China’s listed SOEs, trading at below-market valuations, might see a boost from the government’s new policy direction
With the worst of the pandemic over, the number of new listings in Hong Kong will increase. Another reason is the introduction of more relaxed regulations, allowing so-called “pre-revenue” tech companies to go to the IPO stage instead of requiring a good track record, says Louis Wong, director of Phillip Securities in Hong Kong, at a recent webinar.
Hong Kong has already given the same leeway to biotech companies that have yet to generate meaningful revenue to list, so they can tap the capital markets to fund their growth. Last year, when Hong Kong was still suffering from the pandemic restrictions, there were 90 listings, which raised some HK$100 billion ($17.2 billion).
This year, citing estimates by Deloitte, Wong says there might be 110 new listings, raising HK$230 billion. Potential IPOs investors can expect it will include the “Alibabies” — spin-offs from Alibaba Group Holding and other offshoots from e-commerce giant JD.com.
In the past 12 years, Hong Kong was the chart-topper in global IPOs in seven. New listings aside, China and Hong Kong markets are set to ride on another growth theme.
Following the years of pandemic-related curbs, the Chinese government recognises the urgent need to reinject growth back to its economy. As part of this broader aim, the markets are set to receive their fair share of supportive policies. One recent theme, seen to be positive for the markets, is China’s stated bid to make its stable of listed state-owned enterprises (SOEs) more attractive to investors and give better returns to its shareholders — including the government itself and retail investors alike. Yi Huiman, chairman of the China Securities Regulatory Commission, first mooted this strategic thrust late last year.
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For years, as newer, nimbler private companies are established and create new market opportunities for themselves, many of the SOEs, the legacy of China’s central economic planning of a previous era, are seen as relative laggards as they tend to be in the traditional industries of utilities, energy and infrastructure. The valuation contrast has become pronounced. The listed SOEs trade at an average of 14% discount to their book values. In contrast, the broader market can fetch a 60% premium. “The low valuation of the SOEs has limited their ability to tap the financial markets,” says Wong.
Ways mooted to boost valuations include spin-offs, asset injection, or paying out higher dividends. Recognising that many institutional investors have reservations about the corporate governance standards of some of these SOEs, this is an area that is being looked at too. The state-owned Assets Supervision and Administration Commission of the State Council, the holding entity of many of these SOEs, has launched a campaign of valuation creation actions, benchmarking the SOEs under its portfolio to world-class enterprises.
Wong expects this trend to continue. Here are some counters — including SOEs and private sector companies — that Wong has flagged for investors to watch.
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PetroChina
Within the oil and gas sector are three key SOEs: PetroChina, Sinopec and China National Offshore Oil Corporation, dubbed China’s three barrels of oil. Within this trio, CNOOC has the cheapest valuation, trading at just 3.4 times P/E, giving a yield of 12.4%. Sinopec trades at 7.5 times P/E and yields 8.8%, while PetroChina trades at 5 times P/E and 10%.
Despite CNOOC trading at the lowest valuation, Wong is not keen on this stock, as he believes it is too sensitive to changes in crude oil prices, given the more upstream nature of its business. This means if prices are high, CNOOC stands to gain more, but the converse is true if prices slump.
His pick from these three stocks is PetroChina, for more well-rounded financial metrics. Many investors share his view as PetroChina’s share price has steadily outperformed the broader market. For FY2022 ended Dec 31, the company reported earnings of RMB149.4 billion ($28.5 billion), up 62.1%, on the back of a 23.9% increase in revenue to RMB3.24 trillion. The company’s gearing has been reduced to 17.4% as of Dec 31, 2022, versus 19.5% in the preceding year. PetroChina has declared an FY2022 dividend of HK$4.41, which translates into a payout ratio of 67%, giving a yield of close to 9%. Wong believes the relatively low gearing ratio enables the company to pay generous dividends to shareholders.
With a better economic outlook this year, PetroChina plans to increase production to 912.9 million barrels, up from 767.4 million pumped in 2022. Recognising the shift towards renewable energy, the company — instead of actively exploring new fields — is instead trying to improve production from older, existing fields. And, of course, it is into new energy, “vigorously” investing in wind power, photovoltaic power, gas power, geothermal, hydrogen energy and other projects.
China Mobile
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Like oil and gas, there are three key SOE telcos: China Mobile, China Telecom and China Unicom. For Wong, the “obvious” top pick is China Mobile, the market leader in the mobile space, trading 9.5 times P/E and giving a yield of 7%, versus China Telecom’s 12.2 times and 5.4%, and China Unicom’s 9 times and 5.5%. In recent years, Wong says that China Mobile managed merely single-digit operating revenue growth.
