China | Equity Strategy
China 14 December 2014 EQUITY RESEARCH China The Year of the Ram: Stars Aligned for a Historic Bull Run Key Takeaway The Ram, the Bull and the Heavenly Twins – the stars are now aligned for China’s historic bull-run. China's stock market offers massive untapped potential given the high savings rate and low penetration. “Keeping Growth Steady” is a top priority for 2015; we expect SHCOMP and HSCEI to test 4,050 and 15,420, up 38% and 37% from current levels. As confidence gains momentum, volatility becomes the investors’ best friend. CHINA China Gallops into a Historic Bull Run. On Nov 20, 2013, we wrote “The Year of the Horse will see China unleash its full potential, as President Xi ushers in a new era of profound change.” “We expect capital markets to gradually gain confidence in China’s ability to drive fundamental reforms and expect Chinese stocks to enter a historic multi-year bull run.” Indeed, 2014 has been a remarkable year. As of Dec.12, SHCOMP surged 39% to 2938, breaking a seven-year bearish trend to become the best performing index in the world.
China Stock Market: Massive Untapped Potential. According to China Household Finance Survey, property accounted for 66.4% of total Chinese household assets in 2013. Financial assets accounted for a mere 10.1% of household wealth. While over 61% of Chinese families have bank deposits, only 6.5% of them invested in the stock market. Given China’s high savings rate and low stock market penetration, we believe the A-share market offers significant upside potential. We believe the rationalization of risk, increasing comfort with online transactions and the impact of social media will help accelerate asset re-allocation and drive stock market participation higher.
Stars Are Aligned; Keeping Growth Steady a Top Priority. As highlighted at the Christie Ju, CFA * Central Economic Work Conference, the key focus in 2015 is to keep economic growth Equity Analyst +852 3743 8012 [email protected] steady. Rising disposable income, lower energy costs and a US recovery will drive domestic Laban Yu * consumption and export growth. We believe the surprise rate cut is a clear “step up” in Equity Analyst government’s pro-growth policy. China has entered a monetary easing cycle; we expect +852 3743 8047 [email protected] Venant Chiang * more RRR and rate cuts ahead to drive a broad based demand recovery. Equity Analyst +852 3743 8013 [email protected] Our Bull Case for A-Share is Gaining Momentum. China’s citizens display remarkable Sean Darby * confidence in the government and its leaders. The Third Plenum outlined a clear roadmap Chief Global Equity Strategist towards future prosperity. China is still the largest contributor to global economic growth. +852 3743 8073 [email protected] Jessie Guo, PhD * Chinese stocks are minimally correlated to the rest of the world. We expect the foreign Equity Analyst ownership of A-shares will increase from 1% to 15-20% by 2020. +852 3743 8036 [email protected] Johnson Leung * How to Position for the Big Rally? We are bullish on the outlook of A shares, and expect Equity Analyst HSCEI to play catch up, as foreign investors gain confidence with reduced risk premium, +852 3743 8055 [email protected] Jessica Li, Ph.D. * reform dividends and improving fundamentals. We recommend investors to buy the airline, Equity Analyst bank, broker, clean energy, conglo, consumer staples, environmental service, healthcare, +852 3743 8010 [email protected] insurance, Internet, IPP, machinery, property and shipping sectors, and underweight coal, Leon Liao * Equity Analyst gold and steel. 852 3743 8021 [email protected] Cynthia Meng * Jefferies’ 2015 Top Picks. Among overseas listed companies, our Top Buys are Baidu, Equity Analyst Bank of China-H, CEI, CGN Power, CITIC Securities-H, COLI, CPIC-H, Haitong Securities-H, +852 3743 8033 [email protected] Ping An-H and Sinopharm. For A-share investors, we like the outlook of Anhui Conch-A, Bank Baron Nie, CFA, AIAA * Equity Analyst of China-A, CITIC Securities-A, Haitong Securities-A, Ping An-A, SAIC and Vanke. Investors +852 3743 8747 [email protected] may find Daqing Railway, Kweichow Moutai and Tongrentang interesting as leaders in their Po Wei * respective sectors. Equity Analyst +852 3743 8067 [email protected] * Jefferies Hong Kong Limited
Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 154 to 158 of this report. Equity Strategy
China
14 December 2014
Exhibit 1: HSCEI target 15,420 (10x 2016 P/E) Exhibit 2: SHCOMP target 4,050 (15x 2016 P/E)
6000 19000
15,420 5000 4,050 15000 4000 +37% 11000 +38% 3000
7000 2000
3000 1000 2015 2015 Target Target
Source: Bloomberg price as of Dec 11, 2014, Jefferies estimates Source: Bloomberg price as of Dec 11, 2014, Jefferies estimates
Exhibit 3: JEF sector allocation Sector Allocation Over-weight Equal-weight Under-weight Sector Fundamental Sector Fundamental Sector Fundamental Airlines Positive Autos Neutral Coal Negative Banks Neutral Cement Neutral Gold Negative Brokers Positive Consumer discretionary Neutral Packaging Paper Negative Clean Energy Positive Gaming Neutral Steel Negative Conglomerate Positive Oil/Gas Positive Consumer Staples Positive Ports Neutral Environmental Positive Tech Neutral Healthcare Positive Telecom Neutral Insurance Positive Internet Positive IPPs Positive Machinery Positive Property Positive Shipping Positive Source: Jefferies
Exhibit 4: Top picks for overseas stocks Exhibit 5: China A share stock ideas Mkt Cap Price PE PB Mkt Cap Price PE PB Company Ticker US$ mn trading 2014E 2015E 2014E 2015E Company Ticker US$ mn trading 2014E 2015E 2014E 2015E Baidu BIDU US 78,929 225.12 36.0 25.9 9.2 6.8 Anhui Conch 600585 17,447 19.96 8.8 7.9 1.6 1.4 Bank of China 3988 HK 149,991 4.10 5.7 5.5 0.9 0.8 Bank of China 601988 149,991 3.34 5.9 5.6 0.9 0.8 CEI 257 HK 6,605 11.42 30.9 24.3 3.2 2.9 China Vanke 000002 21,694 12.03 8.1 7.3 1.5 1.3 CGN Power 1816 HK 20,605 3.62 19.3 20.6 2.4 2.2 Citic Securities 600030 43,421 24.71 40.5 32.1 2.9 2.7 Citic Securities 6030 HK 43,421 27.15 27.4 17.9 2.5 2.3 Daqin Railway 601006 24,678 10.27 10.1 9.0 1.8 1.6 COLI 688 HK 24,199 22.95 8.3 7.0 1.5 1.3 HT Securities 600837 29,098 19.55 36.9 29.6 2.9 2.7 CPIC 2601 HK 36,310 32.65 19.7 17.1 2.1 1.9 Kweichow Moutai 600519 32,466 175.89 12.9 11.8 3.7 3.2 HT Securities 6837 HK 29,098 18.32 20.6 15.2 2.1 1.9 Ping An 601318 79,362 56.82 11.5 9.9 1.9 1.5 Ping An 2318 HK 79,362 73.70 11.9 10.2 2.0 1.6 SAIC 600104 40,043 22.47 8.6 7.6 1.6 1.4 Sinopharm 1099 HK 10,030 28.10 20.0 16.9 1.7 1.6 Tongrentang 600085 4,688 22.12 37.5 31.5 5.2 4.7
Average 20.0 16.1 2.8 2.3 Average 18.1 15.2 2.4 2.1 Source: Bloomberg, Jefferies, priced as of Dec 11, 2014 Source: Bloomberg, Jefferies, priced as of Dec 11, 2014
page 2 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
The Year of the Ram: Stars Are Aligned
China Stock Market - Massive Untapped Potential 4
The Third Plenum: A Roadmap for Future Prosperity 8
2015: Keeping Growth Steady a Top Priority 11
The Bull Case for China A Shares 13
Our Journey Begins with China 2025 16
China Macro: Monetary Relaxation 26
Jefferies Sector Allocation & Top Picks
2014 Sector Performance 33
Summary of Sector Views 35
2015 Sector Allocation & Top Picks 37
China 2015 Sector View
Autos & Machinery 72
Consumer 76
Conglomerate & Gaming 81
Energy (Oil & Gas, Coal) 87
Financials (Banks, Insurance & Brokers) 92
Healthcare 95
IPPs, Clean Tech & Environmental Services 101
Metals & Mining (Cement, Steel & Gold) 113
Property 126
TMT (Telecom, Internet & Tech) 131
Transportation (Airlines, Ports & Shipping) 139
page 3 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
China stock market – massive untapped potential The potential for asset reallocation With an extraordinarily high savings rate, Chinese citizens should have ample liquidity to invest. In the past decade, much of this liquidity was funnelled towards real estate. The remainder was kept as bank deposits, with some yield chasing through shadow banking products. Equity markets were given short thrift.
According to China Household Finance Survey (CHFS), property accounted for 66.4% of total Chinese household assets in 2013. Financial assets accounted for a mere 10.1% household wealth. Over 61% of Chinese families have bank deposits, but only 6.5% of them invested in the stock market. Given China’s high saving rates, we believe the A-share market will benefit from asset re-allocation and rising disposable incomes.
Exhibit 6: Household wealth by asset class (%) Exhibit 7: Household financial market participation (%)
66.4 62.7 60.9 61.0 2011 2013 2011 2013
16.8 13.2 10.1 8.3 8.8 7.1 6.8 6.5 4.8 3.5 4.2 3.1 3.6 1.1 0.8 0.7
Property Business Financials Durable/car Land Bank deposit Stock Fund Others Bond
Source: CHFS, Jefferies Source: CHFS, Jefferies
Low market participation Urban residents have a much higher participation rate than rural households, whose participation is negligible. But even urban residents’ participation rates are much lower than the US, Japan and Hong Kong. There should be ample room for growth.
Exhibit 8: Stock market participation by country
2011 2013
60% 50% 40% 30% 20% 10% 0% US Japan Hong Kong China
Source: CHFS, Economy and Finance Survey, HK Stock Exchange, Japan Exchange
Exhibit 9: Stock market participation in China (%) 2011 2013 Urban 16.6 11.1 Rural 1.9 0.4 Total 8.8 6.5 Source: CHFS, Jefferies. page 4 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Overcoming obstacles to invest in stock market… Besides lack of money, the key reasons households are not willing to take part in the stock market according to the CHFS are 1) lack of relevant knowledge, 2) a belief that the market is too risky and 3) never heard of it.
Exhibit 10: Why not invest in the stock market (%)? 2011 2013 Lack of relevant knowledge 52.6 44.2 Insufficient money 50.7 43.4 Market is too risky 18.7 15.1 Never heard of it 10.4 19.4 Don’t know how to open an account 2.3 1.7 The procedure is too complex 1.8 1.5 Don’t know where to open accounts 1.5 1.3 Have lost money in stock market 1.2 1.7 Return is too low 1.0 1.3 Security company is too far away 0.9 0.6 Source: CHFS, Jefferies
… through rational pricing of risk We believe the financial risk in China’s economy is rationalizing. The real estate bubble has cooled and is no longer viewed as a one-way bet. The government is slowly but surely extricating itself from implied guarantees on financial products that have lulled the public into a false sense of security.
China has introduced a bank deposit insurance system guaranteeing deposits up to Rmb500K. China has just put the country on notice that bank deposits above Rmb500K should be considered at risk. The clear implication should be that shadow banking products are even more at risk.
Online brokerage and social media help drive stock market penetration We also believe the explosive growth of online banking, brokerage and social media and will help accelerate the penetration of stock market in China. Viral peer pressure through WeChat groups should be more enticing and educational than a newsstand of financial magazines, in our view. The growing comfort of China’s citizenry with online transactions should also assuage lingering anxieties over online trading accounts.
