Small/Mid-Caps Sector update(2015-05-05)

Small/Mid-Caps Sector update

Haitong International Research Limited

Position ahead during current liquidity drive

Maintain Overweight sector rating. Since the announcement《公开募集证券投资基金参与沪港通交易指引》made by the China Securities Regulatory Commission (CSRC) on March 27, 2015 that allowed mainland mutual funds to invest in Hong Kong shares through the Shanghai-Hong Kong Stock Connect (SHKSC), the Hong Kong market has reacted highly positively in the past month. The HSI is up 15% since the announcement, while the Hang Seng Composite MidCap Index (HSMI) and Hang Seng Composite SmallCap Index (HSSI) have further outperformed, up 26% and 32% respectively. With the newfound liquidity in the market driven by domestic capital, we believe this could serve as a major re-rating catalyst for small/mid-caps.

Three major expectations from SHKSC to serve as catalysts. We expect in the not-too-distant future that there will be three extensions to mutual market access, including opening up the Shenzhen Stock Exchange, an expansion in eligible stocks to include small-caps in the HSSI, and the relaxation of the current investor eligibility requirement. We believe this makes sense given Shenzhen’s high average daily turnover and as its predominantly retail investor base is small/mid-caps and momentum-trading driven. Therefore, we think our above assumptions are likely to be implemented and that investors should position ahead in the small/mid-caps sector.

China uncertainties may divert attention to small/mid-caps. Another reason why we think the sector should be a focus is that while the overall Hong Kong large-cap market has performed well in 2015, we believe it has been largely driven by abundant liquidity rather than a positive change in fundamentals, and that investors have currently brushed upside previous concerns such as weak economic statistics and China’s financial health. We suggest investors look for alternatives, namely in the small/mid-caps sector, where we believe individual opportunities exist, and where we feel the risk-reward profile for long-term outperformance is higher given the existing real economy backdrop.

Sectors/themes to focus on in 2015. We recommend the following sectors/themes, and suggest investors look for small/mid-cap opportunities in these sectors: healthcare, TMT, new energy, consumer (mass-market discretionary). We believe overall fundamentals for these sectors remain solid in 2015 and are less likely to be affected by global economic uncertainties. Some may also benefit from continued government policy support.

 PW Medtech, which is one of the market leaders in both the advanced infusion set and orthopedic implant industries in China. With the acquisition of the new regenerative medical biomaterial business from Beijing Tianxinfu in August 2014, we expect the company to record strong earnings growth in 2015 with full-year consolidation of the regenerative medical biomaterial business, as well as further margin expansion. Upside catalysts also include further potential M&A and company/management buybacks in the pipeline. 

Company rating: Buy 
TP: HK$4.1 

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