Newsletter August 2005

Yuan’s Revaluation is Likely to Give Asia a Lift   On a quiet Thursday, July 21st, China scrapped the Yuan's decade-old peg  to the U.S. dollar and shifted to an undisclosed basket of currencies to manage the currency. As part of the move, the central bank revalued the Yuan to 8.11 to the dollar, effectively a 2.1% in crease in the Yuan's value. The rise in the value of the Yuan is small, and the currency might not gain much more in the coming weeks. Still, the Yuan’s un-pegging from the dollar could mark the beginning of a new area for Asia. Under the new scenario, Asian currencies would rise against thedollar , Asian nations would trade more with one another and the region’s economies would flourish under ow interest rates and strong domestic demand. A healthy growth from Asia would give a kick-start to the global economy and boost growth in areas such as Europe or the U.S. Over the long run, Asian currency appreciation will fundamentally change what Asia means for the rest of the world.  For decades, much of Asia’s growth have been fueled by exporting low-cost goods for the developed world. And by doing it, there was a brutal competition among  the region’s exporters to keep costs down, with exchange rates a central part of the equation. But even while China enjoyed some of the lowest costs in the region, maintaining the Yuan's peg was an increasingly costly exercise. China’s central bank had to buy many of the dollars that flooded into the country to keep its exchange rate stable against the dollar. That resulted in a massive build-up of foreign-exchange reserves. While it makes a lot of sense for smaller countries to focus on exports, huge countries like China has huge domestic economy to offset urge to export. If the Yuan keeps appreciating, other Asian currencies are likely to follow suit. Reason being that other Asian countries that were reluctant to lose their competitive-price advantage might not feel that pressure anymore and let their currencies to appreciate, too. If Asian currencies appreciate in tandem, that could stimulate the holy grail of Asian growth: domestic consumption. There are lots of people in Asia but they don’t spend much per capita. With an appreciating currency, consumers have much more buying power abroad and may be induced to spend more on foreign goods, including  U.S. and Europe.   Chinese Earnings Season Kicks In   If the Yuan revaluation was not enough to shake up global investors, earnings from the world’s second largest economy will certainly help. Not that Chinese companies  will deliver too much surprises but whatever is happening there will echo over the ocean. Moreover, this is the time when intelligent investors can separate the darlings from the dogs. Let’s see. We have twenty three NYSE or AMEX listed Chinese ADRs. Most of them don’t disclose quarterly results. Exceptions are Huaneng Power (NYSE:HNP) and Sinopec Shanghai PetroChem (NYSE: SHI) that disclosed results for the first half of 2005already. Others submit partial operating results to the listing exchanges but one can hide too many thing behind partial reports. The picture is rosier at Nasdaq listings. We have twenty four Chinese ADRs listed at the Nasdaq and most of them have already set the date when they will disclose quarterly results. Two of them have already done so, starting with AsiaInfo (ASIA) on July 26 and Sohu.com on July 27. Both were disappointing as they met previous estimates but guided lower. Unless  China Online (JRJC) or Netease.com (NTES) change the trend when they report the coming days, we may face some serious price  erosion of Chinese internet equities as Shanda (SNDA) demonstrated when it dropped nearly ten percent after Sohu’s disappointment.   Yuan Revaluation 101   The fact that the Chinese currency could occupy center stage on Wall Street s a reflection of how much the world has changed. Should China truly allow her currency to float and not to keep it within narrow band against the dollar, the impact on trade and on the world financial system could be huge. It could be weeks before investors get a clear idea of China’s intention. In the sort run, nervousness about China’s plans roiled stock on Thursday, the 21st. So let’s see who are the possible winners and who the losers of the equation. U.S. exporters become more competitive. Reason being that U.S. made goods will cost less in Chinese local currency when selling it for the same dollar amount. So U.S. companies can keep the same dollar price as before yet the product will cost less in Yuan. This effect is making U.S. goods cheaper abroad. Chinese exporters make less in Yuan if they are selling for the same dollar amount. So companies that are selling to Wall-Mart for example will make less in Yuan for the same dollar