There has been for a while an influential cottage industry based on shorting Chinese stocks. The most visible China short is probably Muddy Waters Research. While I strongly believe these guys add value to the marketplace, unless you have an account to invest in Hong Kong (which opens your universe by around 1500 stocks), which US listed China stocks do I think are relatively safe from bad accounting publicity?
It is interesting that very few of the stocks that have been the focus of vocal short sellers are actually listed in Hong Kong ("H-Shares" or "Red Chips") and/or mainland China (A-Shares). Jonestown Research's bearish views on Winsway Coking Coal* is the only example I can think of.
The stocks the shorts have focused on are ones that decided to list in far-away America, even though there are perfectly viable capital markets in Shanghai, Shenzhen and Hong Kong.
In the honest cases, management just wanted the prestige and liquidity of being listed in the US. In the fraudulent cases, I would say that it's because the penalty in mainland China for white collar crime can be anything up to and including the death penalty.
While this may not be the case in Hong Kong, typically investors here are more able to understand what's going on in the mainland. The investor base in Hong Kong is sophisticated and knowledgeable about China for obvious reasons. Value Partners (OTCPK:VPGLF) is a good example of a fund house with rigorous, on the ground, investigative research and analysis.
Consider my Chinese "Blue Chips"
Whether you like it or not, economic power and economic growth is in Asia and the driver of that is China. The current "slowdown" in China and market underperformance should prove to be a good opportunity to invest in China plays. The government has already started easing policy. In the medium term policymakers recognize the need to increase the level of household spending and in the longer term financial system reform is planned.
My "Blue Chips" have at least two sets of regulators to report to. As already mentioned, one of which management really do not want to violate in particular. I believe the following stocks are highly unlikely to be the subject of Muddy Waters' or other short sellers' criticisms based on accounting irregularities alone.
Stocks listed in US, Hong Kong and mainland China
- PetroChina (NYSE:PTR)
- Sinopec (NYSE:SNP)
- Yanzhou Coal Mining (NYSE:YZC)
- Sinopec Shanghai Petrochemical (NYSE:SHI)
- Huaneng Power (NYSE:HNP)
- CHALCO (NYSE:ACH)
- Guangshen Railway (NYSE:GSH)
- China Eastern Airlines (NYSE:CEA)
- China Southern Airlines (NYSE:ZNH)
- China Life Insurance (NYSE:LFC)
China stocks listed in Hong Kong but not listed in mainland China
- CNOOC (NYSE:CEO)
- China Telecom (NYSE:CHA)
- China Mobile (NYSE:CHL)
- China Unicom (NYSE:CHU)
- Melco Crown Entertainment (NASDAQ:MPEL)
- HSBC (HBC) - also listed in London
Over the coming weeks and months I plan to profile some of these stocks in greater detail from a fundamental valuation point of view. In the meantime, currently from a growth point of view, on a two to three year horizon, I have the following thoughts.
I like CNOOC and Yanzhou Coal Mining. I strongly believe all hydrocarbons have to price higher for global supply and demand to balance and these are two of the main suppliers of energy to China, where energy consumption per capita is still relatively low. In addition to crude oil, CNOOC is expanding in natural gas exploration and production. Yanzhou is expanding in Australia.
PetroChina and Sinopec I'm not so keen on. They can and are suffering negative refining margins. With this constraint I think they will underperform CNOOC.
Similarly, power generation suffers from artificially squeezed margins, so I would avoid Huaneng Power for now.
This is all because price controls for gasoline, diesel and electricity are supposed to limit inflation, something that the Chinese government is very sensitive about. The inputs however, crude oil and coal, have to sell at international prices.
CHALCO faces a sector with rampant overcapacity and inefficiency. Strong competition from RUSAL (486 HK) and state and other private aluminum producers does not help. In this sector, growth will be minimal until the multi-year process of industry consolidation is well under way.
Currently I have no particularly strong view on the telecoms. The key will be who can win the race in the (affordable) smartphone and data package segments. This is not something I have been following closely although the Apple (NASDAQ:AAPL) iPhone is still very much for the Chinese "1%".
As for transportation stocks, the airlines are highly limited in their fuel hedging activities. This is due to having made huge losses in "hedges" in recent years. A lack of hedging fuel costs may prove a headwind in a higher price environment. On the positive side, if the RMB continues to appreciate, the two airlines will make FX gains as their revenues are in RMB and their debt is largely in USD. At the moment I'm not sure which of FX or fuel will win out.
Over a two to three year view, I would have a slightly bullish bias for Guangshen Railway. I do not see a harsh economic slowdown in China and Guangshen has a mix of passenger and freight services within the key Pearl River Delta region. I expect revenues should correlate highly with China's economic growth. I expect China's GDP growth to average around 7-8% during the next central government's ten year tenure.
HSBC derives a large proportion of its profits from Asia, in particular China and Hong Kong. However, I think the market will ignore this until the outcome of the Eurozone crisis and new banking regulations are clearer. Therefore, HSBC along with other large global financial institutions are just a high beta global macro play at the moment.
Finally, China Life. I understand the float is mostly invested in Chinese A-Shares since the fixed income market is still underdeveloped. I will need to investigate further their underwriting standards to have a stronger view on their medium term return potential.
Note: for those interested in corporate governance in Hong Kong listed companies, check out David Webb.
*CHALCO is proposing to purchase 29.9% of Winsway, a resources trading company.