Strategy Equity Research
Huatai Research
25 May 2018
Strategy | China Road Ahead 2H18 – navigating through the uncertainties
Opportunities amid rising uncertainties Cheng LV +86 21 2897 2057 We expect 6/12% upside for the HSI/HSCEI in 2018E from their current levels, and Strategist [email protected] hold an optimistic view on the broad consumption area, banks, energy, and select Zhixuan LIN +86 21 2897 2090 bottom-up picks for their sanguine growth potential and attractive valuations. Our Analyst [email protected] view allows for major changes in the market environment since end-2017, which Shujin CHEN, CFA +852 3658 6231 include more volatile and turbulent global and domestic financial markets, subdued Analyst [email protected] investor risk appetite, as well as emerging concerns over the economic prospects Bruce WANG +86 21 2897 2099 for China and globally. Despite facing more uncertainties in 2H18, growth quality Analyst [email protected] improvement has not been disrupted, in our view; at the same time, we believe Qian YAO +852 3658 6064 financial deleveraging should lower tail risks, consumption outlook remains Analyst [email protected] resilient, and valuation correction so far has unveiled opportunities. We slightly Hanzhi DING +852 3658 6058 Analyst [email protected] raise our end-2018E target for HSI to 32,600 and maintain our end-2018E target for HSCEI at 13,500 to reflect the strong 2017 earnings results and our more Wen DAI +86 21 2897 2078 Analyst [email protected] prudent stance on valuation. Saiyi HE +852 3658 6236 Analyst [email protected] What has changed? Chunli ZHAN +852 3658 6230 Greater volatility in Hong Kong’s stock market year to date has mirrored the greater Analyst [email protected] turbulence in global markets which has been due to a rapid upthrust in 10Y US Xiaofeng SHEN +86 21 2897 2088 Treasury bond yield, evolving Sino-US trade tensions, and more recently, a Analyst [email protected] strengthening US dollar, which generally impacts emerging markets more than Tony LIU +852 3658 6043 developed ones. Southbound investors have turned more cautious and lowered Analyst [email protected] their positions in the Hong Kong market. Our analysis suggests that in fraught Zezheng ZHANG +86 21 3847 6205 times, both A-share and Hong Kong markets’ correlation with the US market can Analyst [email protected] Strategy top picks spike, and that the Hong Kong market is synchronizing with A shares. Zoey ZONG +852 3658 6235 CompanyAnalyst Code [email protected] (HKD) Rating Relative certainties amid rising uncertainties BCA 1114 HK 25.00 BUY Financial deleveraging has taken a toll on the economy by prompting higher Li Ning 2331 HK 9.90 BUY financing costs, especially for smaller companies, along with more credit default Chow Tai Fook 1929 HK 10.60 BUY cases; at the same time, however, it lowers the long-term tail risks for the China PetroChina 857 HK 8.00 BUY market. Consumption will remain solid in the coming quarters despite sluggish CMB 3968 HK 44.56 BUY growth in 4M18: as we see it, the trend of structural shifts is undisrupted and CITIC Bank 998 HK 6.66 BUY favorable policies — eg, those spawned by competition for talent among many new CSPC Pharma 1093 HK 23.80 BUY tier-1&2 cities — could have positive spillover into consumption. New-economy stocks could continue to capture the spotlight but amid a relatively cautious Conch Venture 586 HK 27.90 BUY environment, we urge prudence when selecting new-economy picks. Valuation Tencent 700 HK 498.50 BUY Hua Hong Semi 1347 HK 21.80 BUY reversal year to date compared with full-year 2017 has been prominent for the auto, semiconductor, software, consumer staples, insurance and real estate sectors, Source: Huatai HK Research estimates where we believe value has emerged for select names.
Sector view and top picks We are OVERWEIGHT: 1) consumer staples, select HK local retailers, and apparel leaders due to our view of a long-term structural shift in household spending and solid consumption outlook in the coming quarters; 2) banks, on both potential NIM and ROE improvement thanks to lower tail risks due to financial deleveraging, and higher lending rates due to liquidity tightening; 3) Internet leaders, on both strong platform advantages, and corrected valuation and weak sentiment; and 4) oil names because of potentially strong oil prices near term. We also like some bottom- up ideas that combine sanguine growth prospects and attractive valuations, such as select stocks in auto, semiconductor, healthcare, and environmental protection. Our top picks are Brilliance China, Li Ning, Chow Tai Fook, PetroChina, CMB, CITIC Bank, CSPC Pharma, Conch Venture, Tencent and Hua Hong Semiconductor.
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 1 Please refer to end pages for analyst certification and required disclosures.
China Strategy
Contents Strategy view on one page ...... 3 1H18 recap – what has changed and what has not? ...... 4 Asymmetrical impact of global market bumps ...... 5 Subdued southbound flows and rotation to defensives ...... 6 On the right track to growth quality improvement ...... 8 Deleveraging taking a toll, but lowers tail risks...... 9 Solid outlook for household consumption ...... 11 Structural shifts will not be disrupted ...... 11 Talent hunt policies could potentially spur consumption ...... 11 Selective on new economy ...... 13 Valuation reversal unveils opportunities ...... 14 Index target and risk analysis ...... 16 Sector recommendation and top picks ...... 17 Appendix ...... 18
Sectors Auto & Auto Parts ...... 21 Banking ...... 27 Constructions Materials ...... 34 Steel ...... 41 Coal Mining ...... 47 Metals & Minings ...... 52 Forest & Paper Products ...... 59 Environment Services ...... 65 Consumer Discretionary ...... 70 Energy ...... 71 Healthcare ...... 78 Internet ...... 99 Property ...... 107 Transportation & Logistics ...... 117 Utilities ...... 129
25 May 2018 2
China Strategy
Strategy view on one page Fig.1. HSI 2018E base case target: 32,600 Fig.2. HSCEI 2018E base case target: 13,500 (%) (%) (%) Change in fwd EPS Change in fwd PE (%) Change in fwd EPS Change in fwd PE HSI performance (rhs) HSCEI performance (rhs) 40 40 30 30
30 30 20 20
20 20 10 10
10 10 0 0
0 0 (10) (10)
(10) (10) (20) (20)
(20) (20) (30) (30) 2012 2013 2014 2015 2016 2017 2018ytd 2018E 2012 2013 2014 2015 2016 2017 2018ytd 2018E Note: data as at 23 May Note: data as at 23 May Source: Bloomberg, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
Fig.3. Growth in consumption by sector
2018 ytd 2017 Mobile internet traffic 1 Movie box office 163 192 Macau gaming Cosmetics Household & Personal products Petroleum products Household appliances Dining & Catering Foodstuff Total retail sales Textiles & Apparel Beverage Tobacco & Alcohol Furniture Building decoration materials Communication appliances Jewelry Automobiles Sports equipment Books & Magazines Life insurance premium (%) (30) (20) (10) 0 10 20 30 40 Note: data for life insurance premium as of March 2018; others as of April 2018 Source: Wind, Huatai HK Research Fig.4. Strategy top picks
Total mkt cap TP 2018E 2018E EPS 2018E 2018E 2018E div Ticker Name Industry Group Rating (USDmn) Price (HKD) (HKD) PE (x) growth (%) PB (x) ROE (%) yield (%) 1114 HK Brilliance China Auto Auto BUY 9,708 15.10 25.00 8.0 77.3 1.9 26.2 3.0 2331 HK Li Ning Consumer Durables BUY 2,527 9.08 9.90 24.9 40.3 3.2 13.6 1.2 1929 HK Chow Tai Fook Retailing BUY 13,405 10.52 10.60 22.7 18.4 3.0 13.6 2.6 857 HK PetroChina Energy BUY 226,106 6.24 8.00 15.8 157.5 0.8 4.9 6.6 3968 HK CMB Banks BUY 113,606 33.40 44.56 8.6 13.1 1.4 16.1 3.6 998 HK CITIC Bank Banks BUY 46,080 5.70 6.66 5.0 10.4 0.6 11.5 6.4 1093 HK CSPC Pharma Pharma BUY 18,694 23.50 23.80 38.5 33.5 7.8 22.1 0.8 586 HK Conch Venture Capital Goods BUY 5,761 25.05 27.90 8.2 31.1 1.5 20.0 2.5 700 HK Tencent Software BUY 492,871 407.00 498.50 38.6 14.4 10.2 30.0 0.0 1347 HK Hua Hong Semi Semiconductor BUY 2,459 18.56 21.80 15.6 9.9 1.4 9.1 1.9
Note: data as at 24 May market close Source: FactSet, Huatai HK Research estimates
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China Strategy
1H18 recap – what has changed and what has not? In 2018 year to date, the China/HK market has already experienced stages of excessive optimism, panic selling, and cautiousness. As of 24 May, the HSCEI and HSI were up by 3.8% and 2.8%, respectively. The healthcare, retail, energy, materials, consumer services and utilities sectors led the market, while the auto, semiconductor, media, tech hardware and diversified financials sectors were among the laggards.
From where we stood at end-2017, the key changes include: 1) a more volatile and challenging global market environment due to a rapid upthrust in 10Y US Treasury bond yield, evolving Sino-US trade tensions, and, most recently, a strengthening US dollar; 2) emerging concerns over growth momentum in China; and 3) the progress and spillover effect of financial deleveraging. These key changes will continue to impact the market throughout the rest of 2018, in our view.
In the meantime, our core thesis for 2018E — that market upside underpinned by slower but better-quality growth — has not changed. The 2017 results turned out stronger than the market expected, laying a solid foundation for further quality improvement. The profitability recovery of non-financials, especially large SOEs, has supported healthier balance sheets and will help lower tail risks in the long term. Financial deleveraging is underway, and though it may cause some short-term pains, it should result in a steadier market in the future.
Fig.5. Huatai HK strategy: key calls
We expect subdued HSI 2018 outlook: emphasized southbound flows and 34,000 slower but better-quality continue to like consumer Initiation: we highlighted quality growth being the durables and apparel, select continuous market driver; highlighted key HK local retailers, healthcare, 33,000 outperformance of large themes, including consumer staples, and select caps and sector leaders consumption structural shifts, oil companies and a later stage of new economy, and SOE 32,000 cyclical upswings deleveraging We recommended 31,000 recalibration to a more balanced strategy till year-end 30,000
29,000 We anticipated a bumpy road We noted that after such a in 2Q18, due to four key 28,000 rapid rise, the market could macro risks, and enter the doldrums in the recommended sticking with short term and become prone sectors with resilient earnings 27,000 to short-term volatility
26,000 Aug-17 Aug-17 Sep-17 Oct-17 Oct-17 Nov-17 Dec-17 Dec-17 Jan-18 Feb-18 Feb-18 Mar-18 Apr-18 May-18
Note: data as of 21 May Source: Wind, Huatai HK Research
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China Strategy
Fig.6. Sector performance in 2018 year to date Fig.7. Sector performance in 2017
Pharma Software Medical Eqpt & Svcs Auto Retailing Pharma Energy Tech Hardware Materials Insurance F&B Retailing Materials Consumer Svcs Real Estate Utilities Consumer Svcs Real Estate Household Products Consumer Durables Southbound Stocks Commercial & Prof Svcs F&B F&B Semiconductors Banks Consumer Durables Southbound Stocks HSI HSCEI Commercial & Prof Svcs HSI Transport Software Retailing Transport Banks Insurance HSCEI Capital Goods Diversified Financials Telecom F&B Retailing Diversified Financials Utilities Tech Hardware Energy Media Capital Goods Semiconductors Medical Eqpt & Svcs Auto Telecom Household Products Media (%) (30) (20) (10) 0 10 20 30 40 50 (%) (20) 0 20 40 60 80 100 120 Note: data as at 23 May Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Asymmetrical impact of global market bumps Volatility in the Hong Kong market has returned to a ‘normal level’ after staying extremely low for quite a while, which was triggered by a sudden correction in the US equity market and deterioration in global investors’ risk appetite. While global markets are all being influenced, the scope and extent are not exactly the same.
A rapid uptick in 10Y US Treasury bond yield could weigh on the overall market valuation. Our analysis of valuation changes of different market segments during the taper tantrum back in 2013 shows that Chinese companies could be hit harder than HK local and foreign companies, and that companies with hefty debt burdens could see the largest valuation downside risks. See our 2Q18 outlook report for detailed analysis.
To make things worse, the USD index recently spiked on the back of a hike in long-term US treasury yield, expectations of rising inflation, and weaker-than-expected economic data in Europe and Japan. This has made emerging markets more vulnerable due to potential capital retreat, particularly for markets with high dependence on USD debts and exports. Historically, the relative performance of emerging markets to developed markets exhibited a strong negative relationship with the trend of USD index, though the latter may not be the sole driving force. This partially explains the weak market performance in the past few weeks.
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China Strategy
Fig.8. Relative performance of emerging to developed markets and USD index
Emerging markets vs Developed markets 1.0 USD index (rhs) 130
0.9 120
0.8 110
0.7 100
0.6 90
0.5 80
0.4 70
0.3 60
0.2 50
Jan-97 Jan-98 Jan-96 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-95 Note: data as of 22 May Source: Bloomberg, Huatai HK Research
Subdued southbound flows and rotation to defensives Southbound investors turned cautious since late March. Overall fund flows turned negative with heavy profit taking in large sectors, including banks, real estate and insurance. On the other hand, select defensive sectors have enjoyed rapid increase in southbound holdings, pushing the sectors’ valuations close to historical highs, as seen in the case of the healthcare sector. Please refer to Review of 1Q18 allocation of mainland investors for detailed analysis.
Fig.9. Estimated southbound flows by sector in Jan 2018 Fig.10. Estimated southbound flows by sector in Feb 2018
(HKDmn) (HKDmn) 25,000 25,000 20,000 20,000 15,000 15,000 10,000 10,000 5,000 5,000 0 0
(5,000) (5,000)
IT
IT
Banks
Banks
Energy
Energy
Utilities
Utilities
Telecom
Telecom
Materials
Materials
Insurance
Insurance
Industrials
Industrials
Healthcare
Healthcare
Cons. Disc.
Cons. Cons. Disc.
RealEstate
RealEstate
Cons. Stap.
Cons. Stap. Div. Financials Div. Financials
Source: Wind, Bloomberg, Huatai HK Research Source: Wind, Bloomberg, Huatai HK Research
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China Strategy
Fig.11. Estimated southbound flows by sector in Mar 2018 Fig.12. Estimated southbound flows by sector in Apr 2018
(HKDmn) (HKDmn) 15,000 3,000
10,000 1,500
5,000 0
0 (1,500)
(5,000) (3,000)
(10,000) (4,500)
(15,000) (6,000)
IT
IT
Banks
Banks
Energy
Utilities
Energy
Utilities
Telecom
Telecom
Materials
Materials
Insurance
Insurance
Industrials
Industrials
Healthcare
Healthcare
Cons. Disc.
RealEstate
Cons. Disc.
Cons. Stap.
RealEstate
Cons. Stap. Div. Financials Div. Financials Source: Wind, Bloomberg, Huatai HK Research Source: Wind, Bloomberg, Huatai HK Research
One shared concern that led to domestic fund retreat from the Hong Kong stock market was the volatile overseas markets, particularly concerns over the US stock market. Some argue that due to their different degrees of openness, the domestic A-share market could be safer than the Hong Kong market.
We agree that as an offshore market, the Hong Kong stock market bears more risk for domestic investors; however, the impression that A-shares are safer might be an illusion. Fig.13 shows that the five-year rolling correlation of the HSI and S&P 500 indices’ weekly performance has stayed significantly higher than that between the CSI300 and S&P500 in the long term. However, the recent trend indicates a notable narrowing of the two, ie, A-shares’ correlation with the US market is picking up and Hong Kong’s correlation to the US market has declined.
More importantly, during times of global risk-off, the correlation of A-shares and the US market could spike quickly, according to one-year rolling correlation data. For example, during the EU debt crisis from 2010-2011, one-year rolling correlation of the weekly performance of the two markets ascended quickly from negative territory to over 55%. Another example is the situation early this year in which the A-share, Hong Kong, and US markets were in sync in their performance, with the correlation of HK vs US and A-share vs US all heightened to 66%.
To sum up, in extreme cases, the A-share market is not necessarily safer than the Hong Kong stock market. Moreover, the Hong Kong market’s swings are becoming more and more influenced by what happens in the domestic market.
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China Strategy
Fig.13. 5-year rolling correlation of weekly performance Fig.14. 1-year rolling correlation of weekly performance
Correlation: HSI vs S&P 500 Correlation: HSI vs S&P 500 0.8 Correlation: CSI300 vs S&P 500 Correlation: CSI300 vs S&P 500 1.0 0.7 0.8 0.6
0.5 0.6
0.4 0.4 0.3 0.2 0.2 0.0 0.1 (0.2) 0.0
(0.1) (0.4) Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Apr-04 Apr-06 Apr-08 Apr-10 Apr-12 Apr-14 Apr-16 Apr-18 Note: data as of 18 May Note: data as of 18 May Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
On the right track to growth quality improvement In our annual outlook report, we laid out our expectation of three aspects of growth quality improvement, including a further improvement in the margins of and lower net gearing for non-financials, and better profitability for the financial sector. So far, progress has been positive. Please refer to our 2017 results review for details.
Among HK and US-listed Chinese non-financial companies, energy and materials contributed 14.4 and 3.4%, respectively, of total net profit during 2014-2017. Strong oil prices and healthy supply-demand dynamic have and will continue to support the profitability of the energy and materials sectors. In the consumption space, which accounted for 9.1% of the aggregate net profit of non-financials, price inflation, solid demand, and product mix upgrade should be positive for margins. As a result, overall non- financials’ EBIT margins will likely to edge up by 0.4pp to 11.4% in 2018E, according to consensus forecasts. ROE of non-financials are also expected to trend up further.
Strong profitability recovery has supported net gearing decline among non-financials, especially for SOEs and the materials sectors. It is not only supportive to lowering financial risks of these heavily-indebted companies, but also benefits the banking sector with lower NPL ratio in the coming quarters.
25 May 2018 8
China Strategy
Deleveraging taking a toll, but lowers tail risks Overall, we believe financial deleveraging will raise the average borrowing cost, but will also lower tail risks for the China market as it enhances leaders’ advantages and could expedite sector consolidation. We are relatively more cautious over smaller companies that have hefty debt burdens.
Since the bond market bubble burst in late-2016, the impact of financial deleveraging on financing of the real economy has started to show. Financing costs are rising as a result of both liquidity tightening and shrinking non-standard financing channels. Bank average loan rate climbed another 22bp in 1Q18 after a small dip in 4Q17. Onshore credit spread continued its upward trend since mid-2017. Recent default cases have amplified the risk- aversion of investors.
On the other hand, financing demand remained solid so far, as evidenced by the recently released April social financing data. This means more accommodative policies are required. Otherwise, deleveraging could backfire on economic growth, which the government may not want to see. The Huatai macro team expects monetary policy to become more flexible in order to accommodate the financing needs of real economy and help lower pressure on banks’ balance sheet, and also expects 1-2 targeted RRR cuts and 1-2 policy rate hikes.
The policy shifts could marginally ease the current pressure, but may not be sufficient to thoroughly change the rising trend of financing costs. HK-listed Chinese companies have the option of issuing bonds in the offshore market, which may come at lower cost than domestic bonds because of the interest rate gap between the US and China risk free rates. But in the wake of rising overseas interest rates and short-term US dollar strengthening, they could also face higher refinancing costs, depending on their business, asset size, and current leverage level.
On the plus side, the deleveraging efforts in the past few years of sectors such as the materials, energy, and capital goods sectors should help control the overall increase in borrowing costs for non-financials, in our view. In our China universe, ie, HK- and US- listed Chinese companies that have a total market cap of greater than USD300mn, the average borrowing cost for non-financials was 5.2% in 2017 (2016: 4.9%), according to our estimates. Smaller companies face more challenges in a higher borrowing cost environment as they generally borrow at higher cost than larger companies, and when liquidity tightens, their borrowing costs could rise faster, as shown in Fig.18.
Fig.15. Bank loan rate has been climbing Fig.16. Credit spread on the rise
(%) (%) Avg loan rate General loan rate 1-year AA+ corporate bond vs treasury bond yield 12 5.0 Bill financing rate Mortgage loan rate 1-year AA- coprorate bond vs treasury bond yield 4.5 10 4.0 8 3.5 3.0 6 2.5 4 2.0
2 1.5 1.0
0
Dec-17 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Jun-09 0.5 0.0 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Note: data as of 1 March Note: data as of 23 May Source: PBOC, Huatai HK Research Source: Wind, Huatai HK Research
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China Strategy
Fig.17. Average borrowing cost of Chinese non-financials Fig.18. Average borrowing cost of Chinese non-financials
(%) (%) Mega Large Mid 7.0 6.1 12 Small Micro 5.7 5.8 5.6 5.7 6.0 5.3 5.3 5.3 5.2 10 5.0 4.9 4.8 4.6 5.0 8 4.0 6 3.0 4 2.0 2 1.0
0.0 0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
2017 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2005 Note: includes HK- and US-listed Chinese non-financials companies with a total Note: Includes HK- and US-listed Chinese non-financials companies with a total market cap of greater than USD300mn. market cap of greater than USD300mn. Ranked by average total assets in the Source: Bloomberg, Huatai HK Research corresponding year, top 10% of companies are mega companies; next 20% are large; middle 40% are mid; next 20% are small; and bottom 10% are micro. Source: Bloomberg, Huatai HK Research
25 May 2018 10
China Strategy
Solid outlook for household consumption Despite slower growth in total retail sales in January to April this year, we remain optimistic on household consumption in the short and long-term, thanks to: 1) continuous structural shifts in households’ overall consumption expense to higher-end products and services, eg, recreation, education and health care; and 2) policy initiatives aimed at competing for talents, which could potentially promote consumption by offsetting high living costs or reducing intangible costs.
Structural shifts will not be disrupted We do not expect the structural shifts to be disrupted in the future. Total retail sales growth weakened in 2018 year to date, causing some concerns over their resilience. We think the slowdown is mainly caused by a decrease in demand in property-related consumption and saturation in select sectors rather than overall sluggish consumption demand. Mobile Internet traffic, movie box office, Macau gaming revenue, cosmetics, household and personal products, textiles and apparels, tobacco and alcohol, and jewelry sales all have seen notable growth acceleration in 4M18 compared to the same period of 2017. Year- on-year growth for life insurance premiums, books and magazines, sports equipment, furniture, building decoration materials, and communication appliances dropped.
Fig.19. Consumption growth by sector, yoy%
2018 ytd 2017 Mobile internet traffic 1 Movie box office 163 192 Macau gaming Cosmetics Household & Personal products Petroleum products Household appliances Dining & Catering Foodstuff Total retail sales Textiles & Apparel Beverage Tobacco & Alcohol Furniture Building decoration materials Communication appliances Jewelry Automobiles Sports equipment Books & Magazines Life insurance premium
(%) (30) (20) (10) 0 10 20 30 40 Note: data for life insurance premium as of March 2018; others as of April 2018 Source: Wind, Huatai HK Research
Talent hunt policies could potentially spur consumption Several city governments announced preferential policies in the past few months aiming to attract talents and to boost their cities’ long-term competitiveness. Those cities include many new tier-1&2 cities such as Tianjin, Wuhan, Chengdu, Qingdao, Zhengzhou and Xi’an. Their policy initiatives mainly cover two approaches: 1) to directly lower living costs of targeted talents, with measures that include providing housing subsidies, providing apartments to talents, or giving discounts on house purchases; and 2) lowering intangible costs, eg, loosening hukou policies, accommodating the educational needs of talents’ children, promising better access to health care, and providing subsidies for employment and start-ups. These methods, in our view, could have positive spillover effects on local consumption.
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China Strategy
Fig.20. Preferential policies of select cities to attract talents City/province Direct measures to lower housing expenses Other intangible subsidies Nanjing No hukou restrictions on purchasing houses for high-level talents Hukou eligibility for talents with college degrees and who are under Monthly rental subsidies for undergraduate, postgraduate, and PhD degree age 40 holders of RMB600, RMB800, and RMB1,000, respectively Hangzhou Maximum rental subsidy of RMB4k per month Hukou eligibility for talents with postgraduate degrees and who are under age 45 Maximum subsidy of RMB1mn for housing purchases Subsidies for start-up or employment within one year after graduation are RMB20k and RMB30k for holders of postgraduate degrees and PhD holders, respectively Xi'an Provide apartments to talents and subsidies to high-level talents for rental or Hukou eligibility for talents with college degrees and who are under
housing purchases age 45 Chengdu Provide apartments to talents Hukou eligibility for talents with college degrees and who are under age 45
Monthly subsidies of RMB3,000 for qualified talents for three years Better access to health care for qualified talents Accommodative policies for the education of qualified talents' children and for the employment of their spouses Hainan No restrictions on purchasing houses and provide rental subsidies for Accommodative policies for the education of high-level talents' qualified talents children Provide rent-free apartments to high-level talents, and grant home property Hukou eligibility for people with college degrees rights for high-level talents after eight years Changsha Subsidies for purchasing houses are RMB30k and RMB60k for Hukou eligibility for talents with college degrees and who are under postgraduate degree holders and PhD holders respectively age 35 Wuhan Provide talent-apartments for graduated students Guidance on minimum annual salary standard for college students, Qualified graduates enjoy 20% discount when purchasing or renting houses eg, RMB60k and RMB80k for holders of postgraduate degrees and PhD holders Qingdao Rental subsidies are RMB800 and RMB1,200 per month for postgraduate Hukou eligibility of talents with college degrees degree holders and PhD holders, respectively
Source: News reports, Huatai HK Research
25 May 2018 12
China Strategy
Selective on new economy In our annual outlook report, we highlighted new economy as a key theme for 2018, were OVERWEIGHT on the healthcare sector as a representative new economy sector, and stressed potential valuation contraction of the Internet sector. So far this year, the healthcare sector has delivered strong outperformance and has pushed forward PE close to historical high since 2011. The software sector has seen 10.6% forward PE de-rating and slightly underperformed HSI in 2018 year to date.
The IPO reform of the HKEX and upcoming potentially strong pipeline of new economy companies will keep market interest high, but may dilute liquidity from incumbent new economy listed companies, in our view. This is especially the case if market sentiment is not strong and valuations of new listings are too high.
In 2017, IPOs in new economy areas gained strong traction, and on average delivered strong price performance on debut days and afterwards till year-end. Please refer to our 2017 IPO review for details. However, the market environment is dramatically different from last year, with a more cautious stance from domestic investors and much higher risk- free rate along with higher USD for overseas investors. That some of last year’s star new economy IPOs’ stock prices have substantially underperformed in the past few months could alert less enthusiasm to expensive new economy companies.
We believe reforms and more new economy launches in the Hong Kong stock market are positive catalysts in the long run, which could improve the market structure and boost valuations. However, amid relatively cautious market sentiment implied by recent underperformance of some of star new economy IPOs, investors should be prudently selective in new economy companies, in our view.
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China Strategy
Valuation reversal unveils opportunities Most sectors experienced valuation reversal in 2018 year to date compared to 2017. Sectors with the largest valuation expansion last year — such as the auto, semiconductor, software, consumer staples, insurance and real estate sectors — generally experienced deep valuation contraction so far this year. We believe value has emerged for select names in these sectors after the market punished them because of various concerns.
Healthcare is the only sector with strong re-ratings in both 2017 and 2018 year to date, which indicates headwinds for large valuation enhancement in the coming months.
Fig.21. Most sectors saw valuation reversal in 2018 year to date (%)
20 Healthcare
15 (Rerating) 10 Media
5 Utilities
Tech Hardware 0 HSCEI HSI Consumer Durables Materials Banks Cons. Stap. (5) Energy Telecom Overall SB stocks Retailing Commercial & Prof Svcs Capital Goods Real Estate Semiconductor (10) Diversified Financials Software Consumer Svcs Transportation Insurance
(15) Change Change 12m in forward PE2018ytd (20)
(25) Auto
(Derating) (30) (30) (20) (10) 0 10 20 30 40 50 (%)
(Derating) Change in 12m forward PE in 2017 (Rerating)
Note: data as at 18 May Source: Bloomberg, Huatai HK Research
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China Strategy
Fig.22. Most sectors saw valuation reversal in 2018 year to date (%)
30 (Rerating) 20 Energy Healthcare
10 Retailing HSCEI HSI Materials 0 Banks Utilities Consumer Svcs Consumer Durables Overall SB stocks Real Estate Diversified Financials Capital Goods Cons. Stap. Insurance (10) Telecom Transportation Commercial & Prof Svcs Media
Change Change 12m in forward PB2018ytd Software Semiconductor (20)
Auto Tech Hardware (30) (Derating) (20) 0 20 40 60 80 100 (%)
(Derating) Change in 12m forward PB in 2017 (Rerating)
Note: data as at 18 May Source: Bloomberg, Huatai HK Research
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Index target and risk analysis We slightly raise our 2018E target for HSI to 32,600 to reflect strong 2017 results and a more prudent view on valuations. We maintain our 2018E base case target for HSCEI at 13,500 given strong results and valuation improvement due to the addition of P chips and red chips with higher valuations. From the current price level (as at 23 May), our base case targets imply 6.3% upside for HSI and 11.7% upside for HSCEI.
Upside risks: 1) government-led funds to support high-end manufacturing may boost manufacturing investment; 2) favorable policies on consumption could advance purchasing by consumers; 3) better-than-expected inflation could translate to better margins for downstream sectors; and 4) marginal improvement of domestic liquidity conditions could enhance investor risk appetite.
Downside risks: 1) faster-than-expected US rate hike and rapid uptick in 10Y US treasury bond yield could further squeeze valuations; 2) HKD liquidity being too tight and HIBOR being too high could lead to risks for the HK real estate market; 3) uptrend for USD index could continue to make equities of emerging markets less attractive; 4) overly stringent domestic liquidity conditions could backfire on economic resilience; and 5) weaker-than- expected global economic recovery and trade tensions could hurt exports.
In our bull case for 2018E, HSI and HSCEI are 34,000 and 14,000, respectively. In our bear case, 2018E HSI and HSCEI are 30,000 and 12,600, respectively.
Fig.23. HSI 2018E base case target: 32,600 Fig.24. HSCEI 2018E base case target: 13,500
(%) (%) (%) Change in fwd EPS Change in fwd PE (%) Change in fwd EPS Change in fwd PE HSI performance (rhs) HSCEI performance (rhs) 40 40 30 30
30 30 20 20
20 20 10 10
10 10 0 0
0 0 (10) (10)
(10) (10) (20) (20)
(20) (20) (30) (30) 2012 2013 2014 2015 2016 2017 2018ytd 2018E 2012 2013 2014 2015 2016 2017 2018ytd 2018E Note: data as at 23 May close Note: data as at 23 May close Source: Bloomberg, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
25 May 2018 16
China Strategy
Sector recommendations and top picks Given our previous analysis, we believe that the market could enjoy decent upside for the rest of 2018, driven by solid growth quality improvement, lower tail risks and resilient consumption growth, and that after valuation reversal, value has emerged in select areas. We avoid small companies that are highly leveraged due to the potentially rapid rise in financing costs.
We are OVERWEIGHT on: 1) consumer staples, select HK local retailers, and apparel leaders due to our view of a long-term structural shift in household spending and solid consumption outlook in the coming quarters; 2) banks, on both potential NIM and ROE improvement thanks to lower tail risks due to financial deleveraging, and higher lending rates due to liquidity tightening; 3) Internet leaders, on both strong platform advantages, and corrected valuation due to weak sentiment; and 4) oil names because of potentially strong oil prices in the near term.
We also like: 1) select names in auto due to decent growth in 2018E-2019E, attractive valuations and mitigation of policy overhang; 2) health care leader, which expects strong growth in the coming quarters to support its current valuation; 3) select semiconductor players due to strong domestic demand and attractive valuations; and 4) select names in industrial waste due to stringent environmental protecting policy stance and number of limited players in the market.
Our strategy top picks are Brilliance China, Li Ning, Chow Tai Fook, PetroChina, CMB, CITIC Bank, CSPC Pharma, Conch Venture, Tencent and Hua Hong Semiconductor.