New accounts opening surging, more accounts activated… As the market gained confidence after a series of new policies, new account openings accelerated. New account openings have surged in recent weeks. New account openings averaged 30K/day in the first 11 months of 2014, above 2012 and 2013 levels. In the first week of December however, daily new account openings surged to 119k/day. Active accounts also increased with the market rebound.
Exhibit 11: New accounts opened starting 2H14 Exhibit 12: More accounts are activated in this period
No. of New account opened ('000) 70 25.0% 800 60 20.0% 50 600 40 15.0% 30 10.0% 400 20 5.0% 10
200 0 0.0%
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 0 Jan-08 No. of Non-zero account (mn) % of active accounts
Source: Bloomberg Source: Bloomberg
page 5 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Confidence in China
Confidence in the government and leadership Surveys conducted by Edelman and Gallup show that the Chinese have more faith in their government than citizens of other countries. Propaganda certainly plays a role but one that should be significantly diminished by the recent emergence of pervasive, noisy and chaotic online social media networks in China.
We believe the decisive policies enacted by President Xi’s administration – from the anti- corruption campaign to steadfast economic reforms – deserve much credit for the citizenry’s positive impressions. These policies demonstrate the government’s determination for high quality sustainable growth and long-term prosperity.
Exhibit 13: Trust in government Exhibit 14: Confidence in gov’t Exhibit 15: Confidence in president
95% 92% 2012 2014 China China 76% 66% 90% India 53% India 55% 85% 82% 80% Germany 49% UK 47% 75% Japan 45% Russia 45% 70% UK 42% France 44% 65% 61% 58% US 37% Germany 42% 60% 55% France 32% US 35% 50% Russia 27% Japan 17% China US 2008-12 2013-Present 2008-Present 20% 40% 60% 80% 0% 20% 40% 60% 80% Hu Jintao Xi Jinping Barack Obama
Source: 2014 Edelman Trust Barometer Source: 2013 Gallup World Poll Source: 2014 Pew Global Attitudes Project
Confidence in the economy and the future The Chinese are quite optimistic about the country’s economy and future. According to the 2014 Pew Research Global Attitudes Project survey, 89% of Chinese interviewees believe China’s economic situation is good, 80% expect the economy to further improve in the future and 85% believe the next generation will have a better future. This confidence in China’s short term, medium term and long term economy is unique among countries surveyed, surpassing the results of both developed and developing countries.
Exhibit 16: National satisfaction/dissatisfaction (%) Dissatisfied Satisfied China 8 87
Germany 38 59
Russia 36 56
UK 55 40
India 60 36
Japan 60 34
US 62 33
Brazil 72 26
Source: 2014 Pew Research Global Attitudes Project
page 6 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 17: Current economy (%) Exhibit 18: Future economy (%) Exhibit 19: For next generation (%) Bad Good Improve Remain the same Worsen Worse off Better off China 6 89 China 80 15 2 China 6 85 Germany 15 85 India 71 16 5 Brazil 25 72 India 30 64 Brazil 63 22 15 India 24 67 Russia 50 44 UK 45 36 17 Russia 21 44 UK 55 43 US 35 33 30 Germany 56 38 US 58 40 Russia 31 44 20 US 65 30 Japan 63 35 Germany 26 52 20 UK 72 23 Brazil 67 32 Japan 15 54 29 Japan 79 14
Source: 2014 Pew Global Attitudes Project Source: 2014 Pew Global Attitudes Project Source: 2014 Pew Global Attitudes Project
Reflexivity – the positive feedback loop of confidence If one believes in the social theory of reflexivity (a la George Soros), confidence can create a positive feedback loop. Confident citizens provide civil support to the government, which allows policies to be implemented more easily and efficiently, which, in turn, reforms the economy, resulting in sustained growth… and more confidence. As a side- effect, this optimism and confidence will help improve market sentiment.
A stock market to match China’s economy A great economy Although China’s economy grew rapidly in the past decade, the A-share market did not respond in kind. At the end of 3Q14, the SHCOMP was only 31% higher than 2000 levels (a ~2% CAGR), while China’s GDP increased more than 220% (8-9% CAGR). We believe China’s A-Shares did not benefit from economic fundamentals because equity markets were poorly regulated and companies poorly governed.
A lagging stock market China’s capitalization rate (market cap/GDP) is much lower than peer countries. The A- share market cap only accounted for 42% of total GDP, compared to 190%, 184% and 139% for Taiwan, Singapore and the US, respectively.
Exhibit 20: SHCOMP growth vs. China GDP growth since Exhibit 21: China’s capitalization rate is low
2000 600% 573% 250% 500% 200% 400% 150% 300% 100% 190% 184% 200% 139% 50% 129% 95% 82% 77% 100% 49% 42% 37% 0% 20%
0% -50%
SHCOMP GDP
Source: Bloomberg, Jefferies Source: IMF, Bloomberg, *HK local registered companies only.
page 7 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
A stock market that China deserves With the implementation of financial and economic reforms, China’s capital market will become safer and more transparent, SOE governance will improve and more companies will raise funds through equity financing. We believe valuations will gradually normalize towards global peer levels as the market’s potential is fully released.
It’s starting… China’s A-share market reached US$5.0tn in market cap in Nov. 2014, surpassing Japan to become the second largest market in the world. We believe further upside will be driven by the gradual acceleration of financial and economic reforms.
Exhibit 22: A Share market cap (Rmb bn) Exhibit 23: …surpassed Japan in Nov 2014 US$ bn 31,000 Japan China 6,000 29,000 27,000 5,000
25,000 4,000 23,000 3,000 21,000 2,000 19,000 17,000 1,000
15,000 -
Source: Shanghai Stock Exchange Source: Bloomberg
Third Plenum: a roadmap for future prosperity Anti-corruption clears the way In November 2012, China’s central government launched President Xi’s signature anti- Exhibit 24: Number of officials corruption campaign. Mr. Wang Qishan, Xi’s right hand man, was assigned to lead The under investigation Central commission for Discipline Inspections (CCDI), the organization responsible for 200 178 investigating government corruption at all levels. 168
150 Unlike anti-corruption effort of the past, this one has been surprising in its tenure, ferocity 114 and breadth. Thanks to the iron-fisted execution, remarkable changes have swept across 100 63 68 China’s government. Extravagances, such as lavish banquets, first-class flights and constructing luxurious office buildings, have been essentially banned. Government 50 33 officials are required to declare personal assets. Monitoring of officials by the Central 1 5 4 0 Commission for Discipline Inspection is now genuinely feared rather than dismissed.
President Xi famously declared that he would pursue corrupt officials at all levels, both Source: CCDI, Jefferies tigers and flies. Breaking the mould, this campaign has reached inside the Standing Committee of the Politburo itself, bringing down Zhou Yongkang, a recently retired powerful member, who was known to represent the vested interests of the SOEs.
Winding down to “maintenance and optimization” mode Wang Qishan has publicly declared that the anti-corruption campaign will continue indefinitely. While we believe Mr. Wang is sincere in his determination to prevent a regression to old habits, much of the rhetoric is for political effect. The number of new cases disclosed at CCDI website declining meaningfully. While a zero tolerance policy may require the investigation of substantially more officials, we believe the anti-corruption campaign has changed cadre behaviour and reined in the worst abuses of past years. page 8 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
The anti-corruption campaign has likely entered a new phase focusing institutional reforms to prevent backsliding. With anti-corruption in “maintenance and optimization” mode, the focus of the Xi administration is likely to shift to economic reform.
Focusing on driving reforms Aggressive and ambitious The Third Plenum proposed a critical set of reforms designed to deepen the market economy and improve livelihoods. These include letting the market play a “decisive role” in resource allocation, promoting “mixed ownership” of SOEs and upgrading the social safety net.
We believe the political reforms highlighted by the Third Plenum are myriad, substantial, and likely to be dismissed by Western observers. Political progress in China (and for all nations) is better judged through the lens of effectiveness rather than on a contrived authoritarian-democratic scale. We believe China is recreating Singapore writ large. Government power is being centralized; priority will shift from economic participation to social administration; SOEs will act less as levers of economic planning and more to maximize value of the nation's assets.
Performing above expectations In our China 2025 report, we argued that 1) inequality is the root cause of low consumption, 2) economic and social reform will happen organically and 3) transfer payments and strengthening the social safety net (healthcare, education, pensions etc.) will push China’s economic growth into the domestic consumption phase.
The third plenum posted a historical landmark, as its scale, scope and timeline beat even our aggressively bullish expectations. A strong visionary, President Xi reached a good balance between Mao and Deng, to his left and right. He has implemented more reforms in the past two years than his two predecessors combined.
Exhibit 25: Reform highlights Economic reform Political reform
Market to play "decisive" role in resource allocation Set up Central Reform Committee Promote "mixed ownership" of SOEs New standards to evaluate officials
Increase SOE dividend pay-out to 30% Strengthen judicial system Transfer some state assets to social security fund Abolish reeducation through labor
Establish unified rural/urban land market Strengthen anti-corruption efforts Support the Free Trade Zones Strengthen environment regulations Accelerate Rmb convertibility Lower entry barriers for private/foreign investors Social reform Strengthen protection of intellectual property Relax one child policy Impose property tax, luxury tax, close loopholes Promote urbanization
Strengthen pension system Strengthen social healthcare system
Strengthen education and vocational training Increase supply of social housing
Increase spending on welfare Source: The Third Plenum. Jefferies: China 2025, A Clear Path to Prosperity.
