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China Strategy: Earnings disappointment overhang; focus on those with earnings certainty and policy

Chinese equities markets have been clouded by regulatory guidance, concerns of an Evergrande spillover and power rationing over the past few months. While valuation has retrenched back to close to historical average level for MSCI China, we expect downward earnings revision will continue for both onshore and offshore Chinese equities and this has kept us to maintain a Neutral recommendation for the time being.

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While further earnings downward revision is likely to be an overhang, we recommend investors to focus on those with earnings certainty and policy support. In this note, we will focus on the 3Q21 earnings and provide an update on power rationing. In addition, we will also discuss the latest guideline on internet and platform companies, and the “re-opening” theme in HK

Regulators have introduced various measures to ease the situation on power shortages and elevated commodity price levels and it is expected that power rationing pressure could ease in 4Q. This would be negative for coal but positive on IPPs. The power shortage development reiterates our thesis that renewables is a multi-year investment theme. The PBOC has recently announced a new financial instrument to support decarbonization, which may help lower the cost of financing for renewable energy operators and equipment makers, and therefore could improve project return profile and lifting equipment demand.

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We believe the latest SAMR’s guidelines on internet and platform classifications could be an overhang for the sector given a lack of implementation details. It could potentially cap the upside of sector valuation multiple from a substantial re-rating in the near-term, but we believe it is unlikely to affect current valuation multiples into 3Q21 earnings announcement. We maintain our view that the road to recovery for the sector is likely to be a long and bumpy one. Within the sector, Baidu is one of the preferred picks and could benefit from potential opening up of content by other platforms and providers for Baidu search.

The HKSAR government is placing top priority on border re-opening with Guangdong province and hence, would be supportive to the “re-opening” theme. While the initial phase will be subject to a limited quota, it will form an expectation of sequential increase in visitor arrival, benefitting the retail sector, retail landlords and other companies and sectors where Mainland visitors are a major driver to their business (such as insurance). We prefer AIA and Wharf REIC. (Research Team)