China Strategy Spotlight:PPP,SOE Reform and 3Q A-share earnings snapshot

Inflection point for PPP; SOE reform to accelerate; 3Q A-share earnings.

    The government is increasingly concerned that PPP is becoming a disguisedborrowing vehicle to circumvent policy restrictions. Since May, the MOF hasannounced three major notices to strengthen PPP controls. The latest –Document 92 – provides more concrete guidelines for removing unqualifiedprojects. Meanwhile, we believe SOE reform will accelerate further in 2018-19.

    In our first report on the SOE reform-related investment theme, we focus onthe context, objectives, guidelines, progress, case studies and implications,with a basket of 20 stocks identified as likely beneficiaries. On 3Q earnings, Ashare’snet income growth edged up to 23.8% yoy (14.9%/21.6% in 2Q/1Q).

    Performance and valuations: MXCI gained 1.6% while CSI300/HSCEI flat.

    In the past four weeks, MSCI China gained 1.6%, outperforming A-shares (flat)and HSCEI (-0.3%). Insurance, IT and healthcare led, while transportation,capital goods, diversified financials and real estate posted losses. The MSCIChina (ex. ADRs) 12m forward P/E stands on par with historical average at11.5x while P/B is at 1.5x, or a 12% discount to the historical average. Nonfinancials’12m fwd P/E and P/B are at 15.6x and 2.0x, respectively. A-shareCSI300 was flat in RMB terms in the past four weeks, with insurancesignificantly outperforming others. The index trades at 13.6x and 1.8x 12mforward earnings and book value, respectively. ChiNext’s valuation hasdeclined to 24.2x 12m fwd P/E, nearly 1-STD below historical average.

    Macro and earnings: 3Q macro data weaker; insurance/IT led earnings upgrade.

    Macro data came in slightly weaker than expected for October: 1) NovemberNBS PMI rebounded slightly to 51.8 from the previous month’s 51.6 andremained in the expansion zone. Caixin PMI dipped to 50.8 vs. prior 51.

    October IP came in weaker than expected at 6.2% vs. 6.3% consensusestimate and is below last month’s 6.6%; 2) New loans and TSF also missedexpectation. Adjusted TSF balance growth was stable at 14.7% yoy while corp.

    M/LT loan balance rebounded slightly to 17.8% yoy; 3) Investment deceleratedas FAI growth slowed across the board, and property investment dropped0.3ppt to 7.8% YTD yoy. On high-frequency data, thermal coal consumptiondeclined to 1% yoy in November, significantly lower vs. last month’s 16%. Interms of commodity prices, cement and rebar trended higher while coal pricesfell slightly. MSCI China 2018E consensus EPS expanded by 1.5ppt in the pastfour weeks, with insurance and IT leading the earnings upgrades.

    Liquidity and sentiment: H/A-share liquidity largely stable; onshore rates rising.

    HK equities’ ADT averaged HKD117bn in Nov’ MTD, higher than the previousmonth and still strong compared to the YTD average (HKD86bn). Connectinflows continued both ways while volatilities subsided. A-share sentiment wasstable. Onshore rates and credit spreads both expanded rapidly (10-yr treasuryyield exceeding 4%, likely due to continued financial deleveraging).

    Risks Key downside risks: 1) tighter-than-expected monetary policy; 2) harsherthan-expected property tightening; 3) any disorderly deleveraging as Chinatightens shadow credit; and 4) sharper-than-expected RMB depreciation.