Market attention is heating up for the construction of a valuation system with Chinese characteristics

On January 24, at a press conference held by the State Information Office, the State Assets Administration Commission stated “Further research on incorporating market value management into the performance assessment of central enterprise leaders”, “guide central enterprise leaders to pay more attention to the market performance of listed companies they control, promptly convey confidence and stabilize expectations through the application of market-based holdings and repurchases, increase cash dividends, and better return to investors.”

From January 25 to 26, the Securities Regulatory Commission held the 2024 System Work Conference, which emphasized “speeding up the construction of a valuation system with Chinese characteristics, supporting listed companies to improve and strengthen through market-based mergers, acquisitions and restructuring, etc., and promoting the integration of market value into the assessment and evaluation system of central enterprises and state-owned enterprises.” Policy guidance is combined with recent statements from various departments to support the capital market, and attention in related fields has increased markedly.

In the past, the assessment system for central enterprises was mainly based on fundamental indicators. This adjustment means taking into account the dimension of value realization.

Starting in 2019, the State Assets Administration Commission began to gradually improve the central management index system, mainly focusing on fundamental areas, and first proposed a “two profit and one rate” index system including net profit, total profit, and balance ratio; in 2020, it added operating income margin and R&D investment intensity to form a “two profit and three rate” index system; in 2021, it increased labor productivity indicators for all employees to form a “two profit, four rate” system; in 2022, the target task of the “two increases, one control, three increases”; in 2023, the “one profit and five rate” index system was proposed, that is, using net assets The yield replaces the net profit index and the operating income margin index with the operating cash ratio to improve the efficiency of enterprise equity capital investment and output efficiency and cash flow safety.

From a value assessment perspective, the State Assets Administration Commission previously stated in the “Work Plan to Improve the Quality of Listed Companies Controlled by Central Enterprises” that it “encourages central enterprises to explore incorporating value realization factors into the performance evaluation system of listed companies”. This study clearly states that market value is an important indicator of value realization, and is expected to be included in the assessment of central enterprise leaders, linking the development of central enterprises to changes in the market value of their listed platform companies, and giving the market a certain weight to optimize the management effectiveness of central enterprise leaders.

We believe this will help guide central enterprise leaders to pay more attention to management efficiency while also paying more attention to shareholders' interests. It is hoped that they will explore diversified market value management methods such as increasing holdings, repurchases, and dividends, which is of positive significance in improving shareholder returns of listed central enterprises.

The integration of market value management of central enterprises into the assessment system is a key part of the construction of a valuation system with Chinese characteristics.

The report of the 20th National Congress of the Party profoundly explained the scientific connotation of Chinese-style modernization. In this context, in November 2022, the Securities Regulatory Commission proposed “exploring the establishment of a valuation system with Chinese characteristics to promote better use of market resource allocation functions.”

We believe that from a structural point of view, the valuation of A-shares is uneven, which is reflected in the long-term undervaluation of some banks and state-owned listed companies. The level of valuation directly reflects the market's recognition of listed companies, as well as future fundamental expectations. We believe that the results of the state-owned enterprise reform over the past ten years are clearly reflected in improvements in the fundamentals of central enterprises, significant increases in profit margins and profitability, relief of debt problems, and improvements in free cash flow. However, valuations have declined further and are at a lower level. Not only are valuations discounted compared to private enterprises, but they are also significantly lower than leading overseas companies. It may also reflect investors' considerations on the mid-term growth, governance mechanisms, and information asymmetry of central enterprises.

This study incorporates market value management into the performance assessment of central enterprise leaders, and is expected to become a key link in solving valuation structure issues. In the medium to long term, central enterprise leaders may be motivated to further optimize corporate governance and increase market-based mechanism development, such as

1) Increasing efforts to give back to shareholders, moderately increasing dividend ratios and stock buybacks is beneficial to boosting investor confidence and optimizing capital structures. Especially in the current environment where growth is relatively scarce and interest rates are declining, companies with high-quality cash flow and stable dividends are receiving more attention from the market, and an increase in dividend rate centers will also enhance the valuation center of enterprises.

2) Promote factor productivity improvement through various capital operation methods and obtain new growth points, such as strategic restructuring, specialized integration, and spin-off and listing;

3) More market-based methods to improve incentive efficiency, such as equity incentives, employee shareholding, etc.;

4) Listed central enterprises actively communicate with the capital market to improve the quality of information disclosure and the problem of information asymmetry, which also helps improve investors' perception of enterprises.

After experiencing a recent market recovery, listed central enterprises are still clearly undervalued, making them attractive for investment.

Since the end of 2022, stock prices of central enterprises have shown relative performance, and valuations have been repaired to a certain extent. However, as of January 26, the overall PE (TTM) /PB valuation of listed state-owned enterprises was 11.65X/1.03X, and the overall PE (high in 2023 was 11.2X/1.04X). In comparison, the valuation of non-state-owned enterprises was 30.0X/2.06X. Currently, listed central enterprises are still in a broken state. The dividend ratio is as high as 3.5%, which is still very attractive for investment compared to other sectors.

From within the industry, central enterprises in most industries also have net market ratio valuation discounts compared to non-state-owned enterprises. Compared with top enterprises in various overseas industries, there is still room for improvement in the overall market capitalization volume in the fields of state-owned banking, construction, oil and gas, telecommunications, and coal, which we focus on, and net market ratio valuations generally have discounts. The reasons for the valuation discount in various industries are different. The ROE of banks and construction is not low, but the PB discount is obvious, which may be related to differences in perception of book value; the PB valuation discount for telecommunications, oil and gas basically matches the significantly lower ROE.

Currently, large central enterprises such as coal, oil and gas, and telecommunications are generally rich in cash, and have relatively low balance ratios. They have the conditions to increase dividends and repurchases to optimize capital structure and increase ROE and market value; the key to construction central enterprises may be to solve the problems of high share of accounts receivable and relatively poor cash flow.

The valuation market value of listed central enterprises has room for continued recovery, focusing on three investment ideas:

1) State-owned enterprises with relatively low capital expenditure and good free cash flow can support state-owned enterprises with stable and high dividends, or state-owned enterprises that currently have a relatively high share of cash assets but low dividend rates, and have the potential to directly increase the level of dividends;

2) The current valuation or market value level is at a historically low level, and the level of cash flow or cash assets is sufficient to support stock repurchases. In particular, central enterprises that have taken stock repurchases may be more aware of this aspect;

3) Expected investment opportunities with expectations of mergers, acquisitions and restructuring, focusing on opportunities for central enterprises in strategic emerging industries, including implementing strategic restructuring and new central enterprise formation, and promoting specialized integration.

Chart 1: State-owned enterprise reform roadmap since 2013

Chart 2: In 2024, the State Assets Administration Commission will maintain the “one profit and five rate” target management system, which specifically requires “steady growth of one profit and continuous optimization of five rates”

Chart 3: Local state-owned enterprises/central enterprise PE (TTM) are 15.3x/10.0x respectively

Chart 4: Local state-owned enterprises/central enterprise PBs were 1.3x/0.9x respectively

Chart 5: State-owned enterprises in most industries have larger discounts compared to non-state-owned enterprises

Chart 6: Valuations of key large banks and central enterprises are clearly discounted compared to leading overseas companies

Chart 7: Large central enterprises in the banking, construction, telecommunications, and petroleum and petrochemical industries generally have PB valuation discounts compared to overseas leaders

Chart 8: Large-scale share repurchases by central enterprises since 2019

Chart 9: Sorting out large-scale major asset restructuring cases of central enterprises since 2019 (incomplete statistics)

Editor/Jeffrey