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China plays: Impact of interest rate rise

In China on 25/10/2010 at 5:25 am

China  announced an unexpected increase of its key interest rates by 0.25 percentage point last week.

Local stockbroker DMG says

Some of the corporates we follow will be positively impacted by the interest rate hike:

There should be a net positive impact on China Essence Group (unrated) with higher borrowing costs likely to be more than offset by savings from US dollar- and Hong Kong dollar-denominated debts. China Essence is a potato starch manufacturer and derives most of its revenue from China’s domestic market. Interest-rate and foreign-exchange risks pertain mainly to its 690 million yuan (S$135 million) in outstanding debts, consisting of a US$50 million short-term bank loan; 90 million yuan in working capital loans; and HK$250 million (S$42 million) in zero-coupon convertible bonds due in December 2011 (with repayable amount at HK$378 million). With a significantly smaller yuan-denominated debt, we see net positive foreign exchange impact on weaker USD and HKD.

Gross margins expansion for C&O Pharmaceutical Technology (‘buy’, TP: S$0.62). C&O’s sales and operations are mainly carried out in China. However, the purchasing costs of its exclusive products (eg, Amoxycilin, Meiact, Europharm cough syrup) are denominated in US dollars. Exclusive products made up 66 per cent of total sales in FY2010 (the year to end-June). Hence, as the yuan appreciates, this would help expand its gross margins. For FY2010, C&O achieved gross margins of 63.3 per cent. We are maintaining our ‘buy’ recommendation on C&O, as we expect its growth momentum to continue, supported by government spending on China’s healthcare industry and the ageing population. Our TP is based on 13 times FY2011 PE, which is a sharp discount to its China-listed peers.

The impact is muted for the following stocks:

ComfortDelGro Corp (‘buy’, TP: S$1.74) – A stronger yuan could contribute to translation gains, but the impact is small as China accounts for only 13 per cent of Ebit. Valuation remains cheap at only 14 times PE.

Hong Leong Asia (‘buy’, TP: S$4.88) – The bulk of its China business is not interest-rate sensitive, eg, refrigerators are sold in cash, and not via hire-purchase. The marginal negative impact on sales of diesel engines would not affect its overall earnings much.

Keppel Land (‘buy’, TP: S$5.00) – KepLand’s China exposure is mainly in government-supportive township projects, and its projects were secured at low costs. It remains a play on the rebounding Singapore office sector.

Noble Group (‘buy’, TP: S$2.24) – Imports of hard commodities into China may weaken due to lower investments, but this could be offset by increased imports of soft commodities as prices in yuan fall. We like Noble for its acquisitions, such as Sempra Energy Solutions, which make its earnings more defensive.

OSIM International (‘buy’, TP: S$1.57) – OSIM uses third-party original equipment manufacturers in China to manufacture all their massage chairs and nutritional supplements. We do not foresee any large impact from the yuan appreciation, as a large portion of sales are in China, but there may be a slight compression in margins for export sales.

The following companies will be adversely affected:

CapitaLand (‘neutral’, TP: S$4.33) – The unexpected rise in Chinese interest rates, coupled with our prognosis of an upcoming trial property tax, points to unreceding policy risks within the broad Chinese real estate sector. We believe this will continue to cap share price upside, given CapitaLand’s 35 per cent RNAV exposure to China (the highest among the Singapore developers), of which 20 per cent is mid- to high-end residential. Further, its planned launches in Shanghai could be delayed. China government’s policy concerns could keep the share price sideways.

China Minzhong (‘buy’, TP: S$1.78) – A stronger yuan could lower export sales to the US and Europe, which are its main export markets.

Fuxing China Group (‘buy’, TP: S$0.255) – Exports account for 30-50 per cent of revenue, and a strengthening yuan is not a positive.

Sino Grandness Food Industry Group (‘buy’, TP: S$0.50) – 70 per cent of revenue is derived from overseas markets.

Yangzijiang Shipbuilding Holdings (‘buy’ – under review, TP: S$2.02) – More than 90 per cent of shipbuilding revenue is from overseas customers. Margins will narrow as sales are in US dollars and costs in yuan.

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