September 2015 China equity market outlook Steven Sun* Head of HK/China Equity Research, Managing Director The Hongkong and Shanghai Banking Corporation Limited +852 2822 4298 [email protected]*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations. View HSBC Global Research: http://www.research.hsbc.com Issuer of report: The Hongkong and Shanghai Banking Corporation Limited Disclosures and Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
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September 2015 China equity market outlook Steven Sun* Head of HK/China Equity Research, Managing Director The Hongkong and Shanghai Banking Corporation.
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September 2015
China equity market outlook
Steven Sun*
Head of HK/China Equity Research, Managing Director
The Hongkong and Shanghai Banking Corporation Limited
*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.View HSBC Global Research: http://www.research.hsbc.comIssuer of report: The Hongkong and Shanghai Banking Corporation Limited
Disclosures and Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
A-share market rout: divergence of fundamentals vs. market performance
Source: Wind, HSBC Equity Strategy
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Analyzing state intervention – funding source and size
· The CSRC tried to gradually exit from “state intervention” on 14 August, which only triggered a second-leg down in the A-share market. According to Caixin, the CSFC borrowed another RMB1.4trn from commercial banks to continue its direct purchase in end-August
· The total size of funding could be over RMB3.3trn, and in relative terms, it’s about 8% of total A-share market cap and 10% of total floatable market cap. If we exclude state-owned shares from the floatable market cap, the ratio could go up to over 18%
Source: various media reports
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Analyzing state intervention – it helped to facilitate deleverage
· Since the peak seen on 18 June (Rmb2.3trn), margin financing balance had declined by over Rmb1.3trn, or over 55% drop by 1 September. The two rounds of state intervention all happened at the time of sharp deleveraging in the A-share market
Source: CEIC
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Analyzing state intervention – further deleverage will be moderate
· Leveraged positions built in 2015 have all be unwounded. Margin financing balance in last December, totaling RMB150bn, could be the next in line for further unwinding – but the pace should be moderate because these positions are sitting on small gains
Source: CEIC
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Analyzing state intervention – and avoid a market liquidity crisis
· At the peak, over 50% of A shares were suspended and now it’s down to less than 5%
Source: Wind
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Analyzing state intervention – but it has done little to help market performance
· But it has done little to help the broader market indices – SHCOMP was actually down 15% compared to the level on 6 July when “national team” started to intervene
Source: Various domestic media report, HSBC Equity Strategy, Bloomberg
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Analyzing state intervention – …and created price distortion
· The Hang Seng China AH Premium index surged over 20ppts during the two rounds of state intervention in the domestic A-share market in early July and end August
Source: Bloomberg
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Analyzing state intervention – …and created price distortion (cont’d)
· In the first two trading days on September, ICBC’s A-share has outperformed its H-share by over 20ppts – same company, same fundamentals
Source: Bloomberg
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Analyzing state intervention – also market volatility remains stubbornly high
· The annualized 30-day market volatility for the SHCOMP peaked at 65% at the end of July, ie., two months after the heavy-handed state intervention, and is still hovering around 60% level in recent trading days, or two to three times compared to that of Hong Kong
Source: Bloomberg
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Five key tasks to get A-share market back to a normal footing
· 1) The six-month temporary suspension of share selling by controlling shareholders and senior managements will expire in next January
· 2) The temporary A-share IPO suspension may not resume until early next year and there are over 600 companies in the pipeline to be listed. Considering also the timetable for amendment of “Securities Act” , IPO registration reform may also have to wait until next year
· 3) Shenzhen HK Stock Connect: a meaningful roll-out hinges on reviving the lukewarm interests on A share market as indicated by the Shanghai HK Stock Connect
· 5) Genuine SOE reform could be the ultimate driver to cut overcapacity, improve profitability and attract fund inflows back to Chinese equities in the long-run
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Task 1: corporate insiders’ behavior restricted by CSRC’s new regulation
· A-share corporate insiders, i.e., senior management and significant or controlling shareholders, had been selling into the current market rally. The total net selling has topped Rmb460bn in the 1H, Rmb145bn alone in May and Rmb107bn for June. It has averaged Rmb110bn net selling on monthly basis in 2Q15 vs. Rmb10bn for 2013-2014
· In July, it has turned into net buying (Rmb44bn) due to the CSRC’s new regulations. That said, net buying has dropped in August (Rmb35bn)
Source: Wind
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Task 2: A-share IPO and IPO registration reform needs to be resumed
· A-share equity financing activities topped Rmb700bn on average for the past five years in 2010-2014 and it stood at Rmb915bn in the 1H of 2015. The CSRC has restarted refinancing in A-share market. But as of now, there are still over 600 companies in the IPO pipeline, which may need another two to three quarters to resume. Historically, IPO has been suspended 8 times and for 5-13 months
Source: CEIC, Wind
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Task 3: When to roll out Shenzhen HK Stock Connect?
Source: Bloomberg
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Task 4: Major types of SOE reform in diversified ownership
· Type 1: Government has strict control and high level of state-ownership. These include financials, oil & gas, electricity, telecom and national defense. Controlling ownership is still the main form
– Industry level: opening at gradual steps, loosening regulation, introducing small portion of private capital and promoting competition
· Type 2: Government has less control but high level of state-ownership. These include steel, coals, nonferrous metals, equipment, construction, auto, transportation and infrastructure. SOE reform aims to reduce the state-ownership percentage. Controlling ownership is not mandatory.
