95 China-based firms' combined net profits slump 52%; analysts wary of more weakness

By LYNETTE KHOO

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SO, the analysts got it right this time, at least with the earnings of S-chips.

A bright spot: Yanlord Gardens in Shanghai. Yanlord's net profit more than doubled to $24.27 million for Q1'09 from $9.31 million for the previous corresponding quarter

In line with projections of a double-digit slump, the combined net profits for 95 S-chips - China-based companies listed in Singapore - that reported their results for the first quarter ended March 31, 2009 tumbled 51.8 per cent from a year ago. Analysts are expecting further weakness in the seasonally slower second quarter.

The total net profit of these S-chips during the quarter was $436.72 million, more than half the level of $905.26 million in the same quarter last year.

It was a mixed bag of results as some went through a rough patch while for others, it was business as usual.

A quarter of these companies were in the red, of which 19 were in the black a year ago. About 42 companies posted lower profits. Still holding up are about 25 companies which reported higher earnings from a year ago, among the 69 S-chips that stayed in the black.

Given the shortage of bright spots on the earnings front, there hasn't been a major re-rating of S-chips. And where earnings are looking up, analysts are assessing the governance aspect of these companies.

CIMB-GK analyst Ho Choon Seng noted that the fall in earnings 'is not unexpected as most companies were hit by the same problems'.

Some chemical fibre companies and retail plays sang the same dreary tunes of dwindling sales and depressed selling prices.

Among them, China Sky Chemical Fibre Co swung to a net loss of $12.9 million from a net profit of $36.28 million and Sino Techfibre recorded a net loss of $8.06 million compared with a net profit of $26.77 million.

China Hongxing's net profit for the first quarter slid 50.9 per cent to $12.44 million, thanks to lower sales and product discounts, while Pine Agritech swung into a net loss of $5.02 million from a net profit of $15.58 million a year ago.

Cosco Corp's net profit plummeted 60.5 per cent year on year to $33.15 million dragged by lower charter rates for dry bulk shipping and the lower profit contributions from the ship-repair, shipbuilding and marine engineering business.

But defying industry trends, Yangzijiang turned in a 30 per cent rise in first-quarter net profit to 483.3 million yuan (S$103.2 million) on a 23 per cent rise in revenue to 2.09 billion yuan, and kept its gross profit margin above 20 per cent, taking a lift from the construction of larger vessels at the group's new yard.

Bolstered by higher selling prices for its high-end projects, Yanlord Land Group's net profit more than doubled to $24.27 million for the first quarter ended March 31, 2009 from $9.31 million for the previous corresponding quarter.

Also showing resilience was China Fishery, whose net profit put on 8.2 per cent to US$43.7 million on the back of higher sales. This triggered a 'buy' call from DMG & Partners Securities in anticipation of its long-term growth potential.

Alan Lok, director at Sabio Global, noted that S-chips come under two different tiers - those with exposure to overseas markets and those that rely on domestic consumption. Unfortunately, the profiles of the S-chips here mostly fall under the first group, with main export markets being the United States and Europe.

The second group of S-chips, however, has held up well but 'the risk is we don't know how long China's consumer market can sustain this kind of results', Mr Lok said.

Henderson Global Investors fund manager Andrew Mattock noted that industrial activity in China has picked up and this could benefit mid-caps with domestic exposure.

There are also tentative signs that the Chinese residential property market may be bottoming out, as transaction volumes in major cities continue to increase. But he is wary of some export-driven industries, which are dependent on a pick-up in global demand.

Given the shortage of bright spots on the earnings front, there hasn't been a major re-rating of S-chips. And where earnings are looking up, analysts are assessing the governance aspect of these companies.

CIMB-GK research head Kenneth Ng has, for instance, noted that China Sky could return to marginal profitability in the second quarter.

But 'the weak environment, the cash burn and a share overhang from the revelation that CEO Huang Zhong Xuan has pledged his 19 per cent stake in the company are reasons for a negative position on the stock', he said, cutting his rating from 'neutral' to 'underperform'.

Kim Eng analyst James Koh said he expects earnings per share of S-chips to be flat, compared with last year.

