20140902-高盛-Connecting_but_not_fully_connected__China_A-share_opportunities_for_international_investors_33页_458kb

GS SUSTAIN: China A-share Opportunities for International Investors

Core Content Overview

The report evaluates the opportunities for international investors in China's A-share market through the HK-SH Connect scheme, which allows access to onshore equities. It highlights the potential and limitations of this access, emphasizing the importance of financial performance and risk factors in identifying high-quality investments.

Main Points

• HK-SH Connect Overview:

  • The scheme offers access to 568 stocks with a combined market cap of $2,891bn, which is 2.4x that of India and 1.8x the value traded in Hong Kong.
  • It significantly increases liquidity for Chinese stocks, particularly benefiting short-term alpha generators.

• Opportunities for Long-Term Investors:

  • The report suggests that the initial opportunities for long-term, fundamental investors are limited.
  • The median CROCI (Cash Return on Capital Invested) for Chinese companies has fallen from 9.9% in 2011 to 8.7% in 2013, 2.9ppt below the US/EU average of 11.6%.
  • Only 44% of Chinese firms achieve CROCI above 8%, compared to 25% in the US/EU.

• Screening Process:

  • A proprietary GS SUSTAIN database was used to screen for high-quality companies based on CROCI and risk factors.
  • Companies were evaluated on their ability to convert earnings to cash, margin resilience, leverage, and cash distribution practices.

• Identified Opportunities:

  • 49 companies with a market cap above $500mn and CROCI above 12% over 2011–2013 were identified.
  • Of these, 34 also passed risk screens, including assessments for falling DACF margins, cash conversion, excessive leverage, and cash burning.
  • These 34 companies are newly accessible via HK-SH Connect and are listed in Exhibit 18.

Key Findings

• Free Float and Liquidity:

  • The HK-SH Connect provides $730bn of free float, a 58% increase for international investors.
  • Free float is more concentrated in Financials, Materials, Industrials, and Healthcare compared to offshore-listed stocks.

• Sector Breakdown:

  • Consumer Discretionary: Qingdao Haier, Fuyao Group, Hisense, Dashang Group, Beijing Wangfujing, Zhejiang Hangmin
  • Consumer Staples: Inner Mongolia Yili, Shanghai Jiahwa United, Yonghui Superstores, Xinjiang Yilite, China National Medicines, Zhangzhou Plentzehuang
  • Health Care: Jiangsu Hengrui Medicine, Kangmei Pharmaceutical, Guizhou Yibai, Inner Mongolia Jinyu, Wanhua Chemical Group, Shantou Dongfeng Printing, Shandong Hualian Mining
  • Industrials: Daqin Railway, Zhengzhou Yutong Bus, Fujian Longking, Sinoma International, Anhui Heli, Camel Group, Wuxi Taiji
  • Information Technology: Aisino, Yonyou Software, Xiamen Faratronic, Universal Scientific, Shanghai East-China Comput
  • Materials: Wanhua Chemical Group, Shantou Dongfeng Printing, Shandong Hualian Mining

• Onshore Opportunities:

  • The report also highlights the GS SUSTAIN China List, which includes onshore companies that have demonstrated strong returns on capital.
  • Some of these onshore names are already accessible through the HK-SH Connect scheme.

Limitations and Risks

• Growing Pains:

  • Many Chinese firms are experiencing falling CROCI due to rising costs, higher capital needs, and unsustainable financing.
  • This trend is more pronounced in less consolidated industries such as Industrials and Consumer & Tech.

• Analyst Coverage:

  • A-share companies are less covered by sell-side analysts compared to offshore-listed counterparts.
  • Only 21% of HK-SH Connect stocks have no analyst recommendations on Bloomberg, while 2% have none on Wind.

Conclusion

• The HK-SH Connect provides a major opportunity for international investors to access onshore Chinese equities, but the initial set of investable stocks offers limited high-return opportunities.
• The scheme is more beneficial for short-term alpha generators than for long-term fundamental investors.
• The report recommends focusing on the 34 newly accessible stocks that meet both profitability and risk screens, as well as onshore names from the GS SUSTAIN China List for long-term investment.
• The report expects the opportunity set to grow as the onshore market opens further, but for now, offshore markets remain more attractive for high-quality investments.