If you are seeking bargain-hunting opportunities in Chinese stocks, there are still some options left. Foremost among them would be mainland retail plays, which have undergone major correction in the recent past.
China’s retail sales growth rate has eased to 10 percent now from a peak of 23 percent in 2008. The slower growth has led to a slide in the share prices of companies involved in the sector.
Parkson Retail Group (03368.HK) and Lianhua Supermarket Holdings (00980.HK), for instance, have fallen more than 70 percent from their peak levels. Elsewhere, Want Want China Holdings (00151.HK) and Tingyi Cayman Islands Holdings (00151.HK) have also dropped to 52-week lows.
The slower industry growth is commonly attributed to a sluggish economy, Beijing’s anti-corruption drive, excessive supply and sector consolidation. But there is also another factor that has been somewhat underestimated: deflation.
China’s consumer price index (CPI) rose by 1.5 percent in April, while the producer price index (PPI) dropped 4.6 percent. The PPI, a gauge of wholesale inflation, has declined for the 38th straight month.
Inflation will reduce the purchasing power, while deflation means consumers can buy more products with the same amount of money. However, if consumers tend to delay their buying, that will depress company earnings and investment, and in turn lead to recession and rising unemployment.
Deflation is the last thing companies want to see. A 3-5 percent decrease in sales revenue could result in 30 or 50 percent profit slide. Take Parkson Retail for example. The company’s sales revenue has been stagnant at 4.5 billion yuan in 2014 compared with 4.3 billion yuan in 2011, while the net profit plunged to 200 million yuan last year versus over 1.1 billion yuan in 2011.
Likewise, Lianhua Supermarket reported that its net profit slid to 30 million yuan last year from over 600 million yuan in 2011. That came even as the revenue actually increased to 29.1 billion yuan in 2014 from 27.3 billion yuan three years before.
Over the past six months, Beijing has adopted interest-rate and reserve requirement ratio cuts, as well as a debt swap program, in a bid to pump more liquidity into the market to offset deflationary risk.
Lower rates and increased liquidity are expected to spur economic activity and encourage people to spend more.
Also, the Stock Connect scheme will bring in more overseas money and buoy the domestic equity market, which will create a wealth-effect and boost consumption.
One should also bear in mind that Chinese authorities have cut back import tariff on some consumer products such as cosmetics, giving another lift to the prospects of the retailing sector.
Now, all these stimulus measures are yet to be reflected in the share prices of retailers, many of which have halved from their peak levels.
Given this situation, one can say that it’s a good time to look for some attractively valued retail plays.
One big question is to determine whether the downturn is cyclical or structural.
If one believes the government stimulus measures will fail, and that China will be plunged into a deflationary cycle, utilities like gas, power and water plays can be the top choice.
But if one is confident that the country will return to inflation path, retail stocks are definitely a good bet.
Individual stocks always outperform, as we’ve already seen in the case of China Mengniu Diary (02319.HK) and ANTA Sports Products (02020.HK), which have gone well ahead of their peers.
Overall, the tipping point will be the bottoming out of the PPI.
This article appeared in the Hong Kong Economic Journal on May 13.
Translation by Julie Zhu
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