Chinese Stocks: Firecrackers They Ain't

It's probably not quite what Mao Zedong had in mind when he said the East was red. These days, investors in Chinese stocks are awash in red--red ink, that is.

Pity the poor holder of Shanghai Hai Xing Shipping stock, which was listed on the Hong Kong exchange just over a year ago. With its secure position carrying coal for China's utilities, the company looked like a slam dunk--until it got caught by rising costs, the loss of its near-monopoly, and government reluctance to let it raise rates. As its first-half earnings tumbled 78%, Hai Xing shares plummeted. Then, as news broke in mid-November that Beijing was ending state subsidies on corporate loans, Hai Xing got hammered again. At 6 cents a share, it's down 71% since November, 1994.

BOUT OF NERVOUSNESS. Hai Xing is hardly the only horror story. Shifting government policies and mounting dismay at many companies' meager disclosure policies are sparking the second major sell-off of mainland issues since summer. Hong Kong's H-share index, which tracks mainland equities listed in the British colony, has plunged 19% since Oct. 31. The market for B shares--stocks in Shanghai and Shenzhen that are available to foreigners--is off 8.6% (chart). Some bottom-fishers think an expected easing of Chinese monetary policy next year could perk up mainland issues. But for now, many strategists, including those at Merrill Lynch & Co. and Schroder Capital Management International Inc., are counseling clients to invest in China via well-established Hong Kong multinationals that have growing operations across the colony's border.

The latest bout of nervousness over Chinese stocks stems from reform efforts in Beijing that will force many companies to pay market interest rates on loans and more realistic prices for capital goods. Companies also will see their tax rate rise to 33%, in some cases more than double what they are paying now. While the moves will help cut China's deficits and bring its tax system in line with World Trade Organization rules, they will wipe out the profits of many highly leveraged companies such as Hai Xing.

But Chinese companies themselves must shoulder much blame for the collapse. "There is a lack of understanding of what the capitalist system is all about," says Graham Muirhead of HSBC Asset Management Hong Kong Ltd. He adds that many companies acted as if foreign investors were "a money tree" to be shaken down for easy cash.

NICE SENTIMENTS. Almost all of the 17 H-share companies have disappointed investors. Analysts are fuming that a major mainland shareholder--and director--of Qingling Motors Co. quietly sold his holdings last summer just before poor earnings were released. And Beiren Printing Machinery Holdings Ltd. put part of the proceeds of its initial public offering into Macao real estate, rather than into expanding its core business, as it promised. "Some companies deliberately misled investors," says William Lo, head of China research at Jardine Fleming Securities.

Investors are just as unhappy with B-share companies. One fund manager complains that while these Shanghai and Shenzhen mutfits had promised investors they would hew to international accounting standards, many have gone back on their word. Few provide reports on their profits or balance sheets more than once a year. "They have little or no regard for minority shareholders," scoffs Heather Crighton, a Schroder vice-president who recently visited 21 Shanghai corporations. "It's difficult to justify holding them at all."

Such complaints are getting through to Beijing. "There have been frequent problems with timely disclosure and misappropriations of funds," admits a China Securities Regulatory Commission official. "Disclosure requirements must be improved. We want to provide better protection for foreign investors." Those are nice sentiments, to be sure. But for now, at least, few investors will be intrepid enough to brave any but the bluest of red chip stocks.

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