Sinotrans Limited: Sinotrans – Negatives in the Price; Valuation

Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

February 23, 2016 MORGAN STANLEY ASIA LIMITED+ Edward H Xu, CFA Sinotrans Limited [email protected] +852 2239-1521 Watson Lau Sinotrans – Negatives In The Price; [email protected] +852 2239-1523 Victoria Wong, CFA Valuation Support From Sinoair [email protected] +852 2239-7817 Yufei Wu Industry View Stock Rating Price Target [email protected] +852 2239-7505 In-Line Overweight HK$5.11 Sinotrans Limited ( 0598.HK, 598 HK ) While we lower our earnings expectations amid sustained macro Hong Kong/China Transportation & Infrastructure / China headwinds, we think the negatives have been priced in by a Stock Rating Overweight Industry View In-Line significant stock correction in the last 3 months. We expect valuation Price target HK$5.11 support from a potential re-rating of Sinoair, which we are Up/downside to price target (%) 59 Shr price, close (Feb 22, 2016) HK$3.21 upgrading to OW. 52-Week Range HK$6.65-2.68 Sh out, dil, curr (mn) 4,406 What's Changed? From: To: Mkt cap, curr (mn) Rmb11,862 EV, curr (mn) Rmb14,276 Sinotrans Limited Avg daily trading value (mn) HK$75 Price Target HK$7.99 HK$5.11 2015e Net Profit Rmb1,606m Rmb1,460m Fiscal Year Ending 12/14 12/15e 12/16e 12/17e 2016e Net Profit Rmb1,721m Rmb1,423m ModelWare EPS (Rmb) 0.26 0.33 0.34 0.39 2017e Net Profit Rmb1,927m Rmb1,735m Consensus EPS (Rmb)§ 0.28 0.31 0.34 0.38 Revenue, net (Rmb 45,863 45,567 45,285 46,892 What has caused the dip: We think the -33% stock performance in the past mn) EBITDA (Rmb mn) 2,604 3,249 3,287 3,574 52 weeks has fully reflected market disappointment caused by: 1) weaker- ModelWare net inc 1,150 1,454 1,518 1,716 than-expected organic business led by a macro downturn; 2) delay in asset (Rmb mn) injections without clarity; and 3) a lack of management incentives with delays P/E 15.8 10.6 7.8 6.9 P/BV 1.4 1.1 0.8 0.7 in SOE reform. Thus 2015 earnings will miss management’s original guidance RNOA (%) 12.3 12.9 12.6 14.1 of 30% growth. As our revised earnings estimate still shows 18.6% growth in ROE (%) 10.0 10.8 10.5 11.0 2015, we think the share price correction is overdone. EV/EBITDA 8.1 5.3 3.8 3.2 Div yld (%) 2.2 2.4 3.2 3.7 FCF yld ratio (%) (4.1) 3.9 10.1 11.9 Potential catalysts: Despite macro challenges, we expect resilient 2016 Leverage (EOP) (%) (5.2) (10.5) (17.2) (23.2) earnings, led by: 1) potential disposal gain (Rmb109m) and cash inflows Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare framework § = Consensus data is provided by Thomson Reuters Estimates (Rmb143m) from the sale of InterBulk shares, for which Sinotrans had made e = Morgan Stanley Research estimates write-downs in 2013-14 (Rmb51m / Rmb111m); 2) progress made in the merger of the parent – CSC & Sinotrans Group with China Merchants Group, which may lead to asset injections; and 3) valuation support from Sinoair following the IPO boom of domestic express firms. Reducing earnings by 9%-11%: Our lower earnings estimates are based on: 1) weaker demand, as seen by continued declines in China’s export volumes in the past 11 months; 2) delays in the planned asset injection, partly due to the Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, merger of its parent. Our revised earnings are in-line with consensus investors should be aware that the firm may have a conflict estimates. We still expect positive growth of 18.6%/4.9%/13.2% for 2015-17 of interest that could affect the objectivity of Morgan amid a difficult macro environment. Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their Valuation attractive: Based on our earnings estimates, the current share investment decision. For analyst certification and other important disclosures, price is implying low multiples of 7.9x 2016e P/E and 0.8x P/BV, near historical refer to the Disclosure Section, located at the end of this lows since 2014. Even applying lower P/E multiples of 10x-12x from 12x-18x report. += Analysts employed by non-U.S. affiliates are not registered w ith FINRA, may in our SOTP model, our PT of HK$5.11 still implies 57% upside, supporting our not be associated persons of the member and may not be subject to NASD/NYSE OW rating. restrictions on communications w ith a subject company, public appearances and trading securities held by a research analyst account.

