The recent rally in China’s stock market has been met with skepticism from investment analysts who believe it is not justified by fundamentals. While the MSCI China Index is outperforming both emerging markets and the S&P 500, the increase in capital seems to be driven by hedge funds rather than long-only funds. Consumer discretionary stocks are expected to have the highest earnings per share growth this year. Companies like Tencent and Alibaba, top holdings in the MSCI China Index, have been increasing stock buybacks with their excess cash, reflecting a focus on free cash flow by investors.
As China’s economy slows down, investors are increasingly looking at free cash flow as an indicator of financial health. China Merchants Securities noted that in an environment of moderating demand, high levels of capital expenditure are no longer generating significant returns, prompting a shift towards industry leaders with high free cash flow. Tencent, Alibaba, and Baidu are set to release quarterly earnings soon, offering insight into their financial performance. Hong Kong-based AlphaHill Capital is specifically looking at Chinese consumer names with free cash flow growth.
Despite a gloomier narrative surrounding China, there are signs of a turnaround in the Chinese consumer market. The Consumer Confidence Index has shown improvement in the past nine months, although it remains below pre-COVID levels. Analysts advise focusing on firms that can create value for consumers and highlight companies like Li Auto, New Oriental Education, and the operator of Beijing-Shanghai High-Speed Railway as picks based on positive free cash flow and expectations of future growth.
State-owned transportation and utilities companies in China have the ability to increase profit margins by raising prices due to their monopoly power. Chinese high-speed train operators have reportedly raised ticket prices by nearly 20% on certain routes, indicating the potential for increased profitability in the sector. Despite the uncertainty surrounding the duration of the current rebound in China’s economy, analysts believe that the lack of significant stimulus measures suggests that the economy may not be as weak as sentiment suggests. Major economic data from China is expected to be released on May 17, including a 3.8% increase in retail sales in April from a year ago.
