2021 Hong Kong Market Investment Outlook - Valuation has Reached the Turning Point
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2021 Hong Kong Market Investment
Outlook — Valuation has Reached the
Turning Point
As JD has completed its secondary listing in Hong Kong with Pinduoduo also showing
willingness to raise an IPO in Hong Kong, it is just a matter of time to have all three major
e-commerce enterprises included in the Hang Seng Index. The weighting of China's new
economy stocks has been increasing, and we think the valuation of HSI has reached the
turning point. The P/E of the Hong Kong market will very likely rise.
iFAST Research Team Published on Dec 14, 2020, 5:56 PM Research Equity Funds , General , HKEX , Equity , Market
Analysis
Photo by Ryan on Unsplash
• Hang Seng Index had low earnings growth and valuation contraction over the past decade. The
combination of multiple headwinds have resulted in its underperformance among major global markets.
• The proportion of the new economy sector in the index is expected to largely increase, accompanied by
an upward revaluation of the index. We believe HSI's valuation has reached its turning point.
• The earnings growth of HSI will strongly rebound in the next two years, which will mainly be driven by
Financial, Communication Services (Tencent) and Consumer Discretionary (e-commerce) sectors.
• Based on the reasonable P/E of 13x and the forecast P/E of 2020, HSI will reach 36,000 points by 2022-
end, translating to a potential growth of 34% (based on the closing price of HSI on 4 December 2020).The Low Earnings Growth and Valuation Contraction of Hang Seng Index (HSI) over the Past Decade After the listing of the Agricultural Bank of China Limited on HKEX in June 2010, the four major state-owned banks also completed their listings. Since then, Chinese stocks have gradually increased their weightings in the Hong Kong stock market. Meanwhile, many traditional industries in Mainland China are stuck in the bottleneck after the financial crisis. "The Three Barrels of Oil" (CNPC, Sinopec and CNOOC), China Mobile and China Life, which were the stock kings from 2003 to 2007, had a downturn in earnings growth. Similarly, Chinese banks also had decelerating earnings growth due to the booming asset size and bottoming of M2 growth, coupled with other negative factors such as deteriorating credit quality. As such, HSI, the indicator of the Hong Kong market, had low earnings growth and valuation contraction over the past decade. The combination of multiple headwinds resulted in HSI's underperformance among major global markets. Chart 1: The relationship between HSI’s earnings growth and P/E ratio The market witnessed negative earnings growth in 2009 and 2015-2016, which caused a sharp rebound in the year that followed. Except these years, the Hong Kong stock market had a low single-digit earnings growth for most of the time over the past decade.
The valuation of the Hong Kong stock market has been in contraction since 2011
because of the declining earnings growth, and the average P/E of HSI after the financial
crisis remained at 11.2x since 2011, way below the previous 16x. In the recent years, the
P/E in bull markets normally peaked at 12x. In the latest market rise on 16 January
2020, HSI was about 29,000 points but its P/E was only 11.5x, showing its descending
tops.
The Turning Point Created by the Return of Chinese Concept Stocks and
Listing of Unicorns
However, as mentioned in “Implications we Get from the Return of China ADRs and the
Listing of Unicorns”, HSI was reformed and it was announced in mid-May that
companies adopting weighted voting rights (W-share) and secondary listed companies
(S-share) would be conditionally included, subject to a maximum 5% weighting cap for
each stock. On 7 September and 7 December, HSI updated its constituents: on 7
September, Alibaba, Xiaomi and WuXi Biologics were announced to be included, while
Sino Land, Want Want China and China Shenhua Energy were removed. In the second
announcement on 7 December, Meituan, ANTA Sports and Budweiser Brewing took the
place of Swire Pacific A. The stocks being removed are those with slow growth and low
valuation, while those newly included ones are from new economy sector with rapid
earnings growth and a relatively expensive valuation.
