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Rethink China’s SOEs, says Premia Partners

Conventional wisdom says Chinese state-owned enterprises (SOEs) are bad investments, but that is not necessarily true, according to David Lai, Hong Kong-based co-chief investment officer at Premia Partners.
Rethink China's SOEs, says Premia Partners
David Lai, Premia Partners
David Lai, Premia Partners

“SOE reform is a quite high prioritised government policy this year. It includes changing the shareholder structure, spinning-off the non-core assets and calling for more innovation,” Lai said at a recent webinar organised by the firm.

In general, profits for Chinese SOEs were up last year. Citing data from the Ministry of Finance, Lai said profits for SOEs owned by the central government were, on average, up 23.5% year-on-year, while those owned by the local government had an average increase of 37%.

SOEs have also been trading at lower multiples than private enterprises, he added.

Chen Zhiwu, a senior advisor at Premia Partners and director of the Asia Global Institute, who also spoke during the webinar, said that since SOEs in emerging markets like China monopolise in some areas, they are able to enjoy very good earnings growth.

Citing findings from various reports, Chen added that the returns for SOE stocks are less volatile and more predictable than privately-owned firms, “even though they will not make you as rich as investing in Tencent”.

Premia Partners is a new player in Hong Kong’s ETF market. It launched two smart-beta China-focused ETFs in October: the Premia CSI Caixin China Bedrock Economy ETF and the Premia CSI Caixin China New Economy ETF. Separately, it recently partnered with US-based Wisdomtree Investments for cooperation in various ways, including the development of smart-beta products for the Asian ETF market.

Two-thirds of the assets of the firm’s China Bedrock ETF are invested in SOEs, according to Lai.

He noted, however, that not all SOEs are good investments. The firm filters the SOE universe to find quality companies, which includes looking at debt coverage, accruals, net operating assets, cash ratio and profit margins.

“We try to screen out companies that have very high debt,” he said.

Other asset managers also see China’s SOEs as an attractive choice for investors.

For example, Philip Li, Hong Kong-based senior fund manager at Value Partners, said previously that although SOEs typically have a higher level of debts and are less profitable, they have room for improvement, particularly in light of the SOE reform to enhance their returns.

SOE bookkeeping

Both Lai and Chen also discussed whether the numbers that SOEs report are reliable.

Chen, who was previously a member of Petro China’s board for six years until May 2017, shared his experience.

“From my insider experience, I knew there was no incentive for the Petro China executives to really take the risk and try to overstate their earnings or financial numbers. I just don’t see incentive too for other central government SOEs to manipulate the numbers.”

He noted, however, that SOEs might be in a position to negotiate special tax treatment with the Ministry of Finance, which could “smooth out earnings through special tax treatment”.

By comparison, Chen said that private companies, especially those listed in Hong Kong and the US, have more incentive to manipulate their numbers to boost their share prices.

Lai added that in China, if an A-share company records a loss for two consecutive years, its stock will be labelled as “special treatment” (ST).

“This is harmful to the liquidity of their stock as many mandates are not allowed to invest in ST companies.”

Part of the Mark Allen Group.