Of the 219 companies in Morningstar’s coverage universe in China, Hong Kong, Taiwan, and Singapore, nine saw fair value increases of 10% or more. The upgraded names represent 4% of our coverage, which is half the quarterly average of 15% in the past five years. Conversely, 21 companies, or 10%, saw their fair value estimate decline by at least 10%, versus the quarterly five-year average of 7%. For four quarters now, companies that received a downgrade of more than 10% outnumber those being adjusted upward to the same extent.
The Outlook for Stocks Continues to Remain Weaker
In Q2 2022, fair values across the four markets declined an average of 3% between April 1 and June 30, compared with the average quarterly increase of 2% in the five years prior. For the quarter, the drag mainly came from property developer Sunac China and several education service providers in China.
Morningstar’s fair value estimate is a measure of what analysts think a company's share price should be worth. The fair value is based on how much cash analysts believe a company will generate in the future. Stocks priced above their fair value estimates are seen as expensive, while those below it are cheap.
Stocks That Earned the Largest Upgrades
Stocks that saw meaningful fair value increases between the start and end of the second quarter, and trade well below those estimates, could provide long-term investors with buying opportunities. Only three names made the cut.
Leading the second quarter’s fair value increases were stocks in the energy sector, whose estimates rose an average of 6%, and the industrials sector, up an average of 1%. By individual names, one of the largest upgrades came from China Longyuan Power Group (00916). While the stock trades at its fair value, our analysts had upgraded the renewable energy company for seven quarters in a row, tripling its fair value estimates to HK$ 15.6 from HK$ 5.2 rated back in October 2020.
Another stock that saw an upgrade streak was United Microelectronics Corp (2303). While its rival TSMC, which snaps top ratings in both economic moat and valuation, remained a top pick by our analysts, UMC is attractively priced, trading at a 40% discount to its fair value of TWD 64.0 after receiving a 23% bump in the second quarter. Two other cheap stocks that received the largest upgrades were insurer PICC Property and Casualty (02328) and oil refinery PetroChina (00857), both trading at slightly more than a 20% discount right now.
Sectors With Large Fair Value Estimate Downgrades
Over the same quarter, of 39 stocks receiving a downgrade. The fair value estimates of 21 companies were trimmed by more than 10%.
The real estate sector in China has yet to resolve its massive debts and is facing another crisis, as homebuyers have begun to refuse to pay mortgages on hundreds of unfinished housing projects. The deepest fair value estimate cut in the quarter was made to Sunac China Holdings (01918), which announced it is unable to make bond interest payments. While Sunac’s shares remain suspended since the end of March because of failure to report financial results, the last closing price is more than 7 times above its new fair value estimate of HK$ 0.55.
Another group of companies that faced a major downgrade was Chinese education providers, reflecting the Chinese government’s move to more stringently regulate the industry. These new rules will prove to become headwinds on their growth trajectory, leading to a 40-65% trim on their fair value estimates.
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