Participants in the Chinese stock market are mostly retail investors with a casino mentality. At the same time, value investing is still relatively unknown in China. This leads often to situations where stock prices are detached from the intrinsic value of companies. A demonstration of the irrationality of the Chinese market is the AH premium. It is also a good place to turn some pages and start looking for opportunities in China.
The AH premium
As a retail investor outside of China, until November 2014, the only way to invest in China was by buying companies listed in Hong Kong (H-shares). Then came along the Shanghai-Hong Kong stock market connect and later the Shenzhen-Hong Kong stock market connect. Both connections allow international investors to buy stocks listed in China mainland (so-called A shares), while Chinese investors gain access to Hong Kong stocks.
95 companies are listed both in Hong Kong as H-shares and at the same time in Shanghai as A shares. One would think that once mainland stock exchanges are connected with Hong Kong, there is no big difference in price between A stocks and H stocks of the same company. In reality, the opposite has occurred: The Hang Seng China AH Premium, which measures the premium of A shares over H shares surged after the connection has been established.
The index takes the value 100 in case A shares and H shares are valued the same. Anything above means that A shares are priced higher than H shares, and vice versa, a value of less than 100 would mean that H shares are cheaper than A shares. Currently, the index is at around 120, which means that H shares are roughly 20% cheaper than A shares on average.
Reasons for the AH premium to occur
There has been some research on the reason for the difference of this abnormality, but most reports don't go much further than simply ascertaining that it exists and that there is no quantitative explanation to it. The consensus among traders is that there are several phenomena at play:
- International investors don't have the possibility to short A stocks, which make traditional convergence trades impossible.
- Mainland investors and international investors are exposed to different information regarding China in general, and therefore value companies differently because they have different viewpoints about the future.
- Paradoxically, many retail investors from the mainland see Hong Kong as a type of "far west" marketplace since it is not as tightly controlled as the market for A shares. Listing requirements, for example, are stricter in Shanghai. Also, when a stock starts sliding significantly trading is suspended. In addition, Chinese retail investors have no experience with stocks other than A shares. Trading in Hong Kong typically requires some additional paperwork as well.
- On the other hand, international investors are suspicious about Chinese firms, their accounting practices, and their often state-controlled management.
While the 20% average AH premium won't go away in the near term, when the price difference is as large as 78% for particular A and H shares of the exact same company, the gap has to narrow in some way: Either the A shares go down or the H shares go up. By doing a throughout value analysis, investors are able to understand in which cases the H shares are undervalued vs. those cases where A shares are overvalued.
Potentially interesting companies subject to AH premium
The following list is based on the data from Aastocks and has the aim of giving a first orientation. A table containing real-time data and stock prices can be found here.
|SA tickers||Name||H share||A share||P/E ratio||Div. Yield %||Price difference H vs. A %||Industry|
|GREATWALL MOTOR||02333.HK||601633.SH||6||4.8||-40.44%||Automotive vehicles and components|
|BANK OF CHINA||03988.HK||601988.SH||6||5.1||-6.62%||Bank|
|(OTCPK:CICOF)||COSCO SHIP HOLD||01919.HK||601919.SH||8||5||-45.37%||Container and oil shipment|
|(OTCPK:CSDXF)||COSCO SHIP ENGY||01138.HK||600026.SH||8||5||-43.33%||Container and oil shipment|
