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Bears and bulls lock horns over China's blue chips

[SHANGHAI] Kweichow Moutai, the Chinese drinkmaker made famous when Richard Nixon drank its fiery sorghum liquor on his historic state visit to Beijing in 1972, has been the toast of the mainland's blue chip stock rally, surging 93 per cent this year.

The stock's eye-popping rise prompted an editorial last month by Xinhua news agency, a government mouthpiece, that singled out Moutai as an example of a major stock vulnerable to value-destructive speculation.

While even the drinkmaker agreed its rally was too hot, the pointed warnings had limited market impact, knocking barely 10 per cent off the stock's gains for the year, with the rally resuming as investors scooped up what they saw as a bargain.

And despite words of caution about a stock bubble from official channels and some market participants, other institutional investors argue a wider blue chip rally could last well into next year as China's investor base widens.

"Moutai's current valuation is not a deviation from fundamentals," said Jacqueline Zhang, Emerging Markets Equity analyst at U.S.-based investment manager OppenheimerFunds, whose China fund remains one of Kweichow Moutai Co Ltd's top 10 shareholders.

"No doubt, Moutai is the most profitable liquor company in the world. The uniqueness of its assets merits the premium." Although OppenheimerFunds slashed nearly one-fifth of its holdings in the firm last quarter as its stock price hit levels double that at the beginning of the year, it maintains that Moutai is not overpriced.

More broadly, the blue-chip index is up about 22 per cent this year, though it's been a bumpy ride higher.

The SSE50, which investors have dubbed China's Nifty 50 index, has far outperformed the broader stock market this year, but posted its worst weekly loss in almost 12 months in the last week of November. Index heavyweights including Moutai, insurance giant Ping An and automaker SAIC Motor saw heavy selling.

Several large investment firms concur that while prices of some large Chinese firms are in bubble-like territory, fresh investment flows from foreign funds looking to partake in China's rapid growth will push share prices even higher.

Shi Bin, the head of China equities at UBS Asset Management in Hong Kong, said this year's sharp rise in blue chips reflects a normalization of previously depressed valuations.

He expects China's inclusion next year into global index provider MSCI's benchmarks will channel more money into China's large-cap stocks, pushing prices higher.

Dutch firm NN Investment Partners has stayed put through the volatility, having picked Chinese businesses it believes have strong underlying fundamentals.

"Some investors are taking profits, especially where the valuations are quite full," said Ashish Goyal, NNIP's head of emerging markets equity. "But many of these companies are still great businesses and will continue to do well operationally." Shane Oliver, the Sydney-based head of investment strategy at AMP Capital, which invests in Chinese securities and operates a mutual fund venture with China Life, believes a cash rotation out of blue-chips and into the broader market is due, given the higher return on equity for Chinese small- to mid-cap firms.

Moutai's stock had surged as much as 115 per cent until Nov 16, when the company itself warned investors the price rise had been too rapid. The selloff that ensued wiped out 110 billion yuan of market value from Moutai's peak.

Even after the recent correction, Moutai trades at more than 30-times earnings compared with just around 13 times two years ago. It commands a market capitalization exceeding 800 billion yuan (US$120.98 billion), dwarfing oil giant Sinopec, and top insurer China Life.

Gu Weiyong, the chief investment officer at Shanghai-based money manager Ucom Investment, said a rise in borrowing costs following Beijing's crackdown on shadow banking is likely to make sectors valued at 30-50-times earnings seem too expensive.

Like OppenheimerFunds, state-backed China Securities Finance Corp and Singapore's state investment firm GIC have pared their Moutai holdings, exchange filings show, while others, such as UBS, have no plans yet to reduce their stakes, citing longer-term gains.

For the bears, however, a continuation of the exuberance into next year will only lead to more pain.

"The blue-chip bubble may be inflated bigger in 2018, before bursting," said Sun Zheng, strategist at China Development Bank Securities.