China H-Share Strategy:A valuation check—before and after the 3rd Plenum

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China H-Share Strategy:A valuation check—before and after the 3rd Plenum

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Expensive sectors become more expensive; otherwise no big changes The MSCI China index now stands at a similar level of end-October 2013. China’s ThirdPlenum seems to have left no trace on the valuations of most sectors. Only a fewwidely loved sectors—healthcare, environmental services, and software—have becomeeven more expensive (see Figure 1). The retailing, automobile, energy, and real estatesectors have moderately de-rated. Real estate and energy sectors are laggards worth revisiting The real estate and energy sectors are among the worst performers since end-October(see Figure 3). However, the contents of Third Plenum should not have added any newscars to these two sectors. According to UBS sector analysts Eva Lee and PeterGastreich, the recent upsurge of funding costs and decline of crude oil prices areinsufficient to explain their underperformance. We thus recommend investors revisit thefundamentals of real estate and oil companies as value has started to emerge. Strong earnings growth of automobile, IT hardware sectors underappreciated A consensus forecast suggests higher than 20% YoY EPS growth for the automobileand IT equipment sectors in 2014. Moreover, their earnings have been revised upwardsby 5.3% and 4.1%, respectively, over the last quarter (see Figure 4). The reform targetsunveiled at the Third Plenum, such as freer rural land transfers and stronger consumerpurchasing power, are in general positive for demand for cars and electronic devices.Recent market conservatism on these two sectors thus looks unjustified, in our view. Valuations stay largely the same, but Third Plenum should not be a non-event We do not think the Third Plenum should simply be shrugged off as though nothingwill happen to China’s economy or society. The reform-driven re-rating was temporarilystifled by year-end liquidity volatility, which we highlighted as a major risk in our reporton 9 December 2013. But when the observable evidence of reform progress starts tosurface (likely from enterprises and households participating in the pilot programmes),we believe the re-rating will resume.