Air controllers jam up China’s skies
The skies above Chinese cities have become cluttered as tens of millions of passengers fly internally or to the outside world. A booming economy has unleashed demand for flight, pushing domestic carriers into an upward trajectory. But in a nation where the state often impedes on business, airlines are looking at a frustrating summer. South China Morning Post reported this week that carriers are required to reduce their number of flights to and from 12 airports in eastern and central China by around 25% between July 20 and August 15 to accommodate “high frequency exercises carried out by other users of the air space.” Only the military, which unlike most other countries still has authority over China’s skies, can interfere like this. People readying for their summer holidays, students preparing to move overseas and even the families of naked officials requested to return to the motherland are going to be inconvenienced. It could also be a buzz kill for airlines, note Barclays Research analysts. “China Eastern (CEA.NYSE, 0670.HKG, 600115.SHA) is most affected by the measure in our opinion, with Shanghai as its main hub, though other airlines are also affected on the routes to the involved airports,” the said in a note. That said, “We expect the overall earnings impact to be neutral as an increase in yield offsets at least partially the capacity cut.” Barclays rate China Eastern as one of the better sector picks and something worth considering when schedules return to relative normality in a country with the world’s worst flight delays.
Li Ning running out of breath
Li Ning (2331.HKG) is running on empty and looks like it might not make it around the next lap. The Chinese sportswear brand founded by the celebrated Chinese gymnast of the same name – the man who ran literally rings around the roof of the Bird’s Nest stadium for the opening ceremony of the Beijing Olympics – issued a profit warning this week revealing significantly higher-than-expected losses. The company is having troubles clearing out old merchandise against a broad background of a weak macro environment and fierce competition from foreign and casual brands, which makes it even harder to pump up sales. The recent shift from a wholesale to retail model has dragged on its near-term profitability even more. Although analysts believe these initiatives could bode well for sales in the long run, things are not going well for now. “We think there is more downside given that the recovery pace in 2H14 will remain slow and earnings visibility remains low,” UOB Kay Hian said in a note. “Revenues expectations are still too high.” Li Ning has tried to bring in a fresh pair of legs through various aggressive acquisitions in recent years but nothing has managed to build momentum. The staggeringly popular World Cup just concluded in Brazil yet Li Ning was nowhere in sight. UOB Kay Hian maintains its “SELL” rating on the company.
Is China cheap?
Last week this column featured a report by equity strategists from HSBC Research that looked at bargain valuations within Chinese stocks, as compared to their regional peers. The question over A-shares was kept up this week when Mark Mobius, head of Templeton, came out to say that investors can still jump into a 20% upside swing in mainland stocks as they rally. He seems state-enterprise reform as a catalyst. We’ve talked about how to play this trend in several pieces this year. Thomas Gatley, a senior analyst at researcher GavekalDragonomics, has come out with his own view on Chinese stocks and their current low valuations. “On examination, the earnings growth rates implied by current prices are in line with expectations for economic growth. In other words, China’s domestic equities are not cheap.” The basis for this research is the Gordon growth model – which creates a theoretical stock price based on a firm’s dividend, expected dividend growth rate and the required return on equity. According Gatley’s numbers, the dividend rate of 9% is close to nominal GDP today and consistent with real GDP of around 6% if assuming 3% inflation. To sum “prices are therefore cheap only if you think China’s growth will be much faster than it is – which looks unlikely.”
There are no scheduled IPOs in Hong Kong next week. But Hong Kong stocks rose to a three-year peak on Thursday amid positive sentiment from a plan to connect the city’s bourse to mainland investors. The market was driven by a strong flow of funds into the city ahead of the Hong Kong-mainland stock connect scheme in October and optimism about economic conditions on the mainland. The Hang Seng Index closed up 0.7% at 24,141.50 points, its highest close since April 2011.
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