26 October 2016
Chinese banks are being forced to compete for deposits in a rapidly changing market after lending almost exclusively to SOEs in the past.   Photo: AFP
Chinese banks are being forced to compete for deposits in a rapidly changing market after lending almost exclusively to SOEs in the past. Photo: AFP

Why Chinese bank counters are in a marathon, not sprint

The market has tipped in favor of Hong Kong since the start of April after domestic stocks lagged far behind their A-share counterparts in the Chinese mainland amid a recent rally.

Massive capital has been flowing into Hong Kong from the mainland and the influx is far from over.

Investors might need to adjust their all-in strategy.

President Xi Jinping and Premier Li Keqiang are facing huge challenges.

The anti-graft crackdown and deepening reform have had various side-effects including a slowdown in the economy.

In addition, the global economy continues to struggle and major central banks are pursuing competitive monetary easing to shore up growth.

China, the world’s second largest economy, is dealing with a stalling economy and its response has been to avert a hard landing and preempt deflation.

In the past six months, the central government has rolled out fiscal and monetary measures to ensure the success of the strategy.

A robust A-share market arising from these measures is part of a bold experiment to create wealth and open up market financing.

Meanwhile, sluggish earnings by a number of Chinese companies have been drawing investors to the stock market on expectation all the bad news has been priced in.

That’s why the market remains bullish, sustaining the stocks’ momentum.

The merger between China CNR Corp. (06199.HK) and CSR Corp. (01766.HK), the world’s two largest train makers, has sparked a fourfold rally in their share prices.

Last week, the China Securities Regulatory Commission (CSRC), said listed firms will be allowed to raise 100 percent of funds intended for acquisitions, up from 25 percent at present.

The move will substantially enhance the M&A flexibility of state-owned enterprises (SOEs).

Beijing wants to cut the number of central SOEs to 40 from from 112 in the next five to seven years. These enterprises usually have a number of subsidiaries, so the consolidation will open up enormous investment opportunities.

Most Hong Kong-listed central SOEs are top players in their sectors, so they will benefit but not as much as their mainland subsidiaries.

That is the reason central SOEs listed in Hong Kong have lagged their mainland-listed counterparts.

PetroChina (00857.HK) and Sinopec Corp (00386.HK) are up 6.47 percent and 7.2 percent, respectively, after a media report that their parents will merge to create a state behemoth.    

Their subsidiaries soared, with Sinopec Shanghai Petrochemical Co. (00338.HK) up 19.5 percent, Sinofert Holdings (00297.HK) 9.43 percent, and Sinopec Oilfield Service (01033.HK) 12 percent.

A number of red-chip SOEs in shipping, telecoms, steel, power and other sectors are grappling with falling earnings. Consolidation will help reduce redundant capacity and boost their global competitiveness.

On the other hand, many central SOEs with monopoly status are lacking efficiency and competitiveness. Sweeping reform of old-economy sectors will create a key investment theme for the foreseeable future.

However, investors need to be patient given consolidation is a lengthy process involving entrenched vested interests.

Those with a medium-term horizon are likely to favor cheaper mainland banking shares, knowing these stocks are policy-driven. Return on equity will be less attractive than those of foreign banks.

Chinese banks are being forced to compete for deposits in a rapidly changing market after lending almost exclusively to SOEs in the past.

In recent weeks, they have found breathing room after the central bank cut their reserve ratio requirement and the central government announced a debt swap with local governments.

At present, their price-to-earnings ratio is about six to seven times and yields are close to 5 percent.

Investors should buy these stocks given that another 2.5 percent cut in the reserve ratio is expected this year.

Interest rate cuts across the globe in the past three years have benefited interest-sensitive sectors.

Investors will reap profit by holding real estate investment trust (REIT) units. The same is true for mainland banking plays.

This article appeared in the Hong Kong Economic Journal on April 28.

Translation by Julie Zhu

[Chinese version中文版]

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columnist at the Hong Kong Economic Journal

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