Yet, for FY2022, this metric has accelerated, growing at 10.5% to RMB937.3 billion, as growth from new business areas, such as mobile cloud, kicked in. Earnings in the same period were up 8% to RMB125.5 billion. As of the end of 2022, the company has 975 million mobile customers, with 614 million on 5G packages. Each of these subscribers generated slightly more revenue, with an average revenue per user of RMB49 per month, up 0.4%.
Wong says China Mobile and other telcos benefit from the government’s push to support the growth and quality of the so-called digital economy. Ways to do so include offering higher value services such as video content and cloud computing and, further down the road, so-called frontier areas such as metaverse, autonomous driving and smart robotics, says Wong.
China Mobile recently passed a peak capex cycle in 2022, with the 5G rollout mostly done and dusted. The next generation of 6G networks probably will not figure until 2024. As such, the company will have more room to pay more than 70% dividends, he adds.
Wong's top pick is Bank of China, for its best well-balanced metrics / Bloomberg
Bank of China
Like there are three key petrol SOEs, the market has four SOE banks: Bank of China, Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (BOC) and China Construction Bank (CCB). “As the economy is recovering, expect faster growth in loan demand. Asset quality will also improve,” says Wong, noting how the FY2022 non-performing loan ratio for the likes of CCB and ICBC had improved over FY2021, albeit slightly.
While the banking system, more heavily influenced by the US Fed’s rate hikes, is set to enjoy better interest margins, Chinese banks do not have the same luxury as China’s monetary policy stance is heading in the opposite direction. This might cap their earnings growth, and even so, China — if required — will cut its rates further, says Wong.
Nonetheless, the bank stocks are deemed attractive from a yield perspective, giving around 8% each. These banks are all trading at a fraction of their book value, at around 0.4 times. Yet, Wong cautions that investors ought not to expect a lot of upside on the share price, for earnings growth is not going to be significant this current FY2023 or even the following FY2024.
Wong’s top pick is BOC, which has higher earnings growth rates and interest margins than the other three banks. It also has attributes that make it more attractive than the other three. For example, the BOC is less exposed to the property sector than the CCB. The BOC is also seen as less subjected to serving the policy goals of the central government versus the ICBC, says Wong. “So, is it worth accumulating all four banks? Yes, if you are eying the dividend yield and less of share price appreciation.”
China Railway Construction
Wong’s top pick from the SOE infrastructure sector is China Railway Construction, which trades at just 3 times earnings and yields 5%. Two other prominent state-owned infrastructure players are China Communication Construction, which has a P/E of 4 times and yields 5%, and China Railway Group, which trades at 4 times and has a yield of 4.8%.
Despite the name, China Railway Construction has projects in industry sectors beyond the railway system, ranging from energy conservancy to water treatment and mobile network infrastructure. For FY2022, the company reported earnings of RMB31.75 billion, up 8.32% over FY2021, with revenue up 7.48% to RMB1.1 trillion. The outlook is positive, with the value of new contracts signed by the end of 2022 up 15.1% to RMB3.25 trillion, exceeding its target by nearly a fifth.
The steady stream of contracts won is underpinned by the country’s ongoing support of regional infrastructure projects and developments in areas ranging from renewable energy, water conservancy, and new urbanisation. The company is busy building new data centres, high-speed rail transit points, 5G-related infrastructure and, more recently, automobile charging points and systems.
According to one key measure, plenty of work must be done. Citing China’s Ministry of Finance, 14,038 so-called public-private partnership projects are registered, with a total investment estimated at RMB20.9 trillion. “This provides the growth momentum for new contract acquisitions,” says Wong.
Alibaba Group Holding
Alibaba Group Holding and its related entities have dominated headlines in and out of China for the past few years. As one of the largest companies under the high-profile technopreneur Jack Ma, Alibaba has been seen as the target of the government’s bid to rein in companies that have grown too big for their good.
On March 28, the company announced that it would be splitting into six “Alibabies” The news was timed with reports that Ma had finally returned to China after over a year. On its own, the spin-off news is positive because the conventional logic is that the hidden value of the six entities can be unlocked. By having their listing status and raising capital, they can be less reliant on the parent company for financing. With their capital and clearer strategic direction, they can chart faster growth paths.
The split up means that these entities are now easier to regulate. Under the current structure, with regulators’ attention on the parent company, the smaller companies are presumably less transparent. After their listings, it will be easier for authorities to supervise and regulate. “The Chinese government may hold golden shares in those spun-off units so they can send directors to the respective boards and have a say in the business decisions of those companies,” says Wong.
He agrees this controversial move for more direct government involvement can be seen as good or bad. “At least, from the regulatory side, the government may be seen as a friendlier party.” Ant Group, the payments entity linked to Alibaba, has finally cleared regulatory hurdles to its IPO. In October 2020, Ant Group was poised to be the world’s largest IPO, with some US$35 billion in proceeds. But after Ma openly criticised the regulators, the listing was yanked at the eleventh hour.
