China Brokerages Least Favored in a Decade, Grim Days Ahead

(Bloomberg) -- Investors haven't been this down on Chinese brokerages in more than a decade, and the outlook is just as grim.

Bloomberg's gauge for China-listed brokerages is at its lowest relative to the Shanghai Composite Index since June 2007, even with the equity benchmark stuck 19 percent below its January peak. The sector trades at 13.4 times 12-month forward earnings, compared with 10.6 times for the Shanghai gauge, near the narrowest difference in a year.

“Neither the brokerage nor investment banking segments provide any bright spots,” said Liao Chenkai, Shanghai-based analyst with Capital Securities Corp. “It will be difficult for brokerage shares to emerge from the doldrums under such circumstances, unless the stock market picks up.”

Trading turnover of equities is near the weakest 30-day average since October 2014. In the first half of this year, initial share sales and private placements slumped 51 percent to 228.6 billion yuan ($33.5 billion), reflecting tighter financial regulation. China International Capital Corp. estimates brokerage profits slipped 17 percent in the first six months of 2018 from a year earlier. Guosen Securities Co. said Monday its first-half net income slid 43 percent.

Mainland equities jumped to a one-month high last week, with brokerage stocks outperforming, after China unveiled a package of targeted easing policies amid an escalating trade dispute with the U.S. The Shanghai Composite rose 0.3 percent Tuesday, while the gauge for brokerages edged up 0.2 percent.

Liquidity Conditions

While the measures will improve liquidity conditions and lift sentiment on stocks, it's unlikely that China's benchmark index or its stock-trading volume will rise sharply this year, according to Richard Cao, Shenzhen-based analyst with Guotai Junan Securities HK Ltd.

“Brokerage stocks might get a boost from policy easing in the near term, but I don't expect any meaningful recovery without the support of a strong uptrend in the broad market,” Cao said. “Deleveraging and risk control will still be the major theme going forward, despite some small policy tweaks as China balances its growth and risks.”

A key concern for brokerages is potential losses on stock pledges. Loans to company founders and other investors that are secured by pledged shares as collateral amounted to 103 percent of brokerages' net capital, and losses on the debt could wipe out 11 percent of their net capital, according to Morgan Stanley. Industrial Securities Co. is the latest to get burned, dropping 8.1 percent after confirming it held 178 million shares pledged by executives of a biotech firm at the epicenter of a vaccine scandal.

Read about the $240 billion lending binge that threatens to burn brokers in China

The sector will remain subdued as long as risks including the trade war with the U.S. and domestic financial deleveraging linger, though some brokerages might outperform in the medium to long term, according to Hong Jinping, an analyst with Huachuang Securities Co. Big brokerages would be able to gain more market share and resources amid China's deleveraging, squeezing the business and shares of smaller peers.

“The capital market almost stalled after tight financial regulation in the past two to three years, so it would be unreasonable for brokers to trade at a premium over the market,” Hong said. “The sector will become polarized with the big ones getting a bigger slice of the market.”

For Guotai Junan's Cao, weak fundamentals will continue to weigh on brokerages in the foreseeable future.

“Even if equity financing recovers in the second half, that's not enough to boost brokerage firms' earnings, ” said Cao. “Forget about growth, they should be happy if they can earn as much profit as last year.”

--With assistance from Ken Wang and Irene Huang.

To contact Bloomberg News staff for this story: Amanda Wang in Shanghai at twang234@bloomberg.net;Mengchen Lu in Shanghai at mlu157@bloomberg.net;Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Reinie Booysen, Will Davies

With assistance from Editorial Board