Fig.25. Strategy top picks
Target Total mkt cap price 2018E 2018E EPS 2018E 2018E 2018E div Ticker Name Industry Group Rating (USDmn) Price (HKD) (HKD) PE (x) growth (%) PB (x) ROE (%) yield (%) 1114 HK Brilliance China Auto Auto BUY 9,708 15.10 25.00 8.0 77.3 1.9 26.2 3.0 2331 HK Li Ning Consumer Durables BUY 2,527 9.08 9.90 24.9 40.3 3.2 13.6 1.2 1929 HK Chow Tai Fook Retailing BUY 13,405 10.52 10.60 22.7 18.4 3.0 13.6 2.6 857 HK PetroChina Energy BUY 226,106 6.24 8.00 15.8 157.5 0.8 4.9 6.6 3968 HK CMB Banks BUY 113,606 33.40 44.56 8.6 13.1 1.4 16.1 3.6 998 HK China CITIC Bank Banks BUY 46,080 5.70 6.66 5.0 10.4 0.6 11.5 6.4 1093 HK CSPC Pharma Pharma BUY 18,694 23.50 23.80 38.5 33.5 7.8 22.1 0.8 586 HK Conch Venture Capital Goods BUY 5,761 25.05 27.90 8.2 31.1 1.5 20.0 2.5 700 HK Tencent Software BUY 492,871 407.00 498.50 38.6 14.4 10.2 30.0 0.0 1347 HK Hua Hong Semi Semiconductor BUY 2,459 18.56 21.80 15.6 9.9 1.4 9.1 1.9
Note: data as at 24 May market close Source: FactSet, Huatai HK Research estimates
25 May 2018 17
China Strategy
Appendix Fig.26. Southbound universe valuation table
Sector Mkt cap PE (x) Net earnings growth (%) PB (x) ROE (%) Div yield (%) weights (%) 2018E 2019E 2017 2018E 2019E 2018E 2019E 2018E 2019E 2018E Energy 3.7 10.3 10.2 163 55 2.1 1.0 1.0 8.3 8.1 5.0 Materials 2.2 8.2 7.2 101 37 10 1.2 1.1 14.0 14.1 4.2 Industrials 6.7 9.9 8.7 33 4.0 15 0.9 0.8 9.8 10.4 3.1 - Capital Goods 3.9 8.2 7.3 21 7.7 13 0.8 0.7 10.2 10.6 3.3 - Commercial & Professional Svcs 0.3 14.0 11.7 22 18 20 2.4 2.1 16.5 17.2 2.2 - Transportation 2.6 16.1 13.3 106 (9.5) 23 1.2 1.1 8.6 9.8 2.9 Consumer Discretionary 9.9 16.7 13.9 5.6 26 19 2.7 2.4 15.9 17.2 2.8 - Automobiles & Components 2.0 10.0 8.2 3.6 28 19 1.9 1.6 16.9 17.5 2.5 - Consumer Durables & Apparel 2.4 16.8 14.1 0.4 20 18 2.4 2.2 15.0 16.6 2.9 - Consumer Services 4.1 24.0 20.2 3.1 27 18 4.5 4.1 19.5 20.3 3.0 - Media 0.4 31.8 24.3 19 151 30 2.5 2.3 8.4 10.1 2.6 - Retailing 1.1 15.2 12.6 37 21 20 1.8 1.7 10.6 13.6 2.7 Consumer Staples 3.4 21.3 18.5 18 18 16 2.9 2.7 13.8 14.8 2.0 - Food & Staples Retailing 0.3 24.9 23.0 8.6 5.9 8.5 3.0 2.8 12.8 13.0 1.6 - Food, Beverage & Tobacco 2.8 21.5 18.5 22 22 17 2.8 2.6 13.2 14.3 1.9 - Household & Personal Products 0.3 17.4 15.8 5.5 5.9 10 3.9 3.6 23.9 24.2 3.8 Healthcare 3.3 27.2 22.8 45 4.4 18 3.4 3.0 13.2 13.9 1.0 - Pharmaceuticals, Biotechnology 2.7 30.9 25.7 45 2.7 20 3.9 3.5 13.6 14.4 0.9 - Health Care Equipment & Svcs 0.6 15.4 13.2 46 7.7 14 1.7 1.6 12.5 12.9 2.1 Financials 29.3 8.9 8.1 11 9.4 11 1.1 1.0 12.3 13.0 4.1 - Banks 20.1 7.9 7.2 8.6 7.5 10 0.9 0.9 12.6 12.9 4.8 - Diversified Financials 2.9 10.6 9.2 (3.5) 30 15 1.3 1.1 8.0 11.4 3.7 - Insurance 6.4 13.8 11.9 36 12 16 1.9 1.7 14.2 15.1 2.2 Information Technology 15.8 30.9 23.1 81 14 27 5.5 4.6 4.9 19.9 0.6 - Software & Services 13.1 36.4 27.6 102 (2.1) 31 8.4 6.6 25.7 26.1 0.3 - Tech Hardware & Eqpt 2.1 18.0 12.2 102 22 21 2.3 2.0 1.8 14.7 2.6 - Semiconductor 0.6 15.2 13.5 22 (2.7) 13 1.4 1.3 9.5 10.1 1.8 Utilities 4.8 15.2 14.0 5.0 15 11 1.7 1.6 11.2 11.3 3.2 Telecom 6.4 12.1 11.3 8.3 4.2 7.8 1.1 1.0 8.9 9.1 4.1 Real Estate 14.4 9.1 7.4 59 (21) 22 0.9 0.8 11.9 11.7 4.3
SB universe 100.0 11.8 10.4 24.6 7.6 13.0 1.3 1.2 11.0 12.3 3.2
Note: earnings growth is calculated based on earnings estimates in RMB; data as at 24 May Source: Bloomberg, Huatai HK Research
25 May 2018 18
China Strategy
Fig.27. China universe valuation table PEG PE (x) Net earnings growth (%) PB (x) ROE (%) Mkt cap Div yield (18E PE weights No.of (%) vs 17-19E Sector (%) cos 2018E 2019E 2017 2018E 2019E 2018E 2019E 2018E 2019E 2018E CAGR) Energy 3.8 21 10.3 10.1 166 54 2 1.0 1.0 8.5 8.2 5.0 0.4 Materials 2.7 56 8.2 7.2 153 32 10 1.2 1.1 14.8 14.0 4.3 0.4 Industrials 6.2 114 9.4 8.3 30 8.0 16 0.9 0.9 10.4 11.1 3.0 0.8 - Capital Goods 3.9 68 7.9 7.0 20 10 13 0.8 0.7 10.6 10.9 3.2 0.7 - Commercial & Prof Svcs 0.5 11 18.0 14.7 6.8 31 27 2.9 2.5 15.7 16.6 1.3 0.6 - Transportation 1.8 35 13.3 11.2 77 1.2 22 1.2 1.1 9.6 11.3 2.9 1.2 Consumer Discretionary 9.2 119 17.9 14.3 24 33 25 2.5 2.2 13.4 14.5 1.7 0.6 - Automobiles & Components 2.1 21 10.0 8.2 3.8 28 19 1.8 1.5 17.1 17.3 2.6 0.4 - Consumer Durables & Apparel 2.3 35 17.0 14.4 16 7.9 19 2.5 2.3 15.9 17.0 2.8 1.3 - Consumer Services 1.8 26 35.2 26.2 80 56 35 4.7 4.1 14.5 16.2 0.9 0.8 - Media 0.5 10 35.5 26.2 (72) 277 34 2.5 2.3 6.8 9.3 - 0.3 - Retailing 2.6 27 25.0 18.5 292 87 42 2.4 2.2 7.0 9.2 0.6 0.4 Consumer Staples 3.4 33 21.6 18.6 29 19 16 2.8 2.6 18.2 14.4 2.1 1.2 - Food & Staples Retailing 0.3 4 25.8 23.6 18 9.1 12 3.0 2.7 10.3 11.7 1.6 2.5 - Food Beverage & Tobacco 2.7 26 21.7 18.5 35 22 17 2.8 2.5 19.3 14.1 2.0 1.1 - Household & Personal Products 0.3 3 18.0 16.2 7.9 7.0 12 3.3 3.0 19.7 19.9 3.4 1.9 Health Care 3.8 53 31.5 27.3 36 4.8 20 3.3 3.0 12.2 13.1 1.0 2.6 - Pharmaceuticals, Biotechnology 3.0 35 37.3 30.1 35 2.7 22 3.8 3.4 12.3 12.9 0.9 3.1 - Health Care Eqpt & Svcs 0.7 18 15.5 19.0 39 8.9 14 1.8 1.6 11.9 13.6 2.0 1.3 Financials 19.4 80 7.1 6.4 6.9 8.6 11 0.9 0.8 13.4 13.4 4.3 0.7 - Banks 13.7 25 6.4 5.8 3.4 7.4 10 0.8 0.8 13.4 13.4 4.8 0.7 - Diversified Financials 2.1 45 7.5 6.5 14 8.1 16 0.9 0.8 10.6 11.3 4.3 0.6 - Insurance 3.6 10 11.5 9.8 34 18 16 1.6 1.4 16.3 15.4 2.5 0.7 Information Technology 32.9 79 30.9 23.0 57 24 29 5.8 4.7 17.6 19.6 0.3 1.2 - Software & Services 29.9 36 33.3 24.5 68 25 31 6.7 5.4 19.2 21.5 0.2 1.2 - Technology Hardware & Eqpt 2.0 30 16.0 12.6 65 28 20 2.4 2.1 13.6 14.8 2.1 0.7 - Semiconductors 1.1 13 14.6 12.4 (21) 1.8 18 1.1 1.0 7.9 8.6 1.3 1.5 Utilities 2.6 36 13.3 11.5 (0.2) 30 18 1.6 1.4 10.7 11.6 2.9 0.6 Telecommunication Services 6.2 7 11.9 11.2 5.7 7.4 8 1.1 1.0 8.9 9.2 4.0 1.6 Real Estate 9.8 89 7.6 6.0 62 7.0 26 1.1 0.9 12.1 17.6 5.0 0.5
Overall China Universe 100.0 687 12.7 10.9 22.4 13.8 14.5 1.6 1.5 12.5 13.2 2.5 0.9 - Ex Banks 86.3 662 15.2 12.6 42.7 18.8 17.6 1.9 1.7 11.9 13.0 2.1 0.8 China non-financials 80.6 607 15.8 13.1 47.8 20.0 17.9 2.0 1.8 11.6 12.9 2.0 0.8
Note: includes HK- and US-listed Chinese companies with total mkt cap greater than USD300mn; data as at 24 May Source: Bloomberg, Huatai HK Research
25 May 2018 19
China Strategy
Fig.28. Southbound sectors: 12-month forward PE (current vs historical highs and lows since 2011) (x) (x) Current Average since 2011 50 50 45 45 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5
0 0
Auto
Media
Banks
Energy
Utilities
Telecom
Retailing
Software
Materials
Insurance
Healthcare
RealEstate
CapitalGoods
Transportation
Semiconductor
TechHardware
ConsumerSvcs
OverallSB stocks
ConsumerStaples
ConsumerDurables Diversified Financials
Commercial& ProfSvcs Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
Fig.29. Southbound sectors: 12-month forward PB (current vs historical highs and lows since 2011) (x) (x) Current Average since 2011 11 11 10 10 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1
0 0
Auto
Media
Banks
Energy
Utilities
Telecom
Retailing
Software
Materials
Insurance
RealEstate
Cons. Serv.
HealthCare
Cons. Cons. Staples
CapitalGoods
Transportation
Div. Financials
Semiconductor
TechHardware
OverallSB stocks
Cons. Dura&Appa. Comm.&Prof.Serv.
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
25 May 2018 20
Auto & Auto Parts Equity Research
Huatai Research
25 May 2018
Equity | China Road Ahead 2H18: buying NEUTRAL opportunity Maintained
Investment highlights Zhixuan LIN +86 21 2897 2090 We believe the auto sector is increasingly attractive now, considering its growth Analyst [email protected] outlook and undemanding valuation. Share prices of auto companies under our coverage have dropped by 8% year to date, underperforming the Hang Seng Index Stock recommendations (up 4%) due to concerns over potential slowdown of China’s macro economy and Company Code TP (HKD) Rating policy uncertainties. Share price correction offers good buying opportunity, in our Manufacturers view, and our top BUY stocks among the auto manufacturers are GAC, BCA, BAIC and GWM. We have BUY ratings on all the auto dealers under our coverage. BCA 1114 HK 25.00 BUY GAC 2238 HK 24.00 BUY Auto stocks underperforming due to macro concerns BAIC 1958 HK 13.00 BUY As of 11 May, share prices of auto stocks under our coverage dropped by 8% year GWM 2333 HK 11.00 BUY to date, underperforming the Hang Seng Index (4% increase). We believe the Geely 175 HK 26.60 HOLD weakness could be attributable to: 1) concerns over the slowdown in China’s macro BYD 1211 HK 48.00 SELL economy, which could hurt consumer confidence and spending on auto products; Dealers and 2) policy uncertainties, including potential cut in tariff on imported autos and Yongda 3669 HK 16.50 BUY lifting of shareholding limits on foreign auto companies in joint ventures (JVs), Zhengtong 1728 HK 10.00 BUY which would impact the overall profitability of China’s auto industry. Baoxin 1293 HK 5.60 BUY Zhongsheng 881 HK 29.00 BUY Three major trends in 2018 Harmony 3836 HK 6.00 BUY We highlight three trends for China personal vehicle (PV) in 2018, including: 1) Meidong 1268 HK 4.50 BUY overall demand remaining weak in 2018E due to expiry of vehicle purchase tax cut. Source: Huatai HK Research estimates The tax rate was raised to a normal level of 10% in 2018 (2017: 7.5%), which resulted in demand frontloading and high base effect; 2) sales performance of individual auto manufacturers expected to vary significantly in the context of demand slowdown. Auto manufacturers with strong model cycles will outperform peers; and 3) consumption upgrade expected to continue in all major sub segments, ie, consumers are upgrading their autos.
Auto demand beat expectations in 4M2018 In 4M18, PV sales increased by 5% yoy, which is solid and exceeded our estimates. Driven by consumption upgrade, sales of premium brands continue to outperform the PV market substantially. In 1Q18, sales of the seven major premium brands (Audi, BMW, Mercedes-Benz, Lexus, Jaguar Land Rover, Volvo and Porsche) jumped 22% yoy, and we expect the strong momentum to sustain.
Valuation close to historical low China plans to cut the tariff on imported autos from 25% to a lower level (10-15%, on our estimates), and to lift the foreign ownership limit in JVs to over 50%. Share prices of auto stocks plunged on the news, and we believe the concerns are overdone. As imported autos account for around 5% of the China PV market, the impact from tariff cut will thus be very limited. International carmakers need support from local partners, thus SOE auto groups are able the share the growth in demand for international brands. Valuations of some auto stocks, especially GAC, BCA and BAIC, are currently nearing their historical lows, which represents a good buying opportunity, in our view.
Auto dealers: rising profit contribution from aftersales services We have BUY ratings on all the auto dealers under our coverage. Rising profit contribution from the high-margin aftersales services makes the dealers less volatile in earnings growth compared with in the past. That said, we believe the dealers should be gradually re-rated going forward. Originally published on 15 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 21 Please refer to end pages for analyst certification and required disclosures.
China Auto & Auto Parts
China auto market Fig.30. 4M18: total PV sales increased by 5% yoy, above our estimate of 2% for 2018E (mn units) (%) PV sales Growth (rhs) 30 18
16 16 25 15 14 20 12
10 10 15 8 25 7 7 24 10 20 21 6 5 18 15 5 14 4 5 8 2 2 0 0 2011 2012 2013 2014 2015 2016 2017 4M18
Source: CAAM, Huatai HK Research
Fig.31. Premium brands delivered strong sales growth in 1Q18 (k units) (%) 1Q18 Growth (rhs) 180 45 41 160 40 40 140 35 120 31 30 100 25 23 170 80 154 153 20 17 60 15 12 40 10 7 55 20 5 38 38 29 0 0 Mercedes- Audi BMW Cadillac Lexus JLR Volvo Benz
Source: Company data, Huatai HK Research
Fig.32. Ongoing consumption upgrade: ASP of PVs rising steadily from mid-2015 low (RMB) 146,000
144,000
142,000
140,000
138,000
136,000
134,000
132,000
130,000
128,000 Jan-08 Dec-08 Nov-09 Oct-10 Sep-11 Aug-12 Jul-13 Jun-14 May-15 Apr-16 Mar-17 Feb-18
Source: NDRC, Huatai HK Research
25 May 2018 22
China Auto & Auto Parts
PE and PB bands of auto stocks Auto manufacturers Fig.33. GAC: one-year forward PE Fig.34. GAC: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 16 3.0
14 2.5
12 2.0
10 1.5
8 1.0
6 0.5
4 0.0 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.35. BCA: one-year forward PE Fig.36. BCA: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 30 6.0
25 5.0
20 4.0
15 3.0
10 2.0
5 1.0
0 0.0 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.37. BAIC: one-year forward PE Fig.38. BAIC: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 12 1.8
11 1.6 10 1.4 9 1.2 8 1.0 7 6 0.8
5 0.6
4 0.4 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
25 May 2018 23
China Auto & Auto Parts
Fig.39. GWM: one-year forward PE Fig.40. GWM: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 16 4.0
14 3.5
12 3.0
10 2.5
8 2.0
6 1.5
4 1.0
2 0.5
0 0.0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.41. Geely: one-year forward PE Fig.42. Geely: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 6.0 20
5.0 16 4.0 12 3.0 8 2.0
4 1.0
0 0.0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.43. Dongfeng: one-year forward PE Fig.44. Dongfeng: one-year forward PB (x) (x) PE +1SD -1SD Average 3.5 PB +1SD -1SD Average 16 3.0
12 2.5
2.0 8 1.5
4 1.0
0.5 0 0.0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
25 May 2018 24
China Auto & Auto Parts
Fig.45. BYD: one-year forward PE Fig.46. BYD: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 80 8.0 70 7.0 60 6.0 50 5.0 40 4.0 30 3.0 20 2.0 10 1.0 0 0.0 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Auto dealers Fig.47. Yongda: one-year forward PE Fig.48. Yongda: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 12 3.0 11 2.5 10
9 2.0 8 7 1.5 6 1.0 5 4 0.5 3 2 0.0 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.49. Zhengtong: one-year forward PE Fig.50. Zhengtong: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 20 4.0 18 3.5 16 3.0 14 2.5 12 10 2.0 8 1.5 6 1.0 4 2 0.5 0 0.0 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
25 May 2018 25
China Auto & Auto Parts
Fig.51. Zhongsheng: one-year forward PE Fig.52. Zhongsheng: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 25 6.0
20 5.0
4.0 15 3.0 10 2.0 5 1.0
0 0.0 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.53. Baoxin: one-year forward PE Fig.54. Baoxin: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 16 4.5
14 4.0
12 3.5 3.0 10 2.5 8 2.0 6 1.5 4 1.0 2 0.5 0 0.0 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
Fig.55. Harmony: one-year forward PE Fig.56. Harmony: one-year forward PB (x) (x) PE +1SD -1SD Average PB +1SD -1SD Average 18 3.0 16 2.5 14 2.0 12
10 1.5
8 1.0 6 0.5 4
2 0.0 Nov-13 Jun-14 Jan-15 Aug-15 Mar-16 Oct-16 May-17 Dec-17 Nov-13 Jun-14 Jan-15 Aug-15 Mar-16 Oct-16 May-17 Dec-17
Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
25 May 2018 26
Banking Equity Research
Huatai Research
25 May 2018
Equity | China Strong real economy demand, OVERWEIGHT expect improving NIM and NPL Maintained
Shujin CHEN, CFA +852 3658 6231 Total social financing beats consensus; maintain OVERWEIGHT Analyst [email protected] The better-than-expected new total social financing (TSF) of RMB1.56tn Alfred HE +852 3658 6275 (Bloomberg consensus: RMB1.35tn) and new RMB loans of RMB1.18tn in Apr Analyst [email protected] (consensus: RMB1.10tn) should ease market concerns on real economy demand, Yetta YANG +852 3658 6234 in our view. We revise up 2018E new RMB loan forecast to RMB15.0tn, indicating Analyst [email protected] 12.5% yoy growth in loan balance, as regulators may slightly loosen loan quota while clamping down on shadow banking. M2 growth rose to 8.3% yoy (Mar: 8.2%), Stock recommendations and deposit growth recovered to 8.9% yoy (Mar: 8.7%) partly thanks to PBOC’s Company Code Price Rating RRR cut. We expect moderate NIM expansion in 2-4Q18, driven by rapid increase SOE banks in new loan yield, higher loan to asset ratio, and stabilized interbank rates. NPL ICBC 1398 HK 7.47 HOLD CCB 939 HK 9.52 BUY ratio inched up 0.3bp qoq to 1.75%, mainly due to stricter NPL recognition. We BOC 3988 HK 4.91 BUY expect NPL ratio to decrease no later than 3Q18, driven by faster NPL disposal, BoCom 3328 HK 6.85 HOLD and to become a key catalyst for H-share China banks’ PB recovery. Maintain PSBC 1658 HK 6.04 BUY Joint-stock banks OVERWEIGHT on China banking sector, and our top picks are now CITIC, CMB, CMB 3968 HK 44.56 BUY and CCB among the big-4 banks. CITIC 998 HK 6.66 BUY Minsheng 1988 HK 8.85 BUY CEB 6818 HK 4.25 HOLD Revise up 2018E loan forecast due to solid demand Municipal banks CQRCB 3618 HK 7.24 BUY Corporate demand remained strong, evidenced by both long-term (LT) corporate Huishang 3698 HK 4.09 HOLD loans (RMB467bn) and corporate bond financing (RMB378bn). Short-term (ST) BoCQ 1963 HK 7.00 HOLD residential loans also became a main driver (14.8% of total loans) – credit card loan Source: Huatai HK Research estimates balance grew 34.7% yoy in 1Q18, according to CBRC. Jan-Apr new RMB loans reached RMB6.0tn (Jan-Apr 2017: RMB5.3tn). We revise up our 2018E new RMB Sector performance loan forecast to RMB15.0tn (2017: RMB13.5tn) from RMB14.3tn as we expect PBOC to slightly loosen loan quota via window guidance due to strong financing PB (x) demand and regulatory clampdown in off-balance sheet financing. This indicates 2.5 12.5% yoy loan balance growth in 2018E (2017: 12.8% yoy). 2.0 1.5 Expect moderate NIM expansion after 1Q18 contraction 1.0 0.88 NIM declined to 2.08% in 1Q18 from 2.10% in 2017, according to PBOC, as most banks except SOE banks reported NIM contraction, mainly due to adoption of 0.5 IFRS 9 on 1 Jan, which reduced NIM by 20bp on average for H-share listed joint- 0.0 stock banks (and regional banks), as well as seasonal factors. However, we expect 2008 2010 2012 2014 2016 2018 moderate NIM expansion in 2Q-4Q18, as increase in loan yield likely more than Source: Huatai HK Research estimates offset the increase in deposit cost (given strong loan demand), while interbank rates remains largely flat. Average yield of corporate/mortgage loans rose to 6.01/5.42% in Mar, up 21bp/16bp from Dec 2017. However, banks’ investment yield is likely to be affected by lower bond yield.
Expect NPL ratio decline going forward China commercial (comm) banks’ NPL ratio rose 0.3bp qoq to 1.75% at end-1Q18, mainly due to stricter NPL recognition, in our view, with: 1) NPL ratio of SOE / joint- stock banks declining 3bp/1bp qoq, but rural comm banks (with less-prudent NPL recognition) seeing 10bp qoq increase in NPL ratio (21bp in 4Q17); and 2) net NPL formation ratio of our covered banks in 1Q18 highly correlated to their >90 day overdue loan / NPL at end-2017. We expect listed banks to report decreasing NPL ratio going forward, driven by stabilized NPL formation, already stricter NPL recognition, and faster NPL disposal spurred by regulatory reduction in provision requirement. In addition, recovery in M2 and loan growth should help ease recent liquidity tightening for corporates. Provision to loan ratio rose 18bp qoq to 3.34%, while NPL coverage ratio rose 9.9pp qoq to 191.3%. Originally published on 14 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 27 Please refer to end pages for analyst certification and required disclosures.
China Banking
Revise up 2018E loan forecast due to solid demand Apr new TSF of RMB1.56tn largely beat Bloomberg consensus of RMB1.35tn, and eased market concerns on real economy demand, in our view. Apr new RMB loans came in at RMB1.18tn, slightly higher than Bloomberg consensus (RMB1.10tn). Corporate demand remained strong, evidence by both long-term (LT) corporate loans (RMB467bn) and corporate bond financing (RMB378bn). Short-term (ST) residential loans also became a main driver (14.8% of total loans) – credit card loan balance grew 34.7% yoy in 1Q18, according to CBRC. Jan-Apr new RMB loans reached RMB6.0tn (Jan-Apr 2017: RMB5.3tn). We revise up our 2018 new RMB loan forecast to RMB15.0tn (2017: RMB13.5tn) from RMB14.3tn as we expect PBOC to slightly loosen loan quota via window guidance due to strong financing demand and regulatory clampdown in off-balance sheet financing. This indicates 12.5% yoy loan balance growth in 2018E (2017: 12.8% yoy).
Fig.57. Monthly new TSF
(RMBbn) Apr-18 Mar-18 Feb-18 Jan-18 Dec-17 Nov-17 Oct-17 Sep-17 Aug-17 Jul-17 Jun-17 May-17 Apr-17 Bank loan (RMB) 1,100 1,142 1,020 2,685 577 1,143 664 1,188 1,147 915 1,447 1,178 1,081 Bank loan (forex) (3) 14 9 27 17 20 (4) (23) (33) (21) 7 (10) (28) Entrusted loan (148) (185) (75) (71) 60 28 4 77 (8) 16 (3) (28) (5)
Trust loan (9) (36) 66 45 225 143 102 237 114 123 248 181 147 Bank acceptance bill 145 (32) 11 144 68 2 1 78 24 (204) (23) (125) 34 Corp bond financing 378 334 71 131 34 92 148 165 114 262 (17) (249) 50 Corp equity financing 53 40 38 50 79 132 60 52 65 54 49 46 77
Others 44 54 35 59 80 60 61 58 67 50 63 69 32 Subtotal 1,560 1,332 1,174 3,070 1,140 1,620 1,036 1,834 1,489 1,196 1,772 1,063 1,388
Source: PBOC, Wind, Huatai HK Research
Fig.58. Year-to-date new total social financing Amount % of total
(RMBbn) 4M17 4M18 yoy(%) 4M17 4M18 yoy (pp) Bank loan (RMB) 5,584 5,947 6.5 67.3 83.3 16.0 Bank loan (forex) 50 47 (6.7) 0.6 0.7 0.1 Entrusted loan 630 (480) (176.1) 7.6 (6.7) (14.3) Trust loan 882 66 (92.5) 10.6 0.9 (9.7) Bank acceptance bill 715 267 (62.6) 8.6 3.7 (4.9) Corp bond financing (101) 915 n.a. (1.2) 12.8 14.0 Corp equity financing 336 182 (46.0) 4.1 2.5 (1.5) Others 198 192 (3.0) 2.4 2.7 0.3 Subtotal 8,294 7,136 (14.0) 100.0 100.0 -
Source: PBOC, Wind, Huatai HK Research
Fig.59. Monthly new loans
(RMBbn) Apr-18 Mar-18 Feb-18 Jan-18 Dec-17 Nov-17 Oct-17 Sep-17 Aug-17 Jul-17 Jun-17 May-17 Apr-17 All new loans 1,180 1,120 839 2,900 584 1,120 663 1,270 1,090 826 1,540 1,110 1,100 Loans to residential 528 573 275 902 329 621 450 735 664 562 738 611 571 - short-term 174 203 (47) 311 18 203 79 254 217 107 261 178 127 - long-term 354 377 322 591 311 418 371 479 447 454 483 433 444 Loans to corporations 573 565 745 1,780 243 523 214 464 483 354 695 566 509 - short-term 74 83 141 375 (98) 20 (11) (52) 70 63 274 247 155 - long-term 467 462 659 1,330 206 428 237 503 364 433 578 440 523 - bill discounting 2 (12) (78) 35 140 39 (38) (2) 32 (166) (160) (147) (198) Loan to non-bank FIs 69 (21) (180) 186 (5) (17) (0) 89 (51) (85) 81 (63) 14
Source: PBOC, Wind, Huatai HK Research
25 May 2018 28
China Banking
Fig.60. Monthly new loan breakdown (RMBbn) 3,500 Residential ST Residential LT Corporate ST Corporate Medium & LT Bills Loan to non-bank FIs 3,000 2,500 2,000 1,500 1,000 500 0 (500) (1,000) 2014 2015 2016 2017 2018
Source: Company data, Huatai HK Research
Fig.61. Long-term residential loan year-on-year growth and as % of total loans
(yoy%) (%) 70 LT residential loan growth LT residential loan as % of total loans (rhs)
60 20
50
40 16
30
20 12
10
0 8 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: PBOC, Huatai HK Research
Fig.62. Nominal GDP growth, M2 growth and TSF outstanding balance growth (yoy%) 40 TSF outstanding balance growth M2 growth Norminal GDP growth 35 30 25 20 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: PBOC, NSBC, Huatai HK Research
M2 growth inched up to 8.3% yoy (Mar: 8.2%), and deposit growth recovered to 8.9% yoy (Mar: 8.7%) partly thanks to PBOC’s RRR cut.
25 May 2018 29
China Banking
Fig.63. M1 and M2 year-on-year growth (yoy%) M2 growth M1 growth 45 40 35 30 25 20 15
10 8.30 5 7.20 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: PBOC, Huatai HK Research
Fig.64. M2, loan and deposit year-on-year growth (yoy%) 37 M2 growth Loan growth Rmb deposit yoy growth
32
27
22
17
12
7 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: PBOC, Huatai HK Research
Expect moderate NIM expansion after 1Q18 contraction NIM declined to 2.08% in 1Q18 from 2.10% in 2017, according to PBOC, as most banks except SOE banks reported NIM contraction, mainly due to adoption of IFRS 9 on 1 Jan, which reduced NIM by 20bp on average for H-share listed joint-stock banks (and regional banks), as well as seasonal factors. However, we expect moderate NIM expansion in 2Q- 4Q18, as increase in loan yield likely more than offset the increase in deposit cost (given strong loan demand), while interbank rates remain largely flat. Average yield of corporate/mortgage loan rose to 6.01/5.42% in Mar by 21bp/16bp from Dec 2017. However, banks’ investment yield is likely to be affected by lower bond yield.
25 May 2018 30
China Banking
Fig.65. NIM: single quarter and year-to-date cumulative
(%) NIM (single quarter) NIM (accumulative) 2.9
2.7
2.5
2.3
2.1 2.08 1.9 2011 2012 2013 2014 2015 2016 2017 2018
Source: CBRC, Huatai HK Research estimates
Fig.66. New loan yield (%) Average loan rate Average corporate loan rate 10 Average bill discounting rate Average mortgage rate 9 8 7 6 6.01 5 5.42 4 3 2 1 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: PBOC, Huatai HK Research
Expect NPL ratio decline going forward China commercial (comm) banks’ NPL ratio rose 0.3bp qoq to 1.75% at end-1Q18, mainly due to stricter NPL recognition, in our view, with: 1) NPL ratio of SOE/joint-stock banks declining 3bp/1bp qoq, but rural comm banks (with less-prudent NPL recognition) seeing 10bp qoq increase in NPL ratio (21bp in 4Q17); and 2) net NPL formation ratio of our covered banks in 1Q18 highly correlated to their >90 day overdue loan / NPL at end-2017. We expect listed banks to report decreasing NPL ratio going forward, driven by stabilized NPL formation, already stricter NPL recognition, and faster NPL disposal spurred by regulatory reduction in provision requirement. In addition, recovery in M2 and loan growth should help ease recent liquidity tightening for corporates. Provision to loan ratio rose 18bp qoq to 3.34%, while NPL coverage ratio rose 9.9pp qoq to 191.3%.
25 May 2018 31
China Banking
Fig.67. NPL ratio (%) SOE banks Joint-stock banks City Comm banks 3.5 Rural comm banks Foreign banks 3.0
2.5
2.0
1.5
1.0
0.5
0.0 2011 2012 2013 2014 2015 2016 2017 2018
Source: CBRC, Huatai HK Research
Fig.68. NPL ratio and net NPL formation ratio (%) NPL ratio 2.0 Net NPL formation ratio 4 per. Mov. Avg. (Net NPL formation ratio) 1.75
1.5
1.0
0.5
0.0
(0.5) 2011 2012 2013 2014 2015 2016 2017 2018
Source: CBRC, Huatai HK Research estimates
Fig.69. Net NPL formation ratio in 1Q18 vs >90 day overdue loan / NPL at end-2017 (%) (%) Net NPL formation ratio >90 day overdue loans as % of NPL (rhs) 3.0 190
2.5 170 150 2.0 130 1.5 110 1.0 90
0.5 70
0.0 50
ABC CEB
CCB
BOC
CMB
ICBC
CITIC
PSBC BoCQ
BoCom
CQRCB Minsheng
Source: Company data, Huatai HK Research estimates
25 May 2018 32
China Banking
Fig.70. NPL coverage ratio and provision to loan ratio
(%) NPL coverage ratio Provision to loan ratio (rhs) 300 3.5 280 3.3 260 240 3.1 220 200 2.9 180 2.7 160 140 2.5 120 100 2.3 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Source: CBRC, Huatai HK Research estimates
Fig.71. RORWA (%) SOE Bank Joint-stock Bank 2.4
2.2
2.0
1.8
1.6
1.4
1.2 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17
Source: CBRC, Huatai HK Research estimates
Fig.72. ROE (%) 22 SOE Bank Joint-stock Bank 21 20 19 18 17 16 15 14 13 12 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17
Source: CBRC, Huatai HK Research estimates
25 May 2018 33
Construction Materials Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: solid supply- OVERWEIGHT demand underpins strong outlook Maintained
Sustained strong outlook for 2H18 Bruce WANG +86 21 2897 2099 A very strong 1H18 for the China cement industry is already underpinned, with Analyst [email protected] GP/tonne for most cement producers set to reach historical highs, on top of Jie GONG +86 21 2897 2097 remaining low inventory and strong cement price rally from late March. Heading Analyst [email protected] into 2H18, we expect the solid supply-demand dynamic to sustain by more than Haipeng LI +86 21 2897 2033 enough to keep the price largely stable at this high level. Two variables to watch in Analyst [email protected] 2H: 1) production control from June to August to avoid major seasonal instability; Liang YU +86 21 2897 2201 and 2) the air quality approaching 4Q18, especially that for Anhui, where the local Analyst [email protected] government will try hard to avoid a consecutive year of underperformance, which is likely to trigger stricter-than-expected off-peak suspension. Reiterate Stock recommendations OVERWEIGHT on the China cement sector on solid outlook for 2H18. CNBM Company Code TP (HKD) Rating (3323.HK, BUY, TP HKD11.3), Conch Cement (914 HK, BUY, TP HKD58.0) and Conch Cement 914 HK 58.0 BUY CR Cement (1313 HK, BUY, TP HKD11.0) are our top picks for the sector. BBMG 2009 HK 4.3 BUY CR Cement 1313 HK 11.0 BUY End-demand stable; shortened strong season to add to tightness CNBM 3323 HK 11.3 BUY
We expect end-demand in 2H18 to be stable year on year, supported by healthy Source: Huatai HK Research estimates property investment as a result of low inventory for most developers, though infrastructure investment growth is slowing down a bit from last year. The impact of more construction work restrictions during the winter and key occasions has now CNBM: key revisions proven to bring about stronger demand in a shortened period of time, which is more New Old Chg (%) inclined to add to supply tightness. While we saw demand being more sluggish in 1Q18, with national cement production down 4.5% yoy — a combined result of: 1) TP (HKD) 11.3 11.3 - nationwide snowfall in January; 2) late Chinese New Year; and 3) slow start of Rating BUY BUY construction work in March due to NPC and CPCCC — a strong comeback has Revenue 2018E 201,076 135,918 47.9 been seen since April, with monthly sales volume reaching a historical high for (RMBmn) some leading cement producers, even stronger than November-December, which is normally the strongest season of the year. Net profit 2018E 9,650 6,318 52.7 (RMBmn) Reaping bigger benefits from supply control Revenue 2019E 204,886 137,406 49.1 Thanks to new capacity restriction policy implemented in recent years, new addition (RMBmn) continues to dwindle, with most of the few new capacity additions located in south Net profit 2019E 10,261 6,587 55.8 China, where robust regional demand can take. Off-peak suspension in northern (RMBmn)
China due to unprecedented focus on air quality improvement has largely eased Source: Huatai HK Research estimates industry overcapacity and has rebalanced the supply-demand dynamic. This is now being adopted by more local governments. Meanwhile, industry coordination is in Sector performance better condition than ever, while experiencing hard times in 2014-2015 has made producers more firm in going further in the current direction, by: 1) maintaining a Huatai cement index (%) stable price rather than making volume the top priority; and 2) instead of going for Rel. to HSCEI (rhs) 2,000 60 head-to-head competition with each other, major producers can compete against grinding stations by limiting clinker sales altogether. 1,600 40 1,200 20 Industry profitability likely to achieve new high 800 Given the outlook of a robust supply-demand dynamic, we expect cement price to 400 0 be largely stable at this high level, only subject to moderate seasonal adjustment. 0 -20 As cement price has already shown a stronger trend than 2011, the strongest year Jan-15 Jan-16 Jan-17 Jan-18 on record, we expect the largely stable price in 2H18E to be more than enough for Source: Huatai HK Research estimates industry profitability to achieve a new high for the year. Upside surprise could arise if stricter-than-expected production suspension is implemented in select regions due to air quality considerations. Key risk to our view: weaker-than-expected property demand due to stricter home purchase restrictions. Originally published on 21 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 34 Please refer to end pages for analyst certification and required disclosures.
China Construction Materials
Key charts
Fig.73. P.O 42.5 cement price hikes since start of March 2018 (RMB/t) Price hikes since start of March 2018 National average 200
150
100
50
0
(50)
(100)
Jilin
Tibet
Anhui
Hebei Hubei
Fujian
Tianjin Henan Hunan Gansu
Beijing
Shanxi
Jiangxi
Hainan
Ningxia
Jiangsu Qinghai
Yunnan
Xinjiang
Sichuan Shaanxi
Guangxi Guizhou
Liaoning
Zhejiang
Shanghai
Shandong
Chongqing
Guangdong Heilongjiang
InnerMongolia
Note: Data as at 18 May Source: Digital Cement, Huatai HK Research
Fig.74. China: national average cement price Fig.75. China: national average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
25 May 2018 35
China Construction Materials
Fig.76. North China: average cement price Fig.77. North China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
Fig.78. Northeast China: average cement price Fig.79. Northeast China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
Fig.80. East China: average cement price Fig.81. East China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
25 May 2018 36
China Construction Materials
Fig.82. South central China: average cement price Fig.83. South central China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
Fig.84. Southwest China: average cement price Fig.85. Southwest China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
Fig.86. Northwest China: average cement price Fig.87. Northwest China: average inventory level (%) 2012 2013 2014 2015 2011 2012 2013 2014 (RMB/t) 2016 2017 2018 2015 2016 2017 2018 90 500 80 450
400 70
350 60
300 50 250 40 200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Digital Cement, Huatai HK Research Source: Digital Cement, Huatai HK Research
25 May 2018 37
China Construction Materials
Fig.88. China: simulated national average GP/tonne Fig.89. Huatai construction index
(RMB/t) (%) 160 50 40 120 30
20 80 10
40 0
(10)
0
Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-14 Sep-15 Sep-16 Sep-17
Sep-13
May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-10 Source: Digital Cement, SXCOAL, Huatai HK Research Source: Company data, Huatai HK Research
Fig.90. PPP projects by stage Fig.91. Property segment overview (%) Property development FAI (RMBbn) Recognition stage Preparation stage (%) 120 GFA started Procurement stage Execution stage GFA sales 20,000 Implementation ratio 42 100 80 15,000 60 38 40 10,000 20 34 0 5,000 (20) (40)
0 30
Mar-13 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Jul-17
Apr-17 Oct-17
Jan-17 Jun-17 Jan-18
Feb-17 Mar-17 Feb-18
Nov-17 Aug-17 Sep-17 Dec-17 May-17 Source: MOF, Huatai HK Research Source: NBS, Huatai HK Research
25 May 2018 38
China Construction Materials
Fig.92. Peer valuation comparison
Stock name Ticker Market cap PE (x) PB (x) EV EBITDA (x) ROE (%) (USDmn) 2018E 2019E 2018E 2019E 2018E 2019E 2018E 2019E Cement-H Conch Cement-H 914 HK 33,214 9.2 8.5 2.0 1.7 5.8 5.4 21.7 20.6 CNBM 3323 HK 7,520 6.4 6.2 0.8 0.7 7.6 7.3 12.7 12.0 Shanshui 691 HK 2,708 18.0 na na na na na na na CR Cement 1313 HK 7,190 7.4 7.3 1.6 1.4 5.0 5.0 21.6 19.7 BBMG 2009 HK 4,938 7.4 6.4 0.6 0.5 8.9 8.4 7.7 8.4 Weighted average 8.9 7.4 1.6 1.4 6.0 5.6 18.2 17.2
Cement-A Conch Cement-A 600585 CH 29,630 8.8 8.4 1.8 1.6 5.4 5.3 20.6 18.9 Jidong Cement 000401 CH 2,336 19.2 11.6 1.3 1.2 7.0 6.6 6.8 10.0 Huaxin Cement 600801 CH 3,352 8.1 6.9 1.5 1.3 4.6 4.3 18.4 18.3 Weighted average 9.4 8.5 1.7 1.5 5.4 5.3 19.5 18.2
Cement-Global Lafarge-Hocilm LHN VX 32,380 15.6 13.3 1.1 1.1 8.1 7.6 7.2 8.2 Indocement INTP IJ 4,343 29.6 25.2 2.4 2.3 15.2 13.3 8.0 9.0 Heidelberg HEI GR 18,756 11.9 10.3 1.0 1.0 7.6 7.1 8.4 9.2 CRH CRH LN 31,592 16.2 14.2 1.7 1.5 9.3 8.5 10.3 10.7 Italcementi IT IM 4,350 41.5 14.7 1.1 na 8.3 7.3 2.6 na Cemex CEMEXCPO MM 8,824 12.7 10.1 0.9 0.8 8.0 7.4 6.8 7.6 Dangote DANGCEM NL 11,549 15.2 13.2 4.4 4.2 10.0 8.8 29.2 32.1 Taiheiyo 5233 JP 4,821 13.5 11.7 1.3 1.2 7.2 6.9 9.7 10.3 Ultra Tech UTCEM IN 15,580 41.8 32.2 4.4 4.0 20.0 16.0 10.5 12.5 ACC Ltd ACC IN 3,794 23.3 19.2 2.6 2.5 11.5 9.8 11.3 12.8 Ambuja ACEM IN 6,144 24.1 19.6 2.0 1.9 9.8 8.2 8.2 9.6 Weighted average 19.6 15.7 2.0 1.8 10.1 9.0 10.0 11.4
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 39
China Construction Materials
Fig.93. Share performance comparison
Bloomberg Market cap Absolute performance (%) 1y relative Stock name code (USDmn) 1d 1w 1m 3m 1y ytd vs Index (%)
HSI 0.3 (0.2) 2.1 (1.2) 23.3 3.8
H shares Conch Cement-H 914 HK 33,214 0.9 2.9 9.8 15.4 91.8 33.9 68.5 CNBM 3323 HK 7,520 1.0 4.3 10.3 23.2 110.0 32.2 86.7 Shanshui 691 HK 2,708 ------(23.3) CR Cement 1313 HK 7,190 1.5 2.9 21.2 50.0 123.3 68.1 99.9 BBMG 2009 HK 4,938 1.4 4.0 0.8 4.9 (7.6) 2.3 (31.0)
Weighted average 1.0 3.1 10.1 19.2 85.0 33.6
Shanghai Composite 1.2 0.9 4.0 (0.2) 3.3 (3.4)
A shares Conch Cement-A 600585 CH 29,630 1.2 2.9 10.0 8.3 72.2 21.6 68.9 Jidong Cement 000401 CH 2,336 (3.8) (6.2) (17.0) (4.2) (39.4) (19.8) (42.7) Huaxin Cement 600801 CH 3,352 (0.4) (1.7) 2.3 7.4 69.0 1.1 65.7
Weighted average 0.7 1.9 7.5 7.4 64.5 16.9
Global shares Lafarge-Hocilm LHN VX 32,380 (0.4) 0.8 (0.2) (0.2) 1.6 0.5 (12.3) Indocement INTP IJ 4,343 (2.3) (11.5) (9.4) (22.1) (7.2) (23.9) (21.1) Heidelberg HEI GR 18,756 (0.5) 0.4 (1.0) (3.9) (3.3) (11.0) (17.2) CRH CRH LN 31,592 1.9 3.1 10.4 11.5 (0.9) 4.9 (14.8) Italcementi IT IM 4,350 - - na na na na na Cemex CEMEXCPO MM 8,824 1.0 (0.4) (8.0) (13.7) (26.9) (20.6) (40.8) Dangote DANGCEM NL 11,549 (1.2) - (1.8) (5.8) 50.3 6.5 36.4 Taiheiyo 5233 JP 4,821 0.1 5.3 5.9 4.7 20.3 (13.7) 6.4 Ultra Tech UTCEM IN 15,580 (2.5) (5.2) (5.4) (6.8) (11.5) (10.7) (25.4) ACC Ltd ACC IN 3,794 (1.9) (6.3) (12.0) (16.2) (18.0) (21.8) (31.9) Ambuja ACEM IN 6,144 (3.3) (3.1) (14.7) (20.2) (16.2) (22.6) (30.1)
Weighted average (0.3) (0.2) (0.1) (1.9) 0.2 (4.9)
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
25 May 2018 40
Steel Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: profitability to OVERWEIGHT sustain as price fluctuates Maintained
Bruce WANG +86 21 2897 2099 Suppressed utilization, stable demand; profitability sustainable Analyst [email protected] We believe supply and demand in 2H18 will mainly be driven by three factors: 1) Xuan YANG +86 21 2897 2239 blast furnace utilization ratio; 2) electric arc furnace (EAF) output from new Analyst [email protected] capacity; and 3) stability of demand. We deem supply and demand to be largely Shengjie XU +86 21 2897 2033 balanced in 2H18E, whereas industry margin will remain elevated, though not Analyst [email protected] without fluctuations. On the supply side, we expect stringent environmental control to persist and to hold back blast furnace utilization, whereas output from EAF will Stock recommendations continue to increase with gradual new releases in 2H18. On the demand side, we Company Code Price Rating expect demand to remain stable, underpinned by the low property inventory and Magang 323 HK 5.8 BUY stable infrastructure investment, despite PPP policy tightening. Maintain Angang 347 HK 10.3 BUY
OVERWEIGHT on the China steel sector and BUY rating on Angang (347 HK, TP Source: Huatai HK Research estimates HKD10.3) and Magang (323 HK, TP HKD5.8).
