Little cheer, profit or growth

Is there a possibility of the China markets recovering any time soon? Riddled with bleak company results, fewer IPOs and a regulatory body keen to reform and discipline market players, there is little to indicate that the tide will turn soon.

Over the years, Chinese companies have built themselves up on the prospect of endless, galloping demand, leaving them grossly unprepared for a phase where growth is more rational and slow. As the period of H1 disclosures for listed companies came to an end last week, investors were left sorely disappointed by the tepid reports that came amidst a backdrop of weak August manufacturing and poor exports.

A total of 2,475 companies listed on the Shanghai and Shenzhen stock exchanges posted a combined first-half net profit of RMB 1.02 trillion, down 1.50 percent from the previous year. The figure marked a steep downturn in combined net profits of listed companies, which had surged over 20 percent year-on-year during the same period in 2011 and 40 percent in 2010.

Among all listed enterprises, 2,130 companies made profits in the first six months but 46 percent of them saw their gains fall, while about 14 percent posted losses.

Declining profitability and a general mistrust of reported financials has pushed the domestic stock market to new lows, not seen since 2009. This period of contracted growth has badly affected cash reserve of companies. Observers warn that Chinese firms are struggling to maintain their cash balance and investors should judge companies on the basis of cash flows and not earnings. With the economy being what it is, experts warn that the quality of profits posted may not stand up to close scrutiny.

Chinese companies listed abroad are also feeling the heat, although for different reasons. Many of these firms are trying to leave foreign stock exchanges to either go private or list domestically in China. Increased pressure of competition and regulatory oversight in Western stock exchanges are forcing these companies to return home. At least 36 Nasdaq-listed Chinese companies have announced plans to privatize since October 2009.

China’s lackluster stock market has also cast a shadow over the earnings of underwriters and brokers, forcing them to redesign their business development strategies. Almost half of the listed 19 securities companies, which released their half year reports by the middle of August, has operating revenue and net income slumping dramatically.

China Securities Regulatory Commission figures reveal stagnancy in new shares. In the first seven months of the year, just 122 companies issued IPOs, compared with 187 in the same period a year earlier, influenced by the gloomy market outlook. New share issues raised RMB 86 billion from January to July, a 53 per cent drop year-on-year.

Moreover, reform measures in the first half of the year to support the market, including improving public company information disclosure systems, increased dividends for shareholders and stepping up efforts to curb insider trading have not worked. If at all, these measures have served as a dampener.

Bargain hunters

The low valuation story, however, may yet win some redemption. Foreign investors are on the prowl to pick Chinese stocks at a time when it is cheap and attractive. The Shanghai A-share market’s price-to-earnings ratio, a measure of valuation, was 11.05 last week, a record low, according to the Shanghai Stock Exchange. The finance and insurance sector has the lowest price-earning ratio of 7.53. The average earnings per share of listed companies also went down almost 7 per cent to reach 0.27 yuan in H1.

With valuations sinking to such lows, foreign investors were seen to be increasing their positions in Chinese equities. Offshore yuan equity funds saw a net inflow of $ 236 million in the last six weeks, making this the highest inflow in foreign investment in Chinese stocks since February. The Shanghai index is hovering just a nip above the psychological mark of 2000 and the doors are opening to bottom feeding, when investors buy up stocks at the level they think are near the bottom of their range.

As early as June, when equities were still considered buoyant, Qatar’s sovereign wealth fund had applied for permission to invest up to USD 5 billion in China under the qualified foreign institutional investor (QFII) programme, which allows overseas financial institutions to invest in local markets. The annualized returns of QFII have averaged 11.9 percent, after being introduced a decade ago, far outstripping that of Chinese fund managers. In response to growing demand, China has increased the QFII quota to $80 billion now. It remains to be seen if foreign funds can now lift the mood, if not stock value.