Buy Now, While The Market Is Recovering

Based on this reasoning, we have an overall buy recommendation for the Hong Kong market and Chinese shares listed in Hong Kong. 

Why Hong Kong, and not China itself? The reason is that the Chinese government currently permits only large institutional investors—not individuals—to invest directly in Chinese securities. But foreign investors can buy and sell Chinese shares listed in Hong Kong without restriction. This restriction on direct share ownership of Chinese shares, combined with the additional restrictions now being imposed on new foreign investments in China, places the large number of Chinese securities listed in Hong Kong—”H-shares”—in an ideal position to rise in value.

As the chart indicates, after a stellar performance in 2003, share prices of Chinese companies listed in Hong Kong fell sharply in the early months of 2004. While they have regained some ground in recent weeks, we believe that there is an excellent chance that the market will test its all-time highs in the first half of 2005 at the latest. We therefore look at the current period of market weakness as a buying opportunity.

These H-shares Have Our Highest Recommendation

Better living through chemistry. In the recent market sell-off triggered by austerity measures, the chemical sector fell with the broader market. However, the austerity measures were designed to limit investment, not consumption. And consumption of refined chemical products such as resins and synthetic rubber continues to increase at a rapid pace. Supply-demand dynamics favor a sharp price increase in this market segment until at least 2006. With a forecast price-to-earnings multiple of less than seven times (dependent on 2004 earnings), we recommend Beijing Yanhua (0325.HK) as a safe bet in this sector.

Put a spark in your portfolio. Power shortages are a regular occurrence in China and the booming economy will only make matters worse. In addition, soaring energy prices—most importantly, in coal—are forcing inefficient power producers out of business. The supply-demand imbalance will eventually be resolved, but electricity will continue to be a growth sector in China for years to come. Our top pick in this industry is Huaneng (902.HK), one of China’s largest and most efficient power producers. While many analysts think it is fully valued, we disagree and recommend accumulating it on any market weakness. Huaneng’s 4% annual yield is a significant downside cushion. Huaneng is also traded in the U.S. as an American Depository Receipt (ADR)—symbol HNP.

A double play on renminbi appreciation. If China eventually revalues the renminbi, as we anticipate, companies with expenses and debts denominated in foreign currencies, but with revenue in renminbi, will benefit from both sides of the revaluation. One industry that fits this category in China is aviation, since the industry's #1 cost is fuel oil, mostly imported from abroad and denominated in U.S. dollars.  Aviation is also a growth industry in China, with a low "penetration rate;" i.e., the vast majority of Chinese citizens have never flown in a plane. In this category, my colleague Matt Hu highly recommends China Eastern Airlines (670.HK), which he believes that it will have positive earnings surprise to investors in 2004.

Milk: It does an investor good. In China, milk has historically been considered a luxury item. Now, increasingly affluent Chinese consumers are drinking much greater quantities of milk. But per capita milk consumption remains far below that of South Korea, Hong Kong, Singapore and Japan, and even further below that of most western countries. We forecast an average annual compound growth rate of 40% for liquid milk consumption for the next few years. In this sector, my colleague Hu Meng recommends Mengniu Dairy (2319.HK). While Mengniu isn’t China’s largest dairy, it is a market leader, and in his view better managed than the number one dairy, Yili. Crucially, Mengniu started as a private company; Yili as a state-owned enterprise. Yili’s bureaucratic management structure has led to management rivalries, creating an opportunity for Mengniu to take over some of its market share.

A safer way to invest in China. There are significant risks associated with investing in individual shares in a developing country such as China. While we believe the prices of all of these shares will be significantly higher in the years to come, price volatility is almost guaranteed. A less aggressive approach than investing in individual shares is to buy the Hong Kong Market Tracker Fund (2800.HK), which tracks Hong Kong’s most broad-based share index, the Hang Seng Index. As there are objective criteria for listed companies to qualify for this index, this fund is an efficient way to gain access to China’s economic growth. 

Another option is to buy into the fund, C T China Investment Fund, managed by Tai Fook Century Asset Management. This firm is a joint venture between Tai Fook Asset Management and Century Holding from China. (Editor’s Note: Due to potentially unfavorable tax consequences, U.S. persons considering offshore funds should consult with an experienced tax advisor prior to making an investment. However, these consequences do not extend to individual foreign shares.) 

Whatever investments you choose to participate in the Chinese “economic miracle,” we believe you will be richly rewarded in the years to come.

For More Information

To learn more about investing in China, or about the shares recommended in this article, contact:
Joseph Lau, Director and Head of Investment Management, Tai Fook Asset Management Limited 25/F., New World Tower, 16-18 Queen’s Road Central, Hong Kong. Tel: +(852) 280-12-475 Fax: +(852) 252-59-265. E-mail: joseph@taifook.com.

Joseph Lau holds a masters degree in Economics and is a Chartered Financial Analyst. After working as a fund manager in Hong Kong for more than ten years at companies such as Schroders and Jardine Fleming, in 2000, Joseph joined Tai Fook. His primary focus is on Chinese shares listed in Hong Kong. Joseph travels extensively in China, and works closely with experienced China fund managers to look for investment opportunities there.