Ten China Plays Poised for Greater Profitability and Better Credit

 | Jun 05, 2017 | 10:00 AM EDT
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Debt isn't a problem if you can pay it off. And that's the case for 10 Chinese companies, many from the most basic of industries, that I'll outline as promising China plays right now. They look set to gain from an upswing in business that leaves them in a better position to pay down their borrowing.

These stock picks come at a time that overleverage is on every China investor's mind. The slow pace of reform with China's state-owned enterprises was at the heart of the concern when, two weeks back, the ratings agency Moody's downgraded China's credit rating for the first time since 1989.

The surprise cut took China watchers off guard, although the sentiment that China's financial strength will erode as growth slows is shared by many. After the downgrade, I last week named names when it comes to the stocks that are most at risk from any negative shift in sentiment on China.

But the end of deflation in China is helping companies push through higher prices. That and the rise in commodity prices are goosing some industrial and materials companies in "China corporate" toward greater repayment capacity on heavy debt loads.

Screening for improving operating profits and interest cover, Société Générale has identified 10 high-debt companies, all but one of them U.S.-listed, that should see their creditworthiness improve at this time of doubt.

Leading the list in terms of performance this year are Air China (AIRYY) , the mainland's flagship carrier, and China Southern Airlines (AIRYY) , both of which are stealing business from Asia's customary flagship bearers, Cathay Pacific (CPCAY) and Singapore Airlines (SINGY) . They're doing that by boosting international operations in a way that balances the profitability they generate from within China's borders.

What's more, China Southern just inked a deal with American Airlines (AAL) for the U.S. carrier to buy an 8.8% stake for $200 million. The combination, and greater connectivity, is something that should improve the international expansion of an airline that still gets 67% of sales from flights within China.

Beijing Capital International Airport (BJCHY) -- operator of the capital's gleaming new hub -- has a $4.8 billion market capitalization that reflects the optimism over the domestic market, too. But with its stock up 44% in 2017, and Air China (up 53%) and China Southern (up 49%) doing even better, they look to be longer-term holdings that may have eaten up short-term gains.

You want paper gains? Nine Dragons Paper (NDGPY) has the paper they're printed on. The company, led by one of China's richest women, founder Zhang Yin, has a fascinating business model that benefits from globalization. It imports waste paper from the United States and reprocesses it into cardboard, which is used to then export goods to the United States. That makes it a play on China's position as the world's factory floor, as well as the U.S. recovery. It is up 33% this year, mind you. 

There's raw-materials exposure through China's largest producer of aluminum, Chalco, full name the Aluminum Corporation of China (ACH) . It's the leader in a smokestack industry that's about to see substantial reform. Fixed-asset investment in coal is down by half since 2012, and more than one-third for steel. Aluminum is likely the next industry to feel Beijing force intractable dinosaur companies into the history books, leaving the largest survivors with a commanding position. At 15%, its gains in 2017 could be set to continue.

Jiangsu Expressway (JEXYY) , up 14% in 2017, is a play on the greater mobility, literally, of Chinese citizens. It built the Jiangsu Province portion of the Shanghai-Nanjing Expressway, as well as other major arteries and toll roads in that province.

China Railway Group (CRWOY) , flat with a gain of 1.7% in 2017, is a broad infrastructure play that belies its name, ranked by some counts as the largest construction company in the world by revenue. Beyond the railways and rail equipment it most definitely builds, it also constructs highways, bridges and tunnels.

Property companies often build up impressive debt loads that they struggle to service, a symptom of their willingness to pay "land-king" prices to set new records for raw real estate in China's biggest cities. China Resources Land (CRBJY) , the development arm of the sprawling state-owned conglomerate China Resources, also makes the SocGen list, but is up 31% in 2017. For standalone property plays, look to Soho China HK:0410, up 17% this year, and the Sino-Ocean Group (SIOLY) , up 16%, for exposure.

Chinese stocks in general could be poised for a fillip. MSCI may opt to include China's domestically listed A shares in in its international indexes -- something the boys in Beijing are desperate to see happen. We've heard that noise before, though, and I'll believe the move when I see it. 

A liquidity crunch as China cracks down on the shady shadow-banking system and mortgage lending, as well as the relatively high price of private companies, may outweigh any index-inclusion gains, SocGen says.

The French bank favors offshore China listings to equities listed in Shanghai or Shenzhen. And that view has paid off in spades.

Onshore markets are flat in China so far in 2017, the CSI 300 index of the largest listings in Shanghai and Shenzhen up 4.8%. By contrast, the Hang Seng China Enterprises Index of Chinese companies listed offshore in Hong Kong is up 13.5% year-to-date.

The farther away from China you go, the better the performance: the MSCI China index of offshore Chinese listings in Hong Kong and New York is up 23% in 2017. You can play that index, which MSCI covers around 85% of the China equity universe, via the iShares MSCI China ETF (MCHI) .

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