page 9 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 26: Significant progress made on deepening reform Key Sectors 60 Points Reform Tasks Time Update on Implementation Progress 1 Guiding Principles 1,2,3,4 Guiding principles to drive comprehensive reform Nov-13 Mandatory training for all senior government officials in party school on Third Plenum initiatives to drive reform. State Council proposed a draft plan for Property Registration system . Dozens of provinces launched pilot plans for 5 Perfect the protection of property rights Jul-14 registration of property ownership. Basic economic Citic Pacific to acquire 100% of parent group, asset valued at US$36bn; Sinopec announced plans to sell up to 2 6 Develop a "mixed ownership" economy Feb-14 system 30% of retail unit to private investors. 7 Improve corporate governance at SOEs Dec-13 SOE management compensation to be appropriately set, with improved audit systems and disclosure system 8 Support healthy development of non-public sector Feb-14 National Energy Administration issued trial Regulatory Measures for fair and open access to oil & gas pipeline. 9 Establish fair, open and transparent market rules Dec-13 Twelve authorities including Ministry of Commerce start to remove regional blockades to break through industry NDRC to improve pricing mechanisms for commodity resources and deepen reforms in power, natural gas, 10 Perfect market-based pricing mechanism Jan-14 railway and aviation sectors Modern market 3 11 Build up unified rural-urban market for constrution land Jul-14 Hainan, Anhui and Shanxi to build rural-urban construction land transaction market. system 12 Perfect financial system Nov-13 CSRC issued the Comments concerning Further Promoting the Reform of New Stock Issuance System State Council approved the Opinion concerning the production and sale of fake, counterfeit and sub-standard 13 Deepen reforms of science and technology system Nov-13 goods and IPR infringement 14 Improve macroeconomic planning system Dec-13 CPC Central Committee suggested it will no longer assess local officials based on GDP ranking Government 4 15 Comprehensive and proper government functions Dec-13 The State Council removed or delegated over 300 administrative approval items functions 16 Optimize administrative structure in governments Nov-13 Henan announced a plan to have ten counties directly supervised by the provincial government 17 Improve budgetary management system Dec-13 The Ministry of Finance will push governments to publicize budgetary planning and improve budget control Fiscal and taxation 18 Improve taxation system Dec-13 State Council to launch pilot business tax to VAT reform in railway transportation and postal industries 5 system Match local governments' rights with spending Finance minister Lou Jiwei proposed to clearly divide the expenditure responsibilities between the central and 19 Dec-13 responsibilities local governments 20 Accelerate buildup of modern agricultural system Feb-14 Ministry of Agriculture issued opinions concerning promoting household farms 21 Grant farmers more property rights Feb-14 NDRC said it will improve the mechanisms for agricultural product pricing to subsidize producers Urban-rural 6 The MOFCOM issued opinions on speeding up the development of modern agriculture to further increase the integration 22 Faciliate balanced allocation of public resources Feb-14 development vitality in rural areas 23 Perfect system for healthy development of urbanization Feb-14 Jiangsu announced relaxation of the conditions for hukou conversion in small towns and cities 24 Lower entry barriers for investments Jan-14 Ministry of Commerce will relax investment entries and restrictions on outbound investments 7 Opening up 25 Accelerate construction of FTZ Feb-14 PBOC announced details on cross-border RMB settlement and FX reform in Shanghai FTZ 26 Expand oepning up of inland regions Dec-13 Central economic work conference decided to promote the construction of economic belt along the Silk Road Local governments including Beijing and Hubei reviewed the development of the people's congress system in past 27 Bring the people's congress system inline with time. Aug-14 sixty years and discuss ways to innovate and improve the system. 8 Political system Many cities including Shanghai, Hangzhou, Ganzhou and Tangshan to introduce plans to promote institutionalize 28 Institutionalizing political consultative mechanisms Aug-14 political consultative mechanism 29 Develop democracy mechanism in local governments Nov-13 Anhui Wuhu to implement six key guidelines to strengthen organization structure in rural areas. 30 Uphold the authority of Constitution and Law Oct-14 Promote the authority of constitution and rule of the law a key focus of the 4th plenum in October. 31 Deepening reform on execution of administrative measures Nov-13 Ministry of Communication and Ministry of Education implemented plans for administrative reform
9 Rule of law 32 Ensure independence and lawful rights of judicial courts Oct-14 Promote judicial reform a key focus of the upcoming 4th plenum in October. The Supreme People's Procuratorate issued 2014-18 plan for enhancing construction of local People's 33 Improve judicial processes and mechanisms Dec-13 Procuratorate 34 Perfect the system for protection of human rights Dec-13 The Standing Committee of the NPC announced the abolition of the reeducation through labor system 35 Establish effective system for check and balance of power Feb-14 Ministries of the central government publicize administrative approval items Restraining the use 10 36 Enhance innovation of anti-corruption mechanism Jan-14 Central Commission for Discipline Inspection sets innovation of anti-corruption mechanism a top priority of power 37 Perfect rules for improve governments' working style Nov-13 The CCP and State Council issued anti-waste regulations to be implemented in governments 38 Perfect cultural sector management system Jan-14 First nation-wide vocational training and appraisal for journalists launched Ministry of Finance and State Taxation Bureau announced waiver of VAT for wholesaling and retailing books from 39 Build up modern public cutural service system Jan-14 11 Cultural system 2013-2017 40 Construct modern public cultural service system Mar-14 A working committee is set up to build a comprehensive public cultural service system in next 3-5 years 41 Improve openness standard for cultural industry Feb-14 Government to enhance cultural exchange and the penetration of Chinese culture in overseas markets 42 Comprehensive cultural and education reform Dec-13 Ministry of Education published details on college entrance mechanism reform Improve the mechanism for facilitating employment and Ministry of Human Resources & Social Security proposed to establish more equitable employment mechanisms to 43 Dec-13 support start-ups eliminate discrimination Raised monthly benefit payment of its 75 million retirees by 10%; government to focus on providing a social safety 44 Form fair and effective income distribution system Jan-14 12 Social services net to people in needs Integrate the pension systems for urban and rural citizens; Ministry of Housing & Urban Residence announced the 45 Establish fair and sustainable social security system Dec-13 merger of low-rent housing system with the public housing system Critical illness insurance to be implemented in trial cities by June 2014; detailed guidelines announced to 46 Deepening reform in healthcare sector Jan-14 accelerate development of private hospitals 47 Improve social governance Jul-14 Jiangxi established plan to improve social governance according to the rule of law (2014-2020). 48 Invigorate non-governmental organizations Dec-13 The Ministry of Civil Affairs will start separating trade associations from administrative organs in 2014 13 Social management Create innovative practices for prevent and disolve social The State Council issued Opinions Concerning Innovative Mass Work Methods to Resolve Acute Petitioning 49 Jan-14 conflicts problems 50 Perfect public security system Jan-14 Xi Jinping was nominated as the head of National Security Commission by the Politburo 51 Perfect the management of natural resources & allocation Jul-14 Guizhou to prepare the balance sheet included natural resources in local regulation The State Council issued circular on the administrative provisions on the adjustment of national-level nature 52 Strengthen natural resource protection Dec-13 Environmental reserves 14 regulation 53 Implement biological compensation rules Dec-13 NPC's environment and resource committee completed biological compensation draft The Ministry of Environmental Protection will restructure current system in 6 areas including waste discharge 54 Reform the system for managing biological environment Feb-14 permit system 55 Deepening reform of military staffing system Mar-14 Xi led China's military reform, to build a strong army focusing on combat readiness Military & national 15 56 Faciliate reform on military policies and regulations Mar-14 Xi led China's military reform, to build a strong army focusing on combat readiness defense 57 Promote military-civilian integration Nov-13 China's Ministry of National Defense announced East China Sea Air Defense Identification Zone 58 Establish a leading group for deepening of reform Dec-13 Xi Jinping was nominated head of the Central Leading Group for Comprehensively Deepening Reform Party leadership to 16 drive reform 59 Deepen reforms on party cadre management system Dec-13 The Politburo approved rules on selection of the Party and government leading cadres 60 Maintain Party's close ties with the mass Aug-14 Ganshu to focus on provide social welfare to those in need and strengthen the connections with mass Source: As of Dec, 2014, Jefferies analysis based on various Chinese media reports
page 10 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015: Keeping Growth Steady a Top Priority On Dec. 11, China’s leaders and senior officials concluded the three-day Central Economic Work Conference, a crucial meeting aiming to set the tone for economic policies in 2015.
While China could reach its social and economic development goals for 2014 relatively well, with the economic growth staying within a reasonable range, leaders stressed that the economy still faces many challenges and relatively big downward pressures such as increasing difficulties for businesses and the emergence of economic risks.
China will strive to keep economic growth and policies steady in 2015 and adapt to the "new normal" of slower speed but higher quality. Continuity and stability are keys to macroeconomic policies. "The proactive fiscal policy should be stronger and the prudent monetary policy should be more focused on striking a proper balance between being tight and loose," according to the official statement.
To reach the 2015 goals, the leaders also vowed to accelerate reforms, further open up the economy, encourage innovation, upgrade agriculture, enhance regional integration, and improve low-income people's life. The meeting highlighted five main tasks in 2015:
Firstly, China should make efforts to keep the economy growing steadily. The key point is to keep balance between stabilizing growth and adjusting structure, and continue to carry out proactive fiscal policies and prudent monetary policies.
Secondly, China should actively seek new economic growth points. That requires China to make the market play a decisive role in resource allocation, promote all-around innovation, use industrialized innovation to foster new economic growth points, and form the policy environment as well as institutional environment that benefits business start-up and market development.
Thirdly, China should accelerate the agricultural development mode. The issues of agriculture, farmers and rural areas are always priorities of the central leadership. China should continue to make solid foundation for agricultural development, accelerate transformation of agricultural development mode, and deepen various reforms in the rural areas.
Fourthly, China should optimize regional pattern of economic development. It is necessary to perfect regional polices, and promote the coordinated development, collaborative development and joint development among different regions.
Fifthly, China should make efforts to guarantee and improve people's livelihood. More attentions will be paid to the low-income people, and ensure that children of poor families can also receive equal and qualified education.
We believe Central Economic Work Conference has identified that China’s top priority in 2015 will be to maintain steady economic growth. We believe China will adopt a more pro-growth strategy to support domestic consumption, drive fixed asset investment and support export growth. We expect the domestic and overseas stock markets to respond positively, with increasing confidence and fundamental improvement.
The start of a monetary easing cycle In a surprise move, China cut one-year benchmark lending rates to 5.6% (-40bps) and one-year benchmark deposit rates to 2.75% (-25bps) in late November 2014. We believe the rate cut marks the beginning of a monetary easing cycle. A cut in benchmark lending rates, as opposed to government directed stimulus spending and credit expansion, is a more market optimal easing strategy.
page 11 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Although PBOC has 'tinkered around the edges' in easing monetary policy, the real threat of deflation ought to mean that more changes in nominal rates are forthcoming. The recent asymmetric rate cut is unlikely to be the last. Alongside the pressure from falling asset prices, global commodity prices have rolled over, led by oil, coal and iron ore. Real borrowing rates are set to climb close to their all-time peaks unless rates are cut further.
We believe the rate cut underscores China’s determination to support growth and avoid a hard landing. The surprise rate cut also provided a much needed boost to market sentiment. We expect more monetary easing ahead and demand recovery to follow. The impact to real economy should be very positive, with property, brokers, and highly geared sectors benefiting the most.
China continues to be largest contributor to global growth In purchasing power parity terms (PPP), China accounted for 15.9% of global GDP in 2013 (12.3% in current US dollar terms) second behind the US. China has led the world in contribution to global GDP growth since 2003.
In 2013, when China’s GDP growth slowed to a 14-year low level of 7.7%, it accounted for nearly 30% of global growth. Considering China’s large GDP base and relatively high growth rate among global peers, we believe this trend will continue.
Exhibit 27: China GDP as % of Global GDP in terms of Exhibit 28: China GDP growth contribution to global PPP GDP growth at international PPP (%)
18.0 120 110 15.9 16.0 100
14.0 80
12.0 60 10.0 40 29 29 22 23 24 25 8.0 19 19 17 14 17 17 20 6.0 - 4.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(20) 2.0
0.0 (40)
China EU United States Japan
Source: World Bank, Jefferies Source: World Bank, Jefferies
Slower “New Norm” growth de-risks “Black Swan” event China’s government has shown their determination in economic reform, anti-corruption and environmental protection. The country is trying to control credit growth and structurally transform the economy, accepting a lower “new normal” growth rate.
On the other hand, China has launched mini infrastructure stimulus plans and has just cut benchmark interest rates. We believe the government is fine-tuning its easing efforts to soft-land the economy. Under this “new normal”, we believe the risk of a “Black Swan” event is largely removed. And in turn, China’s risk premium should decline, which is also very positive to drive strong performance of stock market.
page 12 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
The Bull Case for China A shares A Share offers the lowest correlation to other markets Based on our analysis, the 3-year correlation between China A-share and US stock market is nearly zero; the two markets are basically acting independently. Correlation with Japan, Europe and Asia ex-Japan is also low, which means that China’s A-shares do not behave like any other market.
Exhibit 29: 3 Year Overall Correlation China A USA Japan Europe Asia ex Japan China A - -0.01 0.13 0.06 0.35 USA - - 0.52 0.81 0.47 Japan - - - 0.50 0.41 Europe - - - - 0.53 Asia ex Japan - - - - - Source: Bloomberg as of Dec 11, 2014; Jefferies
Exhibit 30: A share has the lowest correlation with other markets
Source: Bloomberg as of Dec 11, 2014; Jefferies
Transparency and shareholder protection improving In the past year, the State Council released new guidelines to further regulate and develop China’s capital markets. The documents emphasizes protecting the rights of investors, improving information disclosure, upgrading the quality of listed companies and implementing delisting systems, etc. It also focuses on capital market liberalization with plans to allow more qualified foreign investors to participate.
Jefferies’ 2015 targets: SHCOMP 4,050, HSCEI 15,420 As of December 12, 2014, the Shanghai Composite (SHCOMP) surged 39% to 2938 points, leading all major global indices. Following a seven year prolonged bear market, this is the first time SHCOMP has outperformed global peers in recent years. Despite the rally, Chinese stocks are still trading at a discount vs. its historical levels and global peers.
