Unpleasant cocktail looms, says Merrill
Merrill Lynch is advising investors to sell down H shares ahead of a heavy year of new issues and what appears to be excessive enthusiasm.
The brokerage estimates US$15 billion of new equity issuance is planned for this year, a hefty supply level when considering the market cap for H shares now is just US$39 billion.
'China H shares are the clearest underweight that we see in the region,' according to the recently released Merrill Lynch report entitled China Chill Factors. 'Excessive valuations, excessive optimism on the potential for further ratings and a truly excessive issuance pipeline make for an unpleasant cocktail.'
Despite an 11 per cent correction in the H-share index since early January, the brokerage warns the relative valuation is reminiscent of the 1997 bubble for China-related shares. At current prices H shares command a price earnings multiple of 14.1, with earnings per share growth of just 5.2 per cent.
Although many are calling for an upwards re-rating of the sector, Merrill Lynch says these arguments are flawed because they do not take into account the lower standards of corporate governance, transparency and minority rights compared to the regional average.
Another negative is the decelerating credit cycle. Merrill Lynch says moves by Beijing to soak up excessive money supply growth should put pressure on earnings, saying most forecasters are likely to take it on the chin as growth momentum decelerates. As an example of over-exuberance, the report points to Tsingtao Brewery and Guangdong Kelon, both of which are now trading at a price premium or at par with their A-share counterparts.
In view of the poor prospects, the report advises investors to focus on Taiwan, Korea and India.
The report also cautions that few forecasters are paying attention to the looming impact of inflation, and the probable consequence that Beijing will move to cool economic growth soon.
