Red Flags Over China

06/09/2008 12:00 am EST

Focus: COMMODITIES

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, editor-in-chief of China Stock Digest, says the Chinese government has been intervening more frequently in the markets, creating uncertainty among investors.

The big news of the moment is the shuffle of China’s telecom companies.

The shuffle began when the world’s largest wireless company, China Mobile (NYSE: CHL), took over a little-known fixed line phone company called China Railcom. China Mobile has been signing up new subscribers at a rate of more than seven million a month, racking up a customer base approaching an almost unbelievable 500 million subscribers.

Meanwhile, China Mobile’s chief competitor, China Unicom (NYSE: CHU), was falling seriously behind because it had inherited two incompatible cell phone technologies, GSM and CDMA. (CDMA is the system used mostly in the US.)

[At the same time], China’s two major fixed-line telephone companies, China Netcom (NYSE: CN) and China Telecom (NYSE: CHA), were losing subscribers to cheaper wireless-service plans—mostly to China Mobile. It was beginning to look like China Mobile would gain a virtual monopoly.

Under the restructuring, China Telecom will be “encouraged” to buy China Unicom’s CDMA cell phone division. Meanwhile, China Netcom will be merged with China Unicom’s GSM division. Each is expected to become a more effective competitor with China Mobile, and China Mobile’s share prices have declined as a result of the government’s intervention. (Its ADRs closed above $18 Friday—Editor.)

There is also continuing uncertainty over the fate of China’s two largest oil companies,
PetroChina (NYSE: PTR) and Sinopec (NYSE: SHI). Sinopec is in the unlucky position of being China’s biggest refiner and seller of fuel. But as international crude oil prices soared above $130 a barrel, both oil companies were prohibited from passing on increased costs to consumers because of government concerns about inflation and unrest.

The result has been predictable. Despite some government subsidies, both companies are facing plunging profits. Sinopec’s profit fell 69% during the first quarter. Sinopec must buy most of the oil it sells from other producers, and that leaves the company exposed to international price fluctuations.

[We have not recommended either company] this year despite booming oil consumption in China. (PetroChina’s ADRs closed below $136 Friday, while Sinopec’s closed at $42—Editor.)

Another sector feeling the heavy hand of government intervention is the electricity sector. A former holding, Huaneng Power (NYSE: HNP) says profits fell almost 80% in the first quarter due to soaring coal prices. Electricity prices have been frozen, but coal prices have not, putting the nation’s five biggest power generators in a brutal squeeze.

China’s five biggest power companies pleaded with the government to lift price ceilings. The government rejected their plea, saying electric power prices would not be allowed to rise until inflation is brought under control. Meanwhile, the government is calling on power companies to increase electricity generation by 40% in three years. (Huaneng’s ADRs closed above $33 Friday—Editor.)

We would caution any China investor to be very wary of buying shares in companies that may be subject to government manipulation.

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