China stock market

Rebound in China’s ChiNext tech stocks won’t last, says Fortune SG

PUBLISHED : Tuesday, 01 August, 2017, 2:21pm
UPDATED : Tuesday, 01 August, 2017, 10:15pm

China’s ChiNext board for start-up firms is in the spotlight after its benchmark index rallied the most in a year last Thursday and a state-backed fund that bought stocks in an attempt to shore up equities during the 2015 market crash purchased major stakes in three ChiNext companies for the first time.

Still, it isn’t enough to convince Fortune SG Fund Management and some of the nation’s biggest brokerages that the board comprising 663 start-up firms is about to pull out of a two-year decline.

While Guotai Junan Securities and Bocom International say slowing earnings growth, relatively high valuations against large-cap stocks and the prospect of faster initial public offerings will deter further buying, Haitong Securities predicts a two-month rebound on the ChiNext stocks before any decline resumes.

“It is a weak rebound and I don’t think ChiNext can stop its declining trend,” said Alexandre Werno, Shanghai-based executive vice general manager at Fortune SG, which manages US$18 billion in assets. “It’s cheap for some ChiNext stocks now. But for the general sector, it’s still too expensive.”

The ChiNext gauge caught traders off guard last Thursday with a 3.6 per cent jump, leaving investors scrambling to find reasons for the surprise advance.

ChiNext sinks further into the doldrums amid lacklustre company earnings

While technical indicators had earlier showed the board’s shares were being oversold, adding fuel to the fire was a rare move by China Securities Finance, a major state buyer during the 2015 market crashwith US$86 billion in assets, to buy a big chunk of shares in Beijing Kunlun Tech, Zhejiang Huace Film & TV, and JSTI in the second quarter, making it the fifth biggest shareholder in the three companies.

The three stocks each jumped at least 18 per cent last week, marking the first time a state-backed fund, dubbed the “national team” by investors, has emerged as a top 10 shareholder in any ChiNext-listed start-up.

National team buying is closely watched by Chinese stock investors who believe the state funds are ahead of curve because of their advantages in research and information access. However, Chuancai Securities said it shouldn’t be taken as a sign of a general reversal in the decline of the ChiNext market.

“ChiNext doesn’t meet basic conditions for a trend reversal in the short term against the backdrop of the faster pace of IPOs and forecasts of significant drops in interim earnings by several big-weighted companies,” said Wang Peng, an analyst at the brokerage. “The downside risk for ChiNext hasn’t been fully revealed.”

The downside risk for ChiNext hasn’t been fully revealed
Wang Peng, Chuancai Securities

Last week’s ChiNext index rally is simply a bounce-back that is likely to last until September, according to Xun Yugen, a strategist at Hationg Securities, the nation’s second-largest brokerage.

Xun’s prediction is based on the duration of the gauge’s last three rebounds since January 2016. Each rebound lasted two months, with the strongest one gaining 27 per cent between February and April in 2016, according to his research note.

He cautions investors against buying ChiNext companies now, citing concerns that a slowdown in earnings growth for the board will persist. Profit growth for ChiNext firms may have slowed to 4.6 per cent in the second quarter from 11 per cent in the first three month of the year, according to Haitong Securities, amid tightened approvals of asset purchases by listed companies, a major contribution to smaller firms’ earnings over the past few years.

The ChiNext index closed 0.1 per cent higher at 1,736.30 on Monday, little changed after last Thursday’s rally. The gauge remains 56 per cent down from its peak in 2015, with turnover tumbling more than 70 per cent from all-time highs. It is valued at 48 times reported earnings, according to the Shenzhen Stock Exchange. That is almost three times as expensive as the CSI Index of large caps.

ChiNext stocks rebound at double the rate of benchmark, but investors see short-lived rally

“Weak earnings plus valuation compression is a bad combination,” said Hong Hao, head of research at Bocom International. “Ignore the bear-market rebound and lessen your load on the rebound.’’ Hong, who correctly predicted the bursting of China’s stock bubble in 2015, said the ChiNext index is likely to fall another 25 per cent from its current level.

State buying of the three ChiNext companies is a bottom-up strategy of picking individual stocks based on valuations and corporate fundamentals rather than a general preference for smaller companies, according to Ken Chen, a strategist at KGI Securities.

Among the three, internet gaming company Kunlun’s first-half profit increased 58 per cent and construction project contractor JSTI’s rose 21 per cent, while Huace Film’s profit growth was 1.2 per cent.

Kunlun is trading at 32 times estimated earnings for this year while the multiple is 25 times for JSTI and 31 times for Huace Film, according to data compiled by Great Wisdom. All are below the average 43 times estimated price-to-earnings ratio for the ChiNext index, based on data from Haitong Securities.

“The national team will only buy stocks with reasonable valuations and secure growth outlook,” said KGI’s Chen. “So they won’t buy ChiNext companies massively, although there are some good stocks among them.”