Newsletter November 2005

Chinese Q3 earnings season and beyond   Even though China’s economy continues to boom, to transform that into the green in our own pocket, is a different story. Investors have to remember that not economic growth but corporate earnings are driving stock prices. For the most part, of course. In addition to current earnings, seasoned analysts have to be able to differentiate between high– and low-quality earnings. Let’s see how did U.S. listed Chinese companies reported so far and what does it tell us for the rest of the earnings season. First it was Huaneng Power (HNP) on October 13 to report a power generation surge in the first nine month of this year on the back of robust demand and expansion of operations. However it was not enough to impress investors as higher coal prices dented into profits and sent shares lower. PetroChina (PTR) came second on October 17 reporting its oil and gas output to rose 5.2 percent in the third quarter from the year-ago period. The bad news came from the refining arm of the company, reporting billions of losses because of state-imposed price caps, which keeps the country’s oil product costs well below world levels. The report sent shares sliding. China TechFaith (CNTF) warned the same day, projecting a third-quarter and full-year revenue at the lower end of its previous forecast, citing softness in the domestic Chinese handset market. Huaneng Power (HNP) reported actual earnings on October 19th. Revenues rose double digits but net profit fell 21 percent due to high fuel costs. China Telecom (CHA) reported next day that revenue fees rose 10.3 percent from a year earlier however the stock went trading lower due to worries about slowing growth in the company’s fixed-line phone service market. The first earnings in-line with expectations came from China Mobile (CHL) on October 20th, reporting a 27.3 percent rise in quarterly earnings and an increase in customer numbers to gain market share. Chalco (ACH) reported in-line with expectations. The Company said that output rose 12 percent year-on-year in the third-quarter, however rising energy prices dented into the bottom line. Baidu.com (BIDU) revealed its earnings on October 26, saying that net profit more than doubled, but higher expenses led results to fall short of investor expectations, knocking shares down. The same day, another NASDAQ listing, Asiainfo (ASIA) reported. A supplier of software used by Chinese carriers to manage their telecommunications networks reported lower net quarterly profit as the company boosted spending on research and development and marketing. Still on October 26, Yanzhou Coal (YZC), the smaller of China’s two Hong Kong-listed coal producers by output, posted a 55 percent decline in third-quarter net profit on reduced coal production. The news sent shares tumbling double digits that day. Next day, October 27th, top ethylene producer Sinopec Shanghai Petrochemical (SHI) reported that its nine-month net profit fell 33 percent on higher crude costs, sending its shares down. Same time, SMIC (SMI) , the word’s third largest contract maker of microchips, reported a fourth straight quarterly loss as higher corporate expenses offset growing consumer product demand. Top Asian refiner Sinopec Corp. (SNP) on October 28 reported a 20.4 percent decline in third-quarter profit due to refining losses that analysts estimated had widened. We have to remember that Chinese refiners continue to bear the brunt of surging crude costs, since Beijing has been slow to raise prices of petroleum products such as gasoline for fear of fanning inflationary pressure that could spark social unrest. China Unicom (CHU), China’s number two mobile carrier, reported a 22.5 percent rise in its quarterly profit on October 28, as it tried to shore up margins while investors worry about a lack of focus. One of the few bright spots was China Southern Airline (ZNH) by reporting a Q3 net profit jump over 300 percent, helped by a strong passenger number and stronger yuan. Chinese chemical company, Jilin Chemical (JCC) posted a net loss for the first nine month of 2005 on high oil prices and said its loss for the full year could be nearly four times that size if prices of refined and crude oil remain unchanged. One of the last companies to report in October was CNOOC Ltd.  (CEO) saying that third-quarter revenue surged 31 percent thanks to high energy prices and output. Even though both top and bottom line reached record levels for CNOOC, the stock price reacted modestly due to fears of missing full-year output targets. And lastly, China Eastern Airlines (CEA) reported and jumped after the firm posted better-than-expected third-quarter earnings on October 31st coupled with weaker oil prices boosting the firm’s margin outlook. Looking forward to November, what do we expect? Most of the NYSE listed Chinese companies already reported except LFC, GSH and CBA. Based on the last earnings estimate for Brilliance Auto (CBA), we will not be surprised to see better-than-expected earnings from the Chinese auto maker. Looking at the NASDAQ listings,  we have to admit it is a tough call. Surely there will be nice positive surprises and some very disappointing numbers, too. We think that Shanda Interactive (SNDA), Ctrip.com (CTRP), NetEase (NTES) and Linktone (LTON) have a good chance to report better than expected. In case it happens lower valued players can get a sizeable lift. We think of Shanda in particular. The stock