Seeking Rewards in China
By Winnie Phua
February 23, 2012
The muted performance of China’s equity markets in 2011 has left many investors a bit wary. Since the beginning of last year, concerns over China’s slowing macroeconomic environment coupled with some corporate governance scandals left many investors on the fence about investing in China. And, even considering a fairly robust underlying business landscape, many Chinese businesses are finding the tight credit environment challenging. With all these factors in mind, market analysts have turned more cautious on the growth outlook for Chinese firms and the market has subsequently seen a number of earnings downgrades.
The table below shows the earnings revisions experienced by the constituents of the MSCI China Index, comprised of approximately 150 companies. From this group, we can easily identify a broad theme of earnings downgrades across most sectors. However, these downgrades should be taken into consideration along with other characteristics of Chinese companies, including the overall growth prospects for this investment universe.
The MSCI China Index remains on track to deliver earnings growth of more than 10% in 2012. Although this anticipated growth is more moderate than the Index’s historical average 5-year earnings growth of about 15%, it still compares well against investment alternatives in many other parts of the world.
The Chinese investment universe also may provide an opportunity for investors to participate in improving earnings quality. From 2003 to 2011, average returns on equity (ROEs) expanded from 12.6% to 17.1%. In 2012, average ROEs are estimated at nearly 19%, which are high when compared to the average costs of equity of 10% to 12%.
Over the last five years, profitability, measured in terms of gross margins, has been constant at about 30%. Sectors such as health care, information technology and consumer discretionary have also seen higher-than-average margin expansion, which highlights the importance of stock picking within this universe.
Investors also get to participate in dividend growth among Chinese firms. Dividends per share have more than doubled since 2005, and even though the macroeconomic landscape has not solidly recovered since 2008, Chinese companies have continued to pay out increasingly higher dividends.
Most certainly, historical financial performance is not indicative of future performance. But China’s longer-term prospects lie in the fact that many industries are still at nascent stages. Given that, we continue to believe Chinese equity markets may offer growth at a reasonable price with an expanding set of investment opportunities. In roughly the past decade, the number of companies in China’s investable universe (excluding China A shares) has more than doubled, and now numbers over 1,900 firms among a variety of sectors. Such a backdrop is encouraging and allows investors to adequately tap growth opportunities in this multifaceted economy.
(C) Matthews Asia