CICC Tops 2015 All-China Research Team
Despite recent economic turbulence, China remains a viable destination for equity investors, analysts insist.
For a fourth year running, China International Capital Corp. leads the All-China Research Team, Institutional Investor’s exclusive annual ranking of the nation’s leading sell-side equity analysts. The firm captures 18 total team positions, seven fewer than last year but three more than second-place Credit Suisse, which rises one rung after increasing its total by four.
Bank of America Merrill Lynch, whose total falls by one, slips from the No. 2 spot to share the third tier with Morgan Stanley, which bolts from fifth place after adding five positions, for a total of 13. The latter’s ascent bumps last year’s No. 4 firm, UBS, down a notch even though its total increases by two, to 12. Click on the Leaders link in the navigation table at right for details on the full list of 15 ranked firms.
This year’s team features 101 analysts, including 25 people appearing for the first time. To view the individuals in first place in each sector, click here or select the appropriate link in the navigation table for more information. The Overview highlights some of the more significant accomplishments of this year’s researchers.
The 2015 All-China Research Team is based on responses from nearly 790 investment professionals at more than 400 institutions that collectively manage an estimated $595 billion in Chinese equities.
China’s painful transition from an export- to a consumer-driven economy has turned it into one of the most shorted markets in the world in terms of investor sentiment toward underweighting. This became especially clear during the summer stock market rout — the Shanghai Stock Exchange Composite Index plunged more than 40 percent between mid-June and late August — which ended only after the central bank spent an estimated 1.5 trillion yuan ($235 billion) to shore up share prices, according to an early September report by Goldman Sachs Group.
However, Hong Liang, head of research and chief economist at CICC in Beijing, believes global fund managers that abandon China do so at the risk of losing out on capturing longer-term growth opportunities. “I would advise investors to maintain some exposure to China, in sectors that are either seeing structural reform opportunities or higher trend growth,” she says. Those categories include consumer consumption, financial services, health care, Internet and manufacturing, adds Liang, who oversees a 64-analyst team that covers some 840 companies in 46 industries.
Credit Suisse remains similarly optimistic about China’s long-term prospects and has expanded its coverage universe, according to Vincent Chan, Hong Kong–based head of China research. His analysts now follow 420 Chinese companies — including 180 A-share entities — up from about 300 a year ago. “We basically covered all sectors,” says Chan, who secures a runner-up spot in Portfolio Strategy for a fourth year running. “Most of the increases in company coverage are in sectors like consumer — both staples and discretionary — capital goods, health care and technology hardware.”
BofA Merrill has also raised the number of stocks its researchers follow, to more than 300 across 15 sectors in the A-share and H-share markets, reports Stephen Haggerty, head of Asia-Pacific research. “Our China equity market strategist, David Cui, expects the market to stay choppy,” he says. Cui, who spent the past four years at No. 1 in Portfolio Strategy but tumbles to third this year, “believes that lower growth and high and rising leverage are likely to have a negative impact on China’s financial system,” adds Haggerty, who is based in Hong Kong. “In this environment David is overweight on defense, nuclear, utilities, services — including logistics and tourism — and noncommodity nonfinancial large-cap state-owned enterprises,” or SOEs.
Jonathan Garner, Morgan Stanley’s head of Asia and emerging-markets equity strategy, says investors should focus on the bright spots in the Chinese economy. “It is true that China’s nominal gross domestic product growth rate has been slowing for some time now, although near term we expect a modest pickup into mid-2016,” the Hong Kong–based researcher says. “For over four years we have been advising clients to focus on what we term the ‘new economy’ sectors of information technology, health care and consumer, and to underweight the ‘old economy’ sectors of materials, energy and industrials. Topline growth, return-on-equity trends and leverage issues all favor new economy over old economy exposure in China structurally.”
