Stock Connect

Tips on picking winning stocks in China’s Shenzhen-Hong Kong link

PUBLISHED : Monday, 28 November, 2016, 7:04pm
UPDATED : Tuesday, 29 November, 2016, 9:37am

Fans of Chinese stocks are now eagerly awaiting the unveiling of the Shenzhen-Hong Kong Stock Connect on December 5 – a trading link that will allow foreign individual investors to directly purchase equities for the first time on the tech-heavy Shenzhen Stock Exchange, the world’s seventh largest by market cap, yet one of the most isolated so far.

A similar linkup with Shanghai was launched in 2014. But as far as investors are concerned, Shenzhen offers something different from the industrial and financial-heavy Shanghai market, a stock universe representing so-called New China.

“While China is on a slowing growth trend, its growth profile is also evolving,” said Kinger Lau, chief China strategist for Goldman Sachs. “We see consumption and services taking charge.”

Besides, although China is losing global market share in low-value-added goods, it is now a dominant global and local player in high-end electronics and industrial equipment, with rising momentum in infrastructure exports.

“Investors need to adjust their investment framework as the economy morphs into a new growth era,” Lau said.

The Shenzhen Stock Exchange, with a total market capitalisation of approximately US$3.3 trillion, is “a powerhouse of private enterprise, tech companies and strategic emerging companies”, said Stephen Sun, head of China and Hong Kong equity strategy for HSBC.

It has 385 consumption-related companies, accounting for 57 per cent of the listed companies in this industry, and 196 information technology (IT) firms, comprising 78 per cent of the industry. The 73 high-end manufacturing companies also take up 70 per cent of the total listed companies in the industry.

Of the 1,795 A-share stocks on the exchange, 881 – which span 109 sub-industries – will be included in the investable universe of the Shenzhen-Hong Kong Stock Connect based on the requirements from the authority. So what do analysts and experts predict would be potential winners and losers?

First of all, the new economy is the key value proposition of Shenzhen stocks for global investors, analysts said.

“[Shenzhen] offers global investors access to new economy sectors with potential high growth, earnings visibility and scarcity value,” said Sun from HSBC.

The definition of New China varies slightly among investors. But the most-widely recognised sectors include IT, services and consumption-related industries such as healthcare, outbound travel, media and entertainment, high-end manufacturing, environmental protection and clean energy.

According to HSBC Research, the IT sector’s representative stocks include iFlytech, China’s biggest speech-recognition technology provider, Hangzhou Hikvision, the country’s leading video surveillance product supplier, Shunwang Technology, an internet cafe and online entertainment platform, Wangsu Science & Technology, a leading provider of content distribution network services (CDN), radio and satellite communication service provider Guangzhou Haige Communication, financial information platform Eastmoney, online travel service supplier Shenzhen Tempus, and Goertech, China’s largest bluetooth earphones and 3D glass manufacturer, among others.

Morgan Stanley gave five technology stocks “overweight” ratings. They are Wangsu Science & Technology, Goertech, Guangzhou Haige Communication, China Aviation Optical-Electrical Technology, which makes optical components and electrical connectors, and Shenzhen O-film Tech, a manufacturer of precision photo electricity thin film components.

Consumption-related industries are a bigger investing group, with typical stocks such as liquor producer Wuliangye Yibin, leading meat processor Shuanghui Group, Guangdong Wen’s Foodstuffs, retailing giant Suning Commerce, home appliance supplier Midea Group, car maker Chongqing Changan Automobile, and Gree, the world’s largest air conditioning manufacturer.

Goldman Sachs Research picked Wuliangye Yibin and rival Jiangsu Yanghe Brewry as their favourites in consumer discretionary industries and offered them Buy ratings.

Sectors that offer scarcity value, such as national defence, medical and health care, may also look appealing to global investors.

AVIC Aircraft, China’s leading military and commercial aircraft manufacturer, and Aerospace Hi-Tech, which owns independent intellectual property rights in several strategic high-tech fields, are representative of the high-end manufacturing sector, HSBC analysts said.

Chinese pharmaceutical companies appear attractive too, such as Yunnan Baiyao Group, one of the country’s largest traditional Chinese medicine manufacturers, and Dong-E-E-Jiao, the biggest producer of donkey-hide gelatin, or ejiao in Chinese, they added.

Besides the “new economy” stocks, northbound investors should also keep close eye on shares with growth at reasonable price (GARP), analysts from Goldman said.

“This is one of the best performing styles in A shares over the past years, and we continue to see these stocks offering sensible risk/reward to international investors,” they said in a recent research report.

On their list of GARP equities are laser processing equipment manufacturer Han’s Laser, cinema operator Wanda Cinema, sewage treatment technology company Beijing Originwater, photovoltaic inverter maker Sungrow Power, opto-electronic components supplier Accelink Technologies,

Luxshare Precision Industry, real estate developer China Merchants Shekou Industrial Zone, and tourist resort operator Shenzhen Overseas Chinese Town.

Goldman analysts also highlighted several Shenzhen stocks that are the most well-known among qualified foreign institutional investors, who are foreign institutional investors with a government permit to invest in Chinese equities under the QFII scheme.

“[Those stocks] should conform to conventional western investment/valuation frameworks,” they said. “In other words, some due diligence work has been done by existing QFIIs.”

These QFII favourites include Jiangsu Yanghe Brewry, Sungrow Power, Hangzhou Hikvision and Shenzhen Airport.

However, Goldman analysts advise that investors should sellbrokerage and stock exchange stocks at high prices, as valuations appear less attractive after recent rallies, and earnings contributions from Shenzhen should be limited in the near term.

For southbound investors from mainland China, Goldman recommends Hong Kong-listed small/mid-cap stocks with high discounts to their A-share sectors, such as China Harmony Auto, property developer BBMG, and sportswear retailer Pou Sheng International.

Analysts from China Galaxy Securities prefer those fundamentally strong Chinese companies listed in Hong Kong, such as Kingdee Software, which has high exposure to cloud-related business and improved profitability, Maple Leaf Educational Systems, one of the largest listed Chinese education industry players, and Shanghai Industrial Urban Development, which has lower valuations to its A-share peers, they said.