Why Chinese stocks are unlikely to be hit hard even if yuan falls further
Originally published at the South China Morning Post on January 26, 2016.
Chinese stocks will not be significantly affected if China’s currency sees further drastic depreciation, say analysts, with the energy sector expected to be a key driver of growth.
The 12-month US dollar to yuan rate is forecast to fall to 6.78, according to a January report by Credit Suisse analyst Vincent Chan. Still, analysts expect MSCI China earnings to grow 31 per cent this year and energy-sector profits to increase threefold following a rebound in energy prices.
“The key swing factor would be energy prices. Earnings growth of the health care, IT and telecom sectors is also expected to be strong, while the consumer discretionary and materials sectors should see significant earnings declines,” analysts said.
Should the currency depreciate further to a rate of 7.5 – about 23 per cent more than the level seen in August 10 – earnings should grow about 0.7 per cent less, the report said. Although other sectors will suffer, earnings from the energy sector should increase by more than 10 per cent. with higher crude oil prices expected to translate into higher yuan prices domestically.
“Generally speaking, extreme RMB movement doesn’t affect earnings too much. Even if the USD CNY rate goes to 7.5, the impact on companies’ earnings would be relatively mild,” analysts said, adding that earnings of health care, consumer staples, utilities and industrials would be “worse off.”
Should the currency depreciate at an “extreme” level, A-share stocks Dongfang Electric Corporation, Fuyao Glass and Shanghai Electric Group would be among the 10 most positively impacted stocks, with an impact of above 15 per cent, the report said.
Industries that will benefit from further depreciation include Chinese automotives, particularly local carmakers like Fuyao, Yutong, Great Wall and Geely, according to the report. As a result of revaluation gains and improved export margins, auto parts exporters will also benefit.
Auto dealers, on the other hand, who leverage on the lower interest rate of their foreign loans, will be negatively impacted, the report said. “For global brands’ joint ventures, they are generally marginally impacted as they have a small portion of imported components,” analysts said.
Chinese power equipment makers such as Shanghai Electric, Dongfang Electric and Harbin Electric will also see positive earnings from depreciation, with thin margins of their domestic businesses spurring larger overseas earnings contribution, the report said.
Yet analysts said that the impact on equity will be very limited, and overseas businesses will see substantial risks. With currencies of emerging markets experiencing more volatility following weakening global commodity prices and changes in the onshore yuan’s foreign exchange, power equipment may become too unaffordable, according to the report.
“Those overseas projects in the backlog also have high financial risks due to forex (foreign exchange) volatility and limited financial credibility of target countries,” analysts said. “We maintain our cautious view on power equipment makers due to the dim outlook of their core domestic businesses despite a potential positive impact from CNY depreciation.”
Onlineprices will also remain competitive despite further depreciation, although the internet sector may experience slight negative impact on cross-border e-commerce with consumers having to pay higher prices in yuan, the report said.
Depreciation will also have a small effect on health care earnings, with the majority of health care companies having light asset bases and fewer debts. “The average gearing ratio for the pharma companies in 2014 was only less than 5 per cent,” analysts said.
Most health care companies also conduct their main operations in mainland China and have minor export businesses, with the exception of Zhejiang Huahai, the report said. Other sectors that will see limited impact include conglomerates, banks, utilities and basic materials.