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Strategy | CHINA 2011 Outlook NOMURA INTERNATIONAL (HK) LIMITED Henry Wu, CFA +852 2252 2122 [email protected] And the China Equity Research Team TOP DOWN ANCHOR REPORT Higher ground Stocks for action Following the rebound of 2009 and consolidation of 2010, we are positive on the Our top picks are front-line beneficiaries outlook for China’s equity markets in 2011F. We have year-end targets for the MSCI of investment opportunities in China in China Index and HSCEI Index of 83 and 16,000, implying 24% and 25% upside 2011, and feature strong earnings potential, respectively. We see index performance being backed by: 1) 21%+ earnings growth potential, healthy balance growth, with large-cap sectors such as Financials and Energy on course to deliver sheets, and attractive valuations. strong earnings; 2) attractive valuations (on our forecasts, 13x FY11F earnings, in line with the past 10-year average, and 2.5x price/book with RoE of 20%); and 3) a positive Price Stock Rating Price target liquidity outlook. We believe fundamentals will provide the surest footing for stock Agile Properties (3383 HK) BUY 11.1 13.3 pickers in 2011. Sectors with improving earnings prospects and strong RoEs are best Agricultural Bank of China (1288 HK) BUY 4.1 4.7 placed to scale the heights, in our view, particularly when there are uncertainties on China Everbright (257 HK) BUY 4.4 6.1 China Life Insurance (2628 HK) BUY 33.7 40.0 the policy front and the cost of capital is on the rise. While concerns over high inflation China Mengniu (2319 HK) BUY 22.7 32.0 could weigh on equity market performance in the short term, we recommend investors China Railway Construction Corp BUY 9.4 11.8 (1186 HK) position themselves for resulting buying opportunities, since historically the market Gome Electrical Appliances (493 HK) BUY 3.2 4.3 tends to rally once inflation has peaked out. Our 10 stocks for 2011: Agile Properties, Perfect World (PWRD US)* BUY 23.7 37.0 ABC, China Everbright International, China Life Insurance, China Mengniu Dairy, Sinopec (386 HK) BUY 7.3 9.6 ZTE Corp (763 HK) BUY 29.4 36.0 CRCC, Gome, Perfect World, Sinopec and ZTE. Priced as at 1 December 2010 close; local currency * Priced as at 30 November 2010 close 20%-plus upside potential for the markets in 2011 Analyst Inflation to weigh on performance in short term Henry Wu, CFA +852 2252 2122 Sector scorecard –leveraging Nomura’s bottom-up research [email protected] And the China Equity Research Team Our top 10 for 2011 Don’t miss our companion outlook reports on Asia, Singapore and Nomura Anchor Reports examine the key themes and value drivers that underpin our Malaysia, published 6 December, 2010. sector views and stock recommendations for the next 6 to 12 months. Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 172 to 176. Nomura 7 December 2010 Strategy | CHINA 2011 Outlook NOMURA INTERNATIONAL (HK) LIMITED Henry Wu, CFA +852 2252 2122 [email protected] And the China Equity Research Team TOP DOWN Action Stocks for action We believe solid earnings growth (21%+ y-y), sufficient liquidity (+18% y-y M2 Our top picks are front-line beneficiaries growth) and undemanding valuations (in line with historical average forward P/E of of investment opportunities in China in 12.6x) will support 20%-plus upside in China’s equity market in 2011. Against a 2011, and feature strong earnings th likely backdrop of surging inflation, interest hikes, RMB appreciation, the 12 FYP growth potential, healthy balance and rising global commodity prices, we spell out our sector winners/losers for 2011. sheets, and attractive valuations. We are Bullish on Financials, Property, Consumer, Oil & gas and Online gaming. Stock Rating Price PT Anchor themes Agile Properties (3383 HK) BUY 11.1 13.3 Agricultural Bank of China (1288 HK) BUY 4.1 4.7 Near-term concern over inflation will weigh on equity market performance. But amid China Everbright Int’l (257 HK) BUY 4.4 6.1 China Life Insurance (2628 HK) BUY 33.7 40.0 tightening monetary policy and price control efforts, any share price weakness China Mengniu Dairy (2319 HK) BUY 22.7 32.0 should present buying opportunities for long-term gains. CRCC (1186 HK) BUY 9.4 11.8 Gome Elec Appliances (493 HK) BUY 3.2 4.3 Our sector scorecard — formulated by gauging a sector’s fundamentals (EPS Perfect World (PWRD US) * BUY 23.7 37.0 Sinopec (386 HK) BUY 7.3 9.6 growth and ROE), valuations (forward P/E, P/BV) and momentum change (price ZTE Corp (763 HK) BUY 29.4 36.0 performance during the previous year) — backs up our individual sector views. Priced as at 1 December 2010 close; local currency * Priced as at 30 November close Higher ground Analysts Henry