Published November 8, 2008

Sector In Focus
S-shares not out of the woods yet

All eyes are on how the Chinese economy pans out and whether fiscal policies will offer buffer. By Lynette Khoo

Email this article
Print article
Feedback

THE rebound by S-shares this week may well turn out to be a dead cat bounce, as negative surprises in third-quarter results could trigger fresh selling, analysts say.

Many Chinese stocks listed here regained some of their losses earlier in the year. Their biggest jump came on Tuesday on the back of a recovery in world markets, which dealers termed a pre-election rally, one day before the US presidential vote on Wednesday.

Investors started picking up S-shares last week when reassurances from the Chinese premier on the stability of the country's markets helped bolster mainland Chinese stocks.

At yesterday's close, the Prime Partners China Index (PPCI) had put on 29.7 per cent to 59.06 points from its all-time low on Oct 29.

The FTSE ST China Index (FSTC) had added 29 per cent to 181.88 points from its all-time low on Oct 29.

Should investors with a longer-term view think of venturing into S-shares, they could look at those trading at two to three times price-earnings ratios or half their book values, a local analyst says.

But the recovery could prove to be short-lived, as more quarterly earnings results are due in the weeks ahead.

Not trough yet

Citi analyst Tan Han Meng says S-shares have yet to reach trough valuations. 'At 0.6 times price to book (P/B), the FSTC index is trending closer to the potential low of 0.5-0.3 times P/B for mid-small caps reached during the 1998/99 downturn.'

Analysts expect more earnings downgrades after the Q3 results, projecting earnings growth in the S-share universe to range from negative to a marginal increase.

DMG & Partners Securities analyst Heng Tong Jin expects S-share companies to post flat to marginal earnings growth on a year-on-year basis due to weak demand. 'It's not time for bottom-fishing,' he says, citing potential share price weakness towards the end of the year.

A local S-share analyst expects overall earnings to decline among the companies he follows, as they could have been hit indirectly by plant closures in Beijing and surrounding cities during the August Olympics, which caused clients to withhold stocking up on inventory.

Some S-share companies have joined the chorus of companies here issuing profit warnings in the past two weeks.

Among them, China New Town Development and Pan Hong Property Group guided for a Q3 loss. Steelmaker Delong Holdings reported a net loss in Q3 due to eroding margins.

But there have been bright spots. Sports apparel firm China Hongxing and backpack maker China Zaino, for instance, reported earnings growth from a year ago.

China Zaino, whose net profit grew 8.2 per cent to 92.64 million yuan (S$20.27 million), also managed to improve its gross margin to 33.2 per cent from 32.6 per cent in Q3 last year.

Its executive chairman Chen Xizhong told BT the current economic outlook will not derail plans for expansion, and the company will use 255 million yuan from its IPO proceeds raised in April for these plans over the next two years.

But analysts say investors can no longer bank on the past super-normal growth of the Chinese economy that has bolstered many S-share companies that feed on domestic demand.

'Recent data has shown that when the world slows down, China slows down as well,' says DMG's Mr Heng. 'Investors who think 2009 will still be a good year run the risk of over-estimating China's strength in this financial turmoil.'

Concern over China's economy has overriden stock-specific or sectoral views when it comes to stock picking, analysts say. All eyes are on how the economy pans out and if fiscal policies will offer any buffer.

The challenge is the lag effect of fiscal stimulus and its impact being potentially confined to specific sectors such as the recently announced investments in railway infrastructure.

'Historical evidence shows that growth supported by government spending tends to be lower-quality growth and may not benefit corporate earnings as witnessed in the period of 1998-2001,' says Citi's Mr Tan. 'We continue to remain cautious on cyclical commodities amid current global downturn and China housing slowdown.'

China's once-roaring economy expanded 9 per cent in the third quarter - the slowest rate since 2003.

Based on the purchasing managers index (PMI), China's manufacturing sector contracted sharply in October.

The slower economic growth outlook and weaker consumption have already prompted DBS Vickers to cut its fiscal 2008 and 2009 forecasts for S-chips.

Based on latest reports, economists at Citi and Credit Suisse believe a soft landing is still the more likely scenario for China, with GDP coming in at high single-digits for 2008 and 2009.

'The key now is demand. Many companies have expanded aggressively over the past few years and if demand does not pick up, there will be excess capacity,' says CIMB-GK analyst Ho Choon Seng. 'The outlook is going to be challenging.'

Also dampening the mood are credibility issues surrounding S-shares, with some touted to have poor corporate governance amid recent scandals.

But Mr Heng points out that everything is measured in risk and reward. 'We can't assume that all Chinese companies are poorly run,' he says. 'If you get it right, you can get about four times the money you put in. Blue chips can't give you that.'

Should investors with a longer-term view think about venturing into the S-shares space, they could look at those trading at two to three times price-earnings ratios or half their book values, one local analyst says.