Sunday, December 14, 2014

What Just Happened in Hong Kong?

On Monday morning Nov 24th Hong Kong time, the market opened with New Century Group Kong Kong (HK:234) opening up slightly at around HK$ 0.16. But 15 minutes into the trading session, all hell broke loose. The stock jumped to HK$ 0.40! That is a 160% rise! But it was too good to last. After two hours it fell back to around HK$ 0.25, which was still up 66%. There it stayed for the rest of the day.

The spike was ostensibly because of an early announcement that H1 earnings are up 390% yoy which, on the face of it, sounds great, until you realize that still means only 0.65 HK ¢. But I guess some investors didn't bother to download last years H1 to see what the announcement really meant, and bid up the stock to HK$ 0.40. For the next three weeks the stock slowly drifted slower to just HK$ 0.166! The falling chart shows the painful descent.

HK:234 Daily Closing Stock Price

And no, I didn't sell it all at the top! I was napping when it happened! Now that the stock is back to just 10% above the level before all this happened, I wonder how could a stock spike up 150% and then drop 60%. Who could have made such a colossal mistake by buying at such high levels? In hindsight, I am sure I didn't miss some behind-the-scenes event. My theory is it happened partially because some buyers did not understand initially that earnings was just up to 0.65 HK ¢, and partially because of an influx of new buyers from Shanghai through the Shanghai-Hong Kong Stock Connect.

The Shanghai-Hong Kong Stock Connect is a pilot program to help China open up its capital markets. Up until Nov 17, Chinese citizens cannot normally invest outside China, nor can outsiders invest in exchanges in China. When I say China I am referring to mainland China excluding Hong Kong. So many chinese companies list on foreign exchanges to get access foreign capital. Alibaba is probably the most well-known example.

The Connect allows any investor in the Hong Kong Exchange to buy certain securities in the Shanghai Exchange. It also allows qualified investors in China to invest in Hong Kong Stocks through the Shanghai exchange. This is the path for China to be a free capital market. However, there is a caveat. On each day there is a limit of how much Shanghai stocks and Hong Kong stocks can be bought by the other market. And there is also an aggregate limit. The aggregate limit is RMB 300 bil for Shanghai to purchase on the Hong Kong Exchange and RMB 250 bil for Hong Kong to purchase on the Shanghai Exchange. The aggregate limit is like the seating limit in a restaurant. Once the limit is reached, waiting customers have to wait for seated customers to leave before getting service. So, once the RMB 250 bll limit is reached, investors in China can no longer purchase Hong Kong stocks until investors in China sell some Hong Kong shares. This means the maximum outflow of capital from China is RMB 250 bil, which is a just 1% of the total RMB 24 bil market capitalization of the Hong Kong exchange. But this may just be enough to tip stocks significantly higher, like what happened to New Century Group. After all, Chinese retail investors are probably less savvy than Hong Kong investors and are much more prone to speculation. And what happened is clearly a case of speculators gone wild.

The current aggregate quote for purchasing Shanghai stocks is RMB 241 bil out of RMB 250 bil. So, it is at the limit meaning there is still pent up demand for Hong Kong stocks.

The current aggregate quote for purchasing Hong Kong stocks is RMB 235 bil out of RMB 300 bil.

Price HK$ 0.166
Market Cap HK$ 957.82 M
($ 123 M USD)
P/E TTM 16.1 x
Div yield 3.9 %
P/BV 0.65
ROE4.0 %
LT Debt/Equity0.11
New Century Group has three main lines of business. One is cruise lines; they own two cruise ships. But that business is low margin and often not profitable. The other is real estate, mostly hotels in Hong Kong and Singapore. One contributor to the increased earnings was the disposal of a hotel in Indonesia. The company properties are valued at HK$629M. The third line of business is securities trading. The biggest contributor of the increased earnings was fair value gains in this line of business. The value of the cash and securities on the books is HK$993 M. The company's equity is HK$1.5 bil, the market cap is HK$ 957M. Note that the market cap is less than the cash and investments on the books! So a shareholder can pay for his shares with the liquid assets on the books and get the profitable real estate minus a small amount of debt for free!

In hinhsight, I should have sold the shares at HK$ 0.25 when it was trading about book, but no point in crying over split milk. I think the shares now are undervalued because of the price to book ratio. In addition I feel Hong Kong stocks can be a play on a more open China capital market as the events of the last three weeks showed. And finally, I feel the Hong Kong stock market is undervalued in general, so investing in this company is like buying a undervalued close-ended equity fund.

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