Small/Mid Cap Strategy and Stock Picks - the DBS Vickers ...

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Regional Small/Mid Cap Strategy Q2 2008 Country Assessment Hong Kong / China Navigating through rough seas in Q2 Given the uncertain international economic environment for 2008, investors have mostly focused on large capitalization and liquid stocks with defensive value. Mid/small cap companies may hardly out-perform, unless they are (i) more leveraged towards domestic consumption in China, (ii) less vulnerable to overseas economic shocks, such as telecom and infrastructure, or (iii) in industries supported by government policies, e g. environment-related. The Hong Kong Market continued to slide in 1Q 2008, with HSI down by19.2% from end-2007, as investor confidence continued to be undermined by fresh news of the troubled US financial sector, uncertain economic outlook, and rising raw material prices. The downfall of financial institutions, such as Bear Stearns, further fueled investor pessimism. Despite the bleak atmosphere, we believe there are still potential outperformers in the small/mid cap universe that are reasonably priced. We like Sino Biopharmaceutical, ZTE, Fortune REIT and Beijing Jingkelong, and Wumart. These stocks trade on attractive valuation and some offer dividend yields in excess of 5%. They are less affected by external economic uncertainty. . Dennis Lam · (852) 2971 1922 · dennis_lam@hk.dbsvickers.com Page 20 www.dbsvickers.com Refer to important disclosures at the end of this report
Regional Small/Mid Cap Strategy Q2 2008 Country Assessment MARKET OUTLOOK Review of 1Q08 In 1Q08, the Hang Seng Index continued to slide to below 22,000 near the end of March, from 27,812 at end 2007. But profit-taking and general risk aversion towards riskier smaller/mid caps again saw the HS Small Cap Index undeperform the HSI since January. And negative news flow from liquidity problems for some overseas financial institutions in mid-March further scared investors away from mid/small cap companies.. HS Small Cap Index vs HSI Rebased (1 Oct 07 = 100) 105 100 95 90 85 80 75 70 65 HS Small Cap Index Hang Seng Index Jan-08 Feb-08 Mar-08 Source: Bloomberg The turnover of small/mid caps in Q1 2008 relative to total market turnover shows much reduced activity than a year ago. The flight to quality behaviour in the market also resulted in a widening valuation gap between big and small/mid cap stocks in Q1 2008. For 2Q08, we expect small/mid cap stocks’ performance to remain suppressed for the same reasons as the previous quarter, which include : 1) US sub-prime impact on the economy. The US financial market is facing unprecedented challenges. As house prices fall and defaults on mortgages continue to rise, the impact will certainly not be contained in the financial sector alone. The resultant impact on the economy could weaken demand, which can have negative implications on Asian exporters. 2) China’s heightening austerity measures to cool down demand, particularly in the property sector. Despite robust growth in domestic consumption, the austerity measures could stunt growth of some sectors, such as industrial, and properties. 3) Risks of rising raw material costs. Costs of raw materials, labour and utilities have been skyrocketing, which have been hitting the margins of many companies, especially those without economies of scale or strong franchises. In short, companies that are exposed to external risks or are targets of austerity policies will remain under pressure, despite the now depressed valuations. Confidence is unlikely to recover in the short term until there is clearer visibility of the magnitude of the impact of a US slowdown and China’s tightening measures. Small Cap Turnover as % of Total Market Turnover 50% 45% 40% 35% 30% 25% 20% 15% 10% Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 Source: Bloomberg Page 21
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