At a time of corrections, where should investors find value? To find out, we screened for companies with the largest fair value upgrades, that also have Morningstar Star Ratings of 5 or 4 stars. Morningstar stock analysts think these businesses worth more--they’re still trading at a discount.
Out of our coverage universe of 174 stocks, 15 stocks made the cut. Tencent is at the top of that list, and is trading at a 57% discount to its fair value. The others were primarily concentrated across the financial and real estate sectors, including blue chip names HSBC (00005), Hong Kong Exchanges and Clearing (00388) and Swire Properties (01972). Let’s look at the financial services and real estate sectors in some detail.
Financials:
At the top of the list are Standard Chartered (02888) and HSBC Holdings (00005). Driving their fair value increases was an improved outlook for net interest margins (NIM).
According to Michael Wu, senior equity analyst, rising interest rates and continued post-pandemic recovery in Asia also play a part in supporting Hong Kong banks over the medium term. Short-term challenges persist as the city will only begin to gradually relax its strict zero-covid policy at the end of April. Wu believes the benefit to NIM would lag an actual increase in U.S. interest rates. Hang Seng Bank is expected to benefit the most in a rate hike environment.
Coupled with a favorable medium-term outlook, valuations of banks in the list are looking inexpensive. Standard Chartered and HSBC are 42% and 29% below their respective fair value estimates. Hong Kong-focused banks are cheap as well. Hang Seng is trading at a 14% discount to its fair value estimate, while BOC Hong Kong is priced 20% below its fair value.
Real Estate:
Top pick Swire Properties (01972) received a 15% upgrade in its fair value estimate during the first quarter. Wu, who also covers the Hong Kong developer, says Swire’s strong growth in the mainland China managed to offset the decline in its rental income collected in Hong Kong. The firm also brings on board a new mixed-use cultural and tourism landmark project in Xi’an, which Wu expects to be a net positive impact to Swire. The stock is 35% below its fair value estimate of HK$ 31.
Another undervalued stock that received a boost in its fair value estimate was China Jinmao Holdings Group (00817). Analyst Cheng Wee Tan said the increase reflected the positive takeaways from the company’s latest earnings report. Tan says: “First, the company continued to have access to debt markets despite the tight liquidity environment. Second, it is cognizant of the government’s push for well-run developers to acquire assets from troubled developers. Third, with the weak physical residential market conditions, the company’s contracted sales was up by 2% year on year. The company is expected to repeat this consistent performance in this year as well.”
The fair value estimate of Henderson Land (00012) was revised higher to factor in the impact of projects to be completed. But our analysts had a less positive outlook than the previously mentioned companies, as the catalysts for developers may take some time to arrive. Wu says: “While the residential property transactions remain resilient during the current downturn, an acceleration in transactions and residential property prices is unlikely until people actually cross the border and economic activities recover.”
Which Stocks Received the Biggest Downgrades?
Our equity analysts also identified stocks exposed growing risks, which is also reflected on more downgrades in fair value estimates in the first quarter.
In the quarter, more stocks were downgraded than upgraded in the Hong Kong and China markets. Downward adjustment happened in one-third of Morningstar’s equity coverage for the region, with a downgrade in fair value estimate ranging between -1% and -66%.
The deepest trim was given to Zhenro Properties (06158), considering slower revenue growth and completion pace to significantly reduce its cash flow as a highly leveraged business. Due to headline risks stemming from coupon defaults, Morningstar analysts do not expect Zhenro’s share price to recover significantly in the near term given the challenging conditions.
The fair value estimate of China East Education (00667) was axed too. While China East is less exposed to regulatory risk compared to after-school tutoring providers, because of its focus in vocational education, Morningstar analysts do not rule out the possibility of the authorities imposing stricter requirements which could result in higher costs. This led to a 66% decrease in fair value estimate within a quarter.
Beijing’s clampdown on China's education sector has slammed the bottom line of TAL Education Group (TAL), which is restructuring and downsizing employees to keep the business afloat. However, our analysts regard this as high risk and costly business, resulting in a downgrade of 62% in the stock’s fair value estimate.
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