China Stocks Cheapest Level in Last 3 Years

China stocks are trading at levels last seen since 3 years ago. P/E in Shanghai is 19x compared with 20x in June 2005, and 26x for S&P 500. But you should still buy the same stocks in HK as they are only trading at 13x.

Start accumulating for the long term.

China"s Inflation Down To 6.3% in July 2008

After hitting a high of 8.7% in February 2008, the inflation rate trended downwards and was 6.3% in July 2008 (5.6% same period last year).

With inflation slowing, this gives the Beijing room to start reducing interest rates and increasing the amount that banks can lend in order to boost economic growth. This shows that Beijing's efforts at reigning in growth is working and inflation for the year should come in around 7% which will still be below GDP growth expected at 10%.

IPO: China Southern Locomotive & Rolling Stock

Stock Code: 1766
Number of Offering Shares: 1,600,000,000 H Shares (subject to Over-allotment option)
Number of Public Offer Shares: 160,000,000 H Shares (subject to adjustment)
Maximum Offer Price: HK$2.76 per Share (HK$2,787.85 per board lot)
Sponsors: China International Capital; Macquarie Capital

Time Table
Offer Period: 13 August 2008 before 12:00 noon
Allocation Result & Refund: August 20, 2008 (Wednesday)
Dealing commences on: August 21, 2008 (Thursday)

Application cut off time if applied through Goldride Securities Limited
- Financing required: August 12, 2008 12:00
- Apply with full deposit: August 12, 2008 16:00
Financing: 90% financing available
- Minimum application amount for margin financing: HK$500,000
- Interest rate applicable (indication only, subject to change): 3.5% p.a
Application Charges: HK$50.00

Clients who intend to make applications through Goldride Securities Limited should contact your accounts executives prior to the cut off time. Clients are requested to deposit sufficient money into their securities account prior to the placement of orders. The margin finance facility will only be available while funding lasts.

HK Fx Reserves Rank 9th Worldwide

HK Fx reserves grew to USD157.7 billion at the end of Jul 2008 (up 0.6%from USD157.6 billion at the end of June 2008). The world's largest foreign currency holdings: China, Russia, India, Taiwan, South Korea, Brazil, Singapore, and HK.

But HK is the only place with no currency controls. In China the government restricts the amount of foreign currency that can be held by the residents and exchanges RMB for your foreign currency holdings. If you need to get foreign currency, for example for travel and trade you will need to apply to exchange your RMB.

China has loosened Fx controls in the past few years on the back of increased foreign currency reserves, and Chinese citizens now can exchange USD20,000 per year. However, that does not mean that they can carry that much out of the country.
In India, citizens can invest USD200,000 per year overseas.

Why Buy Into The China Story?

Bank of East Asia: Earnings dives 52% in 1st half 2008 due to losses in financial instruments while net profits from maniland China operations rose 50% or 26% of income(excluding writedowns).

HSBC: 29% down in earnings

StanChart Bank: 30% growth in 1st half profits. Operating profits from China operations (excluding last year's one off profits) were up 50%. India first half pre tax profits up 89% while HK accounts for 25% of profits. The bank is looking to list in India and China eventually.

If the foreign banks are looking to list in China, and China accounts for over 50% of their profits, then it is obvious that the Chinese banks themselves are a good buy. The competition will be growing but the pace of foreign banks expansion into China is restricted and they will not have a major deposit base.

The analogy is the foerign banks in HK find it difficult to compete with HSBC, StanfChart and bank fo China for local deposits relying instead on borrowing from them on the inter bank market.

The biggest assets of the Chinese banks are their huge deposit base and branch networks. A foreign will have no chance of duplicating that.

How to invest in Chinese RMB?

RMB deposits in HK rose by RMB 48 billion from November 2007 to April 2008. By May 2008 RMB deposits were RMB 77.68 billion (three times RMB 26.16 billion in May 2007, and 87 times RMB 895 million when RMB deposits first started in HK in 2004).

