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4 Companies Poised To Benefit From Hong Kong-Shanghai Link Up
Corporate Digest | 13 October 2014
By: Peter Ng
Articles (81) Profile

The upcoming Shanghai-Hong Kong Stock Connect has gathered a lot of talk recently.

Given the wider range of equities choices, we took the opportunity to list four companies spanning across the gaming, manufacturing, technology and financial sectors that are poised to benefit from the link up.

Sands China (1928.HK)

Since its entry into Macau, Sands China, a subsidiary of Las Vegas Sands, has been climbing up the market share game before ending up in the second place (18 percent) amongst five other casinos operating in Macau, according to FY13’s gross gaming revenue.

Sands China differentiates itself by focusing its operations towards targeting the mass and premium mass player market segments compared to other casino operators which rely more heavily on VIP players. This is logical as a mass market table allows the group to extract a gross margin that is four times higher than a VIP table.

Being the least dependent on the VIP segment since it is mainly targeting the mass market, Sands China will be the most resilient in terms of business operations amidst anti-graft measures that continues to hurt Macau casinos’ gaming revenue from the VIP segment.

Further, its strong free cash flow position along with a low leverage as seen by a falling debt to equity ratio (FY09: 83.5 percent, FY13: 50.1 percent), allows the company to command an annual dividend yield of 4 percent.

Key Statistics
Market capitalisation: HK$340 billion
Return on equity (five-year average): 19.6 percent
Return on assets (five-year average): 10.6 percent
Dividend yield: 4.1 percent
Price to earnings ratio (PE ratio): 19.8 times
Notable peers: Galaxy Entertainment (0027.HK), Melco Crown (6883.HK)

Lenovo Group (0992.HK)

Lenovo Group made its debut into the international markets in 2005 when it first acquired the personal computer business from International Business Machines Corporation, and subsequently Intel Corporation’s server business and Motorola Mobility from Google earlier this year. The company carries the legendary brands of Think and Idea personal computers.

Lenovo became the largest personal computer (PC) maker in 2Q13 when it shipped 12.6 million computer units, besting Hewlett-Packard which came in in second place. The group has rooted its success to two fundamental factors, a strong manufacturing and an extensive distribution channel that dominated the Chinese market. By housing an efficient manufacturing line, Lenovo was able to oust competition by cutting prices of PC equipment by 30 percent to a level where prices are marginally above costs.

While the personal computer industry is one which commands lower margins as seen from the single digit operating margins of Lenovo, the company is well-positioned to tap on growth opportunities in the event of an industry consolidation backed by its financial strength.

Key Statistics
Market capitalisation: HK$119.5 billion
Return on equity (five-year average): 19.2 percent
Return on assets (five-year average): 3 percent
Dividend yield: 2 percent
Price to earnings ratio (PE ratio): 18.4 times
Notable peers: FIH Mobile (2038.HK), ZTE Corporation (0763.HK)

Hong Kong Exchanges and Clearing (0388.HK)

The second largest in Asia, Hong Kong Exchanges and Clearing (HKEX) is a security exchange that operates the securities and derivatives markets and their related clearing houses in Hong Kong. The company generates revenue mainly in the form of transaction costs, which are levied during the process of buying and selling of securities or derivatives via the Hong Kong Stock Exchange (HKSE). HKEX also owns the London Metal Exchange in London, the world’s largest market in options and futures on base and other metals.

With the impending Shanghai-Hong Kong Stock Connect, trading volumes between the two stock exchanges would benefit as mainland Chinese investors are given an additional venue to grow and diversify their funds via investments into the 266 companies listed on HKSE. Secondly, international investors will be able to participate in the economic growth of China for the first time in history, since the inception of the Qualified Foreign Institutional Investors II and Renminbi Qualified Foreign Institutional Investor (RQFII) programmes that only apply to financial institutions.

As the gateway to China, Hong Kong maintains its competitive advantage by bridging international markets which seek to enter the world’s second largest economy via various factors such as the country’s excellent infrastructure, a business-friendly landscape and most importantly its geographical proximity to China. Subsequently, the country’s financial markets will stand to gain in tandem with the potential business growth as activities in the financial markets accelerate, which HKEX will be able to benefit.

Key Statistics
Market capitalisation: HK$198.1 billion
Return on equity (five-year average): 43.5 percent
Return on assets (five-year average): 8.1 percent
Dividend yield: 2 percent
Price to earnings ratio (PE ratio): 44 times

Tencent Holdings (0700.HK)

Tencent Holdings is the second largest internet company in China according to market value after Alibaba Group. The company is principally engaged in providing internet, mobile and telecommunications value-added services, online advertising and e-commerce transaction services. Some of its product offerings are the WeChat messaging application and, one of the largest web portals in China.

The prowess of this company lies in the mobile platform where even Alibaba has acknowledged that the rapidly evolving mobile commerce trend is a significant risk factor in its IPO prospectus. This is because Tencent’s dominant position in the mobile platform, notably WeChat is a force to be reckoned with. Between April and June this year, WeChat has a pool of 438.2 million monthly active users (MAU) mainly from China, compared to Facebook’s WhatsApp’s international base of over 600 million MAU. While boasting a lower MAU, its earnings prowess is way beyond Facebook’s (US$788 million) where Tencent has reported a net profit of US$1.99 billion in 2Q14 that was mainly stemmed from WeChat’s growth.

Although WeChat has been experiencing spectacular growth in China, however, as the application is not free from the Chinese Government’s clutches on censorship, Tencent is facing headwinds to pursue expansion of user base for WeChat outside of Asia.

Key Statistics
Market capitalisation: HK$1,100 billion
Return on equity (five-year average): 34.6 percent
Return on assets (five-year average): 20.3 percent
Dividend yield: 0.2 percent
Price to earnings ratio (PE ratio): 46.1 times

Although not an exhaustive list of companies from the 266 stocks that are participating in the Shanghai-Hong Kong Stock Connect, however, we like these four companies for their strong earnings both in terms of operating profits and cash flow generation coupled with a reasonably low leverage, where stability is key.

Backed by a strong interest in investments, Peter's research spans across a range of industries, with his focus placed on companies listed on the SGX.

Please click here for more information about this author.

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