Hong Kong Market Strategy:Investment opportunities amidSOE reforms

Reforms on SOEs have begun and subsequent announcement on related policies are expected

    The second supporting document solved the problem of SOE reform implementation by adopting the Temasek model. The divisions of state-owned capital ownership and management authorities will be clearly defined and separated. We expect to see more M&As of SOEs following the document. Provinces and cities will integrate various suitable platforms for the integration and securitization of SOE assets.

    Substantial investment opportunities in SOE reform theme

    There are around 276 SOE related stocks in the HK equity market, accounting for c.50% of market cap. The valuation and profitability of SOEs are lower than market average. The ROE was mainly driven by leverage. SOE reforms could help release the real return of SOE assets and improve valuation.

    Investment logic of SOE reforms

    Reforms on mixed ownership will accelerate under the SOE categorization. SOEs will be classified into three categories. SOEs with core operations fall within perfectly competitive sectors are allowed to conduct market-oriented reforms thoroughly. State-owned capital can own a controlling stake or a major stake or participate as a financial investor. As an independent entity in the market, maximizing the return and improving operating efficiency will be the only target of this type of SOEs. We have selected a list of stocks with higher potential on the improvement of operating efficiency.

    Larger and stronger SOEs to be established through mergers. State-owned capital must have a controlling interest in commercial/public SOEs that take certain social responsibilities (national economy and people’s livelihood, national security, national missions). Mixed ownership reforms on this type of SOEs will be relatively conservative. We believe such reforms will focus on SOE mergers to form a group of larger and stronger SOEs that can represent national interests. Asset injection from parent groups will be the catalyst. Based on past cases, we believe SOEs in industries with overcapacity, facing global competitions, or in natural monopolies have the potential for mergers.

    Listing of the parent groups brings new investment opportunities. Supervision on capital markets and the pricing mechanism will effectively prevent the loss the state-owned assets. Listing can promote the establishment of modern corporate governance system and introduce employee shareholding schemes. We believe the existing listed SOE platforms will be the suitable targets for asset injection from parents. Non-listed SOEs are likely to be merged with other listed SOEs.。

    Best strategy for the SOE reform theme: early deployment and portfolio investment

    As reform-related events are difficult to predict in advance accurately in terms of time and targets, the price performance of this topic tends to be event-driven, we suggest selecting a stock portfolio with high potential of reforms before the announcements come out. We have selected a few investment portfolios for the SOE reform theme, based on both quantitative and fundamental analysis.