While some economic indicators in China seem to suggest that things are picking up, fundamental positive developments 'should likely still be industry and company specific rather than broad-based', he added.

By LYNETTE KHOO

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S-CHIPS have been the epicentre of recent corporate scandals but they are not inferior to other small caps when it comes to corporate governance, a study shows.

Prof Mak: To build trust and confidence, S-chips may need to do more than what other small firms do

They had similar scores on governance and transparency to non-Chinese listings with a market cap of less than $50 million or below $300 million. But S-chips are more likely to have busy directors sitting on their boards.

These facts emerged after a more in-depth study by NUS Corporate Governance and Financial Reporting Centre (CGFRC) on the Governance and Transparency Index (GTI).

The GTI database contains 136 S-chips as some companies may not have released an updated annual report at the time of scoring. Each firm can score up to 100 points in the core corporate governance (CG) index.

The mean CG score for 136 S-chips was 36.89, close to the mean score of 36.52 among 300 non-Chinese listings with a market cap of less than $50 million, and not far away from the mean score of 37.26 among 453 non-Chinese listings with a market cap below $300 million.

All three categories of companies have the same median score of 37.

Similarly, there were no major statistical differences on how S-chips scored on board matters compared to small non-Chinese listings with a market cap of less than $50 million or those below $300 million.

Under board matters, S-chips have a mean score of 13.52 versus 13.43 for non-Chinese listings below $50 million in market cap, and 13.8 for those below market cap of $300 million.

In areas of 'remuneration' and 'accountability and audit', S-chips also scored similarly as the typical small caps, with the same median score of 5 and 11 respectively.

S-chips scored a higher mean of 7.79 for transparency and investor relationships, compared to non-Chinese small caps with market values below $50 million that scored a mean of 7.76, but still lower than the mean of 8.12 among non-Chinese stocks with a market cap below $300 million.

But in most categories of the GTI, the maximum scores of S-chips tend to be lower than other small caps. The GTI scores do not capture the robustness of the business model, the governance and management 'culture', ethics, and of course the economic conditions.

Some 47.8 per cent of S-chips have at least one busy director (holding at least six directorships), while the proportion of other small caps with such board profile is about 37 per cent. Those with 'busy' directors include China Aviation Oil, China Essence, China Sky, China Yongsheng and Ocean International.

'To build trust and confidence, particularly amidst the problems involving a disproportionate number of S-chips, S-chips may need to do more - not just do as much as the other smaller companies,' said Mak Yuen Teen, co-director of CGFRC and regional research director for Asia-Pacific at Watson Wyatt.

Prof Mak noted that the biggest change needed may be a mindset change on the part of controlling shareholders to set the tone from the top and to welcome good independent directors (IDs) who are truly able to contribute and challenge their thinking.

'I think trying to get one very good ID would be a good start, and this ID should be given an instrumental role . . . to try to bring about culture change and improvements in those other areas,' he added. 'But the reality is that better directors will need convincing to sit on S-chip boards.'

Market talk has it that some S-chips that have fallen into negative spotlight have difficulties in getting new directors on board.

A case in point is Zhonghui Holdings, which defaulted on a loan and where special accountant PricewaterhouseCoopers found an advance payment of 50 million yuan (S$10.7 million) for an acquisition made without board approval.

Its last ID quit last month, citing difficulty in discharging his duty due to a lack of accurate, timely and complete information from management. No replacements have been appointed so far.

'Companies need to examine who are the members of the audit committee and whether they have the time to make that commitment because they need the time and effort to continually educate the companies on corporate governance,' said Robson Lee, partner at Shook Lin & Bok LLP.

But Mr Lee, who sits on board seven listed companies including Youcan and Qian Hu as an ID, noted that 'busy' is a relative thing.

It is more important that companies bring in directors with the experience of dealing with Chinese companies and an understanding of their culture and way of doing things, instead of a novice who may not add value to the company, he said.

Fewer margin calls now but the trick is to separate winners from black sheep

By LYNETTE KHOO

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(SINGAPORE) S-chips or Chinese listings have seen their market values increase, but analysts are holding back their re-ratings of these stocks as they have largely been driven by the broader market momentum - with uncertainties in the sector still persisting.