RMB deposit rates: 1% pa

Morgan Stanley: RMB still undervalued. Expect RMB 6.60 by end 2008, and 6.30 by end 2009 to the USD.

Credit Suisse: 6.75 (2008) and 6.15 (2009)

HSBC: 6.77(2008) and 6.33 (2009)

How to take advantage of the strength of the RMB? Well, you can't buy RMB because of foreign exchange control but you can buy Chinese companies listed in HK with RMB assets and RMB income streams. The dividends is in RMB but converted to HK$ which is pegged to the US$. Therefore, this is a proxy for investing in RMB.

HKEx Launched Gold ETF

The HKEx has just launched a Gold ETF (#2840). For those who wants to take a punt on the price of gold, this is a new vehicle which is a lot safer than gold futures or trading in commodities.

The SPDR Gold Trust is one of the world's largest commodity ETF (fund size > US$19billion). See www.spdrgoldshares.com.

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It's Official! Sell-Off in Chinese Banks "Irrational"

In the first half of 2008, the shares in Chinese banks have fallen 43% in Shanghai, and 13% in HK wiping out US#300 billion of market value. However, JP Morgan belivese that the current sell-off in the Chinese banks is irrational due to misplaced fears over margins, bad debts, etc. according to a recent report.

If you will recall, I have been saying just that for a number of months. Now it's official. At current levels, they are a BUY and HOLD for medium to long term and a trading opportunity for the short term.

I particularly like the Chinese banks without foreign shareholders. Those with foreign partners are overvalued vis-a-vis their peers because of the "halo" effect. However, the foreign partners do not have control (either from management or operationally) and can only provide "technical" assistance for new products. The thinking is that with foreign partners on board, the banks are unlikely to make bad loans. Well, the HSBC subsidiary in the US made big bad decisions on sub prime too. When banks made bad decisions it doesn't matter who is on board. Without a steady partner, the Chinese banks can "cherry pick" and choose the "best of breed" partner for each new product.

Actually, Chinese companies are a screaming BUY. The current pessimistic view is a result of "transference" i.e. anaylsts are projecting the current problems in the western economies to China. Too often I hear the argument that "If the US economy is down, how can the Chinese economy which depends on exports to the US remain bouyant?" Well we need to look at the portion of US exports to GDP and compare that to internal consumption which is growing soo rapidly that the Chinese government has to hold it down. In the US, the government is worrying about recession. In other words, internal consumption will make up for short fall in the US market. Also, exports to Europe and the rest of Asia are up.

At the end of the day, the best way to participate in a growing economy is through ownership of bank shares. You don't have to pick individual sectors.

Where is the A share Market Going?

On average chinese companies (A Shares) will be posting +21% earnings growth. This of course falls short of the heady days of 2007 when they were posting multiples growth. However, 21% is nothing to sneeze at.

The average P/E of companies listed on the Shanghai exchange is now down to 21x from over 70x, and the index is down 60.

Time for a rebound.

Play With The Big Boys?

The HKEx reminded brokers that the FTSE Xinhua China 25 Index will be rebalanced on 21 July. The related trading activities may start as early as next Friday as the rebalancing of the FTSE Xinhua China 25 Index will be effective the following Monday. Be prepared to see huge fluctuations during next Friday’s closing auction session.

In a down market, funds will first sell the stocks they don't want to keep or where they need to trim their holdings. Then they will look to buy into those that they want for their portfolios or add to their holdings. This is because they are not worried that the market will run away from them, and in fact would expect the market to retreat on their selling.

In a rising market, they take the opposite tactic by first buying the stocks they want and then selling the ones they don't want to keep.

Since we are in a down market, I would expect that they will sell first and buy in later. Keep this strategy in mind for your own trading.

ICBC Redux

Yesterday, I talked about ICBC (#01398). The bank has just announced that net profits for the first half of 2008 will be up at least 50%! This is in spite of the tightening of credit on the Mainland.