1 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

Sinotrans Limited: Financial Summary

Exhibit 1: Sinotrans: Financial Summary 2013-2017E

Source: Company data, Morgan Stanley Research (E) estimates

2 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

Risk-Reward Snapshot: Sinotrans (0598.HK, HK$3.26, OW, PT HK$5.11)

Risk-Reward View: Stub Value Amid Macro Headwinds Investment Thesis Lower PT by 36% to HK$5.11, implying 57% upside potential, as we factor in: 1) weaker-than- expected organic business performance led by a macro downturn in general; 2) delay in asset injection without any further clarity; 3) delays in SOE reform. Sinotrans will benefit from an Rmb109mn estimated disposal gain and Rmb143.1mn cash inflows from the sale of InterBulk shares, potential asset injections and sustained low oil price. We believe the -33% share price correction in the past 12 months is overdone given positive earnings growth of 18.6%/4.9%/13.2% for 2015- 17. The currently depressed valuation is attractive at 7.9x 2016e P/E and 0.8x P/BV vs. 9.8% ROE. Price Target HK$5.11 Probability-weighted: bull case (20%), base case (75%), and bear case (5%). Sum-of-the-parts valuation using discounted P/E Key Value Drivers multiples to global peers. China’s foreign trade growth. Bull HK$7.02 Substantial valuation gains in logistics assets: Stronger-than- Domestic consumption and logistics demand. 16.8x 2016e base case P/E expected revenue growth (+10% YoY) led by recovery in both Operating margins of key business segments external and domestic demand in 2015-17e. Higher-than-expected including freight forwarding and express services. operating margin (+0.5% YoY) for all core businesses. Additional land appreciation potential for land assets valued at HK$11bn. Potential Catalysts Disposal gain and cash flow from sale of InterBulk Chinese exports growth remain relatively flat at -1.4 / 2.6 / - Base HK$4.82 shares 11.5x 2016e base case P/E 1.6% in 2015-17e. Forecast -1% / -1% / 4% revenue growth in 2015-17e with ROEs at ~10%. Potential asset injection as further progress is made in the merger of parent group Bear HK$1.81 Margins halve for all core operations: Worsening of China’s CSC&Sinotrans Group with China Merchants Group 4.3x 2016e base case P/E foreign trade growth hits revenue by 10% in 2015-17e. Sustained low oil price that would benefit international business such as DHL JV

Key Downside Risks Prolonged cycle of weak external demand and domestic slowdown Sentiment impaired by further delay in asset injections and SOE reform Exogenous risks

3 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

Investment Thesis

Sinotrans has underperformed the market (HSCEI) by 6% over the past 3 months by correcting 22%, mainly reflecting market disappointment with weaker earnings growth and the delay of asset injections. Although we are cutting our earnings by 9%-11% and PT by 36%, we find current valuation attractive as the shares are trading at 7.9x 2016e P/E, 45% below its historical mean.