We believe China’s stock market has entered a historic bull market, and expect stock prices to continue to appreciate, as the market gradually gains confidence in reform dividends and fundamental improvements.
Our SHCOMP 2015 target is 4,050, based on a 15x 2016 P/E, which we see as reasonable given the reduction of risk premium and an estimated earnings growth of 12%.
Our HSCEI target is 15,420, based on 10x 2016 P/E. We expect HSCEI to catch up to the A share rally, as foreign investors gradually gain confidence in Chinese leaders as reform dividends start to pay off, and the fundamentals start to show improvement.
page 13 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 31: 2007-2013 index performance Exhibit 32: YTD Index Performance
SHCOMP 38.3% NASDAQ 72.9% NASDAQ 12.1% KOSPI 40.2% NIKKEI 225 5.9% DJIA 33.0% DJIA 5.8% HSI 16.7% HSCEI 4.1% FTSE 100 8.5% Euro Stoxx 1.3% HSCEI 4.6% HSI 0.0% NIKKEI 225 -5.4% FTSE 100 Euro Stoxx -20.6% -4.4%
SHCOMP -20.9% KOSPI-4.7%
-40% -20% 0% 20% 40% 60% 80% -10% 0% 10% 20% 30% 40% 50%
Source: Bloomberg Source: Bloomberg, as of Dec 11, 2014
Exhibit 33: Major index comparison Index Price PB PE EV/EBITDA Div Yield Score* FY1 FY2 FY1 FY2 FY1 FY2 HSI 23,312.5 1.31 10.96 10.31 9.25 8.62 3.63 3.85 -0.25 HSCEI 11,255.4 1.20 7.82 7.30 6.82 6.20 4.08 4.38 -0.71 CSI 300 3,183.0 1.98 12.91 11.23 11.26 9.73 2.28 2.55 0.43 MSCI AeJ 558.4 1.45 12.87 11.55 9.27 8.39 2.65 2.87 0.06 Topix 1,397.0 1.29 15.39 13.71 10.13 9.21 1.77 1.94 0.35 S&P 500 2,035.3 2.75 16.89 15.68 10.47 9.88 1.97 2.13 0.83 Euro Stoxx 339.3 1.52 15.86 13.66 8.45 7.93 3.30 3.58 0.04 600 MSCI EM 938.4 1.42 12.11 10.84 8.11 7.44 2.91 3.13 -0.13 MSCI EMEA 270.4 1.19 10.12 9.28 5.81 5.62 3.87 4.15 -0.64 Source: Bloomberg, as of Dec 11, 2014 * Combination score of PB, PE FY1, EV/EBITDA FY1, Div. Yield FY1 (Lower the better)
Exhibit 34: Chinese stocks are still valued at a discount to US
1 0.8 0.8
0.6 0.4 0.4 0.4
0.2 0.0 0.1 0
-0.2 -0.1 -0.4 -0.2
-0.6 -0.6 -0.8 -0.7 H Shares EM EMEA HK EM Europe AeJ Japan A Shares US
Source: Bloomberg, as of Dec 11, 2014
page 14 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Chinese stock market: too big to ignore
China is the world’s second largest economy with the second largest stock market, however, it only accounts for 3% of the MSCI AC World Index at this time. MSCI initiated a review of China A-shares for potential inclusion into their Emerging Market Index. Even though they decided not to include China A-share in 2014, they stated that the decision would be reviewed again in 2015. Limited access is a major obstacle to inclusion.
The Shanghai-Hong Kong Stock Connect scheme allows foreign investors to invest directly in stocks listed on the Shanghai exchange, with less restriction and procedures required compared with the QFII system. Investors are able to invest in as many as 568 stocks with a combined market cap of US$2.6 trillion. The SH-HK Connect is a milestone in the globalization of China’s equity markets. We believe the ongoing liberalization of China’s A-Share market will soon qualify it for inclusion in major global indices.
… foreign A-share ownership may increase from 1% to 15-20% in 10 years With continued liberalization and globalization efforts, we believe foreign ownership may increase from 1% currently to 15-20% by 2020.
Exhibit 35: Current MSCI EM index status Exhibit 36: Pro forma weight of China in MSCI EM index
Source: MSCI, March 2014 Source: MSCI, March 2014
Exhibit 37: Market cap – US is 5 times that of China Exhibit 38: A Share weekly trading volume higher than the US
US$ bn China US 200,000 30,000 US China US 25,000 150,000
20,000 100,000 15,000
10,000 50,000 5,000 China - -
Source: Shanghai Stock Exchange, Jefferies Source: Shanghai Stock Exchange, Jefferies
page 15 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Our Journey Begins with China 2025 In November 2012, Jefferies’ HK/China Research team took a long hard look at China’s long-term prospects to understand how the economy will evolve, which industries will prosper and how investors should be positioned for the long haul. Based on the collective insights of our analysts, we published a 430-page report China 2025: A Clear Path to Prosperity in January 2013.
In this landmark strategy piece, we wrote that economic reforms in China are required, well understood and will develop organically. Reforms such as economic rebalancing, reducing inequality, financial liberalization, environmental protection, liberalizing rural land transfers etc. have become boilerplate, discussed by various government entities in many different forums. We believe the necessity of reform has won the argument at many levels of China’s government; the challenge is to overcome inertia and vested interests.
China's old growth model has run its course, revealing vulnerabilities in an unbalanced economy. As expected, policy uncertainty made 2013 challenging for equities. In our report China 2013: Transformation and Volatility in the Year of the Snake published February 2013, we wrote: “We expect 2013 to be a volatile year for China equities, as the market comes to terms with the developing policy trajectory. We would not be surprised if China stocks ended the year not far from where they began”.
2014 will be different, in our view. In our report China 2014: The Year of the Horse: China Gallops into a Historic Bull Run published in November 2013, we wrote:
We believe China is recreating Singapore writ large. Government power is being centralized; priority will shift from economic participation to social administration; SOEs will act less as levers of economic planning and more to maximize value of the nation's assets.
We believe President Xi is a determined reformer. After consolidating power, he now has the political capital to rapidly implement bold and myriad policies, in our view. We expect capital markets to gradually gain confidence in China’s ability to drive fundamental reforms and expect Chinese stocks to enter a historic multi-year bull run.
Since then, we also published a dozen reports to discuss the reforms and their implications on equity markets, the most notable being:
Despite a volatile start, we reaffirm our bullish view on China. Chinese stocks have lagged global peers in 2013 and since 2007; with valuation at historical low, we see downside risk as limited. China is on the cusp of a multi-year bull run, we expect capital market to gain confidence on improved policy clarity. 22 January, Darkness Before Dawn
We believe SH-HK Stock Connect is a landmark in the globalization of China’s capital market. China remains the largest contributor of growth, offering low correlation to other markets. 8 October, China A Share Outlook Bullish
China’s rate cut marks the start of a monetary easing cycle and also provides a much-needed boost to market sentiment. We expect more monetary easing ahead, and real impact to drive demand recovery to follow. Our Bull Case for A shares is getting stronger; we expect the stock market to rally, and property, broker and high beta stocks to outperform.
23 Nov. Surprising Rate Cut to Drive China Stock Market Higher
page 16 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
2014 defining moments: Captured by Jefferies
As we are heading into 2015, we want to highlight our China 2025 and China Strategy reports, which have captured 2014’s defining moments highlighted above.
China 2025: A Clear Path to Prosperity In this report, we hope to shine a light on China’s economic path to 2025. We hope to convincingly show that inequality, not excess savings, has suppressed consumption. We believe urbanization will be China’s growth engine, and transfer payments will be the ignition key. We believe the timing is ripe for reforms to occur organically. We highlight China’s defining trends till 2025 and suggest how to be positioned for the long haul.
China 2013: Transformation & Volatility in the Year of the Snake The Year of the Snake will see China shedding its old skin and growing a new one – shifting from export and FAI driven growth to the new paradigm of domestic consumption. We believe 2013 could be a volatile year for Chinese equities, as the market comes to terms with the new growth trajectory.
China 2014: The Year of the Horse: China Gallops into a Historic Bull Run The Year of the Horse will see China unleash its full potential, as President Xi ushers in a new era of profound change. A journey of a thousand miles begins with the first step. With a clear path to prosperity in sight, we believe China will gallop into a historic multi- year bull run.
Darkness Before Dawn: China on the Cusp of a Historic Bull Run Despite a volatile start, we reaffirm our bullish view on China. Chinese stocks have lagged global peers since 2007; with valuation at historical low, we see downside risk as limited. China is on the cusp of a multi-year bull run, we expect capital market to gain confidence on improved policy clarity. We expect SHCOMP and HSCEI to triple in 3-5 years.
All Eyes on Reform; Strong Earnings to Drive Re-rating We see reform accelerating as China takes bold steps to integrate urban and rural pensions and expand national critical illness insurance. Investor confidence should gradually improve on Third Plenum reforms, clearing the path for higher-quality growth and market re-rating.
No Hard Landing; Poor Interims Paving the Way for Future Performance China's GDP grew 7.5% in Q2, 1H FAI jumped 17.3% as industrial production expanded 9.2% in June. We believe China is back. As new loan growth and power demand are turning positive, we see no hard landing ahead. With reforms accelerating, we expect poor interim earnings to help market consolidation, paving the way for outperformance.
The Road to Recovery Is Never a Straight Line China has made significant progress on 58 out of 60 key reform measures from the Third Plenum; we expect the rule of law will be the focus of Fourth Plenum. Weak Service PMI underscores the challenges on the road to recovery, more mini-stimulus and targeted liquidity should support steady growth. With improving fundamentals and ample catalysts ahead, we believe a real bull market is not far away.
China A Shares Outlook Bullish; the Likely Winners SH-HK Stock Connect is a landmark in the globalization of China’s capital market. China is the largest contributor of growth, offering low correlation to other markets. SHCOMP was the best performing index YTD, we believe the bull case for A-shares is compelling, and expect it to double or triple in next 3-5 years. In this report, we provide a summary of A50 Index composites and highlight the likely future winners.
Surprising Rate Cut to Drive China Stock Market Higher China’s rate cut marks the start of a monetary easing cycle and also provides a much- needed boost to market sentiment. We expect more monetary easing ahead, and real impact to drive demand recovery to follow. Our Bull Case for A shares is getting stronger; we expect the stock market to rally, and property, broker and high beta stocks to outperform.
page 17 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Jefferies’ Key China Strategy Reports
page 18 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
page 19 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 20 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 21 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 22 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 23 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 24 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
page 25 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
China Monetary Relaxation Alongside Firmer Dollar and Stronger US Economy ‘We expect a similar pattern in 2014 with China's stock market outperforming its Sean Darby emerging market peers helped by better economic growth compared to Brazil, India and Chief Global Equity Strategist Indonesia. Expectations of tightening in US monetary policy, a firmer US dollar and falling +852 3743 8073 coal prices have generally been a positive for China's equity markets. Despite the better [email protected] economic data, the Chinese equity market multiple contracted relative to the rest of the world during the last year’, China: The Year of the Horse: China Gallops into a Historic Bull Kenneth Chan Run, 20 November 2013 Quantitative Strategist +852 3743 8079 A tailwind of domestic reform, falling energy prices, revival in US consumer spending and [email protected] flat US interest rates ought to mean a period of outperformance for Asian equities versus their emerging market peers. Moreover, firm tech exports and falling input costs ought to Vivien Hu keep trade balances healthy and central banks more willing to loosen monetary policy. Equity Associate Investors are likely to back economies demonstrating reforms with improving monetary +852 3743 8078 conditions even though global economic growth may be lower than historical trends. [email protected] We believe that a number of China A shares demonstrate improving financial ratios and
strong ROEs as well as increasing dividend payout ratios. We also feel these China A
share companies will benefit from the global ‘reach for yield’ since domestic
retail investors, which dominate turnover, have overlooked this catalyst for A combination of reforms, falling share prices. Interestingly, the China A share market is very under-researched crude oil prices and a wide range of versus its global peers. monetary policy tools keeps us A combination of reforms, falling crude oil prices and a wide range of monetary policy Bullish on China A shares. tools keeps us Bullish on China A shares. Valuations are also appealing while investors are skeptical. The overall China market trades on 10.3x 12-month forward PE, 1.41x 12- month forward PB and 3.26% 12- month forward dividend yield. The market expects 12- month forward earnings growth of 13.4%.
