Bargains emerge in Hong Kong
Written by Esther Lee of The Edge Malaysia
Monday, 22 July 2013 00:00
IT is not surprising that Hong Kong's equity market has undergone a tumultuous first half of the year considering its high foreign investing interest and proximity to mainland China.
The Hang Seng Index has been dubbed one of the worst-performing stock indices in Asia-Pacific, sliding 5.38% year-to-date. This is a far cry from its performance in 2012, gaining 20.02% during the year.
The selldown in the Hong Kong market, which is perceived to be a proxy to the Chinese economy, has been plagued by a host of external economic conditions. By the same token, this could give rise to more opportunities for bargain-hunting, given that valuations in the equity market are cheaper than before.
Three out of four of the Hang Seng sectoral indices — namely property, finance and commerce & industry, have given up their earlier gains and are trading below last year's closing. The Hang Seng utilities sector was the only sub-sector on the benchmark index that managed to record a growth of 1.53%.
The Hong Kong market suffered a major blow when China's growth was reported to be decelerating faster than expected. Meanwhile, the possibility of a credit crunch in the world's second largest economy seemed to have added fuel to the fire and spooked investors further.
"China has 7.5% as its GDP growth target for this year, but it could miss it for the first time in the past two decades. In our view, China should be able to defend 7% growth in the near term, barring policy missteps," says Citi Research in its strategy report for 2H2013.
"China's growth momentum continues to weaken. Its YTD growth has been mainly driven by strong infrastructure investment, whose growth rate since 2010 has been the strongest, thanks to the launch of new projects since late last year."
China's official target of 7.5% growth this year is lower than the 7.8% GDP achieved a year ago.
Before the shock from mainland China, the Hong Kong equity market was sent reeling when the US Federal Reserve indicated that it would taper off its bond repurchase programme in June. This certainly does not augur well for equity markets, especially Hong Kong with its large exposure to foreign fund investments.
Nevertheless, it looks like the market can take a breather from the worries over the tapering of the bond buying programme for now, as US Federal Reserve chairman Ben Bernanke said in a statement during the week of July 8-14 that stimulus would be kept in place "for the foreseeable future".
Many agree that valuations are getting appealing in Hong Kong. However, with the uncertainties on the horizon, some equity strategists are advising clients to be more cautious and avoid cyclical sectors.
"We recommend sectors that have low leverage ratios, resilient earnings growth and those that stand to gain from reforms. We therefore overweight consumer staples, low-end discretionary sectors, property and healthcare.
"Distressed valuations are another reason to long these sectors, but they could go lower before stabilising. We are neutral on banks and utilities, and underweight cyclical sectors — energy, materials and telecoms," says Citi Research.
The property sector — one of the key growth drivers of the Hong Kong economy, appears to be one of the hardest hit this year. The Hang Seng Property Index, which has nine constituents, has corrected more than 7% YTD as authorities implemented cooling measures to curb foreign buying in the most expensive real estate market in the world.
In October 2012, the government imposed an additional 15% tax on purchases by companies and non-residents. This cooling measure has led to physical property prices declining 4% since March, says Macquarie Equities Research in a note.
According to Macquarie, valuations in the Hong Kong property sector are looking more attractive now based on its price-to-book value of 0.7 times. The research house upgraded the sector to "equal-weight" from "underweight" previously.
"In our view, valuation is not demanding and most of the upcoming negative events are in the price," it adds. Despite the attractive valuations, Macquarie analysts opine that there is a lack of catalyst in the property sector.
Hong Kong developers are beginning to diversify from development to seeking rental-based income. Based on Macquarie's research report, rental properties account for about 47% of these developers' gross annual value (GAV).
"Rental properties and other non-property businesses are making their earnings more resilient and valuations less volatile, in the face of swings in physical market conditions in Hong Kong," says the research house.
The 12 constituent members of the Hang Seng financial sector have also taken a beating as worries over the Chinese banks' credit quality come back to haunt investors. YTD, the index has slid 3.27%. Bloomberg data shows that the finance index is currently hovering at eight times price-earnings ratio, while giving a dividend yield of 4.29%.
China-based banks make a big part of the Hang Seng financial sector, so it is no surprise that the index fell this year, given the credit crunch scare just last month (in June).
According to Citi Research, investor are shying away from Chinese banks on concerns of policy uncertainty, credit tightening that will impact the economy and non-performing loans (NPL), and increased recapitalisation risk for banks.
"The Shibor incident in June is a stark reminder of the weaknesses of China's banking system — low transparency, policy risks, risks from rapid growth in shadow banking," says the research house in a report.
On June 19, banks in China ran short of cash, causing a scramble in interbank borrowings. This caused a surge in both the seven-day repo interest rate and the Shanghai interbank offered rate (Shibor) — the average rate at which major banks say they will lend — the very next day, and resulted in a cash crunch scare.
Citi Research says it prefers the bigger banks as they are less susceptible to deposit rate liberalisation while having fewer shadow-banking activities. However, Citi is of the view that the sector is oversold compared with other Asian banks.
The research house's top pick is China Construction Bank Corp (CCB) for its solid fundamentals and reputation as the best capitalised state bank, with a conservative expansion in the risky interbank business. Its valuations look attractive with an estimated PER of 5.2 times, a price-to-book ratio of one times and a return on equity (ROE) of 20.63 times. CCB's share price closed at HK$5.44 on July 12.
Another Hang Seng-listed China bank selected by Citi Research is the Bank of China Ltd. Some of its merits, as highlighted by the research house, are that it has the least exposure to China and it is the most defensive bank in terms of net interest margin pressure due to the rate liberalisation.
Citi Research also highlighted that it was the cheapest state bank on the block, with a valuation of HK$3.17 on July 12. The bank has an estimated ROE of 16.87 times, while its PER is estimated to be at 4.78 times.
South China Research Ltd is positive on the Hong Kong market for the second half of the year, as it does not expect a hard-landing for China's economic growth and there is ample liquidity in the global markets.
"We maintain our view that the Hang Seng Index (HSI) will rally to a high of 26,000 points in 2013. We believe the case is strong, given that the Hong Kong stock market has been a laggard YTD when the peripheral markets have been testing new highs, and that the HSI is trading at an undemanding 2013 forward PER of 10.7 times," it says.
This story first appeared in The Edge weekly edition of July 15-21, 2013.
Publish date: 22/07/13