Exhibit 2: Sinotrans: Price performance vs. HSCEI and Sinoair

Source: Thomson Reuters, Morgans Stanley Research While we think most negatives should already be in the price, we expect potential catalysts from the following:

1) Potential disposal gain (Rmb109m) and cash inflows (Rmb143m) from the sale of InterBulk shares, for which Sinotrans had made write-downs in 2013-14 (Rmb51m / Rmb111m);

2) Progress made in the merger of the parent – CSC & Sinotrans Group with China Merchants Group (CMG). According to the firm, it announced its parent, CSC &Sinotrans Group was preparing a strategic reorganization with China Merchants Group on Nov 11th, 2015. We think the merger could be the reason behind the delayed asset injection as originally scheduled. It is possible that other asset injections could be included following the parent merger with CMGAs. CMG has unlisted China Merchants Logistics. According to China Merchants Logistics, it made a profit of Rmb286mn in 2014 with revenues of Rmb6.74bn, implying 4.2% margin and 4.7% ROA.

4 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH 3) Valuation support to Sinoair from the IPO boom of domestic express firms. We expect 2016 to be the year of IPOs of private express firms in China. For example, on Oct 23, 2015, STO announced its plan to go public through a back-door listing, by acquiring the shares of Zhejiang IDC Fluid Control (002468.SZ; NR). After that on Jan 16, 2016 , YTO also announced its plan to go public through a back-door listing by acquiring Dalian Dayang Trands (600233.SS; NR).

Exhibit 3: Summary of Listing Progress of the Express Companies in China

Source: Company announcement, Sina, W SJ Case Study: How did KLN’s IPO affect Sinotrans’ share performance

Kerry Logistics Network (KLN) announced the IPO plan in Hong Kong and the deal was completed in Dec 2013. Given the relatively higher valuation of KLN shares at 18x forward P/E during the IPO versus only 7.4x forward P/E for Sinotrans, investors became more enthusiastic about Sinotrans shares, pushing the shares to re-rate by 84%.

Exhibit 4: Sinotrans: 6 Month Share Price Performance After Kerry Logistics IPO

100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% -10.0%Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Kerry Logistics (636.HK) Sinotrans (598.HK)

Source: Thomson Reuters, Morgan Stanley Research

5 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

Earnings Estimates and Valuation

T rimming Net Profit Estimates for 2015-17 by 9-11%

Our new net profit estimates mainly reflect worse-than-expected earnings performance due to macro headwinds, as well as further delay in asset injections and SOE reform.

Our recurring net profit estimates imply growth of Exhibit 5: Sinotrans: Morgan Stanley Net Profit 10%/12.5%/7.9% for 2015-17, without consideration of Estimates vs. Consensus any further asset injections. Our revised net profit estimates are now 3% / 0% / 1% above consensus estimates for 2015- 17e.

We lower our EPS estimates by 9-11% for 2015-17 to HK$0.33, HK$0.35, and HK$0.39, respectively. Source: Thomson Reuters Consensus, Morgan Stanley Research L ower PT to HK$5.11

We lower our PT by 36% to HK$5.11 from HK$7.99 as we take into account the weakness in the macro environment. We cut our net turnover estimates by 5-13% for 2015-17e, and lower our net profit estimates by 9-11% for the same period. With a 33% share price correction in the past 12 months, we believe the negatives have already been priced in, and the shares are now trading at an attractive 7.9x 2016e P/E and 0.8x P/BV vs. 9.8% ROE. We maintain our OW rating.

We continue to value Sinotrans on a probability-weighted approach with the same 75% weight for our base- case scenario, 20% weight for our bull-case scenario and 5% weight for our bear-case scenario. Overall, we prefer 3PL players for their less-cyclical nature amid macro headwinds.

Although we believe the base case is the most likely scenario, we place a 20% probability on our bull case to capture a higher likelihood of this scenario occurring, given growing momentum seen in China’s logistics industry with increasing express volumes and better 3PL penetration.

We apply a 5% probability to our bear-case scenario, in which China’s foreign trade growth worsens with a double-dip or a sustained stagnant global economy. As the market has already priced in a worsening scenario, we see near-term risk diminishing for the current situation to further deteriorate.

