SHANGHAI (Reuters) – As Chinese policy makers extend their economic reforms, state-owned enterprises (SOEs) have taken pole position in the nation’s stock market this year, gaining rapid strength at the expense of private firms.
The “guo jin min tui” trend of advancing state firms and retreating private companies has become particularly pronounced, making betting on Chinese stocks a bit of a one-dimensional exercise.
An index tracking China’s listed SOEs .CSI000926 has jumped nearly 12 percent so far this year, with a gauge tracking the top 100 of them .CSI000927, including banking giant ICBC (601398.SS) and power behemoth China Yangtze Power (600900.SS), surging over 16 percent.
In contrast, an index tracking private-run enterprises .CSI000938 has slipped nearly 5 percent.
The performance gap is glaring, but investors say there is a reason.
State firms dominate upstream industries such as raw materials and energy, so they are the biggest beneficiaries of Beijing’s “supply-side” reforms that aim to slash capacity and have helped boost commodity prices.
And at a time when the government is increasing spending on public facilities to bolster growth, state firms retain an edge over their private rivals in winning contracts in major infrastructure projects, and getting access to bank loans.
David Dai, general manager of Shanghai Wisdom Investment Co Ltd, said investors prefer listed SOEs because “their valuation is relatively low, and we’ve seen strong recovery in sectors such as coal and steel, which benefit from a reduction in capacity.”
However, there are obvious risks of state patronage, including crowding out of private capital, misallocation of resources and inefficiencies caused by an uneven playing field – the very things policy makers want to put right through their broad reform efforts.
“Obsession about a strong recovery in the upstream is dangerous to economic management,” said Hong Hao, chief strategist at BOCOM International, who warns that the strength of state-dominated upstream industries risks devouring profit from other sectors.
MAKE HAY WHILE SUN SHINES
For now, however, SOEs seem to be in the driving seat.
China has set up a series of government-backed funds to finance mergers and acquisitions by debt-ridden SOEs and support the so-called mixed-ownership reforms, which has seen many SOEs including China Unicom (600050.SS) raise fresh money from private investors.
But private firms’ financing and investing activities are being increasingly scrutinized by the government. Earlier this year, China’s banking regulator ordered a group of lenders to assess their exposure to offshore acquisitions by a handful of private companies including HNA Group HNAIRC.UL, Dalian Wanda Group Co, Anbang Insurance Group ANBANG.UL, Fosun International Ltd (0656.HK) and Zhejiang Luosen.
That aligns with Beijing’s efforts to curb “irrational” offshore investments by Chinese companies, though not all SOEs are subject to the same strict restrictions.
The advantages enjoyed by the SOEs show up in their bottomlines.
Industrial profit at SOEs jumped 44.2 percent during the first seven months of this year, but profit growth at private firms was a more modest 14.2 percent.
It was a different story a year earlier, when profits at SOEs fell 6.1 percent while those of private firms grew 8.7 percent.
That also partly helps explain why even after strong price gains, the valuations of SOEs remain modest – at roughly 15 times earnings.
In contrast, underperforming shares of private firms are twice more expensive, trading at earnings multiples of 34 on average, as their profit growth fails to catch up with previously lofty expectations.
Among the winners, state giants Baoshan Iron & Steel Corp (600019.SS), Aluminum Corp of China Ltd (Chalco) (601600.SS) (2600.HK) and Sinopec (600028.SS) all reported a surge in first-half profit, beating expectations.
In China’s recent economic recovery, “SOEs in the upstream have made the most money, but private firms in the midstream didn’t make much money, and some even lost money,” Zhong Zhengsheng, economist at CEBM Group told a financial conference recently.
“Only SOEs are increasing investment,” Zhong said. “Other types of companies are all recoiling.”
Reporting by Samuel Shen and John Ruwitch; Additional reporting by Patturaja Murugaboopathy in BANGALORE; Editing by Shri Navaratnam