was testing the $40s couple of times and may get back there easily should Q3 earnings came ahead. Ctrip.com pulled back lately as investors became cautious about actual earnings. We don’t see signs of softening within the traveling sector and are expecting to get positively surprised. Ctrip competitor eLong Inc. (LONG) will report on the same day, November 10th, giving investors the opportunity to distinguish between the two at current valuations. We think Linktone (LTON) and NetEase (NTES) will report good execution of their respective business models, just as they did in the past. NetEase pulled back over 20 percent lately while Linktone  looks more stable at this time. Touching upon Chinavestor dogs,  -here we think of names that are most likely to disappoint-, our list starts with old timer  Sina Corp. (SINA). Seeing no fundamental changes in Sina’s operations during third-quarter, coupled with the last two disappointing quarters, we think Sina is facing a possible big dip should she disappoint again.   China’s economy is slowing. Or may be not...   There is endless debate about the health of national economies, how to improve it, how to stimulate or slow growth. So is the debate over at  the pace the Chinese economy  is growing. Some fear that too fast growth may end up in hard landing. Others argue that China needs to keep up about 9 percent GDP growth just to create enough jobs to keep social unrest under control. So far things are looking good. China’s economy grew 9.5 percent in both 2003 and 2004 and expanded 9.4 percent in the first nine month of the year. But some fear that the economy is set to expand at a slower rate. The modest performance of Chinese markets this year reflects a belief among investors that China’s economy is slowing. Others are pointing to a government figure released on October 25. According to this release, China’s urban spending on construction, factory equipment and other fixed assets rose at its fastest pace so far this year in September, though the country’s top economic planner forecast slower growth in years to come. For longer term U.S. investors the thumb rule is this: as long as China continues to develop and westernize its financial systems while maintaining high economic growth, we are golden. Shorter term investors has to add a few variables to this simple equation though. So how do we do with the economic reform then? On this day, November 1st, The Chicago Board Options Exchange (CBOE) announced that it reached an agreement with China’s Shenzen Stock Exchange on the potential development of derivatives products and markets in China. Just a few days before, we learned that Beijing amended law to allow derivatives to trade on October 27th. CSFB boosted investors’ morale a week prior by making public that it is in talks to buy a second tier China brokerage. In the meantime China expands the stock sale scheme and addresses the chronic problem of its stock markets derived from the high percentage of state shareholdings. And as long as Hong Kong remains Asia’s second largest destination for foreign direct investment, long term investors get all the reason to sleep well.   Is the Chinese IPO bonanza over?   Hong Kong’s benchmark Hang Seng Index fell over 1,000 points, or 7 percent, in October following weakness in overseas markets and on concern about rising interest rates and the spread of the deadly bird flu. In addition to market weakness the latest IPO was not executed properly either. Even though China Construction Bank (CCB) managed to complete the world’s biggest IPO in four years, the company had lifted its indicative price range by 6 percent before pricing the deal near the top of the revised range. Traders complained that left little room for any early gains.  Given the recent equity market weakness and the huge size of the deal, no wonder China Construction Bank trades flat on the market since the IPO. There are additional signs of the  IPO market softening. Wheel loader manufacturer China Infrastructure Machinery Holdings Ltd decided to postpone a stock listing plan in Hong Kong on October 28. Samson Holding Inc., which arranged a management roadshow in Hong Kong on October 31st, announced revised plans to trim its IPO size by about 20 percent. In addition to Samson Holdings and Infrastructure Machinery, knitwear maker Shenzou International Group called off a deal worth over hundred million dollars. One would ask: why do we U.S. investors bother what’s going on in Hong Kong? Aren’t we mostly interested in U.S. listed Chinese companies? It is true but we should not miss a trend. Companies from the Chinese mainland make up around one-third of the Hong Kong stock market’s total market capitalizations and growing, Hong Kong Trade Development Council said on October. Statistics released by the council also revealed that some 90 percent of the mainland companies listed outside the mainland chose Hong Kong as the listing place. How to benefit from this phenomenon then? Just because the sun rises earlier in Hong Kong than in the western hemi spare, U.S. investors can get a taste what to expect from the day  even before it starts here.  Not to mention the tremendous information disclosed to the HK Stock Exchange. Moreover nuanced investors can track competitors of U.S. listings such as Yanzhou Coal’s (YZC) peer Shenhua Energy (1088.HK) and avoid a double digit dip on earnings day. To access latest Newsletter and other research content, please register!