Tencent Holdings
Gaming and internet services giant Tencent Holdings was the subject of some regulatory curbs, although not as much as Alibaba. The company behind the massively popular WeChat all-in-one app is also the publisher of numerous online games. For FY2022, the company’s revenue dipped by 1% to RMB554.6 billion. However, earnings dropped by 16% in the same period to RMB188.2 billion, with its 1HFY2022 numbers, especially under strain.
In the meantime, the company streamlined its cost structure, rationalised non-core business and launched new revenue-generating businesses, thereby helping to lift revenue in 2HFY2022. The company’s recent FY2022 conference call indicated that it is seeing positive signs of recovery in the first two months of this year. “They should be a rebound in 2023, with China’s macroeconomic conditions stabilising, which will help boost advertising and the game business,” says Wong.
He adds that regulators have signalled that they are easing the crackdown on the gaming industry, as they began to grant new licenses regularly, versus an all-out-halt.
Xiaomi Corp
Xiaomi is famous for its portfolio of budget but feature-packed smartphones. In recent years, the company has been steadfastly adopting the so-called premiumisation strategy, which places more emphasis on selling higher prices and, therefore, presumably higher-margin products. Xiaomi owns the largest market share within the RMB3,000 to RMB4,000 price segment of China’s smartphone market. It holds the second largest market share within the higher RMB4,000 to RMB5,000 segment, as it faces stiffer competition from Samsung Electronics.
In contrast, Apple’s iPhones go for at least RMB8,000 or more. For FY2022 ended Dec 31, 2022, Xiaomi’s smartphone business revenue reached RMB167.2 billion, with some 150.5 million units sold. The average selling price reached RMB1,111, which is a record. The company’s revenue was down 14.7% to RMB280 billion for FY2022, with earnings down by a bigger magnitude of 61.45% to RMB8.5 billion.
A key reason was that the company, actively trying to create new businesses besides smartphones, has invested heavily in new areas, specifically electric vehicles. Wong says the move to diversify from the highly competitive smartphone business is laudable, and the company will push into another equally highly competitive one of making EVs. “The outlook remains uncertain,” he cautions.
Meituan
Food delivery platform Meituan has, in FY2022, turned profitable. Adjusted ebitda and adjusted net profit were RMB9.7 billion and RMB2.8 billion, respectively. In the same period, revenue rose 22.8% to RMB220 billion over FY2021. Some of the growth came from relatively new business segments, such as grocery delivery and its group buying platform, with revenue up 39.3% to RMB59.2 billion.
Wong says Meituan is mulling an expansion of its food delivery business to Hong Kong and has started hiring. Still, he is concerned Meituan is facing tougher competition on its home ground even as it casts its eyes on market expansion. ByteDance, better known for its viral short video platform, is experimenting with its food delivery offerings, as the food delivery market worth US$66.4 billion ($89.8 billion) last year proved irresistible. There is already strong competition from Alibaba’s existing food delivery unit, ele.me. “Competition will become more intense,” adds Wong.
JD.com
Like Meituan, another high-profile, new economy stock JD.com faces a stiffer fight, despite turning around in FY2022. From an FY2021 loss of RMB3.6 billion, the e-commerce platform reported earnings of RMB10.4 billion for the year ended Dec 31, 2022. Revenue was up 9.9% to RMB1.05 trillion, with so-called net service revenues up 33.3% to RMB181.2 billion.
Wong says CEO Xu Lei has cautioned that while the government has introduced a series of stimulus measures, it will take a “relatively long time” for the effects to “reach consumers’ wallets,” suggesting that the pick up in consumption will not be readily apparent quickly. To escalate the competition against the likes of Nasdaq-listed Pinduoduo, trading as PDD Holdings, JD.com has in early March launched a subsidy campaign worth RMB10 billion.
Phillip HK Newly Listed Equities Index ETF
Besides investing in individual stocks, investors can participate in the China and Hong Kong story by taking positions in a couple of ETFs, such as the Phillip HK Newly Listed Equities Index ETF — the first Phillip ETF in Hong Kong.
This ETF fully replicates the Solactive Hong Kong Newly Listed Equities Index, described as a “rules-based” equity benchmark designed to track the performance of securities with a recent IPO or new listing on Hong Kong’s mainboard. While new listings that have attracted attention tend to be tech stocks, this ETF has a more diversified mix, says Wong.
Within the top 10 holdings of the ETF are so-called old economy names such as Yum China Holdings, which runs fast food chains KFC, Pizza Hut and Taco Bell, logistics company ZTO Express Cayman and real estate services firm KE Holdings. There are also tech names: The largest individual holding is Netease, followed by Baidu and JD.com.