|(NYSE:HNP)||(OTCPK:HUNGF)||HUANENG POWER||00902.HK||600011.SH||8||6.2||-37.76%||Electric Power|
|(OTCPK:CCCGF)||(OTCPK:CCCGY)||CHINA COMM CONS||01800.HK||601800.SH||9||2.7||-45.73%||Infrastructure construction|
|HUADIAN POWER||01071.HK||600027.SH||9||4.7||-42.44%||Thermal and electricity power, coal|
|(OTCPK:SEXHF)||SICHUAN EXPRESS||00107.HK||601107.SH||9||3.7||-40.31%||Construction and management of highways|
|(NYSE:ZNH)||(OTCPK:CHKIF)||CHINA SOUTH AIR||01055.HK||600029.SH||9||2.1||-39.95%||Airline|
|(OTC:XJNGF)||(OTC:XNJJY)||GOLDWIND||02208.HK||002202.SZ||9||2||-31.99%||Wind power turbines and equipment|
|(OTC:CWYCF)||(OTCPK:CWYCY)||CHINA RAIL CONS||01186.HK||601186.SH||9||1.6||-25.42%||Infrastructure construction (railways)|
|(OTC:CHVKF)||(OTC:CVKEY)||CHINA VANKE||02202.HK||000002.SZ||9||4.5||-8.85%||Property development and management|
|(OTCPK:AUHEF)||(OTC:AUHEY)||ANHUI EXPRESSWAY||00995.HK||600012.SH||10||4.2||-60.63%||Highway (toll) operator|
|CGS||06881.HK||601881.SH||11||2.6||-49.21%||Financial services (Brokerage, advisory, etc)|
|(NYSE:CEA)||(OTC:CHEAF)||CHINA EAST AIR||00670.HK||600115.SH||11||2.6||-43.95%||Airline|
|(OTC:CRWOF)||(OTCPK:CRWOY)||CHINA RAILWAY||00390.HK||601390.SH||11||1.5||-34.11%||Infrastructure construction (railways)|
|XINHUA WINSHARE||00811.HK||601811.SH||11.08||9.85||-63.08%||Publishing, book sales, education;|
|(OTCPK:BEIJF)||BEIJING N STAR||00588.HK||601588.SH||11.3||2.2||-53.05%||Property development and management|
|GAC GROUP||02238.HK||601238.SH||12||2.6||-55.12%||Automotive vehicles and components|
|(OTC:HISEF)||(OTC:HNKLY)||HISENSE KELON||00921.HK||000921.SZ||12||3.1||-31.65%||Household appliances (refrigerators etc)|
|(OTC:SHZNF)||(OTCPK:SHZNY)||SHENZHEN EXPRESS||00548.HK||600548.SH||12||3.4||-24.95%||Highway (toll) operator|
|EB SECURITIES||06178.HK||601788.SH||13||2||-32.15%||Financial services platform|
|(OTCPK:CUAEF)||(OTCPK:CSUAY)||CHINA SHENHUA||01088.HK||601088.SH||13||18.5||-18.51%||Coal and power|
|GF SEC||01776.HK||000776.SZ||13||2.5||-14.08%||Financial services|
|(OTCPK:BBMPY)||BBMG||02009.HK||601992.SH||14||1.3||-55.84%||Capital markets service provider|
|SINOPEC CORP||00386.HK||600028.SH||14||4.6||-3.46%||Oil and Gas|
|(OTCPK:AHCHF)||(OTCPK:AHCHY)||ANHUI CONCH||00914.HK||600585.SH||14||2.2||14.51%||Construction materials|
|(OTCPK:JEXYY)||(OTCPK:JEXYF)||JIANGSU EXPRESS||00177.HK||600377.SH||14.8||4.2||6.46%||Highway (toll) operator|
|TIANJIN CAPITAL||01065.HK||600874.SH||15||2||-75.87%||Water supply and sewage water treatment|
|DZUG||01635.HK||600635.SH||15||1.9||-49.26%||Shanghai gas utility|
|CC SECURITIES||01375.HK||601375.SH||16||6.2||-65.16%||Financial services (Brokerage, advisory, etc)|
|DFZQ||03958.HK||600958.SH||16||2.3||-53.67%||Capital markets service provider|
|(OTCPK:HAITY)||(OTC:HTNGF)||HAITONG SEC||06837.HK||600837.SH||16||2||-22.38%||Financial services|
|(OTC:CIIHF)||(OTCPK:CIIHY)||CITIC SEC||06030.HK||600030.SH||16||2.5||-11.07%||Financial services|
|FIRST TRACTOR||00038.HK||601038.SH||16.1||1.6||-61.42%||Agricultural machinery|
|(NYSE:YZC)||(OTCPK:YZCHF)||YANZHOU COAL||01171.HK||600188.SH||16.4||2.15||-49.71%||Coal mining|
|(OTCPK:WEICF)||(OTCPK:WEICY)||WEICHAI POWER||02338.HK||000338.SZ||18||3.2||-1.09%||Automotive, diesel engines|
|(OTC:FYGGY)||FUYAO GLASS||03606.HK||600660.SH||20||2.9||9.36%||Automotive components (glass)|
|(OTCPK:BYDDF)||(OTCPK:BYDDY)||BYD COMPANY||01211.HK||002594.SZ||20.8||1.4||-19.64%||Automotive vehicles, components, batteries|
|SH ELECTRIC||02727.HK||601727.SH||21||-||-62.10%||Heavy equipment, mainly for thermal and nuclear power|
|FOSUN PHARMA||02196.HK||600196.SH||22||1.3||-10.35%||Pharma and medical equipment|
|(OTC:SHNXY)||SHANDONG XINHUA||00719.HK||000756.SZ||23||-||-58.35%||Pharmaceutical ingredients and chemicals|
|(NYSE:GSH)||(OTCPK:GNGYF)||GUANGSHEN RAIL||00525.HK||601333.SH||23||2||-18.94%||Railway operator|
|(OTCPK:CCOZF)||(OTCPK:CCOZY)||CHINA COAL||01898.HK||601898.SH||24||1.2||-42.99%||Coal mining|
|(OTCPK:ZIJMF)||(OTCPK:ZIJMY)||ZIJIN MINING||02899.HK||601899.SH||26||0||-28.45%||Precious metal mining and refinery|
