Newsletter December 2005

Beyond the Q3 earnings season   Chinese Companies have come a long way compared to even a year ago. It used to be hard to find relevant information about financials, quarterly reports submitted to the Exchanges on time were the  exceptions. The current quarter was a nice surprise for financial analysts. Out of 44 Chinese listings we cover, 33 reported quarterly earnings. It is exactly seventy-five percent of the companies Chinavestor covers. Most NYSE names, we mean NYSE listed Chinese ADRs, reported quarterly earnings for the first time. Also, the quality of the reports is significantly improving. Those days are gone when the “miscellaneous” expenses dominated income statements rendering financial analysis useless. Having said that, let’s see the earnings and the reactions so we may predict what to expect from the subsequent quarter. Looking at stocks from a market listing point of view, NASDAQ names became much more volatile to earnings releases than NYSE names. It should be no surprise. However the magnitude of price swings certainly raises eyebrows. China Tech Faith (CNTF) , the handset developer, rocketed 54 percent higher the day following reports that earnings more than tripled and revenue nearly doubled. The stock continued to extend gains and traded 75 percent higher by the following week. And the market corrected just as quick when this year’s favorite NetEase.com Inc. (NTES) disappointed sending share prices 30 percent down by week’s end. Double digit dips were not uncommon, demonstrated by eLong (LONG), Shanda (SNDA), and KongZhong (KONG) just to name a few. Breaking down the Chinese stock universe by sectors, airliners did best, both China  Southern Airlines (ZNH) and China Eastern Airlines (CEA) reporting better than expected. Telecoms reported strong with little surprise. Wireless giant China Mobile (CHL) and China Unicom (CHU) came out ahead, while China Telecom (CHA) reported in-line. City Telecom (H.K.) Ltd. disappointed. Petrochemicals were mixed, Jilin Chemical (JCC) and Shanghai Petrochemical (SHI) both coming out short however privatization rumors sent Jilin shares higher. The oil & gas sector disappointed investors despite record high crude prices. Beijing’s firm grip on domestic refined prices kept oil companies profits at bay.   Integrated oil majors PetroChina (PTR) and Sinopec (SNP) were hurt by refining margins but offshore oil producer CNOOC Ltd. (CEO) reported a strong third quarter. The basic materials sector was hurt by the poor performance of Yanzhou Coal Mining (YZC). China’s second largest coal miner reported production decline coupled with slower growth estimates for 2006. Aluminum Corp. of China (ACH) reported ahead of expectations thanks to huge demand and solid alumna prices. The online travel sector was hurt by the avian flu reoccurrence in South-East Asia. Both Ctrip.com and eLong Inc. shares lost over 10 percent the day they reported. And while eLong reported an increase in operating loss, Ctrip came out stronger as quarterly profits rose 71 percent. The online gaming sector presented the biggest disappointment for investors as all major players fell short of analysts’ expectations. Long time favorite NetEase (NTES) lost thirty percent of market value the day it reported. The stock has been trading near all time highs of $96 right before earnings and became extremely vulnerable to negative news. And while the Company’s quarterly profit more than doubled, it forecasted its fourth-quarter profit and revenue to be roughly flat, sending shares to a free fall. Shanda Interactive (SNDA), China’s biggest online game company, said its quarter-on- quarter revenue declined for the first time as its most popular title faded, sparking a share sell-off. Smaller players followed suit, The9 Ltd. gave up 10 percent of its value the same day. Internet stocks in general proved to be very sensitive to  negative market sentiment. Small cap internet stocks showed little resilience to negative news. I-Cable Comm. (CTEL), Kongzhong (KONG), China Finance Online (JRJC), and Asia Info (ASIA)  dropped over ten percent after reporting in-line or slightly negative earnings growth.  Yet, the internet sector presented the biggest winners of the quarter. China Techfaith Wireless (CNTF) rocketed after reporting record revenue and profit numbers. The normally thinly-traded ADR notched volume of more than 5.3 million on the day she reported. Tom Online (TOMO), a leading wireless internet company, achieved record levels of revenue and profits, propelling the stock to all time highs. Among long-timer internet portals, Sina Corp. (SINA) continued to be on the loosing streak while  Sohu.com (SOHU) came in at the high end of the company forecast on strong advertising sales. Let’s step back from the third-quarter for a moment. Looking at the shear numbers, investors’ reactions to the financial reports resemble those of a consolidating emerging market. We say emerging market because investors get cold feet easily. This notion is best demonstrated by the high number of companies loosing 8 percent or more after earnings release. Overall, over fifty percent of the companies moved more than 8 percent following the week they reported. In other words, the market is still quite volatile compared to mature markets however extreme price moves are limited in number. Another sign of emerging markets is that investors react to negative news much more profoundly than to positive news. This notion holds true to mature markets as well, but to a lesser extent. We say that the Chinese ADR stock universe is consolidating at the same time. We see an increasing number of mature companies, best demonstrated by Sohu.com when she reported slightly lower earnings but the results came in at the high end of previous forecast sending the share twelve percent higher throughout the following week. Another example