Table 1: Changes Taken Effect on 7 September 2020
Est EG Est P/E
Inclusion Est EG 2021 Est P/E 2021
2020 2020
Xiaomi 2% 37% 41.12X 29.88X
Alibaba 38% 22% 26.12X 21.67X
WuXi Biologics 19% 39% 169.60X 122.40X
Est EG Est P/E
Removal Est EG 2021 Est P/E 2021
2020 2020
Sino Land -37% 24% 7.26X 8.69X
Want Want China 5% 9% 14.38X 13.65X
China Shenhua Energy -10% -1% 6.40X 6.46X
Source: Bloomberg and iFAST CompilationsTable 2: Changes Taken Effect on 7 December 2020
Est P/E Est P/E
Inclusion Est EG 2020 Est EG 2021
2020 2021
Budweiser Brewing -36% 72% 68.93X 39.86X
ANTA Sports -3% 52% 47.19X 31.03X
Meituan 11% 210% 276.89X 89.44X
Est P/E
Removal Est EG 2020 Est EG 2021 Est P/E 2020
2021
Swire Pacific N.M (Negative EPS) N.M N.A 12.56X
Source: Bloomberg and iFAST Compilations
Due to the escalating China-US tensions and spread of rumours that the US may consider
restricting Chinese companies from raising funds in the US, more US-listed Chinese
companies have shown willingness to list on HKEX. Besides, amidst the uncertainties
due to the China-US tensions, Chinese unicorns (large unlisted sci-tech innovation
enterprises) prefer raising IPOs in Hong Kong over doing so in the US. An increasing
number of large technology companies may choose to list on HKEX, and they will
eventually be included in the HSI. The weighting of the new economy sector will largely
increase, causing an upward revaluation. Based on the abovementioned factors, we
believe the HSI has reached its turning point.
Earnings Growth Driven by Financial, Communication Services (Tencent)
and Consumer Discretionary Sectors (E-commerce)
In terms of earnings, many sectors under the HSI are expected to record declines due to
the COVID-19, except Communication Services (led by Tencent), Utilities and
Healthcare sectors which have recorded positive growth. In the coming two years, we
expect the earnings growth of HSI to have a strong rebound. The forecast growth for
2021 and 2022 are 14.9% and 13.1% respectively, among which Financial,
Communication Services (Tencent) and Consumer Discretionary (e-commerce) sectors
will be the major driving force.1. Chinese Insurance Companies (Ping An) and Hong Kong Financial stocks (AIA and HSBC) In terms of financial stocks, Chinese insurance companies (Ping An) and Hong Kong financial stocks (AIA and HSBC) have strong forecast earnings growth for 2021 and 2022. As AIA and HSBC have significantly higher growth rates, coupled by their nearly 18% weightings in the HSI, the overall financial sector is expected to be driven upwards (see Appendix 1). It is worth mentioning that AIA's domestic and Southeast Asian business are growing rapidly. Its local business is expected to recover soon, and its earnings in 2022 are going to return to or even exceed the pre- pandemic level. For HSBC, despite the strong growth figures, its earnings rebounded mainly due to the low base effect caused by the sharp decline this year. The market currently estimates that its earnings in 2022 is yet to catch up with the pre-pandemic level. 2. Valuation Correction in China Bank Stocks China bank stocks take up over 12% of the HSI. Although earnings of these stocks are estimated to have a slower growth in the coming two years, the upward revaluation will still contribute positively to the HSI's valuation. Over the past decade, valuation contraction was the prime culprit for the weak performance of China bank stocks. From 2010 to 2013, major China banks still recorded positive growth each year in spite of the decelerating growth rate, while their prices remained moving sideways. From 2017 to the present, the case is similar except their prices keep decreasing. As such, the overall P/B once dropped to a record low of 0.46x in this September (Figure 1). As the pandemic has been under control, China’s economy is gradually recovering. Concerns over credit quality reduced, and the risk-free interest rate (10-year Treasury yield) has surged in the year-to-date. The net interest margin of major China banks is expected to improve, which increases the possibility of valuation correction. 3. Tencent's Mobile Games plus Fintech will Support the Growth In terms of the Communication Services sector, the market expects Tencent, the largest constituent that accounts for 10% of the HSI, to realise a 20%
earnings growth in 2021 and 2022 (Appendix 2). We believe this estimates could be achieved. Online games contribute the most to Tencent’s revenue, and its mobile games business has accelerated growth rate this year. Although the revenue growth from enterprise services slowed down due to the pandemic, its overall fintech and enterprise services business still recorded a year-on-year growth of more than 20% in the third quarter. As such, we believe that it is not difficult for Tencent to meet the market's expectation in the next two years. 4. E-commerce Led by Alibaba and Meituan will be the Strongest Sector As for Consumer Discretionary, since Alibaba and Meituan each take up 5% of the HSI, they are pivotal constituents for both the industry and the HSI. Both of them have solid growth estimates for the coming two years, especially Meituan. The market estimates Meituan to have more than doubled earnings growth in 2021, dragging its high forecast P/E down to the double-digit level. Currently, the China’s online retail takes up about 24% of the total consumption, and online shopping still have room to grow in the future. Even if the total online retail sales once plunged due to the pandemic and logistic interruption, it rapidly rebounded by 15% soon after the pandemic was under control and economy recovered. Comparatively, this sector outperforms the overall social consumption, which only had single-digit growth. E-commerce is forecasted to have fast earnings growth in the next two years.
