Shares plunge. Investors panic. Regulators panic. Shares surge. If you wanted to make an action video game for investors, you would certainly choose the Chinese stock market for your backdrop.
In recent weeks the market has been fascinated and terrified by the twin challenges of wild share gyrations in China, the world’s second largest economy, and the back and forth negotiations between the Eurozone and Greece, an economy roughly the size of Oregon, using Gross State Product (GSP) data.
We thought we’d take a look at the Chinese A share market at the stock level and see what kinds of optimism and pessimism are embedded in current valuations.
While the market has swooned in recent weeks, it’s important to put these moves in perspective. The Eikon price change monitor makes it very clear that over the medium term (YTD and 52 weeks), Chinese shares have performed spectacularly. Sadly, of course, these performance figures are unlikely to represent the average performance of the leveraged retail investor who probably is nursing larger losses, having piled in nearer to the top.
Source: Eikon
Individual performance
A 73.6% percent, 52 week return sounds pretty good this late in a bull market, but of course down 25% over four weeks is the more recent experience. So let’s look at some individual shares, since the overall index numbers can be quite deceiving, particularly given the disconcerting habit of Chinese companies to simply suspend their shares when the going gets tough.
First, let’s look at Petrochina Co. Ltd. (PTR.N), the largest stock in the Chinese market by market cap and fourth-largest stock in the world (Apple, Google, Microsoft, before you ask), with ExxonMobil Corp. (XOM.N) right behind. The company is trading at a forward 12 month (StarMine Smart Estimate) P/E of 28.9, against a large/mid cap aggregate of 15.0. In fact, no other oil major has a P/E above 20, and for the bold, Gazprom (GAZP.MM) trades at 2.8 times next year’s earnings. One could amuse oneself for hours trying to think through the geopolitical and investment permutations of a pair trade short Petrochina, long Gazprom.
Source: Eikon
Number-two stock
Petrochina’s current share price implies 7.1% EPS growth every year for the next five, which seems a little rich, particularly in light of the volatility of the price of oil and investor concerns about a medium term supply glut as the U.S. fracking revolution continues. To put that in perspective, XOM’s implied EPS growth over the same time horizon is -4.0%. Perhaps industry capital expenditures will choke off supply over time, but I certainly wouldn’t want that built into my base case.
Looking more reasonably priced, China’s second-biggest stock is Industrial & Commercial Bank of China (601398.SS), or ICBC. It can be yours for only 7x forward 12 month earnings, or 1.1x book value. The Chinese banking system makes Enron’s accounts look transparent and definitive, so investors must buckle up, given the complete unknown on the quality and exposures of the underlying loan portfolio (assets).
Source: Eikon
Take it to the bank?
If, like the Chinese investor, one is willing to assume the Chinese regulatory put is the real deal, then such concerns barely matter; I wonder what the correct symbol in Chinese is for “moral hazard?” So the banking sector looks more reasonably valued, but perhaps still not reflecting all of the potential risks built into the asset base. Large cap U.S. banks, themselves not paragons of virtue on the transparency front, trade at 1.1 times book value as well. Given the greater concern over the Chinese economy, there again seems to be a premium in Chinese valuations that is hard to justify.
Another concerning aspect of the Chinese market is that eight of the 10 largest firms are in banking & insurance, with Petrochina and China Petroleum Chemical Corp. rounding out the list. This seems particularly worrying for those who take their China exposure via traditional cap weighted ETFs. Against what was until recently a backdrop of capital market liberalization, China appears to be a market too big to ignore – but it’s certainly not for the faint hearted and stock picking seems absolutely crucial to avoid the many pockets of apparent over-valuation. It’s been a while since I quoted Warren Buffett and this one seems particularly apt: “When you combine ignorance and leverage, you get some pretty interesting results.”
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