priced good. Assuming Wal-Mart can successfully pressure smaller Chinese manufacturers to swallow the price decrease in local currency, e.g. Yuan, it will not effect U.S. consumer prices at all. U.S. importers pay more in dollars. Should it be the other way around, e.g. Chinese suppliers will not bulk under pressure and sell the same goods for the same Yuan amount, Wal-Mart for example will have to increase the price of goods in dollars. This is making Chinese exporters less competitive in the global arena and U.S. consumers will pay more. Outsourcing to China costs more. U.S. businesses will pay more for an hour of Chinese labor in dollars even if workers don’t get any increase in Yuan. This is likely to slower capital flows to China and will keep U.S. manufacturing jobs at home. Would be Chinese merger partner spends less. The Yuan revaluation opens  doors for Chinese companies to look abroad. Keeping their books in Yuan, Chinese companies will have more purchasing power in the global arena and will likely to use it as well. Expect more CNOOC-Unocal, Hayer-Maytag like acquisitions to come. To sum it up, the stronger Yuan means that China will benefit on the domestic front as it will spur domestic consumption and will be less vulnerable to global economic climate. In the short term however direct foreign capital investment is likely to slow down because Chinese export will be more expensive and so will be the Chinese labor. Welcome China in the new area.   Stocks and the Revaluation   The Yuan’s 2.1 percent appreciation announced on Thursday, which caught investors around the world by surprise, prompted a gain in the benchmark Shanghai composite index after it propelled airlines and energy stocks higher. We believe that the revaluation will stimulate the consumption and investments in the longer term—supporting stocks—but exporters might feel the pain. Sectors that rely on imports, such as petrochemicals and airlines, will do well. Airliners, which import large quantities of jet fuel and carry heavy dollar-denominated debt from aircraft purchases are likely winners. Export-oriented firms that sell overseas will likely be hurt as they will be less price competitive in the global arena. Here is our list of stocks to watch: PetroChina (PTR), China Petroleum and Chemical (SNP), Jilin Chamical (JCC), China Southern Airlines (ZNH), China Eastern Airlines (CEA).   China’s forex reserves still rising fast   China’s foreign exchange reserves rose $51.9 billion in the second quarter to a record $771 billion. China has the world’s largest stockpile of reserves after Japan’s. In the second quarter it added to its hoard at a rate of $570 million a day, or nearly $24 million an hour. The rise in reserves in the second quarter was a bit bigger than the first-quarter increase of $49 billion, but was dwarfed by the $95 billion surge seen in the last three months of 2004. China posted a trade surplus of $23 billion in the second quarter, while foreign direct investment was about $15 billion. That means other capital inflows accounted for $14 billion of he increase in reserves, down from $19 billion in the first quarter and $55 billion in the fourth quarter of 2004. The rapid growth in reserves complicates China’s efforts to manage monetary policy because the central bank has to issue Yuan in exchange or foreign currencies to maintain the Yuan's value.   Chinese Airliners Got Problems   The Yuan revaluation couldn’t come better for the financially weathered Chinese airliners. Airliners, having much of the debt they owe denominated in dollars, did more than welcome the Central Bank’s move. Yet, both major foreign listed airliners, China Eastern (CEA) and China Southern (ZNH) are trading at a 20 percent discount versus a month ago. What went wrong? Surging jet-fuel prices threaten to wipe out profits of China’s publicly traded carriers, with their combined interim losses exceeding $49 million. The financial pain intensified at the end of July when Beijing announced its third increase since February in the price that Chinese airlines must pay a state-run monopoly for their domestic fuel supplies. Chinese airliners buy the bulk of their fuel from a domestic monopoly, China Aviation Oil holding Co. This will likely result substantial cumulative losses that could crimp the ability of these companies to invest in new aircraft. China’s airlines are burdened by an inability to recoup any of their higher fuel expenses through fuel surcharges on domestic flights. Yet, fuel is the biggest operating cost for Chinese carriers, making up almost a third of what they spend. By year end, China Southern’s debt-to-equity ratio could reach an alarming 380% with others following closely. To access latest Newsletter and other research content, please register!