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Europe holds the key for Chinese stocks in June

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EU_1 June, 2012 (Chinavestor) The month of May 2012 is one for the record books. Considering that the underling fundamentals that drove indexes down for May remain, our estimate for June is not much better. The DJIA (INDEXDJX:.DJI) and the NASDAQ fell the most in two years. The DJIA (INDEXDJX:.DJI) plunged over 6 percent erasing all previous gains for the year just as the chart on this page testifies. Chinese stocks didn't do any better in Hong Kong where the Hang Seng Index (INDEXHANGSENG:.HSI) plunged 12.0 percent in May. It was only Shanghai, where mainland investors didn't pay as much attention to European woes, that fell a relatively modest 1.0 percent for the month. Chinese stocks listed in the US, measured by the China ADR index and calculated by Chinavestor, plunged as much as 7.8 percent in May. The index is in the red for the year as a result of May’s dive.

nl_2012June1

Evidence mounts that China's economy is soft landing and may have a hard time to achieve the desired GDP growth of 7.5% for the year. China's largest trading partner, the European Union, is in disarray ahead of Greece's decisive parliamentary elections in the middle of June. Should euro skeptic parties win the national election, Greece has a good chance of leaving the euro zone with unforeseen consequences for the whole of Europe.

Greece's exit will inevitably lead to deposit runs from other peripheral countries like Portugal, Ireland and Spain, possibly Italy. Such deposit run will surely collapse the banking sector in those countries affected. Given that Italy has the third largest economy in the euro zone after Germany and France, an Italian exit would certainly mean the end of the common currency as we know it. The end of the euro may very well give the kiss of death to any economic growth for the next few years at best, most likely pushing Europe to a double dip recession. America and China are going to be surely negatively affected, hampering economic growth globally. Recent headlines highlight manufacturing slowdown in China not to mention last Friday's enormously disappointing May jobs numbers on the home front. Signs of global economic slowdown are in the wires already, increasing risk aversity. That is bad news for equity investors globally going forward.

But it's not necessarily all gloom and doom. Remember that stock prices climb the wall of worry. This creates opportunities for the intelligent investor.

First of all, it would be a huge mistake taking Greece's exit from the euro zone for granted. While Greeks resent austerity measures associated with the EU, their collective memory of Greece before the euro is still alive. Latest polls suggest that voters might actually favor pro-euro parties despite widespread disdain of the austerity measures and economic decline associated with Brussels.

Europe may also avert a full blown meltdown by accelerating a fiscal union where an euro bond would replace country bonds, thus reducing financing rates by throwing Germany’s and France’s credit rating into the pot.

Should any of these actually succeed, stocks that fell the hardest have a chance to shine the brightest.

nl_2012June2

Looking at Chinese sector performance for May on the chart, it is apparent that capital goods, consumer non-cyclical, services and energy stocks fell the hardest in May. On the other hand basic materials and consumer cyclical stocks outperformed the overall market.

China Ming Yang Wind Power Group (NYSE:MY) plunged as much as 45% in just one month, significantly contributing to the sector’s weakness. The stock fell before earnings and disappointing numbers coupled with a weak outlook just accelerated the decline in the second part of the month. Xinyuan Real Estate (NYSE:XIN) fell 25% on the same time despite a sound quarterly report. This suggests that XIN has a good chance to make a comeback should the macro economic environment improve.

Small cap Synutra International (NASDAQ:SYUT) and Zhongping Inc. (NASDAQ:HOGS) punished the consumer durable sector, stocks that reported not all that disappointing first quarter numbers. Again, both stocks have a chance to make a strong comeback should market sentiment improve.

Large cap Chinese telecoms fell hard, weighing down the services sector. China Mobile (NYSE:CHL), China Unicom (NYSE:CHU) and China Telecom (NYSE:CHA) declined as much as 11.5%, 22.3% and 19.6%, respectively, recording the steepest monthly decline in years. Investors should note that these are another set of quality stocks that may very well come back strong should market sentiment turn around.

The last sector I want to highlight is the energy sector. Disappointing performance of the sector was driven by index heavy weight Petrochina Co. Ltd. (NYSE:PTR), Sinopec (NYSE:SNP), CNOOC Ltd. (NYSE:CEO) and Yanzhou Coal Mining (NYSE:YZC). But it would be a mistake not to pay attention to the relatively liquid Chinese solar sector that suffered extremely heavy blows throughout the month of May. The importance of the sector is that all major players lost 70%-85% of their market value in the last 52 weeks, creating a huge investing opportunity for those companies that will survive industry consolidation.

We created five charts in order to understand what’s happening within the sector. The first two are revenue and net income/net loss charts from 2010 Q1 to 2012 Q1.

solar_revenue2012Q1

Revenues have declined since 2011 for each and every Chinese solar company in our universe. But what separates darlings from the dogs are accumulated net losses since 2010 and liquidity measures as a result of the difficult times.

solar_net_income2012Q1

Suntech Power (NYSE:STP), the world’s largest producer of solar panels, accumulated the most losses by far, in excess of $1.15 billion. LDK Solar (NYSE:LDK) is next with an over $600 million loss not counting latest quarter—the company yet has to report first quarter earnings. Yingly Green Energy (NYSE:YGE) lost just over $500 million, another big number compared to the rest.

But what really matters is liquidity at this point. Who will survive hard times?

solar_debt_to_equity

Investors fled LDK Solar (NYSE:LDK) in the last two weeks of May and for a good reason. The company is one of the highest leveraged in the industry, making debt financing difficult going forward.

solar_cash_ratio

solar_current_ratio

What’s really troublesome for LDK Solar (NYSE:LDK) is that the company has the lowest cash and current ratio, a huge red flag when it comes to liquidity. Unless the company gets a government driven bail out, it is unlikely that it will survive a cash crunch given its low cash reserve and huge debt load. Suntech Power (NYSE:STP) is another company that may fall victim later on given its good sized debt load and low cash reserve.

Liquidity is not an issue for JA Solar (NASDAQ:JASO), Trina Solar (NYSE:TSL). Yingli Green Energy (NYSE:YGE) is another good looking company. Wish you successful investing, Blaze Fabry.




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