Analysts sound warning as red chips gain in appeal

HONG KONG investors seem eager to shrug off the economic problems in China as red chips came to the fore on the stock market last week. Buying was not limited to the more established names, as new issues like Guangzhou Shipyard and Shanghai Petrochemicalalso enjoyed the limelight.

Analysts continue to warn, however, that there may be a lot of earnings disappointments due to the economic problems in China. Things are likely to get worse before they get better, especially with the Chinese property market in the doldrums.

However, there are some China plays which still offer a good buy.

''We are expecting poor earnings from many listed companies with China investments, especially those involved in property,'' warned research director at G. K. Goh Securities, Mary McBain.

Ms McBain said many of the problems faced by companies invested in China would not be made explicit to shareholders, they may come from poor property sales, or even no sale at all.

Ms McBain explained most of these investments would probably be kept off the balance sheets.

Companies involved in the China property market have faced mounting problems. Many find there are no funds availing in China and have had to go offshore , yet ultimately the properties will probably be sold to local users.

Ms McBain said this could all be a blessing in disguise. She said: ''Some projects are sure to be shelved now. Prices are collapsing; overseas interest drying up. There remains some interest in Hong Kong. But this will be swamped by properties coming on stream.'' The situation seems different for office properties in certain areas and retail space. There is a shortage of good quality property in these sectors in many cities, save Shenzhen.

McBain said: ''A lot of companies took minority stakes in property joint ventures, for example Winsor Industrial, and any problems will go straight to the dividend account. We will never know what the commitment was. There has also been a lot of arm-twisting, persuading the mainland shareholder to buy their partners out. But wriggling out will become less easy in the future.'' Hongkong Bank's managing director of China services, Anthony Russell, also believed there would be a lot more problems before the situation corrected itself. He explained: ''The credit squeeze has only just started and there is a long way to go.

''You can't have a credit squeeze without someone getting hurt. But Hong Kong companies, at least those which have established a presence in China, due to the lower production costs there and the fact they are selling goods in markets overseas, should not be affected too badly.

''If anything, they should benefit from lower inflation once that is under control.'' Among the companies worst hit by the credit squeeze will be those selling goods in China. In its attempt to cut the trade deficit, China has announced stringent cutbacks on imports such as steel.

Mr Russell also warned about those exposed to the property market.

Despite these problems, senior analyst at Dao Heng Securities, Jeannie Cheung, insisted investors should not write off all China plays.

She said: ''We can now classify these stocks into two groups, the one with solid backgrounds and good fundamentals, the others comprising basically shell companies whose earnings look fragile in the face of the austerity programme.'' The austerity programme will have an effect on all investments in China but certain sectors should escape the brunt of the squeeze. Ms Cheung said if the investment was in infrastructure or in industrials providing basic necessities, the situation did not look that bleak.

An example of a stock which should prove somewhat immune to the economic problems on the mainland was Guangdong Investment. Ms Cheung said: ''More than 60 per cent of the company's investments are in the Guangdong region, and some 30 per cent of its income is from tourism.'' But investors should beware of the shell companies, where China interests have obtained access to the Hong Kong stock market in order to raise capital. These companies are promising to inject China assets into the company.

It was these companies Ms Cheung wanted investors to treat with caution as the squeeze in China could easily effect their asset-injection plans.

Ms Cheung believed some China property companies also remained interesting possibilities.

''A company such as Chinese Overseas Land has good fundamentals and it is backed by the largest state-owned construction company in China - it should not find its earnings dampened too much.'' China's trade deficit has continued to grow, as the figures for July show, but there is also some optimism that the clampdown is having the right effect.

Mr Russell explained: ''It is early days, but are some signs of early results. The price of steel has come off fractionally, the government has successfully stabilised the exchange rate and personal deposits are rising again as they are not being diverted into a consumer binge.

''But it will be several months before the evidence is conclusive. We have to watch to see if the rate of inflation is under control, if growth is slackening, if there is an improvement in the balance of trade and if the exchange rate holds at this levelfor several months. We cannot expect the controls to work too quickly.''