CICC: Short-term Hong Kong stocks benefited from interest rate cuts, growth sectors are more resilient. Dividends and technology growth are the main themes.

CICC released a research report stating that since August, Hong Kong stocks have shown a "independent trend" different from A shares. In addition to more thorough valuation and position clearing, the profit advantage of Hong Kong stocks compared to A shares is undoubtedly an important reason. In addition, in the probable continued fluctuating market, sectors such as internet e-commerce and consumer services have a higher level of prosperity, while utilities such as telecommunications and water and electricity have stable profits and are still worth paying attention to as dividend targets. The profit growth rate of overseas Chinese stocks in the first half of the year improved year-on-year, but more driven by costs rather than demand, with companies generally adopting shrinkage strategies. From a market perspective, combined with profitability and the impact of the Federal Reserve's interest rate cuts, Hong Kong stocks are still believed to have greater resilience than A shares. Growth sectors that benefit in the short term from interest rate cuts may have higher elasticity, such as semiconductors, automobiles (including new energy), media and entertainment, software, and biotechnology. However, in the medium term, the structural market fluctuation remains the main trend. The direction of allocation depends on the outlook for fundamentals, with dividends and technology growth as the main themes. Key points from CICC: Growth situation: Growth in the first half of the year was 2.3%, better than A shares; high growth in internet e-commerce, export chains, and metals were bright spots, while real estate and banks dragged performance down. The profit growth rate of overseas Chinese stocks in the first half of 2024 year-on-year improved to 2.3%, from 0.2% in 2023. Measured in Hong Kong dollars, the profit growth rate of overseas Chinese stocks in the first half of the year increased by 2.3%, with a 1.1% year-on-year decline in financials (vs. -2.7% in 2023) and a 6.3% increase in non-financials (vs. 3.9% in 2023). Metal mining and export chains are bright spots, e-commerce and internet maintained high growth, while real estate and banks accelerated decline. By sector: Upstream resource industry recovery. Raw material profit growth of 24.0% (vs. -27.1% in 2023), rising prices boosting the performance of the metal mining sector; energy profit fell slightly by 1.0% (vs. -15.0% in 2023) mainly due to coal price declines, oil and gas profit grew by 6.0%, compared to a decline of 12.4% in 2023 turned positive. Midstream manufacturing is weak. Rising prices of upstream resources squeeze profits, capital goods profits fell by 8.9% (vs. -7.3% in 2023); airlines reduced losses, with some shipping and port companies boosting performance due to rising freight rates; automobile and parts sectors grew by 17.6%, compared to 9.9% growth in 2023, supported mainly by a 0.4 percentage point year-on-year increase in profit margins (vs. -0.5% in 2023), but revenue increased by 6% year-on-year, slowing from a 22.3% growth in 2023. Downstream consumer resilience. Essential consumption increased by 1% (vs. -3.9% in 2023), discretionary consumption increased by 49.4% (vs. 67.3% in 2023), benefiting from durable consumer goods (+30.9%) and e-commerce sectors support, with PDD Holdings Inc. Sponsored ADR Class A (PDD.US), JD.com, Inc. Sponsored ADR Class A (09618), and Meituan (03690) seeing double-digit profit growth. TMT overall strong, software services significantly reduce losses, telecommunications and technology hardware grew by 2% and 20%, better than 1.2% and 17% in 2023, respectively, media and entertainment maintained high growth of 32.8% (vs. 49.8% in 2023). Defensive healthcare and utilities slowed down in growth on a high base, healthcare declined by 2.8% (vs. 37.2% in 2023), utilities grew by 0.7% (vs. 42% in 2023). Financial and real estate profits declined, dragging overall performance down. Real estate accelerated decline by 52.1% (vs. -15.2% in 2023); financial profits fell by 1.1%, narrowing from a -2.7% decline in 2023, insurance (+19.3%) profits significantly improved, but narrowing interest rate spreads caused bank profits to decline faster (-4.5% vs. -2.9% in 2023), diversified financial (-7.3%) performance also at the bottom. Nevertheless, Hong Kong stocks are still significantly better than A shares by 3%, especially in the non-financial sector, which grew by 6.3% year-on-year, compared to a decline of 5.5% in non-financial A shares. The main reason for this is that Hong Kong stocks have a more advantageous