In one sense, the authorities need to move the bubble from the property market to the equity market. There does seem to have been a sea-change in sentiment towards the equity market by retail investors (see exhibits 1 and 2).
Exhibit 39: No. of Shanghai A Share Brokerage Accounts Exhibit 40: No. of Shenzhen A Share Brokerage Accounts Net Openings and Closings since 2010 Net Openings and Closings since 2010
Source: Wind, Jefferies Source: Wind, Jefferies Ultimately, HK stands at the forefront of the largest capital account opening of a country since WWII. Longer term, we would expect that the Chinese fixed income market will also be relaxed and that the Shanghai-HK connect will be utilized in this respect. It would mean that eventually the HK$ would become redundant as more and more commercial transactions are undertaken in RMB. Globally, China will be testing the waters of its own in recycling of its huge FX reserves offshore.
page 26 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
The backdrop for equities is similar in some ways to the late 1990s. Then, Japan and We believe there is a sea-change in Germany were dealing with their own economic restructuring while the emerging global purchasing as consumers in markets were still healing their wounds post the 1994 and 1998 crises. The US was the the US, China, India and Indonesia only economy growing helped by a strong US consumer and relaxed monetary policy stand to benefit from increased courtesy of disinflation in commodity prices and an ultra-easy Fed Chairman, called Alan purchasing power through a rise in Greenspan. real incomes. Equity investors continue to experience a very disinflationary environment with crude oil prices remaining under pressure, a strong US dollar and low inflation readings from the US and Japan. However, we would stress that it is by no means a deflationary world. We believe there is a sea-change in global purchasing as consumers in the US, China, India and Indonesia stand to benefit from increased purchasing power through a rise in real incomes. Moreover, according to the IMF, a drop of US$20 per barrel of oil ought to boost Global real GDP by 0.5% but the relationship is much higher for countries such as China. Indeed, it ought to mean China, India and other EMs dramatically ease monetary policy. The benefits of ‘the windfall commodity tax cut’ will be most felt by low income earners and it ought to mean that the income disparity that has afflicted many nations narrows. We remain long global consumer, short commodity producers.
One risk for China is the ongoing devaluation of the yen caused by the QE policies of the BoJ. If this was compounded by other central banks following suit then there might be a very deflationary impact on Chinese exports (see exhibit 3).
Exhibit 41: RMBJPY Spot Exchange Rate
Source: Bloomberg, Jefferies
The recent asymmetric rate cut is Although overbought in the short term, the fundamental picture for the US dollar unlikely to be the last. Alongside the remains bullish. Ongoing balance sheet expansion by the ECB and the BoJ, better pressure from falling asset prices, incremental US economic data and earlier rate hike expectations than its developed world global commodity prices have rolled peer group, suggest that the dollar will remain well bid. over, led by oil, coal and iron ore. Real borrowing rates are set to climb Unlike the West, Asia and its emerging market peer group have been forced into close to their all-time peaks unless undertaking structural reforms. The early boom caused their economies to overheat, rates are cut further. thereby trapping future growth in a vicious downward spiral of lower GDP, sticky inflation and over-valued exchange rates. This was most obviously seen in China and India. To release the stranglehold of stagflation, Asian leaders have introduced in many cases painful measures to unblock the arteries that provide the support for growth. Premier Li Keqiang, Modi, Jokowi and the rest of the Asian leaders are only in the early stages of these programs.
Although PBOC has 'tinkered around the edges' in easing monetary policy, the real threat of deflation ought to mean that more changes in nominal rates are forthcoming. The recent asymmetric rate cut is unlikely to be the last. Alongside the pressure from falling asset prices, global commodity prices have rolled over, led by oil, coal and iron ore. Real borrowing rates are set to climb close to their all-time peaks unless rates are cut further.
page 27 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Indeed, China’s central bank has been easing policy to combat deflation while the Brazilian central bank has been tightening to defeat inflation. We would prefer Chinese equities versus Brazilian equities.
Exhibit 42: China Real 1 Year Lending Rate (%) Exhibit 43: Brazil Real Interest Rate (%)
Source: Bloomberg, Jefferies Source: Bloomberg, Jefferies Note: real 1 year lending rate (%)= 1 year base lending rate (%) Note: real interest rate (%)= Brazil Selic Target Rate (%) minus minus CPI % y-y CPI % y-y
In our view, the Chinese authorities have a great of deal of monetary and fiscal tools to manage the economy while the unemployment rate is low and inflation concerns are ebbing. Concerns over the strength of the RMB are overdone as the trade surplus should expand given the fall in commodity import prices and the PBOC has a large cushion of excess reserves.
Exhibit 44: China Government Bond Yield Curve (%, 10Y Exhibit 45: Brazil Government Bond Yield Curve (%, 10Y minus 2Y) minus 2Y)
Source: Bloomberg, Jefferies Source: Bloomberg, Jefferies
First, the working capital of China There are two other subtle changes. Firstly, the working capital of China companies companies should improve given the should improve given the near 25% drop in input costs. This ought to boost cash-flows near 25% drop in input costs. This and make a significant shift in the number of companies producing negative cash-flow. ought to boost cash-flows and make a Secondly, the fall in commodities prices should boost consumption. At the margin, significant shift in the number of discretionary spending should pick up. companies producing negative cash- flow. Secondly, the fall in commodity The recent fall in commodity prices should mean a significant boost to the trade account prices should boost consumption. At while lowering inflation pressures further. Indeed the PBOC will find itself in a position of the margin, discretionary spending envy versus the rest of the world with plenty of room to cut rates. The biggest beneficiary should pick up. is the Chinese consumer.
page 28 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 46: China Real Effective Exchange Rate Broad Index Exhibit 47: Brazil Real Effective Exchange Rate Broad Index
Source: Bloomberg, BIS, Jefferies Source: Bloomberg, BIS, Jefferies
In contrast to China, Brazil’s central bank remains on a policy tightening path. Brazilian inflation remains sticky while the economy is experiencing a negative terms-of-trade (export prices to inputs) shock. By itself, the Chinese rate cut is unlikely to stimulate GDP meaningfully and hence is not set to encourage increased import of commodities. China’s terms of trade are improving fast given that a significant proportion of its commodities are priced on a cash basis. We remain long China, short Brazil.
Exhibit 48: China CSI 300 Index/Ibovespa Brasil Sao Paulo Stock Exchange Index (x, US$,2009=100)
Source: Bloomberg, Jefferies
China’s competitiveness remained the same compared to 2013-14, according to the World Economic Forum Competitiveness Report 2014-15. The latest report highlighted that ‘Access to loans remains very difficult for a large number of SMEs’. The functioning of the market is also improving, but various limiting measures and barriers to entry, along with investment rules, greatly limit competition. China is becoming more innovative, but it is not yet an innovation powerhouse. There is very little change in the assessment of the country’s governance structures.
page 29 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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China
14 December 2014
Exhibit 49: The Global Competitiveness Index 2013-2014 rankings and 2012- 2013 comparisons GCI 2014-2015 Rank among 2013-2014 GCI 2013-2014 Country/Economy Rank (out of 144) Score (1-7) economies* (out of 148) Switzerland 1 5.70 1 1 Singapore 2 5.65 2 2 United States 3 5.54 3 5 Finland 4 5.50 4 3 Germany 5 5.49 5 4 Japan 6 5.47 6 9 Hong Kong SAR 7 5.46 7 7 Ntherlands 8 5.45 8 8 United Kingdom 9 5.41 9 10 Sweden 10 5.41 10 6 Norway 11 5.35 11 11 United Arab Emirates 12 5.33 12 19 Denmark 13 5.29 13 15 Taiwan,China 14 5.25 14 12 Canada 15 5.24 15 14 Qatar 16 5.24 16 13 New Zealand 17 5.20 17 18 Belgium 18 5.18 18 17 Luxembourg 19 5.17 19 22 Malaysia 20 5.16 20 24 Austria 21 5.16 21 16 Australia 22 5.08 22 21 France 23 5.08 23 23 Saudi Arabia 24 5.06 24 20 Ireland 25 4.98 25 28 Korea, Rep. 26 4.96 26 25 Israel 27 4.95 27 27 China 28 4.89 28 29 Source: World Economic Forum The Global Competitiveness Report 2014-2015, Jefferies Note: * this column ranks all those economies for 2014–2015 that have been covered both in the 2013–2014 and 2014–2015 editions, hence a constant sample of 143 economies.
Exhibit 50: The most problematic factors for doing business in China
Source: World Economic Forum The Global Competitiveness Report 2014-2015, Jefferies Note: From the list of factors above, respondents were asked to select the five most problematic for doing business in China and to rank them between 1 (most problematic) and 5. The bars in the figure show the responses weighted according to their rankings.
page 30 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 51: China Return on Equity (12 month forward) Exhibit 52: China FY1 Earnings Revision
Source: FactSet, Jefferies Source: FactSet, Jefferies Note: Earnings revision= no. of up estimates minus no. of down estimates/total no. of estimates
Exhibit 53: China FY2 Earnings Revision Exhibit 54: Equity Market Flows into China
Source: FactSet, Jefferies Source: Bloomberg, EPFR, Jefferies Note: Earnings revision= no. of up estimates minus no. of down estimates/total no. of estimates
Exhibit 55: Weighting of China in an Asia ex-Japan portfolio Exhibit 56: Weighting of China in a GEM portfolio vs. its vs. its five-year average five-year average
Source: EPFR, Jefferies Source: EPFR, Jefferies
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Equity Strategy
China
14 December 2014
The Year of the Ram: Stars Are Aligned
China Stock Market - Massive Untapped Potential 4
The Third Plenum: A Roadmap for Future Prosperity 8
2015: Keeping Growth Steady a Top Priority 11
The Bull Case for China A Shares 13
Our Journey Begins with China 2025 16
China Macro: Monetary Relaxation 26
Jefferies Sector Allocation & Top Picks
2014 Sector Performance 33
Summary of Sector Views 35
2015 Sector Allocation & Top Picks 37
China 2015 Sector View
Autos & Machinery 72
Consumer 76
Conglomerate & Gaming 81
Energy (Oil & Gas, Coal) 87
Financials (Banks, Insurance & Brokers) 92
Healthcare 95
IPPs, Clean Tech & Environmental Services 101
Metals & Mining (Cement, Steel & Gold) 113
Property 126
TMT (Telecom, Internet & Tech) 131
Transportation (Airlines, Ports & Shipping) 139
page 32 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
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14 December 2014
Jefferies Sector Allocation & Top Picks Chinese A shares had a good run in 2014; the CSI 300 surged 37% YTD on average, vs. only 4% on average for Hong Kong listed domestic shares (HSCEI).
Within the CSI 300, Utilities, Financials and Industrials are the best performers, rising 63%, 59% and 54% YTD, respectively. Industrials, Telecom and Utilities did better than others in the Hong Kong market, improving 28%, 14% and 13%, respectively during the same period.
Exhibit 57: HSCEI sector performance YTD % Exhibit 58: CSI 300 sector performance YTD %
Industrials 28 Utilities 63 Telecom 14 Financials 59 Utilities 13 Industrials 54 Financials 10 Materials 41 Health Care 7 Telecom 36 Energy -7 Consumer Discretionary 32 Materials -7 Consumer Staples 19 Consumer Discretionary -7 Health Care 15 Consumer Staples -18 Energy 14
-25 -15 -5 5 15 25 35 0 10 20 30 40 50 60 70
Source: Bloomberg, Price as end of Dec 11, 2014 Source: Bloomberg, Price as end of Dec 11, 2014
Within the HSCEI universe, we believe financials, energy, utilities, telecom and materials are undervalued comparing with other sectors. In the CSI300, we see financials, energy, utilities, telecom and consumer discretionary are more attractive in terms valuation.
