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China rebalancing presents winners and losers

Elizabeth Collins  |  28 Sep 2017Text size  Decrease  Increase  |  
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China's economic rebalancing means an overvalued basic materials sector, but consumption growth creates opportunities in areas such as telecom.


The Morningstar Global Markets Index has returned more than 17 per cent year to date and 18 per cent over the past year. The market-cap-weighted price/fair value ratio for our equity analysts' coverage universe is 1.04.

Communication services is the most undervalued sector, with a price/fair value ratio of 0.94. Basic materials is the most overvalued sector, with a price/fair value ratio of 1.37.

Although communication services does stand out as the most undervalued sector when looking at price/fair value of the companies we cover, we don't have any 5-star ratings on communication services companies, and in fact only 11 companies in this sector sport a 4-star rating.

This speaks to the overall dearth of 5-star or even 4-star opportunities we see today. That said, one of the most important stories we're telling about the communication services sector is that China Mobile is undervalued, based on our expectations for market share gains and the competitive benefits of the industry shift to 4G.

The Chinese telecom market is one of our analysts' favourites in the region, with organic growth stemming from favourable consumption growth over the next 10 years.

Another stock-specific story we're telling is for Roche, although we don't see the healthcare sector as being particularly undervalued overall when looking at price/fair value. At the start of the year, the healthcare sector sported a price/fair value of 0.87, but since then, concerns about branded drug prices have abated and the overall sector looks more fairly valued now.

Still, our analysts argue that the market underappreciates Roche's drug portfolio and industry-leading diagnostics that in combination create formidable advantages over peers. The collaboration between Roche's diagnostics and drug-development groups gives the firm a unique in-house angle on personalised medicine.

More broadly speaking, the most emphatic message from our coverage universe is that the basic materials sector is overvalued. The miners we cover are particularly overvalued, reflecting our expectation of a structural change in demand growth from China as its economy matures and transitions toward less commodity-intensive economic growth.

Take BHP Billiton (ASX: BHP), which is trading at a 36 per cent premium to our fair value estimate. The company's future profits will be determined primarily by prices for iron ore, copper, and metallurgical coal.

In addition to the shift away from China's commodity-intensive economic growth, these metals are likely to suffer from the bearish forces of rising scrap availability, which will add material amounts of supply to the market.

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Elizabeth Collins, CFA, is Morningstar's director of equity research, North America. She is responsible for leading the firm's team of North American-based equity research analysts. This article initially appeared on the Morningstar US website.

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