Profits were up over 77% for 2008Q1, and margins have been under some pressure in the second quarter. In 2007 first half profits were up over 60%. Overall, we should see the effects of tightening measures in the second half as investors move to longer term deposits increasing funding costs for banks. However, we expect fees and other non interest income to rise. Banks in China do not have the wide range of financial products that we are used to seeing, and the potential for increased profitability from these products will be substantial. We still maintain a strong BUY recommendation.

HK Near Bottom

Yesterday 3 July 2008, the Hang Seng Index (HSI) was down 2.1% to 21,242 with most stocks at 52 week low. At this level, stocks are trading at an average P/E is 13% with dividend yield is 3%, very close to historical lows.

The market has retreatced almost 5,000 points from the mid May high and may be due for a rebound. We have tested the 21,000 support level 3 times and it appears to be holding.

Accumulate China stocks with strong stories and earnings.

Buy ICBC on Weakness

At HK$5.36 per share, ICBC is the biggest bank in the world by market capitalisation (US$252 billion). Just how big is that? Well, it's worth almost 2 times JP Morgan.

It also has reserves of US$130 billion which means it can afford to buy out Citigroup.

The sub prime crisis only had a minimal impact (thank god for unsophisticated bankers who don't understand "high finance") and is primed to grow while western banks are scrambling to rebuild their balance sheets after writing off billions in sub prime losses.

What's Wrong With +20% Profit Growth?

Analysts have bemoaned the slowdown in profits growth at Chinese companies which fell from 42% for the 1st 6 months of 2007 to 20% in 2008. Anywhere else, a 20% profit growth would have been trumpeted as outstanding. When you have been used to exceptional high growth, it is a big comedown to just high growth.

Last years profits growth have been boosted by returns from investments in the Mainland stock market. This year, not only have the stock market not grown but in fact had fallen by some almost 60% from the peak. Under fair value accounting, this would have hit the bottom line of companies which are still holding onto the stocks they bought last year. On top of this, there is the surge in oil price to add to costs of operations, and the effects of the blizzards in January and February which greatly affected sales. Not to mention interest rates hikes and a clamp down in bank lending.

+20% growth profits growth with all the bad news is nothing to sneeze at!!!

SJM's (#880) Offer Oversubscribed

Stanley HO's SJM (stock code #880) HKD5.1 billion IPO was oversubscribed although the institutional portion (85% of the issue) was only 2x covered. The pricing is expected to be at the low end of the HKD3.08 to HKD4.08 indicative range. The stock will be traded on Monday, 10 July 2008.

The timing seems to be right for those willing to take a chance on this IPO as the Macau Government just announced that in the month of June 2008, Macau's casino revenues increased 69.7% year-on-year to Patacas 9.7 billion, the 3rd best month ever.

In the first 6 months of 2008, total casino revenues increased 54% to Patacas 58.5 billion. SJM with 27% is the leader, followed by Venetian at 22%, Wynn 17%, Melco 16%, Galaxy 10%, and MGM 8%. Although the headline numbers look good, the casinos have been locked in a price war over commission rebates to junket operators.

HK's Exports Performance

How much has negative sentiment in the US and Europe affected HK? Let's take a look at HK's external trade figures. Total exports grew 9.4%, and 9.2% repectively in 2006 and 2007. In the 1st quarter of 2008, total ex[ports grew 10.5%. This is certainly not what was expected from the "sub prime" crisis. However, as the slowdown starts to bite in the US, we do expect growth to moderate in the 2nd quarter with slight improvements in the latter half of the year. Exports to the US which account for 12% was down 1%).

The 1st quarter's performance was enhanced by increased trade intra Asia, with significant increases in exports to the Mainland which accounts for 48% of our exports, was up 11%. Europe at 14% of exports was steady (up 8%) because of the weakness of the USD (HKD is pegged to the USD) vis-a-vis the Euro. The rest of Asia (14% of exports) was up 23%.

Overall, we expect HK exports to grow by a modest 7% in 2008 with China and Asia the main engine of growth.

