Chinese Stocks May Continue To Run, Here’s Why

Chinese stocks, especially those listed on the U.S. and Hong Kong stock exchanges are performing well over last two-three weeks, even though some of the hot trendy names of April, including those benefiting from ‘stay at home’ trend like Slack Technologies (Nasdaq: WORK) and V-shape comeback plays like airlines, are starting to show signs of tiredness.

Most ETFs with Chinese stocks, including Invesco China Technology (NYSE: CQQQ) have come back nicely since the March lows. Indeed, China Technology ETF is up more than 35% over last one year, even though the ETF doesn’t own e-commerce names like Pinduoduo (PDD) that is up more than 100% over the last few weeks.

Why is this comeback noteworthy?

Ideally, one would assume that the Chinese stocks should be in a penalty box given there is no shortage of challenges for the underlying businesses. Be it the weakness in the macroeconomy due to Coronavirus, the threat of HFCAA passing that will increase the bar to list in the U.S. for Chinese stock or sales fraud at Luckin Coffee (NYSE: LK) that cratered the stock by more than 90%.  

Rather than running for the hills, investors have instead hoarded up on some of the stocks.

So why should you bother

Simple physics. As any trader would tell you, if extreme negative catalysts can’t keep the stock down, even small positive news will have a disproportionately large impact on the stock. Now if you are the one to scoff at technical led investment philosophy, fundamentals do explain some of the investor excitement as well.

The country went in first, but China was also one of the first ones to come out of lockdown and the comeback was evident in monthly sales numbers coming out of some of the companies, be it Tesla (Nasdaq: TSLA) or NIO Limited (NYSE: NIO), both of whom saw sales shooting up to near pre-pandemic levels in a matter of days.

Can the momentum continue? Looks like it

One of the biggest draws for Chinese stocks is still the valuation gap, especially when one looks at the faster-growing businesses. Over the last two weeks, we have written on many of those companies, across different industries.

 Next Yr PEP/ SalesMarket Cap (B)Gross margins 2019Operating expenseSales Growth 2019
Tencent Music 33 5.9 $2234%17%34%
Spotify Loss 5.1 $4226%25%26%
Warner Music 45 3.6 $1746%38%12%

The music streaming business, which was covered in our notes on Tencent Music (NYSE: TME) and Warner Music (NYSE: WMG)

 Rev 2019Sales growth Q1 2020Price/ SalesGross MarginOperating Margin
Dada nexus $442109% 68%-56%
Wayfair $9,12720% 224%-8%
Meituan Dianping $13,932-13% 733%5%

Fast growth retail, which was covered in our recent Bullish note on Dada Nexus (Nasdaq: DADA)

Efforts to dominate fast-growth emerging technologies

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KraneShares CSI China Top Holdings

Out of the broader market, stocks of high-growth companies are performing exceptionally well. Case in point, KraneShares CSI China Internet ETF (NYSE: KWEB), which holds names like Meituan Dianping (3690.HK) that has more than doubled over past few weeks, is up close to 30% over last one year.

We have also covered electric vehicle space in a recent note and looking closely at the space it becomes clear very quickly that two countries – U.S. and China, are pretty much cornering the fast-growth industry.

 Next Yr PEP/ SalesMarket Cap (B)Gross margins 2019Sales Growth Next Yr
Tesla 313.0 7.1 $18617%40%
NIO Limited Loss 7.0 $8-15%53%
NIU Technologies 36.0 4.0 $1.024%47%

Within the space, stocks of Chinese companies are trading at a discount, which gets pronounced when growth and near-term momentum is taken into consideration.

The success of recent dual listings

A sudden spurt of dual listings among Chinese companies listed on the U.S. exchanges is another thing that is driving up the investor investors. We have covered the topic in detail in a note last week. Over the last few weeks, Netease (Nasdaq: NTES), (NYSE: JD), Daqo New Energy (NYSE: DQ), and Yum China (Nasdaq: YUMC) have either raised cash through listing on Hong Kong exchange or have announced plans to do the same.

Given the strong interest shown by investors for dual listing, driven by increased demand, liquidity and availability of more capital at a premium valuation, it is not surprising that ADRs on the U.S. exchanges have benefited from the same. Secondly, the potential threat of the U.S. delisting subsides after a successful dual listing.

Valuation gaps that still stand out

Although the stocks have run-up, the valuation gap between some of the U.S. majors and their Chinese counterparts is still stark, whether it’s Alibaba (Nasdaq: BABA) vs. Amazon (Nasdaq: AMZN), NIO Limited (NYSE: NIO) vs. Tesla or Baidu (Nasdaq: BIDU) vs. Alphabet (Nasdaq: GOOG).

While looking at the ETFs, kindly look at the detailed holdings since much of the investor interest right now is currently surrounding high-growth businesses and some of the old slow-growth businesses are still not drawing much interest, e.g. iShares MSCI China ETF (Nasdaq: MCHI), which is market-cap weighted and carries slow-growing large enterprises, hasn’t done much for the investors.

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