'Investors need to be vigilant still, though the general upturn of the market should reduce the margin calls from pledged shares,' said CIMB-GK analyst Ho Choon Seng.

Year-to-date, the combined market caps of 149 S-chips grew 19.8 per cent to $29.14 billion. The Prime Partners China Index surged 25 per cent from the start of this year to 77.1 points yesterday and the FTSE ST China Index put on 17.7 per cent to 218.9 points. This compares to a 25 per cent jump in the benchmark Straits Times Index year-to-date.

UOB KayHian dealing director Chan Tuck Sing noted that the surge in S-chips was largely a result of investors seeking out underperforming stocks to play catch-up with the broad market rally.

'S-chips are generally considered higher beta stocks, so they have rebounded sharply along with the market,' added Kim Eng analyst James Koh.

Analysts feel that perhaps more could be done to assure investors that good companies do exist among S-chips.

Most are still trading at undemanding valuations of below 5 times historical price-to-earnings ratio and less than one time price-to-book (P/B).

Guangzhou Investment Co remains the biggest S-chip by market cap at $3.71 billion, while the rest played musical chairs. Yanlord moves up two places to be runner-up, nudging Cosco Corp off to fourth place. Epure got into the top 10, while China Hongxing fell off the league.

Since the beginning of this year, Yanlord's market cap has doubled from $1.63 billion to $3.23 billion and Yangzijiang's market cap surged 62.6 per cent to $2.7 billion.

Interestingly, Yanlord is also well placed in the Governance and Transparency Index (GTI), an index launched by The Business Times and NUS Corporate Governance and Financial Reporting Centre (CGFRC); of the 676 companies reviewed, it came in 111th.

Midas, ranked 61st on the GTI, enjoyed an 11.2 per cent growth in Q1 earnings and saw its market value jump 24.7 per cent year- to-date to $511.4 million.

The same story could be told for some other S-chips as well, suggesting that investors tend to reward companies for good governance.

But recent scandals in S-chips have caused investors to turn the other way and paint the whole sector with the same broad brush. Mr Chan of UOB KayHian noted that many fund managers got their fingers burnt by S-chips such as FerroChina and Fibrechem. 'These sorts of memories may cause them to avoid such stocks,' he said.

A more significant reason for these stocks falling off the radar of fund managers, however, is that many S-chips - Beauty China, China Energy, China XLX, Delong, Fibrechem and China Sky - have now been reduced to penny stocks.

China Aviation, China Fishery, Cosco Corp and Yanlord are among the handful in the sector that trade above a dollar.

CIMB-GK analyst Ho Choon Seng noted that the free-float in many cases is also quite low since a large chunk of shares are held by insiders.

Some brokerages have slowly shrunk their coverage of these stocks. Westcomb Securities, for instance, has dropped its coverage of S-chips, except for those that come under the SGX Research Incentive Scheme, which is a paid scheme under the Exchange.

CIMB-GK has also dropped seven S-chips from its coverage this year while Kim Eng has stopped covering one or two S-chips.

'The market has certainly lost some interest in S-chips, after corporate governance issues with the likes of Fibrechem and China Sun,' said Mr Koh of Kim Eng. 'Also, some management 'guidance' in terms of plans and profits has proved quite misguided.'

Analysts feel that perhaps more could be done to assure investors that good companies do exist among S-chips.

'While there are black sheep among them, if the communication issue had been dealt with in a more mature manner, we would not have this kind of depressed valuation,' said Alan Lok, director at Sabio Global.

In assessing the valuation of S-chips using the P/B ratio, there is a concern that the accounting book 'may not be the actual book' given the credibility issues clouding the sector, Mr Lok said. 'If we factor in the corporate governance issue, a P/B ratio of 0.5-0.7 times would be a good target.'

There is also the opaque issue of pledged shares. But don't write off S-chips just yet, analysts say.

Henderson Global Investors fund manager Andrew Mattock said he sees 'exceptional value in some of the Chinese property stocks' and favours mid-caps with domestic exposure.

Mr Lok suggests that investors look into S-chips whose earnings have not been badly hit by the crisis - those with a sound business model, good branding and reasonably low valuation.

'I would go into the mid-caps that are on the way to becoming blue chips,' he said.