The novel coronavirus driven economic slowdown has been globally synchronized. And while we may pay the most attention to the U.S. market, China stocks are also feeling the effects.
According to the International Monetary Fund, Asia’s economy is unlikely to grow in fiscal year 2020. However, as economies get back to work, GDP growth will recover in the coming quarters. China’s services purchasing managers’ index increased to 55 in May 2020 from 44.4 in April, which is its highest level since late 2010.
This is an early indication of return to normalcy. And therefore, it’s a good time to consider exposure to quality Chinese companies. Once the coronavirus driven headwind is navigated, China’s GDP growth can trend around 5%.
Investors will point to the recent tensions between the United States and China. However, as Wedbush Securities explains in an email to InvestorPlace:
“Investor worries heading into Friday’s announcement from President Trump were around any changes to/destruction of the Phase 1 trade agreement between the two countries. With those fears unfounded and the U.S. firmly committed to this key Phase 1 deal, we believe worries of retaliatory measures against US companies and Apple in particular are in the rear-view mirror (for now) and should add more fuel to the rally in tech stocks moving forward.”
With a relatively positive outlook, the following China stocks are worth considering as the economy recovers:
So, with all of that in mind, let’s dive in.
China Stocks to Buy: Alibaba Group (BABA)
BABA stock is a long-term value creator, and I believe that there is significant upside for the stock in the coming years. China’s e-commerce industry is in a high growth trajectory, and the coronavirus pandemic is likely to accelerate online shopping. Additionally, Alibaba has made inroads in Southeast Asia, which is another promising market for the long-term.
Moreover, Alibaba’s cloud business has also been growing at a robust pace. And while the business is still not positive at EBITDA level, I see that happening in FY2021. Even in the core commerce business, I expect EBITDA margin to expand. With Tmall and Kaola accelerating cross-border e-commerce, margins are likely to get a boost.
From a fundamental perspective, Alibaba reported free cash flow of $18.5 billion for the last financial year. Robust cash flows allow Alibaba to maintain a strong balance sheet. In addition, Alibaba has pursued inorganic growth and that’s likely to continue with ample financial flexibility.
Analyst estimates suggest that Alibaba’s earnings will grow at 18% annually over the next five years. That said, a forward price-to-earnings (P/E) ratio of 25.9 is not expensive for a high growth stock. Therefore, BABA stock worth considering at current levels.
CNOOC (CEO)
Among China stocks, I also like CNOOC considering the fact that China is energy thirsty. In the coming decade, energy demand will continue to increase in China — and CNOOC is in great position to benefit. And with energy prices still subdued, it’s a good time to consider exposure to CEO stock.
The first reason to like CNOOC is the company’s strong fundamentals. As of December 2019, the company reported a gearing ratio of 26%. With low leverage, the company is well-positioned to navigate the crisis.
From an asset perspective, CNOOC reported total reserves of 5,185mmboe with a reserve life of 10.2 years. With a strong reserve replacement ratio, the company has multi-year production inventory and hence cash flow visibility.
CNOOC plans to increase production to 590mmboe by FY2022 from 503mmboe in FY2019. Considering the company’s reserves coupled with investment in exploration and production, this target is realistic. Furthermore, high financial flexibility will allow the company to accelerate investments as oil trends higher.
Also, CNOOC has also been increasing dividends in the last few years. And while there are near-term headwinds for cash flows, I expect dividends to sustain and increase once oil is around $55 to $60 per barrel. So, considering these factors, CEO stock is attractive for long-term exposure.
JD.com (JD)
JD stock recently touched a 52-week high, which is an indication of the underlying strength of the company. Investors might question if the stock is overbought. However, valuations are still attractive.
To underscore my view, JD stock trades at a forward P/E ratio of 41.5. However, analyst estimates suggest that JD.com’s earnings will grow at 8% annually over the next five years. Therefore, valuations are not expensive considering the growth outlook.
I believe that one of the key advantages with JD.com is the company’s robust logistics network. This will allow the company to expand faster in lower-tier cities, which can accelerate earnings growth. JD.com has also made inroads in the luxury commerce segment, which is likely to help the company in margin expansion.
During the period of lockdown due to the coronavirus, the company’s online supermarket sales also surged. This is likely to be another game changing segment for the company in the coming years. Therefore, with all of this in mind, JD stock a potential core portfolio name among China stocks.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.