for market consolidation is Baidu.com (BIDU). The stock is in tight correlation to a foreign peer, Google. The fact, that a Chinese internet stock is trading on Google news carries enormous importance. The message is this; China and the Chinese market is out of the bottle. And again, we can not overemphasize the fact that the corporate governance is significantly improving. Our analyst team is finding increasing number of evidence of it while processing the data. We recall that NYSE listed companies had hardly prepared financial reports during previous quarters. If we got a chance to look at semi-annually reports we were pleased. But this quarter was different. Names like YZC, PTR, HNP, SHI, SNP, CHU, CHA, CEA, ZNH, CHL, CEO, JCC, all reported not to mention most of the NASDAQ listings. Yes, there is still room for improvement. We would like to see all Chinese ADRs reporting in a timely fashion and presenting quality reports. But the trend is very encouraging and we are eager to see more company reports in the next quarter.   China is modernizing its financial system   China is quietly modernizing an array of financial safeguards as policy makers grow increasingly nervous about side-effects of opening  up the economy at breakneck speed. We understand that the financial system still bears all the legacies of a planned economy. Core of the problem is the lack of competitiveness within the financial sector, making it  vulnerable to foreign competition in advance of December 2006, when China will throw open most banking business to foreign competition in line with pledges made when China joined the WTO.  Party officials are trying to put the world’s seventh largest economy on a stable, sustainable path. Following is a list of main steps taken this year. Jan. 1— China sets up  the “Insurance Security fund” to help compensate policy holders in case insurers fail. Jan. 7— Regulators order banks to adopt independent audits. April 30— Stock regulators revive a program to float $250 billion in non-traded state holdings in listed firms. Sept. 29– China launches a multi-billion dollar fund that will step in to protect investors when stockbrokers fail. Nov. 10– The central bank says it will let banks facing an intra-day cash crunch to borrow at preferential rates. It’s about time for China to look into the future to build up mechanisms for long-term financial stability.   How communist China really is?   I came across a very intriguing article at the Wall Street Journal on Friday, November 18. This article examined if China should be regarded as friend or foe for the U.S. Regardless of the conclusions the author made, the interesting point was the fact that the general public and business leaders see China much more favorable than politicians. So one would ask: is China really a communist state? And if so, what does that mean for my investment of Chinese stocks?  Are they safe? First, let’s see if China is a communist state in deed. And if this assumption is right, let’s worry about the consequences. Meeting with Mr. Weidong Yin, CEO of Sinovac Ltd. (SVA) two months ago in NYC resembled    anything but a communist party official who runs a company.  On the contrary, Mr. Yin was disclosing financial and production plans. He shared his view of improving investors relations and improve shareholder structure.   First of all, Mr. Yin came to the U.S. to an investors’ conference and went on a road-show to secure financial backing for the expansion of a production facility in China.  It’s as far from a planned socialist economy with government control as it gets. Then, another WSJ article  a week later by Murray Herbert highlighted that “After four years in WTO, Beijing scores on tariff cuts, not on intellectual property.“ It says that “Four years after China joined the World Trade Organization, foreign companies gave Beijing a fairly positive card for moves such as cutting tariffs and opening up financial services—but they say there is a lot left to do in other areas”. The next surprise came just a day ago on November 30 when we learned that growth in Asia’s residential mortgage-backed securities market will likely come from China, South Korea, and Taiwan. As banks start to restructure their balance sheets in these countries they may decide, regulations permitting, that they will act more as a middleman for lending, connecting investors with borrowers. Now, general understanding of a communist China would resemble a country where private property or real-estate ownership is non-existent, not to mention mortgages underwritten by banks. What about the IPOs? It’s clear that the Hong Kong stock market has hosted a record volume of initial public offerings in 2005, headlined by the multi-billion dollar listings of China Construction Bank and the Link REIT. Dongfeng Motor Group Co., China’s third-largest automaker, raised $509 million after setting its IPO price on November 30, Wednesday. And there is more to come. So skeptics would ask: what do IPOs have to do with communism? What do stock exchanges do with communism in the first place? And the last piece of the matrix comes the same day, November 30: Chinese automaker declares bankruptcy after 50 years. According to a Kyodo report, The Beijing No. 2 Automotive Manufacturing Company, one of China’s original automakers, has declared bankruptcy after having failed to adjust to changes wrought by the market economy, local media said Wednesday. Yes, there is government price control of strategically important commodities in China, such as petrochemicals. And this control does cause surprises when major petrochemical report earnings. But remember that the media took an immediate notice in the U.S. and political pressure was mounting, when Exxon Mobil reported close to double digit billion quarterly profit in this quarter. To access latest Newsletter and other research content, please register!