Stringent environmental controls hold back output Sector performance We have seen restrictions on blast furnaces carried out beyond the winter heating season, which ended on 15 March. Since then, multiple cities — including Handan, Tangshan and Xuzhou — have come forward with off-peak production plans or environmental protection plans which effectively extend production restriction. As a result, we have yet to see and do not expect to see full recovery in capacity utilization of blast furnace back to their prior levels. According to Mysteel, average blast furnace utilization ratio (excluding exited capacity) in April was 81.2%, up 3pp from March, though down by 9.1pp from 90.3% in April 2017, and also from 90.4% in September 2017 ahead of winter cut. Addressing potential output increase from utilization recovery to the mid-80% level from now, we believe iron fluid will partially Source: Huatai HK Research estimates substitute scrap usage in converters, hence reducing the impact on effective output increase.
New EAF capacity not likely to jeopardize industry profitability According to Mysteel estimates, total output from EAF will increase by more than 20mt to reach 100mt in 2018E, coming from improving utilization rate and new capacity releases. While we are aware that higher output from EAF may limit upside potential of steel price, we believe EAF may serve as a supply valve given its operational flexibility and smooth out profitability of producers employing long steel making process. Currently, average per tonne margin of EAF is more than RMB600/t lower than that of long steel. As a result, when steel price drops, EAF reaches breakeven long before traditional producers do, while its flexibility enables it to cut production promptly, in turn providing price support. On the flip side, EAF will resume production when price rebounds, which will cap price upside.
Exchange scheme caps total capacity, not a point of concern MIIT announced a steel industry capacity exchange scheme at the beginning of the year in which any form of new steel capacity is subject to the exchange scheme and is required to be accompanied by corresponding capacity shutdown. Detailed measures were clearly outlined, leaving little room to maneuver, with: 1) types of capacity that are subject to the policy identified to ensure all forms of possible net addition is exchanged; 2) ‘1 Must 6 Forbids’ to determine the eligibility of outgoing capacity to ensure no double counting or illegal exchange for legal; 3) exchange rate specifications set at 1:1 at the highest; and 4) criteria for capacity exit Originally published on 21 May 2018 confirmation to ensure exits must take place before start of new project operations.
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 41 Please refer to end pages for analyst certification and required disclosures.
China Steel
Key charts Fig.94. Steel spot price performance Fig.95. Per tonne profit
(RMB/t) Rebar Medium & heavy plate (RMB/t) Rebar CR plate HR plate 1,600 5,500 Cold rolled products 1,400 5,000 1,200 4,500 1,000 800 4,000 600 3,500 400 200 3,000 0 2,500 (200) 2,000 (400) (600) 1,500 May-14 Jan-15 Sep-15 May-16 Jan-17 Sep-17 May-18 Apr-14 Nov-14 Jun-15 Jan-16 Aug-16 Mar-17 Oct-17 May-18 Source: Wind, Huatai HK Research Source: Wind; Huatai HK Research estimates
Fig.96. Crude steel production Fig.97. Average daily production of major producers
(kt) Crude steel Steel products (mt) Crude steel production Change (rhs) (yoy%) 2,000 76 12 1,900 74 10 8 1,800 72 6 1,700 70 4 1,600 68 2 1,500 0 66 (2) 1,400 64 (4) 1,300
62 (6)
Apr-14 Apr-15 Apr-16 Apr-17 Apr-18
Dec-14 Dec-15 Dec-16 Dec-17
Aug-14 Aug-15 Aug-16 Aug-17
Jun-15 Jun-16 Jun-17
Jun-14
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-16 Dec-14 Sep-15 Dec-15 Dec-16 Sep-17 Dec-17 Sep-14 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.98. Social inventory of steel products Fig.99. Mill inventory of steel products Rebar Wire rod Total social inventory Rebar (kt) (kt) CRC (rhs) HRC (rhs) Wire rod HRC (rhs) Medium & heavy plate (rhs) 25,000 CRC (rhs) 6,000 4,800 2000
20,000 5,000 3,800 1600 4,000 15,000 2,800 1200 3,000 10,000 1,800 800 2,000
5,000 1,000 800 400
0 0 (200) 0
Jul-15 Jul-16 Jul-17
Jan-16 Jan-17 Jan-18
Mar-16 Mar-17 Mar-18
Nov-15 Nov-16 Nov-17
Sep-15 Sep-16 Sep-17
May-15 May-16 May-17 May-18
Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17
May-13 May-14 May-15 May-16 May-17 May-18 May-12 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
25 May 2018 42
China Steel
Fig.100. Steel products net exports Fig.101. Exports by product Bar & rod Angle, shape & section (kt) (yoy%) (mt) Steel products net exports Exports (yoy%) Sheet & plate Others Imports Change (rhs) Change (rhs) 12 1.8 12,000 120 11 10 90 9,000 9 1.4 60 8 7 6,000 30 6 0 1.0 5 3,000 4 (30) 3 0 (60)
2 0.6
Jun-14 Jun-15 Jun-16 Jun-17
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17
Sep-14
Apr-17 Oct-15 Apr-16 Oct-16 Oct-17 Apr-18 Apr-15
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.102. Coking coal price performance Fig.103. Iron ore price performance
(RMB/dmt) Tangshan iron ore fine, 66% (RMB/t) Liulin #4 coking coal, FOB 1,800 900
1,600 800
1,400 700
1,200 600 500 1,000 400 800 300 600 200
400
Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Nov-15 Nov-14 Nov-16 Nov-17
Aug-14 Aug-15 Aug-16 Aug-17
May-16 May-15 May-17 May-18
May-14
Feb-15 Feb-16 Feb-17 Feb-18
Nov-14 Nov-15 Nov-16 Nov-17
Aug-14 Aug-15 Aug-16 Aug-17
May-16 May-15 May-17 May-18 May-14
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.104. Coke inventory at major steel mills Fig.105. Iron ore inventory at port (imported) (mt) (kt) 180 5,000 160 4,600 140
4,200 120
3,800 100
80 3,400
60
3,000
Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Aug-14 Nov-14 Aug-15 Nov-15 Aug-16 Nov-16 Aug-17 Nov-17
May-14 May-15 May-16 May-17 May-18
Jul-17
Oct-17 Apr-18
Jun-17 Jan-18
Mar-18
Feb-18
Nov-17 Aug-17 Sep-17 Dec-17 May-18
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
25 May 2018 43
China Steel
Fig.106. Property and infrastructure FAI Fig.107. Excavator production (units) Excavator production Change (rhs) (yoy%) (yoy% ytd) Property Infrastructure 30,000 100 30 80 25,000 25 60 20,000 20 40
15,000 20 15 0 10,000 10 (20) 5,000 5 (40)
0 (60)
0
Mar-15 Mar-16 Mar-17 Mar-18
(5) Mar-14
Sep-14 Sep-15 Sep-16 Sep-17
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-12
Source: Wind, Huatai HK Research Source: Mysteel, Huatai HK Research
Fig.108. Commercial car production Fig.109. Commercial car sales ('000 units) Commercial car sales Change (rhs) (yoy%) ('000 units) Commerical car production Change (rhs) (yoy%) 3,000 40 3,000 40 2,500 30 2,500 30 20 2,000 20 2,000 10 1,500 10 1,500 0 1,000 0 1,000 (10) 500 (10) 500 (20) 0 (20)
0 (30)
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-15 Sep-16 Sep-17
Sep-14
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-17 Sep-15 Sep-16 Sep-14 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.110. HDT production Fig.111. HDT sales ('000 units) HDT sales Change (rhs) (yoy%) ('000 units) HDT production Change (rhs) (yoy%) 40,000 120 40 120 35,000 35 80 80 30,000 30 25,000 40 25 40 20,000 20 15,000 0 15 0 10,000 10 (40) (40) 5,000 5 0 (80)
0 (80)
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-16 Sep-15 Sep-17
Sep-14
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-15 Sep-16 Sep-17 Sep-14 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
25 May 2018 44
China Steel
Fig.112. Covered stock price performance (HKD) Magang Angang 10
8
6
4
2
0
Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Aug-12 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 Aug-15 Nov-15 Aug-16 Nov-16 Aug-17 Nov-17
May-13 May-14 May-15 May-16 May-17 May-18 May-12
Source: Wind, Huatai HK Research
Fig.113. Peer valuation comparison Bloomberg Market cap PE (x) PB (x) EV EBITDA (x) ROE (%) Stock code (USDmn) 2018E 2019E 2018E 2019E 2018E 2019E 2018E 2019E H shares Angang 347 HK 7,484 7.1 6.3 0.9 0.8 4.4 3.3 12.8 13.1 Magang 323 HK 3,924 4.5 3.9 0.9 0.7 2.9 2.4 21.0 20.1 Weighted average 6.2 5.5 0.9 0.8 3.9 3.0 15.6 15.5 A shares Angang 000898 CH 7,065 7.7 7.6 0.8 0.8 5.5 5.5 10.7 10.2 Magang 600808 CH 4,539 6.8 6.6 1.1 1.0 5.0 5.1 15.8 14.5 Hebei Steel 000709 CH 5,443 13.9 13.1 0.7 0.7 10.4 9.9 5.3 5.5 Taigang 000825 CH 5,357 7.6 6.4 1.1 1.0 6.9 6.2 14.6 15.1 Shougang 000959 CH 3,482 8.7 8.3 0.8 0.8 na na 9.7 9.2 Shagang 002075 CH 5,576 100.8 92.1 10.6 9.6 25.6 24.0 10.5 10.4 Baoshan Steel 600019 CH 30,647 9.0 8.2 1.1 1.0 5.6 5.4 12.1 12.2
Weighted average 16.8 15.4 1.8 1.6 7.2 6.8 10.9 10.9 Global China Steel 2002 TT 12,287 20.9 19.5 1.2 1.2 10.1 9.8 5.5 5.9 Nucor Corp NEU US 4,398 17.2 15.9 na na na na na na Steel Dynamic STLD US 12,000 10.6 11.4 2.8 2.3 6.9 7.3 26.7 20.5 US Steel X US 6,494 7.1 6.8 1.5 1.2 4.4 4.4 21.4 17.8 ArcelorMittal MT US 36,339 8.2 8.9 0.8 0.8 4.9 5.1 10.3 8.6 ThyssenKrupp TKA GR 15,727 14.8 11.8 3.4 2.8 5.4 5.2 22.6 23.3 Voestalpine VOE EU 9,608 11.1 10.8 1.3 1.2 6.0 5.9 11.9 11.4 NLMK NLMK LI 15,696 9.5 10.7 2.3 2.2 5.8 6.5 23.6 20.6 Nippon Steel 5401 JT 21,600 11.8 10.0 0.7 0.7 8.3 7.6 6.3 7.1 JFE Holdings 5411 JT 13,802 9.1 8.9 0.7 0.7 7.2 6.7 8.1 7.8 Kobe Steel 5406 JT 3,979 8.9 9.3 0.6 0.6 5.7 5.3 6.8 6.2 POSCO 005490 KS 29,030 9.0 8.6 0.7 0.6 5.1 5.0 7.2 7.2 Tata Steel TATA IN 10,468 9.3 8.0 1.4 1.1 6.5 5.9 na na
Weighted average 10.8 10.3 1.3 1.2 6.1 6.0 11.6 10.7
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 45
China Steel
Fig.114. Peer performance comparison Bloomberg Market cap Absolute performance (%) 1y relative Stock name code (USDmn) 1d 1w 1m 3m 1y ytd vs Index (%) HSI 0.6 0.1 3.1 -1.4 20.3 5.5 H shares Angang 347 HK 7,484 (0.6) 0.6 1.9 (8.5) 67.4 13.6 47.1 Magang 323 HK 3,924 0.0 0.0 14.9 (6.8) 52.1 8.4 31.8 Weighted average (0.4) 0.4 6.4 (7.9) 62.1 11.8 41.9
Shanghai composite 1.2 0.9 3.3 (0.2) 3.3 (3.4) A shares Angang - A 000898 CH 7,065 1.0 (1.0) 0.6 (13.6) 24.1 (1.9) 20.8 Magang - A 600808 CH 4,539 0.3 (2.1) 7.1 (9.2) 20.1 (9.0) 16.8 Hebei Steel 000709 CH 5,443 0.3 (0.3) (2.1) (14.8) (28.0) (16.2) (31.3) Taigang 000825 CH 5,357 0.0 0.0 0.0 (10.4) 44.2 21.0 40.9 Shougang 000959 CH 3,482 1.2 (1.9) (5.8) (23.5) (38.0) (29.8) (41.3) Shagang 002075 CH 5,576 0.0 0.0 0.0 0.0 0.0 0.0 (3.3) Baotou Steel 600010 CH 14,362 0.0 (0.5) (7.8) (13.4) (4.3) (18.3) (7.6) Baoshan Steel 600019 CH 30,647 0.8 (2.6) 0.5 (14.6) 47.6 1.6 44.2 Weighted average 0.5 (1.4) (1.2) (13.0) 21.1 (4.5) 17.7
SP500 (Global) (0.2) (0.5) 0.2 (0.7) 14.7 1.5 Global steel China Steel 2002 TT 12,287 0.2 (0.6) 0.0 (1.1) (4.9) (5.5) (8.2) Nucor Corp NEU US 4,398 0.1 1.5 (9.7) (12.0) (18.6) (6.1) (7.6) Steel Dynamic STLD US 12,000 (0.9) 5.5 7.6 3.0 50.3 18.0 16.5 US Steel X US 6,494 (1.4) 3.5 (1.3) (17.3) 93.0 5.1 3.6 ArcelorMittal MT US 36,339 (1.4) (0.4) 2.7 (2.5) 63.3 10.1 8.5 ThyssenKrupp TKA GR 15,727 (0.1) (7.1) (6.5) (6.8) (6.6) (11.3) (12.8) Voestalpine VOE EU 9,608 0.0 (1.0) 2.3 (2.3) 19.1 (7.1) (8.6) NLMK NLMK LI 15,696 1.0 2.9 6.7 (1.8) 39.7 2.6 1.1 Nippon Steel 5401 JT 21,600 0.0 1.8 6.9 (2.1) 5.7 (13.0) (14.5) JFE Holdings 5411 JT 13,802 0.2 5.2 12.7 (0.5) 40.9 (8.1) (9.6) Kobe Steel 5406 JT 3,979 0.1 2.0 8.3 4.0 18.6 15.7 14.2 POSCO 005490 KS 29,030 0.1 0.7 3.1 (0.8) 33.5 8.4 6.9 Tata Steel TATA IN 10,468 (3.1) (2.6) (1.7) (14.3) 29.1 (14.3) (15.8)
Weighted average (0.4) 0.6 3.1 (3.1) 31.9 0.4
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 46
Coal Mining Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: major peak OVERWEIGHT seasons to support coal price Maintained
Re-emphasize distinct seasonality on more balanced S-D Bruce WANG +86 21 2897 2099 We re-emphasize our full-year view that loosening supply will result in more Analyst [email protected] balanced supply-demand condition in 2018E and distinctive seasonality effect. We Xuan YANG +86 21 2897 2239 expect raw coal output to remain stable at the current level, and in turn, marginal Analyst [email protected] changes in demand will drive coal price in 2H18E. We expect coal price to Shengjie XU +86 21 2897 2033 strengthen in June throughout the summer peak season to August, though not as Analyst [email protected] high as in 1Q18 given higher hydro-power contribution. Following a potential correction in September-October to the price green zone, thermal coal price is likely Stock recommendations to peak again in the November-December winter heating season, possibly breaking Company Code TP (HKD) Rating above the RMB700/t level. Our full-year thermal coal price forecast remains Yanzhou Coal 1171 HK 17.0 BUY unchanged at RMB620/t. Maintain OVERWEIGHT on the China coal sector on China Shenhua 1088 HK 31.5 BUY cheap valuations, and highlight Yanzhou Coal Mining (1171 HK, TP HKD17.0) as China Coal 1898 HK 4.6 BUY our top pick in the sector. Shougang Fushan 639 HK 2.35 BUY
Source: Huatai HK Research estimates Supply to see acceleration in yoy growth, though on low base We expect to observe acceleration in year-on-year output growth in 2H18; however, this should not be interpreted as equivalent to a pick-up in supply expansion as it Sector performance is the result of a low base from 2H17. Raw coal production saw a marked decline from July to October last year, on tightening control of Meiguanpiao quota in Shaanxi and Inner Mongolia, restriction on the use of explosives for open-pit mines in Inner Mongolia, production suspension in Shanxi due to multiple coal mine accidents and strict safety inspections ahead of the 19th CPC Congress. On a month-on-month basis, we expect flat output growth given three sources of supply, namely: 1) new capacity; 2) approval of additional capacity of existing mines; and 3) less frequent production disruptions as laid out above, which are largely stretched at full, meaning that further upside in output within the year is very limited.
Regulatory interference: a constant presence Source: Huatai HK Research estimates We expect regulatory interference to be ever-present in 2H18, as the NDRC is determined to keep coal price within the price green zone (RMB500-570/t). We believe adjustments in NDRC measures to contain coal price to be more effective in the off season as periodic oversupply will serve in regulatory favor, though they will be less effective in the consumption peak season as there are very few tricks in the bag to spur short-term supply to reverse a shortage, especially with most operational mines already at work. We believe import policy may be the most frequently-adjusted measure for the government to micro-manage market supply, though it could backfire if not implemented carefully. Overall, we believe a shift in regulatory stance may be used to determine a turning point for coal price in the off season, and market fundamentals will drive peak season price.
Coking coal: price differentiation between categories We have seen continued strength in environmental controls on steel as well as the coking industry, not limited to the end of the winter restriction period, which closed on 15 March. Since then, multiple cities came out with off-peak production plans for blast furnaces and coking plants for full-year 2018. As a result, we have yet to see, and do not expect this year, a full recovery in capacity utilization ratio of blast furnace to return to levels prior to the winter heating season. As restriction of downstream users may hurt coking coal demand this year, we expect coking coal price to favor low-sulfur coking coal, especially premium coking coal due to its scarcity, whereas supplementary coking coal will feel most of the pressure and is likely to experience large fluctuation in prices. Originally published on 21 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 47 Please refer to end pages for analyst certification and required disclosures.
China Coal Mining
Key charts Fig.115. Thermal coal: price Fig.116. Coking coal: price CCI Liulin low-S premium coking coal (RMB/t) CCI5500 import CFR (RMB/t) CCI5500 CCI Jining gas coal Peak Downs hard coking coal CFR 800 BSPI Thermal active future contract 2,500 Coking coal active future Shanxi Linfen Fat Coal (mine mouth) 700 2,000
600 1,500
500 1,000
400 500
300 0 Jul-17
200 Jul-16
Jan-16 Jan-17 Jan-18
Mar-18 Mar-16 Mar-17
Sep-15 Nov-15 Sep-16 Nov-16 Sep-17 Nov-17
May-17 May-18 May-13 May-14 May-15 May-16 May-17 May-18 May-16
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.117. Thermal coal: production Fig.118. Coking coal: production (mt) Coking coal production Change (rhs) (yoy%) (mt) Thermal coal production (lhs) Change (rhs) (yoy%) 300 25 140 25 20 20 120 250 15 15 100 10 10 200 5 5 80 0 150 0 60 (5) (5) 100 40 (10) (10) (15) (15) 20 50 (20) (20) 0 (25)
0 (25)
Jul-14 Jul-15 Jul-16 Jul-17
Jan-15 Jan-14 Jan-16 Jan-17
Mar-18
Jul-14 Jul-15 Jul-16 Jul-17
Jan-14 Jan-15 Jan-16 Jan-17 Mar-18 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.119. Six major IPPs: average daily consumption Fig.120. Six major IPPs: total inventory 2012 2013 2014 2015 2012 2013 2014 2015 (mt) 2016 2017 2018 (kt) 18 900 2016 2017 2018
16 800
14 700
12 600
10 500
8 400
6 300 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
25 May 2018 48
China Coal Mining
Fig.121. Six major IPPs: inventory days Fig.122. Thermal coal: port inventory Caofeidian Qinghuangdao Jingtang 2012 2013 2014 2015 (kt) (days) 2016 2017 2018 8,000 40
35 6,000 30
25 4,000
20
15 2,000
10 0 5 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 May-18 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.123. Coking coal: inventory at independent coke Fig.124. Coking coal: port inventory plants (kt) Jingtang Qingdao (kt) Independent coke plant inventory 6,000 11,000 5,000 10,000
9,000 4,000
8,000 3,000
7,000 2,000 6,000 1,000 5,000 0 4,000 May-14 Nov-14 May-15 Nov-15 May-16 Nov-16 May-17 Nov-17 May-18 Nov-16 Feb-17 May-17 Aug-17 Nov-17 Feb-18 May-18 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.125. Thermal coal: monthly import volume Fig.126. Coking coal: monthly import volume Bituminous coal (kt) Coking coal (yoy%) (kt) (yoy%) Anthracite 9,000 Change in coking coal imports (rhs) 150 30,000 Lignite 80 Change in thermal coal imports (rhs) 8,000 60 100 25,000 7,000 40 6,000 20,000 50 20 5,000 4,000 15,000 0 0 3,000 (20) 10,000 2,000 (50) (40) 5,000 1,000 (60) 0 (100)
0 (80)
Jun-14 Jun-15 Jun-16 Jun-17
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17
Sep-14
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-15 Sep-16 Sep-17 Sep-14 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
25 May 2018 49
China Coal Mining
Fig.127. Steel and coke production Fig.128. Thermal power generation (bn kWh) Thermal power generation (yoy%) (yoy%) Coke production Crude steel Change (rhs) 500 15 40 450 10 30 400 350 5 20 300 250 0 10 200 (5) 0 150 100 (10) (10) 50 0 (15)
(20)
Jul-15 Jul-16 Jul-17
Jan-15 Jan-16 Jan-17 Jan-18
Mar-15 Mar-16 Mar-17 Mar-18
Nov-15 Nov-16 Nov-17
Sep-15 Sep-16 Sep-17
May-16 May-17
May-15
Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-12 Sep-14 Sep-11 Sep-13 Sep-15 Sep-16 Sep-17 Sep-10 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.129. China Shenhua: coal production and sales Fig.130. China Coal Energy: coal production and sales (mt) Commercial coal production Coal sales (mt) Commercial coal production Coal sales 18 60 16
50 14 12 40 10
30 8 6 20 4
10 2 0 0 Mar-15 Jul-15 Nov-15Mar-16 Jul-16 Nov-16Mar-17 Jul-17 Nov-17Mar-18 Mar-15 Jul-15 Nov-15Mar-16 Jul-16 Nov-16Mar-17 Jul-17 Nov-17Mar-18 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
25 May 2018 50
China Coal Mining
Fig.131. Peer valuation comparison Bloomberg Market cap PE (x) PB (x) EV EBITDA (x) ROE (%) Stock code (USDmn) 2017E 2018E 2017E 2018E 2017E 2018E 2017E 2018E Coal-H share China Shenhua-H 1088 HK 55,743 7.0 6.8 1.1 1.0 4.2 3.7 15.7 14.8 China Coal-H 1898 HK 6,249 9.9 8.3 0.4 0.4 7.1 6.4 4.4 5.1 Yanzhou Coal-H 1171 HK 7,571 4.8 4.8 0.9 0.8 6.7 6.4 19.6 17.3 Yitai 3948 HK 4,129 4.6 4.4 0.6 0.6 5.6 5.2 15.3 14.2
Shougang Fushan 639 HK 1,513 11.6 8.9 0.7 0.6 4.6 3.2 6.2 7.5 Weighted average 7.0 6.6 1.0 0.9 4.8 4.3 14.9 14.1 Coal-A share China Shenhua-A 601088 CH 69,489 9.2 9.2 1.3 1.2 5.2 5.3 14.5 13.8 China Coal-A 601898 CH 11,014 17.2 16.8 0.7 0.7 9.1 9.1 4.6 4.3 Yanzhou Coal-A 600188 CH 12,003 9.2 9.2 1.3 1.2 6.9 7.0 15.9 14.5 Shaanxi Coal 601225 CH 13,856 8.1 7.7 1.6 1.3 5.2 5.0 22.5 20.1 Shanxi Lu'an 601699 CH 5,186 9.7 9.2 1.4 1.3 na na 15.4 14.9 Jizhong Energy 000937 CH 2,686 12.1 11.4 na na na na 6.5 6.1 Shanxi Xishan 000983 CH 4,193 na na 1.2 1.2 8.2 8.4 9.7 9.0
Yangquan Coal 600348 CH 2,805 8.8 8.8 1.1 1.0 na na 12.7 12.8 Weighted average 9.6 9.4 1.3 1.2 5.4 5.4 14.3 13.4 Coal-Global CONSOL CNX US 3,556 29.0 30.6 na na 6.1 5.2 na na Coal India Coal IN 24,349 16.3 11.3 7.3 7.6 9.5 6.5 39.3 59.7 Teck Resources TECK US 16,265 6.4 7.7 0.7 0.7 3.9 4.4 13.0 9.5
Banpu Public BANPU TB 3,447 9.1 9.5 1.2 1.1 8.2 9.3 12.9 11.9 Weighted average 13.4 11.4 4.1 4.2 7.2 5.9 25.5 34.6
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
Fig.132. Peer performance comparison Stock name Ticker Market cap Absolute performance (%) 1Y relative (%) (USD mn) 1W 1M 3M 1Y YTD vs. index HSCEI (0.1) 3.1 (1.4) 20.3 5.5 - China Shenhua - H 1088 HK 55,743 7.6 16.5 (1.1) 37.9 8.6 17.6 China Coal - H 1898 HK 6,249 5.1 19.7 1.6 7.2 4.8 (13.0) Yitai Coal - H 3948 HK 4,129 5.5 9.7 (12.3) 53.2 9.3 32.9 Yanzhou Coal - H 1171 HK 7,571 10.0 25.3 (4.9) 110.8 32.4 90.5 Shougang Fushan 639 HK 1,513 2.8 18.5 5.2 76.4 33.3 56.1 Shanghai Composite 0.9 3.3 (0.2) 3.3 (3.4) (16.9) China Shenhua - A 601088 CH 69,489 0.1 0.4 0.0 (0.1) 0.1 (20.4) China Coal - A 601898 CH 11,014 1.5 6.4 (2.6) (0.2) (7.3) (20.5) Yanzhou Coal - A 600188 CH 12,003 1.7 17.9 (4.1) 48.9 7.4 28.6 Shaanxi Coal 601225 CH 13,856 3.0 17.6 (0.6) 56.7 8.3 36.5 Shanxi Lu'an 601699 CH 5,186 3.8 8.1 (10.0) 58.5 (2.8) 38.2 Jizhong Energy 000937 CH 2,686 0.8 (1.4) (12.5) (20.9) (16.7) (41.2) Shanxi Xishan 000983 CH 4,193 5.3 11.6 (7.7) 12.0 (16.3) (8.3)
Yangquan Coal 600348 CH 2,805 2.6 8.6 (11.4) 20.0 0.8 (0.3) Global Coal India COAL IN 24,349 (1.5) (6.4) (12.1) (3.5) 1.5 (23.8) Consol CNX US 3,556 4.9 0.6 10.6 23.1 11.6 2.8 Teck Resources TECK US 16,265 1.8 5.0 (4.8) 59.0 8.2 38.7 Banpu Public BANPU TB 3,447 5.4 11.4 (0.9) 22.2 10.3 1.9
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
25 May 2018 51
Metals & Minings Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: fundamentals NEUTRAL remain wary in aluminum market Maintained
Turning point not in sight, profitability remains along breakeven Bruce WANG +86 21 2897 2099 We expect aluminum market fundamentals to remain weak in 2H18, with leveling Analyst [email protected] up in price supported by higher raw material and energy costs, though industry Xuan YANG +86 21 2897 2239 profitability may remain along breakeven point. We note three main risks that may Analyst [email protected] hold back aluminum price: 1) 3-4mtpa in new capacity; 2) anti-dumping (AD) and Shengjie XU +86 21 2897 2033 countervailing (CVD) duties raised by the US; and 3) potential weakening in winter Analyst [email protected] cut on greater environmental efforts by producers. Maintain HOLD on Aluminum Corporation of China with target price at HKD4.8 based on 1.4x 2018E PB. Key Stock recommendations risk: regulatory interference significantly tightening aluminum supply. Company Code Price Rating Chalco 2600 HK 4.80 HOLD
Bauxite and alumina prices to remain elevated in 2H18 Source: Huatai HK Research estimates We believe clampdown on illegal mine exploitation in Shanxi and regular safety as well as environmental inspections in major production provinces will continue to push bauxite price higher in 2H18E. Meanwhile, for alumina, supply shortage came after Alunorte, the world’s largest alumina refinery (capacity of 6.3mtpa), was ordered to cut production by 50% in early March due to concerns over possible water contamination. Subsequently, Australia FOB price soared from USD366/t (9 March) to USD625/t (27 April). Oversea price strength was able to feed back to the domestic market and resulted in significant rise in alumina price since end- March. We expect alumina price to remain at elevated level supported by both bauxite price and production uncertainty at Alunorte.
New capacity to cap upside potential in price
According to Aladdiny estimates, a total of 3.3mtpa in new capacity may come on stream in 2018. Despite slow commencement of new capacity so far this year due to weak industry profitability, we expect price advances to spur progress on not- yet-commenced projects and to cap the upside potential for aluminum price. In addition, capacity exchange measures released by MIIT in early January requires that all quota eligible for exchange be exchanged by the end of the year, and that quota may be transferred to illegal projects that are ready to operate, which would result in higher output.
Anti-dumping and countervailing investigations may hurt exports We expect to see opposing forces from the international market to impact aluminum exports from China. On the positive side, the global market (excl. China) will continue to see a supply shortage, which will in turn further widen the price gap between LME and SHFE and lift export volume. On the negative side, the US slapped steep AD (48.6-106.1%) and CVD (17.1-81.0%) on Chinese aluminum foil based on the final ruling of the International Trade Commission in March. The US also launched AD and CVD on common alloy aluminum sheet from China in November 2017, and preliminary findings show that exports from China are being subsidized.
Potential weakening in winter restriction in 4Q18 As of now, only Henan province has released its 2018 winter production restriction plans for the aluminum industry, stating that if producers are able to meet special emissions standards before October, winter restrictions can be lowered to 10% (2017: 30%). A total of 893ktpa in aluminum capacity was cut during the 2017-2018 winter heating season, of which 683ktpa came from Henan province. Lowering capacity cut to 10% would mean a 455ktpa reduction in capacity restriction, at Originally published on 21 May 2018 maximum. If other regions are to be on par with Henan, the effect of winter cut would be negligible.
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 52 Please refer to end pages for analyst certification and required disclosures.
China Metals & Minings
Key charts
Fig.133. Timeline: US sets AD and CVD determinations on Chinese aluminum foil
27 February 2018 9 March 2017 28 March 2017 US Department of 13 April 2018 A coalition of US US Department of Commerce USITC announced aluminum foil Commerce initiated determined that affirmative final producers filed a AD and CVD aluminum foil is sold determinations in AD of petition on investigations of in the US at less 48.64-106.09% and CVD of investigation of aluminum foil from than fair value is 17.14-80.97% investigation dumped and unfairly China. subsidized by the of imports of certain subsidized aluminum government of aluminum foil from China. foil. China.
Source: US Department of Commerce, USITC, Huatai HK Research
Fig.134. Timeline: US launched AD and CVD investigations into Chinese common alloy aluminum sheet
19 March 2018 28 November 17 April 2018 2017 The Aluminum 3 April 2018 30 August 2018 Association US Department US Department of Common Alloy US Department USITC scheduled of Commerce Commerce calculated Sheet Trade of Commerce announcement of announced the preliminary subsidy Enforcement postponed the final determination self-initiation of margins ranging from Working Group preliminary on AD and CVD of AD and CVD 31.20% to 113.30% of made a request determination of Common Alloy investigations of the value of the for a 50-day the Less-Than- Aluminum Sheet. imports of imported common alloy postponement of Fair-Value Date may vary. common alloy aluminum sheet. the preliminary Investigation. aluminum sheet determination in from China. this investigation.
