Tuesday, March 3, 2015

Notes on Some Chinese Industries

I watched a Chinese environmental documentary 雾霾调查:穹顶之下 recently and found it surprisingly relevant. I happen to be doing a quick scan through some of China's basic industries - just figuring out who does what, and get some very basic sense of growth prospects and valuation. As a first cut I tend to skip over the environmental issues. When I saw the video however, I realized that it tied together the various industrial /political dynamics I'm researching, but through the environmental lens.

It's one of those lectures that ties everything together. Chai Jing (柴静) traced China's air pollution issues to coal and diesel oil, then attributes those pollutants to various industries: steel, power generation, refining...etc. She then related that to industry over-capacity. Then she links all that to conflicts of interest in the governing bodies, and how that led to lack of law enforcement and the dynamics of "forced cheating" (if everyone else cheats and you don't, you'll be out of business the next month. So by not cracking down on cheaters the government is effectively forcing people to cheat).

When I think of China, I think of big brother blocking your Gmail and people chanting party slogans (well, one guy quoted Chairman Xi in the video). So I was pleasantly surprised to find a fairly unbiased, constructive criticism of the government. I mean, Chai Jing was standing there calling out various regulatory bodies, blaming government directed investments and trumpeting market based economies. It seems to me that the fact that this video went viral (instead of say censored), shows that she's got the back of some powerful politicians serious about taking on the issues above.

Miscellaneous Notes 

Anyways, going back to the investing. I've been looking across Chinese energy, power gen, ports, shipping, gas distribution...etc. These are really notes for my own references.

  • Gas Distribution
    • Looks like revenue growth will run in high single digits, yet many of these trade at low teens P/E.
    • China Resource Gas and China Gas are the big ones. My worry with these is they both get about half of gross profit from "connection revenue", which is basically an one-off revenue as a new building gets connected. Not only will that eventually tail off, it also means exposure to a weak residential construction market. The offset is residential gas penetration is still very low in China, and companies (China Gas for example) is starting to focus on connecting to existing buildings, as opposed to new buildings.
    • Beijing Enterprises Holdings (0392.HK) looks attractive to me.
      • Slower but more stable growth at cheap price. BEH has lower risk from residential construction slow down because Beijing is already highly penetrated and it seems they do not get much revenue (if any) from new connection fees. There's very little industrial exposure as gas sales are mostly for power generation and cooling/heating related. 
      • At the same time, the company still has many growth opportunities: continued policy push toward natural gas (for example conversion toward gas plants), more pipelines coming online, expansion into suburban areas, LNG/CNG...etc. 
      • Big into the environmental theme with stakes in BE Water, China Gas, and solid waste management business. The part that does not fit is Yanjing Beer (up for sale?), but that is a great asset in itself.
      • The stock trades about 12x LTM earnings after I back out some of these publicly traded subsidiaries. There are lots of non-recurring items so I have to take a deeper look, but my gut feeling is valuation would be solid even without those items.

  • Ports:  
    • Most likely GDP growth, which for China is a solid 5-7% the next few years. Valuation is reasonable. Stocks tend to trade low teens P/E, solid 2-3% dividend yield (some much higher). 
    • China Merchants (114.HK) looks most interesting 
      • I would prefer diversified ports over location specific ones such as Tianjin Port and Qinhuangdao Port. These specific ports have more sector exposures (very heavy on coal and iron ore), which I imagine is in turn tied to property exposure.
      • COSCO Pacific (1199.HK) is diversified but gets 1/3 of its profit from container leasing which is a bit much for my taste.
      • China Merchants looks like mostly containers, which I associate with higher valued added goods (compared to dry bulk), which is the direction China is going.
    • Port companies would seem likely beneficiaries for China's "One Belt, One Road" policy.

  • Oil & Gas
    • PetroChina /CNPC is more upstream; SinoPec traditionally more downstream; CNOOC is offshore & LNG
    • There's some rumor about CNPC merging with SinoPec to create a national champion that rivals ExxonMobil. That makes no sense considering PetroChina is a plenty big company already.. How does that encourage competition? Unless you say energy is a "strategic industry" and government wants even tighter control. The other theory is that CNPC has experienced some scandals and this would be part of the political shake out.  
    • I'm sure these guys will take advantage of the current situation and buy some international oil & gas companies...

  • Power Generation
    • Cheap for a reason: low growth, undesirable regulatory/pricing regime, outdated infrastructure.
    • China's power consumption growth was only about 4% - I would have thought that number is much higher -- maybe in certain areas?
    • Undesirable regulatory regime. Costs (coal) are priced by the market, but revenue are set by the government. When coal prices go down the government cuts power tariffs, which basically limits the margins of these companies.
    • Companies are still mostly using coal plants, except for China Power Investment (hydro) and Longyuan (wind)
      • Habits die hard - some have vertically integrated structure with a coal mining operations (China Resource Power and Datang)
      • Just my gut feeling - given the public's and government's desire to shift from away from coal, I can see major capex yet to be incurred (perhaps for natgas CCGT plants?) Any regulatory penalty for pollution/CO2 could mean higher cost of business or "maintenance capex". But some of these are so highly leveraged I'm not sure how they would move to natgas. 
    • Supposedly Huaneng and Huadian have higher mix of gas-fired plants. I would be more interested in those.

  • Shipping. I quickly skimmed this one over without getting to specific names.
    • I already have tanker exposure, not sure I want more of this ultra-cyclical industry with chronic over-capacity issues.
    • It's true that the container industry has shaped itself into global alliances like "2M", "Ocean Three", "G6"...etc, but it seems like these are more for market access as opposed to pricing rationalization. 
    • Is shipping a "strategic industry" for China?  Or is it shipbuilding? If it's shipbuilding, which would makes more sense for military/strategic reasons, then the over-capacity issue will always persist (especially given the excess steel China has).  

    I meant for this to be a quick scan but it was a lot more time consuming than I projected. It's only when you tried to invest in foreign companies that you realize how good U.S. analysts have it. Here are just a few problems I encountered in this process: 1) you really have to know your Chinese. The English presentations of companies are often vague or just don't make sense - until you read the Chinese version which says something different. 2) corporate pyramids obscure true source of profit. For example, you might get a revenue breakout in the footnotes that suggest this company makes most of it's money from "x" line of business, then you realize it actually gets even more profits from associates, which is in a totally different business. 3) Multiple sets of accounting: Some companies show financial statements in HK accounting, then the MD&A refers to Chinese accounting numbers. That's just massive confusion. 4) lots of companies don't do conference calls, much less transcripts..

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