In August 2015, China shocked the world by devaluing the Yuan. That triggered turmoil in the global markets and heightened investors’ concerns on the state of China’s economy on the backdrop of slowing growth. Since then macro concerns on China have remained. We explore into 94 Chinese companies listed in Hong Kong and found that while 1H16 earnings have fallen 8%, the HSI index rallied and is up 7% YTD as earnings beat expectations.

The biggest beat came for the Energy and Materials sectors where earnings fell 61% and 23% but beat estimates by 17%pt and 12%pt respectively with Petrochina and China National Building Materials leading the way as commodity prices rebounded more than expected. Earnings from these sectors are still expected to rebound sharply in 2H16 albeit structural difficulties. However after the recovery in commodity prices, we are reluctant to form a strong opinion on the direction of these prices at current levels due to political and policies uncertainty. Utilities sector is also heavily influenced by policy adjustments by the authorities. Not only are they impacted by the tariff decisions and demand, policy decisions on resources like coal affects their input costs too. We are cautious on the fundamental outlook for coal IPPs as they continue to face oversupply and lackluster demand growth, valuations are inexpensive and the dividend yields they offer may be attractive to some investors. Thus we remain neutral in the space.

The brightest spot came from the Information Technology sector led by Tencent whose earnings grew 40% YoY and still beat estimates by 8%. Consumer discretionary continued to beat estimates with its stellar growth profile led by sportswear and auto names. The stronger beat came from auto names though as more car owners bought with credit. Great Wall Motor which beat estimates by 11% experienced a 140% percent increase in interest income, mainly because of its finance subsidiary. These trends should persist into 2H16.

August property sales by floor space increased 27% YoY for the 30 major cities according to Shanghai-based E-House China R&D Institute. China’s National Bureau of Statistics (NBS) said most big and medium-sized cities saw new-home prices rise every month this year through July and home sales value rose 41% YoY for 7M16. We believe that while property prices are toppish in certain cities, the government has chosen to tighten in the selected cities and we would not see market wide tightening measures. As such, despite expecting ASP pressure in some cities we do not anticipate a sharp correction in overall property prices and look forward to a continual healthy recovery of the property sector at a slower pace.

Within the financial sector, Hong Kong listed Chinese banks will continue to be a beneficiary of southbound flows. Local Chinese investors consider these banks to be cheap and given that the China Insurance Regulatory Commission (CIRC) has given the green light on 8 September 2016 for China insurance firms to invest in Hong Kong listed stocks through the connect, we expect further positive momentum for the banks going forward. Brokerages will face earnings pressure due to the high base comparison from the rout last year but we believe that the risk is to the upside.

Industrials’ performance looked tepid but there were major disappointments in the construction names. There were great mismatches of top line growth against the extremely strong new orders that companies have been reporting. However, after clarifying with the companies, we believe the slower revenue recognition is mainly due to the slower start of the projects as they have shifted to a PPP (public-private partnership) model. In addition, just a couple of weeks ago, the Ministry of Finance announced that it has selected an additional c.1 trillion yuan (c.$150 billion) worth of PPP projects. Therefore despite taking off slower, we believe we should see the impact of the infrastructure stimulus programs (announced since 2H15) to show in 2H16 and into 2017.

Lastly in Consumer Staples, we were not surprised by the missed in earnings and remain skeptical on the consensus’ expectations on the growth in 2H16 due to 1) slowing disposable income growth; 2) high penetration and competition; 3) continual input cost pressures.

In conclusion, we expect the divergence in earnings performance to continue in the various sectors and being position in the right sectors and companies will be of paramount importance for the remaining of the year as we enter into 2017. China is the world second largest economy and despite GDP growth slowing towards 6%, the amount of economic growth is immense. With diverging fundamentals across the sectors, we continue to see investment opportunities in China.

By Dave Wang, Equities Analyst, Truston Asset Management Singapore

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