Base Case: 75% weighting (unchanged) Exhibit 6: Sinotrans: Probability-weighted Price Scenario Value: HK$4.82 (vs. HK$7.54 previously ) Target Our base-case scenario value is based on flattish export volume in 2015-17e, lower than our previous assumption of 8% growth. We lower our base-case value as we take into account a worsening macro environment, and weak sentiment in the market. We Source: Morgan Stanley Research apply the following multiples: 1) freight forwarding at 10x 2016e; 2) logistics at 10x 2016e; 3) storage & terminal services at 12x 2016e; and 4) express and unallocated costs at 12x 2016e. The P/E multiples applied to segments are at significant discounts to global industry averages, reflecting Sinotrans’ weaker operational efficiency and margins.

Bear Case: 5% weighting (unchanged) Scenario Value: HK$1.81 (vs. HK$2.83 previously )

Our bear case reflects much worse macro and micro scenarios, causing operating margins to halve for all core 6 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH operations. In addition, worsening of China’s foreign trade growth hits revenue by 10% in 2015-17e.

Bull Case: 20% weighting (unchanged) Scenario Value: HK$7.02 (vs. HK$10.98 previously)

In our bull-case scenario, we continue to assume stronger revenue growth vs. our base case of 1% / -1% / 4% revenue growth in 2015-17e, led by strength in both external and domestic demand, as well as higher operating margins vs. our base case (+0.5% YoY) for all core businesses.

Downside Risks to Our Earnings Estimates and Price Target : 1. Prolonged cycle of weak external demand and domestic slowdown 2. Sentiment impaired by further delay in asset injections and SOE reform 3. Exogenous risks, including wars, diseases or other natural disasters that hamper business operations.

Exhibit 7: Sinotrans: Forward P/E, Sep-03 to Exhibit 8: Sinotrans: Forward P/B vs. ROE, Sep-03 Current to Current

Source: Bloomberg, Morgan Stanley Research Source: Bloomberg, Morgan Stanley Research

7 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH Exhibit 9: Sinotrans: New vs. Old Estimates, 2015-17E

Source: Morgan Stanley Research (E) estimates

8 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH Exhibit 10: Sinotrans: SOTP Valuation Base Case

Source: Morgan Stanley Research estimates

9 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH Exhibit 11: Global Logistics Valuation Comps Sheet

E = Morgan Stanley Research estimates NA = Not available. Source: Thomson Reuters, Morgan Stanley Research.

10 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

Valuation Methodology and Risks

600270.SS Our Sinoair PT is Rmb24.36. We continue to value Sinoair on a probability-weighted approach derived from a sum-of-the-parts valuation using forward P/E multiples based on 2016 estimates. Specifically, base-, bear- and bull-case scenarios were weighted at 75%, 5% and 20%, respectively, with SOTP valuation at HK$23.31, HK$16.32 and HK$30.3. We apply the following multiples: 1) DHL-Sinotrans JV using 16x 2016 P/E, given the relatively high earnings growth outlook that we expect for 2015-17; 2) International air freight forwarding, express services and domestic logistics services at 12x 2016 P/E; and 3) Other business at 12x 2016 P/E.

Key catalysts to our PT : 1) further progress in Cross-border e-Commerce; 2) potential recovery in air freight outlook; 3) favorable policy to support 3PL development in China.

Key downside risks to our PT : 1) Further macro weakness; 2) loss of market share due to intense competition; 3) further disposal in Sinoair shares by Sinotrans following their most recent disposal on May 14, 2015.

11 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

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12 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC) STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL % OF RATING IBC CATEGORY Overweight/Buy 1206 36% 323 43% 27% Equal-weight/Hold 1432 42% 331 44% 23% Not-Rated/Hold 79 2% 9 1% 11% Underweight/Sell 658 19% 86 11% 13% TOTAL 3,375 749

Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months. Analyst Stock Ratings Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months. Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index. Stock Price, Price Target and Rating History (See Rating Definitions)

13 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

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15 Sinotrans Limited | February 23, 2016 MORGAN STANLEY RESEARCH

INDUSTRY COVERAGE: Hong Kong/China Transportation & Infrastructure

COMPANY (TICKER) RATING (AS OF) PRICE* (02/22/2016)