In the near term the slowdown and its impact on the rest of the global markets have just begun, insists CICC’s Liang, who debuts in first place in Economics. “Both shrinking U.S. dollar liquidity and slowing China domestic demand have put pressure on raw materials prices since 2013,” she observes. “We believe China still has a year or two to go in capacity consolidation of the heavy industrial sectors, before supply-demand balance may be restored. China will likely go through more deflation in the basic materials sector, as well as some capacity reduction in 2016. However, the magnitude of producer price deflation should be much more moderate next year.”
Looking at the valuations of overseas-listed Chinese equities, Liang believes that a lot of the pessimism over the growth momentum of the world’s second-largest economy may already be priced in. “Globally, if the U.S. and China continue to export deflation next year, the worst performer will definitely not be China, where expectation is already low and policy elbow room is still large.”
CICC’s Hanfeng Wang, who jumps from third place to first in Portfolio Strategy, maintains that the issues facing the mainland economy are structural rather than cyclical. “The investment-related sectors — basic materials, energy, machinery and so on — are still suffering from the overall slower growth. I do not think the timing to build positions in these sectors is coming yet. But those names that gradually are becoming interesting are industry leaders and cheaply valued, and may play an important role in consolidating their industries — especially given the fact that China is trying to push forward with SOE reforms.”
Moreover, there are still a number of sectors that hold promise, Wang declares. Chief among them is health care, which he argues should continue to enjoy a secular uptrend. The Beijing-based strategist has been urging investors to overweight the category and has highlighted Lianyungang’s Jiangsu Hengrui Medicine Co., a leading innovator in antineoplastics, medicines that fight the spreading of cancer by affecting cell-division processes. The stock bolted 75.3 percent year to date through mid-November.
Wang’s colleague Junhua Mao is the only analyst to top two sectors this year: Banks, for a third year in a row, and Insurance, for the first time. The CICC researcher, who works out of Beijing, began recommending shares of Hong Kong–headquartered multiline insurer China Taiping Insurance Holdings Co. in July 2014. The stock had trailed the sector in 2012 and 2013 when the company focused on volume and relied on bancassurance channels with a focus on low-margin businesses, Mao told investors, but it had since made a successful restructuring and started emphasizing agent development. “We thought the group became a hero from zero and thus put it as our most preferred name in China insurance space,” Mao says.
Good call. By mid-November 2015 the stock had soared 62 percent, from HK$15.62 to HK$25.30.
Preferred names in the banking sector include Beijing-based Bank of China, Shanghai’s Bank of Communications Co. and Chongqing Rural Commercial Bank Co. The analyst has been especially bullish on the latter firm, citing its strong fundamentals and dubbing it a beneficiary of the central government’s targeted easing for rural China. Recommended in late October 2014 at HK$3.58, the shares rocketed to HK$6.66 in late April before being dragged down by market turbulence. By mid-November they had slid to HK$4.73, for a gain of 32.1 percent.
These institutions notwithstanding, Mao sees clouds on the horizon of China’s banking sector as a whole. “While signs of macro stabilization are still unclear, we believe the reduction of excess capacity for the real economy, and potential pro-active systematic nonperforming loan disposal, will become the main catalysts for banks in the second half of 2016,” he says. Investors should look at small- and midcapitalization lenders, Mao adds, because “they are more flexible in adjusting their asset and liability composition.”
Research directors agree that consumer spending will be a key gauge of China’s growth going forward. Chen Luo, who repeats in first place in Consumer/Discretionary and also earns the No. 3 spot on the Consumer/Nondiscretionary roster, says fund managers should be picky when it comes to choosing stocks as retailers of nonessential goods and services will continue to face challenges in the near term, especially as the nation’s economic slowdown continues.
Certain companies stand a better chance of weathering the headwinds, the BofA Merrill analyst contends, and they include athletic footwear and apparel maker Anta Sports Products. The Jinjiang-based company has a strong execution track record, Chen says, adding that he sees the beginning of a cyclical upturn in China sportswear as more consumers take up sports in their leisure time. Despite the recent market sell-off, Anta shares were up 67.7 percent year to date through mid-November.
