In spite of keen retail interest in Air China's A-share IPO, the counter ended its first day of trading flat and continued to fall until news of falling oil prices gave the stock a good kick. This, on the back of Bank of China's slumping IPO, indicates to me that many local investors look both to the company's fundamentals as well as to market regulatory issues before buying a stock, a practice which will complicate future force-feeding of poor quality stocks onto unwitting investors.
It is difficult to assess just how much of institutional investors' perceived reluctance is due to concern that a raft of large IPOs might drain liquidity from China's equities markets. Proposals to make all shares of some listed companies fully tradable – in other words, for the government to sell completely its stake in some A-share companies – have met with mixed response and are probably due for another round at the drawing board.
That said, two upcoming issues are rather smaller than the blockbusters we saw in Bank of China and Air China.
The key, of course, is that new issues of themselves do not necessarily drain market liquidity. The arrival of new players can in fact bolster stock markets, as witnessed by Bank of China's IPO in which the index actually rose even as Bank of China's shares fell. Accordingly, if the regulator chose to list medium size investment grade companies, China's A-share markets would probably respond quite positively.
We will have a chance to test this idea with China's next two IPOs. Shanxi Lu'an Environmental Energy Development is looking to raise just under RMB2 billion (US$250 million) in Shanghai, while Jiangxi Black Cat Carbon Black is asking investors for around RMB260 million (US$32.5 million).
Fund raising of this size should not tax any capital market, so we will see if investors read the fine print and decide to buy.
We suspect the answer will be positive since the index's recent rise has been without the benefit of some large cap stocks. With this in mind, a month ago we reduced our holdings in Baosteel and in Bank of China, converting to cash as these two stocks began their price declines. These declines continued in September bucking the trend of the rising A-share market.
Meanwhile, other A-share listed banks have seen sharp increases in their share prices since the announcement of the interest rate hike, especially Pudong Development Bank and China Minsheng Bank, which have both rocketed up throughout August.
However, their share prices appear to have reached the resistance levels and, with both banks now trading at over three times price to book, there appears to be little upside potential.
Instead of jumping in at the top with Pudong Development Bank and Minsheng bank, let's buy some stock in Huaxia Bank 600015. The bank is now trading at approximately 1.6 times book, on the low side relative to other China banks.
Moreover, the share price saw little appreciation in August so Huaxia may be a candidate for rotational buying as investors take profit in other bank A-shares.
Huaxia has lagged its competitors' share price appreciation in part because of first half results which included significantly higher charges for non-operating expenses. This dragged profitability down to 58% from 67% in first half 2005.
For emerging market banks, however, this can be merely part of the ride as gradual deregulation, rapid growth in the loan book, and a changing economy all make their way through the balance-sheet.
On the positive side, the composition of Huaxia's loan book has improved, with 92% of loans performing in the first half of 2006 versus 90% at year end 2005. And about half of the loss category loans were charged off in the first six months of the year, even as the bank continues aggressive classification of non-performing loans.
At Huaxia's current share price of around RMB4.1, our cash rich Red Dragon Fund can afford to buy 500 shares and wait for higher lending rates to filter through the bank's financial statements.