HK Depositary Receipts (HDR)

Come 1 July 2008, companies already listed elsewhere in a jurisdiction acceptable to the HK authorities will be able to have their shares listed in HK by way of HK depositary receipts or "HDR". The sponsor for the HDR will either buy a batch of existing shares of the company in the home market or take a new issue of shares, and package them into a HDR which in turn will be listed in HK. This is very similar to a closed ended fund consisting of shares in a single company.

The idea is that a company that has met the listing requirement's of a regulated exchange will be able to list its shares without going through the whole application process for a new listing. This gets around the requirements of some countries that restrict their companies from listing on overseas markets. For example, many Russian listed companies have listed on the London Stock Exchange by way of "GDR's". A key requirement though is that the home market must be regulated to a similar level as HK.

Members of IOSCO, the international federation of securities regulators, have signed a multi-lateral memorandum of understanding (MOU) which would make it easier to regulate across boundaries. Therefore, companies listed in those markets will find it easier to list HDR's in HK. However, it seems that the demand comes mostly from companies whose home markets are still developing and therefore will not have been able to reach the requirements set out in the multi MOU.

GEM (Growth Enterprise Market)

On 1 July 2008, new rules will come into effect in an effort to breath new life into GEM. The GEM Board hit a peak in 2004 with 21 companies raising over HK$2.7 billion when the HKEx closed the door on backdoor listings (pun intended). Since then, fewer companies seeking listings on the GEM Board and so far this year only 2 companies have come to market raising just over HK$200 million.

Why? Because the GEM Board is not as prestigious as Nasdaq on which it was modelled. There are many reasons including rubbish companies, crooked management, etc. The end result is that companies stayed away if they could wait for a listing on the Main Board. It is hoped that the new rules will raise the threshold a bit and keep out the truly undesreving.

Key provisions:
1. Positive cashflow of at least HK$20 million for the 2 years before listing
2. At least 2 years operations under the same management
3. Continuing reporting requirements made more stringent
4. Easier promotion to the Main Board

During the review of the performance of GEM, it had been suggested that rather than tightening the rules, it should go the route of the AIM Board in London where it is "caveat emptor" (let the buyer beware). However, it was decided that the HK investor is not sufficiently sophisticated to make the appropriate judgment on a stock. Let's see if the new rules will make any difference.

Footnote: Since 2004, corporate finance advisers have found ways around the backdoor listing prohibition.

China's Foreign Currency Reserves US$1.8 Trillion

China's foreign currency reserves reached US$1.8 trillion at the end of May 2008. In May the increase was US$40.3 billion but this was slow compared to an increase of US$75 billion in April. In China, the government exchanges RMB for foreign currencies earned by Chinese companies and citizens. This creates enormous inflationary pressures as RMB are created to soak up the foreign currencies.

The People's Bank of China, the central bank, then issues bonds to soak up the excess RMB. This means that banks are flushed with cash and so the government has to raise the banks reserve ratios to try and limit lending growth.

The central bank also suspects that there is "illegal" inflow of foreign currency betting on an increase in the RMB exchange rate. This "illegal" inflow consists of over billing foreign companies, or foreign companies under billing and leaving RMB balances behind.

Retesting the 22,000 Support

I think we should look at the macro environment first.

The sub prime crisis in the US and Europe will impact consumer spending in those countries and in turn impact China's exports. However, China's own internal growth is accelerating and this will offset the impact of any US and European downtuen.

With the winding down of building and construction for the Olympics, we had originally forecast a slowdown. However, the re-building in Sichuan will be substantial, and the knockon effect (i.e. improved construction materials etc.) will mean this sector will continue to develop.

Therefore, construction and building materials companies should be on your list.

I would stay away from insurance companies. Not because of their losses in Sichuan but because insurance companies make their money from investing the premiums they collect before having to make payouts. With the stock market falling in China since last year, the investment income will be low if not negative. therefore, I expect that insurance companies will be reporting much lower profits this year.

I would also stay away from Hsbc as it is a global bank with assets in the US and Eurpoe which will suffer from the sub prime and other write downs of securitied instruments. Stay with chinese banks.