Source: US Department of Commerce, USITC, Huatai HK Research
Fig.135. China aluminum: capacity cut during 2017-2018 winter-heating season Province Company Capacity cut (ktpa)
Henan Jiaozuo Wanfang Aluminum 130
Yugang Longquan Aluminum 180
Wanji Aluminum 160
Zhongfu Industrial 100
Yongdeng Aluminum 40
Linfeng Aluminum 73
Shanxi Zhaofeng Aluminum 70
Taiyuan Donglv Aluminum 30
Shandong Shandong Xinfa Aluminum 110
Total 893
Source: Aladdiny, Huatai HK Research
25 May 2018 53
China Metals & Minings
Fig.136. Potential impact of government funds levy on captive power plant Government funds levied on captive power plants Estimated per tonne cost increase for Percentage of captive power plant Province (adjusted, cent/kwh) aluminum smelters (RMB/t) (%) Shandong 4.18 564 99.8 Xinjiang 4.99 674 97.0 Inner Mongolia 5.66 764 89.1 Henan 4.90 662 84.3 Shaanxi 4.36 589 77.5 Chongqing 2.15 290 68.0 Guangxi 5.45 736 54.1 Gansu 4.76 643 46.1 Hubei 5.18 699 45.5 Shanxi 5.69 768 42.2 Ningxia 7.04 950 27.1
Notes: 1) Per tonne cost increase estimates assume 13,500 kwh of electricity is needed to produce one tonne of aluminum. 2) Government funds levied on plants in Inner Mongolia is estimated using those for western and eastern Mongolia. Source: Aladdiny, MOF, NDRC, Huatai HK Research estimates
Fig.137. Aluminum price Fig.138. SHFE-LME aluminum price ratio 1.4 (RMB/t) SHFE 3-month aluminum price (USD/t) LME 3-month aluminum price (rhs) 26,000 3,500 1.3 24,000 22,000 3,000 1.2 20,000 2,500 1.1 18,000 16,000 2,000 1.0 14,000 0.9 12,000 1,500 10,000 0.8
8,000 1,000
Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17
May-08 May-09 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18
Nov-17 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Nov-14 Nov-15 Nov-16
Nov-08
May-08 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-09 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.139. Domestic alumina price Fig.140. Australia FOB alumina price (USD/t) (RMB/t) Henan (average) Shanxi Guiyang 4,000 650 600 3,500 550 500 3,000 450
2,500 400 350 2,000 300 250
1,500
Oct-17
Apr-18
Jan-18
Feb-18 Mar-18
Nov-17 Dec-17
Aug-17 Sep-17
May-18
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-13 May-14 May-15 May-16 May-17 May-18 May-12 Source: Wind, Huatai HK Research Source: Bloomberg, Huatai HK Research
25 May 2018 54
China Metals & Minings
Fig.141. China monthly aluminum production Fig.142. China monthly alumina production Monthly alumina production (kt) (yoy%) (kt) Monthly aluminum production (yoy%) Change (rhs) Change (rhs) 7,000 40 3,000 30 25 6,000 30 20 20 2,500 5,000 15 10 10 4,000 2,000 5 0 0 3,000 (10) (5) 1,500 (10) 2,000 (20) (15) 1,000 (30)
1,000 (20)
Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17
Mar-18 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17
Nov-14 Nov-11 Nov-12 Nov-13 Nov-15 Nov-16 Nov-17
Jul-14 Jul-12 Jul-13 Jul-15 Jul-16 Jul-17
Jul-11
Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Nov-11 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.143. LME aluminum inventory Fig.144. SHFE aluminum inventory (kt) (kt) 1,000 4,500 900 4,000 800 3,500 700 3,000 600 500 2,500 400 2,000 300 1,500 200 1,000 100 0
500
Feb-15 Feb-16 Feb-17 Feb-18
Aug-14 Nov-14 Aug-15 Nov-15 Aug-16 Nov-16 Aug-17 Nov-17
May-15 May-16 May-17 May-18
May-14
Jan-15 Jan-16 Jan-17 Jan-18
Sep-15 Sep-16 Sep-17
May-16 May-17 May-18 May-15 Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Fig.145. China aluminum social inventory Fig.146. World aluminum monthly production (kt) World aluminum production volume (yoy%) (kt) Change (rhs) 2,500 6,000 20
5,500 15 2,000 5,000 10 1,500 4,500 5 1,000 4,000
0 500 3,500
3,000 (5)
0
Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17
Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Nov-16 Nov-12 Nov-13 Nov-14 Nov-15 Nov-17
Jul-16 Jul-17
Jan-17 Jan-18 Mar-18
Mar-17
Sep-16 Nov-16 Sep-17 Nov-17
May-17 May-18 May-16 Source: Wind, Huatai HK Research Source: International Aluminum Institute, Huatai HK Research
25 May 2018 55
China Metals & Minings
Fig.147. China aluminum: 2018E projected capacity addition
(ktpa) 2018E (total) 1Q18 2Q18E 3Q18E 4Q18E Shaanxi Shaanxi Meixin 200 0 100 100 0 Inner Mongolia Huayun New Material 100 0 50 50 0 Chuangyuan Metals 400 70 150 150 30 Mengtai Aluminum 190 70 50 70 0 Shanxi Chalco Huarun 500 0 150 200 150 Guizhou Huaren New Material 250 100 150 0 0 Denggao Aluminum 50 0 50 0 0 Guangxi Hualei New Material 200 100 80 20 0 Laibin Yinhai Aluminum Phase II 190 110 80 0 0 Longlin Baise Mining Aluminium 20 0 0 0 20 Debao Baise Mining Aluminium 300 0 100 150 50 Tianlin Baise Mining Aluminium 300 0 100 150 50 Xinjiang Xinjiang Qiya Aluminum 350 0 150 180 20 Yunnan Yunnan Aluminum Haixin 150 0 20 80 50 Gansu Zhongrui Aluminum 100 0 30 70 0
Total 3,300 450 1,260 1,220 370
Source: Aladdiny, Huatai HK Research estimates
25 May 2018 56
China Metals & Minings
Fig.148. Peer valuation comparison
Bloomberg Market cap PE (x) PB (x) EV EBITDA (x) ROE (%) Stock code (USDmn) 2017E 2018E 2017E 2018E 2017E 2018E 2017E 2018E
H shares Jiangxi Copper-H 358 HK 5,082 10.8 12.1 0.7 0.6 6.0 6.4 6.1 5.3 Zijin Mining-H 2899 HK 10,474 13.2 11.7 1.8 1.7 9.0 8.4 14.0 15.0 China Hongqiao 1378 HK 9,573 6.2 4.4 1.0 0.8 5.1 4.5 15.4 18.8 Chalco 2600 HK 8,316 18.4 12.1 1.2 1.1 15.2 12.9 7.0 9.8 Zhaojin Mining 1818 HK 2,560 23.8 22.1 1.1 1.1 12.4 12.1 4.8 4.9
China Molybdenum 3993 HK 16,096 22.7 20.2 2.3 2.2 8.4 7.7 10.1 10.9
Weighted average 16.0 13.6 1.6 1.5 9.0 8.2 10.7 12.2
A shares Jiangxi Copper-A 600362 CH 9,668 21.5 17.8 1.2 1.2 11.1 10.2 5.7 6.6 Zijin Mining-A 601899 CH 14,334 17.5 14.7 2.1 1.9 9.4 8.5 12.1 12.8 Chalco 601600 CH 10,467 23.5 15.3 1.6 1.4 9.7 8.7 6.7 9.2 Zhongjin Gold 600489 CH 4,664 58.2 46.1 2.2 2.1 14.0 14.1 3.7 4.6 Shandong Gold 600547 CH 7,954 27.9 24.5 2.8 2.6 12.1 10.8 10.1 10.5 China Molybdenum 603993 CH 27,766 34.7 31.7 3.9 3.7 13.7 12.4 11.2 11.8 Zhongjin Lingnan 000060 CH 3,498 17.1 15.5 2.1 1.9 8.6 8.1 12.4 12.3 Tianqi Lithium 002466 CH 10,954 25.7 19.4 6.1 4.8 16.0 11.9 23.7 24.5
China Northern 600111 CH 7,250 78.1 59.8 4.2 4.0 35.3 28.9 5.4 6.7
Weighted average 31.6 26.0 3.1 2.8 13.8 12.0 10.7 11.5
Global BHP Billiton BHP AU 181,434 15.2 16.9 2.3 2.2 6.5 6.9 15.0 13.0 Southern Copper SCCO US 39,494 19.3 17.8 4.9 4.2 10.7 10.0 25.2 23.7 Glencore GLEN LN 73,791 10.5 11.4 1.4 1.3 5.8 6.0 13.3 11.8 Rio Tinto RIO US 101,861 12.1 13.6 2.2 2.1 6.1 6.6 18.6 15.6 Vale Vale US 77,523 10.7 11.8 1.7 1.6 6.5 6.7 15.8 13.7 Teck Resources TECK US 16,294 8.2 9.9 0.9 0.8 4.7 5.3 11.4 8.6 Anglo American AAL LN 32,481 10.2 12.3 1.3 1.2 4.8 5.5 12.9 10.1 Fortescue FMG AU 11,366 10.0 10.5 1.1 1.1 4.3 4.6 11.4 10.3 Freeport-McMoran FCX US 24,456 8.4 14.1 2.2 1.9 4.7 6.9 26.4 13.6 Barrick Gold ABX US 15,259 17.3 17.4 1.5 1.4 5.7 5.8 8.7 8.1 Newmont Mining NEM US 20,894 26.3 22.8 1.9 1.8 8.6 7.9 7.2 7.9 Newcrest NCM AU 11,948 39.1 17.1 1.5 1.4 10.3 7.2 3.9 8.3 Alcoa AA US 9,483 11.2 11.7 1.6 1.4 3.7 4.2 14.6 12.2 United RUSAL 486 HK 3,561 1.9 1.7 0.5 0.4 4.5 4.3 28.6 24.7 Norsk Hydro NHYDY US 13,167 13.3 11.3 1.2 1.1 5.9 5.2 8.9 9.8 Alumina limited AWC AT 5,948 9.8 13.8 2.5 2.5 na na 25.1 17.9
Norilsk Nickel MNOD LI 27,139 8.2 8.3 5.3 4.9 6.3 6.2 64.0 59.8
Weighted average 13.5 14.2 2.2 2.1 6.4 6.6 17.7 15.3
Note: data as 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 57
China Metals & Minings
Fig.149. Peer performance comparison Stock name Ticker Market cap Absolute performance (%) 1y relative (%) (USD mn) 1d 1w 1m 3m 1y ytd vs. Index HSCEI 0.3 (0.2) 2.5 (0.2) 23.5 3.8 Metal-H shares Jiangxi Copper-H 358 HK 5,082 1.1 1.4 (0.2) (9.3) (1.5) (7.1) (25.1) Zijin Mining-H 2899 HK 10,474 1.4 1.4 (5.8) (8.9) 37.3 21.0 13.8 China Hongqiao 1378 HK 9,573 0.5 (0.8) (8.5) (10.1) 23.7 (0.3) 0.2 Chalco 2600 HK 8,316 1.6 (0.9) (15.0) (11.3) 23.0 (21.6) (0.5) Zhaojin Mining 1818 HK 2,560 1.6 3.3 (3.0) (1.6) (5.5) 3.1 (29.0)
China Molybdenum 3993 HK 16,096 1.4 2.8 2.6 1.0 127.6 16.5 104.1
Weighted average 1.2 1.2 (4.5) (6.1) 54.5 5.3 Shanghai Composite 1.2 0.9 3.3 (0.2) 3.3 (3.4) Metal-A shares Jiangxi Copper-A 600362 CH 9,668 2.3 0.7 2.2 (2.1) 19.0 (11.7) 15.6 Zijin Mining-A 601899 CH 14,334 1.3 (3.6) (7.0) (13.5) 22.5 (13.5) 19.2 Chalco 601600 CH 10,467 0.7 (1.8) (12.5) (44.6) 6.2 (44.6) 2.8 Zhongjin Gold 600489 CH 4,664 0.5 (3.4) (12.2) (1.1) (16.1) (12.8) (19.4) Shandong Gold 600547 CH 7,954 1.0 (4.9) (12.4) 2.7 (9.8) (12.4) (13.2) China Molybdenum 603993 CH 27,766 1.2 0.6 4.3 21.7 89.8 19.2 86.5 Zhongjin Lingnan 000060 CH 3,498 1.3 (2.8) (3.3) (5.7) (4.3) (16.1) (7.7) Tianqi Lithium 002466 CH 10,954 0.3 1.8 17.1 4.3 53.1 15.0 49.7
China Northern 600111 CH 7,250 0.6 (1.7) (5.4) 4.6 14.9 (12.7) 11.6
Weighted average 1.1 (1.1) (1.1) (0.0) 37.1 (4.0) SP 500 (0.2) (0.5) 0.2 (0.7) 14.7 1.5 Metal-Global BHP Billiton BHP AU 181,434 (1.0) 2.8 10.2 8.4 40.4 15.3 37.0 Southern Copper SCCO US 39,494 (1.8) (1.3) (10.9) 1.1 51.8 7.7 48.4 Glencore GLEN LN 73,791 (4.5) (1.6) 3.5 (0.2) 34.1 (0.7) 30.7 Rio Tinto RIO US 101,861 (0.3) 2.4 3.4 1.7 45.4 11.0 42.1 Vale Vale US 77,523 (2.3) 0.5 4.8 4.0 83.5 20.0 80.2 Teck Resources TECK US 16,294 (0.8) 1.9 5.2 (4.6) 59.2 8.4 55.9 Anglo American AAL LN 32,481 (1.0) 0.3 3.4 6.6 74.7 20.3 71.4 Fortescue FMG AU 11,366 (0.8) (1.4) 3.2 (9.2) (7.3) (0.4) (10.6) Freeport-McMoran FCX US 24,456 0.6 3.7 (12.0) (9.9) 49.5 (11.0) 46.2 Barrick Gold ABX US 15,259 (0.8) (3.1) (1.4) (0.8) (20.8) (9.6) (24.1) Newmont Mining NEM US 20,894 (0.5) (3.1) (4.7) 0.1 17.5 4.3 14.2 Newcrest NCM AU 11,948 (1.9) (6.8) 3.0 (8.0) (0.7) (9.2) (4.1) Alcoa AA US 9,483 0.3 (5.7) (14.4) 7.4 59.4 (5.6) 56.0 United RUSAL RUSAL FP 3,561 na na 0.0 (9.1) 8.8 (9.9) 5.5 Norsk Hydro NHYDY US 13,167 (2.2) 3.5 (10.6) (17.8) 15.0 (17.9) 11.7 Alumina Limited AWC AT 5,948 (0.4) 0.0 (4.2) 17.5 49.5 13.2 46.1
Norilsk Nickel MNOD LI 27,139 (1.9) (0.9) 1.0 (10.7) 17.8 (8.5) 14.4
Weighted average (1.5) 0.8 3.0 2.0 43.7 8.4
Note: data as 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 58
Forest & Paper Products Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: stay cautious NEUTRAL on new capacity addition Maintained
Stay cautious on paper for 2H18E Bruce WANG +86 21 2897 2099 We maintain our cautious view on the China paper sector for 2H18, when it is likely Analyst [email protected] to be the beginning of the next wave of strong new capacity addition, which will Jie GONG +86 21 2897 2097 largely undermine the record-high profit margin currently enjoyed. Tightened Analyst [email protected] imported old corrugate container (OCC) restrictions will further enlarge the price Haipeng LI +86 21 2897 2033 gap between domestic and imported OCC, but we believe this will not be enough Analyst [email protected] to make major paper mills with imported OCC exposure immune to weakened Liang YU +86 21 2897 2201 profitability. With the whole industry making good money since 2016, the new round Analyst [email protected] of industry reshuffle could be fiercer than usual. Reiterate NEUTRAL on the China paper sector. Maintain HOLD on Nine Dragons Paper (NDP, 2689 HK, TP Stock recommendations HKD14.0) and Lee & Man Paper (LMP, 2314 HK, TP HKD8.5). Company Code TP (HKD) Rating Nine Dragons Paper 2689 HK 14.0 HOLD 15mtpa of new capacity in 2018-19E set to undermine S-D dynamic Lee & Man Paper 2314 HK 8.5 HOLD
As a direct result of high profitability enjoyed since 2016 and a lack of government Source: Huatai HK Research estimates restrictions over new capacity addition, paper mills’ expansion plans started to soar since last year. After over a year of construction, many new mills will commence operation from 2H18. We expect to see a total of 15mn tonnes of new capacity Sector performance coming online in 2018E-2019E, representing around 25% of total capacity by end- Huatai paper index (%) 2017, adding to the harsh supply pressure on the market, which may prompt a new Rel. to HSCEI (rhs) 4,000 200 round of industry reshuffle under the deteriorated supply-demand dynamic. Profit margin will be significantly squeezed from the current high level.
2,000 100 Major paper mills unlikely to be immune from margin contraction Restrictions on imported waste paper have tightened since last summer. Not only has the granting of import quota been extremely slow, but the high import standard 0 0 together with strict examination policies have also made actual imports significantly Jan-16 Jan-17 Jan-18 lower compared with last year. As a result, domestic OCC price is soaring, while Source: Huatai HK Research estimates import price has been kept low. The situation will stay the same if the government's restriction on imported waste paper is unchanged. However, we believe this will not be enough to make major paper mills immune to margin contraction as: 1) major paper mills themselves are forced to use a bigger proportion of domestic OCC, which is subject to bigger cost inflation from rising domestic OCC price; and 2) under a deteriorated supply-demand dynamic, paper mills will find it harder to hike paper price, breaking the loop of passing cost inflation directly to downstream users.
Expect to see 2-3 quarters of irrational pricing Given that the whole industry's balance sheet has largely improved during the past few years amid the longest industry recovery since 2010, the process of industry reshuffle could be much fiercer than usual, before bottoming out. Small paper mills will be able to afford a selling price below cash cost for quite some time before being squeezed out as they hope to survive longer than others, while at the same time, profit margin for large-scale paper mills will be dragged down significantly as well. We would not be surprised to see NDP and LMP's net dollar margin to run below their long-term equilibrium level for 2-3 quarters. Key upside risk: lower-than- expected capacity expansion. Originally published on 21 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 59 Please refer to end pages for analyst certification and required disclosures.
China Forest & Paper Products
Key charts Fig.150. Containerboard supply/demand model (mn tonnes) 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E Capacity (mtpa) 44.4 48.4 53.5 58.4 57.2 58.7 61.2 67.8 72.3 73.8 yoy% 11.5 8.9 10.6 9.2 (2.1) 2.7 4.3 10.8 6.6 2.1 New capacity addition (mtpa) 6.6 6.7 7.8 5.9 2.3 3.0 4.0 8.1 6.0 3.0
Old capacity closure (mtpa) (2.0) (2.7) (2.7) (1.0) (3.5) (1.5) (1.5) (1.5) (1.5) (1.5) Production (mt) 39.7 41.0 42.3 43.4 44.7 45.8 47.2 49.0 50.8 52.7 yoy% 5.9 3.3 3.2 2.5 3.1 2.3 3.2 3.8 3.8 3.7 Import (mt) 1.1 1.0 0.9 0.9 0.9 1.0 2.0 2.0 2.0 2.0 yoy% 5.8 (10.9) (8.2) 1.1 2.2 9.7 97.8 - - - Export (mt) 0.2 0.1 0.3 0.3 0.4 0.4 0.2 0.2 0.2 0.2 yoy% (15.8) (12.5) 85.7 30.8 11.8 10.5 (61.9) - - - Net import (mt) 0.9 0.8 0.6 0.6 0.6 0.6 1.9 1.9 1.9 1.9 yoy% 10.6 (10.6) (23.8) (10.9) (3.5) 9.1 209.7 - - - Demand (mn tonnes) 40.6 41.8 42.9 43.9 45.3 46.4 49.1 50.8 52.7 54.6 yoy% 6.0 3.0 2.6 2.3 3.0 2.4 5.8 3.6 3.6 3.6 Utilization ratio (%) 89.3 84.7 79.0 74.2 78.2 77.9 77.1 72.2 70.3 71.4
Source: Company data, Huatai HK Research estimates
Fig.151. Major containerboard players in 2014 Fig.152. Major containerboard players beyond 2019E
Source: Zhuochuang, Huatai HK Research Source: Zhuochuang, Huatai HK Research estimates
25 May 2018 60
China Forest & Paper Products
Fig.153. Paper price capped by rising imports Fig.154. Containerboard: consumption breakdown (000 tonnes) (RMB/t) (%) 300 7,000 6 Containerboard imports Net imports as % of consumption 250 6,000 5 5,000 200 4 4,000 150 3 3,000 100 2 2,000
50 1,000 1
0 0 0
Apr-16 Oct-16 Apr-17 Oct-17
Jun-16 Jun-17
Feb-16 Feb-14 Feb-15 Feb-17 Feb-18
Feb-16 Feb-17 Feb-18 Aug-14 Nov-14 Aug-15 Nov-15 Aug-16 Nov-16 Aug-17 Nov-17
Aug-17 Aug-16 Dec-16 Dec-17
May-15 May-16 May-17 May-14 Source: RISI, China Customs, Huatai HK Research Source: RISI, Huatai HK Research
Fig.155. Paper mills using imported OCC enjoy lower cost Fig.156. OCC price: imported vs d omestic (RMB/t) (RMB/t) 4,000 50% imported OCC 2,500
0% imported OCC Imported Domestic 3,500 2,000
3,000 1,500 2,500 1,000 2,000 500 1,500
0
Oct-12 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17
Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-12 Before 2H17 Post 2H17 Note: OCC – old corrugated containers Source: RISI, Huatai HK Research Source: RISI, SXCoal, Huatai HK Research estimates
Fig.158. 2018 ytd: imported waste paper quota, 12 Fig.157. 2017: imported waste paper quota, 11 batches batches
Others Others 36% 41%
Liansheng NDP Paper 30% 6% NDP Liansheng 33% Paper 6% Shanying Paper Shanying 11% Paper LMP LMP 9% 14% 14% Source: Zhuochuang, Huatai HK Research Source: Zhuochuang, Huatai HK Research
25 May 2018 61
China Forest & Paper Products
Fig.160. Imported waste paper quota falling sharply in Fig.159. Changes in allocation among batches in 2018 2018
(000 tonnes) (000 tonnes) (mn tonnes) Imported OCC quota 2017 1st batch 30,000 2018 1st batch 3,000 60 OCC imports 2017 other batchs (rhs) 25,000 2,500 2018 other batches (rhs) 50 20,000 2,000 40 15,000 1,500
10,000 1,000 30
5,000 500 20
0 0 10
0
1stbatch
4thbatch 5thbatch 6thbatch 7thbatch 8thbatch 9thbatch
3rd batch
2nd batch
11thbatch 12thbatch 10thbatch 2012 2013 2014 2015 2016 2017 2018 ytd Source: Zhuochuang, Huatai HK Research Source: Zhuochuang, China Paper Association, Huatai HK Research
Fig.161. Containerboard: simulated GP/t trend Fig.162. Linerboard and waste paper prices
(RMB/t) (RMB/t) (RMB/t) 2,500 Linerboard Corrugated medium 6,000 Linerboard 4,000 Wastepaper - US #11 (rhs) 3,500 5,000 2,000 Domestic OCC (rhs) 3,000 4,000 1,500 2,500 3,000 2,000
1,000 1,500 2,000 1,000 500 1,000 500
0 0 0
May-13 May-10 May-11 May-12 May-14 May-15 May-16 May-17 May-18 May-09 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-09 Source: RISI, SXCoal, Huatai HK Research estimates Source: RISI, Wind
Fig.163. Capacity addition by year Fig.164. Huatai paper demand index
(mtpa) (%) 30 12 25 10 20 15 8 10 6 5
4 0 (5) 2 (10)
0
2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-09 Source: RISI, SCI99, Huatai HK Research estimates Source: NBS, Wind, Huatai HK Research
25 May 2018 62
China Forest & Paper Products
Fig.165. National average inventory by year Fig.166. Paper mills: utilization ratio
(%) 2014 2015 2016 (%) 2014 2015 2016 25 2017 2018 100 2017 2018
20 90
15 80
10 70
5 60
0 50 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: SCI99, Huatai HK Research Source: SCI99, Huatai HK Research
Fig.167. Peer valuation comparison Stock name Ticker Market cap PE (x) PB (x) EV EBITDA (x) ROE (%)
(USDmn) 2018E 2019E 2018E 2019E 2018E 2019E 2018E 2019E Paper-H Lee & Man Paper 2314 HK 5,183 10.0 11.4 1.7 1.5 9.1 10.1 16.7 13.5 Nine Dragons Paper 2689 HK 7,610 6.2 9.2 1.3 1.2 5.5 7.0 21.7 13.6
Weighted average 7.8 10.1 1.5 1.4 6.9 8.3 19.7 13.6
Paper-A Chenming-A 000488 CH 4,647 6.5 5.6 1.0 0.9 na na 15.7 16.2 Huatai 600308 CH 1,085 8.8 7.5 0.9 0.8 5.4 5.2 9.9 10.4 Jingxing 002067 CH 844 7.2 na na na na na na na Shanying 600567 CH 3,195 8.0 6.9 1.6 1.3 6.0 5.6 19.9 19.5 Sun Paper 002078 CH 4,747 11.6 9.7 2.4 1.9 7.2 6.2 20.3 19.7
Weighted average - 8.7 7.0 1.5 1.3 4.1 3.7 16.8 16.7
Paper-Global International Paper IP US 22,758 10.8 9.7 2.8 2.4 7.6 7.1 26.1 24.8 Stora Enso STERV FH 16,232 14.9 15.2 2.1 1.9 8.7 8.7 14.0 12.7 UPM UPM FH 19,798 15.0 15.2 1.8 1.7 9.3 9.5 12.2 11.5 Weyerhaeuser WY US 27,593 24.7 23.7 3.0 na 14.6 14.3 12.3 na Packaging Corp of America PKG US 11,433 15.3 13.8 4.3 3.6 9.3 8.8 28.2 26.3 Smurfit Kappa SKG ID 9,438 13.9 13.4 2.8 2.5 7.9 7.6 20.0 18.6 Fibria Celulose FBR US 10,486 10.5 10.2 2.2 2.0 6.3 6.3 21.4 19.1 West Rock WRK US 15,923 15.5 13.0 1.3 1.2 7.7 7.0 8.5 9.6 Long Chen 1909 TT 1,276 10.1 na na na na na na na
Weighted average 15.9 15.0 2.5 1.7 9.4 9.1 16.8 13.5
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 63
China Forest & Paper Products
Fig.168. Peer performance comparison Market cap Absolute performance (%) 1y relative (%) Stock name Ticker (USDmn) 1d 1w 1m 3m 1y ytd vs Index
HSI 0.3 (0.2) 2.1 (1.2) 23.3 3.8
H shares Lee & Man Paper 2314 HK 5,183 2.2 (1.1) 5.9 8.1 40.3 (1.3) 17.0 Nine Dragons Paper 2689 HK 7,610 1.6 (3.5) 8.9 8.7 44.9 2.1 21.6
Weighted average 1.9 (2.5) 7.7 8.4 43.0 0.7
Shanghai Composite 1.2 0.9 4.0 (0.2) 3.3 (3.4)
A shares Chenming-A 000488 CH 4,647 1.7 (0.6) 0.2 (8.8) 34.8 (8.2) 31.4 Huatai 600308 CH 1,085 2.6 3.1 9.8 (6.0) 14.0 (5.6) 10.7 Jingxing 002067 CH 844 1.3 (0.8) (13.4) (17.2) (16.8) (19.0) (20.1) Shanying 600567 CH 3,195 1.6 0.0 6.7 (2.0) 26.7 2.8 23.4 Sun Paper 002078 CH 4,747 1.8 1.0 15.8 3.2 77.0 25.9 73.6
Weighted average 1.7 0.3 6.6 (3.7) 42.2 4.9
Global shares International Paper IP US 20,855 (0.2) 2.4 2.9 (5.2) 7.5 (5.1) 26.9 Stora Enso STERV FH 9,485 0.2 1.2 4.6 21.8 56.0 32.3 12.5 UPM UPM1V FH 12,714 (0.3) 1.6 4.7 12.1 27.6 21.6 22.7 Weyerhaeuser WY US 26,190 0.4 (0.5) 0.5 4.3 10.4 3.4 9.8 Packaging Corp of America PKG US 8,577 0.7 3.9 4.3 2.0 22.0 0.5 70.3 Smurfit Kappa SKG ID 6,012 (0.5) (4.4) (5.6) 13.6 35.3 19.9 (2.7) Fibria Celulose FBR US 5,074 (0.2) (2.9) (3.3) (1.7) 88.5 28.8 (41.2)
Weighted average 0.1 0.7 1.9 5.1 24.3 9.4
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
25 May 2018 64
Environment Services Equity Research
Huatai Research
21 May 2018
Equity | China Road Ahead 2H18: industrial OVERWEIGHT waste is our preferred segment Maintained
Positive on 2H18 outlook for China environment service sector Jie GONG +86 21 2897 2097 We remain optimistic on the outlook for the China environment services sector in Analyst [email protected] 2H18. We expect demand for environment service to remain robust, given the Bruce WANG +86 21 2897 2099 government’s stance on environment issues seems more serious than ever. Our Analyst [email protected] preferred subsector is industrial waste (both regular and hazardous), where a Liang YU +86 21 2897 2201 limited number of qualified service providers are being kept busy by discovery of Analyst [email protected] previously concealed contaminated sites. This mismatch is likely to continue and Haipeng LI +86 21 2897 2033 therefore maintain treatment fee and profit margin at a high level. In the municipal Analyst [email protected] environment service sector, we prefer waste to energy (WTE) over waste water treatment (WWT), given the market is less mature and its lower dependence on the Stock recommendations public-private partnership (PPP) model. Reiterate OVERWEIGHT on China environment services sector. Our top picks are Conch Venture (BUY, TP HKD27.9), Company Code TP (HKD) Rating CEI (BUY, TP HKD12.7) and Canvest (BUY, TP HKD6.0). Conch Venture 586 HK 27.9 BUY CEI 257 HK 12.7 BUY Industrial waste: buoyant sentiment to continue in 2H18 Canvest 1381 HK 6.0 BUY The recent ‘Waste Clearing Activity’ initialized by China’s Ministry of Environmental Dynagreen 1330 HK 5.5 BUY Protection (MEP) in 11 provinces along the Yangtze River found, in only one week, BEWG 371 HK 5.9 BUY CTEG 1363 HK 2.0 BUY more than 1,300 cases of waste mishandling, with no investigated province exempted. Meanwhile, the sudden emergence of increased industrial waste Source: Huatai HK Research estimates treatment demand has pushed up treatment fee in many areas. It is recognized industrywide that the actual production of industrial waste is much bigger than the Sector performance reported number, with much still concealed, illegally dumped or mishandled. We Sector index believe the Waste Clearing Activity is not a one-off incident and that enhanced (x) (%) government supervision is set to prolong the prosperity the industry is enjoying. 40,000 Rel. to HSI (rhs) 40 Conch Venture is our sector top pick. As a leading player using cement kilns to incinerate industrial waste, it has advantages in: 1) large treatment capacity; 2) 20 lower treatment cost; and 3) synergies with cement producers. Local government’s 20,000 renewed focus on industrial waste issues will also likely accelerate the 0 implementation of Conch Venture’s signed projects. 0 (20) WTE: stable growth in 2H18, top brands favored Jan-15 Jan-16 Jan-17 Jan-18 We expect stable growth for the WTE industry to continue in 2H18, with incineration Source: Huatai HK Research estimates gradually becoming the mainstream treatment method for household garbage as landfill capacity starts filling up. Offering a low treatment fee is no longer a panacea to obtain projects, as operation quality is increasingly emphasized by both local government and residents. Therefore, we believe big brands with rich experience in WTE plant construction and operation are better positioned and that waste treatment fee will hold up well. Our sub-sector top picks: CEI and Canvest.
WWT: growth likely to slow in 2H18 Water body renovation has become a key growth driver for WWT players in the past few years, as the municipal wastewater market is becoming saturated. However, high initial investment and intensive construction work have made water body renovation projects highly dependent on the PPP model and the leverage of social capital. Under the current background of financial market deleveraging and stricter supervision of PPP, development of the water ecology comprehensive renovation market will inevitably slow, as some water body renovation projects have already been removed from the PPP project reservoir. Though demand is still Originally published on 21 May 2018 robust, bottom-line growth for WWT players is likely to be unexciting in 2H18. Downside risks: weaker-than-expected treatment demand.
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 65 Please refer to end pages for analyst certification and required disclosures.