Edward H Xu, CFA Air China Limited (0753.HK) O (11/16/2015) HK$5.04 Air China Limited (601111.SS) E (01/21/2016) Rmb7.09 Beijing Capital Int'l Airport (0694.HK) E (12/17/2013) HK$6.82 Cathay Pacific Airways (0293.HK) E (08/19/2013) HK$12.34 China Eastern Airlines (0670.HK) O (11/16/2015) HK$3.80 China Eastern Airlines (600115.SS) E (11/16/2015) Rmb6.54 China Merchants Hldg Intl (0144.HK) E (04/01/2015) HK$22.40 China Southern Airlines (1055.HK) O (11/16/2015) HK$4.84 China Southern Airlines (600029.SS) U (04/08/2015) Rmb6.86 CIMC (2039.HK) E (07/14/2014) HK$11.56 CIMC (000039.SZ) U (01/19/2015) Rmb14.80 COSCO Pacific (1199.HK) HK$8.59 Daqin Railway Co. Ltd. (601006.SS) O (01/07/2010) Rmb6.96 Guangshen Railway (0525.HK) U (04/28/2014) HK$3.66 Guangshen Railway (601333.SS) U (07/18/2014) Rmb4.03 Hutchison Port Holdings Trust (HPHT.SI) E (03/05/2014) US$0.45 Kerry Logistics Network (0636.HK) O (03/27/2015) HK$11.30 Shanghai International Airport (600009.SS) O (08/28/2015) Rmb28.31 Shenzhen International Holdings (0152.HK) O (05/27/2014) HK$12.28 Sinotrans Air Transportation Development (600270.SS) E (05/18/2015) Rmb19.74 Sinotrans Limited (0598.HK) O (05/27/2014) HK$3.21 SITC International Holdings Company (1308.HK) O (08/08/2011) HK$3.60 Spring Airlines (601021.SS) O (08/31/2015) Rmb52.00

Qianlei Fan, CFA Guangzhou Baiyun Int'l Airport (600004.SS) U (01/27/2016) Rmb12.98 Shenzhen Airport Company (000089.SZ) O (01/27/2016) Rmb7.57 Xiamen International Airport (600897.SS) E (01/27/2016) Rmb19.59

Victoria Wong, CFA Anhui Expressway Co. Ltd. (0995.HK) O (10/07/2015) HK$6.10 Anhui Expressway Co. Ltd. (600012.SS) U (01/15/2016) Rmb14.22 China COSCO (601919.SS) Rmb6.29 China COSCO (1919.HK) HK$2.78 China Merchants Energy Shipping Co. Ltd. (601872.SS) O (06/25/2015) Rmb5.18 China Shipping CL (2866.HK) E (07/09/2012) HK$1.60 China Shipping CL (601866.SS) U (08/19/2014) Rmb4.96 China Shipping Development (1138.HK) O (10/23/2013) HK$4.96 China Shipping Development (600026.SS) O (06/25/2015) Rmb6.73 Hopewell Highway Infrastructure (0737.HK) E (08/12/2014) HK$3.56 Jiangsu Expressway Company Limited (600377.SS) U (10/06/2015) Rmb8.02 Jiangsu Expressway Company Limited (0177.HK) E (10/06/2015) HK$9.50 Orient Overseas Int'l Limited (0316.HK) O (03/05/2014) HK$28.25 Pacific Basin Shipping (2343.HK) O (11/03/2014) HK$1.29 Shenzhen Expressway Company (600548.SS) E (01/15/2016) Rmb8.73 Shenzhen Expressway Company (0548.HK) E (01/15/2016) HK$6.07 Sichuan Expressway Co. Ltd. (601107.SS) U (10/07/2015) Rmb4.24 Sichuan Expressway Co. Ltd. (0107.HK) U (10/07/2015) HK$2.37 Zhejiang Expressway Company (0576.HK) O (10/06/2015) HK$7.43

Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted.