It may be a very bumpy earnings season in China.
The first of China's more than 3,000 listed companies have started reporting results for the first half of the year. With the weakest economic growth on record reported this week in China, some blue chips have issued warnings of big drops in profits.
One of the most popular stocks with foreign traders " fabled Kweichow Moutai " tumbled 3.1 per cent this week after it posted its slowest quarterly sales growth in three quarters.
The fiery liquor maker isn't likely to be crying into its baijiu alone.
The companies trading on the benchmark Shanghai Composite probably will announce a decline in earnings growth for the three-month period ended in June, according to Bloomberg data.
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A rebound may be ahead in the third quarter. But investors will want to keep a close eye on their favourites and be prepared for some at least short-term pain, as some big names that are often on the top list of foreign buying through the trading stock connects between Hong Kong and the mainland are no exception to the slowdown.
Among them, second-quarter profit growth for Anhui Conch Cement may have slowed to 9.1 per cent, only a third of the growth rate for the previous three-month period, according to Bloomberg data. Midea Group and Gree Electric Appliances, the nation's biggest makers of household appliances, probably both reported profit declines, the data showed.
The three " as well as Kweichow Moutai " are heavy favourites with analysts, who overwhelmingly recommend them as "buys." But traders may have to keep their nerve when shares of reporting companies get a buzz cut on disappointing numbers.
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Strong results are vital to restore investor confidence after the rally that had driven up the Shanghai Composite by as much as 31 per cent this year faltered in April. The index is now off 11 per cent from this year's high, stuck in a narrow trading band over the past two months.
A good strategy to playing the earnings season would be to wait on the sidelines, advises Wang Zheng, chief investment officer at Jingxi Investment Management in Shanghai.
On a whole, the interim results would be mediocre because of the sluggish economic growth," he said. "There are few new drivers that can fuel growth now. That's a major hangover that's holding back stocks."
Official reports from China's statics bureau this week showed the nation's economic growth slid to 6.2 per cent in the second quarter, the slowest pace since the quarterly data began to be released in 1992.
The pain was immediately felt at the corporate level. Dong-E-E-Jiao, which makes traditional Chinese medicine from donkey-hide gelatin, and Han's Laser Technology Industry said earnings for the first six months may have dropped at least 65 per cent from a year earlier, citing shrinking demand from downstream industries.
Dong-E-E-Jiao had a track record of posting profit growth for 12 consecutive years, while Han's Laser was a darling among overseas traders, so much so that trading of the stock had to be suspended in the stock connect because it reached the foreign ownership limit.
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The negative guidance underscores the risk of worse-than-expected earnings facing investors. The companies on the Shanghai Composite probably posted a 1.3 per cent decline in second-quarter earnings, compared with an 8.4 per cent increase for the preceding three-month period, Bloomberg data showed.
Even the consumer sector, which is largely seen as a shield from a slowdown in the economy, may also endure some moderation in growth, said Chen Li, chief economist at Soochow Securities, who correctly predicted the run-up and the subsequent decline on China's stocks this year.
Earnings growth in the second quarter "will be slower than the first quarter," said Hong Hao, managing director at Bocom International Holdings in Hong Kong. "That's why stocks are stuck in a range."
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Still, some analysts say a buying opportunity may be emerging as the worst for earnings could be over soon.
A stabilisation in a slew of key economic data on June alone has reignited some hope that earnings growth will pick up for the rest of the year. Industrial production, fixed-asset investment and retail sales last month all beat analysts' projections, although some analysts said the recovery was unsustainable and mostly buoyed by car purchases that were brought forward before a change of emission rules.
"The first half could be a nadir for earnings growth this year and growth will rebound going forward," said Ken Chen Hao, a Shanghai-based strategist at KGI Securities. "So you will see a rebound in stocks sometime in the third quarter alongside with a rise in the risk appetite."
The consensus forecast is pretty positive: corporate earnings growth will probably accelerate to 32 per cent in the third quarter, according to Bloomberg data.
Chinese companies' profit growth is likely to bottom out in the second half of the year, coinciding with an end to the downside on inventories and the return-on-equity ratio for listed companies, according to Xun Yugen, a Shanghai-based strategist at Haitong Securities. His prediction was based on the calculation of the average duration of each historical economic cycle in China.
"All the trade issues have made people more conservative on their earnings forecasts," said Gerry Alfonso, director of the international business department of Shenwan Hongyuan Group in Shanghai. "The third quarter is looking better, clearly with the caveat of no major new disruptions from the trade front. If there is no further deterioration on the trade front, there should be an improvement in earnings."
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