Beijing Jawboning Boosts Fanhua and its U.S. Listed Brethren

Lately China’s President Xi Jinping is sounding more like a fervent capitalist than the leader of the largest communist country in the world.  In early July 2020, his government published an editorial in the state-owned China Securities Journal extolling the merits of the ‘wealth effects of the capital markets’ and the potential for a bull market.  Individual investors appeared to have heard the call loud and clear.  The Shanghai Composite Index jumped 5.7% in the first day of trading following the article’s debut.  

The Shanghai Composite Index represents a RMB 32.7 trillion (US$4.7 trillion) in market capitalization and is thus an excellent proxy for China’s equity market.  The index has risen 27.6% over the ten years from early July 2010 up through the last trading day before Beijing dropped its editorial comments.  Except for a significant bubble that peaked in June 2015, the index had experienced few trading sessions with gains as significant as that triggered by Beijing’s bravado.

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Created in 1995, the Shanghai exchange is at an early stage compared to other exchanges around the world.  Approval to trade is still time consuming and a costly exercise.  Consequently, China companies have looked outside the country for posting public shares.  Indeed by early 2020, there were over 150 Chinese companies listed on major U.S. exchanges with a combined market capitalization near US$1.8 trillion.

We wondered what happens to the stock price of these companies with their operations entwined in China’s economy, but their stocks bobbing on the waves of a stock exchange on the other side of the world.  Does Beijing’s bullish talk echo around the world? 

To answer that question we looked at a group of 39 consumer services companies that we have used as comparables to value a company in our coverage universe, Fanhua, Inc.(FANH: Nasdaq), an independent insurance agent catering to middle market consumers in China.  Like Fanhua these companies provide financial, education and wealth management services to the very individuals Beijing was targeting in its investment editorial.        

Closer Look at Beijing’s Bull Case

 ‘Jawboning’ the stock market higher is not unfamiliar to U.S. presidents.   The occupant of the White House in Washington D.C., Donald Trump, spent much of February 2020, trying to talk the U.S. stock market higher and the U.S. Federal Reserve benchmark interest rate lower.  True enough the Federal Reserve cut its rate to zero in early March 2020.  However, whatever gains appeared in U.S. stock prices were ultimately wiped away by a widespread and deep correction later in the month as U.S. traders reacted to the coronavirus threat and lack of a national response to minimize its spread.

The success of Xi Jinping’s administration in moving China’s nascent stock market is enviable.  Beijing’s editorializing on the stock market may be getting better results at least in China because it follows directly on the heels of coordinated government economic stimulus plans.  There is also the appearance of at least temporary control of the coronavirus pandemic in China. 

With most people sequestered away in their homes during the first three months of 2020, the Sleeping Giant became more reality than fable.  In April 2020, China reported that its first quarter gross domestic product had contracted by 6.8% from the same time in the previous year.     Even though anticipated, the news was still hard to receive given that China’s economy had not contracted even once in over 40 years.  As reported by the People’s Bank of China, retail sales of consumer goods appeared to lead the way down with a 19% year-over-year reduction. 

With the bad news already out, in mid-May 2020, Beijing announced a massive government stimulus program composed of RMB 3.6 trillion (US$500 billion) for tax cuts, rent reductions and infrastructure spending.  The government has also pledged to create nine million new urban jobs. 

Spending promises are probably not enough to inspire China’s investors.  Confidence that the worst of the health crisis is in the rear view mirror may also be necessary.  On July 6^th, the day of Beijing’s stock market editorial, the country reported just four new diagnosed cases and no new deaths.  In the days that followed the statistics remained impressively low even as certain localities such as Anxin county in Hebei province had to reinstate lockdown orders in response to a cluster of coronavirus cases sprouted in mid-June.

Fate of Fanhua and its Comparable Group

Tax cuts, rent reductions and new jobs strike directly at consumer spending and that very  important middle market customer of Fanhua and our comparable group companies.  An earlier article “Fanhua Targets Burgeoning Middle Class Chinese Consumer” published in July 2019, made note of the opportunity in China's underserved insurance market.  

