HSBC Asset Management favours Chinese commodity stocks, based on strong government reforms

Mining and metal prices have made a dramatic recovery in the past year, with market players expecting relatively stable levels to remain strong in 2018.

Stock valuations of China’s raw materials sector, however remain low, near bankruptcy levels at only 0.7 or 0.8 times, implying room for their recovery to continue, according to Mandy Chan Suk-man. investment director, head of China and Hong Kong equities at HSBC Global Asset Management.

Coal overcapacity has been slashed by 15 per cent in the past two years, while overcapacity in iron and steel has been cut 10-15 per cent, with plants reaching break-even levels because the government’s supply side reforms have been very successful, Chan said, referring to its shift to a stronger focus on supply quality and economic rebalancing.

“Typically when shareholders’ ROE (return on equity) is 12-15 per cent, they should not have PEs (price/earnings) bankruptcy levels.

“If raw material companies can maintain their earnings this year, their valuations will be raised in the second stage of a bull run,” Chan said.

In general, Hong Kong’s Hang Seng China Enterprises Index, or H-share market, remains attractive given it is forecast to produce 19 per cent earnings growth this year, Chan added.

“China has detached itself from a downturn in earnings, finally. So the economy is currently in a golden spot, as production capacity isn’t going to come back under environmental-related restrictions,” she said.

“Price earnings of H-shares are just 10 times compared to about 12 times in the past. We like those sectors that are especially cheap, and that investors had been avoiding.”

John Tivey, global head of mining and metals at White & Case, added that as car manufacturers move to the use electric batteries in their vehicles, the demand for copper, cobalt, lithium and nickel will increase to varying degrees, depending on the battery compositions that emerge as the market grows.

“Demand remains supported for copper, lithium, cobalt and nickel which are all part of the growth story around the battery powered EVs (electric vehicles), in line with China’s aims to make the industry more environmentally friendly,” Tivey said.

Mining stocks such as China Molybdenum have been recognised by investors in recent years with strong stock price gains.

Tivey said the government was likely to continue to allow well-managed, state-owned and provincial government enterprises to invest strategically, albeit in a more disciplined manner.

Chan also likes food companies, given the rebound in China’s producer price index is likely to spread to consumer and food prices.

Companies making drinks, food and low-end consumer goods will start raising prices this year because raw material prices have gone up, she added. And large Chinese food companies face less competition currently, after consolidation in the industry.

“When demand remains stable, companies will have a lot of pricing power,” Chan said, “and will have good stock performance.”