In recent years there has been much talk about Stock Connect – the channel that links mainland China’s two key bourses with Hong Kong’s stock exchange. But where the country’s equity markets are concerned right now the talk is much more about a ‘disconnect’. For while the primary markets are booming and IPOs are trading well, the secondary market remains depressed, with the main indices all down on a year-to-date basis.
It has been a similar tale with cross-border capital flows via Stock Connect itself. Northbound traffic is accelerating – driven by MSCI’s inclusion this month of 234 A-shares (see WIC412) – but the southbound flow is shrinking thanks to the torpor afflicting Chinese investors.
The IPOs on the A-share market are drawing much of the local buying interest. Partly that’s because the China Securities Regulatory Commission (CSRC) is both encouraging and fast-tracking the kind of companies China’s retail investors want to own. These include rapidly-growing technology companies.
Recent examples include Taiwan’s Foxconn Industrial Internet (FII) and battery manufacturer Contemporary Amperex Technology (CATL). Both companies whizzed through the CSRC’s IPO approval stage in record time (five weeks and four weeks respectively) and both began trading in the past week after respectively raising Rmb27.13 billion ($4.22 billion) and Rmb5.461 from their initial public offerings.
Their opening share price performance has also followed exactly the same route and climbed by the permitted first day trading limit (set, somewhat mysteriously, at 44%).
FII’s share price rose from an offer price of Rmb13.77 to Rmb19.83 on its Shanghai Stock Exchange debut. It closed this Tuesday at Rmb23.99, up 74.2%. FII now represents the largest A-share technology stock with a market value of Rmb472 billion. FII’s Taiwan-listed sister firm Hon Hai Precision, in comparison, is worth about $50 billion (or $24 billion less).
At this level FII is trading at 30 times 2017 earnings, well above the regulator’s 23 times IPO price cap (a regulation that virtually ensures a hot new listing will soar on its first day of trading).
Likewise, CATL rose from an offer price of Rmb25.14 to Rmb36.2, up 43.99% after it began trading on Monday on Shenzhen’s ChiNext. It is now trading at 39 times 2017 earnings, but about 23 times consensus 2019 forecast earnings.
Analysts note that in its original prospectus, CATL proposed raising Rmb13.12 billion by issuing the same number of shares (217 million) at a much higher IPO price of Rmb60.46 per share. They attribute the subsequent scale-back to the regulatory earnings cap. As we noted in WiC411, this is one of the many quirks which regulators will need to address in coming years if China’s bourses want to be taken seriously as fully developed markets.
Within the next month, Chinese equity markets will also achieve another important landmark when the first Chinese Depositary Receipts (CDRs) begin trading (allowing mainland investors to buy overseas-listed Chinese companies that issue them). Smartphone manufacturer Xiaomi is expected to come first as part of a Hong Kong listing. CICC says it expects three to six companies to issues CDRs within the next six months, most likely including the BAT troika (Baidu, Alibaba and Tencent).
“We believe they will raise Rmb100 billion to Rmb200 billion,” the securities house said in a recent research report. “We believe they will have some impact on A-share market liquidity, but the impact should be manageable.”
Current liquidity shows just how depressed conditions have become, with daily turnover averaging Rmb350 billion according to CICC compared with roughly Rmb460 billion in 2017 and Rmb518 billion in 2016.
Brokers note that the average valuation of all A-share companies has continued to decline, with the trailing price-to-earnings ratio (based on last year’s financials), back to its five-year average of 15 times. The consequence: measured at Tuesday’s close the Shanghai Composite Index is down 6.88% year-to-date, while the Shenzhen Composite Index is down 7.38%.
Financial analysts attribute the negative sentiment to the looming threat of trade tariffs pending the publication of the final list of US tariffs today and the government’s economy-wide deleveraging efforts, which are raising companies’ cost-of-funding. However, this pessimistic view stands in stark contrast to Hong Kong where sentiment is much stronger, steadily narrowing the premium gap for those firms that have both A-share and H-shares.
Hong Kong’s China-focused markets are among Asia’s top performers year-to-date with the Hang Seng China Enterprises Index up 4.25% to Tuesday’s close.
But mainland Chinese investors are not driving this sentiment. Southbound flows on the Stock Connect have not only been steadily falling since January (now Rmb0.5 billion per day), but are now less than northbound flows, which have been rising since April (now Rmb1.5 billion per day).
Indeed, northbound flows are the highest since the first heady days of Stock Connect in late 2014. As we wrote in WiC412, the increased take-up has much to do with the formal inclusion of A-shares within the MSCI index suite on June 1. MSCI describes the move as the “world coming to China” and its own strategists predict $20 billion of net inflows this year based on the inclusion of 234 A-share stocks within the MSCI Emerging Market Index and All Country World Index, rising to $400 billion over the next 20 years.
Yet clearly the excitement is still to spread to China’s legion of retail investors, who feel less bullish on many existing A-shares. The situation is very different for some of the local blockbuster IPOs, where getting an allocation is viewed as akin to a winning lottery ticket.
PICC, which listed in Hong Kong in 2012, is set to be the fifth Chinese insurer to also list on the A-share market – where the CSRC recently approved its plan to raise up to Rmb10 billion.
PICC is the market leader in property insurance and, according to the insurance regulator, its premium income in the first quarter was Rmb136 billion – up by 16.29% on a like-for-like basis.
This is higher than the industry’s average growth rate, but whether it is stellar enough performance to ensure that PICC emulates CATL and FII and rises 44% on its first day of trading remains to be seen.
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