– Industry level: encourage to introduce private capital, merger & acquisition and asset restructuring
· Type 3: Industries have low state-ownership. These include agriculture, machinery, chemical, light industry, textile, electronic, home applicants, health care, business and tourism, SOE reform aims at minority equity ownership or complete divesture
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Task 4: SOE restructuring
· The characteristics of SOE restructuring
1. Restructuring led by government– Influenced by the change of national industry planning: planning to become a leading
– Influenced by the change of stated-back investment: strategic infrastructure and major construction projects; regional national strategy, such as “one belt and one road”; national development plan such as “exploring overseas”; urban infrastructure and public facility construction
2. Asset restructuring transactions done through the market
· Major forms of the SOE restructuring
1. Government-led restructuring : alliance between giants, alliance between the strong and weak, merger of corporation and divestiture
2. Market-oriented restructuring
– Different type based on industries: horizontal M&A, vertical M&A and hybrid M&A
– Different type based on equity ownership: controlling shareholding through takeover, merger of acquisition and consolidation
– Different type based on takeover approach: takeover of listed companies, indirect acquisition, tender offer, secondary market acquisition, equity auction and takeover agreement
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Fundamentals – Margin rebounded but A-share profitability is still depressed
Source: Wind, HSBC Equity Strategy
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Fundamentals – A-share profitability is still depressed (cont’d)
Source: Wind, HSBC Equity Strategy
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Fundamentals – A-share profitability is still depressed (cont’d)
Source: Wind, HSBC Equity Strategy
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Fundamentals – A-share profitability is still depressed (cont’d)
Source: Wind, HSBC Equity Strategy
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Macro – property investment recovery is key to GDP rebound in 2H
Source: HSBC Economic Research Team
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Macro – as well as acceleration of infrastructure investment
Source: HSBC Economic Research Team
Projects approved so far in 2015
Key infrastructure projects Investment value (RMBbn)
Railway 373 Airport 46 Port 73 Urban rail transit 489 Highway 64 Others (Bridges, hydro power) 22 Underground pipelines and infrastructure facilities in 10 pilot cities 35 Water pollution treatment in 18 provinces 27 National-wide broad band system 430 Total 1,558
Source: Various media reports, HSBC
Macro – Internet+ strategy to drive transformation and productivity gain
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Innovation by everyone (万众创新 )
• Service sector as % of GDP – 49.5% in 1H2015 vs. 48.2% in 2014 and 46.9% in 2013
• New business formation: over 3.6m in 2014, or on average 10,000 new start-ups per day. 6x compared to that of US and 18x compared to UK
• China’s internet economy is estimated to be close to 5% of GDP in 2014, already larger than those of the US, France and Germany
• State decision to establish Rmb60bnn fund to help SMEs and innovations in China in early September Source: Xinhua News Agency
Note: 3W coffee is a tech incubator in Beijing
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Market valuation check
Source: Thomson Reuters Datastream
12-month fwd PE MSCI China H-share Red-chip A-share SH A-share SZ Hang Seng MSCI HK
As of 31 Aug 8.6 5.8 10.8 12.1 25.2 9.6 13.6
L5Y avg. 9.5 7.0 11.0 10.2 19.5 10.4 14.8
Diff. -10% -17% -2% 19% 29% -8% -8%
2008 bottom 5.7 4.9 6.7 10.3 9.6 6.5 8.0
Diff. (2008) 50% 19% 63% 18% 162% 48% 69%
2011 bottom 6.9 5.4 8.7 8.7 13.6 7.7 10.9
Diff. (2011) 25% 7% 24% 39% 85% 24% 25%
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A-share market cap has room for growth in the long term
· Total A-share market cap peaked at Rmb71trn on 12 June and came down to Rmb43trn on 31 August (USD7trn). It lost over Rmb18trn market cap, or 40% decline in ten weeks
· Buffett Indicator (market cap to GDP) indicates room for moderate upside in A-share market over the medium term
– In the past 10 years, US’s securitization ratio has swung between 60% and 140%, averaging 110%
– A-share Buffett indicator is at 63% now, or only half of the level when the bubble burst in 2007
· Household asset allocation indicates the rebalancing to stocks still has distance to go
Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Steven Sun
Important disclosures
Equities: Stock ratings and basis for financial analysis
HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.
From 23rd March 2015 HSBC has assigned ratings on the following basis:
The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.
Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates).
Upside/Downside is the percentage difference between the target price and the share price.
Prior to this date, HSBC’s rating structure was applied on the following basis:
For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.
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*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.
Rating distribution for long-term investment opportunities
As of 02 September 2015, the distribution of all ratings published is as follows:
Buy 44% (31% of these provided with Investment Banking Services)
Hold 42% (28% of these provided with Investment Banking Services)
Sell 14% (17% of these provided with Investment Banking Services)
For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.
HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis.
Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.
Whether, or in what time frame, an update of this analysis will be published is not determined in advance.
For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.
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Additional disclosures 1 This report is dated as at 02 September 2015. 2 All market data included in this report are dated as at close 02 September 2015, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's
analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.
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Disclaimer * Legal entities as at 30 May 2014 ‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking Corporation Limited, Hong Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Bank Canada, Toronto; HSBC Bank, Paris Branch; HSBC France; ‘DE’ HSBC Trinkaus & Burkhardt AG, Düsseldorf; 000 HSBC Bank (RR), Moscow; ‘IN’ HSBC Securities and Capital Markets (India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities Egypt SAE, Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch; The Hongko ng and Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv; ‘U S’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC México, SA, Institución de Banca Múltipl e, Grupo Financiero HSBC; HSBC Bank Brasil SA – Banco Múltiplo; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR; The Hongkong and Shanghai Banking Corporation Limited, Bangkok Branch
Issuer of report
The Hongkong and Shanghai Banking Corporation Limited