The analyst, who works out of Singapore, also prefers Guangdong-based home appliance makers Gree Electric Appliances and Midea Group, believing they will benefit from industry consolidation in 2016. Although Gree’s share price was little changed by mid-November, Midea’s gained 5.6 percent.
BofA Merrill’s Yuanyuan (Tina) Long, who debuts atop the Consumer/Nondiscretionary roster, has been urging clients to buy Kweichow Moutai Co., one of China’s leading liquor producers. In mid-November the Guizhou-based distiller’s stock was changing hands at 215.11 yuan a share, up 59.2 percent in the trailing 12 months.
“We like the stock because of [the company’s] strong brand equity and market share gain capability,” among other factors, says Long, who is stationed in Hong Kong. In addition, Kweichow Moutai may benefit from future reforms in state-owned enterprises, especially if government officials decide to sell larger chunks of the shares to the investor public.
She is cautious on other players in the industry, however. “China’s consumer nondiscretionary sector will be negatively impacted by the prevailing deflationary environment, a result of the China slowdown, hence falling demand,” Long believes. “Most listed names have little pricing power to reap the gains from falling raw materials costs. In contrast, price competition has been intense, which both impacts revenue growth and also weighs on margins.”
Wai (Eddie) Leung, who celebrates his fourth year in first place in Internet, offers a mixed outlook on his sector, “as its business models range from games and subscriptions, which are not cyclical, to advertising and commerce, which are. However, we still expect an increase in user activity regardless of the economic cycle, so we expect revenue growth to continue to outpace that of the overall economy.”
The BofA Merrill analyst’s stock picks include two providers of mobile games and related services: NetEase, a Beijing-based outfit whose American depositary shares trade on the Nasdaq Stock Market, and Shenzhen’s Tencent Holdings, owing to “their strong cash flows and limited exposure to cyclical businesses amid investors’ macro concerns, which increased throughout the year,” the Hong Kong–based researcher points out.
Shares of NetEase and Tencent climbed 50.9 percent and 35.6 percent, respectively, year to date through mid-November.
It’s a different story for vehicle manufacturers, according to Morgan Stanley’s Jack (Yuhin) Yeung, who vaults from runner-up to finish in first place for the first time in Autos & Auto Parts. The Hong Kong–based analyst believes that falling demand has less to do with macroeconomic factors than with lack of production of what buyers want.
“Despite a high base and macro uncertainty, we noticed the growth slowdown in China was also caused by a supply-demand mismatch — for example, too many sedan models and not enough SUVs,” says Yeung. “The normalizing growth will lead to divergent performance among vendors in the food chain. We expect auto and auto parts makers that have competitive product portfolios — especially SUV and good price-and-performance models, and room for further cost-down via increasing localization — to outperform.” Hebei-based Great Wall Motor Co., the nation’s largest sport utility vehicle maker, is among the companies he recommends.
Another Morgan Stanley analyst marking his first time as sector champion is Yu (Andy) Meng, who rises from second place in Energy. His favorite name this year is Shanghai-based synthetics and resin producer Sinopec Shanghai Petrochemical Co.
“We like the stock mainly thanks to its pure exposure to downstream businesses, including refining and chemicals,” the Hong Kong–based researcher explains. “The refinery business has sustainable earnings thanks to China’s market-oriented oil price adjustment measures, while the chemicals business is going through a significant turnaround because of the low oil prices.”
Not everyone sees cause for optimism. “We are advising investors not to increase their China exposure at this time,” says Yankun Hou, who directs Chinese equity research at UBS in Hong Kong (and also earns a runner-up spot in Autos & Auto Parts). “We believe that the MSCI China’s 9.5 times forward price-earnings ratio is fair, but the prospects for a substantial pickup in growth are remote in most sectors.”
Exceptions include industries devoted to consumer service — health care, insurance, media and tourism, among others. Hou says UBS is advising clients to focus on growth stocks in these areas, despite what appear to be demanding valuations and poor liquidity.
“American depositary receipts have also been overlooked,” he contends. “They stand to account for 16 to 17 percent of the MSCI China Index but are currently underweighted by most investors.”