|(OTCPK:DLPTF)||DALIAN PORT||02880.HK||601880.SH||31||1.25||-60.15%||Harbour services (terminal operation)|
|(NYSE:LFC)||(OTCPK:CILJF)||CHINA LIFE||02628.HK||601628.SH||31||1.2||-19.17%||Life insurance|
|(OTC:ZHHJY)||ZHEJIANG SHIBAO||01057.HK||002703.SZ||34||1.5||-74.44%||Automotive (supplier)|
|NANJING PANDA||00553.HK||600775.SH||34||1.6||-62.88%||Electronics (equipment, parts, consumer)|
|CMOC||03993.HK||603993.SH||34.3||1.7||-52.34%||Non ferrous metal mining|
|(OTC:JIAXF)||(OTCPK:JIXAY)||JIANGXI COPPER||00358.HK||600362.SH||43||1.4||-34.36%||Copper mining and refining|
|(OTC:CITAF)||(OTC:CITAY)||COSCO SHIP DEV||02866.HK||601866.SH||50||-||-61.91%||Container shipments|
|CIMC||02039.HK||000039.SZ||81||0.5||-25.83%||Machinery and equipment for manufacturing|
|(NYSE:PTR)||PETROCHINA||00857.HK||601857.SH||119||1.2||-37.17%||Oil and gas|
|(OTC:LUOYF)||LUOYANG GLASS||01108.HK||600876.SH||230||-||-78.53%||Glass production for construction|
|(OTCPK:SHANF)||(OTC:SHANY)||SHANDONG MOLONG||00568.HK||002490.SZ||-||-||-77.34%||Machinery for oil extraction|
|JINGCHENG MAC||00187.HK||600860.SH||-||-||-71.20%||Machinery and equipment (gas cylinders)|
|NE ELECTRIC||00042.HK||000585.SZ||-||-||-71.17%||Power transmission equipment|
|KUNMING MACHINE||00300.HK||600806.SH||-||-||-65.72%||Machine tools, turbo machines|
|SINOPEC SSC||01033.HK||600871.SH||-||-||-62.72%||Chemical fiber|
|CHONGQING IRON||01053.HK||601005.SH||-||-||-56.73%||Production of coke coal, iron, steel, energy|
|DATANG POWER||00991.HK||601991.SH||-||-||-56.33%||Thermal and electricity power and plants|
|(OTCPK:CHOLF)||(OTCPK:CHOLY)||CHINA OILFIELD||02883.HK||601808.SH||-||0.8||-45.19%||Oil and Gas|
|(OTC:DONGY)||DONGFANG ELEC||01072.HK||600875.SH||-||-||-37.47%||Thermal and wind power plants equipment|
|(OTCPK:ZLIOY)||(OTCPK:ZLIOF)||ZOOMLION||01157.HK||000157.SZ||-||4.8||-26.88%||Construction and agricultural machinery|
|(OTCPK:ZTCOF)||(OTCPK:ZTCOY)||ZTE||00763.HK||000063.SZ||-||-||-25.72%||Telecom and networking equipment|
Source: Author, based on data from Aastocks, 5.6.2017
There is no general pattern between valuation in terms of price over earnings and the AH premium, but there are some interesting observations to make. First, banks are cheap in terms of valuation, and also the premium is low. In a recent article about Bank of China (OTCPK:BACHF) (OTCPK:BACHY), I pointed out that the company was undervalued, but that the impact of China's most recent efforts to deleverage its economy is uncertain when it comes to the impact it is going to have on banks.
On the other side of the spectrum, one can observe that the premium is particularly high for companies that are making losses (mostly those positions in the table without P/E ratio) or are in troubled industries such as steel manufacturing. These companies are suffering from overcapacity and lower growth rates of the Chinese economy. Companies linked to the production of power using coal are also under fire as China is busy tackling its smog problems and pollution in general.
Based on the P/E ratio, dividend yield, and the considerations just made there are a couple of companies subject to the AH premium. I am going to have a closer look by publishing through and through analyses on Seeking Alpha. These are Xinhua Winshare (OTC:SHXWY) (OTCPK:SHXWF), Chenming Paper, Tianjin Capital (OTC:TNJIF) (OTCPK:TCEPY) and CRRC (OTC:CRCCY), even though I find the latter interesting for its innovative products and its almost monopoly-like position in a growing market rather than price and dividend.
I also hope that by then the recent slide in the Chinese stock markets will have bottomed, which should offer an interesting buying opportunity for investors that want to diversify away from overpriced Western stock markets.
Disclaimer: The article reflects my personal opinion and reality to the best of my knowledge, but I can't guarantee for content or outcomes. Please do your own research before making any investment decisions. Be aware that investing in a single stock may lead to complete loss of capital.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.