China Environment Services
Key charts Fig.169. Illegal waste mishandling: 38mn tonnes found across 11 provinces
(‘000 tonnes) Total Shanghai 134 Jiangsu 1,049 Zhejiang 135 Anhui 1,121 Jiangxi 592 Hubei 3,638 Hunan 86 Chongqing 2,983 Sichuan 7,032 Guizhou 21,296 Yunnan 34 National total 38,100
Source: MEP, Huatai HK Research
Fig.170. Peer valuation comparison Stock name Ticker Market cap PE (x) PB (x) EV EBITDA (x) ROE (%)
(USDmn) 2018E 2019E 2018E 2019E 2018E 2019E 2018E 2019E Environmental-H CEI 257 HK 6,087 11.3 10.7 1.8 1.6 9.5 9.1 16.3 15.4 Conch Venture 586 HK 5,633 8.1 7.2 1.5 1.3 7.4 6.6 18.5 17.8 BEWG 371 HK 5,312 9.4 8.3 1.6 1.4 9.9 8.9 17.3 17.4 Tianjin Capital - H 1065 HK 776 11.5 10.9 1.1 1.0 5.7 5.4 9.6 9.3 CTEG 1363 HK 901 9.1 7.1 1.7 1.4 6.6 5.3 19.2 20.3 Dongjiang-H 895 HK 1,419 15.9 13.4 1.8 1.5 10.6 8.8 11.5 11.4 Canvest 1381 HK 1,364 14.5 13.6 1.9 1.7 10.3 9.1 13.3 12.7 Dynagreen 1330 HK 547 6.3 4.9 1.0 0.8 6.1 4.7 15.6 17.2
Weighted average 10.3 9.3 1.7 1.5 8.9 8.0
Environmental-A Origin Water 300070 CH 9,059 18.1 14.2 2.7 2.3 13.7 10.4 15.0 16.2 Tus Sound 000826 CH 4,980 19.7 15.9 2.1 1.8 13.8 10.9 10.4 11.6 Beijing Capital 600008 CH 3,642 29.6 26.5 2.0 2.0 15.6 14.4 6.8 7.4 Dongjiang-A 002672 CH 2,293 25.0 20.0 3.1 2.7 15.1 12.3 12.4 13.3 Tianjin Capital - A 600874 CH 2,890 31.9 30.0 3.3 3.1 15.2 14.4 10.4 10.2
Weighted average 21.4 17.6 2.5 2.2 14.2 11.5
Environmental-Global Waste Management WM US 35,230 20.3 18.6 5.4 5.0 10.7 10.2 26.8 26.8 Republic Services RSG US 21,843 21.7 19.7 2.8 2.7 10.4 9.9 12.9 13.6 Veolia VIE FP 13,231 16.9 15.0 1.7 1.6 6.0 5.7 10.1 11.0 Waste Connection WCN US 19,729 29.7 26.8 3.0 2.9 14.9 13.8 10.1 10.7 Suez SEV FP 9,198 19.4 17.1 1.2 1.2 6.9 6.7 6.1 6.9 Stericycle SRCL US 5,457 13.7 13.2 1.8 1.6 10.4 9.7 13.2 12.2 Covanta CVA US 2,054 314.0 157.0 3.8 5.6 10.4 10.0 1.2 3.6 Clean Harbors CLH US 2,869 66.4 38.6 2.4 2.5 9.0 8.3 3.7 6.4
Weighted average 28.2 22.6 3.4 3.2 10.4 9.9
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research estimates
25 May 2018 66
China Environment Services
Fig.171. Peer performance comparison Stock name Ticker Market cap Absolute performance (%) 1y relative (%)
(USDmn) 1d 1w 1m 3m 1y ytd vs Index Environment-H Conch Venture 586 HK 5,633 (0.2) 1.0 5.8 13.2 64.0 35.4 43.7 CEI 257 HK 6,087 0.4 (2.9) (2.0) (6.5) 8.2 (4.5) (12.1) BEWG 371 HK 5,408 0.9 (2.0) 2.7 (11.9) (23.2) (25.5) (43.6) CTEG 1363 HK 901 (0.9) (1.8) (5.9) (20.6) (25.2) (22.8) (45.6) Dongjiang-H 895 HK 1,364 1.4 1.6 - (0.5) 3.1 (5.4) (17.3) Canvest 1381 HK 547 2.8 5.7 4.3 (2.4) (4.0) (8.7) (24.3) Dynagreen 1330 HK 1,419 1.5 5.2 22.7 18.5 1.0 2.6 (19.4)
Weighted average 0.5 (0.5) 3.0 (1.1) 12.4 0.2 (7.9)
Environment-A Dongjiang-A 002672 CH 2,293 (0.1) 7.1 11.9 14.9 (4.4) 1.5 (7.7) Beijing Capital 600008 CH 3,642 1.0 - (2.4) 3.9 (37.9) (6.2) (41.2) Tus Sound 000826 CH 4,980 (0.2) 2.1 6.0 12.7 (5.2) (5.8) (8.5) Shengyun 300090 CH 1,912 - - - - (3.9) - (7.2) Grandblue 600323 CH 1,958 3.4 3.0 14.5 19.6 15.5 2.2 12.2
Weighted average 0.6 2.2 5.2 10.1 (10.2) (3.0) (13.5)
Environment-Global Waste Management WM US 35,230 - (1.8) (1.4) (4.3) 15.6 (5.6) 1.7 Republic Services RSG US 21,843 - (1.9) 1.1 2.3 8.5 (1.5) (5.4) Veolia VIE FP 13,231 1.4 (3.7) 2.7 3.5 3.2 (6.2) (10.8) Waste Connection WCN US 19,729 (0.1) (1.1) 1.3 5.6 22.2 5.6 8.3 Suez SEV FP 9,198 3.3 6.3 5.9 15.7 (22.6) (14.3) (36.5) Stericycle SRCL US 5,457 (0.1) (0.7) 4.8 (16.1) (23.7) (6.2) (37.6) Covanta CVA US 2,054 - (0.6) 1.6 (2.8) 10.6 (7.1) (3.3) Clean Harbors CLH US 2,869 (1.6) (2.9) 5.7 (2.6) (11.0) (5.8) (24.9) Weighted average 0.5 (1.0) 1.4 1.0 6.4 (4.0) (7.5)
Note: data as at 18 May close Source: Bloomberg, Huatai HK Research
Fig.172. Conch Venture: one-year forward PE bands Fig.173. Conch Venture: one-year forward PB bands
(x) (x) 20 2.5 18 16 2.0 +1SD: 12.8x +1SD: 1.6x 14 12 Avg:9.8x 1.5 Average: 1.4x 10 -1SD: 1.1x
8 -1SD: 6.8x 1.0 6 4 0.5 2
0 0.0
Jun-14 Jun-15 Jun-16 Jun-17
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Dec-13 Sep-14 Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17
Jun-16 Jun-14 Jun-15 Jun-17
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-14 Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17 Dec-13 Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
25 May 2018 67
China Environment Services
Fig.174. Conch Venture: one-year-forward EV EBITDA Fig.175. CEI: one-year forward PE bands bands
(x) (x) 20 35
30 15 25 +1SD: 24.1x +1SD: 10.7x 20 Avg: 18.2x 10 Avg: 8.4x 15 -1SD: 12.4x -1SD: 6.0x 5 10
5 0
0
Jun-14 Jun-15 Jun-16 Jun-17
Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Sep-14 Sep-15 Sep-16 Sep-17
Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-08 Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
Fig.176. CEI: one-year forward PB bands Fig.177. CEI: one-year forward EV EBITDA bands
(x) (x) 4.5 30 4.0 3.5 +1SD: 16.2x +1SD: 2.9x 3.0 20 2.5 Average: 2.3x Avg: 13.0x 2.0 -1SD: 1.6x 1.5 10 -1SD: 9.9x 1.0 0.5 0.0
0
Jun-14 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-15 Jun-16 Jun-17
Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-08
Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
Fig.178. Canvest: one-year forward PE bands Fig.179. Canvest: one-year forward PB bands
(x) (x) 40 5.0
35 4.5
30 4.0 +1SD: 24.0x 25 3.5 +1SD: 3.2x Avg: 19.1x 20 3.0 Average: 2.5x 15 2.5 -1SD: 1.8x 10 -1SD: 14.2x 2.0
5 1.5
Jun-15 Jun-16 Jun-17
Mar-16 Mar-15 Mar-17 Mar-18
Dec-14 Sep-17 Sep-15 Dec-15 Sep-16 Dec-16 Dec-17
Jun-15 Jun-16 Jun-17
Mar-15 Mar-16 Mar-17 Mar-18
Dec-14 Dec-15 Dec-16 Dec-17
Sep-16 Sep-17 Sep-15
Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
25 May 2018 68
China Environment Services
Fig.180. Canvest: one-year forward EV EBITDA bands Fig.181. BEWG: one-year forward PE bands
(x) (x)
25 50 45 40 +1SD: 15.4x +1SD: 31.5x 20 35 30 25 Avg: 22.5x 15 Avg: 12.9x 20 -1SD: 13.5x 15 10 -1SD: 10.4x 10 5 0
5
Jun-11 Jun-09 Jun-10 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Jun-15 Jun-16 Jun-17
Mar-15 Mar-16 Mar-17 Mar-18
Dec-09 Dec-08 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17 Dec-14 Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
Fig.182. BEWG: one-year forward PB bands Fig.183. BEWG: one-year forward EV EBITDA bands
(x) (x) 6.0 50
5.0 40 +1SD: 3.5x 4.0 +1SD: 27.3x 30 3.0 Average: 2.7x Avg: 20.1x
20 2.0 -1SD: 1.9x -1SD: 12.9x 1.0 10
0.0
0
Jun-14 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-15 Jun-16 Jun-17
Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-08 Source: Huatai HK Research estimates, Bloomberg Source: Huatai HK Research estimates, Bloomberg
25 May 2018 69
Consumer Discretionary Equity Research
Huatai Research
25 May 2018
Equity | China
Road Ahead 2H18: cherry picking OVERWEIGHT Maintained
Investment highlights Qian YAO +852 3658 6064 Looking into 2H18, we remain positive on the consumer sector on continuous Analyst [email protected] consumption upgrade trend in China and recovering consumer sentiment. For Tingting CHEN +86 21 3847 6725 sportswear, we believe top domestic players will continue to benefit from trade-up Analyst [email protected] by low-income customers and industry consolidation. For textiles, we prefer large- Shijia YAO +86 21 2897 2063 scale supply chain players such as Shenzhou which are likely to take more wallet Analyst [email protected] share from smaller ones due to: 1) strong overseas presence; 2) shorter lead times; 3) R&D capability; and 4) better ESG and CSR. For HK jewelers, sales momentum Stock recommendations is likely to be supported by the completion of the Guangzhou-Shenzhen-Hong Kong Express Rail Link in 3Q18 and weak HKD vs CNY. We cherry pick the stocks among Company Code Price Rating our sub-sectors: Li Ning (2331 HK), Shenzhou (2313 HK) and Chow Tai Fook (1929 Li Ning 2331 HK 9.9 BUY HK). Shenzhou 2313 HK 84.0 BUY Chow Tai Fook 1929 HK 10.6 BUY
Sportswear – demand remains strong Source: Huatai HK Research estimates In 2H18, the overall sportswear industry will continue to benefit from supportive government policies, rising health awareness and consumers’ lifestyle changes. Leading domestic sportswear players such as Anta and Li Ning should benefit more, driven by improving innovation capabilities and operational improvement. Short-term demand, however, is likely to be affected by uncertainties in weather. Our top BUY in the sector remains Li Ning as we are positive on its continuous efforts to improve its fundamentals and brand rejuvenation. We also rate Anta at BUY on its multi-brand strategy.
Textiles – industry consolidation likely to accelerate We think industry consolidation is likely to accelerate considering recent Sino-US trade tensions. Companies that can afford to relocate and those that can survive the industry consolidation will be deemed winners with strong potential to: 1) increase capacity; 2) win orders from brand owners; and 3) better absorb raw material price hikes and unfavorable exchange rate fluctuations. Shenzhou remains our top BUY in the sector, on its: 1) accelerating overseas expansion; 2) nimble response to clients; 3) R&D capability; and 4) better ESG and CSR.
Jewelers – HK retail sales to remain solid
Mainland Chinese visitations to HK grew by 13% during January-March (2017: 4%), leading to 14% growth in Hong Kong retail sales during the same period (2017: 2%). Going forward, the sales momentum is likely to be supported by the completion of the Guangzhou-Shenzhen-Hong Kong Express Rail Link in 3Q18 and weak HKD vs CNY. Chow Tai Fook (CTF) remains our top pick in this sector due to: 1) operating leverage effect in HK/Macau market; 2) solid sales momentum; and 3) better offering of products with higher ASP.
Risks to our view Major risks to our OVERWEIGHT rating on the sector are: 1) slower-than-expected demand growth; 2) policy and forex risks; 3) new-brand and business-development failure; 4) intensifying competition; and 5) raw material price volatility.
Originally published on 21 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 70 Please refer to end pages for analyst certification and required disclosures.
Energy Equity Research
Huatai Research
25 May 2018
Equity | China Raise 2018 average Brent forecast OVERWEIGHT to USD70 as supply tightens Maintained
Raise oil forecast to USD70 in 2018/19 on tightening fundamentals Hanzhi DING +852 3658 6058 We raise our 2018/19 average Brent price forecast to USD70/70 from USD64/66 Analyst [email protected] on improved supply/demand fundamentals and lingering geopolitical tensions Wenrui YU +86 21 2897 2218 despite unchanged long-term estimate of USD68. While demand appears to play Analyst [email protected] an increasingly important role, in particular during the driving season, we believe the global oil market remains supply-driven, and full compliance of OPEC Energy stocks under coverage production cut (4M18: 138-162% vs 2017: 95%) should last into the coming Company Code Rating TP (HKD) quarters, while we do not rule out the possibility of Saudi Arabia slightly raising PetroChina 857 HK BUY 8.0* output to alleviate the impact from potential Iran export curb. In a nutshell, our Sinopec 386 HK BUY 8.9* positive oil view is mainly driven by: 1) Saudi Arabia’s continued commitment to CNOOC 883 HK HOLD 15.0* output cut ahead of the potential IPO of Aramco in 2H18-2019; 2) prolonged SEG 2386 HK BUY 10.0 production slump in Venezuela and Angola on lack of oilfield investment owing to Kantons 934 HK BUY 5.6 fiscal crisis; 3) increased costs associated with E&P and transportation likely to COSL 2883 HK SELL 6.5 slow the growth of US shale oil production; 4) c. 3mbpd annual output decline in SSC 1033 HK BUY 1.8 Anton 3337 HK BUY 1.8 ageing conventional oilfields globally; 5) potential Iran export reduction due to US Honghua 196 HK BUY 1.1 withdrawal from nuclear deal, though the magnitude is still questionable; and 6) Hilong 1623 HK BUY 1.7 improving global oil demand growth at an estimated 1.5mbpd yoy in 2018. SPT 1251 HK BUY 1.0 Tsaker 1986 HK BUY 4.7
Large-caps: Raising TP for all, but still prefer PetroChina most Note: *TP revised Factoring in our increased oil forecast for 2018/19, we raise our PetroChina Source: Huatai HK Research estimates 2018E/2019E EPS by 17/13% and PB-based TP to HKD8.0 from HKD7.0. We reiterate PetroChina as our top BUY due to its attractive valuation of 0.7x PB, which represents a significant discount to its 10-year average of 1.3x PB and 5-year average of 0.9x PB. We raise our Sinopec 2018E/2019E EPS by 3/1% to reflect our new oil prices, but reduce chemical margins as we think the lower-than- expected chemical profitability in 1Q18 should persist into 2Q-3Q18, and maintain BUY while slightly raising our PB-based TP to HKD8.9 from HKD8.0. We raise our CNOOC 2018E/2019E EPS by 20/12% after we bake the new oil assumptions into our model, raise our PB-based TP to HKD15.0 from HKD13.4, and maintain HOLD on full valuation and cost inflation.
Oil servicers: Ride on oil rally & shale gas; Prefer Anton, Honghua
We prefer onshore servicers to offshore as we believe there is severe oversupply in the global offshore rig market, which should take over 2-3 years to resolve, considering that there is a large volume of undelivered and uncontracted jackups and semi-subs lying in various Chinese shipyards. Global offshore rig dayrates will remain under pressure as inexpensive Chinese new-build rigs gradually come to the market and as low-grade warm/stacked rigs are reactivated. Anton is our top pick among onshore oil servicers, driven by strong market share gain in the Iraqi market and elevated capex in shale gas by PetroChina and Sinopec. Honghua is another preferred name, mainly on its offshore spin-off and higher barriers to entry in new equipment innovation and production such as the 6,000-hp electric fracturing pump and flexible water container.
Mid-caps: SEG and Sinopec Kantons are preferred names Our BUY on SEG mainly rests on: 1) Sinopec’s capex upcycle on refining and chemicals in 2017-21; 2) solid earnings outlook supported by strong new order intake and ample order backlog (1Q18: RMB27/112bn of new orders/backlog, up 364/26% yoy); and 3) visible ROE improvement driven by the H-share appreciation rights scheme. We also like Kantons on our estimated 11% annual growth in China oil imports in 2018/19 and attractive valuation at 5.9x 2018E PE. Originally published on 9 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 71 Please refer to end pages for analyst certification and required disclosures.
China Energy
Rising oil price to USD70 from USD64/66 in 2018/19 We note improved supply/demand fundamentals of the global oil market have led Brent to a fresh peak of USD75 from a low of USD44 in June 2017. We raise our 2018/19 average Brent price forecast to USD70/70 from USD64/66 on improved supply/demand fundamentals and lingering geopolitical tensions despite unchanged long-term estimate of USD68. While demand appears to play an increasingly important role, in particular during the driving season, we believe the global oil market remains supply-driven, and full compliance of OPEC production cut (4M18: 138-162% vs 2017: 95%) should last into the coming quarters, though we do not rule out the possibility of Saudi Arabia slightly raising output to alleviate the impact from potential Iran export curb.
In a nutshell, our positive oil view is mainly driven by: 1) Saudi Arabia’s continued commitment to output cut ahead of the potential IPO of Aramco in 2H18-2019; 2) prolonged production slump in Venezuela and Angola on lack of oilfield investment owing to fiscal crisis; 3) increased costs associated with E&P and transportation likely to slow down the growth of US shale oil production; 4) c. 3mbpd annual output decline in ageing conventional oilfields globally; 5) potential Iran export reduction due to US withdrawal from nuclear deal, though the magnitude is still questionable because non-US deal signatories seem more likely to preserve the deal, suggesting that a 1.0mbpd export fall is unlikely; and 6) improved global oil demand growth at an estimated 1.5mbpd yoy in 2018. Key risk to our view lies in US shale output growth.
Fig.184. Oil: global supply and demand
(mbpd) (mbpd) 110 Global production Global consumption gap (rhs) 2.5 2.0
105 1.5 1.0 0.5 100 0.0 (0.5) 95 (1.0) (1.5) 90 (2.0) 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18
Source: IEA, Huatai HK Research
Fig.185. US dollar index vs oil price (USD/bbl) 140 Brent oil price DXY (rhs) 110
120 100 100
80 90
60 80 40 70 20
0 60 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18
Source: Bloomberg, Huatai HK Research
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China Energy
On a longer time horizon, we doubt that oil price would be able to sustain above USD70 for an extended period, given that oil demand would increasingly be impacted by electric cars and renewable energy resources, and that oil price exceeding USD70 should trigger more incremental supply, including supply from high-risk, high-cost projects which are not economically viable in a sub-USD70 oil environment. As such, we keep our long-term oil price assumption unchanged at USD68.
Fig.186. Huatai oil price forecast Brent (USD) 2017 2018E 2019E Long term New 54 70 70 68 Old 54 64 66 68
Source: Huatai HK Research estimates
OPEC compliance ratio exceeds expectations, but is it sustainable? What has surprised us is that the compliance ratio of OPEC production cut repeatedly exceeded market expectations year to date, which hit a record high of 162% in April, boosting the year-to-date average compliance ratio to 152%, 62pp higher than the same period last year. We note that three OPEC members contributed significantly to the increment: 1) Saudi Arabia, which, as the primary driver for the execution of the curtailment deal, has strong incentive to lift oil price, in our view, given the potential Saudi Aramco IPO in 2H18-2019; also, a reasonably high oil price environment is favorable to OPEC countries’ fiscal situations (the IMF estimated in April that Saudi Arabia needs an average oil price of USD88 per barrel to balance its budget); 2) the state of Venezuela, which is still cash-strapped, and we believe its oil output is likely to hover around bottom for most of 2018; and 3) Angola, the second-largest Africa oil exporter, faced a similar production slump trend with a 17% oil output fall in April from a peak in 2016, largely due to limited investment in its mature offshore oil fields.
Fig.187. OPEC: change in production (by member state) Fig.188. OPEC production vs Brent oil price (mbpd) (USD/bbl) (mbpd) Saudi Arabia Iran Iraq OPEC output Brent oil price (rhs) 35 80 1.5 Libya Nigeria Others Total 34 70 1.0 60 33 0.5 50 32 40 0.0 31 30 (0.5) 30 20
(1.0) 29 10
28 0 (1.5) Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 Feb-18 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
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China Energy
Fig.189. OPEC members: compliance ratio since Jan 2017 Fig.190. OPEC members: compliance ratio in April (%) (%) Compliance ratio OPEC compliance ratio 180 600 OPEC average compliance ratio Average compliance ratio in 2017 160 500 140 400 120 300 100 200 80 100 60 0
40
Iraq
UAE
Qatar
Gabon Kuwait Algeria
20 Angola Ecuador
0 Venezuela Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 SaudiArabia Source: Reuters, Huatai HK Research Source: Reuters, Huatai HK Research
Fig.192. Saudi Arabia has highest fiscal breakeven oil Fig.191. Saudi Arabia driving total OPEC production price (USD/bbl) (mbpd) (mbpd) Iraq Saudi Arabia 120 Kuwait UAE 35.0 OPEC Saudi Arabia (rhs) 11.0 Iran 34.0 100 10.5 33.0 80 32.0 10.0 60 31.0 30.0 9.5 40 29.0 9.0 20 28.0 0 27.0 8.5 2000-2014 2015 2016 2017 2018E 2019E Jan-14 Sep-14 May-15 Jan-16 Sep-16 May-17 Jan-18 Source: Bloomberg, Huatai HK Research Source: IMF, Huatai HK Research estimates
Fig.193. Venezuela: production in past decade Fig.194. Angola: production in past decade (mbpd) (%) (mbpd) (%) Oil production yoy (rhs) Oil production yoy (rhs) 2.5 30 3.0 10 25 5 20 2.5 2.0 15 0 10 2.0 1.5 (5) 5 1.5 (10) 0 1.0 (5) (15) 1.0 (10) (20) 0.5 (15) 0.5 (25) (20) 0.0 (25) 0.0 (30) Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
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Fig.195. Iran: production in past decade Fig.196. OPEC: sustainable crude production capacity Angola Iran (mbpd) Iraq Kuwait Nigeria Saudi Arabia (mbpd) (mbpd) UAE Venezueia 4.5 Others Total OPEC (rhs) 40 36.4 4.0 3.5 30 36.0 3.0 2.5 20 35.6 2.0 1.5 10 35.2 1.0 0.5 0 34.8 0.0 2017 2018E 2019E 2020E 2021E 2022E 2023E Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Source: Bloomberg, Huatai HK Research Source: IEA, Huatai HK Research estimates
Indeed, uncertainty still exists regarding whether such a high compliance ratio could sustain into the incoming quarters due to the unknown magnitude of the potential Iran export curb, which would trigger a possible production increase by Saudi Arabia and its peers to offset the gap and to ease the potential global oil supply shortage that would otherwise result in an unexpected overshoot of oil prices. While we do not rule out the possibility of downside risk in compliance ratio in the coming months, we do expect full compliance of the production cut to sustain into the rest of 2018.
Growing US oil demand to absorb potential supply increase from shale While onshore oil rig count in the US has increased by 92 to 834 year to date, suggesting meaningful shale oil production growth likely from 2H18, we note US oil demand has also been resilient in 3M18 (up 0.5mbpd yoy), and that commercial oil stockpiles declined to around the five-year average level, supporting the absorption of a part of incremental production from shale. Furthermore, we note that the breakeven cost in the Permian basin, which currently accounts for c. 58% of total US operating rigs (2017: 54%), has also been growing due to rising E&P and transportation costs as the oil price rises, which is likely to slow output growth, in our view.
Fig.197. US: oil production vs rig count Fig.198. US: rig count vs Brent oil price (USD/bbl) (Rigsl) (mbpd) (Rigs) US oil production US rig count (rhs) 140 Brent oil price US rig count (rhs) 1,800 12 1,800 1,600 1,600 120 10 1,400 1,400 100 1,200 8 1,200 80 1,000 1,000 6 60 800 800 600 4 600 40 400 400 20 2 200 200 0 0 0 0 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: Bloomberg, Huatai HK Research Source: Bloomberg, Huatai HK Research
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China Energy
Fig.199. US: oil production breakdown Fig.200. US: shale oil production breakdown by region (mbpd) (mbpd) 6.0 Permian Bakken Eagle Ford Other 12 Conventional oil Shale oil 5.0 10 4.0 8 3.0 6 2.0 4 1.0 2 0.0 0 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: EIA, Huatai HK Research Source: EIA, Huatai HK Research
Fig.201. US commercial crude oil inventory vs oil price Fig.202. US: commercial crude oil inventory (mbbls) (mbbls) US commercial oil inventories (USD/bbl) 5-year range 5-year average Brent oil price (rhs) 550 2017 2018 600 140
500 120 500 100 400 450 80 300 400 60 200 40 350
100 20 300 0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: Bloomberg, EIA, Huatai HK Research Source: EIA, Huatai HK Research
Fig.203. US: seasonality in oil and liquid fuels demand Fig.204. US: gasoline stockpile (mbpd) (mbpd) 2013 2014 2015 2013 2014 2015 270 21.0 2016 2017 2018 2016 2017 2018 20.5 250
20.0 230 19.5 210 19.0
18.5 190
18.0 170 17.5 150 17.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Bloomberg, Huatai HK Research Source: EIA, Huatai HK Research
On the other hand, we note that the annual supply losses from ageing conventional oilfield globally have amounted to c. 3mbpd over the past few years, led by non-US and non- OPEC countries, though the natural decline rate appears to have normalized to a more mild level in 2014-2017.
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Fig.205. Natural decline rates for post-peak convt’l oil Fig.206. Annual supply loss from post-peak convt’l oil fields fields
(%) (mbpd) OPEC non-OPEC 12 0.0 (0.5) 10 (1.0) 8 (1.5) (2.0) 6 (2.5) 4 (3.0) (3.5) 2 (4.0) 0 (4.5) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Source: IEA, Huatai HK Research Source: IEA, Huatai HK Research
Global oil demand supported by resilient economic outlook While we note that the IMF’s forecast for 2018 global GDP growth remained unchanged at 6.9% in its April 2018 World Economic Outlook report; it revised up GDP growth for advanced economies by 0.2pp to 2.5%, with the US is expected to see 2.9% GDP growth in 2018, up 0.6pp yoy from 2.3% in 2017. Meanwhile, the IEA, in its April Oil Market report, also adjusted up its world oil demand forecast by 0.1mbpd to 99.3mbpd to echo the IMF’s positive prospects on global GDP growth.
Fig.207. IMF: overview of world economic outlook
2016 2017 2018E Difference from previous 2018E World 3.2 3.7 3.9 - Advanced economies 1.7 2.3 2.5 0.2 United States 1.5 2.3 2.9 0.2 Euro area 1.8 2.4 2.4 0.2 Germany 1.9 2.5 2.5 0.2 Emerging and developing economies 4.4 4.7 4.9 - China 6.7 6.8 6.6 - India 7.1 6.7 7.4 -
Source: IMF, Huatai HK Research estimates
Fig.208. IEA: oil demand forecast (mbpd) Africa Americas Asia/Pacific Europe FSU Middle East 120
100
80
60
40
20
0 2017 2018E 2019E 2020E 2021E 2022E 2023E
Source: IEA, Huatai HK Research estimates
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Healthcare Equity Research Huatai Research
25 May 2018
Equity | China Road Ahead 2H18: stay tuned for
OVERWEIGHT innovation-driven growth Maintained
Strong profit and PE prospects in 2H18: maintain OVERWEIGHT China’s drug manufacturing industry, partially driven by the 2017 National Wen DAI +86 21 2897 2078 Analyst [email protected] Reimbursement Drug List (NRDL) and nationwide influenza (4Q17-1Q18), saw significant growth in 1Q18, both in revenue (RMB625bn, up 16.1% yoy) and net Yun LI +86 21 38476288 Analyst [email protected] profit (RMB77bn, up 22.5% yoy). For 2H18, we look for steady improvement in profit growth and valuations at leading innovative-driven companies, on: 1) benefits of medical reforms (eg, priority review, low-tax incentives); 2) emergence Stock recommendations of domestic class 1 new drugs (eg, PD-1/TNF-a/Her-2 antibodies); and 3) market Company Code TP (HKD) Rating optimism as more biopharmaceutical start-ups list on the HKEX. We recommend CSPC 1093 HK 23.8 BUY firms with competitive platforms and innovative pipelines. Livzon 1513 HK 78.6 BUY HEC 1558 HK 41.8 HOLD Chemical and biological drugs: preference for leading giants Sinopharm 1099 HK 36.4 HOLD Healthcare reform is deepening and is favoring leading firms, in our view. The Source: Huatai HK Research estimates reform focuses on: 1) integrity of national medical insurance to further eliminate low-end adjuvant drugs; 2) low-tax incentives for anti-cancer drugs (free of import duties; VAT cut from 17% to 3%), which in the short run should bring profit increment and in the long run should encourage domestic R&D; and 3) ‘Internet + Healthcare’, which we predict will increase grassroots penetration. We are optimistic that medium-sized companies (market cap, RMB20-60bn; PE, c. 30x) will benefit from increases in both EPS and valuation, and recommend Livzon (1513 HK) and CSPC (1093 HK), as well as subsector leaders HEC (1558 HK) and SSY Group (2005 HK).
TCM sector: brand power matters Opportunities are emerging in the traditional Chinese medicine (TCM) sector in
2018. We believe: 1) branded pharmaceuticals will move to center stage, given the consumption upgrade in China; 2) the first batch of a classical prescription directory has been published, and we look for more prescriptions to be recognized in the next three years; and 3) TCM preparations (in ready-to-use form) and dispensing granules will continue to see high demand growth, and high quality standards look set to accelerate industrial consolidation, favoring the likes of China TCM (0570 HK).
Distribution and retail: opportunities from market consolidation We see market consolidation in the distribution and retail business being driven by significant policy reforms: 1) in distribution, expect an industry recovery from 2H18 as the ‘two-invoice policy’ is implemented nationwide; and 2) in retail, standalone drug outlets are facing strong competition from chain stores and hospital pharmacies (in terms of GSP compliance management and profitability), and we estimate market concentration will increase (CR3 is now around 8% in China versus around 90% in the US). We believe that as the biggest pharmaceutical distributor in China, Sinopharm (1099 HK) will benefit in the long term.
Risks to our view 1) Tender-price cut; 2) delay or failure of new launches; 3) channel establishment pace below expectation; 4) slower-than-expected M&A; and 5) interest rate volatility.
Originally published on 24 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 78 Please refer to end pages for analyst certification and required disclosures.
China Healthcare
1Q18 review: robust profit growth and valuation Healthcare sector share prices kept rising in 1Q18, despite the overall downtrend in the H-share market. We attribute the outperformance to: 1) nationwide implementation of 2017 NRDL and two-invoice policy; and 2) catalysis from influenza during 4Q17-1Q18. And we look for: 1) launch of more class 1 new drugs in 2H18; and 2) ramp-up at medium- sized firms bringing considerable profit increment.
Highlight 1: PE continues to be bullish PE: sustains uptrend. Healthcare has outperformed the market by the following indicators: 1) sector outperformance (HSHCI up 19% vs HSI up 2%); and 2) historically high PE of 41x (TTM; 15 May), showing a large premium to the H-share market. We predict a further lift in PE given the market optimism towards innovation (new launches of class-1 drugs and potential listing of biopharmaceutical start-ups on HKEX) in 2H18.
Fig.209. Share price performance: healthcare index vs HSI
(%) Healthcare Index HSI 25 21 19 20 16 15 14 14 15 9 12 13 10 7 11 11 9 6 9 3 7 2 3 5 1 6 2 2 1 2 4 0 (1) (0) (1) 2 3 3 (1) (2) (2) 0 (3)
-5 (5)
-10
Apr-18 Apr-18 Apr-18 Apr-18
Jan-18 Jan-18 Jan-18 Jan-18
Mar-18 Mar-18 Mar-18 Mar-18 Mar-18
Feb-18 Feb-18 Feb-18 Feb-18
May-18 May-18
Note: base = 1 Jan 2018 Source: Bloomberg, Huatai HK Research
Fig.210. Historical PE (TTM): healthcare sector vs H-share average
PE (x) H share Healthcare(GICS) 120 100 80 60 40 20
0
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-12 Sep-13 Sep-14 Sep-15 Sep-08 Sep-09 Sep-10 Sep-11 Sep-16 Sep-17
May-08 May-09 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18
Source: Bloomberg, Huatai HK Research
Unicorns to accelerate innovation. HKEX announced (end-2017) there will no longer be a threshold, on earnings or income, for biopharmaceutical start-up IPOs. In April, detailed regulations were launched, and we predict a first batch of companies will list in 2H18. We expect it to attract market attention for innovation and boost valuation of both the A- and H-share healthcare markets.
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Fig.211. HKEX main board listing rules: green channel for biological companies
Source: HKEX, Huatai HK Research
Fig.212. Unicorns: decent R&D pipeline
Source: Insight, Huatai HK Research
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Highlight II: rapid profit growth Healthcare sector: 1Q18 profit growth improved. According to the National Bureau of Statistics, the pharmaceutical sector reported 1Q18 revenue of RMB625bn, up 16.1% yoy (1Q17: 11.0%). Net profit of RMB77bn was up 22.5% yoy (1Q17: 13.4%), outperforming the industrial average by 11pp.
Fig.213. Pharmaceutical industry: revenue Fig.214. Pharmaceutical industry: net profit (yoy%) (RMBbn) (yoy%) (RMBbn) Revenue Growth (rhs) Net profit Growth (rhs) 3,000 40 400 50
2,500 40 30 300 2,000 30 1,500 20 200 20 1,000 10 100 500 10
0 0 0 0
Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-11 Sep-10 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-14 Sep-11 Sep-12 Sep-13 Sep-15 Sep-16 Sep-17 Sep-10
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Sector differentiation intensifies, pharmaceutical sector leads. Under stimulation of diverse drivers, we saw all sectors rally in 1Q18. Chemicals: 1) preparations — quick growth driven by NRDL implementation and rigid demand from influenza since 4Q17; and 2) API — which benefited from continuous price increase; Biologicals: vaccine sector returned to growth, and we see further expansion after several blockbusters are launched (eg, tuberculosis vaccine, PCV13 and tetravalent influenza vaccine); Traditional Chinese medicine: 1) branded drugs could post stronger growth in 2H18 given China’s consumption upgrade; and 2) TCM preparations (in ready-to-use form) and dispensing granules are heading for increasing consolidation (high quality standard), in our view; Medical distribution: anticipate rebound in 2H18, given digestion of impact from ‘zero mark-up’ and increasing consolidation under two-invoice policy; Retail: favorable policies (related to classified management, prescription outflow, among others) were launched in 1H18, and should see faster expansion via M&A between chain stores in 2H18; Medical device: higher growth likely in 2H18 given import substitution and increasing grassroots penetration.
Fig.215. Healthcare subsectors: historical profit performance (yoy%) 2011 2012 2013 2014 2015 2016 2017 1Q18 Healthcare 15.0 12.0 12.2 25.3 23.7 24.0 30.9 39.7 Chemical API (19.5) 25.0 (16.3) 19.1 21.5 41.2 27.6 128.3 Chemical preparation 26.4 12.3 (1.7) 14.5 35.2 30.9 47.3 27.7 TCM 25.4 16.0 30.1 23.9 21.6 15.0 16.0 28.4 Biologicals (8.8) (7.5) 13.7 14.9 11.0 28.5 28.0 29.8 Medical distribution 32.7 13.4 15.3 42.1 29.9 26.0 43.9 30.5 Medical devices 77.0 1.1 9.0 31.2 4.9 50.2 52.3 51.7 Medical services 25.2 151.3 (9.0) 259.9 44.6 (9.4) 16.8 62.0
Note: 1) here we use profit performance from A share healthcare sector to represent the whole sector as most H share companies have yet to issue their 1Q18 financials; 2) we eliminate Yihua Healthcare, Bihuacun and Shanghai RAAS as their non-recurring items impacted greatly on historical profit. Source: Wind, Huatai HK Research
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Fig.216. Companies with 1Q18 profit performance ahead of market expectation
Source: Wind, Huatai HK Research
We conclude that the rapid 1Q18 improvement in profit and PE had three drivers: Driver I: increasing healthcare expenditure. We see the following two trends: 1) larger coverage of medical insurance (as rural residents from the New Rural Cooperative Medical System have been combined with urban residents since 2017); and 2) some products (newly entered into 2017 NRDL) are have seen significant sales growth since 4Q17, and we expect momentum to sustain for at least the rest of the year.
Fig.217. China basic medical insurance: coverage Fig.218. China urban basic medical program: balanced Basic medical insurance fund income (mn) (RMBbn) (yoy%) Basic medical insurance fund expenditure 1,400 Urban workers Urban residents Urban and rural residents 2,000 Revenue growth (rhs) 40 1,200 Expense growth (rhs) 35.2 34.7 34.2 32.8 1,000 1,500 33.4 30 28.6 26.5 800 25.125.3 873 25.2 22.7 1,000 20.8 20 600 18.9 19.6 17.3 15.4 16.9 377 449 17.4 15.6 296 315 14.5 400 221 272 182 195 500 10 118 200 295 303 200 219 237 252 265 274 283 289 0 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Note: in 2017, rural coverage was combined with urban coverage Source: Ministry of Human Resources and Social Security, Huatai HK Research Source: Ministry of Human Resources and Social Security, Huatai HK Research
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Fig.219. Apatinib: sales expansion after entering NRDL Fig.220. Ilaprazole: ramp-up after entering NRDL （RMBmn) （RMBmn) Sample hospital sales Sample hospital sales Growth (rhs) (yoy%) 50 70 90 45 60 80 40 35 50 70 30 40 60 25 20 30 50 15 10 20 40 5 10 30 0 0 20
Source: PDB, Huatai HK Research Source: PDB, Huatai HK Research
Driver II: nationwide influenza boosted sales substantially. From 4Q17-1Q18, we saw strong sales of: 1) anti-influenza chemicals (eg, oseltamivir from HEC); 2) anti-influenza TCM (eg, Pudilan and Xiaoerchiqiao from Jichuan); 3) influenza vaccines (mainly trivalent influenza vaccine); and 4) IV infusion (eg, cephalosporin).
Fig.221. Reported number of influenza cases (weekly, Oct 2017- Feb 2018)
(Number) 11,253 12,000 10,000 7,861 7,825 8,000 6,480 2018 2017 6,000 7,730 4,930 3,369 3,457 4,000 2,664 803 874 1,193 2,000 447 610 252 114 0
Source: National Influenza Center, Huatai HK Research
Fig.222. Representative companies and products driven by influenza
HEC Pharma Sunflower Pharma Feirekechuan oral liquid
Yiling Pharma Lianhua Qingwen capsule Oseltamivir Chemicals
Taloph Pharma Shuanghuanglian oral liquid SSY Group Lingrui Pharma Infantile umbilical paste Kelun Pharma Infusion TCM Sanjiu Medical Ganmaoling granules CR Double-Crane Livzon Antiviral granules Zhifei Bio Xiangxue Pharma Antiviral oral liquid Kangtai Bio Vaccine Jumpcan Pharma Pudilan oral liquid Changsheng Bio Chiqiao clearing-heat granules
Source: Wind, Huatai HK Research
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Driver III: two invoice policy promoted reported profit growth. We see policy driving profit growth in two ways: 1) for manufacturers, the sales mode transformation (from agent to direct sales) pushed up reported revenue and profit growth rate in 1Q18; and 2) for distributors, we anticipate growth recovery in 2H18, given increasing industry consolidation from the two-invoice policy and digestion of impact from the ‘zero mark-up’ policy.
Fig.223. Two-invoice system: nationwide coverage
Full implementation
In transition
Source: Wind, Huatai HK Research
We are optimistic on the prospects for profit growth and valuation increase at medium- sized companies, particularly those with a strong innovative pipeline and comprehensive platforms (from R&D to academic sales).
Chemicals and biologicals. 1) innovation-driven platforms; includes Livzon Pharma (1513 HK), CSPC (1093 HK) and HEC Pharma (1558 HK); 2) subsector leaders; examples are Tonghua Dongbao (600867 SZ), Changchun High & New Tech (000661 SZ) and SSY Group (2005 HK); 3) firms with moderate valuation but likely to accelerate growth, including CR double-crane (600062 SZ), Nhwa Pharma (002262 SZ) and CMS (867 HK); and 4) CRO for innovative drugs: Wuxi Biologics (2269 HK) and Wuxi AppTec (603259 SH).
TCM. Consumption upgrade will likely benefit Pien Tze Huang (600436 SH), Yunnan Baiyao (000538 SZ) and China TCM (570 HK), in our view.
Distribution. The national and regional leaders look well placed to benefit from consolidation. These include China Meheco (600056 SZ), Jointown (600998 SH) and Liuzhou Pharma (603368 SH).
Medical devices. We highlight Autobio (603658 SH) and Lepu Medical (300003 SZ).