Wu, CFA +852 2252 2122 20%+ upside potential for the markets in 2011 [email protected] We are positive on the prospects for China’s equity market in 2011, after its rebound in 2009 and consolidation in 2010. We forecast the MSCI China Index and Yang Luo HSCEI Index will reach 83 and 16,000 by end-2011, for 24% and 25% upside +852 2252 2141 potential, respectively. We see market performance being backed by: 1) 21%-plus [email protected] earnings growth, with large-cap sectors such as Financials and Energy set for Michael Shen strong earnings; 2) attractive valuations (13x 2011F earnings, in line with the past +852 2252 2140 10-year average; 2.5x P/BV with RoE of 20%); and 3) a positive liquidity outlook. [email protected] Inflation to weigh on performance in short term Concern over high inflation will continue to weigh on market performance in the And the China Equity Research Team short term, we believe. Our examination of past performance shows the market tends to experience a short-term correction when inflation surprises on the upside and gains upward momentum before CPI has peaked (as in 2003-04). CPI in China has been above 3% for four consecutive months since July, compared with an 18-month run between May 2007 and October 2008 (including 10 months on the rise) and an 11-month run between December 2003 and October 2004 (9 months on the rise). Sector scorecard – leveraging Nomura’s bottom-up research The goal of our new sector scorecard is to estimate potential performance by gauging Nomura’s view of several factors: fundamentals (estimated EPS y-y growth % and forecast RoE), valuation (12-month forward P/E and P/BV) and momentum change (performance during the previous year). By giving different weight to each parameter, we then rank them from the highest score to the lowest representing our opinion from the most liked to the least. Our top-ranked sectors for 2011: online gaming, property, consumers and banking, as well as oil & gas. Our top 10 for 2011 Our top 10 stocks: Agile Properties, ABC, China Everbright International, China Life Insurance, China Mengniu Dairy, CRCC, Gome, Perfect World, Sinopec and ZTE. Nomura 1 7 December 2010 Strategy | China Henry Wu, CFA Contents Executive summary 4 Investment risks 19 Higher ground 20 Macro-economic growth will remain healthy in 2011… 21 … and corporate earnings growth too 22 Sufficient liquidity will add fuel 25 Undemanding looking valuations 32 Investment opportunities in 2011 36 Consumption – long-term positive 36 Inflation makes the difference 36 Price controls – 2003, 2007, 2011? 38 Interest rate hikes – can’t be any more aggressive than in 2006-07 45 Implementation of 12th FYP presents investment opportunities 47 We know how to appreciate renminbi appreciation 47 Commodity price hikes: thank you, QE! 50 Scorecard — playing to win 51 It has worked in the past 52 Nomura insights 54 Nomura’s China coverage 54 Major calendar events in 2011 55 Stocks: historical performance recap 55 Nomura Survey – Ideas for 2011 55 MSCI China Index components 55 Nomura 2 7 December 2010 Strategy | China Henry Wu, CFA Sector summaries Autos and Auto Parts 66 Banks 68 Cement 70 Container box manufacturing 72 Food & Beverages 74 China Healthcare & Pharmaceutical 78 Industrials 82 Insurance 84 Online gaming & media 88 Macau gaming 92 Oil and Gas 94 Retail 98 Shipping 102 Steel 104 Telecom services 106 Telecom equipment 108 Transport 110 Power, Utilities, Coal and Renewable 112 Property 116 Stock picks 121 Agile Properties 122 Agricultural Bank of China 126 China Everbright International 130 China Life Insurance 134 China Mengniu Dairy 138 China Railway Construction Corp 142 Gome Electrical Appliances 146 Perfect World 150 Sinopec 154 ZTE Corp 158 Appendix Valuation methodology and risks 162 Nomura 3 7 December 2010 Strategy | China Henry Wu, CFA Summary Executive summary We are positive on China’s equity market in 2011 after its rebound in 2009 and We forecast MSCI China and consolidation in 2010. We forecast the MSCI China Index and HSCEI Index will reach HSCEI will offer >20% upside in 2011F 83 and 16,000 by the end of 2011, implying 24% and 25% upside potential, respectively. We believe the strong performance will be backed by: 1) 21%+ earnings growth, with large-cap sectors such as financial and energy set to post strong earnings; 2) attractive valuation (13x 2011F earnings, in line with the 10-year average; 2.5x price/book with RoE of 20%). Note that 2011 will also be the first year of China’s 12th Five Year Plan, and we think the sectors set to benefit, such as the seven emerging industries with strategic importance, will receive a boost in sentiment.
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