China News Now: The Beneficiaries of Beijing's New Stimulus

A new round of fiscal stimulus could drive China's infrastructure stocks higher.

In the midst of the financial crisis, China's policy response was one of the most decisive anywhere with a massive $635 billion fiscal stimulus to kickstart its economy. A slowing domestic growth rate and more turmoil in Europe have brought Beijing off the sidelines again, presumably to help keep its economy chugging along nicely at 7% to 8% rate over the next few years.

The government stepped in last week to start fast-tracking $157 billion of infrastructure and industrial projects. Beijing is bringing forward pending projects originally slated for 2013 and 2014 and funding them this year. "The moves seem to suggest that the government has become more active in dealing with the growth downturn," notes Dong Tao, an economist at Credit Suisse in Hong Kong.

While Beijing is worried about slower growth, Tao doesn't see any hint of 2009-like response. Credit Suisse is forecasting infrastructure investment growth in China to accelerate from 9.6% last year to 14.3% this year. The investment bank notes if the government turns more aggressive, there is room for the investment growth to accelerate to around 20% this year.

Just don't expect Beijing to roll out another massive 2009-like stimulus plan to spur higher economic growth, says Qian Liu, deputy director of the Economist Intelligence Unit in Beijing. Minor tweaks like last week's decision to fast-track projects should be more than enough. "China's exports are still growing at 8% per annum despite weak consumption in its main markets, the United States and Europe, compared with 30% negative year-on-year growth in export China saw in late 2008," she says.

So far the markets haven't been excited by the stimulus measures because investors seem focused on deteriorating profitability amid slower growth. The difference between the 2009 measures and the current ones is that new policies are aimed at unleashing private investments and support for services sectors says Steven Sun, China strategist for HSBC in Hong Kong. Sun expects China stocks to do much better in the second half of the year as the effects of the measures seep through.

He recommends that investors buy infrastructure-related stocks on weakness. Cement, railway equipment manufacturing, and selected construction machinery are Sun's particular favorites. Chinese cyclical stocks have underperformed this year and are trading at under 12 times this year's earnings, or a 20% discount to their five-year average valuations, but the trend is likely to reverse as Beijing again pursues pro-growth policies.

Citigroup's Eric Lau likes China State Construction, or CSCI, (3311.Hong Kong) and plastic-pipe maker China Liansu (2128.Hong Kong), two Chinese mid-cap infrastructure stocks that are down 11% and 26%, respectively, from their year-to-date highs. Liansu supplies its wares to water, drainage, power, telecom and gas projects in China and Hong Kong, and Lau sees gross margins of 24.2% this year and 23.4% next year on strong revenue growth. The shares trade at an inexpensive 6.8 times this year's earnings and 5.5 times next's. CSCI is a growing player in China's social-housing projects for lower-income groups, a segment of the housing sector where China is doubling down on construction. CSCI is pricier, at 11.7 times this year's earnings or 9.8 times next year's.

Macquarie Securities' Pelen Ji advocates a selective look at beaten-down cement stocks in China as a play on the infrastructure theme. Capacity utilization in the cement sector has begun to improve in recent months and inventory levels are starting to drop, Ji notes. Macquarie's top cement picks: China National Building Material (3323.Hong Kong), which it believes is oversold and ready for a rebound. Ji has a 14 Hong Kong dollar (US$1.80) price target, or potential 60% upside for the stock over next 12 months. Ji also likes BBMG (2009.Hong Kong), which has exposure to under-served northern China. For BBMG he has a 12-month target price of HK$10, or 76% upside.

Longer-term though, better bargains may be outside the long-favored infrastructure sector. "The China story is moving from infrastructure plays that were the key to the last boom to more consumer-focused plays that will be the key to the next phase of development there," says Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management in New York.