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Fig.224. Peers valuation comparison (H share) Total Ticker Price Market cap EPS (HKD) PE (x) Name shares (HKD) (RMBmn) (mn) 2017 2018E 2019E 2017 2018E 2019E CSPC 1093 HK 23.80 148,584 6,243 0.45 0.61 0.80 52.9 39.0 29.8 SSY Group 2005 HK 8.80 25,632 2,913 0.22 0.32 0.39 39.8 27.5 22.6 HEC Pharma 1558 HK 41.15 18,601 452 1.66 2.09 2.44 24.8 19.7 16.9 Livzon Pharma-H 1513 HK 59.25 32,779 553 2.07 2.62 3.26 28.6 22.6 18.2 3SBio 1530 HK 20.00 50,776 2,539 0.43 0.57 0.72 46.7 35.3 27.8 Fosun Pharma-H 2196 HK 45.15 112,655 2,495 1.64 1.87 2.24 27.5 24.2 20.2 Sino Biopharma 1177 HK 18.28 135,495 7,412 0.35 0.42 0.49 51.9 43.9 37.2 Chemicals/biologicals-average 74,932 3,230 0.98 1.21 1.48 38.9 30.3 24.7 Tonrentang Tech 1666 HK 13.88 17,777 1,281 0.64 0.72 0.79 21.6 19.4 17.6 Tonrentang CM 8138 HK 16.48 13,795 837 0.58 0.69 0.79 28.3 24.0 21.0 Baiyunshan 874 HK 37.20 60,479 1,626 1.38 1.80 2.05 27.0 20.7 18.2 China TCM 570 HK 7.43 32,926 4,432 0.33 0.37 0.44 22.8 20.2 17.0 TCM-average 31,245 2,044 0.73 0.89 1.02 24.9 21.1 18.4 Sinopharma Group 1099 HK 34.45 95,326 2,767 2.25 2.66 3.06 15.3 13.0 11.3 Shanghai Pharma 2607 HK 22.70 61,038 2,689 1.61 1.78 2.05 14.1 12.8 11.1 CR Pharma 3320 HK 11.12 69,884 6,285 0.54 0.63 0.73 20.6 17.6 15.3 Distribution/retail-average 75,416 3,914 1.46 1.69 1.95 16.7 14.4 12.5 China Resources 1515 HK 10.00 12,967 1,297 0.38 0.43 0.49 26.0 23.2 20.6 Kangning Hospital 2120 HK 40.00 2,922 73 1.37 1.71 2.14 29.2 23.4 18.7 Medical Service-average 7,944 685 0.88 1.07 1.31 27.6 23.3 19.7 Weigao 1066 HK 6.27 28,355 4,522 0.40 0.40 0.45 15.9 15.7 14.0 Medical Devices-average 28,355 4,522 0.40 0.40 0.45 15.9 15.7 14.0 Industry average 43,578 2,879 0.89 1.05 1.24 24.8 21.0 17.9
Note: 1) companies highlighted in blue are under Huatai coverage; 2) data as at 23 May close Source: Bloomberg, Huatai HK Research estimates
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Healthcare reform deepens, new era is arriving Healthcare reform has been accelerating in 2018, and includes a deepening of both innovation inspiration (priority review, green channel for overseas clinical trial results) and generic market clearance (consistency evaluation) policies as well as the NDRL. We see more thorough and detailed policies to come out in 2018 (ministry reform, low-tax incentives for anti-cancer drugs, and ‘Internet+ Healthcare’ development).
Ministry reform: integration of medical insurance to help efficiency The new medical system, established after ministry reform (in March), is composed of the China Drug Administration (for drug review), National Health Commission (for administration), and Medical Security Bureau (for medical insurance payment). We predict this system will: 1) effectively manage the medical insurance budget; 2) improve affordability for innovative drugs and clinically urgent drugs; and 3) set limits for low-end adjuvant drugs to clear out lower-quality products.
Fig.225. New medical system: after integration of medical insurance
National Health Commission • Retain the Office of the National Committee on Aging but as a sub-department Existing: • National Health and Family Planning Commission • State Council Leading Group for Deepening the Reform of the Medical and Health System • Ministry of Industry and Information Technology’s Implementation of the Framework Convention on Tobacco Control Functions • State Administration of Work Safety’s Functions of Supervising and Managing Work Safety and Health
Medical service State Market Supervision Administration National Social Security Fund Council • China Drug Administration (CDA) as a sub- • Under the administration of the Ministry of department Finance Existing: Functions include: • State Administration for Industry and • Basic medical insurance and maternity Commerce insurance system for urban employees and • General Administration of Quality Supervision, urban residents Inspection and Quarantine State • The new rural cooperative medical system • NDRC’s price supervision and antitrust Council • Price management of drugs and medical enforcement functions institutional service • Ministry of Commerce’s Antitrust reform • Medical assistance Enforcement Functions • State Council’s Office of Antitrust Committee Medical Medicine insurance
Source: State Council, Huatai HK Research
The 36 Rules: new guidelines for healthcare reform Launched by the State Council in October 2017, ‘The 36 Rules’ consolidate the content of CFDA File Nos. 52-55 under six themes, and stress two key reforms: 1) innovation inspiration (priority review, patent compensation and green channel for overseas early- phase clinical results); and 2) clearance in generic market (consistency evaluation, related review and Marketing Authorization Holder [MAH]).
Fig.226. The 36 Rules: healthcare reform engine Record-filing system for clinical trial institutions (encourage investment on drug Open up channel of clinical trial and development) production application for innovative drugs overseas Announcement of clinical trial protocol shifted Improve review from express to imply (start when no query) efficiency International Conditional authentication on BE data Full implementation of MAH (in chemical and overseas (green channel for ANDA medical device sectors) 36 rules varieties) Punish data fraud (initiative supervision) 6 themes Consistency evaluation，to build Chinese Priority review (rare disease/ clinically urgent For an effective & well- orange book (oral: finish by 2018, injection: drugs) established healthcare finish in 5-10 years) system Life-cycle management (eg, unannounced Patent protection & patent term Inspection, verification, registrant compensation (innovation protection) High accountability) Innovation efficacy Improve NRDL dynamic adjustment Related review of materials and packaging mechanism
Source: CFDA, Huatai HK Research
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We analyze two of the most significant policies — priority review and consistency evaluation — and see how they contribute to the growth of innovative and generic drug markets.
Innovative drugs Priority review improves efficiency, in our view. The CDE settled 9,680 applications in 2017 (backlog almost worked through) by increasing review staff (estimated to number 400 in 2018), which shortens the review cycle. The launched 26 batches of priority review lists includes 280 varieties, of which 183 are innovative drugs, 73 are first-to-market (FTM) generics and 24 are abbreviated new drug application (ANDA) varieties. We expect innovative drugs (clinically urgent) and FTM generics to benefit from priority review, and ANDA varieties to fast-track through CFDA approval.
Fig.227. CDE: backlog and finished approvals Fig.228. Priority review list: 26 batches (as of 18 May) Innovative drugs FTM generics ('000) Backlog Finished work (Number) ANDA 20 25 18 19 22 17 20 16 14 14 17 17 12 15 15 12 11 12 12 11 10 10 10 10 10 10 8 9 9 9 9 8 8 8 8 7 7 8 6 6 6 6 5 5 5 5 5 6 5 4 4 4 5 5 3 4 4 2 2 2 2 2 2 2 2 1 1 1 1 1 1 1 1 1 1
2 0 0
1 2 3 4 5 6 7 8 9
11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 0 10 2011 2012 2013 2014 2015 2016 2017 (Batch number)
Note: CDE - Center for Drug Evaluation Source: CDE, Huatai HK Research Source: CDE, Huatai HK Research
Generics Consistency evaluation is clearing out inferior products, in our view. The CFDA has clarified its consistency evaluation procedure as follows: 1) builds selection standard for reference formulation, and launches reference directories; 2) transits from approval system to registration and recording system, to encourage clinical resources; 3) offers ‘green channel’ to ANDA (launched in US/EU/Japan); and 4) has committed to a 120-day review cycle. To date, 29 approvals in three batches have passed the evaluation, and some provinces (eg, Tianjin and Shanxi) have launched favorable policies for drug tender and procurement. We believe the first movers will enjoy advantage in future bidding and price negotiation.
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Fig.229. Drugs that have passed consistency evaluation (as of 13 April) No. Application No. Drug name Company name CFDA acceptance date CDE start date 1 CXHB1700043 Clopidogrel sulfate Salubris 2017/9/26 2017/12/29 2 CYHB1703361 Paroxetine hydrochloride Huahai Pharma 2017/9/25 2017/12/29 3 CYHB1703363 Fosinopril Huahai Pharma 2017/9/25 2017/12/29 4 CYHB1703366 Irbesartan Huahai Pharma 2017/9/25 2017/12/29 5 CYHB1703987 Cefuroxime Sinopharm Zhinjun 2017/9/25 2017/12/29 6 CYHB1704044 Resuvastatin calcium CTTQ 2017/9/25 2017/12/29 7 CYHB1704195 Irbesartan Hisun-pfizer 2017/9/25 2017/12/29 8 CYHB1704196 Irbesartan Hisun-pfizer 2017/9/25 2017/12/29 9 CYHB1704197 Irbesartan Hisun-pfizer 2017/9/25 2017/12/29 10 CYHB1704618 Lisinopril Huahai Pharma 2017/9/25 2017/12/29 11 CYHB1704619 Lisinopril Huahai Pharma 2017/9/25 2017/12/29 12 CYHB1704621 Potassium chloride Huahai Pharma 2017/9/25 2017/12/29 13 CYHB1704622 Potassium chloride Huahai Pharma 2017/9/25 2017/12/29 14 CYHB1704624 Resperidone Huahai Pharma 2017/9/25 2017/12/29 15 CYHB1704627 Irbesartan and Hydrochlorothiazide Huahai Pharma 2017/8/17 2017/12/29 16 CYHB1704856 Gefitinib Qilu Pharma 2017/8/17 2017/12/29 17 CYHB1740001 Tenofovir disoproxil fumarate Brilliant Pharma 2017/9/28 2017/12/29 18 CYHB1703082 Resuvastatin calcium Jingxin Pharm 2017/7/5 2018/2/11 19 CYHB1750006 Resuvastatin calcium Jingxin Pharm 2017/9/26 2018/2/11 20 CYHB1704091 Escitalopram oxalate Kelun Pharma 2017/9/25 2018/2/11 21 CYHB1704598 Tenofovir dipyril fumarate Qilu Pharma 2017/8/10 2018/2/11 22 CYHB1750011 Amlodipine besylate The Yellow River 2017/10/9 2018/2/11 23 CYHB1704834 Amoxicillin capsule United Laboratories 2017/9/25 2018/4/8 24 CYHB1750013 Azithromycin CSPC 2017/10/23 2018/4/8 25 CYHB1750014 Azithromycin CSPC 2017/10/23 2018/4/8 26 CYHB1750017 Clopidogrel sulfate Salubris 2017/10/26 2018/4/10 27 CYHB1703441 Maleic acid enalopril Yangtze River 2017/9/25 2018/4/8 28 CYHB1703442 Maleic acid enalopril Yangtze River 2017/9/25 2018/4/8 29 CYHB1703389 Irbesartan/Hydrochlorothiazide CTTQ 2017/9/25 2018/3/26
Source: CFDA, Menet, Huatai HK Research
Low-tax incentives: anti-cancer drugs to benefit A series of policies targeting anti-cancer drugs was launched in April, in particular: 1) tariff exemption for imported anti-cancer drugs — we believe the policy will directly benefit imported drugs, and prompt domestic enterprises to focus on early stage R&D; and 2) value-added tax reduction (from 17% to 3%) — we look for short-term cost decline under lower tax, and long-term sales boom and profit increment, given price decline after centralized procurement.
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Fig.230. Incentive policies for anti-cancer drugs Resolution of the State Council executive Announcement on the Anti-cancer Drug meeting (12 April 2017) VAT Policy (27 April 2017) 1 1 Reduce import tariffs on all the VAT general taxpayers involved in anti-cancer drugs to zero production, sales and distribution of anti-cancer drugs shall pay 2 VAT at 3% Centralized government procurement、timely inclusion of urgently needed anti-cancer 2 drugs to NRDL Reduce the VAT rate for imported anti-cancer drugs to 3% 3 Speed up the listing of imported 3 innovative drugs The sales of anti-cancer drugs shall be accounted for separately 4 Strengthen the protection of 4 intellectual property (6 years of Issue the first batch of anti-cancer patent protection for innovative drugs (including 103 preparations chemical drugs) and 51 APIs)
Source: State Council, Ministry of Finance, Huatai HK Research
Fig.231. Anti-cancer drugs included in NRDL: prime beneficiaries of low-tax incentives Drug name Company Dosage Medical insurance payment (RMB) Trastuzumab Genentech Injection 7,600 (440mg [20ml]/vial) Bevacizumab Genentech Injection 1,998 (100mg [4ml]/vial) Nimotuzumab Biotech Pharma Injection 1,700 (10ml:50mg/vial) Rituximab Genentech Injection 2,418 (100mg/10ml/vial); 8,289.87 (500mg/50ml/vial) Erlotinib Roche Tablet 195 (150mg/pill); 42.97 (100mg/pill) Sorafenib Bayer Tablet 203 (0.2g/pill) Lapatinib GSK Tablet 70 (250mg/pill) Apatinib Hengrui Pharma Tablet 136 (250mg/pill); 185.5 (375mg/pill); 204.15 (425mg/pill) Bortezomib Ben Venue Injection 6,116 (3.5mg/vial); 2,344.26 (1mg/vial) Recombinant human endostatin Medgenn Injection 630 (15mg/2.4×10^5 U/3ml/viral) Chidamide Chipscreen Tablet 385 (5mg/pill) Everolimus Novartis Tablet 148 (5mg/pill); 87.05 (2.5mg/pill) Lenalidomide Celgene Tablet 866 (10mg/pill); 1,101.99 (25mg/pill) Compound Realgar Natural Indigo Tablet Yifan Pharma, Tiamkang Pharma Tablet 10.5 (0.27g/pill) Astragalus polysaccharide Zhongxin Pharma Injection 278 (250mg/vial) Shenyi capsule Yatai Pharma Capsule 6.65 (10mg/pill) Icotinib Betta Pharma Tablet 1,399 (0.125g/pill) Gefitinib Qilu, AstraZeneca Tablet 2,358 (0.25g/pill)
Source: Ministry of Human Resources and Social Security, Huatai HK Research
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Chemicals: leading players keep ramping up We highlight the following nine medium-sized companies, based on the criteria of strong innovative platform, exposure to anti-influenza products, leadership in biological subsectors, and being beneficiaries of 2017 NRDL.
Strong innovative platform 1) CSPC (1093 HK). NBP is delivering fast revenue growth (we expect over 35% in 2018); we estimate its oncology franchise will double its sales in 2018 (given approval of blockbuster albumin-bound paclitaxel). API (mainly vitamin C and caffeine) makes high profit contribution, and we expect launch of at least two new molecular entities (NME) in the next 2-3 years.
2) Livzon (1513 HK). Ilaprazole is the leading variety in chemical preparation sector and we put its revenue growth at over 80% yoy in 2018, with combined sales (tablets + injections) amounting to RMB800mn. We expect several RMB1bn-sized potential blockbusters to emerge from the ‘MAb+ microsphere’ platform during 2019-2020.
Fig.232. CSPC: revenue breakdown and growth Fig.233. CSPC: innovation-driven pipeline NBP Common generics Approved for Phase III PendingPhase production III approval Oncology drugs API Phase I Phase II NDA productoin (HKDbn) Revenue growth (rhs) (yoy%) Paclitaxel for 12 25 HER2/CD3 DBPR108 rE4 Dronedarone 10.61 Injection Butylphthalide Amlodipine/ 10 8.77 Amoxetine Bortezomib 8.14 20 (Dementia) atorvastatin 7.35 7.97 Astragalus 8 HA121-28 15 (rhinitis) Cardiovascular 6 SKLB1028 10 Anti-cancer 4 CSPCHA115 Neurological 5 Anti-infection 2 Amoxetine
0 0 13 ANDA (Metformin/Clopidogrel included) 2013 2014 2015 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Fig.234. Livzon: chemical preparation is profit engine Fig.235. Livzon: Mab and microsphere R&D platforms
Shenqi Fuzheng injection Approved for (%) Phase I Phase II Phase III Launched Ilaprazole+Urofollitropin+Leuprorelin+NGF clinical trial 80 66 RANKL CD20 TNF-α rhCG Illaprazole for 70 62 Injection 60 52 69 47 Leuprolide HER-2 Shenqi 50 Fuzheng (soft 55 48 53 52 bag) 40 PD-1 45 Dantrolene 30 41 40 41 40 38 MAbs 20 Menotrophin TrIptorelin 27 Chemicals 22 10 18 Microspheres 0 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Source: Company data, Huatai HK Research estimates Source: Company data, Huatai HK Research
Companies with exposure to anti-influenza products 3) HEC (1558 HK). Flagship oseltamivir achieved significant volume growth during 4Q17- 1Q18, and we expect launch of anti-HCV drugs (yimitasvir) and insulin series in 2019- 2010, as well as future blockbusters (eg, Morphothiadin) from its research group. 4) SSY Group (2005 HK). IV infusion benefiting from product-mix shift (in favor of high margin products) and influenza, and the group has therapeutic blockbusters (hydroxyethyl
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starch and peritoneal dialysis fluid) in pipeline. We anticipate significant profit contribution after the company’s API manufacturing base in Cangzhou begins production in 2019. 5) CR-Double Crane (600062 SH). IV infusion benefiting from structural optimization and influenza. The preparation is enjoying fast expansion (eg, pitavastatin, Kelisu), and we predict 3-4 products to be launched every year during 2019-2020.
Fig.236. SSY Group: revenue breakdown and GM Fig.237. HEC: oseltamivir sales boom under influenza Non-PVC soft bag Upright soft bag Granule sales (HKDmn) PP plastic bottle Glass bottle (%) (RMBmn) Capsule sales (yoy%) Gross margin (rhs) Granule growth (rhs) 3,000 2,784 70 1,600 1,401 300 Capsule growth (rhs) 1,400 2,500 60 250 2,063 1,200 1,941 2,007 50 2,000 200 1,000 40 736 1,500 800 150 30 992 600 1,000 454 100 20 400 194 500 10 50 200 70 0 0 0 0 2014 2015 2016 2017 1Q18 2013 2014 2015 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Leaders in biological subsectors 6) Changchun High & New Tech (000661 SZ). Leader in growth hormone area, with a vaccine business that saw recovery in 1Q18, and a real estate business that makes a stable profit contribution. 7) Tonghua Dongbao (600867 SH). Pioneer in domestic insulin market, with new generation of diabetes product lines to be formed in two years (including glargine, aspart, liraglutide and in-licensed BC lispro and combo).
Beneficiaries of 2017 NRDL 8) Huadong Medicine (000963 SZ). Drug manufacturing segment is growing fast (eg, Bailing, acarbose), and consolidation of the company’s distribution segment is accelerating. We are optimistic about its ‘in house R&D + license in’ mode. 9) Nhwa (002262 SZ). As the leading pharma in the central nervous system area, the company is expected to benefit (in psychiatry, neurology and anesthesiology) from the accelerated tender process, as well as sales reform.
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Traditional Chinese medicine: brand power matters Opportunities emerging in sector We believe: 1) branded pharms will come to the fore, given China’s consumption upgrade; 2) the publication of the first version of a classical prescription directory will prompt the emergence of more recognized prescriptions during 2019-2020; and 3) TCM preparations (in ready-to-use form) and dispensing granules will continue to see high demand growth, and that the high quality standards will accelerate industry consolidation.
We believe this backdrop will favor the leaders, and highlight Pien Tze Huang (600436 SH), Yunnan Baiyao (000538 SZ) and Kangmei Pharma (600518 SH). Other companies to watch, in our view, are Tongrentang (600085 SH), Tianjin Zhongxin (600329 SH) and China TCM (0570 HK).
Branded TCM: benefiting from consumption upgrade We have noticed consumption upgrade being promoted by two factors: 1) brand power matters to chain stores; and 2) the GM gap between branded and non-branded drugs is diminishing.
Brand power matters to chain stores Brand power matters to chain stores, given: 1) brands attract more consumer traffic; and 2) stores usually sign direct sales contracts with branded pharms (for higher gross margin and stronger business connection).
Branded vs non-branded: GM gap diminishing The GM gap between branded and non-branded drugs is diminishing, owing to: 1) non- branded drugs suffering a GM decline of 8pp after ‘business tax to VAT’ policy (no longer allowed to purchase from standalone drugstores without invoice); and 2) larger investment for branded drugs, given low input-output ratio in advertising; we expect accelerated sales via precise promotion and service.
Fig.238. Pharmacies: chain stores as % of all stores Fig.239. Pharmacies: sales breakdown by product type
(%) Chemicals TCM finished drugs (%) 60 Nutrition Herbs Medical devices Others 100 50 49 50 7 7 46 5 6 9 40 80 13 39 8 36 37 34 35 16 30 60 28 24 20 40
43 10 20 34
0 0 2010 2011 2012 2013 2014 2015 2016 2017 National drug store Provincal drug store Source: CFDA, Huatai HK Research Source: China Medical Materials Association, Huatai HK Research
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Fig.240. GM of drug stores by product type
(%) 70
60
50
40
30
20
10
0 Branded OTC Branded Rx OEM products Herbs Nutritions Medical devices
Source: Huatai HK Research
We prefer companies with: 1) flagship products reflecting strong brand power; 2) a diversified pipeline (for high gross margin); and 3) high utilization of cashflow and salesforce. We highlight Pien Tze Huang (600436 SH), Yunnan Baiyao (000538 SZ), Tongrentang (600085 SH) and Tianjin Zhongxin (600329 SH).
Classical prescriptions: creating a superior therapeutic TCM market Launch of directory of high-quality TCM preparations. The State Administration of Traditional Chinese Medicine issued the first version of its Classical Prescription Directory (100 prescriptions included), and we expect the directory to promote R&D into clinically effective TCM preparations.
Fig.241. First version of Classical Prescription Directory: breakdown by formula San Plaster 3% 1%
Zhusan 23%
Decoction 73%
Note: these are all special names (some in Chinese Pinyin) of formulations in TCM sector Source: State Administration of TCM, Huatai HK Research
Classical prescription to facilitate industrial consolidation. Classical prescriptions share a similar logic with consistency evaluation in chemical sector, so we predict this reform will work.
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Fig.242. Comparison: consistency evaluation vs classical prescription Consistency evaluation Classical prescription Drug type Chemicals TCM First mention Jan 2012 Jan 2008 Launch date of the opinion Nov 2015 Oct 2017 Launch date of the first directory May 2016 Apr 2018 Product number in the first directory 289 100 Benchmark Reference preparation Standard decoction
Source: CFDA, Huatai HK Research
We believe classical prescriptions will reshuffle the TCM market, given: 1) large market potential — the first version of the directory contains a wide variety of prescriptions, focusing on clinically urgent areas like cardiovascular disease, chronic disease, cancer and gastric disease); and 2) less competitive market landscape, as the high quality standard is expected to weed out inferior players. We highlight Kangmei Pharma (600518 SH) and Tongrentang (600085 SH).
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Dispensing granules: leaders stand out Higher regulatory requirements in production and treatment We used to see: 1) only six companies approved for production; and 2) only tier-2 and above hospitals allowed to prescribe after filing. In 2015, the CFDA indicated it would remove these limitations, but place a higher quality-control requirement on enterprises (the ‘Opinion of Management Method), driving market clear out.
Fig.243. Dispensing granules policies: looser limits on distribution, tighter quality control Launch time Institution Documents Contents July 2001 CFDA Provisional regulations on TCM granules Named as TCM granules and included under regulation of TCM pieces October 2003 CFDA Registration regulations of TCM granules (trial Six firms authorized: Guangdong Yifang, Jiangsu Tianyin Tianjiang, paper) Shenzhen Sanjiu, Sichuan New Green, Beijing KRT, Pura Pharma December 2006 CFDA Reply to the question of administrative penalties for Firms without permission shall not be allowed to produce or sell TCM TCM granules in unauthorized hospitals granules, nor shall hospitals be allowed to use them without approval December 2010 CFDA Notice on regulations of TCM granules Looser regulation: all Chinese Medicine Hospitals in tier-2 or above allowed to use TCM granules December 2015 CFDA Regulations of TCM granules (consultation paper) Included plan to lift controls (manufacture & use) on February 2016 State Council Plan for the development of TCM (2016-2030) TCM granules
Source: State Council, CFDA, Huatai HK Research
We predict liberalization will focus on three aspects: 1) production; 2) treatment; and 3) NRDL.
Production. We expect: 1) long-term trend of full liberalization; and 2) a limited number of new entrants. This view rests on: 1) three years left for the first batch of standards to be implemented (slated for launch in 2018 with 100 herbs included); and 2) most SMEs cannot meet the government standard, given weakness in R&D, raw material acquisition and inventory management.
Treatment. We do not think grassroots penetration will be a future trend, given: 1) the ‘Opinion of Management Method’ refers to ‘hospital’ rather than ‘medical institution’; and 2) limited room for expansion (limited number of TCM doctors and scenarios for prescription).
NRDL. We think inclusion of dispensing granules in the NRDL is highly likely, given price of dispensing granules is not a heavy burden on insurance (1.3-1.5 times that of ready- to-use TCM preparations).
As sales of dispensing granules depend largely on the company salesforce, and we prefer companies with: 1) direct sales as the dominant sales mode; and 2) strong academic promotion. We highlight Kangmei (600518 SH) and China TCM (0570 HK).
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Medical distribution: look for revival in 2H18 Look for a rebound in 2H18, given: 1) two-invoice system now covers most provinces and industry consolidation is increasing; and 2) impact from zero mark-up policy has already been digested, in our view, and we expect relatively stable financing cost compared to that in 2H17.
Leading players stand out. The Matthew effect is evident in the distribution sector as different companies are faced with different market landscapes and business modes. Amid market consolidation, we reckon the standout companies will have: 1) robust profit performance and cash flow; and 2) a well-established platform. We highlight national distribution leader China Meheco (600056 SH) and regional distribution leader Liuzhou Pharma (603368 SH).
Fig.244. Distribution: competitive landscape in Guangxi Fig.245. Liuzhou Pharma: distribution revenue (RMBmn) (yoy%) 9,000 Revenue Growth (rhs) 35
Others 8,000 30 58% 7,000 25 6,000 Liuzhou 20 Pharma 5,000 24% 4,000 15 3,000 10 2,000 1,000 5 Jointown Sinopharm Guangxi Guangxi 0 0 4% 14% 2012 2013 2014 2015 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Fig.246. China Meheco: commercial revenue Fig.247. China Meheco: commercial net profit (RMBbn) (yoy%) (RMBbn) (yoy%) 25 45 0.6 90 Revenue Growth (rhs) Net profit Growth (rhs) 40 80 20 35 70 30 0.4 60 15 25 50 20 40 10 15 0.2 30
5 10 20 5 10 0 0 0.0 0 2015 2016 2017 2015 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
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Retail: sequence of policies driving consolidation Retail: delivering steady growth. Retail sector revenue reached RMB365bn in 2017 (up 8.1% yoy), outperforming the healthcare sector average (up 7.6% yoy).
Fig.248. Retail: terminal sales and growth (2011-2017) (RMBbn) (yoy%) 400 Sales Growth (rhs) 16 350 14 300 12 250 10 200 8 150 6 100 4 50 2 0 0 2011 2012 2013 2014 2015 2016 2017
Source: Menet, Huatai HK Research
Gradual policy implementation. 1) classified management (Guangdong started pilot project in April) — once this is implemented, standalone drugstores will face strong competition from chain stores and hospital pharmacies (easier to gain high-ranked pharmacy qualification given advantage in licensed pharmacists); 2) prescription outflow trend has been enhanced (digital prescription outflow piloted in Chengdu and Tianjin, among others); and 3) opening-up of medical insurance coordination accounts is being piloted in Hangzhou and Wuzhou (for payment system of prescription outflow).
Listed chain stores: further expansion via M&A power. We conclude listed chain stores have three advantages over standalone stores: 1) diversified financing channels and low financing cost; 2) precise management; and 3) a well-established talent cultivation system. We expect: 1) further development of chain stores and hospital pharmacies (given GSP compliance management and profitability); and 2) market concentration to increase (CR3 is at around 8% in China vs around 90% in the US). We highlight leading players LBX Pharmacy (603883 SH), Yifeng Pharmacy (603939 SH) and Dashenlin (603233 SH).
Fig.249. Representative pharmacies: no. of chain stores Fig.250. Representative pharmacies: revenue (Number) Guoda Drugstore Dashenlin (RMBbn) 6,000 Yixintang LBX Pharmacy 10 Guoda Drugstore Dashenlin Yixintang LBX Pharmacy Yifeng Pharmacy 5,000 Yifeng Pharmacy 8
4,000 6 3,000 4 2,000
2 1,000
0 0 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017
Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
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China Healthcare
Medical devices: substitution of imports continues Medical device sector is ramping up, with two long-term trends: 1) import substitution (given high quality, cost efficiency and supportive government policy); we expect domestic enterprises to seize more market share and deliver stronger growth; and 2) increasing demand from grassroots. After implementation of a hierarchical medical system (a reform to direct cases to different medical institutions, depending on a disease’s severity), we expect domestic devices to become the first choice, given their advantage in both cost and quality.
Against this backdrop, we highlight Lepu Medical (300003 SZ), Autobio (603658 SH), Yuyue Medical (002223 SZ), Sinocare (300298 SZ) and MicroPort (0853 HK).
Fig.251. Lepu Medical: stent revenue Fig.252. Autobio: magnetic-particulate revenue (RMBmn) (yoy%) (RMBmn) (yoy%) Revenue Growth (rhs) 1,400 25 600 200 Revenue Growth (rhs) 180 1,200 500 20 160 1,000 140 400 800 15 120 300 100 600 10 80 200 400 60 5 40 200 100 20 0 0 0 0 2014 2015 2016 2017 2014 2015 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Fig.253. Yuyue Medical: sector revenue Fig.254. Sinocare: retail and hospital sales Homecare (RMBmn) (RMBmn) Retail revenue 1,500 Clinical business 1,200 50 Hospital revenue Medical breathing and oxygen supply 964 45 1,000 40 35 1,000 800 746 30 600 25 20 500 400 15 10 200 35 51 5 0 0 0 2014 2015 2016 2017 2016 2017 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
25 May 2018 98
Internet Equity Research
Huatai Research
25 May 2018
Equity | China Earnings strength depends on OVERWEIGHT ecosystem and business model Maintained
Internet sector faces pressure from high-base effect Saiyi HE +852 3658 6236 China’s Internet sector reported decent earnings growth in 1Q18, with leading Analyst [email protected] Internet companies reporting record-breaking core earnings growth, a strong reflection of the robust outlook for their platforms and core businesses. However, Stock recommendations all Internet subsectors are facing high-base effect, and investors are seeking more Company Code TP (local) Rating proof on the sustainability of their growth prospects. Leading online game, social Weibo WB US 149.1 BUY media and e-commerce companies will lead sector growth, but they also need to find new areas of business growth to keep up with market expectations and Sina SINA US 123.2 BUY maintain their valuations in 2H18. We continue to expect Weibo, Sina, Tencent and Tencent 700 HK 498.5 BUY Alibaba to deliver consensus-beating earnings growth. Alibaba BABA US 222.6 BUY Ctrip CTRP US 54.4 BUY E-commerce: customer experience remains the key to excellence Vipshop VIPS US 21.4 BUY Online commerce still only accounted for 16.4% of total China national YY Inc YY US 126.5 BUY consumption in 2017. Leading e-commerce platforms such as Alibaba are Momo Inc MOMO US 47.7 BUY becoming more deeply entrenched in offline and high-frequency businesses to NetEase NTES US 348.6 HOLD increase e-commerce penetration. However, in the near term, their offline JD JD US 46.4 HOLD expansion will put pressure on their margins. We believe customer experience is Baidu BIDU US 255.2 HOLD the most important factor for stimulating revenue generation in the e-commerce Meitu 1357 HK 10.2 HOLD
industry, while data technology, logistics services, and transaction services are all Source: Huatai HK Research estimates crucial supporting factors. Alibaba is still our top pick in 2H18. As long as Alibaba can maintain robust core commerce business growth, it has enough margin operating leverage to support new business expansion.
Online games to see further consolidation We forecast China online game market to grow by 21.8% yoy to reach USD42.5bn in 2018E, primarily driven by mobile games growth. Tencent and NetEase will continue to dominate the gaming market, and will invest in e-sports to boost interest in online games. Given the intense competition in user time spend among different game genres, we expect both Tencent and NetEase to increase the promotion of various genres of games and to try to appeal to a wider player base. Tencent has superior social networking power, and may give NetEase some pressure.
Social media platforms to take more new media ad budget We expect social media advertising to continue to see robust growth in 2H18, and that Weibo and Tencent’s WeChat and QQ will continue to gain significant market share from other digital media platforms. The market share of social advertising in China is still small compared to global social advertising (China, 8.7%; global, 21%). We believe Weibo’s growing content ecosystem and large user base will offer greater commercialization potential, and that the company will report strong earnings growth in the next few quarters to relieve market concerns that its advertising business is not shaken by competitors.
Live streaming: invest in content and product innovation China’s live streaming industry is entering a period of consolidation, driven by tighter regulation, intensified competition in new traffic acquisition, as well as rising difficulty in user retention. With their more abundant experience in and capacity for dealing with regulators, leading platforms such as Momo and YY have the edge to grow their businesses. We believe the winners of consolidation need to have premium content, as well as the ability to develop innovative and entertaining monetization methods.
Originally published on 24 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 99 Please refer to end pages for analyst certification and required disclosures.
China Internet
Online games market to see further consolidation We expect consolidation to continue in China’s online gaming market, and expect Tencent to extend its leading position with its superior gaming and social networking platforms. As well as leveraging its entertainment ecosystem and game live broadcasting channels, we expect Tencent to collaborate with more game developers and distribution platforms to further expand its market share. Due to the competitive environment in the game market, NetEase’s game business could face growing competitive pressure in 2018, in our view.
According to iResearch, China online game market size reached USD34.9bn in 2017, up 29.7% yoy. We forecast the total online game market to grow by 21.8% yoy to USD42.5bn in 2018E, primarily driven by robust mobile game growth. We expect the number of online game users to remain stable in 2018, and look to increasing paying ratio and rising average revenue per user to act as the future drivers of game market growth.
As the user size of online games enters into a modest growing period, competition for user time spend in the game market is becoming intense. We see different game genres are competing with each other for user time. We believe Tencent can expand its market share through its comprehensive deployment on all game genres (eg, MOBA, MMORPG, racing games, casual games), as well as strong distribution capability, which can drive game revenue growth by deepening cooperation with its strategic partners in distribution.
Fig.255. Online games: market size Fig.256. Online games: market share Others (USDbn) (yoy%) China online games market 24% 60 Growth (rhs) 35
50 30 NetEase 25 40 18% 20 30 15 20 10
10 5 Tencent 0 0 58% 2015 2016 2017 2018E 2019E 2020E Source: Analysys, Huatai HK Research estimates Source: Analysys, Huatai HK Research
For mobile games, we expect mobile game to maintain robust growth in 2018, with Tencent further expanding its leading position. Tencent recorded 68.2% yoy growth in its mobile game business in 1Q18, driven by robust performance of Honour of Kings during Chinese New Year, as well as stellar new game titles such as QQ Speed and MU Awaking.
Tencent also saw solid performance in globally popular game genres — survival sandbox games. The combined MAU of Tencent’s two survival sandbox games — PUBG Stimulated Battlefield and PUBG Full Strike — has reached 50mn only six months after their official release. Due to regulatory issues, Tencent has yet to monetize these two games.
For PC games, as we see more players shifting to mobile games, we expect the PC game market to grow at a low single digit in 2018E, reflecting player time shifting to mobile.
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Social media ads to outperform in online advertising We believe China’s advertising budgets will increasingly shift from offline platforms to online social media platforms. Online social media platforms can give advertisers more precise targeting and more breadth on the Internet. Based on data from iResearch, in 2017, China’s online advertising market grew 25.8% yoy to USD54.6bn, with social media advertising taking up 8.7% of market share. We forecast the social media ads market to see 2017E-2019E CAGR of 50.6%, with its size to reach RMB81.8bn and to take a market share of 12.9% on online advertising in 2019E.
Fig.257. China: online advertising market Fig.258. China: social advertising market (yoy%) (RMBbn) (%) E-commerce Search engine Portal 90 90 Video Social platform Others Market size Growth (rhs) 100 80 80 90 70 70 80 60 60 70 60 50 50 50 40 40 40 30 30 30 20 20 20 10 10 10 0 0 0 2012 2013 2014 2015 2016 2017E 2018E 2019E 2012 2013 2014 2015 2016 2017E 2018E 2019E Source: iResearch, Huatai HK Research estimates Source: iResearch, Huatai HK Research estimates
As social networks will become increasingly important in collecting effective user data and preference information, we believe Tencent’s WeChat and QQ, along with Weibo, will remain the most valuable social networking platform in China. Compared to Facebook, which took 23% of the total market share of the global online ads market, the two largest social media companies in China, Weibo and Tencent, only occupied 13% of the online ad market in 2017, there is ample potential for these two leading social platforms to increase their market share.
Fig.259. Facebook: market share of global online ads Fig.260. Weibo: market share of China online ads (2017) (2017)
Weibo 2%
Others Tencent 66% 11% Facebook Others 23% 77%
Baidu 21%
Note: Global online ad market excludes China Source: Company data, Huatai HK Research Source: Magna Global, company data, Huatai HK Research
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E-commerce: customer experience is vital We believe the competition within the e-commerce industry will center on customer acquisition and improvement of customer experience. We continue to favor companies with large ecosystems, combining logistics, promotion and social networking and payment systems capabilities.
According to data published by iResearch on 4 May, the market size for online sales reached RMB6.1tn in 2017, up 29.8% yoy. As a percentage of total retail sales of consumer goods, online sales increased from 14.2% in 2016 to 16.4% in 2017, and is expected to increase further to 21.9% in 2020E.
