CMB Securities: May high ROE high FCF leading strategy is expected to become a new investment paradigm

According to the Zhitong Finance and Economics APP, CMB Securities released a research report stating that looking ahead to May, the A-share capital expenditure growth rate confirmed in this year's annual report and first quarter report is declining, free cash flow (FCF) is improving, and the dividend ratio continues to increase, bringing real intrinsic returns to investors in the A-share market. The high ROE and high FCF leading strategy is expected to become a new investment paradigm. In addition, the technology sector is expected to return after the earnings disclosure period, and the market will present a situation where the FCF leaders represented by the CSI A50 and SSE 300 quality indices, as well as the Sci-Tech Innovation 50, will advance to a new level.

Overall judgment and core logic: Enterprises are moving forward and advancing to a new level.

After the disclosure of the first quarter report, profit differentiation is evident. Excluding the real estate and real estate-related sectors, as well as the new energy sector, the net profit growth rate of the non-financial sector in 24Q1 turned positive to 1.6%, which is also the first time since the third quarter of 2022 that the net profit of the same component stocks has turned positive. Special bonds and special national bond projects are expected to accelerate in the second quarter, coupled with an improvement in exports, leading to further improvement in profits in the second and third quarters. On the liquidity front, the implementation of the new nine regulations and the convening of the Third Plenary Session in July are expected to improve domestic fund risk appetite; the strengthening of the Renminbi and Hong Kong Dollar, as well as the surge in Hong Kong stocks and Chinese concept stocks, indicate an accelerated inflow of foreign capital into Chinese assets. Overall, May is expected to continue the trend of simultaneous improvement in economic fundamentals and liquidity seen previously, with major indices poised to reach a new level in the second and third quarters.

Industry allocation core strategy: Dual-drive of high ROE high FCF style and Sci-Tech innovation style.

At the style level, May and June are traditional periods of performance vacuum. After the earnings disclosure period, sectors with low penetration and significant industry trends are expected to regain attention. Areas such as AI computing power, applications, low-altitude economy, and robotics are expected to become active again, with technology and innovation sectors expected to revive. With the disclosure of annual and first quarter earnings forecasts, the stabilization of performance of high-quality sectors and industry leaders is expected to gradually be confirmed. The improvement in free cash flow due to declining capital expenditures will be further confirmed, as listed companies overall increase their dividend payout ratios, raising investors' expectations for real returns from high-quality A-share leading companies. The high ROE and high FCF leading style represented by the CSI A50/300 quality indices and the GICS performance is expected to undergo a third round of valuation repair, with a clearer stock selection strategy based on the improvement of free cash flow. The dual-drive of Sci-Tech innovation and high ROE high FCF quality/performance leaders.

At the industry selection level, focus on short-term performance improvement directions, and long-term focus on turning points in profitability and capacity expansion. Taking into account previous performance, valuation, trading activity, economic changes, policies, and event catalysts, CMB Securities recommends focusing on the technology growth areas of electronics, computers, and biopharmaceuticals; leading companies in the consumer cyclical sectors such as food and beverage, home appliances, non-ferrous metals, automobiles, and machinery. In May, the focus is on five major tracks with marginal improvements: AI computing power (servers, optical modules, PCB), industrial metals (copper, aluminum), integrated circuits (storage chips, semiconductor equipment), low-altitude economy (flying cars, digital infrastructure, unmanned freight), and shipping (shipbuilding, oil transportation) Liquidity and Fund Supply and Demand: Inflow of Foreign Capital Expected to Improve A-share Fund Supply and Demand Structure.

In terms of liquidity, due to factors such as the small amount of government bond issuance in April and the small amount of reverse repurchase expiries, overall market liquidity is relatively abundant, in line with seasonal patterns. Various types of fund interest rates are running steadily, and the phenomenon of fund stratification is easing. In April, the US ISM Manufacturing PMI fell into the contraction zone, the increase in non-farm employment in the US in April was significantly lower than expected, the unemployment rate unexpectedly rose, and wage growth slowed down. With the economic cooling, market expectations for the Fed's first rate cut have been brought forward from November to September, US Treasury yields have fallen, and the US dollar index has weakened significantly.

