It’s rare to read the financial headlines these days without seeing a story about the massive rally in Chinese brokerage stocks, which is being fueled by several factors. The brokerages themselves haven’t been blind to the fact, and are racing to take advantage of the positive sentiment to raise big chunks of new cash.
Now, leading brokerage Citic Securities (06030.HK; 600030.CN) and mid-sized player Guosen (002736.CN) have joined the binge, with new share issues that could end up collectively raising up to US$6.5 billion.
Before we look at details of these two latest fund-raising plans, it’s worth taking a broader look at the huge recent rally for mainland brokerage shares and asking whether the gains are really justified. A good representative of the group is Haitong Securities (06837.HK; 600837.CN), whose Hong Kong-listed shares have more than doubled since mid-March and whose Shanghai-listed shares have nearly tripled over the same period.
Haitong’s shares now trade at relatively rich price-to-earnings valuations in the 25-30 range, reflecting extreme investor bullishness about the sector’s growth potential. Two main reasons are behind the bullishness, led by a recent rally in China’s stock market that has seen the main Shanghai index soar more than 50 percent since the middle of this year. The other factor is the recently launched Hong Kong-Shanghai Connect program, which gives ordinary international investors access to domestic Chinese stocks for the first time.
The mainland stock rally looks rather unsustainable to me, though perhaps some of the huge recent gains are justified due to previous weakness that made China’s domestic stock markets some of the world’s worst performers over the last few years. The Hong Kong-Shanghai Connect program could have more longer-term potential, though early progress has been slow and increased trading volumes that will benefit brokerages will only come gradually as rules are tweaked.
All that said, this latest cash-raising binge looks like a smart move by the brokerages to make hay while the sun shines, since such positive sentiment is unlikely to linger beyond the next six months or so. Let’s start with a look at the bigger of the two fund-raising deals that comes from Citic Securities, China’s largest and most globally-minded brokerage. Under its new plan, Citic Securities will issue up to 1.5 billion new shares in Hong Kong.
The shares would be issued within the next 12 months, and could raise up to HK$41.6 billion (US$5.3 billion), based on calculations using its share price at the time of the announcement. I would expect Citic to issue these new shares sooner rather than later to capitalize on the recent bullishness towards Chinese brokerages, though its stock could see some near-term weakness due to the big size of the new float.
Next let’s look at Guosen, which has just raised 7 billion yuan (US$1.1 billion) through a new IPO on the Shenzhen stock exchange. Guosen priced its shares at 5.83 yuan, and then saw them jump by the maximum 20 percent limit when trading began in Shenzhen on Monday. They continued to climb during the day, and ended their first trading day up by their daily limit of 44 percent.
The other major fund-raising move from the sector came just a week ago, when Haitong floated its own new shares to raise nearly US$4 billion. That means that between these three major offerings alone, Chinese brokerages could end up raising about US$10 billion in new funds between December and the end of the first quarter of 2015.
Investors will undoubtedly be watching closely in the months ahead to see if Guosen, Haitong and other major brokerages start to show major revenue growth as a result of the recent stock market rally, and also from underwriting fees for new IPOs. We’re likely to see such an uptick when the companies report their fourth-quarter results in March and April, since much of China’s stock market rally has occurred since the central bank made a surprise move and lowered interest rates in November.
After that it’s anyone’s guess how the markets will move. Many believe the central bank may further cut rates next year as China’s economy shows growing signs of slowing. Such cuts could help the nascent stock market rally maintain some short-term momentum, though that’s likely to end quickly once the rate cuts are done. When that happens, look for a sharp pullback in the brokerage stocks, which are likely to face a challenging environment in the second half of next year.
Bottom line: Chinese brokerages are in a fund-raising frenzy to take advantage of strong market sentiment, but their shares could pull back sharply in the second half of next year if China’s stock market rally runs out of steam.
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