Are things really as bad in China as you might have been led to believe? The answer to that depends on whom you ask, and perhaps what country you live in. Still, what does it tell you if you get a large brokerage firm upgrading two of China’s top companies on the local exchange?
Credit Suisse decided to raise its ratings to Outperform on both CNOOC Ltd. (NYSE: CEO) and China Life Insurance Co. Ltd. (NYSE: LFC). Both calls came with substantial upside, even if they were not directly made on the American depositary shares (ADSs) that trade in New York.
CNOOC was raised to Outperform from Neutral and the upside translation was for almost 50% upside. Credit Suisse referred to its fresh earnings report from the first half of 2015, signaling that CNOOC’s results beat expectations on cost controls and on a higher dividend payout.
The first-half results were 10% ahead of market expectations, even though the earnings per share portion of the report was down 56% from the same time in 2015. Still, CNOOC raised its dividend payout to 62% from 27% in the same time in 2014. The state-oil company also was shown to be determined to retain this dividend policy going forward, and Credit Suisse thinks that a 5% yield is sustainable at $50 oil.
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Credit Suisse raised its 2015 to 2017 earnings due to lower cost assumptions and on a higher dividend payout. CNOOC was now shown to be Credit Suisse’s top pick within the China oil sector. Its report said:
The first half’s total production rose 13.5% year over year, with offshore China volumes rising 19% led by new project ramp-ups. In addition, the company delivered a spectacular cost-cutting effort which resulted in a 19% yearly decline in operating expenses and 35% decline in SG&A. These are the two key elements that have driven the strong beat.
China Life was also raised to Outperform, but this upgrade was from a prior Underperform rating. The firm’s local price target in RMB also implied almost 50% upside.
China Life’s first-half results came with a strong new business value growth of 39% and demonstrated a strong solvency position. China Life’s value of new business was up 39%, rather than up by 18% or so that was expected, versus 9% in 2014. The company’s solvency position improved further, to 309% from 294% at the end of 2014.
There were some negatives observed as well. The quality of growth was weaker, with agency value of new business margin falling to 52% from 61% in the first half. Also, the 4% guarantee product sold in the first quarter led to an increased interest rate sensitivity. Another issue was that the equity backing ratio increased to 16.9% at the end of June 2015.
Credit Suisse’s local RMB price target was raised to 33 from 32, versus a 21.95 current market price. That was based on an embedded value plus 10 times the value of new business multiple.
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These may not seem like big moves in terms of U.S. ADS trading. That being said, these are huge moves at a time when China is still looking for any solid sentiment and any solid news that it can find.
China Life Insurance saw its ADSs trading up almost 5% at $17.42 in New York, against a 52-week range of $13.39 to $26.29. That ADS was up at $24.00 at the start of June.
CNOOC was the bigger gainer of the two. After an hour of its ADSs trading in New York, the gain was up 11% to $118.10, against a 52-week range of $98.05 to $202.33. This stock was down at $100 just this week, but it was north of $150 in early June.
One caveat thought is that these upgrades are on the heels of earnings reports from the first half (June 30 end). That means that the big concerns brought in the past few weeks were after the period of the report. Still, it might smooth out some of the broad negativity when you consider what these companies talked about going forward.
A second caveat is that these are big Chinese companies. They just might not have the same reporting standards and management may not be held to the same standards on guidance due to such a heavy government involvement. Hey, it is China after all.
The reaction in the ADSs was very positive after earnings and after the upgrades. China’s government buying stocks directly may have a hand in the strength as well.
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