China’s stock market went from pauper to prince last year, posting a 36 per cent gain, which puts it among the top of major global index ratings and eclipses the rally in its US counterparts.

China’s blue-chip CSI300 Index ended the last session of 2019 at an eight-month closing high of 4,096.58 points, up 36.1 per cent from the start of the year. The Shanghai Composite Index gained 22.3 per cent this year, closing the day at 3,050.12 points.

The S&P 500 has gained 28.5 per cent and Dow Jones Industrial Average is up 22.01 per cent.

The Morningstar Asia-Pacific Markets Index rose 6.4 per cent in the December quarter as equity markets in the region rallied in anticipation of progress in US-China trade deal. Boris Johnson’s emphatic election win in the UK also lifted spirits.

Investors have brushed off the fallout from the trade war, and Morningstar analysts say an agreement between the two superpowers will boost growth in Asia.

Morningstar’s Asia Equity Market Outlook for the first quarter of 2020 contains several bargain stocks, spanning communication services, consumer cyclicals, industrials, and financial services.

Communication services

China Mobile is among the five-star stocks on the Asia Equity Outlook. With a customer base of 943 million, it is the world’s largest wireless telephone operator by far and dwarfs its rivals.

“In an industry with high fixed costs, this scale allows China Mobile to benefit from cost advantage and it remains the only Chinese telco earning above cost of capital returns,” says Morningstar director Dan Baker.

Baker’s fair value estimate of HKD91 implies a forward price/earnings of 16.1 times and a dividend yield of 3.4 per cent.

“We expect the company to maintain its earnings growth at low- to mid-single-digit rates per year in the medium term.”

person holding mobile phone

China Mobile is the world’s largest wireless telephone operator with a customer base of 943 million

Another telco to watch is China Unicom. The company has managed to reverse several years of poor cash flow and poor market share and is now in five-star territory.

It is trading at a 46 per cent discount to fair value, which implies a PE ratio of 30.4 times and a dividend yield of 1.3 per cent. Baker expects it to generate operating income of 14 per cent a year as operating margins improve.

Consumer cyclicals

Despite fierce competition in e-commerce, several big names are expected to grow their user numbers, say Morningstar analysts Ivan Su and Chelsey Tam.

These include Alibaba, the world’s largest online and mobile commerce company, followed by JD.com, China's second-largest e-commerce company after Alibaba, and Pinduoduo, an e-commerce platform that allows users to participate in group buying deals.

Another name to watch is gaming powerhouse MGM China, which is trading at a 40 per cent discount to fair value.

“As one of six casino licence holders in Macau, MGM China benefits from the Chinese population’s strong demand for gaming, low penetration ratio, infrastructure improvement in in-hotel capacity, and new casino resorts improving the attractiveness of Macau,” says Tam.

Industrials

The Morningstar Asia-Pacific Industrial Index shone in the December quarter, with a three-month trailing return of 9 per cent, beating the broad market by about 160 basis points. Industrial conglomerates remain among the most undervalued companies in the Asian equity landscape.

Founded in 1997, Beijing Enterprises Holdings, or BEH, is the listed flagship of the Beijing municipal government. It has a diversified business portfolio with focus on public utilities, including gas distribution and transmission, sewage and water treatment, and waste-to-energy business. It also owns 80 per cent of Yanjing Beer, the third-largest domestic brewer.

BEH shares are undervalued by almost 40 per cent. “We expect that China's switch to using natural gas over coal will continue to drive a five-year net profit compound annual growth rate of 7 per cent for BEH between 2019 and 2023,” says Morningstar equity analyst Jennifer Song.

Another five-star industrial name is CK Hutchison Holdings, which is trading at a 30 per cent discount to fair value. CK Hutchison Holdings is a conglomerate controlled by Hong Kong tycoon Li Ka-Shing and his family, with key businesses in ports, retail, infrastructure, energy, and telecommunications.

“We kept our fair value estimate for no-moat CK Hutchison Holdings unchanged at HKD 106 per share after the company revealed more resilient ports and retail business performance in the first-half result,” says Song.

“Cash flow generation is within our estimates and on the whole, we are not concerned about CKHH's ability to keep generating free cash flow going forward.”

china port

CK Hutchison Holdings is a conglomerate controlled by Hong Kong tycoon Li Ka-Shing and his family, with key businesses in ports, retail, infrastructure, energy, and telecommunications

Rounding out the list of five-star industrials is Guangshen Railway, which is trading at a discount of about 50 per cent. Guangshen Railway is one of the key railway operators in southern China's relatively prosperous Guangdong province.

It provides passenger and freight transportation through its wholly owned Guangzhou-Shenzhen intercity express rail line and Guangzhou-Pingshi rail line, as well as a few long-distance passenger lines.

Guangshen also provides high-speed rail operation services to its parent and operates the Kowloon-Guangzhou through trains in cooperation with MTR, a Hong Kong-listed railway operator.

“We think Guangshen's focus on passenger railways will continue to put the company's existing operations on a stable growth outlook with robust cash flows,” says Song. “China's railway reform will also boost Guangshen's profitability and drive the company's long-term investment value.”

Financials

Sumitomo Financial Group has been the standout among mostly underperforming Japanese banks. It has a 7.1 per cent share of domestic loans and 8.1 per cent of deposits as of March, and is one of Japan’s big three banking groups, along with Mitsubishi UFJ Financial Group and Mizuho.

By the end of last year, the shares had risen 5 per cent compared with declines for all the other major Japanese banks but still trade at only 0.50 times book value and yield 4.7 per cent, notes Morningstar equity analyst Michael Makdad.

Despite a no-moat rating, SMFG has a fair value estimate of JPY 5775 per share, which is 50 per cent above recent share price.

“SMFG has consistently achieved a higher return on equity than its megabank competitors MUFG and Mizuho, allowing it over time to build more capital while still increasing shareholder returns,” says Makdad.

“SMFG will continue to press its cost-efficiency advantage against its two megabank rivals and has ample room to reduce expenses further.

"SMFG remains our top pick in an industry that is facing severe pressure from extremely low domestic interest rates and changes in consumer behaviour with the proliferation of smartphones.”