Weighting of China's New Economy Stocks Expected to Rise; HSI will Reach 36,000 points by 2022-end Chart 2: HSI earnings and Stock Price Trends As JD has completed its secondary listing in Hong Kong while Pinduoduo has also shown willingness to raise an IPO in Hong Kong, it is just a matter of time to have the three major e- commerce enterprises included in the HSI. The proportion of China's new economy stocks in HSI will keep increasing and the P/E of the Hong Kong market is highly possible to rise. Regarding earnings, the growth rate will be driven by Financial, Communication Services (Tencent) and Consumer Discretionary (e-commerce) sectors in the coming two years. HIS will likely meet market expectation. Based on the reasonable P/E of 13x and the forecast P/E of 2020, HSI will reach 36,000 points by 2022-end, translating a potential growth of 34% (based on the closing price of HSI on 4 December).
Appendix 1: Relevant Investment Products
Conventional
Principal Greater China Equity Fund - MYR
Islamic
Eastspring Investments Dinasti Equity Fund
Appendix 2: Forecasted earnings growth and forecasted P/E ratio of the financial
sector
Index 2020 2021 Est 2022 2020 2021
Company Sector
Weighting Est EG EG Est EG Est PE Est PE
China Banks
ICBC 3.41 Banks -7.67% 5.42% 6.57% 4.86 4.61
China Construction Bank
6.33 Banks -6.86% 6.03% 6.85% 5.07 4.78
Corp
Bank of China Ltd 2.12 Banks -7.67% 3.71% 6.47% 4.01 3.87
Bank of Communications
0.36 Banks -8.20% 4.68% 6.76% 3.82 3.65
Co Ltd
China Insurance
Ping An Insurance Group
4.88 Insurance -36.98% 18.99% 15.92% 10.53 8.85
Co of China Ltd
China Life Insurance Co
1.28 Insurance -13.32% 7.77% 14.10% 8.38 7.77
Ltd
HK Financials
AIA Group Ltd 9.95 Insurance -19.64% 27.15% 11.74% 26.12 20.54
HSBC Holdings PLC 7.68 Banks -65.21% 64.31% 32.70% 19.68 11.98
Hong Kong Exchanges &
4.16 Diversified Finan Serv 17.61% 15.23% 11.85% 42.71 37.06
Clearing Ltd
BOC Hong Kong Holdings
0.87 Banks -16.03% 1.25% 11.09% 9.72 9.60
Ltd
Hang Seng Bank Ltd 0.98 Banks -28.12% 4.91% 8.44% 14.59 13.91
Source: Bloomberg and iFAST CompilationsAppendix 3: Forecasted earnings growth and forecasted P/E ratio of the
communications services and consumer discretionary sectors
Index 2020 Est 2021 Est 2022 Est 2020 Est 2021 Est
Company Sector
Weighting EG EG EG PE PE
Communication Service
Tencent Holdings 10 Internet 32.90% 23.53% 20.77% 38.50 31.16
China Mobile Ltd 3.13 Telecommunications 0.65% 1.72% 2.55% 7.58 7.45
China Unicom Hong
0.3 Telecommunications 12.16% 15.18% 12.76% 9.77 8.48
Kong Ltd
Consumer Discretionary
Alibaba Group
5 Internet 38.00% 22.71% 23.04% 26.45 21.55
Holding Ltd
Sands China Ltd 0.89 Lodging N.M N.M 63.06% N.A 28.10
Galaxy
1.22 Lodging N.M N.M 51.76% N.A 30.46
Entertainment Group
Geely Automobile 1.07 Auto Manufacturers -13.95% 36.34% 13.71% 25.56 18.75
SHENZHOU INTL 1.04 Apparel 4.30% 19.46% 15.98% 33.65 28.17
Meituan 5 Internet 11.11% 208.89% 69.06% 288.18 92.94
ANTA Sports 0.99 Apparel -3.02% 51.81% 26.62% 48.36 31.87
Source: Bloomberg and iFAST Compilations
Figure 1: The valuation of China banks will be repairedYou can also read