Fanhua shares have risen 26.6% over the last two months, we believe in part due to growing optimism among shareholders and traders for the company’s prospects with a recovering China consumer.  Collectively, Fanhua and the group of 39 comparable companies have averaged 80.1% share price increase over the last two months.    This compares to a more tepid 5.1% increase in the S&P 500 Index and 11.9% increase in the Nasdaq Composite Index in the same time period.  (A full list of companies in the comparable group and details of recent fundamental and stock price performance is available is available here.)

It is expected that no matter where a stock trades long-term economic trends and far reaching government policies would impact a company’s value.  However, our question relates to particular remarks made by politicians in a company’s home country.  U.S. stock markets opened as China’s business day had already turned to evening, giving Yankee traders plenty of time to catch morning headlines from Beijing.

Fanhua closed 5.7% higher in the first trading session following Beijing’s editorial.  This was just a pinch better than the 5.4% increase of the 40 companies as a group (Fanhua plus the other 39).  Indeed, only 3 of the 40 experienced a decline in price on the day.  In the same session the S&P 500 Index rose 1.0% and the Nasdaq Composite Index increase 2.2%.  There is a myriad of factors that contribute to stock prices.  However, the comparisons suggest that Beijing’s voice was indeed heard by traders around the world, droving stock prices ‘on Wall Street’ as well as in Shanghai.  

Lessons for Investors in China Companies

Our analysis is more broad brush than a definitive study on China policy makers’ influence on stock prices.  Nonetheless, it appears investors would be well advised to keep an ear tuned carefully to Beijing to catch potential up or down drafts.

There may be another important take-away from the price movement of Fanhua and its fellows in the consumer sector.   Our investment thesis in FANH is based in part on company’s lead in adopting ‘insuretech’, the migration to digital technologies to facilitate access to insurance and wealth management products.  Even before the coronavirus pandemic and the government’s lockdown policies drove China’s consumers to their computers for everything from toilet paper to banking, Fanhua had invested in network systems for agents to manage their work on network platforms as well as to let customers complete insurance policy purchases online. 

Within the comparable group we observed better stock price performance by those companies self-identified as having an online capacity for at least part of their business processes.  As a subset the ‘online’ group (Fanhua included) experienced an average 102.0% price increase since May 2020, compared to an average 56.7% price increase by those companies that have no online capacity.  Of particular note in this group is China Online Education Group (COE:  NYSE), and China Finance Online Co. (JRJC:  Nasdaq), a financial data provider. 

Being able to land on their feet in a pandemic threatened environment seems to have worked for some of the China companies listed in the U.S.  That is certainly the case for Fanhua.  With networks and Internet platforms already installed before China’s lockdown orders were issued, Fanhua was able to keep agent recruiting, training and sales activity up and running even as many of their competitors were idled. 

Of course, earnings performance still dominates in driving stock prices.  The group with online capacity has also experienced better revenue growth performance with average sales growing nearly five times faster in the most recently reported quarter than the rest of the group relying on brick and mortar or in-person practices.  Notable in terms of topline growth was Vipshop Holdings (VIPS:  Nasdaq), an online retailer of discount consumer goods, and LexinFinTech Holdings (LX:  NYSE), an online consumer finance platform. Both experienced exceptional growth in the first months of 2020.   

The chink in our case for the superiority of the group with online capacity lies in profits and not growth.  Fanhua has maintained a strong operating profit margin near 12%, while the rest of its peer group with online capacity clocked in at 9.9% average operating profit margin over the last twelve months.  However, the group with conventional business models averaged a significantly higher 14.3% operating profit margin.  Thus is appears that the benefits of shifting at least some business activities to an online platform has translated to capture of market share, but operating efficiency may be yet to follow.

Conclusion

Beijing clearly has the ear of investors far and wide.  However, it may still be underlying fundamentals that have the greatest influence over company valuations and stock prices.  To that end the usual ‘blocking and tackling’ of operational issues is more likely than not to lead to long term success.  That makes companies like Fanhua and others in its peer group of consumer services with proactive modernization strategies more appealing than others for long-term stock ownership.

    

 

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

Underwriters of the Prime series may have a beneficial interest in, serve as agents of, or act as advisors to the companies mentioned herein.