CICC released a research report saying that the profit of overseas Chinese stocks increased by 1% in 2023, the downstream consumer sector improved, upstream performance such as raw materials and energy was poor, and the technology sector was divided.

In the first quarter of 2024, the nonferrous, energy, education, and telecommunications sectors boomed, and technology hardware performance may still be under pressure. Based on the actual growth situation in the first quarter, CICC slightly raised its 2024 profit forecast from 4.5% to 5% under the benchmark situation, but it is still lower than the current market's consensus forecast of 10%. Mainly considering that profits for the full year of 2024 have been repaired but endogenous motivation is insufficient, progress in implementing subsequent policies is still the key.

The market may turn volatile in the second quarter, and re-inflationary transactions represented by the procyclical cycle may cool down, and dumbbell allocations and high dividends may make a comeback.

The main views of CICC are as follows:

1. Overall situation: Profits increased slightly in 2023. Raw materials, energy, etc. are the main drag, and consumption and utilities are highlights

Overseas Chinese stocks (Hong Kong stocks, Chinese stocks and US Chinese securities) have basically completed the disclosure of their 2023 performance reports. The bank summarized the quarterly and annual report results of nearly 400 overseas Chinese stocks from the bottom up. Looking at the details,

The profit of overseas Chinese stocks increased by 1% in 2023, low and high from beginning to end. Recovery from the pandemic in 2023 fell short of market expectations, mainly due to insufficient private sector willingness to ease credit and fiscal contraction year on year. As a result, overall credit expansion was limited, and leniency could not be transmitted to easy credit, further reducing growth and return on investment, causing negative feedback.

As a result, on the basis of negative profit growth of -4.6% in 2022, profit continued to decline -1.8% year on year in the first half of 2023. Driven by intensive real estate finance and other policies in the second half of the year, the year-on-year increase recovered to 4.7%. For the whole year, profits from overseas Chinese stocks in Hong Kong dollars increased slightly by 1%.

The downstream consumer sector improved, the upstream performance of raw materials, energy, etc. was poor, and the technology sector was divided. Affected by factors such as declining PPI, corporate inventory removal, and falling commodity prices, upstream sectors such as raw materials (profit growth rate of -30.6%) and energy (-11.6%) did not perform well, and capital goods fell -6% year on year.

The IT sector's profit growth rate changed from negative to positive, with profit growth of 10.2% in 2023. Among them, technology hardware was boosted by consumer electronics profit recovery as the main contribution (+53.2%), but the software services sector continued to lose money, and the semiconductor sector's growth rate declined sharply (-31.3% vs. 8.1% in 2022). Real estate profits fell sharply. Double-digit e-commerce growth (+70.1%). Utilities maintained steady double-digit growth of 15.5%. The improvement in healthcare profitability (+2.6% vs. -15.3% in 2022) was mainly driven by biotechnology.

2. Growth drivers: The decline in revenue reflects weak demand, and costs drive improved profit margins

Further focusing on the non-financial sector, although revenue growth declined to 0.4% (+6.6% in 2022) due to falling prices in 2023, reflecting a decline in overall demand, the net profit margin recovered, rising from 4.2% in 2022 to 4.5% in 2023.

The decline in revenue reflects sluggish demand. The revenue growth rate of the non-financial sector fell to 0% in 2023, mainly driven by sectors such as information technology, energy, and raw materials. Upstream sectors such as energy (revenue growth rate of -10.4%) and raw materials (-5.8%) declined significantly, while software services (-6.0%), technology hardware (-4.6%), and semiconductors (-1.3%) were also relatively low, driving the IT sector's revenue down 4.1% year on year.

The optional consumer and industrial sectors are the highlights. Revenue in 2023 increased by 14.7% and 4.8% respectively. Among them, revenue growth in the optional consumer sector was mainly driven by consumer services (+28.3%) and automobiles (+22.0%), while revenue growth in the industrial sector was mainly supported by the transportation sector (+19.5%).

The cost side benefited from an improvement in commodity price declines. Cost reduction supported the net profit margin by 0.3 ppt to 4.5% compared to 4.2% in 2022. Net profit margins for semiconductors (-4.6ppt) and raw materials (-1.2ppt) declined; net profit margins improved in most other sectors, such as downstream consumer services (+10.2ppt), media entertainment (+6.5ppt), and technology hardware (+2.2ppt).

In terms of costs, financial expenses such as taxes and interest expenses for Hong Kong stock listed companies rose overall in 2023. Although the benchmark interest rate declined, due to changes in factors such as corporate credit levels and guarantee conditions, the actual financing costs of enterprises may not have decreased, causing the company's interest expenses to rise. However, at the same time, commodity prices declined, and overall inflation declined in 2023. CPI fell 1.76% from 2022, PPI fell 6.82%, and the gap with CPI widened. While responding to sluggish demand, it also improved profit margins in some downstream sectors by reducing costs.

3. Quality of growth: The decline in asset turnover and leverage ratios is dragging down ROE, corporate deleveraging and inventory removal

ROE fell from 11.4% in 2022 to 9.6% in 2023. Among them, the financial sector ROE fell to 10.7% from 13.2% in 2022; non-financial ROE fell from 9.3% to 8.5%. According to DuPont's analysis, although the net profit margin increased, the leverage ratio fell from 364% in 2022 to 343%, and the asset turnover ratio fell from 58% in 2022 to 49%, all of which dragged down ROE.