Exhibit 59: Sector valuation - HSCEI Sector PB PE EV/EBITDA Div Yield Score* FY1 FY2 FY1 FY2 FY1 FY2 Consumer Discretionary 1.47 14.59 10.96 13.93 10.25 0.02 0.02 0.29 Consumer Staples 3.78 28.89 25.83 16.34 14.07 0.01 0.01 1.05 Energy 1.01 9.46 9.51 5.20 5.03 0.05 0.04 -0.39 Financials 1.13 6.51 6.07 na na 0.05 0.05 -0.54 Health Care 1.15 20.69 17.04 6.23 5.25 0.01 0.02 0.17 Industrials 1.12 9.94 8.72 8.96 8.13 0.02 0.02 -0.02 Materials 1.18 9.66 9.05 7.15 6.88 0.02 0.02 -0.11 Telecom 0.17 15.87 14.41 1.35 1.26 0.02 0.02 -0.29 Utilities 1.33 9.80 8.94 6.79 6.22 0.05 0.05 -0.33 Source: Jefferies, Bloomberg * Combination Score of PB, PE FY1, EV/EBITDA FY1, Div Yield FY1 (Lower the better), priced as of Dec 11, 2014
Exhibit 60: Sector valuation – CSI 300 Sector PB PE EV/EBITDA Div Yield Score* FY1 FY2 FY1 FY2 FY1 FY2 Consumer Discretionary 2.70 15.03 12.16 11.54 9.50 0.02 0.03 -0.09 Consumer Staples 3.49 18.04 15.64 11.57 10.15 0.02 0.02 0.13 Energy 1.39 13.46 13.44 6.73 6.50 0.03 0.03 -0.53 Financials 1.36 7.71 7.11 na na 0.04 0.04 -0.87 Health Care 4.02 27.41 21.99 18.65 15.02 0.01 0.01 0.74 Industrials 1.94 17.05 14.32 11.32 9.91 0.02 0.02 -0.04 IT 3.29 30.81 23.26 21.58 16.62 0.01 0.01 0.73 Materials 2.04 28.50 21.71 13.08 11.32 0.01 0.01 0.26 Telecom 1.48 24.81 20.39 3.91 3.59 0.02 0.02 -0.16 Utilities 1.94 12.73 11.76 8.88 8.36 0.03 0.03 -0.41 Source: Jefferies, Bloomberg * Combination Score of PB, PE FY1, EV/EBITDA FY1, Div Yield FY1 (Lower the better), priced as of Dec 11, 2014
page 33 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 61: HSCEI sector valuation Score Exhibit 62: CSI 300 sector valuation Score
1.2 1.1 1 1 0.8 0.7 0.7 0.8 0.6
0.6 0.4 0.3 0.4 0.3 0.2 0.1 0.2 0.2 0
0 -0.2 -0.1 0.0 0.0 -0.2 -0.2 -0.1 -0.4 -0.4 -0.4 -0.3 -0.3 -0.6 -0.4 -0.5 -0.6 -0.5 -0.8 -0.8 -1 -0.9
Source: Bloomberg, Price as end of Dec 11, 2014 Source: Bloomberg, Price as end of Dec 11, 2014
Our Top Picks Portfolio beat all major Indices Jefferies HK/China research team initiated our Top Pick portfolio on Feb 22, 2013; all stocks on the Top Buy/Top Sell list are equally-weighted. We update the list as needed, usually a few times a year. Since inception, our long/short portfolio has grown 11.2%; it outperformed HSI and HSCEI China Indices by 8.9 and 11.8 ppts.
Our Top Buy portfolio increased 12.6%, beating HSCEI and HSI by 13.1 and 10.3ppts respectively; our Top Sell portfolio is largely in line with the index.
Since we are bullish on the outlook of the market in 2015, we close the sell portfolio. For the Buy portfolio, we only retain Baidu (BIDU US, Buy), Bank of China (3988 HK, Buy) and Ping An insurance (2318 HK, Buy), and we expect them to continue outperforming the market. We add CEI (257 HK, Buy), CNG Power (1816 HK, Buy), Citic Securities (6030 HK, Buy), COLI (688 HK, Buy), CPIC (2601 HK, Buy), Haitong Securities (6837 HK, Buy) and Sinopharm (1099 HK, Buy).
JEF Top Picks have outperformed since inception
Exhibit 63: JEF Top Buy/Sell Portfolio Performance
120.0
115.0
110.0
105.0
100.0
95.0
90.0
85.0
80.0
75.0 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14
HSI HSCEI TOP BUY & SELL
Source: Bloomberg, Jefferies, as of Dec 11, 2014
page 34 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Summary of sector views We have a positive view on airline, brokers, clean tech, conglomerate, consumer staples, environmental services, healthcare, insurance, internet, IPPS, machinery, oli/gas, property and shipping sector. We are bearish on coal, steel, gold and packaging paper sectors. Our Exhibit 64: Summary of sector views on auto, banks, cement, consumer discretionary, gaming, telecom, tech and port views are neutral.
Sector Preference Auto & Machinery Auto & Machinery We close our 3-year long bearish positions in the Chinese construction machinery space as - Auto continuous infrastructure investment may start to turn around machinery sales in 2015. - Machinery We expect earnings to bottom out from 2014, then stay low in 2015 before meaningfully picking up in 2016, driven primarily by volume growth. Consumer - Staples Auto sector growth should slow to 7% in 2015, from expected growth of 10% in 2014. - Discretionary Recall in 2013, growth was at a high 16%, and in 1H14, it was at 11%. From the recent Congo & Gaming monthly sales figures, in September, growth decelerated to 7.1% and further slowed in October to 6.6%. We believe that growth will continue to decelerate next year because 1) - Conglomerate the pre-buying impact has just started 2) more cities will have a license restriction in 2015 - Gaming and 3) weaker demand in tier 3-4 cities. Energy - Oil & Gas Consumer - Coal We have long argued that the consumer sector will face growth slowdown and intensifying competition hence a gradual de-rating is inevitable in the long run. For 2015, Financial we take a positive view on consumer staples since favourable agri-supply/prices and weak - Banks gasoline prices could benefit their margins. A number of heavily de-rated stocks have a - Broker chance of re-rating. We are neural on department stores, electronic goods distributors and - Insurance jewellery. We remain negative on apparel and footwear due to fierce competition and Healthcare threat from E-commerce; on restaurants due to weak growth and rising operating costs IPPs, Clean Tech Conglomerates and gaming - IPPS Rate cut and monetary easing will benefit conglomerates with high exposure to the - Clean Energy property and financial services sectors. SOE reform should accelerate, we see more M&A - Environmental and restructuring in 2015. Mix-ownership and profitability improvement will be the key Metals & Mining focus; we expect listed conglomerates to benefit. - Cement For gaming stocks, while short-term pain may linger, we believe stocks may have - Steel bottomed, and see sentiment improving on positive catalysts. We expect solid growth to - Gold resume in 2H2015; strong profitability and good return to shareholders should follow. - Packaging Paper Energy Property Celebrations/dirges for the new normal of lower oil prices are premature, in our view. The TMT recent slowdown in China's oil demand growth was not unexpected. Likewise, we believe - Internet China's oil demand will recover with a vengeance. While industrial oil demand is - Telecom flat/falling, consumption demand rises exponentially. Investors with longer time horizons - Tech should be overweight oil and gas. Before China really starts driving.
Transport We are negative on coal; we believe coal demand in China is at best flat. While economic - Airline rebalancing has been slower than expected, substitution and efficiency gains have - Port exceeded expectation. We believe China is now trying to soft-land the coal industry, - Shipping which some in the market have misinterpreted as an industry rescue.
Financials
We expect the implementation of the Third Plenum plans to drive long-term re-rating of Source: Jefferies estimates H-share banks, with near-term pressures from growth deceleration, asset quality deterioration & deposit rate deregulation likely to be offset by accommodative monetary & regulatory policies. Given these cross currents, we are Neutral on the sector (though valuation provides strong downside support as capital risk recedes), and prefer the Big 4 banks for their high dividend yield.
page 35 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
With Third-Plenum plans to promote a registration-based IPO system gaining impetus, we believe 2015 will be a positive year for Chinese brokers. The lacklustre start for the Shanghai-Hong Kong Stock Connect (SC) has tamed our enthusiasm for HKEx & the HK brokers, but we believe it is too early to dismiss the SC (especially as admin uncertainties & unfamiliarity should get sorted out in the next few months) and will be looking for attractive entry points. At the same time, we expect Cinda to benefit from the easing liquidity environment, accelerating its asset disposal process.
We maintain our positive outlook on the China insurance sector. On life business, we expect the sector to benefit from 1) supportive policies; 2) stable fundamental growth; and 3) solid investment performance. On P&C insurance, we expect auto-insurance margin to be stable, or potentially improve, despite the upcoming pricing deregulations.
Healthcare We remain positive on the outlook for the Chinese pharmaceutical industry, capable of sustaining mid-teen% growth, given the robust demand growth trend. The government aims to introduce more market mechanisms into the sector, which should favour leading innovative players. Drug tenders will progress faster in 2015, and overall pricing risk is manageable.
IPP, Clean Tech & Environmental services We are positive on clean energy in China. The Energy Development Strategy Action Plan (2014-20) highlights China’s intent to tackle air pollution, climate change, habitat and other environmental challenges head on. We expect policy support to remain firmly in place for natural gas, wind, nuclear and solar infrastructure.
While a significant earnings recovery should taper off with slowing decline of coal prices, we believe China’s ongoing power reform will transform China IPPs from a cyclical sector into real defensive utilities. We also believe there is plenty of growth ahead for the wastewater treatment and solid waste treatment sectors. Our long-term view is that capacity for both markets should more than double within the next 5-10 years in order to keep up with demand.
Metals & Mining After strong growth in 2014, we expect cement companies’ earnings growth will be much slower in 2015, with earnings decline potential for some companies in the first half. After growing by <4%, we don’t expect demand to rebound strongly in 2015. Our top pick of the sector is Conch-A due to cheap valuation.
Iron ore price fell off the cliff in 2014 to ~US$70/ton from US$130/ton at the beginning of 2014. We believe the lower input costs will benefit Baosteel the most. We believe the risks to our long term gold price forecast ($1,200/ounce) are modestly to the downside given a potentially stronger dollar and ultimately rising interest rates. China’s packaging paper capacity growth is likely to be strong in 2015. However, we still don’t see an inflexion point for demand. We expect industry supply to outgrow demand in 2015, leading to decline in GP.
Property With the Golden Age fading out, future growth will likely be steady. We expect the sector to perform better in 2015 than in 2014 on demand & supply rebalancing, favorable policy and improving company credit. Still, no sharp rebound is expected but opportunities will emerge for select developers that manage to acquire market share as a result of enhanced capital structure.
TMT We maintain a positive view on China’s Internet sector based on multiple secular trends: 1) long-term Internet demographic shifts to more mature population with higher consumption power; 2) proliferation of affordable smartphones and data plans as well as improving 3G/4G coverage drives mobile monetization, including mobile commerce, advertising and games, which is still at a nascent stage; 3) low Internet penetration in rural areas implies huge potential for e-Commerce growth. page 36 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
We are neutral on Telecom. Mobile voice revenue decline should continue. Telcos should focus on 4G migration as wireless penetration peaks. 4G capex remains high, which will benefit equipment providers.
We are conservative on China tech in 2015. We expect the smartphone market growth to further slow to below 10% in 2015. The weaker growth will lead to a challenging environment for both handset makers and component suppliers for China smartphones in 2015. Prefer upstream to downstream but wait for better entry points.
