CapitalVue‘s Elias Glenn explains how to own a piece of a Communist Party Newspaper or Zhou Enlai’s favorite liquor with the SH-HK Stock Connect
Baijiu is going global: Under a program to be launched in October, individual investors in Hong Kong will be able to finally buy stock in Kweichou Moutai, the world’s biggest seller of Chinese baijiu liquor, along with over 550 other companies listed on China’s domestic Shanghai Stock Exchange. The program, dubbed the Shanghai-Hong Kong Stock Connect, allows Hong Kong and Shanghai investors to trade certain shares listed on each other’s stock exchanges for the first time.
Interest in the program is high, as market participants we talk to on both sides are rushing to add Hong Kong or mainland market data before the fast-approaching deadlines. The linkup marks a key step in the evolution of China’s financial and capital markets, and presents opportunities for individual overseas investors to buy into leading Chinese companies for the first time.
The program, however, will not provide a massive influx of funds to either market. There are significant limitations to the Stock Connect—a total of RMB300 billion in investment is allowed into Shanghai (the Northbound link), and RMB250 billion into Hong Kong (Southbound). The RMB300 billion for Shanghai is equal to less than 2% of the total market capitalization of A-shares listed in the city.
The daily amount that can be invested into Shanghai is RMB13 billion, with Hong Kong’s daily quota set at RMB10.5 billion. The Shanghai amount accounts for about 14.7% of average daily trading in Shanghai A-shares this year, though once the total amount is hit, the daily quote will not be available.
About half of Shanghai-listed companies will be available to Hong Kong investors, though the entire Shenzhen Stock Exchange and its 1,600+ companies are still off limits. Many of China’s most interesting, high-growth companies are listed on Shenzhen’s growth boards. The expectation is that if things go well, the program will be expanded with higher quotas and more stocks available for investment. Reports say the Shenzhen Stock Exchange has already begun exploring setting up a similar program.
Despite the limited scope, the connection has sparked renewed interest in poor-performing mainland equity markets. Since the program was announced on April 10, the benchmark SSE Composite Index has gained 9.7%, while the SSE 380 Index, whose constituents will be included in Stock Connect, has risen 17.8% Perhaps even more important, trading volume has increased significantly since early August (see chart), when a clearer schedule for the launch of the Stock Connect was announced, showing that local investors are finally coming back to the markets.
The program is important for the further opening of China’s financial markets as well as the internationalization of the yuan. Chinese investors have famously lacked options to invest their money outside of property, and there are tight restrictions on moving funds outside of China’s borders. The Stock Connect will not allow mainland investors to move funds outside of their broker accounts holding Hong Kong shares, and there is no yuan convertibility, but it marks a move towards opening financial markets and allowing individuals to directly invest in assets outside the mainland.
The program will also encourage further use of the yuan outside of China. It will be needed to trade A-shares, and there are reports that the limit for yuan conversion will be raised. The Stock Connect, and other developments, are all part of the long-term goal of free yuan convertibility and market-driven financial markets in China.
China’s capital markets have been effectively cut off from the rest of the world, and the Stock Connect program opens up many large, industry–leading companies to a much larger group of foreign investors. We are already seeing increased interest in mainland stock markets because of the program. After being overvalued relative to other markets for many years, several years of poor performance (the Shanghai Composite Index has fallen 62% since the 2007 peak) mean that Shanghai-listed A-shares were valued at only 11.11 times earnings as of September 23, compared to an average of 23.4 over the last 10 years. The Dow Jones U.S. Industrial Average is currently valued at 16.2 times earnings.
In April 2007 the Heng Seng China AH Premium Index, which measures the difference in price between companies listed on both mainland and Hong Kong exchanges (known as A/H shares), showed A-shares were valued over 40% higher than their corresponding H shares. As of September 23, A-shares were 4% cheaper than H shares. This disparity will move toward equilibrium with the launch of the Stock Connect, leaving the most interesting opportunities in sectors not heavily represented by companies listed overseas or in stocks that are undervalued compared to peers in Hong Kong or other markets.
The companies available to individual Hong Kong investors for the first time include the aforementioned Kweichou Moutai, China’s most-famous baijiu brand. The company generated liquor sales of RMB30.9 billion in 2013 and profits of RMB15 billion. While the baijiu sector has been battered during the last year by Xi Jinping’s anti-corruption campaign, strong brands such as Moutai stand to come out the other side stronger after sector reshuffling.
Another first-time offering is Shanghai Automotive, China’s largest automaker and a partner of Volkswagen and General Motors in China. The company sold 5.1 million cars in 2013, is valued at less than 8 times earnings. General Motors sold 9.7 million cars last year and has a P/E ratio of 12.
Bright Dairy, meanwhile, has a high valuation at almost 50 times 2013 earnings, but it is part of one of the big 4 dairy groups in China, giving it a strong position in a major secular growth story, and has a strong outlook with state-owned enterprise reform and overseas expansion. BesTV is a Shanghai-government-backed new media company that is Microsoft’s partner to bring the Xbox to China.
And who wouldn’t want to own a piece of People.cn, the online arm of the official Communist Party mouthpiece? The company’s profits grew 29.75% last year.
Investors, both QFII and locals, have shunned the local stock markets in recent years due to a lack of transparency, poor performance, and a perception that it is not market-driven, but the SH-HK Stock Connect has rekindled interest and may finally shed some well-deserved light on A-shares. Investors will need to do their homework, but there are likely quality opportunities waiting for those that do.
(Cassie Xing helped research this article.)
CapitalVue is a Shanghai-based provider of data and content on China’s local financial markets. For more information about Chinese A-shares, including company tearsheets and financials, news and market data feeds, email info@capitalvue.com.