After the market closes on September 1, Country Garden (02007), China’s largest surviving (for now) property developer will no longer be a constituent in the Hang Seng Index.
The index review decision came after the firm missed a US$ 22.5 million interest payment on two offshore bonds on Aug. 7. Morningstar believes that the company will likely default on its bond payments after the 30-day grace period, given its weak sales and elevated overseas funding costs. Our equity analyst Jeff Zhang has cut his fair value estimate for Country Garden Holdings to HK$ 1.20 from HK$ 2.80.
But this was not the only change announced in this review. The developer’s property management subsidiary Country Garden Services Holdings (06098) will also be removed from the Hang Seng China Enterprises Index. What has taken its place?
Sinopharm Is a New Blue-Chip Stock
The Hang Seng Index has a total of 80 constituents, and Country Garden will be replaced by state-owned pharmaceutical company Sinopharm (01099). The narrow-moat-rated Sinopharm has been put under review by Morningstar. Our most recent fair value estimate for the Sinopharm stock was HK$ 29.50. It is trading in the undervaluation range.
For the Hang Seng China Enterprises Index, which tracks 50 Chinese H-shares, online travel agency Trip.com Group (09961) is the new addition, in place of Country Garden Services (06098). Trip.com is currently rated 4 stars with a Narrow economic moat. Our senior equity analyst, Kai Wang, forecasts travel spending by mainland Chinese tourists to tick back up again.
Wang says: “For the full year, we forecast overall revenue to increase 114% year on year, or 20% from 2019 levels, which reflects that the domestic hotel vacancy rate and air traffic in China have already surpassed that of 2019.” He thinks any further improvements will hinge on the recovery of international travel in China, which is now at 40% of its 2019 levels and will only reach pre-pandemic levels in the second half of 2024 at its earliest.
What is an Index Review?
The Hang Seng Index Company is responsible for conducting index reviews for the Hang Seng Index, a widely tracked benchmark of the Hong Kong stock market. The index review is performed in March, June, September, and December each year and involves a comprehensive evaluation of the constituent stocks within the HSI.
The purpose of the review is to ensure that the index accurately reflects the performance and composition of the Hong Kong stock market. During the review process, the Hang Seng Index Company assesses various factors such as market capitalization, liquidity, and sector representation to determine whether any changes are required in the index composition.
Changes in the Tech Index
The Hang Seng Technology Index has maintained the number of constituents at 30. In this review, online extracurricular education provider East Buy Holding (01797) will be added as an index constituent while AAC Technologies Holdings (02018) will be removed.
AAC Technology is under the Morningstar equity research team’s coverage. The firm’s profit warning is concerning, according to our analyst Phelix Lee. The 4-star stock warned that its net profit for the first half of 2023 would fall by 55%- 65% from the year-earlier period, citing a delay in efficiency improvements.
“For now, we maintain our fair value estimate for AAC Technology at HK$ 23.50 and plan to update our estimates after AAC reports first-half earnings in late August. Similar to other optics suppliers, we estimate that AAC’s optics segment suffered from a significant discounting of its average selling prices to clear inventory, and since AAC is more exposed to low-end phones, AAC may have suffered more than peers such as Largan and Sunny Optical.”
:quality(80)/cloudfront-us-east-1.images.arcpublishing.com/morningstar/EWMG3XJM2RA4ZLC5J5M6SSVVZA.jpg)
.jpg "Kate Lin")