profit structure: In terms of industry structure, Hong Kong stocks have a higher proportion of new economy companies and a lower proportion of midstream manufacturing. E-commerce and internet sectors, which saw double-digit year-on-year profit growth in the first half of the year, have a larger weighting in Hong Kong stocks, accounting for nearly 20% of market value, while such companies are less common in A shares; most of the midstream manufacturing companies under profit pressure are concentrated in A shares, with the industrial sector accounting for over 18% of market value, significantly higher than the 7% in Hong Kong stocks, where the power equipment and new energy sector, which saw a 53% year-on-year profit decline in the first half of the year, accounts for 5% in A shares and only 0.5% in Hong Kong stocks. In terms of concentration, the contribution effect of top companies is more significant. The top 10 companies in overseas Chinese stocks accounted for 44% of net profits in the first half of the year, the top 20 companies accounted for 60%, while in A shares, the top 10 companies accounted for only 33% of net profits, and the top 20 companies accounted for 45%. Therefore, top companies have a greater impact on performance, with Tencent, Meituan, CNOOC, and others showing strong performance in the first half of the year, all with double-digit growth. This is more apparent in specific sectors, such as the automotive sector, where Great Wall Motor (02333), XPeng, Inc. ADR Sponsored Class A (09868), and BYD Company Limited (01211) all contributed to the increase; in the transportation sector, China Eastern Airlines (00670) significantly reduced losses and JD LOGISTICS (02618) exceeded expectations for performance, driving more than half of the increase; in energy, CNOOC (00883) grew by 19.8% year-on-year, basically offsetting the drag from coal decline. Quality of growth: more driven by costs than demand, companies generally adopt shrinkage strategies The improvement in profits is more driven by costs, with demand actually declining. The net profit margin of overseas Chinese stocks increased from 5.2% in 2023 to 6.2% in the first half of the year. Compared to 2023, most sectors saw an increase in net profit margins, with a 6.2% net profit margin in the first half of the year.Profitability has improved in sectors such as media and entertainment (+5.4ppt), retail (+3.4ppt), utilities (+2.7ppt), and durable goods and clothing (+2.3ppt) compared to 2023, with only the real estate sector experiencing a slight decline of 0.8ppt. In the first half of the year, overseas Chinese-listed companies saw a decrease in taxes and a slower growth in interest expenses compared to the previous year. Companies are cutting costs to maintain operations in a weak demand environment.In contrast, the non-financial industry's income decreased by 1.3% year-on-year (vs. -1.3% in 2023), and operating cash flow decreased by 24.4% year-on-year (vs. 3.2% in 2023). In the first half of the year, sectors such as transportation (+13.2%), information technology (+12.7%), and durable consumer goods (+11.4%) achieved year-on-year revenue growth, with a significant improvement in revenue growth compared to 2023. On the other hand, sectors such as automobiles (-16ppt), real estate (-10ppt), capital goods (-8ppt), and healthcare (-6ppt) showed a significant slowdown in growth compared to 2023. Corporate investment has contracted, and net debt has decreased. In the first half of the year, overseas capital expenditures by Chinese-owned stocks decreased by 4.2% year-on-year. The leverage ratio remained basically unchanged at 343% compared to 2023, with the capital goods sector showing the highest increase in leverage ratio (+41ppt), while the transportation sector saw a 10ppt decrease. It is worth noting that the net gearing ratio decreased from 45% in 2023 to 41% in the first half of 2024, indicating a deleveraging trend among companies. However, with a background of destocking in the first half of 2024, inventory turnover continued to decline, accounts receivable increased year-on-year, and in an environment of limited investment returns and weak domestic demand, companies adopted a contractionary business management strategy. Therefore, the increase in ROE is mainly due to cost-driven profit margin improvement. ROE increased from 10.9% in 2023 to 11.6% in the first half of 2024. The financial sector's ROE remained flat at 10.8% compared to 2023, while the non-financial sector's ROE increased from 11.0% to 12.7%. The insurance, essential consumer goods, utilities, and telecommunications sectors saw ROE expansions of 7.9, 4.4, 3.5, and 2.5ppt respectively, while the banking, information