As turnover ratio and margin financing/stock lending balances are expected to have peaked off in China, analysts at CITIC research have downgraded the Chinese brokerage sector to Neutral.
Shao Ziqin and team at CITIC Research in their June 29, 2015 research note conservatively estimate leveraged trades account for 25% of total A-share transactions.
Deleveraging risks will manifest
Ziqin and colleagues note thanks to the crackdown on speculative margin financing, the A-share market in China has dropped 19% from its peak on June 12. They point out that the drop in A-share market dragged the SSE Composite / SZSE Component / ChiNext indices to fall 7.4%/8.24%/8.9% respectively on June 26.
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The CITIC analysts argue that the latest move by the PBoC to trim both benchmark interest rates and the RRR sent out clear signals of authorities trying to shore up investor confidence.
Focusing on margin financing, Ziqin et al. note the financing means ranked in descending order of leverage risks are: (a) private lending (5-20x leverage), (b) umbrella trusts (3-5x leverage), and (c) margin financing/stock lending (2-2.4x leverage).
They note the majority of margin traders funded by private lending have already been forced to sell off their holdings, while 5% of the margin financing / stock lending trades have triggered the red line.
However, the analysts highlight that despite the latest actions from the PBoC, the domino effect suggests the deleveraging trend is irreversible. They note deleveraging risks will manifest through contagion from private lending into umbrella trusts with substantial leverage.
Turnover ratio, stock lending to fall in concert
Highlighting the impact of the recent developments on brokerage stocks, they note turnover ratio, commission rates, balance of margin financing/stock lending and increases in market cap represent key drivers underpinning brokerage stocks during a bull market.
However, amid widespread deleveraging, the CITIC analysts argue that the closely related indicators of turnover ratio and margin financing balance will fall in concert. They note turnover ratio reached a peak of 41.13% at end-May, while balance of margin/stock lending has reached its peak of Rmb2.19 trillion for this year. The analysts also point out that commission rate for the brokerage sector dropped by 22.59% YoY during Jan-May 15.
Keeping in view the above factors, Ziqin et al. have revised their 2015E earnings forecast for the China brokerage sector downward from Rmb234.7 billion (+143.17%) to Rmb 191.4 billion (+98.31%:), and lowered the sector rating to Neutral:
Providing more insight into the sector, the CITIC analysts point out that a number of brokerages have priced their H-share follow-on offerings at steep discounts to their A-share prices. Taking cue from historical data, they note as the sector’s prospective P/E valuation has risen to 3.1x from the average of 2.0x at the beginning of the latest rally, the analysts anticipate the sector will drop correspondingly.
In line with their changes to assumptions used for their 2015E earnings forecast for the Chinese brokerage sector, Ziqin and team have trimmed 2015/16E EPS forecast for various securities firms including Haitong Securities, Huatai Securities, China Merchants Securities, GF Securities, Guosen Securities, and lowered their ratings to Hold. The following chart sets forth the forecast for Huatai Securities: