Mobius Says Not Too Late to Buy China With 20% Upside

Mark Mobius says it’s not too late to buy into the rally in Chinese stocks.

The executive chairman of Templeton Emerging Markets Group predicts the nation’s equity market will climb another 20 percent, following a 19 percent surge in the Hang Seng China Enterprises Index from March 20 through yesterday. Mobius, whose $12 billion Templeton Asian Growth Fund has outperformed 94 percent of peers this year, favors state-owned banks and energy companies because of their cheap valuations and the government’s plans to open up state-dominated industries.

An extension of the rally would give investors another chance to profit after they pulled almost $700 million from U.S. exchange-traded funds tracking China stocks since the advance started, the biggest outflows among emerging markets tracked by Bloomberg. Chinese shares are rebounding as policy makers accelerate spending and loosen some banks’ reserve requirements to keep economic growth from slipping below their 7.5 percent annual target.

“Usually when you enter a phase like this, you’re looking at at least 20 percent upside” from current levels, Mobius, 77, who oversees more than $40 billion in emerging markets, said in an interview yesterday in Hong Kong. “If you look at the valuations of SOEs, you’ll see that they are very cheap.”

Relative Value

The Hang Seng China Enterprises Index rose 1.1 percent yesterday after a private gauge of manufacturing in the world’s second-largest economy increased to an 18-month high. The equity measure climbed 0.5 percent in Hong Kong today to the highest close since Dec. 13, while the Shanghai Composite Index rose 1 percent.

Policy makers have accelerated infrastructure spending, cut reserve-requirement ratios for some lenders and allowed some local governments to loosen property curbs as a slumping real-estate market threatens to derail economic growth.

Even after the advance, the gauge of mainland companies listed in Hong Kong, known as H shares, is valued at 7.3 times estimated earnings for the next 12 months. That’s the lowest multiple in emerging markets after Russia’s Micex index, according to data compiled by Bloomberg.

Mobius’s rally forecast pits him against bearish analysts at Bank of America Corp. and Deutsche Bank AG. BofA’s David Cui, the No. 1 ranked China strategist by Institutional Investor magazine, said July 14 that the stimulus that’s sparking the rally is actually making equities less appealing as leverage rises and free cash flow dwindles. Deutsche Bank’s John-Paul Smith reiterated this month his concern that rising debt levels pose a risk to China’s economic stability.

Fund Holdings

Emerging markets are coming back into favor among investors in U.S.-listed exchange-traded funds. Flows into the funds turned positive for the year yesterday, by $109 million, reversing investor flight that had drained as much as $13.9 billion in the first 2 1/2 months of the year.

PetroChina Co., Industrial & Commercial Bank of China Ltd. and Bank of China Ltd. have contributed most to the H-share index’s rebound as President Xi Jinping pushes to increase the role of private investors in state-owned companies. Templeton’s holdings include shares of Beijing-based PetroChina, Guangzhou Automobile Group Co., China Merchants Bank Co. and Aluminum Corp. of China Ltd., according to fund data compiled by Bloomberg.

No Enthusiasm

PetroChina, the nation’s biggest company by market value, is considering opening up pipeline, exploration and refining units to private investment. The firm said in May it will sell assets valued at 39 billion yuan ($6.3 billion).

“The focus on state-owned companies is simply because of this reform program,” said Mobius, who declined to give a time frame for his prediction of a 20 percent rally. “They’re the biggest game in town.”

Mainland investors are less enthusiastic about the government’s plan to overhaul SOEs. PetroChina shares in Shanghai are valued at levels 11 percent lower than those listed in Hong Kong and reached a record discount of 13 percent this week. China Petroleum & Chemical Corp. is 16 percent cheaper on the mainland, while Agricultural Bank of China Ltd. trades at a 17 percent discount.

“Because sentiment is quite negative in China, they look at every piece of news as half glass empty,” Norman Chan, an investment director at NAB Private Wealth Advisory Ltd. in Hong Kong, said yesterday. “The restructuring is perceived as a negative fix. But foreign investors probably have a different perspective, they probably think it will allow them to be more sustainable.”

Reassessing China

Mobius says valuations on SOEs are too low to pass up. PetroChina trades at about 12 times reported earnings, versus an average multiple of 20 for global peers, according to data compiled by Bloomberg. ICBC, China’s biggest lender, has a price-to-book ratio of 1.07, about half the level of its historical average.

While concerns over rising bad loans have weighed on bank valuations as nonperforming loans increased for 10 straight quarters through March, Nikko Asset Management Asia Ltd. says shares will rally as government stimulus buoys the economy.

“We have been underweight the Chinese banks for many many years,” Peter Sartori, Singapore-based head of Asian equities at Nikko Asset, whose Tokyo-based parent holds $158 billion in assets globally, said in an interview last week. “The time is right to reassess that. Banks have stopped underperforming. There will have to be more reforms in China for banks to start outperforming.”

China issued new rules in March allowing banks to sell preferred stock, expanding their financing options. Regulators increased banks’ lending capacity this month by changing the way loan-to-deposit ratios are measured.

Mobius says that will help fuel gains in stocks as banks in China and around the world deploy more capital into the economy.

The rally “is sustainable because of the incredible amount of money available for the markets,” he said. With lower loan-to-deposit ratio, “banks are sitting on a lot of fuel to add to the fire.”