate to more than 3 per cent next year.

Even mainland banks, which as a sector are valued at a high 2006 P/E of more than 20 times, offer some good deals. Loan growth could slow down next year in order to curb overheated fixed asset investment growth, which will more or less limit profit growth of the listed Chinese banks. Nevertheless, even taking this into account, their 2007 valuations should be low enough to offer more or less some unrealised value, but investors should be very selective. China Merchants and the Bank of Communications are clearly better than their rivals. These counters could under perform in the coming months, but in the long term the good ones should outperform, so take advantage of any correction.

The Hong Kong retail sector probably experienced its worst time in a while last year, when expenses rocketed on rental contract renewal. Many shops signed their leases in 2003, when rental charges were at rock bottom; in 2005, these two-year contracts began to expire and were renewed at much higher rates, eroding profits.

As economic growth will likely be moderate next year, gains in rent should be milder than this year. In addition, rental contracts of many of the shops were renewed this year, which means their costs for their space should not surge next year. Valuations of several jewellery retailers are rather affordable, but beware that these counters are higher risk than the major banks and developers.

Rather stable in nature, Chinese ports are also valued reasonably low. Their moderate throughput and profit growth should allow them to earn meaningfully higher profits in the future, justifying much higher valuations.

Cyclical sectors that are coming back from their bottoms are heavy trucks and wheel loaders. Another is probably container shipping, which has been hit by overcapacity. The peak of new vessel deliveries should be this year. Afterwards, the increase in world-fleet capacity should moderate to a nominal 13 per cent or less, not much higher than world demand growth of 11 per cent. The fear of oversupply is probably overdone for counters like Oriental Overseas and Cosco Holdings, creating opportunities for risk-taking investors. However, other cyclical sectors like metals and oil could undergo a medium-term correction on temporary oversupply, especially since the American property market is slowing.

But as always, the equity market overreacts to create opportunities for risk-taking investors.

As of Friday, my HK$10 million simulated portfolio earned a return of 29 per cent excluding dividends since inception in January 2005, outperforming the Hang Seng Index by two points. Including dividends, it returned 37 per cent, which would rank among the top 10 Hong Kong equity funds. This portfolio, which closes this week, demonstrates that buying high-quality companies at low valuations and sitting back and letting them work for you is the best investment strategy. There is absolutely no need to flip nondescript companies all the time. That will benefit not you, but your broker.

Henry Chan is the head of research at Quam