An interesting thing is happening in China's A share markets: international investors are buying A shares while Mainland institutional investors have become net sellers. These foreign players are attracted by the relatively low price to earnings ratios of A shares – around 17 times for Shanghai A shares, down from highs of 50 – as well as their growth potential. (Shenzhen A shares post a PE of 25 times, down from over 150 back in 2002.) While there is a bit of the 'two billion armpit' theory of Chinese marketing to this trend, there are industries where China is making a mark and will continue to do so. International investors are seeing the need to stake out positions in sectors such as steel, building materials and automotives.
In contrast, domestic institutional investors are heading for the exits because they see little prospect of earnings growth and are tired of losing money as A share indices break one support level after another. Local fund managers have been forced to invest in A shares by regulatory limitations; their only alternative investments are domestic bonds, which must be starting to look good given continued drops in A shares. Shanghai A shares have fallen 36% from a peak of 1,800 in April 2004 to around 1,155, whilst their Shenzhen counterparts have shed 43% over the same period, falling from 460 to around 260. At least with bonds, you fire pretty sure of getting your money back.
The intriguing thing about this changing of places is that it is happening during a time of profound regulatory change as China's government finally begins to unwind its holdings in A shares. This promises to remove a massive overhang on the market, as investors of all stripes feared that any government sell-down would swamp the markets. In the interim, however, investors must face uncertainty, which normally sends foreign investors to the sidelines and encourages local players who felt that they know more than the rest of us. The opposite is happening now.
Our last stock pick, Shanghai Oriental Pearl 600832 CH, has done okay over the past month, rocketing from RMB12.00 all the way to RMB13.00 before giving back nearly half that gain and retracing to just over RMB12.50. But hey, we don't want stocks with unsustainable gains now, do we? At any rate, we fire up about 4% for the month – a lot better than most banks I can think of!
Oriental Pearl has a PE of 38, somewhat above the Shanghai A share average PE of 17. While this differential constitutes something of a risk factor, the stock has outperformed the Shanghai A share index over the past month.
On balance, Oriental Pearl is a defensive stock, offering elevator rides and other services to the many tourists who flock to Shanghai's financial district, as well as providing television broadcast services from its tower. While Oriental Pearl's advertising revenues dropped 11% in 2004, it more than doubled its entertainment revenues that year. With more Chinese making the pilgrimage to its tower, the entertainment sector looks ready to keep expanding.
It could also be argued that Oriental Pearl is a community oriented stock, providing free navigational services to many Shanghai residents and visitors, who can see its tower from nearly everywhere.
So it's decided: roll the dice again on Oriental Pearl, especially as we are heading into the holiday seasons of Christmas through Chinese New Year. We put in RMB4,888 which has now risen to RMB5,092.
For our next stock, let's look at an industry which literally will power China's continuing GDP growth. In China, electrical generation capacity is being added at about the equivalent of one UK's worth of capacity per year. XJ Electric 000400 CH provides the automated systems for power stations, the key to delivering power from the generator to the grid. Sales of power control systems made up around two-thirds of 2004 turnover, and grew at over 20% since 2002.
XJ's shares are priced at below book value, having just unwound some of the government's stake and dropping one-third in the bargain. The counter is small, market capitalisation of RMB1.6 billion and average daily value traded over the past six months of RMB20.2 million. Viewing the glass half full, any positive press can only serve to push the share price upward. Let's go in for RMB2,000 and see how things develop.
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