technology, and capital goods sectors saw a decline of 0.5, 0.4, and 0.3ppt respectively. DuPont de Nemours, Inc. analysis shows that the increase in net profit margin supported the rise in ROE, while the leverage ratio remained stable and the asset turnover ratio decreased from 49% in 2023 to 47%. With a lack of demand for new profit growth points, companies' profitability is limited. Growth prospects: a slight downgrade to 2% for full-year 2024; recommended focus on e-commerce internet, consumer services, telecommunications, and utilities Currently, the market consensus expects a 9.5% full-year growth for overseas Chinese-owned stocks, implying a nearly 20% year-on-year growth in the second half of the year. In terms of sectors, the market uniformly expects e-commerce, insurance, media and entertainment to remain major contributors to profit growth; consumer services, real estate, insurance, and semiconductor sectors are expected to perform significantly better in the second half of the year. CCB believes that the market consensus may be too optimistic or may contain a synthetic error. On the one hand, effective demand is still insufficient, the real estate market is weak in terms of volume and price, inflation continues to put pressure, and the economy's internal growth momentum is weak and needs fundamental improvement. On the other hand, the stabilization of exports in the first half of the year, better than market expectations, provides support for the profitability of export chain companies. However, with freight rates continuing to decline recently, the comparison of exports year-on-year in the second half of the year may weaken. The root cause of the current growth pressure still lies in credit tightening, especially since fiscal measures have slowed down since February and the second quarter of this year, unable to effectively offset the continuous deleveraging in the private sector. Solutions include lowering financing costs and leveraging up fiscal measures. The government deficit accelerated year-on-year in July, and the Federal Reserve's rate cut in September will also provide a loose policy window for domestic policies. However, the focus for the rest of the year may be on implementing existing policies, as the Ministry of Finance has recently emphasized the prevention of excessive fiscal policies and new projects. Therefore, the expectation for strong stimulus is not realistic, and fundamentally, the lack of a basis for high-speed profit growth in the second half of the year. In a baseline scenario, considering the actual growth in the first half of the year, CCB has lowered its profit growth forecast for 2024 from 3-4% to 2%, below the current consensus of 10%. However, due to the higher proportion of new economy sectors and lower proportion of manufacturing, Hong Kong stocks' performance will still be better than A-shares. At the sector level, it is recommended to focus on industries with higher growth potential such as e-commerce internet and consumer services, which have seen profit upgrades since the beginning of the year and are expected to have a higher ROE in 2024 compared to the past five years, with a PB ratio lower than the past five years. They are expected to become bright spots in the overall trend of moderate profit growth. In addition, utilities such as telecommunications and hydroelectric power have stable performance and are worth focusing on as dividend sources. From a market perspective, considering the impact of profit and the Federal Reserve's rate cut, CCB still believes that the elasticity of Hong Kong stocks is greater than A-shares. In the short term, growth sectors benefiting from rate cuts may have higher elasticity, such as semiconductors, automobiles (including new energy), media and entertainment, software, and biotechnology. However, in the medium term, a structural bull market of range-bound trading remains the main trend. With the 10-year U.S. Treasury yield falling to 3.8%, the rate cut expectations are already priced in, and if risk premiums return to last year's levels, the Hang Seng Index is expected to be around 19,000; if profits grow by 10% on this basis, the Hang Seng Index could reach around 21,000. The direction of allocation depends on the outlook, with a focus on dividends and technological growth: 1) as overall returns decline, focus on stable returns with high dividends and high buybacks, such as cash-rich cash cows, from cyclical dividends to bank dividends, and then to defensive low volatility dividends; 2) selectively leverage up, such as in industries with high industry sentiment (Internet, gaming, education) or government-supported technological growth (tech hardware and semiconductors).