Performance of China’s Hong Kong Shares Has Been a Long-Term Letdown

July 4, 2013, 5:34 p.m. ET

Performance of China’s Hong Kong Shares Has Been a Long-Term Letdown

DANIEL INMAN

When Tsingtao Brewery Co. 600600.SH +0.48% went public in Hong Kong in July 1993, runaway investor demand for the beer maker’s new shares lifted them 29% on their first trading day. Since then, nearly 600 other big Chinese companies have raised a total of about $250 billion through initial public offerings in Hong Kong, according to Dealogic. IPOs by banks, real-estate developers and other firms opened the door for foreign investors eager to bet on China’s booming economy—and vaulted Hong Kong into a big-time rival to New York and London in the global battle for new stock listings. But the performance of so-called H-shares, as Hong Kong listings of companies incorporated in China are known, has been a letdown. The Hang Seng China Enterprises Index is up 43% since its birth in 1994. Economic growth in China has averaged 10% over the past two decades. In comparison, Japan’s Nikkei Stock Average lost 30% in a prolonged period of economic stagnation, and the U.K.’s FTSE 100 index gained 101%.

The Standard & Poor’s 500-stock index in the U.S. had jumped 241% in the same period, through Wednesday, before the Independence Day holiday. Both the S&P 500 and the FTSE 100 did better than the China Enterprises Index, even though the underlying economies grew more slowly.

“Over the last 20 years, it would have been better to buy [China’s] economic growth rather than the stock market,” says Paul Chan, chief investment officer for Asia, excluding Japan, for investment manager Invesco IVZ -0.13%Hong Kong Ltd., a subsidiary of Invesco Ltd., who has covered the Hong Kong and China markets for more than 20 years.

The performance of Chinese stocks isn’t the only way to measure the impact of the H-share listings. Charles Li, chief executive of Hong Kong Exchanges and Clearing Ltd.,0388.HK +1.21% which owns the Hong Kong stock exchange, says that the wave of IPOs was a big step in opening China’s financial system to the rest of the world.

The significance of the H-share listings “was to really open up a new chapter for Hong Kong’s overall growth, particularly for capital markets,” Mr. Li says. “In many ways it was beginning of the opening of China’s capital account.”

In recent years, the city has played a key role in the fast-rising, world-wide market for Chinese company bonds and increasing liberalization of China’s currency.

Now, though, the China Enterprises Index is down 21% year to date, and hunger for Hong Kong IPOs has diminished. The city ranks sixth globally for new listings so far in 2013, according to Dealogic. Chinese companies have only raised $4 billion in Hong Kong so far in 2013, a far cry from the $41.8 billion they raised in all of 2010.

Chinese companies with shares listed in Hong Kong have churned out strong revenue growth that tracks the country’s overall economy. But the largest Chinese companies are laggards in measurements that sway many investors, such as earnings growth and return on equity.

In the past decade, profits at China’s biggest companies rose an average of 15% a year, compared with 20% at U.S. companies currently in the S&P 500, according to an analysis by The Wall Street Journal. The U.S. firms’ return on equity—a measure of how effectively companies use shareholders’ money—averaged 23%, compared with 19% for the Chinese ones.

The calculations are based on the 100 largest Chinese companies listed in Hong Kong. The figures exclude major Chinese banks because of heavy government involvement in their businesses.

Most of China’s big companies are far younger than those in the U.S. and haven’t gone through as many downturns, which force companies to consolidate and boost efficiency.

Still, the recent slide is troubling to analysts and investors as China tries to shake up its economy and shift away from investment spending and toward consumption. Efficient companies can respond more quickly to changing consumer tastes and encourage more consumption that leads to higher profits—and stock prices.

Tsingtao is a good example. Two years after its listing, Tsingtao’s profits and share price were down, and it had stumbled to third place among Chinese brewers. Trading was temporarily suspended because the company lent money from its IPO to other Chinese companies rather than spend it on expansion as promised.

Then came a turnaround. The shares now are up 1,923% from their IPO price, beating even some of the strongest U.S. stocks during the same period, such as IBMCorp. IBM +0.91% and Intel Corp. INTC +0.18%

“Tsingtao Brewery has been listed for 20 years, and it has been a constant process of learning, as well as continuous improvements and maturity,” Tsingtao said in a statement.

In contrast, shares of Maanshan Iron & Steel Co., 600808.SH 0.00% the fifth state-owned Chinese company to sell H-shares in Hong Kong, are down 26% since their IPO in 1993.

Maanshan Steel is typical of many Chinese companies as it grapples with excess capacity, slower economic growth, falling profit margins and rising debt levels.

Su Jiangang, Maanshan Steel’s chairman, says the IPO proceeds allowed the company to grow from a medium-size steelmaker to a major producer, expand internationally and improve the quality of management. Yet it must do better, he says.

“Share-price performance generally links with acompany’s earnings performance. We’ll try to cut costs and enhance our competitiveness to improve profitability,” Mr. Su says.

Some analysts attribute the struggles of companies like Maanshan Steel to the growing pains of a developing economy, while others say state-owned companies that dominate the market are poorly run because they serve the need of the government to generate jobs and economic growth rather than profits.

One problem: Many top executives are judged by Communist Party officials rather than shareholders, says Gary Greenberg, head of emerging markets at asset-management firm Hermes Fund Managers in London

“There is a shadow hierarchy in the Chinese corporate world,” Mr. Greenberg says. There are “a lot of leaders wearing two hats and, of the two hats, the most important one is the Communist Party hat, because that’s how they will get their next job.”

Critics say the weak performance is a glimpse of how China’s biggest businesses likely will perform as the economy slows. “For Chinese companies to put in such a showing in a booming economy only goes to show how badly run they are,” says Fraser Howie, a former banker in China and co-author of “Red Capitalism.”