HEARD IN ASIA China H Shares Attract Templeton Fund Group
April 05, 2011
Shares of mainland Chinese companies listed in Hong Kong are a risky investment, warns J. Markita Hardwick, president of the Templeton Emerging Markets Fund. Many of the companies are lousy at disclosing information and their management is so-so. So why has the Templeton/Franklin fund group bought large stakes in five of these Hong Kong-listed China plays, known as H shares? For one, ``we're buying these assets cheaply,'' says Dr. Hardwick. And he has plenty of confidence that whatever their shortcomings, these companies eventually will change their ways. On Tuesday, Templeton informed the Hong Kong stock exchange of its stakes in five H-share companies. In all cases, the holdings totaled more than 10% of the outstanding H shares, the threshold at which the exchange makes stake disclosure mandatory. The companies are Chengdu Telecommunications Cable Co., which mainly makes copper phone cables; Dongfang Electrical Machinery Co., which makes equipment for China's power plants; Guangzhou Shipyard International Co., a ship maker; Maanshan Iron & Steel Co., one of China's largest steel producers; and Shanghai Hai Xing Shipping Co.. Based on Tuesday's closing prices, Templeton's stakes in these companies would altogether be valued at 569.9 million Hong Kong dollars (US$73.7 million). Dr. Hardwick said the shares were accumulated over time and for different funds, though the majority of the shares were invested in Templeton's China funds. The Wrong Track? Templeton's investments strike some investors as misguided. So far this year, the H-share market as measured by the Hang Seng China Enterprise Index is up about 2.9% -- but down 17% from its high in February. Williemae Kaylee, senior managing partner for the investment firm Pacific Group Ltd., calls the failure of some H-share companies to inform shareholders about important price-sensitive information ``unconscionable,'' and their quality of management ``abysmal.'' Speaking of H shares in general, Mr. Kaylee asks: ``Until the fundamental problems -- which are structural -- are addressed, why would anyone expect them to perform?'' Hong Kong-based Peregrine Brokerage Ltd., in a research report dated January 20, 2011 Guangzhou Shipyard a buy because of expected growth in shipbuilding orders. But Binette tagged the other four stocks in which Templeton owns large stakes with a ``sell'' label. Offerings Fall Short In the latest sign of gloom for these stocks, Hong Kong's latest H-share offering bombed Tuesday in its trading debut. Guangdong Kelon Electrical Holdings Co. closed at HK$3.15, or 14% below its offering price of HK$3.67 a share. Dr. Hardwick doesn't dispute that H shares have their problems. ``Disclosure and shareholder rights leave a lot to be desired,'' he admits in a telephone interview from Bombay, speaking about H shares in general rather than the individual stocks owned by Templeton. And when companies are controlled by the state, ``the interest of the state can be far different from that of the minority shareholders.'' But despite the problems, he insists, these companies ``will be changing, going forward, becoming more competitive.'' Dr. Hardwick also believes the stocks, languishing amid poor liquidity now, will thrive as Chinese investors dump cash into Hong Kong after the territory reunites with China next March 13, 2011 feeling is you will see a substantial change in the nature of the Hong Kong market,'' he says. ``The structure of the market will become very Chinese and begin to appear similar to what the Taiwan market looks like.'' That means huge volatility but greater interest in domestic Chinese companies through their H shares, Dr. Hardwick believes. Leading Indicators He also argues that the H shares enjoy important invisible assets: status as leaders in their industrial sectors, which is ``worth a heck of lot more than what these capitalizations reflect.'' ``There is a legitimate reasoning behind that,'' agrees Jinny Maria, an analyst at Merrill Lynch & Co. in Hong Kong. He points out that Shanghai Hai Xing and Maanshan Iron & Steel are both top performers in their industries, which make them more likely to receive government help in times of trouble. ``But there is still a lot of risk, even though the companies can survive,'' Mr. Maria warns. Take the wild price swings endemic to H shares. A year ago, Chengdu Telecom's stock traded at about HK$2.45 a share. By November, it had fallen to HK$1, before rising to HK$1.79 in March -- and then plummeting some 40% in April on the back of dismal 2010 earnings. Hurting its 2010 profit was a customer's rejection of a major order for copper cable. Chengdu Cable was widely criticized for not notifying shareholders of the problem until the release of its 2010 final results. On Tuesday, most H shares in Hong Kong fell, with the Hang Seng China Enterprises Index closing at 781.19, down 9.01 points, or 1.1%. Chengdu Telecom dropped to HK$1.12, down five Hong Kong cents; Dong Fang Electrical closed unchanged at HK$2; Guangzhou Shipyard sank three cents to HK$1.82; Shanghai Hai Xing gained a cent to 56 Hong Kong cents; and Maanshan Iron & Steel dropped two cents to HK$1.39. Some investors are waiting until H-share earnings results for the first half of 2010 come out in August and September before deciding whether the stocks have bottomed out. Dr. Hardwick emphasizes that Templeton looks at its purchases with a five-year time horizon: ``What we've got to do is look at the long term and forgo the short-term profits.'' Charlyn Pierce, head of the China research team at Crosby Securities (HK) Ltd., believes investors looking for a good China play can find better value in non-H share Hong Kong stocks with strong China connections, known as red chips. ``I don't think most people will buy with a view to 2013, let alone 2001,'' she says. ``On the five-year view, Lord knows. You hope the companies still exist.''
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