Still room for optimism in mainland B shares

A LOT has been written about the pending flotations of nine mainland companies. The fear is that the B share markets in Shanghai and Shenzhen will be overshadowed.

The greater regulatory safeguards available in Hongkong, combined with the still massive demand for new share issues in the territory, is not to be denied.

Shanghai and Shenzhen's B share markets have been out of favour anyway and discounts to A shares have slid again to more than 70 per cent. While analysts are writing that B shares will be crowded out by the likes of Shanghai Petrochemical and Citic Pacific, it is worthwhile being contracyclical and examining Shanghai and Shenzhen's B share market prospects once again.

There are a number of positive factors that should give comfort and optimism to B share investors at recent prices.

The massive discount to the A share prices could easily be narrowed by permitting local investors to buy B shares and there is buying now in advance of this.

China's high urban inflation rate and lack of investment alternatives leads to asset allocation towards A shares. Demand could spread over to B shares, with the right permissions and marketing.

Shanghai's attempts to modify its custodian system to appease the SEC in Washington if successful, would lead to US institutional buying of B shares.

Big companies like Shanghai Tyre and Rubber and Shanghai Chlor-Alkali would seem cheap then in relation to Brilliance China listed on the New York Stock Exchange currently trading at twice their price earnings ratios.

The authorities in China have not been slow to respond to investors' criticism. The 1993 new issue queue will be less than half in money terms than in 1992. The time delay between placement and listing will be shortened considerably and new issue prices,in terms of price earnings ratios, will be lowered significantly, albeit not to Hongkong levels, but probably to around eight to 10 PER.

Late in 1992 the corporate tax rate for B share companies was dropped to 15 per cent and per values were split, taking a US$8 stock down to US$0.80, to make the shares psychologically more marketable.

December 1992 results will be a good testing point for the B share companies and the first to make an announcement was Shanghai Erfangi (Shanghai No 2 Textile) which reported excellent figures, way above prospectus forecasts, reducing 1992's price earnings ratio below 12 and 1993 forecast's to below 10.

Holders of Shenzhen B shares have been hit by the recent devaluation of the yuan swap centre rate which, although not widely publicised, has had a dramatic fall. B shares in Shanghai are quoted in US dollars and over the last couple of months have been very stable and are now enjoying a dramatic rally.

But Shenzhen B shares are quoted in yuan and when these are translated back to US dollars for valuation purposes they look rather sick after a one-year depreciation of about 30 per cent.

The yuan swap centre rate has now met parity with the Hongkong dollar and fear of further depreciation should not deter potential Shenzhen B share investors.

Duncan Mount is managing director of CEF Investment Management Limited which may have an interest in and/or hold positions in securities mentioned above