Political risk in China not to be neglected

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French asset manager La Française AM and JK Capital Management Ltd, a Hong Kong based fund management company part of La Française AM, lists the sectors exposed to policy risk in China in February and explains the following consequences.

One of the key characteristics of investments in China is the exposure to policy risk. Decisions are made by the central government without any warning, with serious consequences for companies operating in the sectors involved.

In February, policy risk played out in pharmaceuticals, electricity generation and Macau gaming.

Pharmaceutical sector:

The health and family planning commission issued its inspection plan to be implemented for large hospitals between 2015 and 2017.

Key aspects include the setting up of a strong punishing and preventive anti-corruption system, the setting up of performance linked incentive systems and a new transparent price publishing mechanism.

Furthermore, the ministry of Health has indicated in a consultation paper its willingness to change the drug reimbursement method. In the future, it is possible that patients will be reimbursed fixed amounts for their medicines and no longer a percentage of the price charged by the hospitals.

In February, a tender for medicines in the Hunan province ended up with a low teen to 20% price cut for flagship products produced by large pharmaceutical companies. It appears quite clearly to us that the good days of the Chinese pharmaceutical sector are over.

Top line growth rates are not in jeopardy but margins are.

Electricity generation:

After having cut tariffs by 3% last November, it was reported in the Chinese press in early February that the government was about to cut prices by another 7%, squeezing the margin of all electricity producers, with a bottom line impact that could be as high as 20%.

Two tariff cuts in such a short period of time is unprecedented. At a time when there is overcapacity in power generation in China we believe the sudden change of attitude of the government towards power producers is a strong signal that came on the heels of very good performances in 2014.

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