Credit Suisse bullish on small-cap stocks

Credit Suisse Group Inc said on Tuesday that it is bullish on Chinese equities this year, favoring small-capitalization stocks that stand to benefit from improving economic fundamentals.

The Hang Seng Index, which dropped 2.27 percent on Tuesday to 23148.53 points, will finish the year almost 10 percent higher at 25500 points, said Kenny Lau, a Credit Suisse research analyst based in Hong Kong.

Lau's end-year target for the Shanghai Composite Index - the A-share market benchmark - is 2600 points, around 7 percent higher than Tuesday's close of 2433.13 points.

The Swiss investment bank said it prefers small-cap stocks, including sportswear maker Anta Sports Products Ltd and jeweler Chow Sang Sang Holdings International Ltd, over their large-cap counterparts.

"Some upstream manufacturing companies have improved their business in the past few months. We expect more Chinese companies in different sectors to show more visible improvement in business," Lau said.

"We see long-term small-cap investment opportunities in China," he added.

In the A-share market, the valuation of small-cap stocks is at a discount in terms of their price-earnings ratio and price-to-book ratio.

After two years of underperformance, the PE ratio of Chinese small-caps is currently at a 2 percent discount compared with large caps. A-share small-caps started rising at the end of the third quarter of 2012.

In Hong Kong, small-caps are trading at a PE ratio of 11.7 times, which represents a 16 percent discount to large-caps.

Small-caps with mainland exposure - especially the leading and upstream manufacturing stocks - have started to show signs of business improvement after a year of economic slowdown on the mainland, Credit Suisse said.

The investment bank recommends eight small-cap stocks in the H-share market: Anta Sports Products, Chow Sang Sang, Champion Real Estate Trust, Kingboard Chemical Holdings Ltd, Lonking Holdings Ltd, Skyworth Digital Technology Co Ltd, Varitronix International Ltd and West China Cement Ltd.

The bank forecasts an average 18 percent increase for the eight stocks over the next 12 months.

The forecast follows a report last week saying that the Chinese economic recovery is firmly on track.

China's official purchasing managers' index, or PMI, showed that factory output kept growing in January, with a reading of 50.4 points compared with 50.6 in December. A reading beyond 50 indicates expansion.

"The strong readings will set a base for the government's reform and fiscal stimulus measures in the second quarter, which will benefit equities," Tommy Ong, an analyst with Singapore-based bank DBS Group Holdings, wrote in a research note.

Ong forecasts a 20 percent rally in the A-share market this year, with the CSI 300 index, which tracks large A-share stocks, ending the year above 3200 points. The index increased 26 percent since December to close at 2771.68 points on Tuesday.