Wednesday, April 8, 2015

Catching a Bull Market - And Chinese Toll Roads

"When I see a bubble forming I rush in to buy, adding fuel to the fire. That is not irrational." – George Soros

Soros didn’t say “when I see a bubble reaching its peak”. He says “when a bubble is forming” – basically this is just spotting a bull market. For that, learning to think like part of the crowd is a good skill to have. It could be as obvious as reading a front page article on The first paragraph basically points out that mainland bulls are heading south to Hong Kong. For those who don’t read Chinese here’s the Google translate: “Policy blowing warm air frequency , funds have to move south, the Hong Kong stock market ushered hot . Hong Kong stocks opened 1.72 percent higher this morning , nearly seven years since the financial crisis hit a new high , up nearly 3 percent midday break through 26,000 points…” English media echoes the sentiment

To confirm that Chinese mainland investors are looking south, I checked the Hang Seng China AH Premium Index. It is indeed retracing from an all-time high, with plenty of room to go!

To be more concrete, here’s a list of dual listed shares. The H-shares basically went through massive re-rating the past couple days, with some going up 20% or even 40%. Is this a real bull market forming? I don’t know, because yesterday’s price action are surely exaggerated by 1) limited supply, 2) H-shares coming off a long weekend while A-shares have ran up. But overall it seems that:

  • Even retail investors in the mainland are worried that A shares are overheated.
  • But the bull is still alive. Government appears to be easing policies (for example tweaking housing rules, lowering power tariffs…etc).
  • Hong Kong shares look cheap on relative basis (and often on absolute basis too).
  • Difficulty of shorting A shares, so Chinese investors more likely to buy H Shares as a relative value play instead.

In any case I still have to do the fundamental work, but knowing that momentum and sentiment tilts the odds in my favor does allow me to be a little more aggressive.

When looking for H-shares, it’s also useful to put them into 3 broad categories/levels with varying support from market technical:
  1. Dual listed shares under the Shanghai-HK Stock Connect scheme. 
    1. These are the most direct beneficiaries. The A share having a strong bid does indicate some level of pent-up demand for the H-shares. 
    2. Toll Roads look interesting: Shenzhen Expressway (548.HK), Sichuan Expressway (107.HK), Anhui Expressway (995.HK). I will discuss in the next section.
  2. H Share stocks with Shanghai-Hong Kong Stock Connect, but not dual listed.
    1. Should still benefit as well but not as much. 
    2. Beijing Enterprises Holdings is an example.
  3. H shares without Shanghai-HK connect. 
    1. These are indirect beneficiaries. But in the future there’s no reason why China wouldn’t open up the capital market further and expand the SH-HK connect to these stocks. 
    2. Investors will have to assume no lift from market technical and focus on the fundamentals. 
    3. Welling Holdings is one such stock I own. 

Exploring the Chinese Toll Roads

For the first category (dual listed shares which have maximum benefit from the bull market), the toll-roads look interesting. These are Shenzhen Expressway (548.HK), Sichuan Expressway (107.HK), Anhui Expressway (995.HK).

The A vs H-share premiums are anywhere from 54% to 106%, providing some basis for H-shares prices to increase. They all pay good dividends. Valuation is cosmetically cheap on (9-12x area on P/E basis). I’m not sure traditional valuation metrics are valid here because toll road concessions are not perpetual – they have finite end dates. But in a bull market, my guess is people will just look at low P/E, high dividend yield, big discount to A-share and bid up the stocks.

Some qualitative considerations:

  • Low oil prices will encourage driving.
  • China’s auto sales have been on a tear the past few years and that should increase traffic on the roads.
  • Toll roads are relatively be defensive –stable cash flows and all.
  • Great visibility – traffic data are available month on the internet
  • There’s a theory out there that toll roads could become local government platforms for financing & investments. Some reports invoke vague notions of SOE reform & asset injections. I’m not sure these are necessarily good things, but if the market is finding reasons to get bulled up about the sector, I’m not going to argue.
  • The worst policy issues could be over, as some of the tariff cuts already happened. (see the risk section)
  • We now have discussion on increasing tariffs. 1) There’s a government draft out there that could lead to extension of toll periods. 2) Guandong is exploring new pricing policies that will likely increase tolls. This could serve as a model for other provinces.

Risks & Why are they cheap
  • Again, traditional valuation metrics may not be reflective of value because of limited concession periods. If you were to value these using a DCF, there would be no “terminal values”.
  • Share prices would collapse if talks of tariff increases turn to tariff cuts.
  • Government has a history of arbitrarily one-off tariff cuts in response to populist demand. These have plagued the industry the past few years.
    • Examples include toll-free policies during national holidays, waviing toll fees of fresh farm products (“绿色通道政策”)…etc.
  • Periodic public backlash against high tolls.
    • Could even lead to charges of “corruption”, which seems to be a very loosely defined term in China. Whatever the definition, to me the risk is high level management gets detained in some secret dungeon, get interrogated by the police, while the company collapses. 
    • Op-eds like this make that sentiment clear.
  • Development of alternative infrastructure (railroads, competing roads…etc) would siphon away traffic. 
  • “Diworsification” (for example Anhui Expressway owns a pawn business that charges 4% per month for car loans. You would think if a toll road company wants to go into the lending business they’d buy a bank. I guess not.)

I still think the upside is more than the downside because some of these issues sounds worse than they actually are. For example if tariff cuts happen, revenue would decline but probably not that much, as the traffic volumes are for the most part fairly stable. Then dividends would help recover some of your potential losses (although I’m more likely to cut my losses fast instead of waiting for dividends).

These are probably not the best investments in the world. As far as spotting a bubble and rushing into it though, they could have a lot of upside. I will allocate a small amount, and be quick to cut losses if things don’t work out.

*** the market is popping as I write this!!   BUY BUY BUY BUY BUY!

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