In terms of stock market fund supply and demand, both trackable fund supply and demand in the stock market narrowed in April, with fund supply and demand in tight balance. On the supply side, the scale of new fund issuance has fallen slightly but still contributes the majority of incremental funds; ETFs saw a slight net inflow, contributing some incremental funds; the Shanghai-Hong Kong Stock Connect saw a significant net inflow; margin financing funds shifted from a significant net inflow to a net outflow. On the demand side, major shareholders have shifted from net selling to net buying; IPO and refinancing scales have fallen again. In terms of major incremental funds in April, public funds contributed the majority of incremental funds, while ETFs and northbound funds saw varying degrees of net inflows. Looking ahead to May, with expectations of economic improvement domestically, US Treasury yields falling, and the US dollar index weakening significantly, foreign capital is expected to continue to flow back, improving the A-share fund supply and demand structure.

Medium-term Economic Outlook and Industry Recommendations: Focus on sectors where performance and capacity expansion turning points are emerging.

Affected by limited demand recovery, rising cost ratios, and drag from heavyweight sectors such as banks, real estate, and new energy, listed companies faced challenges in performance recovery in the first quarter, with differentiation in specific sectors. The proportion of overseas revenue in total revenue continues to rise, while in the context of slowing capacity expansion growth, listed companies have seen increases in dividend yield and dividend payout ratio. Among major industries, utilities, consumer services, and information technology have relatively high growth rates in annual and quarterly performance. Looking ahead, resource industries, healthcare, and information technology are showing marginal improvements in performance.

Short-term recommendations focus on sectors with high growth rates or marginal improvements in performance, mainly in: 1) consumer/travel-related industries (hotels and catering, tourist attractions, airports, beverages and dairy products, snacks, etc.); 2) export-related industries (specialized equipment, marine equipment, commercial vehicles, automation equipment, auto parts, home appliances, small appliances, textile manufacturing, etc.); 3) some resource industries such as basic chemicals, petroleum and petrochemicals, industrial metals, precious metals, etc.; 4) some TMT sectors (consumer electronics, semiconductors, communication equipment, computer equipment) etc. In the medium to long term, considering capacity expansion, it is recommended to focus on resource industries, information technology, healthcare that have limited capacity expansion previously and are showing profit turning points, as well as the arrival of the end of capacity digestion in the midstream manufacturing industry and the emergence of profit turning points.

Investment in Tracks and Industry Trends: Government intensively introduces low-altitude economic policies, focusing on three major sub-sectors of flying cars, unmanned freight transportation, and digital infrastructure. Investment Opportunity 1: Flying Cars, eVTOL technology has advantages such as low noise, low cost, and high resource utilization. Many manufacturing companies are entering the flying car industry, promoting the civil and commercial use of flying cars, and accelerating the development of the low-altitude economy industry.

Investment Opportunity 2: Unmanned Freight Transport, "Low-altitude Economy + Logistics" is currently the most widely used commercial application scenario. Many logistics companies are entering the field of drone logistics, and some food delivery platforms are also exploring the use of drones for delivery.

Investment Opportunity 3: Digital Infrastructure, based on communication perception integration technology, relying on infrastructure such as cellular mobile communication networks, to build an integrated low-altitude network of communication, perception, and intelligent computing, solving pain points in the development of the low-altitude economy and promoting its rapid development.

On the policy front: In April, there are four major directions of industrial policies worth paying attention to: 1) New Quality Productivity, focusing mainly on the low-altitude economy and artificial intelligence; 2) Data Elements, the National Data Bureau issued the "Work Points for the Digital Society by 2024"; 3) Dual Carbon/Wind Energy Storage, the "Thousand Villages and Ten Thousand Villages Wind Power Action" has been launched, and the pilot work to supplement the shortcomings of county-level charging and swapping facilities has begun; 4) Pharmaceutical and Biological, local innovative drug support policies are being successively introduced