According to China International Capital Corp (CICC), China's largest and most prestigious investment bank, investors should be 'cautious' of Chinese stocks. Among the reasons for its concern, CICC predicts slowing economic expansion and corporate earnings growth. The investment bank recommends defensive stocks. What makes this investment call more unusual is that if this is true, U.S. investors should be cautious of some of the below-listed stocks:
Forward P/E: 8.04
ROA (ttm): 6.06%
POSCO is a Korean-based international steel maker that has flourished amid Asia's recent economic growth. To be clear, POSCO is not an expensive stock. POSCO investors have a lot of things to like about the stock including cheap valuations, sales growth from Japan's reconstruction, Asia's low term growth trends and Warren Buffett's seal of investor approval via Berkshire Hathaway's (NYSE:BRK.A) 3,947,555 share position.
While its 98% capacity utilization rate in 2010 illustrates strength, as a company with major capital expenditures, POSCO can have outsized sensitivity to decreases in sales. In 2010, China represented around 8.5% of POSCO's sales, but also represented a large portion of POSCO's foreign demand growth. For example, from 2009 to 2010, Chinese sales growth jumped 25%.
We would not recommend an aggressive bearish position on this stock, regardless of your view of China. But considering the potential consequences of a prolonged slow down in China, we think that it is prudent for investors to at least be cautious of this stock and understand that the stock may not be as cheap as the trailing statistics suggest. For the company to achieve its forward P/E, POSCO would have to achieve earnings above its record 2008 earnings. While this is ambitious, the company has increased its total asset base by 30% since then, so as long as Asian economies continue to flourish, this goal is possible.
CNOOC LTD (NYSE:CEO)
Forward P/E: 10.48
ROA (ttm): 15.49%
CNOOC is a Hong Kong headquartered explorer, producer and developer of petroleum products. We previously listed CNOOC in our article, 16 High Priced Stocks That We Consider Cheap. While we continue to believe that the stock has long term potential because of its proximity to Asia, in the short term, the company could be sensitive to any slowdown in China. It has net proven reserves of 2.66 billion barrels of oil equivalents. Almost all of the reserves and production are located offshore in China. In 2010, CNOOC produced 900,702 barrels of oil equivalent/day. Of this total, only 180,736 barrels/day were produced overseas.
In 2010, the company's average realized sales price on crude oil was $77.59 per barrel and the average realized sales price on natural gas was $4.27 per mcf. While this is far below the current spot price, there are issues such as contracts and hedging that can get in the way of producers realizing the full spot price. In 2008, when crude oil prices touched $147 per barrel, the company's actual realized sales price on crude was $89.39 per barrel.
From 2009 to 2010, CNOOC increased daily crude oil production by almost 50% because of Bodhai Bay production which jumped from 253,884 barrels per day to 408,946 barrels per day. The oil from Bodhai Bay is mostly heavy oil with higher density than light crude and as such receives a lower sales price because it is harder to refine. It is unclear how the margins associated with this production would be affected if there were a meaningful decline in the realized oil sales price.
Management (and hence the market) expects the company to grow production to 355 to 365 million barrels oil equivalent (BOE) in 2011. This is an 11% increase from 2010 levels and an 89% increase from 2008 production levels. Going forward, with 84% of sales from customers in the People's Republic of China (PRC) and management projected production growth at an annualized rate of 6% to 10%, any decrease in demand because of a slowing Chinese economy will likely hurt the stock.
PETROCHINA CO (NYSE:PTR)
Forward P/E: 9.55
ROA (ttm): 7.73%
The China-based petroleum exploration and production giant is heavily exposed to Chinese demand. Driven by Chinese's growing economic prowess, despite its size, it was able to double total assets between 2006 and 2010.
In 2010, 74% of the company's sales were from within Mainland China. In 2009, this figure was around 78%.
In addition to the company's economic sensitivity to China, PetroChina may have a second derivative sensitivity to any slowdown in China because of CNPC's (previously, China National Petroleum Company) 86.2% ownership of the company's shares outstanding.
China Stock Funds
MORGAN STANLEY CHINA A-SHARE FUND (NYSE:CAF)
According to the prospectus, at least 80% of the fund's net assets are invested in A-shares of Chinese companies listed on the Shanghai and Shenzhen Stock Exchanges. The Fund may also invest up to 20% of its assets in other types of investments including B-Shares and H-Shares.
iSHARES FTSE CHINA 25 INDEX FUND (NYSEARCA:FXI)
According to the iShares website:
The iShares FTSE China 25 Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the FTSE China 25 Index.
Top Holdings (as of April 13, 2011)
China Construction Bank (OTCPK:CICHF)
China Mobile (NYSE:CHL)
Industrial and Commerical Bank of China (OTCPK:IDCBY)
Bank of China (OTCPK:BACHF)
China Unicom Hong Kong (NYSE:CHU)
Ping An Insurance Group (OTCPK:PNGAY)
Petrochina Co LTD (PTR)
China Telecom Corp (NYSE:CHA)
China Shenhua Energy (OTCPK:CUAEF)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.