For any long-term investor that’s interested in the phenomenal growth of China, Hong Kong’s stock market clearly provides a great hunting ground for quality companies.
Yet when we select individual stocks, we have to be acutely aware that picking losers can cause serious damage to our long-term returns.
In Hong Kong stock market’s case, there are actually many stocks that are primarily focused on Hong Kong for the majority of their revenue and income.
Unfortunately for shareholders of these companies, that’s been a recipe for value destruction.
So, here are four Hong Kong stocks – which are also part of the Hang Seng Index – that I think investors should avoid at all costs in 2021 and beyond.
1. MTR
MTR Corporation Limited (SEHK: 66), which is the sole operator of Hong Kong’s mass transit railway system, had a terrible 2020.
Its loss in 2020 was HK$11.9 billion (US$1.5 billion), as revenue fell around 21.9% year-on-year to HK$42.5 billion.
More importantly, though, it saw a recurrent business loss of HK$1.1 billion, compared to profits of HK$5 billion in 2019.
With capex also set to total a massive HK$47.1 billion in the next three years, MTR’s hard-hit rail business is unlikely to be made up for by its property development revenues.
Uncertainty reigns in Hong Kong’s property market given Covid-19 so for MTR, its path for recovery is as murky as ever.
2. Cathay Pacific
Investing great Warren Buffett once said that “we have no ability to forecast the economics of the airline industry”.
That was way back in 1989 but he tacitly admitted his mistake again early last year, in the depths of the Covid-19 pandemic, by selling out of his holdings in a group of US airlines.
For investors, that same logic could also be applied to Hong Kong carrier Cathay Pacific Airways Limited (SEHK: 293).
Results and profits (or lack thereof) have been absolutely abysmal for Cathay as Hong Kong’s borders have been shut.
Cathay Pacific posted a record loss in 2020 of an eye-watering HK$21.6 billion (US$2.8 billion), swinging from a profit of HK$1.69 billion in 2019.
Admitting that it’s in “survival mode”, Cathay had to cut 5,900 jobs in 2020 and shut down its regional brand; Cathay Dragon.
Like local flagship carrier Singapore Airlines Ltd (SGX: C6L), Cathay has no local market to serve/fly to, unlike its Chinese and American peers which can fly to multiple domestic destinations.
With closed borders likely for the foreseeable future, and business travel unlikely to return to prior highs given the success of remote work tools like Zoom Video Communications Inc (NASDAQ: ZM), long-term investors should be closing off Cathay Pacific from their portfolios.
3. HSBC Holdings
Hong Kong- and Asia-focused bank HSBC Holdings plc (SEHK: 5) had a pandemic year to forget. The big bank replaced its CEO John Flint with an “interim CEO” Noel Quinn in August 2019 before finally deciding to give the job to Quinn on a permanent basis in March of 2020.
One of his first major acts as permanent CEO was to suspend HSBC’s dividend in early April – causing an outcry for investor reliant on its dividend payments.
Although HSBC’s full-year 2020 earnings beat (admittedly) low expectations, its return on tangible equity (ROTE) was just 3.1%, down from an already-poor 8.4% in 2019.
Poor capital allocation and bloated costs mean the company is weighed down by inefficiencies. For any long-term investor, HSBC shares are better left untouched until the bank can prove the business is turning around for good.
4. Wharf REIC
One major property landlord I would avoid is Wharf Real Estate Investment Company Limited (SEHK: 1997).
Better known as Wharf REIC, the landlord owns multiple well-known properties in Hong Kong such as Harbour City and Times Square.
Unsurprisingly, the company was hit hard in 2020 as visitors to Hong Kong plummeted amid the Covid-19 pandemic as visitor arrivals from Mainland China plunged.
This hit Wharf REIC hard as its malls rely heavily on tourism. With anti-government protests in 2019 also scaring away Chinese tourists, there’s no guarantee they will even return to shop in the city once restrictions and unregulated visitor arrivals are permitted.
Finally, Wharf REIC also holds a sizeable net debt position of HK$52.0 billion. In an environment as uncertain as this, with the potential for rising interest rates, that doesn’t bode well for the future for shareholders.
Avoid being short-sighted
Although many of these companies have seen strong share price recoveries in 2021 on some recovery in their businesses, that’s mainly a function of investor rotating into poor quality “value” stocks.
Nothing much has changed with these businesses to merit being more optimistic on a five-year or 10-year time horizon.
For that reason, long-term investors should ignore the short-term price movements and focus on adding just quality companies to their portfolios.
Disclaimer: ProsperUs Head of Content Tim Phillips owns shares of Zoom Video Communications Inc.