Transportation We reiterate our positive view on the airline sector into 2015, due to 1) structural improvement on supply/demand balance, 2) lower fuel cost, which is yet to be fully factored in, 3) cargo earnings recovery. We prefer Chinese airlines names to regional ones on their zero fuel hedges, and more significant improvement in supply & demand.
Shipping sector will benefit from lower oil in more than one way; we prefer tanker and container over dry bulk. Tanker is a beneficiary of OPEC supply; container will outperform as the benefit from oil is underestimated. Dry bulk recovery remains sluggish with Panamax, Handymax and Handysize all seeing lower rates than 2013.
On the port side, we expect tamed volume growth may limit the sector’s valuation upside and the small ports’ free trade zone fad should quickly fade. On the other hand, large ports may leverage up for overseas M&A, the pace and quality of which should be a key criterion for stock selection.
2015 Sector Allocation In the short run, China must endure the pain of slower growth, in order to weed out excess capacity to restore economic health. We expect fundamental reform to accelerate, uncertainties to increase. A revival of US demand, rising income and falling fuel prices bode well for export and consumption, monetary easing will support FAI and property.
Within our coverage universe, we recommend investor to overweight airline, banks, brokers, clean energy, conglomerate, consumer stables, environmental services, healthcare, insurance, internet, IPPs, machinery, property, and shipping. We recommend investors to underweight coal, gold, packaging paper, steel and equal-weight autos, cement, consumer discretionary, gaming, oil/gas, ports, tech and telecom.
Exhibit 65: Jefferies China 2015 Sector Allocation Sector Allocation Over-weight Equal-weight Under-weight Sector Fundamental Sector Fundamental Sector Fundamental Airlines Positive Autos Neutral Coal Negative Banks Neutral Cement Neutral Gold Negative Brokers Positive Consumer discretionary Neutral Packaging Paper Negative Clean Energy Positive Gaming Neutral Steel Negative Conglomerate Positive Oil/Gas Positive Consumer Staples Positive Ports Neutral Environmental Positive Tech Neutral Healthcare Positive Telecom Neutral Insurance Positive Internet Positive IPPs Positive Machinery Positive Property Positive Shipping Positive Source: Jefferies
page 37 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Jefferies China 2015 ideas
In 2015, we recommend investors to overweight Airlines, Banks, Brokers, Clean Energy, Conglomerate, Consumer Staples, Environmental, Healthcare, Insurance, Internet, IPPs, Machinery, Property and Shipping. Our Top Buys for overseas stocks are Baidu, BOC, China Everbright International, CGN Power, CITIC Securities, COLI, CPIC, Haitong Securities, Ping An Insurance and Sinopharm.
Our Top Buy portfolio is concentrated on financials (50%) with equal weighting (10%) on Utilities, Environmental, Healthcare, Property and Internet.
For A-shares, we like the outlook of Anhui Conch-A, Bank of China-A, CITIC Securities-A, Haitong Securities-A, Ping An-A, SAIC and Vanke. Investors may find Daqing Railway, Kweichow Moutai and Tong Ren Tang interesting as leaders in their respective sectors.
Exhibit 66: Top Buy portfolio weighting by sector Exhibit 67: A Share industry leaders weighting by sector
Utilities 10% Cement, 10% Environment Healthcare, al10% 10% Financials, 40% Healthcare Financials Property, 10% 50% 10%
Property 10% Consumer Discretionary, 10% Industrials & Internet 10% Auto, 20% Source: Jefferies Source: Jefferies
Exhibit 68: Valuation metrics Mkt Cap PE PB Div Yield Company Ticker Rating US$ mn price 2013 2014E 2015E 2013 2014E 2015E 2013 2014E 2015E Top H share Buys Baidu BIDU US Buy 78,929 225.12 46.5 36.0 25.9 12.7 9.2 6.8 0.0% 0.0% 0.0% Bank of China 3988 HK Buy 149,991 4.10 5.8 5.7 5.5 1.0 0.9 0.8 6.0% 6.4% 6.7% CEI 257 HK Buy 6,605 11.42 35.0 30.9 24.3 3.8 3.2 2.9 0.7% 0.9% 1.1% CGN Power 1816 HK Buy 20,605 3.62 19.3 19.3 20.6 3.1 2.4 2.2 0.0% 0.0% 0.0% Citic Securities 6030 HK Buy 43,421 27.15 45.2 27.4 17.9 2.7 2.5 2.3 0.7% 1.5% 2.2% COLI 688 HK Buy 24,199 22.95 8.1 8.3 7.0 1.7 1.5 1.3 2.0% 2.4% 2.9% CPIC 2601 HK Buy 36,310 32.65 25.6 19.7 17.1 2.4 2.1 1.9 1.5% 1.7% 2.0% HT Securities 6837 HK Buy 29,098 18.32 34.8 20.6 15.2 2.3 2.1 1.9 0.8% 1.9% 2.6% Ping An Insurance 2318 HK Buy 79,362 73.70 16.5 11.9 10.2 2.5 2.0 1.6 1.1% 1.3% 1.4% Sinopharm 1099 HK Buy 10,030 28.10 25.2 20.0 16.9 2.6 1.7 1.6 1.2% 4.0% 4.7% Average 26.2 20.0 16.1 3.5 2.8 2.3 1.4% 2.0% 2.4% Interesting A shares Anhui Conch 600585 CH Buy 17,447 19.96 11.3 8.8 7.9 1.9 1.6 1.4 1.8% 1.8% 2.5% Bank of China 601988 CH NC 149,991 3.34 6.0 5.9 5.6 1.0 0.9 0.8 5.9% 6.3% 6.6% China Vanke 000002 CH Buy 21,694 12.03 8.8 8.1 7.3 1.7 1.5 1.3 3.4% 3.7% 4.2% Citic Securities 600030 CH NC 43,421 24.71 51.5 40.5 32.1 3.1 2.9 2.7 0.6% 1.0% 1.3% Daqin Railway 601006 CH NC 24,678 10.27 12.1 10.1 9.0 2.0 1.8 1.6 4.2% 5.0% 5.7% Haitong Securities 600837 CH NC 29,098 19.55 46.5 36.9 29.6 3.0 2.9 2.7 0.6% 1.1% 1.3% Kweichow Moutai 600519 CH NC 32,466 175.89 13.3 12.9 11.8 4.7 3.7 3.2 2.3% 2.7% 3.3% Ping An Insurance 601318 CH Buy 79,362 56.82 16.0 11.5 9.9 2.5 1.9 1.5 1.1% 1.3% 1.5% SAIC 600104 CH Buy 40,043 22.47 10.0 8.6 7.6 1.8 1.6 1.4 5.3% 3.8% 4.4% Tongrentang 600085 CH NC 4,688 22.12 44.2 37.5 31.5 5.8 5.2 4.7 0.9% 1.1% 1.3% Average 22.0 18.1 15.2 2.8 2.4 2.1 2.6% 2.8% 3.2% Source: Jefferies, company data, Bloomberg for NC companies. Priced as of Dec 11, 2014
page 38 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Anhui Conch – A (600585 CH, Buy, TP Rmb24.6)
Po Wei Cheap Valuation for an Undisputed Industry Leader Equity Analyst Key Takeaway +852 3743 8067 [email protected] Despite strong earnings growth of ~50% yoy for 9M14, Conch-A is still trading at a historical trough valuation. We expect 2015 earnings growth will be slower due to difficult yoy ASP comparison, especially in 1H15. However, Exhibit 69: Price Performance we believe at ~8x/1.4x forward PE/PB, an ROE of 18%, <10% net debt/equity 35 and 8% FCF yield, Conch-A is a bargain, for an undisputed leader in the basic materials space. 30
25 Lower valuation vs peers: At just 7.9x 2015 PE, Conch-A is a very attractive. Conch’s H shares are still trading at a 13% premium to the A-share. Compared to peers, the A-share is 20 trading at a lower valuation than Shanshui and the industry average. Conch-A is at near historical PE/PB troughs. 15
10 M&A should continue to drive volume going forward: In 1H14, Conch grew its capacity by 6% yoy to 245mt per year. Of the 14mt newly added capacity, 5.5mt (or 40%) 5 came from M&A. Going forward, Conch has guided annual capex/M&A spending of
0 RMB10bn (vs operating cash flow of >RMB15bn/year), which should translate into volume Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 growth of ~25mt/year (or 10% per year). Source: Bloomberg as of Dec 11, 2014 Positive outlook on East China: Unlike other regions in China, Conch’s core markets
in the east should see relatively little supply added in 2015. With the exception of
Shandong, where CNBM will ramp up one 5kt/d line and Shanshui will add one 4kt/d line,
Ticker 600585 CH the other provinces will have no new supply. Excluding Shandong, FAI across the region Market Data has also come down significantly from the 2009/2010 peak. We think cement 52 Week Range: Rmb14.18 – Rmb21.56 companies’ GP/ton in East China should remain stable next year. Total Entprs. Value (M): Rmb 118,298.9 Market Cap. (M): US$ 17,439.5 Valuation/Risks Shares Out. (M): 3,999.7 Conch A-share are trading at a 8% discount to H-shares, and at 7.9x forward PE, Conch-A Float (M): 1,733.9 is cheaper than Shanshui’s valuations of 8.5x. Our TP of RMB24.6/share implies a forward Avg. Daily Vol. (M): 46.2 PE valuation of 10x. Downside risks: a slowdown in demand growth in 2015; slower Source: Bloomberg as of Dec 11, 2014 than expected capacity expansion via M&A.
