Aberdeen manager cautious on China stocks

HONG KONG (Reuters) - Expensive valuations, weak economic fundamentals and government meddling in the operations of companies are making Aberdeen Asset Management wary of Chinese equities, a fund manager said.

The recession in the United States and other western economies is hurting Chinese exports and manufacturing and local consumption is not rising fast enough to pick up the slack. Those conditions may bring pain for firms in the next year or two, said Nicholas Yeo, Hong Kong and China equities manager for Aberdeen.

"With U.S. consumer confidence down, what's there for Chinese manufacturers? To be frank, not much," Yeo told Reuters in an interview on Thursday.

"People talk about domestic consumption as the next engine, but it's too early to tell as well."

Chinese consumption only accounts for 5 percent of worldwide spending, limiting its global influence.

Chinese exports, the country's traditional growth engine, fell 22.6 percent in April from a year earlier, marking their sixth straight monthly decline.

Weak external demand has also exacerbated overcapacity in some industries, which could dampen the outlook for earnings growth in industrial companies in 2010, Yeo said.

Yeo added that Hong Kong and China stocks are overpriced in the short term, given their extended rallies. China's Shanghai Composite index .SSEC is up 43 percent in 2009, the second-best performing major market in the world.

With about $20 billion in Asian assets excluding Japan, UK-based Aberdeen is one of the region's biggest retail fund managers.

Aberdeen's $300 million China fund owns roughly 30 companies including China Mobile (0941.HK), China Merchants Bank (600036.SS) as well as oil and gas producers PetroChina (0857.HK) (PTR.N) (601857.SS) and CNOOC (0883.HK) (CEO.N).

The fund also includes Hong Kong property developers Hang Lung Group (0010.HK) and Sun Hung Kai Properties (0016.HK), and retailers Li Ning Co (2331.HK) and Giordano International (0709.HK).

Aberdeen prefers exposure to China through Hong Kong-listed stocks, and is cautious on Chinese companies because they are relatively young and lack experience in managing through major economic downturns, Yeo said.

"The Chinese companies have not seen the bad times yet," he said. "That's why when it comes to investment decisions, they tend to have a blue-sky optimism that is factored in the decision-making process."

SOVEREIGN RISK

China's state-owned enterprises, which are often required to align their business with Beijing's political ambitions, also present another challenge for Aberdeen, Yeo said.

"There's a risk --- you're not just buying into the company risk, you're buying into the sovereign risk as well," he said.

Yeo favours PetroChina and CNOOC because of their upstream assets, but does not like Sinopec because its refining business is closely tied to government policy.

The fund shuns China's coal miners such as China Shenhua Energy (1088.HK) (601088.SS) due to its exposure to a sole commodity and its operational standards, he said.

China's B-shares now trade at an average of 2.8 times book value, while Hong Kong companies trade at 2 times. Both valuations are higher than the long-term average of 1.7 times, Yeo said.

In a few cases, however, the fund manager is willing to accommodate richer valuations for long-term growth.

Sportswear retailer Li Ning is one such case, trading at 20 times forward earnings compared with Nike Inc's (NKE.N) 14 times, according to Reuters data.

"It's still fair for the long term potential," Yeo said, referring to Li Ning.

(Editing by Muralikumar Anantharaman)