Fig.261. Online sales: market size and penetration rate (RMBtn) (%)
12 Market size 25 As % of total retail sales of consumer goods (rhs) 10 20
8 15 6 10 4
5 2
0 0 2013 2014 2015 2016 2017 2018E 2019E 2020E
Source: iResearch, Huatai HK Research estimates
Online e-commerce platforms are facing increasing difficulty in new customer acquisition, and average marketing spend per new active user continues to increase. We believe that providing premium content can be one of the keys to attracting more new users. By incorporating live streaming function and key opinion leaders (KOL) in diverse verticals, Taobao has successfully increased its user stickiness. Also, by leveraging Youku Tudou, the video platform within Alibaba’s ecosystem, Alibaba boosted the growth of its annual active buyers to 21.6% in 4QFY18, compared to 11.2% and 16.3% seen in 2QFY18 and 3QFY18, respectively. By end-March, mobile Taobao maintained its leading position in average number of times used and average time spend, per data from QuestMobile.
Fig.262. Average times used per month (March 2018) Fig.263. Average time spend per month (March 2018) (min) (times) 350 100 90 300 80 250 70 60 200
50 150 40 100 30 20 50 10 0 0 Mobile Taobao Pinduoduo JD VIPS Mobile Taobao Pinduoduo JD VIPS
Source: Analysys, Huatai HK Research Source: Analysys, Huatai HK Research
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China Internet
Alibaba is leveraging its technological advances to improve the effectiveness of its e- commerce marketplace. We believe Alibaba has the ability to grow its core commerce business by upgrading its algorithm and releasing its ad inventory on its platform in the near term, and that its current investment in offline business will bear fruit in the mid to long term.
As for JD, we continue to expect the company to require heavy investment in its logistics network and technology to facilitate business growth. We would turn more positive on JD’s long-term outlook if the company could improve its cash flow and margins through business model improvements and if it gains more support from its business partners to fund future growth.
Looking at VIPshop (VIPS), customer acquisition through cooperation with JD and Tencent has yet to pay off, while management believes the alliance will become more effective from 2H18 onwards. However, cooperation has already started in the areas of procurement, logistics and payment. We maintain our positive view on VIPS, as the company has a differentiated market positioning, and its cooperation with Tencent and JD will relieve the rising pressure of investment in customer acquisition and logistics.
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China Internet
Online travel: shifting towards high-margin business Growth of online travel slowed in 2017. The total size of the online travel market reached RMB892.3bn in 2017, up 20.7% yoy (2016: 56.1%). The penetration rate for online travel reached 16.5% in 2017, compared to 11.5% and 15.8% seen in 2015 and 2016, respectively.
Fig.264. Online travel: market size Fig.265. Travel industry: market size
(RMBbn) (yoy%) (RMBtn) (%) Market size 1,600 Growth (rhs) 60 6 Market size 18 Online penetration rate (rhs) 16 1,400 5 50 14 1,200 4 12 40 1,000 10 3 800 30 8
600 2 6 20 4 400 1 10 2 200 0 0 0 0 2013 2014 2015 2016 2017 2016 2017 2018E 2019E 2020E
Source: Analysys, Huatai HK Research estimates Source: Analysys, Huatai HK Research
The restriction on bundled sales in the online ticketing business has brought some negative impact to the online travel industry, and the competition among platforms will continue to shift from the low-margin business to high-margin business, such as online vacation booking and accommodation reservation. Online vacation booking accounted for 18.1% of total online travel transaction value in 2017 (2016: 16.5%), per data published by Qianzhan.
As for online vacation booking, total market size reached RMB94.8bn in 2017, up 24.8% yoy, showing faster growth than the online travel industry during the same period. Both online travel and online vacation booking delivered CAGR of over 39% 2012-2017, higher than that of the overall travel industry.
Fig.266. Online vacation booking: market size Fig.267. 2012-2017 CAGR comparison (China) (%) (RMBbn) (yoy%) 45 200 70 Market size Growth (rhs) 40 180 60 35 160 30 140 50 25 120 40 20 100 80 30 15 10 60 20 40 5 10 20 0 Online vacation Online travel Travel industry GDP 0 0 booking 2013 2014 2015 2016 2017 2018E 2019E 2020E
Source: Analysys, Huatai HK Research estimates Source: Analysys, Huatai HK Research
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We believe the trend of consumption upgrade will benefit the online travel industry, while the ability to provide premium service and customized products will become the core competency. Emerging Online Travel Agencies (OTAs) such as Fliggy and Tongcheng are leveraging Alibaba and Tencent, respectively, to compete aggressively for market share. With increasingly intensified competition, the loss of low-margin but high volume ticket booking traffic may lead to higher traffic acquisition cost in the long term, thus becoming a key risk for the current leading OTA platforms in the future.
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China Internet
Live streaming: competing for user retention China’s live streaming industry is entering a period of consolidation, in our view, primarily driven by: 1) tighter regulation on both content and user conduct; 2) the constant need to invest in innovative features to retain user attention; and 3) the growing cost of new traffic acquisition. We believe premium content and continuous product innovation remain the key to attracting new users, as well as to converting existing active users into paying ones. Also, deepening the relationship with guilds can help live streaming platforms acquire more high-quality hosts, thereby building solid comparative advantage within the industry.
Fig.268. Total live streaming market size in China (RMBbn) (yoy%)
120 113.7 250 Market size Growth (rhs) 99.3 100 200 191.3 84.6 80 65.4 150 60 44.4 100 90.6 40 23.3 50.9 50 20 47.3 5.3 8.0 29.4 17.4 14.5 0 0 2014 2015 2016 2017E 2018E 2019E 2020E 2021E
Source: iResearch, Huatai HK Research estimates
According to data provider iResearch, the market size of the live streaming industry increased by 191.3% yoy to RMB23.3bn in 2016, and is expected to reach RMB99.3bn in 2020E. YY and Momo together accounted for approximately 40.7% of the total market in terms of revenue generation in 2017. Given the tightening regulatory environment, we believe such market leaders are able to further consolidate the market and grow their businesses.
Fig.269. Revenue generation for indicative live streaming platforms Name of the platform RMBmn YY live streaming 8,601.4 Huya live streaming 2,069.5 Momo live streaming 7,387.4 Inke 3,941.6 Bilibili live streaming and VAS 176.4
Note: exchange rate USD/RMB calculated as 6.7:1 Source: Company data, Huatai HK Research
We prefer Momo to YY in the live streaming industry, as Momo has unique social networking features which can help it to acquire new traffic more easily. Also, as Momo has formed good relationships with guilds, and it has less exposure to KOLs, the company sees less volatility in revenue generation.
25 May 2018 106
Property Equity Research
Huatai Research
25 May 2018
Equity | China Road Ahead 2H18: focus is back NEUTRAL on tier-2 cities Maintained
A long cycle with stable tightening policy Chunli ZHAN +852 3658 6230 Since local governments imposed sale restrictions across some major tier-2 cities Analyst [email protected] during September and October in 2017, the policy noise has been largely muted in 1Q18. With slowing property sales and generally stable ASP across most cities in Stock recommendations China, we expect the market to experience a calm period with low policy Company Code TP (HKD) Rating expectations and to await a stabilized physical market in 2H18. In fact, with rising China Jinmao 817 HK 6.20 BUY loan interest rates and tightened mortgage policy, we maintain our view on soft correction in national home sales volume in 2H18. We expect national sales volume Shimao 813 HK 27.20 BUY to decline by 5% yoy in 2018E, with largely flat ASPs. Yuzhou 1628 HK 6.80 BUY CIFI 884 HK 8.10 BUY Future Land 1030 HK 9.50 BUY Policy initiatives provide more opportunities in tier-2 cities With still-stringent policy controls in tier-1 cities and cooling investment demand in Source: Huatai HK Research estimates tier-3&4 cities, the market has shifted its focus to some tier-2 cities due to resilient ASP and relaxed hukou policies. Local governments of some tier-2 cities (such as Nanjing, Chengdu and Xi’an) have introduced specific hukou loosening policies or rent allowance to attract degree holders, high-end talents, and highly-qualified specialists in order to strengthen the high-tech industry and drive their cities’ economic growth. We believe these policy initiatives will boost demand in local housing markets. On the other hand, the inflow of talented people will continuously improve the cities’ attractiveness in the future.
Greater Bay Area plan to be announced, but not a big catalyst We note that the development plan of the Greater Bay Area (GBA) is set for release by end-May. We expect more details of an action plan for better resource allocation, technological development and smart manufacturing in this region. However, based on the central government’s strong stance of minimizing housing speculation in the Xiong’an New Area and Hainan, we see limited upside potential for the property sector. Even more, we expect constraining housing policies to come out along with the GBA’s development plan. Since the concept of the GBA has been fully priced in in the stock market, we do not expect it to be a big catalyst. In our view, we believe polycentric development with different regional core cities in China will be a trend in the long term.
Sales slowing, but investment holding momentum According to a National Bureau of Statistics (NBS) disclosure (15 May), 4M18 national property sales volume recorded growth of 1.3% yoy, lower than the 3.6% yoy in 3M18. Correspondingly, the 4M18 national property sales value also slowed to 9.0% yoy growth (3M18: +10.4% yoy). However, investment in the property industry has held its momentum. In 4M18, investment in the property industry nationwide still recorded growth of 10.1% yoy, a decline of just 0.1pp compared to 3M18. We believe this is mainly due to developers’ richer pipelines in 2H18, hence, there was a strong need for new starts in 1H18. In our view, most developers’ back- loaded project launch plans for 2H18 will also help to soften the sales decline in 2H18.
Prefer Jinmao, Shimao and Yuzhou We maintain our cautious view on the sector given the downward cycle and tightening policy. Consequently, we carefully consider the operational divergence in developers’ sales growth, margin trends and leverage levels. Our high-conviction names include China Jinmao, Shimao and Yuzhou, given their differentiated competitive edges and undemanding valuations. Originally published on 18 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 107 Please refer to end pages for analyst certification and required disclosures.
China Property
Focus is back on tier-2 cities In 2017, the market focused on tier-3&4 cities due to strong ASP growth and strong investment demand spilling over from tier-1&2 cities. With still-stringent policy controls in tier-1 cities and cooling investment demand in tier-3&4 cities, the market has now shifted its focus to some tier-2 cities due to resilient ASPs and relaxed hukou policies.
The local governments of some tier-2 cities (such as Nanjing, Chengdu and Xi’an) have introduced specific hukou loosening policies or rent allowances to attract high-end talents, degree holders and highly qualified persons in order to strengthen the high-tech industry and drive their cities’ economic growth. We believe these tier-2 cities are boosting their attractiveness, given the relatively lower home prices and more job opportunities created in the high-end technology and smart manufacturing industries.
We believe these policy initiatives will boost demand in local housing markets. According to CRIC track records on 27 tier-2 cities, Xi’an, Qingdao, Guiyang, Chengdu, Kunming and Chongqing recorded the strongest year-on-year ASP growth in March, at 46.2%, 37.7%, 33.0%, 31.4%, 30.5% and 27.3% yoy, respectively. Also, shorter inventory destocking periods also suggest strengthened housing demand in some tier-2 cities. According to CRIC data, Chongqing, Wuhan, Nanjing, Kunming, Nanchang and Xi’an recorded the shortest inventory destocking periods, with inventory-to-sales ratios of 2.1, 3.7, 5.4, 7.4, 7.6 and 7.7 months, respectively.
In our view, we believe polycentric development with different regional core cities in China, a country with 960mn sq km of land, will be a trend in the long run. Tier-2 cities are still the major battleground for most national developers, which is reflected in most developers’ persistently strong appetites in the land market and busy M&A activity in tier-2 cities. We believe the resilient ASP in tier-2 cities and meaningful launch projects in 2H18 will soften the sales decline on a national basis.
Fig.270. ASP: year-year-year growth rate (March 2018) Fig.271. ASP trend in select tier-2 cities (RMB/sqm) Xi'an Qingdao (yoy%) 16,000 Guiyang Chengdu 50 46.2 Kunming Chongqing 14,000 45 12,000 40 37.7 33.0 10,000 35 31.4 30.5 30 27.3 8,000 25 6,000 20 4,000 15 2,000 10 0
5
Jul-17
Oct-17
Apr-17 Jan-18
0 Jun-17
Mar-17 Feb-18 Mar-18
Nov-17 Dec-17
Aug-17 Sep-17 May-17 Xi'an Qingdao Guiyang Chengdu Kunming Chongqing Source: CRIC, Huatai HK Research Source: CRIC, Huatai HK Research
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China Property
Fig.272. Inventory–to–sales ratio in select tier-2 cities (March 2018) (months) 12 10.4 9.9 10 8.2 8.4 8.6 7.4 7.6 7.7 8 5.4 6 3.7 4 2.1 2
0
Xi'an
Harbin
Wuhan
Ningbo
Nanjing
Qingdao
Kunming
Chengdu
Nanchang Chongqing Zhengzhou
Source: CRIC, Huatai HK Research
Fig.273. Hukou relaxation and housing support policies in select tier-2 cities City Hukou relaxation and housing support policies Individuals holding a college degree (and under age 40) can obtain a local hukou directly. No age restrictions for postgraduate or higher degrees; Nanjing qualified workers can enjoy the following housing benefits: purchase of joint ownership property and receive home purchase subsidies or rental allowances. For qualified workers, there are no hukou restrictions for purchasing homes in the city. Individuals holding a college degree (and under age 45) can obtain a local hukou directly; Xi'an qualified talents can obtain a maximum of RMB1mn in subsidies for home purchase, or enjoy a rent allowance of RMB1,000-6,500/month. Individuals holding a college degree (and under age 45) can obtain a local hukou directly; Chengdu qualified workers can obtain a three-year rent allowance of RMB2,000-3000/month after obtaining a hukou for the city. Ningbo A maximum of RMB80,000 in subsidies for home purchase can be entitled to those who launch start-ups, as well as to graduates or qualified workers. Individuals with a college degree (and under age 45) can obtain a local hukou after signing an employment contract; Jinan PhD holders can obtain a three-year rent allowance of RMB1,500/month, Postgraduates can obtain a three-year rent allowance of RMB1,000/month. Qualified workers can obtain a maximum of RMB1mn in subsidies for home purchase or live in a rent-free apartment for five years. Individuals with a college degree (and under age 35) can obtain a local hukou; Changsha PhD holders can obtain RMB60,000 in subsidies for home purchase, while postgraduates can obtain RMB30,000. Individuals with a college degree (and under age 45) can obtain a local hukou directly. Age capped at 50 for postgraduate or higher degree holders; Qingdao rental allowance of RMB800/month for postgraduate and RMB1,200/month for PhDs. Up to RMB2mn award for qualified talents after settling down in the city. Qualified PhD holders can obtain RMB300,000 when sign contracts of more Fuzhou than 3-years with local institutions.
Source: Local government announcements, Huatai HK Research
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China Property
Greater Bay Area plan not a big catalyst in short run We note that the development plan for the Greater Bay Area is set for release by end- May. But in our view, the GBA development plan is not recognized as a big catalyst for the sector.
The Greater Bay area includes nine mainland cities — Guangzhou, Foshan, Zhaoqing, Shenzhen, Dongguan, Huizhou, Zhuhai, Zhongshan and Jiangmen — along with Hong Kong and Macau. At present, the GDP contribution from the tertiary sector in GBA is relatively higher than the national average. We believe this percentage will continue to increase due to the government’s emphasis on high technology and the development of the service sector.
Based on the central government’s strong stance of minimizing any potential housing speculation in the Xiong’an New Area and Hainan, we see limited upside potential for the real estate sector in the GBA. With the government’s target of developing the high-tech, smart manufacturing and service industries, we expect positive GDP outlook for this region. But for the property sector, we expect even more constraining policies to come out along with the GBA’s development plan to stabilize the physical market. Since the positive theme of the GBA has been fully priced in in the stock market, we do not expect it to be a big catalyst in the short run.
Fig.274. Greater Bay Area: 2017 GDP of nine cities (RMBbn) 2,500 2,244 2,150 2,000
1,500 955 1,000 758
383 345 500 269 256 220
0
Zhuhai
Foshan
Huizhou
Zhaoqing
Jiangmen
Shenzhen
Dongguan Zhongshan Guangzhou
Source: NBS, Huatai HK Research
Fig.275. Greater Bay Area: 2017 GDP composition of nine cities
(%) Primary sector Secondary sector Teritary sector 100 90 49 80 38 48 48 45 41 70 59 52 71 60 50 40 30 20 10
0
Zhuhai
Foshan
Huizhou
Zhaoqing
Jiangmen
Shenzhen
Dongguan Zhongshan Guangzhou
Source: NBS, Huatai HK Research
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China Property
Fig.276. Guangdong: sales value Fig.277. Guangdong: sales volume (k sqm) (RMBbn) 180,000 2,000 160,000 1,800 140,000 1,600 1,400 120,000 1,200 100,000 1,000 80,000 800 60,000 600 40,000 400 20,000 200 0
0
2015 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2016 2017
2004
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2004 Source: Guangdong Bureau of Statistics, Huatai HK Research Source: Guangdong Bureau of Statistics, Huatai HK Research
Fig.278. Guangdong: year-on-year growth in sales value Fig.279. Guangdong: year-on-year growth in sales volume (yoy%) (yoy%) 60 100 50 80 40 60 30 20 40 10 20 0 0 (10)
(20) (20) (30)
(40)
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
2004
2006 2005 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2004 Source: Guangdong Bureau of Statistics, Huatai HK Research Source: Guangdong Bureau of Statistics, Huatai HK Research
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Sales slowing, but investment holding momentum According to a National Bureau of Statistics (NBS) data disclosure (15 May), 4M18 national property sales volume recorded growth of 1.3% yoy, which is lower than the 3.6% yoy growth in 3M18. Correspondingly, the 4M18 national property sales value also slowed to 9.0% yoy (3M18: 10.4% yoy). Sales volume slowed as we expected. We maintain our view on a soft correction in national home sales volume in 2H18. We forecast national sales volume to decline by 5% yoy in 2018E, with largely flat ASPs.
On the other hand, the investment in property industry still holds momentum. In 4M18, investment in the property industry nationwide still recorded growth of 10.1% yoy, a decline of just 0.1pp compared to 3M18. We believe the main reason behind this is developers’ richer pipelines in 2H18, hence the strong need for new starts in 1H18. Considering developers’ aggressive land replenishment since 2H17 and abundance of projects to be launched in 2H18, we expect cumulative national investment to sustain at a high level of around +8% yoy in 2018E.
Fig.280. April property sales grew by 6% yoy in value Fig.281. April property sales declined by 4% yoy in GFA (RMBbn) (mn sqm) 2011 2012 2013 2014 2,000 250 2011 2012 2013 2014
2015 2016 2017 2018 2015 2016 2017 2018 千 1,800 千 1,600 200 1,400 1,200 150 1,000 800 100 600 400 50 200 0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: NBS, Huatai HK Research Source: NBS, Huatai HK Research
Fig.282. April new starts grew by 3% yoy Fig.283. April real estate investment grew by 10% yoy
(mn sqm) (RMBbn) 2011 2012 2013 2014 300 2011 2012 2013 2014 1,400 2015 2016 2017 2018
2015 2016 2017 2018
千 千 250 1,200
1,000 200 800 150 600 100 400
50 200
0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: NBS, Huatai HK Research Source: NBS, Huatai HK Research
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Fig.284. China Jinmao: NAV discount Fig.285. China Jinmao: PB bands (%) (x) (30) 1.6
1.4 (40)
+1SD 1.2 (50) Avg =-58 1.0 +1SD (60) 0.8 Avg = 0.7x -1SD (70) 0.6 -1SD
(80) 0.4
Jul-13 Jul-13
Oct-14 Apr-12 Apr-17 Apr-12 Oct-14 Apr-17
Jan-11 Jun-11 Jan-16 Jun-16 Jan-11 Jun-11 Jan-16 Jun-16
Mar-15 Feb-13 Feb-18 Feb-13 Mar-15 Feb-18
Nov-16 Nov-11 Dec-13 Nov-16 Nov-11 Dec-13
Sep-12 Aug-15 Sep-17 Sep-12 Aug-15 Sep-17 May-14 May-14 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.286. China Jinmao: PE bands Fig.287. China Jinmao: dividend yield bands (%) (x) 8 16 7 14 6 +1SD 12 5 Avg = 3.8 4 10 +1SD 3 8 Avg = 7.7x 2 -1SD 1 6 -1SD 0
4
Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-15 May-13 May-14 May-16 May-17 May-18 May-12 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.288. Shimao: NAV discount Fig.289. Shimao: PB bands (%) (x) 0 1.3 (10) 1.2 1.1 (20) +1SD 1.0 (30) +1SD Avg =-43 0.9 (40) 0.8 Avg = 0.8x (50) 0.7 0.6 (60) -1SD -1SD 0.5 (70) 0.4
(80) 0.3
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Jan-13 Jan-18 Jan-12 Jan-14 Jan-15 Jan-16 Jan-17
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-12 May-13 May-14 May-15 May-16 May-17 May-18
May-13 May-14 May-15 May-16 May-17 May-18 May-12 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
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Fig.290. Shimao: PE bands Fig.291. Shimao: dividend yield bands (%) (x) 10 10 9 9 8 8 +1SD 7 +1SD 7 6 6 Avg = 6.3 5 Avg = 5.4x 5 -1SD 4 -1SD 4 3 3
2
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-12 May-13 May-14 May-15 May-16 May-17 May-18
Jan-18 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-16 May-13 May-14 May-15 May-17 May-18 May-12 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.292. Yuzhou: NAV discount Fig.293. Yuzhou: PB bands (%) (x) (30) 1.8 1.6 (40) 1.4 1.2 (50) +1SD 1.0 +1SD Avg =-61 (60) 0.8 Avg = 0.7x 0.6 (70) -1SD 0.4 -1SD
(80) 0.2
Jul-13
Apr-12 Oct-14 Apr-17
Jan-11 Jun-11 Jan-16 Jun-16
Jan-18 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17
Mar-15
Feb-13 Feb-18
Sep-17 Nov-11 Sep-12 Dec-13 Aug-15 Nov-16
Sep-12 Sep-11 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-14
May-12 May-13 May-14 May-15 May-16 May-17 May-18 May-11 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.294. Yuzhou: PE bands Fig.295. Yuzhou: dividend yield bands (%) (x) 16 6 14
12 +1SD 5 10 +1SD Avg = 9.3 4 8 Avg = 3.3x 6 -1SD 3 4
-1SD 2
2
Jul-13
Apr-12 Oct-14 Apr-17
Jan-11 Jun-11 Jan-16 Jun-16
Mar-15
Feb-13 Feb-18
Nov-11 Aug-15 Sep-12 Dec-13 Nov-16 Sep-17
May-14
Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17
May-17 May-12 May-13 May-14 May-15 May-16 May-18 May-11 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
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Fig.296. CIFI: NAV discount Fig.297. CIFI: PB bands (%) (x) (20) 2.0
(30) 1.8 1.6 (40) 1.4 +1SD (50) 1.2 +1SD Avg =-60 1.0 (60) Avg = 0.8x 0.8 (70) -1SD 0.6 -1SD
(80) 0.4
Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Dec-17 Dec-12 Sep-13 Dec-13 Sep-14 Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17
Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17
Sep-14 Sep-15 Sep-16 Sep-17 Sep-13 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.298. CIFI: PE bands Fig.299. CIFI: dividend yield bands (%) (x) 14 9 12 8
7 10 +1SD
6 8 +1SD Avg = 6.9 5 6 Avg = 3.8x 4 -1SD 4 3 -1SD 2
2
Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Mar-17 Mar-18 Mar-13 Mar-14 Mar-15 Mar-16
Dec-12 Sep-13 Dec-13 Sep-14 Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17
Jun-13 Jun-14 Jun-15 Jun-16 Jun-17
Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Sep-13 Dec-13 Sep-14 Dec-14 Sep-15 Dec-15 Sep-16 Dec-16 Sep-17 Dec-17 Dec-12 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
Fig.300. Future Land: NAV discount Fig.301. Future Land: PB bands (%) (x) 0 3.5 3.0 (15) 2.5
(30) 2.0 +1SD 1.5 +1SD (45) Avg = -52 1.0 Avg = 0.8x (60) -1SD 0.5
(75) 0.0 -1SD
Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Nov-12 Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17
Aug-14 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-13 Aug-15 Aug-16 Aug-17
May-16 May-14 May-15 May-16 May-17 May-13 May-14 May-15 May-17 May-13 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
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Fig.302. Future Land: PE bands Fig.303. Future Land: dividend yield bands (%) (x) 10 9 9 8 8 +1SD 7 7 6 6 +1SD 5 Avg = 5.3 5 4 Avg = 4.1x 3 -1SD 4 2 3 1 -1SD 0
2
Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 Aug-15 Nov-15 Aug-16 Nov-16 Aug-17 Nov-17
May-15 May-13 May-14 May-16 May-17
Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18
Nov-12 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17
Aug-13 Aug-14 Aug-15 Aug-16 Aug-17
May-14 May-15 May-16 May-17 May-13 Source: Company data, Bloomberg, Huatai HK Research estimates Source: Company data, Bloomberg, Huatai HK Research estimates
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Huatai Research
17 May 2018
Equity | China Road Ahead 2H18: upbeat outlook OVERWEIGHT for dry bulk and express delivery Maintained
Upbeat outlook for dry bulk and top express delivery companies Xiaofeng SHEN +86 21 2897 2088 We expect robust dry bulk shipping rates in 2H18 and maintain our view: an Analyst [email protected] industry upturn, supported by gradual demand growth and contraction of supply in Lisa LIN +86 21 2897 2209 the next two years. For logistics, we believe top express delivery companies such Analyst [email protected] as ZTO Express will see robust growth given demand for express delivery has Xenia CHEN +86 21 28972065 rebounded, growing market share and significant economies of scale. For airlines, Analyst [email protected] we think PLF and yield will improve, driven by both tightening supply, and airfare deregulation, yet the continuing rise in oil price might be a concern. Our top picks Stock recommendations in the China transportation and logistics sector are Pacific Basin Shipping, Company Price TP (local) Rating Sinotrans Shipping and Cosco Shipping, TravelSky, ZTO Express, China Southern Pacific Basin 2343 HK 2.5 BUY Airlines (CSA) and Air China. Sinotrans Shpg 368 HK 2.9 BUY
Cosco Shpg Hldgs 1919 HK 4.5 BUY Upbeat outlook for dry bulk; steady recovery for container TravelSky 696 HK 27.2 BUY We expect robust dry bulk shipping rates in 2H18 and maintain our positive view, which envisages continued earnings improvement in the next two years supported ZTO ZTO US 19.3 BUY by gradual demand growth and contraction of supply (limited orderbook and CSA 1055 HK 11.2 BUY potential demolition of non-compliant vessels under ballast water treatment Air China 753 HK 13.0 BUY regulations). For container shipping, we expect improvement in freight rates in SZI 152 HK 19.8 BUY 2H18 to be driven by rising demand in the high season and slowdown in new vessel Kerry Logistics 636 HK 14.2 BUY deliveries. We see steady industry recovery this year, given megaship deliveries Cathay Pacific 293 HK 14.7 HOLD and gradual demand growth. Tanker remains our least favored segment, given fleet BCIA 694 HK 12.0 HOLD oversupply and uncertainties facing the industry (Iran sanctions, OPEC production Sinotrans 598 HK 5.3 BUY decision to be made at June 2018 meeting). Our top picks for 2H18: Pacific Basin Source: Huatai HK Research estimates Shipping (2343 HK), Sinotrans Shipping (368 HK) and Cosco Shipping (1919 HK).
Upbeat outlook for top express delivery companies We believe top express delivery companies such as ZTO Express will see robust growth, given a demand rebound for express delivery, growing market share and significant economies of scale: 1) a boost to express delivery demand has come from emerging e-commerce platform Pinduoduo (拼多多), which saw online retail sales of physical consumer goods grow 34.4% in 1Q18 (2017, 28.0%; 2016, 25.6%); 2) the Matthew effect has become more pronounced in the industry as market leaders enjoy lower operating cost; 3) economies of scale have been prompted by greater automation at sorting facilities. The freight forwarding/contract logistics segment has seen steady earnings improvement this year and we are cautiously optimistic on freight forwarders’ existing business mix and prospects for margin improvement. We prefer express names over freight forwarders, given the continued higher growth in express delivery volume.
Airlines in upcycle, yet rising oil price might be a concern We think both PLF and yield will significantly improve in 2018E thanks to the supply tightening policy and airfare deregulation. However, the rising Brent oil price is almost certain to hurt earnings. We like Air China and CSA most and Cathay Pacific least, considering earnings sensitivity, network quality, fleet expansion plans and previous results performance. Although slot tightening looks set to slow traffic growth, we think airport stocks are still worthy of allocation, based on: 1) steady earnings growth mainly supported by non-aeronautical performance, as well as attractive, stable dividends; and 2) their reasonable valuations. We prefer TravelSky to BCIA as it dominates the fast-growing China market.
Originally published on 17 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 117 Please refer to end pages for analyst certification and required disclosures.
China Transportation & Logistics
Shipping: upbeat on dry bulk; container recovery Dry bulk shipping: continued earnings improvement as upcycle begins We maintain our positive view on dry bulk shipping throughout 2018-2019 given contraction in supply, on limited orderbook and non-compliant vessels under ballast water treatment regulations. We estimate 1.80/1.78% supply growth in 2018E/2019E, while demand growth should remain gradual at 2.7-3.0% throughout 2018E-2019E.
Moreover, the rising price of secondhand vessels also supports our view of an industry upturn. According to Clarksons, the index of secondhand vessel price rose to 106 points (up 55% from January 2016) which indicates positive demand for dry bulk vessels and an industry recovery. We expect freight rates to surge in 2H18 given the high season in second half. Pacific Basin Shipping (2343 HK) and Sinotrans Shipping (368 HK) are our most favored names in the shipping sector.
Fig.304. Dry bulk shipping: supply/demand growth
(%) 18 Supply Demand 17.0 16 14.9 14 12 12.1 10 10.6 8 5.7 6 6.2 6.3 5.9 5.4 4.0 4 4.4 2.2 2.4 3.0 2.7 2 1.6 1.8 0.0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018E (2)
Source: Clarksons, Huatai HK Research estimates
Fig.305. Baltic Dry Index (BDI) Fig.306. Dry bulk vessel price: newbuild vs secondhand
(Index) (%) 2016 2017 2018 Secondhand vessel price index 2,000 250 120 Price ratio: secondhand/newbuild (rhs) 100 1,600 200
80 1,200 150 60 800 100 40
400 50 20
0 0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Baltic Sea Exchange, Huatai HK Research Source: Clarksons, Huatai HK Research
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Container shipping: steady recovery in 2018; optimistic on 2019 We see steady industry recovery in 2018E given megaship deliveries and gradual demand growth. The heavy delivery schedule — with the majority of megaships being delivered in the first half — and trade wars fears have depressed freight rates year to date. However, we expect freight rates to improve in the second half, given the coming peak season and slowdown in new deliveries.
We expect supply growth to be relatively high at 4.7% in 2018E, and fall to 3.0% in 2019E. Demand growth remains steady at 5.1/4.6% in 2018E/2019E, while intra-Asia trade is projected to accelerate further, driven by firm economic growth in emerging markets. Overall, we expect a strong rise in freight rates to start in 2019, given muted orderbook and discipline on pricing among major carriers.
Fig.307. Container shipping: supply/demand growth
(%) 20 Supply Demand
15
14.2 8.6 10 8.3 5.5 6.0 5.8 6.3 6.6 9.1 5.1 4.6 5 7.9 2.4 4.8 5.3 3.8 4.7 0 3.6 3.0 1.3 0.5 (5)
(10) (8.3) 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E Source: Alphaliner, Huatai HK Research estimates
Fig.308. Shanghai-Europe spot freight rate Fig.309. Shanghai-US West spot freight rate
(USD/TEU) (USD/FEU) 2016 2017 2016 2017 2018 2018 1,400 2,500
1,200 2,000 1,000
800 1,500
600 1,000 400 500 200
0 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: SSE, Huatai HK Research Source: SSE, Huatai HK Research
Tanker: industry downturn; effects of new Iran sanctions yet to bite Year to date, the tanker market has been in choppy waters due to significant oversupply, and freight rates have deteriorated noticeably despite relatively firm demand. The Baltic Dirty Tanker Index (BDTI) fell by 24% yoy and VLCC rate (one-year timecharter) dropped to USD19,594/day (down 23% yoy and below breakeven level). Following a high volume of newbuild deliveries in 2016-2017, we expect supply growth in 2018E to slow to 1.5% yoy (2017: 5.3%), while 4.5% demand growth is expected. The industry is at the bottom, in our view, and we saw record-high vessel demolition in 1Q18. We expect shipping rates to turn positive then gain momentum in late 2018 or early 2019, supported by accelerating scrapping activity tightening supply.
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On the other hand, we think the effects of new Iran sanctions remain to be seen, given both Iran-related oil trade and Iran’s fleet are restricted by the sanctions. Scenarios: 1) bull case — if OPEC raises production to fully compensate for the decline in Iranian supply, while active fleet supply is tighter given Iranian VLCC vessels are banned for shipping, VLCC rates are expected to emerge from the trough sooner; 2) bear case — if OPEC does not ramp up production to fully compensate for the decline in Iranian supply, the shortage will be met by inventory drawdown, which would curb oil trade. However, given the tanker sector is already at the bottom, any downside risks are limited in our view.
Fig.310. Tanker shipping: supply/demand growth
(%) 8 Supply Demand 7.0 6 5.9 5.8 6.0 5.4 5.5 4.3 5.3 4.5 4 3.9 4.1 4.1 4.2 3.8 2.5 2 1.8 1.3 1.7 1.5 0.8 1.0 0 (0.2)
(2) (1.6)
(4) (5.0) (6) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E Source: Clarksons, Huatai HK Research estimates
Fig.311. VLCC: one-year time charter rate
(USD'000/day) 60
50
40
30
20
10
0 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
Source: Clarksons, Huatai HK Research
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Top picks Pacific Basin Shipping (2343 HK): strong earnings improvement in 2018-2019 We expect strong earnings recovery for Pacific Basin (PB) to continue throughout 2018- 2019 given the industry’s upcycle has begun, in our view. Market spot rates for Handysize and Supramax have averaged USD8,664 and USD10,922 year to date (up 25% and 29% yoy), and we estimate PB’s 2018 Handysize and Supramax time charter equivalent (TCE) rates will average USD9,680 and USD12,550 (up 16% and 31% yoy). We maintain our 2018E earnings forecast of USD101mn, and our target price of HKD2.5. Reiterate BUY.
Sinotrans Shipping (368 HK): freight rates and earnings to accelerate in 2H18 The BDI has averaged 1,176 points year to date (up 17% yoy), which is lower than we expected due to weak steel production activity in 1Q18 (negative impact from Chinese New Year holiday and the government congress meeting held in March). We estimate the company’s 2018 average TCE rate will rise by 44% yoy to USD15,050. We maintain our earnings forecast of USD77mn in 2018E and our target price of HKD2.9. Reiterate BUY.
Cosco Shipping Holdings (1919 HK): steady earnings recovery We have seen positive volume growth year to date but weak shipping rates due to the large number of newbuild deliveries in the first half of the year. The Shanghai Containerized Freight Index (SCFI) has averaged 769 points year to date (down 11% yoy) and market spot rates for Shanghai to USWC and to Europe declined by 22% and 15% yoy respectively. However, we expect improvement in freight rates in 2H18 to be driven by rising demand in the coming peak season and slowdown in newbuild deliveries in the second half. We maintain our earnings forecast of RMB4.3bn in 2018E and our target price of HKD4.5. Maintain BUY.
Risks to our view Downside risks: 1) lower-than-expected freight rates; 2) higher-than-expected supply growth; and 3) global economic downturn.
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Logistics: upbeat on top express delivery companies Upbeat outlook for top express delivery companies We believe the top express delivery companies such as ZTO Express will see robust growth, given: 1) a rebound in demand for express delivery; 2) growing market share; and 3) significant economies of scale.
Express delivery demand rebound. Demand in the express delivery industry beat our expectations as merging e-commerce platform Pinduoduo saw growth in online retail sales of physical consumer goods rise to 34.4% yoy in 1Q18 (2017, 28%; 2016, 25.6%). Pinduoduo has not only promoted consumption by existing e-commerce consumers but has also cultivated new users — typically female, over 40 years old, living in a smaller Chinese city, and new to online shopping — via its social features and group-buying function. We believe the additional express volume from Pinduoduo will contribute to the express delivery industry’s growth.
Growing market share. The Matthew effect on the industry has become more pronounced as market leaders are enjoying lower operating costs. Smaller companies are quitting the market as they are unable to match on cost, and the industry’s CR8 rose in April to 81.1% (April 2017: 77.4%). We expect the concentration trend to accelerate in 2H18.
Economies of scale. Increased automation at sorting facilities and self-owned line-haul trucks have promoted scale economies. We believe strong demand will improve the utilization of fixed assets (sorting facilities and trucks) and lead to a lower unit cost.
Steady growth in freight forwarding; customized-logistics demand rising As a low-margin business within third-party logistics (3PL), freight forwarding will see earnings limited to single-digit growth this year, in our view, given rising costs on shipping rates despite firm trade. On the other hand, we see rising demand for customized logistics, driven by growing cross-border e-commerce business and inefficiencies of the existing supply-chain in China, ASEAN and Belt and Road countries. We think performance among logistics companies is uneven, and dependent on each company’s sub-sector exposure. Overall, we are cautiously optimistic on freight forwarders’ existing business mix and prospects for margin improvement.
