Banking & Finance

A very hard sell

How a research report on PICC spooked Chinese stocks last Friday


PICC’s chairman Miao Jianmin: what does he make of Citic Securities’ call?

At the height of the stock market bubble in 2000 ‘sell’ ratings made up just 1% of the recommendations of investment bank’s equity analysts. In a regulatory revamp after the Enron debacle, Wall Street brokerages were required to explain the meaning of all the ratings in their reports, and disclose the percentages assigned to the buy, hold or sell categories.

The ‘sell’ rating is still a rare breed, though. According to a Wall Street Journal report in 2017, out of thousands of ratings for S&P500 companies tracked by market data provider FactSet, only about 6% were ‘sell’ or ‘underweight’.

Over in China’s investment banking landscape, the Securities Times reported last week that the buy-sell-hold split is also lopsided. Perhaps that is why a bearish research report by leading brokerage Citic Securities was enough to trigger an almost 5% slide in the world’s second biggest equity market last Friday.

The report in question was published late last Thursday and its focus was on the high-flying insurance sector. In particular, Citic Securities noted that People’s Insurance Company of China, or PICC, was trading at more than double what it deemed its true value. As such there was room for the giant’s shares to slide by as much as 50% over the next year, Citic Securities declared.

The A-share market has been on a bullish run as of late (see WiC443) but the research report put a dampener on investor sentiment and PICC’s Shanghai-listed stock fell by the 10% daily limit last Friday. The broader market – as defined by the benchmark Shanghai Composite Index – also plunged 4.4% that day to close below the 3,000-point threshold.

“This sell rating is like a depth charge for the market,” Lin Qi, a fund manager at Lingze Capital, told Bloomberg. “The unwritten rule is that a securities firm will not be short on the market, much less single out a specific company. Given the size and importance of Citic Securities, such a move is significant.”

Prior to this PICC had been a symbol of the stockmarket’s recent renaissance. Riding high on euphoria for A-shares that took hold in early February, PICC climbed by the 10% daily limit for several trading sessions. That led its shares to nearly double over the past two months.

Founded in 1949 as China’s first state-backed insurer, PICC grew into the country’s biggest property and casualty insurance provider. That said, it only got the green light to list its shares on the Shanghai bourse last November (giving it a dual listing with Hong Kong where it issued stock in 2012). PICC’s shares were priced at Rmb3.34 for its IPO and by March 7, or the day the Citic Securities report was published, they had reached Rmb12.83, or nearly four times their debut value. At this point, PICC’s market value stood at Rmb567 billion ($84.5 billion).

In its note, the brokerage noted that PICC’s price-to-earnings (PE) ratio stood at close to 30 as of March 5 as compared with the market average of 20.3 for all seven listed insurers. Fundamentals did not support the run-up, the broker reckoned, as PICC’s net profits climbed just 16% for the first nine months of 2018.

“PICC is clearly overvalued. We have initiated coverage on the company with a ‘Sell’ recommendation. We believe the rational value [of PICC] should be around Rmb4.71 to Rmb5.38 per share, which implies a potential downside of more than 53.9%,” it concluded.

Citic Securities also argued that the outlook for PICC’s business was clouded by intensifying competition in the car insurance market and more volatile returns on its investment portfolios – PICC is one of the largest institutional investors in the Chinese financial markets.

The bearishness was reserved for the insurer’s Shanghai-listed share price. In the same report, Citic also put a ‘buy’ rating on PICC’s Hong Kong-listed H-shares, then trading at HK$3.8 per share. That meant that, taking exchange rates into account, PICC’s A-shares were trading at a nearly 400% premium to its H-shares in Hong Kong.

The so-called ‘A-H premium’ or price gap allows ample room for institutional investors to arbitrage, says, by selling down or (even short-selling) PICC on the Shanghai bourse and buying its shares in Hong Kong.

Citic’s analysis also stoked cynicism from some investors who questioned the motive for publishing such a bearish review of an index heavyweight in the face of a red-hot market.

“Perhaps Citic Securities was carrying out an order from someone senior. Such as: this is the time to cool down the A-share market a bit,” one investor remarked on (where the PICC report was published and extensively shared). Others wondered the same thing, noting that Citic Securities is backed by Citic Group, a powerful financial conglomerate directly under the control of the State Council (rather than the state-owned assets watchdog Sasac). The implication: that the research report was probably a warning from the authorities against over-speculation on A-shares.

Some suspected other motives.“Citic Securities is short-selling A-shares again?” another contributor fumed on the same website, using an angry expletive. Two years ago the brokerage was fined by regulators for violating margin financing and short-selling rules, which were blamed for much of the market meltdown in 2015 (see WiC293).

Conspiracy theories aside, others recognised the impact of the report, with Sina Finance ranking it as one of the top three research notes ever published in China in terms of how much it moved the market with a single ‘sell’ recommendation.

“Although for the time being no one is quite sure about the real motives for this research report, many of us hope that more analysts will be courageous enough to publish their own objective analysis and observations… Hopefully there will be more ‘sell’ reports from Chinese analysts which are based on industry logic,” a market insider told Sina Finance.

In the past the reputations of the domestic brokerages and their research rested on rankings like New Fortune magazine’s annual polls, where sell-side analysts would be ranked by votes from buy-side fund managers and bankers.

The New Fortune polling was compromised by a recent scandal (see WiC427) and the Securities Times is proposing that analysts should be rated by newer yardsticks. One is more of a balance in their recommendations. “If ‘Sell’ reports were as common as ‘Buy’ reports, our financial market would be much healthier,” the state-run newspaper opined.

As matters stand, equity analysts are still overwhelmingly bullish about the Chinese insurance market because an aging population should drive sales of retirement annuities and health-related cover. That has sparked corporate activity in the sector and Chinese investors have been taking control of the Hong Kong units of a number of providers (see WiC436).

Firms like Hong Kong-listed AIA have also tapped into surging demand from mainland Chinese customers who have bought coverage in Hong Kong in large numbers during trips to the city (see WiC347).

In fact AIA’s market value had climbed 26% this year to an all-time high of HK$943 billion ($73 billion) as of Tuesday on expectations that the Chinese government will open up the sector further.

Last year Beijing raised ownership caps for foreign investors in life insurance firms from 50% to 51% and restrictions will be removed completely in 2021. France’s Axa and Germany’s Allianz have already moved to take fuller control of their Chinese joint ventures. That will mean more competition for incumbents like PICC and fintech firms pose another threat to the profits of the existing players.

AIA, which was spun off from the American giant AIG in 2010, also got approvals last month from the China Banking and Insurance Regulatory Commission to start preparations for new sales and service centres in Tianjin and Hebei’s Shijiazhuang, while Chubb, a major insurer headquartered in Switzerland, was cleared last week to take control of its life insurance joint venture Huatai Insurance.

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