Both the leverage ratio and asset turnover ratio have declined, indicating that enterprises lack the will to invest and expand credit when the relative return is low, making it difficult for enterprises to obtain new profit growth points, and profitability is limited. At the sector level, RoE in the optional consumer, utilities, and telecommunications sectors expanded by 4.4 ppt, 2.5 ppt, and 0.9 ppt respectively; the transportation, information technology, and energy sectors declined by 8.1, 6.8, and 4.2 ppt, respectively.

In terms of leverage, leverage ratios declined in most sectors. The increase in the leverage ratio for capital goods in 2023 (+66ppt); the leverage ratio for real estate assets fell 60ppt, and the leverage ratios for information technology, essential consumption, and raw materials declined by 19, 13, and 13 ppt, respectively. Meanwhile, the net gearing ratio (net gearing) fell from 58% in 2022 to 45% in 2023, further indicating the reduction in the size of corporate debt and insufficient willingness to invest and expand.

In terms of cash flow, operating cash flow in the non-financial sector increased 3% in 2023, down from 6% in 2022. Expected lower return on investment and insufficient domestic demand momentum have led to limited willingness to invest, poor performance, and a decline in operating cash flow growth. At the same time, in the context of inventory removal, inventory and inventory sales ratios continued to decline. Corporate accounts receivable were reduced by 4% in 2023, and cash flow management was more careful.

4. Growth prospects: 1Q24 non-ferrous, energy, education, and telecommunication boom improved; slight increase to 5% for the full year of 2024

Hong Kong stock earnings recovered slightly in the first quarter of 2024. Currently, less than 5% of overseas Chinese stock companies have disclosed their results for the first quarter of 2024. FactSet markets agree that MSCI China's profit for the first quarter will increase 5% year-on-year, up from the end of 2023. In terms of sectors, sectors such as industry, communication services, and information technology contributed the most to profit growth, contributing 2.18%, 1.83%, and 0.72%, respectively. Raw materials (-0.62%) and real estate (-0.21%) remained the main drag.

The boom in the non-ferrous, energy, education, and telecommunications sectors is rising, and technology hardware performance may be under pressure. The bank combined the opinions of CICC industry analysts and consistent market expectations and found that:

1) Demand in the non-ferrous metals sector recovered in spring, asset allocation was skewed towards the resource sector due to increased uncertainty about the geographical situation. The performance of related targets such as gold is likely to exceed expectations, and profits are expected to increase significantly year-on-year;

2) The oil and gas sector has benefited from OPEC's extended production cuts and improved oil price expectations, and the company's performance may improve year over year.

3) The thermal power sector turned losses into wins. There were improvements over the same period last month, and the trend was better than expected.

4) The education and training sector has been repaired as a whole, and the software service sector has benefited from the gradual implementation of AI-related applications or improvements in industry prosperity;

5) The telecom sector continues to benefit from steady returns and defensive attributes, and some leading telecom companies say they will gradually increase their dividend ratio;

6) The technology hardware sector's performance may decline due to the pressure on the overall performance of the consumer electronics sector.

Looking ahead to the full year of 2024, profits have recovered but endogenous motivation is insufficient, and progress in implementing subsequent policies is still the key.

Since the beginning of the year, despite some correction in fundamentals, the MSCI China Index's profit forecast for 2024 has been lowered by 3%. Among them, profit expectations for the consumer services (+21%) and food retail (+17%) sectors have increased more, while profit expectations for the biotech (-27%), semiconductor (-26%), and real estate (-24%) sectors have declined more. The current market forecast is expected to grow by 10% for the full year of 2024. Although the forecast for the first quarter was slightly raised, the full-year forecast is still lower than at the end of 2023, which may indicate that the market still lacks confidence in the prospects for restoration throughout the year.

Based on the actual growth situation in the first quarter, the bank slightly raised the 2024 profit growth forecast from 4.5% to 5% under the benchmark situation, but it is still lower than the current 10% consensus forecast, mainly considering:

1) Endogenous growth momentum is still insufficient. The March CPI and PPI data fell short of expectations. The “crackling” between PPI and PMI driven by new export orders indicates export recovery or “price in exchange for volume”. Recent real estate and high-frequency data have also not performed well. Weak monetary and credit data indicate that capital for enterprise revitalization is still weak;

2) Fiscal policy, which is a key driver of credit facilitation, is progressing slowly. In March, government bonds decreased by 138.3 billion yuan over the same period last year, local projects started slowly, the issuance of local special bonds slowed down, and the transformation of finance to social finance and the real economy will still take time;

3) Expectations for the Fed to cut interest rates have converged to less than two interest rate cuts during the year, which will also limit the central bank's room for short-term easing. The bank suggests focusing on sectors where the profit growth rate is expected to be high (20% or more) in 2024 and a significant improvement from 2023, such as automobiles, consumer durables and clothing, food and beverages, healthcare equipment, and raw materials.

From a market perspective, the bank reiterated the view that the second quarter might turn volatile. Reinflation transactions represented by the procyclical cycle may cool down, and dumbbell allocations and high dividends may make a comeback. The bank advises investors to pay attention to the expectation that the Federal Reserve will cut interest rates in the middle of the year and whether the Politburo meeting can be a turning point for further policy increases.

editor/tolk