Top picks ZTO Express (ZTO US): demand beat, upbeat on 2H18 outlook We see ZTO enjoying a virtuous cycle and establishing cost leadership, with: 1) its leading market share giving it significant economies of scale and lower operating cost; 2) lower cost leading to competitive price, stable network and expanding capacity; and 3) high capacity, with quality service contributing to consolidation of the company's market share. We maintained our target price at USD19.3; reiterate BUY.
Risks to our view Downside risks: 1) slower-than-expected e-commerce growth; 2) weaker-than-expected economic and trade growth in China; and 3) US-China trade war.
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Airlines: oil price to temper 2H18E earnings rise We saw PLF improve by 1.6/0.6pp respectively to 84.3/81.5% for CSA and Air China in April 2018, supported by demand growth of 16.2% yoy for both companies. With the continuing strict supply control policy on domestic routes, both CSA and Air China’s capacity weighted towards international routes, matching the demand growth. For CSA, total supply increased by 13.9% yoy in April, with a 12.1/18.2% yoy increase on international/domestic routes and 14.3/20.5% yoy increase in demand, leading to a 1.6pp improvement in PLF on both domestic and international routes. For Air China, we saw a respective 0.7/0.2pp yoy improvement in PLF on domestic/international routes with international supply increasing by 24.2%, more than twice the growth of supply for domestic routes.
According to management, thanks to the better supply-demand balance, RASK improved in April. We think both PLF and yield will continue to improve in 2018 considering the continuing supply tightening policy and the implementation of airfare deregulation. The Civil Aviation Administration of China (CAAC) is still keeping a tight grip on slot allocation for the summer season. Planned industrywide flight growth has slowed to 3.2% yoy and domestic flight growth by local carriers has slowed to 3.6% yoy, 2.5pp and 4.2pp lower than in the recent winter season respectively.
On concerns over safety and punctuality, we think the strict control policy will continue in 2H18. We have seen airfare deregulation being implemented gradually since April with various airlines raising the full price of an economy class ticket on several routes between tier-1 cities, eg, Shenzhen Airlines’ Beijing-Shenzhen route, and CSA’s Guangzhou- Beijing and Guangzhou-Shanghai routes. Management at both airlines guided that the first round of airfare hikes will be completed in June, which makes room for more profit.
Amid strong demand, tightening supply and lingering geopolitical tension, the Brent oil price has risen by 22.6% since 1 March from USD63.83/bbl to USD78.23/bbl and the average price since 25 April has been USD75.35/bbl. With the continuing upward trend in oil price, we think the ex-factory jet fuel price will most likely exceed RMB5,300/tonne in June, which would trigger implementation of fuel surcharge. We think earnings will be hurt significantly if the Brent oil price continues to rise in 2H18.
Fig.312. Historical gap between supply and demand growth, PLF improvement, Big-3 average yield growth (2007-2017) (%) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Gap between supply and demand growth 4.8 (2.9) 2.8 5.8 2.2 (3.1) 3.0 (0.6) 1.0 0.7 0.8 PLF improvement (yoy) 3.1 (2.1) 1.8 3.9 1.6 (2.2) 2.2 (0.4) 0.7 0.5 0.6 Big-3 average yield growth (yoy) 4.3 2.3 (12.7) 15.4 6.6 (1.7) (8.8) (2.2) (8.3) (5.8) 0.0
Source: Wind, Company data, Huatai HK Research
Fig.313. Aircraft introduction plans
Introducing Retiring Net growth in Net growth in Airlines 2017 Wide-body Narrow-body Wide-body Narrow-body 2018E no. of aircraft (%) no. of seats (%)] Air China 655 14 40 3 19 687 4.9 5.8 CSA 754 15 100 2 27 840 11.4 12.0 Others 1,887 36 206 17 7 2,087 10.6 10.7 China industry 3,296 65 314 22 53 3,614 9.6 10.0
Source: Company data, Huatai HK Research estimates
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Fig.314. Annual growth of ASK and aircraft movements (2007-2017)
(yoy%) Movements ASK 16
14
12
10
8
6
4
2
0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Wind, CAAC, Huatai HK Research
Fig.315. Airlines: supply and demand growth vs PLF (2006-2018E）
(%) PLF (yoy%) Demand growth（rhs） 86 25 Supply growth（rhs） 84 82 20 80 15 78 76 10 74
72 5 70 68 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E Source: Wind, CAAC, Huatai HK Research estimates
Fig.316. Brent oil: price trend Fig.317. USD/RMB trend
(USD/bbl) (USD/RMB) 2016 2017 2018 2016 2017 2018 90 7.2
80 7.0
70 6.8 60 6.6 50 6.4 40 6.2 30 20 6.0 10 5.8 0 5.6 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
Investment thesis: CSA and Air China are our top picks Taking sensitivity, route network quality, aircraft introduction plans and previous earnings performance into consideration, we like CSA and Air China most; we like Cathay Pacific least due to: 1) weak local demand and mainland China/international transfer passengers being diverted to competitors; 2) transformation plan is has got off to a good start, but this is not a quick fix, in our view; and 3) the continuing rise in fuel price is narrowing fuel hedging losses, yet is still a drag on total operating costs.
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Fig.318. Percentage of flights btwn BJ/SH/SZ/GZ by Fig.319. Flights on deregulated-pricing routes by airline airline Flights between BJ/SH/GZ/SZ (No. of flights) Others 35% 7,000 Flights for deregulated-pricing routes between top 10 airports (excl. BJ/SH/GZ/SZ ) 796 6,000 Flights for deregulated-pricing routes between21 coordinated airports (excl. Top 10 airports ) 5,000 1,585 Spring Airlines 704 4% Air China 4,000 23% 3,000 1,911 Hainan 280 Airlines 9% 2,000 4,271 642 Juneyao 1,000 2,242 84 Airlines 3% 1,376 200 112 386 121 CSA 26% 0 188 CSA Air China Hainan Juneyao Spring Airlines Airlines Airlines Source: CAPA, Huatai HK Research Source: CAPA, Huatai HK Research
Fig.320. Deregulated-pricing routes between top-10 Fig.321. Deregulated-pricing routes between 21 airports: % of flights by airline coordinated airports: % of flights
Others 38% Others 37%
Air China 20% Spring Airline Air China Spring Airline s 2% 26% s 2%
Hainan Hainan Airlines 9% Airlines 10%
Juneyao Juneyao Airlines 3% Airlines 3% CSA 28% CSA 23%
Source: CAPA, Huatai HK Research Source: CAPA, Huatai HK Research
Fig.322. Air China: ASK and RPK monthly growth Fig.323. Air China: monthly PLF
ASK（2016） RPK（2016） (%) (yoy%) ASK（2017） RPK（2017） 86 2016 2017 2018 20 ASK（2018） RPK（2018） 84
15 82
10 80
78 5 76
0 74 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
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Fig.324. CSA: ASK and RPK monthly growth Fig.325. CSA: monthly PLF
(yoy %) ASK（2016） RPK（2016） (%) 2016 2017 2018 20 ASK（2017） RPK（2017） 85 ASK（2018） RPK（2018） 84 83 15 82 81 10 80 79 78 5 77 76 0 75 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
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Airports: worthy of allocation Decreasing aircraft movements in 4M18 due to supply control In 4M18, with the strict slot control policy, except for BCIA, rise in aircraft movements slowed, with Baiyun and Shenzhen’s total aircraft movements increasing by 3.1% yoy and 5.9% yoy, respectively (4.8pp and 2.0pp less than in 4M17). However, we saw year-on- year growth of passenger throughput largely exceed growth of aircraft movements, mainly attributable to an increasing proportion of wide-body aircraft and improving PLF performance. For BCIA, given the low base caused by middle runway maintenance in April 2017, we saw its traffic data back on track this year with growth of 18.5/17.9% yoy respectively in aircraft movements and passenger throughout in April, a result of expanding growth of traffic in 4M18 compared with 4M17.
Fig.326. Airports: operating data (4M18) Passenger throughput ('000) Aircraft movements ('000) Cargo throughput ('000 tonnes)
Airports yoy% Chg (pp) yoy% Chg (pp) yoy% Chg (pp) Pudong* 17,941 5.5 (2.1) 124 2.7 (0.7) 885 3.1 (9.9) Baiyun 23,118 7.3 (3.9) 157 3.1 (4.8) 578 8.2 0.8 Shenzhen 16,321 10.5 2.4 117 5.9 (2.0) 373 5.9 (2.0) BCIA 33,022 5.9 3.0 201 4.1 6.5 - - - Xiamen* 6,436 4.6 (6.8) 48 3.3 3.2 81 0.2 (8.8)
Note: * Operating data for 3M18, as companies have not yet issue data for April Source: Company data, Huatai HK Research
Investment thesis: we like companies with good fundamentals and better mix Although the aeronautical revenue growth is limited by the slowing traffic growth due to the slot tightening policy, we still merit the sector’s allocation value for: 1) steady earnings growth supported by non-aeronautical performance, as well as attractive, stable dividends; 2) reasonable valuations. We like companies with good fundamentals and a better mix. For BCIA, we maintain HOLD due to: 1) rise in international traffic proportion is helping margins, but capacity bottleneck is constraining traffic growth; 2) the CAAC’s slot cut policy looks set to damage earnings; and 3) uncertainty over aviation development fee refund and second airport diversion remain as overhangs.
Global distribution system (GDS): business growth to remain solid For Travelsky, we maintain our previous earnings forecast and our BUY call given its continuing solid business growth based on: 1) solid organic growth supported by 2018E- 2020E CAGR of 10-11% in air passenger numbers for its aviation information technology (AIT), accounting, and data & network businesses, and by the 50 new/expanded airports in the 13th Five-Year Plan which will spur demand for its system integration service; 2) launch of the Shunyi Operating Centre enhancing its IDC capacity; and 3) monetization of Umetrip.
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Fig.327. Terminal capacity: utilization rate (2018E) Fig.328. Runway capacity: utilization rate (2018E)
Passenger throughput (mn pax) (%) ('000) Aircraft movements (%) Capacity utilization (rhs) 100 110 600 Capacity utilization (rhs) 100 90 105 550 95 80 100 500 90 70 95 450 60 90 400 85 50 85 350 80 40 80 300 75 30 75 250 70 20 70 200 10 65 150 65 0 60 100 60 Xiamen Shenzhen Baiyun Pudong Beijing Xiamen Shenzhen Baiyun Pudong Beijing (PEK) (PEK) Source: Company data, Huatai HK Research estimates Source: Company data, Huatai HK Research estimates
Risks to our view Downside risks: 1) economic downturn; 2) oil price surge; and 3) RMB depreciation.
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Huatai Research
25 May 2018
Equity | China Road Ahead 2H18: IPP earnings to OVERWEIGHT trend up Maintained
OVERWEIGHT on utilities sector with selective stock picks Tony LIU +852 3658 6043 Our pecking order for the utilities subsectors in 2H18 (in descending order) is: IPPs, Analyst [email protected] wind operators, gas distributors, then solar. For 2018E, we forecast China power Zezheng ZHANG +86 21 3847 6205 demand growth of 5.9%, and gas apparent demand growth of 13%. Our positive Analyst [email protected] view on IPPs mainly hinges on lower fuel cost helping earnings recovery and an Zoey ZONG +852 3658 6235 attractive 2018E dividend yield. We forecast higher average utilization hours for Analyst [email protected] existing wind projects nationwide, which should benefit domestic wind power operators. Gas distributors will continue to benefit from the apparent demand Stock recommendations growth in China. Our top picks in Utilities are: Huaneng Power (902 HK), China Company Code TP (HKD) Rating Longyuan (916 HK) and CR Gas (1193 HK). Thermal
Huaneng Power 902 HK 6.77 Thermal – earnings in upcycle, top pick Huaneng (902 HK) BUY Huadian Power 1071 HK 4.30 BUY Even with the coal-power tariff linkage policy suspended, we are still positive on the prospects for IPPs, and forecast an earnings recovery in 2018E driven by lower CR Power 836 HK 18.25 BUY fuel cost from coal. We estimate average QHD5500 coal price at RMB600/t in Jingneng 579 HK 2.10 HOLD 2018E (2017: RMB611/t). And we have already seen the central government cap Renewables 2018 coal prices under long-term contracts for coal-fired power plants at 2017 China Longyuan 916 HK 8.20 BUY prices. We estimate the on-grid tariff for IPPs will rise slightly following cancellation HN Renewables 958 HK 3.90 BUY last July of a government fund, and that the discount on direct power sales tariff will GCL-Poly Energy 3800 HK 1.07 HOLD narrow in 2018. Our top pick in the subsector is Huaneng Power, considering its Gas Utilities earnings recovery and 70% dividend payout ratio could deliver an attractive yield CR Gas 1193 HK 31.00 BUY in 2018E. We also rate Huadian (1071 HK) and CR Power (836 HK) at BUY. ENN 2688 HK 73.50 BUY
China Gas 384 HK 28.20 BUY Renewables – wind operators driven by lower curtailment Tianlun Gas 1600 HK 8.30 BUY Strong 1Q18 results enhanced our positive view on wind operators, and we think Beijing Enterprise 392 HK 56.00 BUY utilization hours for wind power in China will continue to rise in 2018, driven by lower curtailment rate. Restriction policy on wind capacity addition has loosened, Towngas 1083 HK 6.30 HOLD and we expect capacity addition to recover in 2H18 which should boost power HK China Gas 3 HK 12.70 SELL Kunlun Energy 135 HK 5.90 SELL generation growth at wind operators in 2019. Based on our assumption, we forecast wind utilization hours will increase by 102 hours year on year nationwide Source: Huatai HK Research estimates (2017: 1,948 hours), given 17GW newly-added capacity in 2018. Our top pick in the subsector is China Longyuan (916 HK), on strong earnings growth driven by Sector performance lower curtailment rate. We also have a BUY rating on HN Renewables, given its solid operating performance. HSI Thermal (%) Renewables Gas Utilities 40 Gas distributors – stable margin in 2018
We think gas distributors will continue to benefit from domestic demand growth, 20 based on our assumption of China gas apparent demand growth of 13.1% in 2018E (2017: 14.1%). We expect dollar margin for downstream gas names to be stable in 0 2018, and look for the next favorable step of gas price reform. We think accelerated implementation of gas storage projects will benefit downstream players in two (20) ways: 1) secure gas supply in the heating season; and 2) lower cost, considering May-17 Aug-17 Nov-17 Feb-18 the seasonal hike in city gate price. We maintain our BUY call on: CR Gas (1193 Source: Huatai HK Research estimates HK), on its stable organic growth in sales volume and rise in dividend payout ratio (from 30% in 2017 to 35% in 2018E); ENN Energy (2688 HK), as the LNG terminal to be launched by its parent company in 2H18 should lower its costs; China Gas (384 HK), the coal-to-gas pioneer in China; and Beijing Enterprises (392 HK), given stable returns from overseas investments.
Originally published on 7 May 2018
Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 129 Please refer to end pages for analyst certification and required disclosures.
China Utilities
Fig.329. China Utilities: valuation comparison Company Rating Ticker Price Mkt cap PE (x) PB (x) Yield (%) Gearing (%) ROE (%) (HKD) (USDmn) 2018E 2019E 2018E 2019E 2018E 2018E 2018E 2019E
Thermal China Resources Power BUY 836 HK 14.90 9,131 8.7 7.5 0.9 0.8 5.9 114.5 10.6 11.6 Huaneng Power BUY 902 HK 5.34 13,980 12.1 9.6 0.7 0.7 5.8 212.5 6.1 7.6 Huadian Power BUY 1071 HK 3.28 5,483 7.3 7.9 0.6 0.6 5.5 201.7 8.1 7.2 Jingneng HOLD 579 HK 2.02 1,768 6.2 6.1 0.6 0.6 4.7 118.1 10.5 9.8 CGN Power Not rated 1816 HK 2.11 12,217 9.0 8.1 1.1 1.0 3.8 202.9 12.4 12.8 China Power Not rated 2380 HK 2.12 2,649 8.7 6.9 0.5 0.5 5.4 160.5 6.5 7.7 Datang Power Not rated 991 HK 2.58 8,539 8.6 7.6 0.7 0.6 5.2 254.3 7.9 8.7
Average 8.7 7.7 0.7 0.7 5.2 180.6 8.9 9.3
Renewables China Longyuan BUY 916 HK 7.65 7,832 10.9 9.9 1.0 0.9 1.9 127.9 9.8 9.9 HN Renewables BUY 958 HK 3.38 4,550 8.0 7.1 1.0 0.9 1.8 166.2 13.9 13.8 GCL-Poly Energy HOLD 3800 HK 0.95 2,250 6.6 6.1 0.6 0.5 - 177.5 9.2 9.1 GCL New Energy Not rated 451 HK 0.42 1,021 5.9 5.4 0.8 0.7 0.5 381.1 11.8 10.3 Shanghai Electric Not rated 2727 HK 2.80 11,872 13.2 13.7 0.6 0.6 2.4 -28.9 4.7 4.6 China Suntien Not rated 956 HK 2.62 1,240 7.1 6.1 0.8 0.8 5.1 206.5 11.9 12.4 Huadian Fuxin Not rated 816 HK 2.17 2,324 6.0 5.2 0.6 0.6 3.8 265.8 10.7 11.1 Datang Renewables Not rated 1798 HK 1.58 1,464 8.1 6.9 0.8 0.7 2.4 336.6 9.6 10.3
Average 8.2 7.6 0.8 0.7 2.2 204.1 10.2 10.2
Gas China Resources Gas BUY 1193 HK 27.90 7,734 14.9 13.6 2.5 2.2 2.1 (2.6) 17.5 17.1 ENN Energy BUY 2688 HK 71.80 9,896 15.9 13.5 3.2 2.8 2.2 25.7 21.7 22.1 China Gas BUY 384 HK 27.95 17,360 18.8 15.4 4.8 3.9 1.6 31.1 28.0 28.1 Beijing Enterprises BUY 392 HK 38.60 6,207 6.5 5.8 0.7 0.6 2.8 54.2 10.6 10.8 Tianlun Gas BUY 1600 HK 5.41 682 9.7 8.5 1.4 1.2 2.4 107.4 15.2 15.4 Towngas China HOLD 1083 HK 7.00 2,418 13.8 12.2 1.1 1.1 1.7 39.7 8.5 9.1 Hong Kong China Gas SELL 3 HK 16.54 29,474 30.3 29.3 3.9 3.8 2.1 40.5 13.1 13.1 Kunlun Energy SELL 135 HK 6.75 6,942 13.9 11.7 1.0 1.0 2.7 21.3 8.2 9.2 Average 16.0 14.2 2.4 2.2 2.2 42.5 15.2 15.6
Note: data as at 4 May close Source: Bloomberg, Huatai HK Research estimates
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Thermal: earnings in an upcycle Even though the coal-power linkage policy was suspended earlier this year, we maintain our positive view on the prospects for IPPs names, and expect earnings recovery to lift sector valuation. Earnings are in an upcycle, based on our assumptions: 1) lower fuel cost from coal; we expect coal price to decline in 2018; and 2) steady power generation growth for thermal, driven by domestic power demand growth.
Thermal power generation growth to be steady in 2018 Based on our assumptions, China is set to see power demand growth of 5.9% yoy in 2018E. On the supply side, we expect thermal capacity addition to slow. Based on the 13th Five Year Plan, generation capacity from renewable power sources will reach 22% of total capacity by 2020E (2016: 16%). We forecast thermal/hydro/renewable power will account for 70/18/12% of total power generation in 2018E. Thus, we think thermal power generation growth will be steady in 2018.
Fig.330. China: power generation structure 2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Power generation (TWh) Thermal 3,900 3,926 4,222 4,227 4,187 4,289 4,551 4,733 4,919 5,098 Hydro 668 856 892 1,060 1,112 1,181 1,195 1,244 1,300 1,345 Wind 74 103 138 160 185 241 306 352 403 447 Solar 1 4 8 24 39 66 118 185 226 260 Nuclear 87 98 112 133 171 213 248 285 339 400 Total 4,731 4,987 5,372 5,605 5,694 5,989 6,418 6,799 7,188 7,549
Generation capacity (GW) Thermal 768 820 870 924 1,006 1,054 1,106 1140 1175 1,210 Hydro 233 249 280 305 320 332 341 355 367 380 Wind 46 61 77 97 131 149 164 181 199 217 Solar 2 3 16 25 43 77 130 165 190 210 Nuclear 13 13 15 20 27 34 36 43 50 58 Total 1,063 1,147 1,258 1,370 1,525 1,646 1,778 1,883 1,977 2,069
Source: CEC, Huatai HK Research estimates
Fuel cost from coal to decline in 2018 We expect lower coal cost for IPPs names, considering: 1) higher proportion of long-term- contract coal; 2) government has capped coal prices under long-term contracts; and 3) we estimate a fall in commodity price, with 2018E QHD5500 coal price to average RMB600/t in 2018E (2017: RMB611/t).
Fig.331. QHD5500 coal price Fig.332. CCI5500 coal index
(RMB/t) (RMB/t) 900 700 800 600 700 500 600 500 400 400 300 300 200 200
100 100 0 0 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18
Source: Wind, Huatai HK Research Source: Wind, Huatai HK Research
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Attractive dividend policy from Huaneng Power (902 HK) Our top pick in this subsector is Huaneng Power. In April 2018, Huaneng announced a specific shareholder return plan for 2018-2020: a dividend payout ratio of no less than 70% with a cash dividend of no less than RMB0.1/share. We believe such a sound dividend policy will result in a high dividend yield for investors, considering the earnings recovery we expect.
Fig.333. Huaneng Power: power generation Fig.334. Huaneng Power: average settlement tariff (RMB/MWh) (bn kWh) (yoy%) 435 110 Power generation Growth (rhs) 35 430
105 30 425 25 420 100 415 20 95 410 15 405 90 10 400
85 5 395 390 80 0 1Q17 2Q17 3Q17 4Q17 1Q18 1Q17 2Q17 3Q17 4Q17 1Q18 Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Fig.335. Huaneng Power: dividend payout Fig.336. Huaneng Power: historical PB (HKD) (RMB) (%) 20.0 0.50 DPS Payout ratio (rhs) 120 18.0 2.5x 0.45 16.0 100 0.40 2.0x 14.0 0.35 80 12.0 1.5x 0.30 10.0 0.25 60 8.0 1x 0.20 6.0 40 0.15 4.0 0.10 20 2.0 0.5x 0.05 0.0 0.00 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 2014 2015 2016 2017 2018E 2019E Source: Company data, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
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Renewables – upward trend for wind operators We think wind power generation growth will mainly be driven by higher wind power utilization hours in 2018E, in turn driven by lower curtailment rate. We maintain our positive view on China Longyuan and HN Renewables as they look set to benefit from solid growth in wind power generation volume.
Fig.337. China: annual wind power operation data
Unit 2013 2014 2015 2016 2017 Wind power generation bn kWh 135 154 186 241 306 Curtailment rate % 11 8 15.4 17.1 12.1 Utilization hours hours 2,074 1,893 1,728 1,742 1,948 Newly-installed capacity GW 14 20 33 19 15 Cumulative capacity GW 77 97 129 149 164
Source: NEA, Huatai HK Research
Fig.338. China: wind power utilization hours & curtailment Fig.339. China: monthly average wind speed (knots) (Hours) (%) 7 China monthly average wind speed 700 Utilization hours Curtailment rate (rhs) 30 6 600 25 5 500 20 4 400 15 3 300 10 2 200 1 100 5 0 0 0 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18
Note: 1 knot = 0.5144 m/s Source: NEA, Huatai HK Research Source: Bloomberg, Huatai HK Research
Solid 1Q18 strengthens our view In 1Q18, wind power generation across China rose by 39% yoy to 97.9bn kWh. The national average for wind utilization hours was 592 hours in 1Q18, representing an increase of 124 hours compared to the same period last year, and benefiting wind power operators throughout China. We saw wind curtailment decline to 8.5% in 1Q18 (1Q17: 16%); meanwhile, average wind speed grew by 5.5% to 5.29 knots (1Q17: 5.06).
China Longyuan – strong upside with potential asset injections In 1Q18, China Longyuan recorded wind power generation growth of 33% yoy, with wind curtailment rate declining to 7.49% (1Q17: 16.4%). We expect the company to see wind utilization hours of 2,200 hours and wind power capacity addition of 1,000MW in 2018E. We also see potential assets injection from its parent company, which would be beneficial.
HN Renewables – sector leaders in utilization hours In 1Q18, HN Renewables saw wind power generation growth of 20% yoy. We forecast the company to see wind utilization hours of 2,240 hours and wind power capacity addition of 600MW in 2018E.
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Fig.340. China Longyuan: monthly wind power generation Fig.341. HN Renewables: monthly wind power generation
(GWh) (yoy%) (GWh) (yoy%) Wind power generation Growth (rhs) 4,500 45 3,000 Wind power generation Growth (rhs) 70 4,000 40 60 2,500 3,500 35 50 3,000 30 2,000 40 2,500 25 1,500 30 2,000 20 20 1,500 15 1,000 1,000 10 10 500 500 5 0 0 0 0 (10) Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18
Source: Company data, Huatai HK Research Source: Company data, Huatai HK Research
Fig.342. China Longyuan: 12-month forward PE Fig.343. HN Renewables: 12-month forward PE (x) (x) 16
25 14
12 20 +1 std 10 Average 15 +1 std 8
Average 6 10 -1 std 4
5 -1 std 2 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Source: Bloomberg, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
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Restriction policy on wind capacity addition loosened In March 2018, the National Energy Administration (NEA) released its new restriction policy on wind capacity addition for 2018. Compared to 2017, the restriction policy was loosened due to better wind power consumption. For the policy in 2018, we have seen Inner Mongolia and Heilongjiang become orange regions (see below) and Ningxia province become a green region. However, for the three remaining provinces (Xinjiang, Jilin and Gansu), new investments in wind power projects are, in principle, still restricted.
Fig.344. Wind power investment restriction policy (2017) Fig.345. Wind power investment restriction policy (2018)
Note: red - installation of new wind projects prohibited; orange - annual Note: red - installation of new wind projects prohibited; green – free for new approved wind projects installation allowed; green - free for new wind wind investment investment Source: NEA, Huatai HK Research Source: NEA, Huatai HK Research
Government subsidies to gradually decline The government aims to lower the renewable on-grid power tariff to match the thermal power level, and we think this target could lead to a gradual decline in subsidies for renewable power during 2018-2020E.
Fig.346. Wind power benchmark tariff (incl. tax)
Wind 2015 2016 2017 2018
Type I 0.49 0.47 0.47 0.4
Type II 0.52 0.5 0.5 0.45
Type III 0.56 0.54 0.54 0.49
Type IV 0.61 0.6 0.6 0.57
Source: NEA, Huatai HK Research
Fig.347. Solar power benchmark tariff (incl. tax)
Solar 2015 2016 2017 2018
Type I 0.9 0.8 0.65 0.55
Type II 0.95 0.88 0.75 0.65
Type III 1 0.98 0.85 0.75
Distributed subsidy
Ordinary 0.42 0.42 0.42 0.37
Poverty alleviation 0.42 0.42 0.42 0.42
Source: NEA, Huatai HK Research
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Uncertainty remains in green energy certificates We have seen the start of the obligatory quota trading scheme in green energy certificates (scheduled for January 2018) delayed and uncertainty still remains on: 1) whether and how many green certificates could be generated from renewable power projects; and 2) whether market demand could meet supply, which may lead to delayed sales or price cuts.
Fig.348. Green energy certificate trading Number of wind certificates listed units 4,834,136 Number of solar certificates listed units 215,037 Number of wind certificates purchased units 27,044 Number of solar certificates purchased units 127 Purchase-to-listed ratio: wind % 0.60 Purchase-to-listed ratio: solar % 0.06 Price range for wind certificates RMB/unit 137-330 Price range for solar certificates RMB/unit 600-873
Source: China Green Energy, Huatai HK Research
RPS and RECs to promote renewable energy power consumption To further promote renewable energy power consumption and lower hydro, wind and solar curtailment in China, the NEA announced (23 March) the “renewable portfolio standard (RPS)” draft and set province by province renewable energy power consumption portfolio targets (total target and non-hydro target) for 2018 and 2020. Based on the draft, currently renewable energy certificates (REC) are market-oriented instruments to promote overall renewable power consumption. The transfer and trading of RECs have no impact on the subsidy issuance for renewable power generation companies in the short run. More details regarding REC pricing and trading are expected to be announced at a later date.
Based on our calculation, if we assume 5.9% yoy growth in total power consumption in China in 2018, the overall required non-hydro renewable power consumption target will be around 552bn kWh, representing year-on-year growth of 10.2% (2017: 35%). In 1Q18, wind and solar power generation rose by 37.9% and 58.7% [yoy?], respectively. As such, we believe the overall non-hydro renewable power consumption target in 2018 will be met.
We believe RPS and RECs will help promote renewable power consumption in China over 2018-2020, based on: 1) consumption target for 2020 ensures a development floor for renewable power, resulting [which should result?] in a rise in utilization hours; and 2) cross-provincial renewable power transactions should drive renewable power generation growth in the region.
Fig.349. Non-hydro renewable power consumption estimation in China (bn kWh) 2015 2016 2017 2018E 2019E 2020E Total power consumption 5,550 5,920 6,308 6,680 7,061 7,414 yoy% 0.5 5.0 6.6 5.9 5.7 5.0 Require: non-hydro renewable power consumption 278 372 501 552 654 774 yoy% 22.0 33.7 35.0 10.2 18.3 18.3 Percentage (%) 5.0 6.3 8.0 8.3 9.3 10.4
Source: CEC, Wind, Huatai HK Research estimates
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Fig.350. Non-hydro renewable power consumption portfolio target by province Province (%) 2015 2016 2018T 2020T 16-18 gap 16-20 gap Beijing 7.6 9.0 10.5 13.0 1.5 4.0 Tianjin 7.6 9.0 10.5 13.0 1.5 4.0 Hebei 7.6 9.0 10.5 13.0 1.5 4.0 Shanxi 7.0 10.0 13.0 15.0 3.0 5.0 Inner Mongolia 12.0 15.3 13.0 13.0 (2.3) (2.3) Liaoning 7.7 8.6 9.0 9.0 0.4 0.4 Jilin 12.2 13.7 16.5 20.0 2.8 6.3 Heilongjiang 11.1 12.4 15.5 22.0 3.1 9.6 Shanghai 1.6 2.0 2.5 3.5 0.5 1.5 Jiangsu 3.3 4.2 5.5 6.5 1.3 2.3 Zhejiang 2.4 3.6 5.0 6.0 1.4 2.4 Anhui 3.9 6.1 11.5 14.5 5.4 8.4 Fujian 3.4 3.7 5.0 7.0 1.3 3.3 Jiangxi 2.2 3.8 6.5 14.5 2.7 10.7 Shandong 6.0 5.6 8.0 10.5 2.4 4.9 Henan 2.3 4.4 8.0 13.5 3.6 9.1 Hubei 3.7 4.7 7.5 11.0 2.8 6.3 Hunan 2.8 4.1 9.0 19.0 4.9 14.9 Guangdong 1.8 1.9 3.0 3.8 1.1 1.9 Guangxi 1.0 1.3 3.0 5.0 1.7 3.7 Hainan 4.0 4.5 4.0 5.0 (0.5) 0.5 Chongqing 1.4 1.6 3.0 3.5 1.4 1.9 Sichuan 1.4 2.3 4.5 4.5 2.2 2.2 Guizhou 2.0 4.6 4.0 4.8 (0.6) 0.2 Yunnan 5.1 12.5 10.0 10.0 (2.5) (2.5) Tibet 8.2 10.1 13.5 17.5 3.4 7.4 Shaanxi 2.7 3.8 8.5 11.5 4.7 7.7 Gansu 11.4 12.5 15.0 15.0 2.5 2.5 Qinghai 13.5 18.3 21.0 25.5 2.7 7.2 Ningxia 13.4 19.1 21.0 21.5 1.9 2.4 Xinjiang 10.5 11.1 14.5 14.5 3.4 3.4
National average 5.0 6.3
Note: T – target Source: NEA, Huatai HK Research
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Gas distributors – beneficial policies leading the way Aside from the double-digit apparent growth, we view the newly released gas storage development plan as positive for gas distributors, given: 1) secure gas supply in the heating season; and 2) lower cost, considering the seasonal hike in city gate price. Furthermore, we expect additional steps in price reform, including: 1) a potential cut in city gate prices for industrial and commercial (I&C) users in the summer season; and 2) potential merging of residential and I&C prices.
China natural gas supply-demand We think natural gas demand will grow by 13% in 2018E, with domestic/import demand rising by 9/20%. As for import volume, we think PNG/LNG volume will rise by 8/30% yoy.
Fig.351. China: natural gas supply balance (bcm) 2015 2016 2017 2018E 2019E 2020E
Domestic production 127 137 148 160 174 189 Pipeline import - Turkmenistan 28 31 33 36 39 42 Pipeline import - Kazakhstan 0 0 1 2 3 5 Pipeline import - Uzbekistan 4 4 4 3 3 3 Pipeline import - Burma 4 4 3 4 4 4 Pipeline import - Russia - - - - - 19 Pipeline import - total 36 40 41 45 48 73 LNG 27 36 52 68 87 90 Total gas import 62 75 93 112 135 163 Total gas export (3) (3) (3) (4) (4) (4) Total gas net import 59 72 90 109 131 160 Total gas supply 186 208 238 269 305 348
Source: NBS, China Customs, Huatai HK Research estimates
Gas storage development plan released As part of a push to speed up the construction of natural gas storage facilities, the National Development and Reform Commission (NDRC) announced (27 April) “Opinions on Accelerating the Construction of Gas Storage Facilities and Perfecting the Market Mechanism of Gas Storage and Peak Load Assist Service”. The development plan has set multiple requirements on gas storage capability for upstream and downstream players and for local governments.
Fig.352. Gas storage development plan Storage capacity requirement Upstream gas supplier Over 10% of its gas sales volume by 2020 City gas distributor Over 5% of its gas usage volume by 2020 Local government Over 3 days local gas demand by 2020
Underground gas storage Storage assets Coastal LNG terminal storage tanks
Inland LNG storage tanks
Source: NDRC, Huatai HK Research
Operations for gas distributors on track in 1Q18 We have seen both CR Gas and ENN Energy record over 20% yoy gas sales volume growth in 1Q18. Which enhanced The data points enhance our positive view on gas distributors, and we also think solid operating data in the heating season will remove market fears of a repeat of the gas shortage that occurred last winter.
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CR Gas – steady and solid In 1Q18, CR Gas recorded gas sales growth of 21.5% yoy, with dollar margin recovering to over RMB0.6/cub m. For 2018E, we expect CR Gas to see gas sales volume growth of 17% yoy with stable dollar margin.
ENN Energy – LNG terminal to start operation in 2H18 In 1Q18, ENN recorded over 20% yoy growth in gas sales volume (excluding wholesale), with dollar margin of RMB0.61-0.62/cub m. We forecast ENN to see gas sales volume growth of 25% yoy with steady margin in 2018E.
Fig.353. Operation data for gas distributors (1Q18) Gas sales volume growth Dollar margin (RMB/cub m) CR Gas 21.50% over 0.6 ENN over 20% 0.61-6.62
Source: Company data, Huatai HK Research
Fig.354. CR Gas: 12-month forward PE Fig.355. ENN Energy: 12-month forward PE (x) (x) 30 25 25 20 +1 std 20 +1 std Average 15 Average 15 -1 std 10 10 -1 std
5 5
0 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Source: Bloomberg, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
Fig.356. China Gas: 12-month forward PE Fig.357. Towngas: 12-month forward PE (x) (x) 30 30 25 25 +1 std +1 std 20 20
15 Average 15 Average 10 10 -1 std -1 std 5 5
0 0 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18
Source: Bloomberg, Huatai HK Research estimates Source: Bloomberg, Huatai HK Research estimates
China Gas – continues to benefit from coal-to-gas market As the pioneer coal-to-gas player, we think China Gas will continue to expand its market share in northern China, and provide sizable earnings growth in the next three years.
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Fig.358. China Gas guidance: gas sales volume Gas sales volume (mn cub m) FY1H17 FY1H18 FY18 guidance FY19 guidance FY20 guidance City gas projects 3,321 4,652 11,439 14,299 17,873
City gas volume growth (%) 40 35 25 25 Residential 686 1,132 Industrial 1,592 2,243 Commercial 542 762 Vehicle 501 515 Wholesale gas 1,411 3,594 6,002 Wholesale gas growth (%) 155 60 double-digit double-digit Others 80 107 Total 4,812 8,352 17,441 Total gas growth (%) 74 43
Note: March year-end Source: Company data, Huatai HK Research
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Analyst Certification The views expressed in this report accurately reflect the personal views of the analyst(s) about the subject securities or issuers; and no part of the compensation of the analyst(s) was, is, or will be, directly or indirectly, related to the inclusion of specific recommendations or views in this report. Bruce WANG; Liang YU; Jie GONG; Hanzhi DING; Xuan YANG; Wen DAI; Yun LI; Lisa LIN; Wenrui YU; Tony LIU; Xiaofeng SHEN; Zezheng ZHANG ; Chunli ZHAN; Shujin CHEN, CFA; Alfred HE; Zhixuan LIN; Qian YAO; Shijia YAO; Saiyi HE; Xenia CHEN; Cheng LV
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