Bottom-fishing investors should rethink when Chinese companies start buying back their shares
Companies returning cash to shareholders have helped propel the US stock market to a record bull run this year. In China, investors take fright when their firms do the same.
This year, more than 700 Chinese firms, or about 20 per cent of actively traded stocks, have announced plans to spend money on their own shares. The 24 billion yuan (US$3.5 billion) shelled out so far is just shy of the past three years combined. Yet the bear market has only deepened.
In theory, a buy-back announcement is a sign of stable cash flow, good corporate governance and more repurchases to come. Yet the Shanghai Composite Index is at a two-and-a-half-year low, and Chinese investors flee when they hear the word.
The reason is the volume of shares that have been pledged for loans. In China, major shareholders routinely use their stocks as collateral to secure short-term bank financing. These loans are more common among privately controlled enterprises, which have weak access to bank credit. In the first half, 22 per cent of listed companies pledged at least 30 per cent of their shares, a 6 percentage point increase from two years earlier.
After this year’s declines, many borrowers are close to facing margin calls. Imagine a Shenzhen-listed company that took out a 400,000 yuan loan at the beginning of the year using 1 million yuan worth of its shares as collateral. The Shenzhen Composite Index, home to more non-state companies than Shanghai, has slumped more than 26 per cent this year. This would have raised the loan-to-value ratio to 54 per cent, dangerously close to the 60 per cent maximum allowed by the government.
An easy and obvious solution is to prop up the company’s shares with buy-backs. In contrast to their US counterparts, Chinese investors are right to be wary. In the second half, a staggering 1 trillion yuan of share-pledged loans will be due. A similar amount of corporate bonds will need to be refinanced, forcing these companies to compete for funding.
Even for firms that aren’t in financial distress, cash rewards cannot disguise weak operations. Midea Group’s 4 billion yuan buy-back plan is China’s biggest this year. But since handing out 1.8 billion yuan to shareholders, the electronic appliance maker’s stock has fallen a further 16 per cent.
Investors understand that Midea must scale back its global ambitions as political tensions check China Inc.’s overseas acquisitions. The Shenzhen-listed company expects only single-digit sales growth this year.
China’s idiosyncratic investment environment often defies the conventional logic of global stock markets. This is just one more example. Foreign investors considering whether it’s time to start bottom-fishing should take note.