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Buying opportunities amid the selloff in China

Lewis Jackson  |  05 Aug 2021Text size  Decrease  Increase  |  
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Several moated stocks are trading at double digit discounts to fair value as a massive sell off in Chinese stocks creates buying opportunities say Morningstar analysts.

Wide-moat tech giants Alibaba Group and Tencent Holdings are trading at a 36 per cent and 44 per cent discount to Morningstar’s fair value, respectively. The sell-off in Chinese stocks has also left narrow-moat China Construction Bank trading at a 32 per cent discount to fair value.

Billions have been wiped off Chinese markets in the last month as regulators crack down on sectors from technology to private education. Over the last month, regulators have fined Alibaba for anti-trust violations and moved to ban profit-making in sections of the multi-billion-dollar private education sector.

Then on Tuesday, a Chinese official blasted video games as “spiritual opium”.

The Morningstar China index is down 8.81 per cent in the last month and 6.9 per cent year to date.

Morningstar senior equity analyst Ivan Su, based on Hong Kong, says fears over further regulatory crackdowns in the tech sector are overblown.

“Most of the regulations announced so far aren’t even regulations, they’re just news items on state media sites,” he says.

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“Even if policy action became tangible, the impact to earnings will likely be small.”
Paras Anand, chief investment officer Asia Pacific at Fidelity, says that some concerns are being overstated and perspective is needed.

“For long-term value investors, the sometimes-indiscriminate selloff in recent days created good opportunities to look for bargains, especially among companies whose growth trajectories remain intact,” he says.

For Australian investors, short of buying shares directly, there are several domestic options to get exposure.

Bronze rated iShares Asia 50 ETF (ASX: IAA) offers exposure to large-cap Asian stocks and has double digit weights to Alibaba and Tencent.

The unrated iShares China Large-Cap ETF (ASX: IZZ) and VanEck FTSE China A50 ETF (ASX: CETF) similarly offer Chinese exposure.

Morningstar senior equity analyst Chelsey Tam reminds investors that uncertainty remains, even as tech-giants trade at historically low valuations:

“The risk is still there for Alibaba and Tencent, but we think it’s more likely than not that the regulatory risks are already reflected in the price,” she says.

“From a risk reward perspective, Tencent and Alibaba are trading at their lowest valuations in about 5 years.”

Tencent Holdings

  • Sector: Communication services
  • Economic moat: Wide
  • Last close: $HK 456.8
  • Fair value: $HK 800
  • Morningstar star rating: 5-star

Tencent is a Chinese Internet giant with businesses and investments in a wide variety of Internet services and contents, including social networking, online video games, cloud services, and financial technology. Tencent has an aggregate monthly active user base of less than 600 million for platform QQ and over 1.2 billion for platform Weixin.

Shares of Chinese online gaming companies were down substantially following an article published in the Economic Information Daily (state media) attacking gaming addiction among minors. The article was later retracted from its website. Based on the drastic share price movements, the market is clearly fearing a replay of the K-12 episode, but there are many reasons for us to think that recent declines in gaming share prices are not warranted. Given that at this stage no tangible policy changes have been proposed, we are keeping our fair value estimates of Tencent unchanged. But even if the government was to ban underage gaming across the board, downsides in valuations are capped at about 5 per cent, in our view.

Senior equity analyst Ivan Su

Alibaba

  • Sector: Consumer cyclical
  • Economic moat: Wide
  • Last close: $HK 192.3
  • Fair value: $HK 293
  • Morningstar star rating: 4- star

Alibaba is the world's largest online and mobile commerce company, measured by gross merchandise volume ($US1 trillion for the fiscal year ended March 2020). It operates China's most-visited online marketplaces, including Taobao (consumer-to-consumer) and Tmall (business-to-consumer). The platforms had a 91 per cent penetration rate among Chinese internet users as of December 2020.

The Ministry of Industry and Information Technology has announced a half-year rectification on Internet companies, which signals further regulatory tightening. We don’t see material concrete impact from this at this stage and have maintained our China Internet coverage’s fair value estimates intact.

Following the severe clampdown on the private tutoring sector in China, including existing after-school academic tutoring being barred from making a profit by the government, investors' concerns about regulatory risks appear to have spilled over to the Chinese Internet sector. We think investors should look at the risk on a case-by-case basis, but in some instances, market fears appear to be an overreaction.

Senior equity analyst Chelsey Tam

China Construction Bank

  • Sector: Financial Services
  • Economic moat: Narrow
  • Last close: $HK 5.49
  • Fair value: $HK 8.10
  • Morningstar star rating: 4-star

China Construction Bank is one of the “big four” banks in China and one of the largest banks in the world by market capitalisation.

Despite mounting challenges in China's banking sector, we believe China Construction Bank's (CCB) leading scale, lower-risk banking assets, and strong capital position should help the narrow-moat bank navigate difficulties better than peers.

We believe CCB's strong deposit franchise is a key differentiating factor amid the accelerating deposit migration, thanks to an extensive network and entrenched relationships with average household and corporate customers.

Deposit competition continued to intensify over the past few years, as a result of ongoing interest-rate liberalization and competition from fintech players and smaller banks. Savers' strong appetite for higher-yield shadow banking and other financial products has led to accelerating deposit outflow. CCB’s deposit strength, evidenced by high proportions of retail deposits and demand deposits, resulted in a milder impact on average deposit costs than most peers.

Senior equity analyst Iris Tan

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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