Exhibit 70: 1-year forward PE of cement players: Conch-A Exhibit 71: Conch-A forward PE historical standard shares are trading at a lower valuation than peers deviation
16.0 14.0 25.0x
14.0 12.0 +1 SD 12.0 20.0x 10.0 10.0 Avg: 8.2x Average 8.0 15.0x 8.0 6.0 6.0 10.0x 4.0 4.0 -1 SD 2.0 2.0 5.0x 0.0 0.0
0.0x
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: Bloomberg price as of 11 Dec 2014, Jefferies Source: Digital Cement, Jefferies
page 39 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
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14 December 2014
Exhibit 72: Anhui Conch A-share (600585 CH) summary financials Income statement Cash flow Rmb m 2012 2013 2014E 2015E Rmb m 2012 2013 2014E 2015E Revenue 45,766 55,262 64,228 70,544 Net profit 6,331 9,389 12,062 13,435 COGS -33,265 -37,275 -41,717 -45,778 Depreciation 3,276 3,859 4,224 4,485 Gross profit 12,502 17,987 22,511 24,766 Change in working cap. 574 275 -485 -386 Operating expenses -3,217 -4,129 -4,866 -5,345 Others 156 432 555 618 Operating profit 9,285 13,857 17,644 19,421 CF from operations 10,336 13,955 16,355 18,152 Share of results of assoc. & JCE's -23 -26 -26 -26 Capex -6,157 -6,426 -8,500 -6,000 Other income 0 0 0 0 Acquisitions and others -2,312 -6,051 -111 -117 Net finance expense -1,137 -1,161 -940 -801 CF from investing -8,470 -12,476 -8,611 -6,117 Pre-tax profit 8,126 12,671 16,679 18,595 Equity raised/ (repaid) 0 0 0 0 Tax -1,639 -2,850 -4,063 -4,542 Debt raised/ (repaid) 953 -1,614 0 0 Profit 6,487 9,821 12,616 14,053 Dividends, interest and others -2,452 -1,432 -2,383 -2,654 Minority interest -156 -432 -555 -618 CF from financing -1,499 -3,046 -2,383 -2,654 Net profit 6,331 9,389 12,062 13,435 Net cash flow 368 -1,567 5,361 9,382 Basic EPS (Rmb) 1.19 1.77 2.28 2.54 Exchange gain -4 -25 0 0 Diluted EPS (Rmb) 1.19 1.77 2.28 2.54 Cash at end of year 8,111 6,519 11,880 21,262
Balance sheet Ratio & financial metrics analysis Rmb m 2012 2013 2014E 2015E 2012 2013 2014E 2015E Cash 8,111 6,519 11,880 21,262 Revenue Growth -5.9% 20.7% 16.2% 9.8% Inventories 4,039 3,693 4,367 4,926 EBIT Growth -43.9% 49.2% 27.3% 10.1% Receivables 10,624 9,501 11,237 12,674 EPS Growth -45.4% 48.3% 28.5% 11.4% Other current assets 848 5,265 6,119 6,721 EBIT Margin 20.3% 25.1% 27.5% 27.5% Fix assets 52,607 56,276 58,506 57,021 Net Profit Margin 13.8% 17.0% 18.8% 19.0% Others assets 11,295 11,841 11,952 12,069 Payout Ratio 0.2% 0.2% 0.2% 0.2% Total assets 87,524 93,094 104,061 114,672 Valuation metrics PER (x) 16.7 11.3 8.8 7.9 ST debt 2,658 2,935 2,935 2,935 EV/EBITDA (x) 9.8 7.0 5.5 4.6 Other current liabilities 11,863 11,611 12,956 14,542 Price to Book (x) 2.2 1.9 1.6 1.4 LT debt 21,080 19,207 19,239 19,239 Balance Sheet Ratios Other LT liabilities 1,119 941 963 987 ROE 13.0% 16.8% 18.6% 18.4% Total liabilities 36,720 34,693 36,093 37,703 ROCE 9.9% 13.2% 16.1% 18.1% Shareholder's equity 48,538 55,764 64,775 73,159 Net debt to Equity 30.8% 26.7% 15.1% 1.2% Minority interests 2,266 2,638 3,193 3,811 Interest coverage (x) 11.1 15.2 23.3 29.9 Total liability & equity 87,524 93,094 104,061 114,672 Book value per share 9.2 10.5 12.2 13.8
Source: Company data, Jefferies estimates, Bloomberg price as of Dec 11, 2014
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Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Baidu (BIDU US, Buy, TP US$283)
Cynthia Meng Key Takeaway Equity Analyst Our checks indicate that mobile search traffic industry growth continues to +852 3743 8033 outpace PC with mobile now accounting for 50% of overall traffic. We believe [email protected] Baidu’s industry-leading technology, including voice, visual and map search, narrowing of CPC gap between PC and mobile, strong app distribution capability and iQiyi-PPS’s leading time spent share on mobile online video Exhibit 73: Price performance will continue to drive Baidu’s mobile search ads growth.
300 Monetizing from strong mobile search demand. Mobile search already accounts for 50% of Baidu’s traffic driven by its industry-leading search technology. Voice and visual 250 search, in particular, currently contributes to 10% of Baidu’s mobile traffic and could potentially reach 50% over the next 5 years, according to management. Mobile revenue 200 accounted for 36% of 3Q14 revenue, but still lagged behind mobile traffic contribution. We believe as more advertisers adopt integrated bidding, improving mobile CPC will 150 narrow the monetization gap between PC and mobile over time.
100 Leading distribution channel powered by app store, search app and browser. We expect Baidu’s distribution capability to remain strong powered by its app store 50 (including 91Wireless), search app and mobile browser. According to Analysys International, Baidu was ranked no.1 with app distribution platform market share of 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 41.8% in 3Q14. Organic search via Baidu app and browser accounted for 50% of mobile traffic while Baidu mobile assistant and 91Wireless delivered a daily distribution volume of Source: Bloomberg as of Dec 10, 2014 160mn in 3Q14, up from 130mn in 2Q14.
Expect continued investment in building out O2O ecosystem. Looking into FY15, we expect Baidu to continue investing in O2O services, including mobile, cloud and LBS. Ticker BIDU US As users increasingly conduct service-oriented search instead of information-based search Market Data 52 Week Range: US$140.7 – US$252.0 on their mobile device, Baidu’s leading map position, mobile search technology and large- Total Entprs. Value (M): Rmb 462,717.4 scale salesforce will help to connect offline merchants to online through O2O solutions Market Cap. (M): US$ 78,929.2 such as Baidu Connect. As Baidu continues to build out its O2O ecosystem with increasing Shares Out. (M): 275.4 closed-loop transactions, we expect to see potential commission revenue opportunities in Float (M): NA the longer term. Avg. Daily Vol. (M): 3.6 Source: Bloomberg as of Dec 10, 2014 Valuation/Risks Maintain Buy; PT at USD283 based on 32.2x FY15 P/E, 24% premium to peer average, with an implied PEG ratio of 0.83x. Risks include execution in mobile transition and monetization, and stronger than expected competition.
Exhibit 74: Mobile search traffic market share by search Exhibit 75: China’s app distribution platform market query (web + app) share (3Q14)
Source: Analysys International as of July 2014, Jefferies Source: Analysys International as of Dec 2014, Jefferies Note: Baidu distribution channels include Baidu Mobile Assistant, 91 Mobile Assistant, HiMarket, Baidu mobile browser and Baidu search.
page 41 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 76: Financial statement Income statement 2011A 2012A 2013A 2014E 2015E 2016E Total Revenue (in RMB mn) 14,501 22,306 31,944 49,140 71,016 93,208 YoY % change 83.2% 53.8% 43.2% 53.8% 44.5% 31.2% Net Revenue (less biz tax & surcharges) (in RMB mn) 13,476 20,734 29,614 45,529 65,779 86,334 YoY % change 81.9% 53.9% 42.8% 53.7% 44.5% 31.2% Cost of revenue (in RMB mn) 2,872 4,876 9,142 15,567 22,930 29,882 Gross profit (in RMB mn) 10,604 15,857 20,472 29,962 42,849 56,452 Gross margin 73.1% 71.1% 64.1% 61.0% 60.3% 60.6% Search selling, general & admin (in RMB mn) 1,693 2,501 5,174 10,223 14,068 16,867 Search R & D (in RMB mn) 1,334 2,305 4,107 6,825 9,614 12,274 Operating Profit (in RMB mn) 7,577 11,051 11,192 12,915 19,167 27,312 YoY % change 91.4% 45.9% 1.3% 15.4% 48.4% 42.5% Adj. Operating margin 56.2% 53.3% 37.8% 28.4% 29.1% 31.6% Net Income (in RMB mn) 6,639 10,456 10,519 12,902 18,079 25,796 YoY % change 88.3% 57.5% 0.6% 22.7% 40.1% 42.7% Adj. Net margin 49.3% 50.4% 35.5% 28.3% 27.5% 29.9% Non-GAAP net income (in RMB mn) 6,791 10,668 11,034 13,771 19,309 27,410 YoY % change 87.6% 57.1% 3.4% 24.8% 40.2% 42.0% Adj. Non-GAAP net margin 50.4% 51.5% 37.3% 30.2% 29.4% 31.7% EPADS, basic (in RMB) 19.03 29.87 29.98 36.80 51.48 73.34 (1 ordinary share = 10 ADS) EPADS diluted (in RMB) 18.99 29.83 29.93 36.65 51.03 72.38 EPADS, basic (in USD) 2.94 4.79 4.95 5.96 8.30 11.83 EPADS diluted (in USD) 2.94 4.79 4.94 5.94 8.23 11.67 Non-GAAP EPADS, basic (in USD) 3.01 4.89 5.19 6.36 8.87 12.57 Non-GAAP EPADS, diluted (in USD) 3.01 4.89 5.19 6.34 8.79 12.40 YoY % change 96.2% 62.6% 6.1% 22.2% 38.8% 41.1% WA ADS basic (mn) 349 350 351 351 351 352 WA ADS diluted (mn) 350 350 351 352 354 356
Balance sheet RMB mn 2011A 2012A 2013A 2014E 2015E 2016E Cash and cash equivalents 4,127 11,881 9,692 13,605 25,751 44,483 Restricted cash 483 395 260 448 448 448 Short-term investments 10,052 20,604 28,735 41,390 49,390 57,390 Accounts receivable, net 600 1,253 2,221 3,931 5,681 7,457 Prepayments and other assets, current 586 541 2,122 3,315 4,405 6,049 Total current asset 15,848 34,674 43,029 62,689 85,676 115,826 Fixed asset, net 2,744 3,888 5,370 7,448 9,440 11,723 Intangible asset, net 929 1,588 3,630 3,902 4,489 5,231 Others 3,820 5,519 18,585 21,071 21,598 22,172 Total non current asset 7,492 10,995 27,957 32,421 35,527 39,126 Total asset (in RMB mn) 23,341 45,669 70,986 95,110 121,202 154,952 Accounts payable and accrued liabilities, current 2,563 3,839 7,362 11,675 17,197 22,411 Other current liabilities 1,843 4,397 3,671 7,048 8,262 9,341 Total non-current liabilities 2,608 10,217 19,288 23,207 23,253 23,300 Total Liabilities (in RMB mn) 7,015 18,454 30,321 41,930 48,713 55,053 Total shareholder's equity 15,390 26,182 40,665 53,180 72,489 99,899
Cash flow RMB mn 2011A 2012A 2013A 2014E 2015E 2016E Operating cash flow 8,179 11,996 13,793 18,331 26,680 34,654 Investing cash flow -14,251 -13,750 -23,323 -20,269 -14,533 -15,923 Financing cash flow 2,426 9,519 7,542 5,851 - - Exchange effect -9 -12 -201 - - - Change in cash -3,654 7,753 -2,189 3,913 12,146 18,732 Cash beginning balance 7,782 4,127 11,881 9,692 13,605 25,751 Cash ending balance 4,127 11,881 9,692 13,605 25,751 44,483 Source: Company data, Jefferies estimates
page 42 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Bank of China Limited (3988 HK, Buy, TP HK$4.80)
Will Hong Equity Associate Well positioned for RMB internationalization, less +852 3743 8750 susceptible to RMB interest rate deregulation [email protected] Key Takeaway BOC is well positioned for RMB internationalization with its overseas Exhibit 77: Price performance footprints and is less susceptible to RMB interest rate deregulation as it has the highest proportion of non-interest income & overseas business. 6
Well positioned for RMB internationalization and less susceptible to RMB 5 interest rate deregulation: BOC has the highest proportion of non-interest income amongst the H-share listed banks, with 33% of its income from non-interest income vs 4 peers’ average of 26% in 1H14; and overseas business contributing 25% of loans and 20% of deposits as of Jun 14, vs peers’ average of <10%, which may also benefit from 3 potentially stronger USD & higher Fed rates.
2 Valuation provides strong downside support as capital risk recedes: As we do not expect a credit crisis to materialize in China, the sub-1x P/B valuation provides strong 1 downside support, especially in light of high ROEs and receding common equity issuance risks (given successful placements of their preferred shares at lower-than-expected yields, 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 suggesting strong demand), in our view.
Source: Bloomberg as of Dec 11, 2014 Summary of 3Q14 results: BOC’s 3Q14 profit was 3% below consensus given weak non-interest income (down -16% QoQ in 3Q14) and higher cost-income ratio (with opex
up +5% QoQ in 3Q14 despite revenue contraction of 3%), but 9M14 profit still achieved
78% of consensus & JEF full-year estimates. NPL growth decelerated a tad (+5.6% QoQ in 3Q14 vs 2Q14’s +6.9%, yielding NPL ratio of 1.07%), though key positive surprise was the Ticker 3988 HK significant increase in T1 CAR to 10.52% (up 115bps sequentially) as risk-weighted assets Market Data contracted for -7% QoQ and RWA/assets declined -4.7ppt QoQ to 61.2%. 52 Week Range: HK$3.03 – HK$4.35
Total Entprs. Value (M): NA Valuation: Our HK$4.80 PT is the wt. avg. of our 3-stage DDM (50%) & fair P/B (50%) Market Cap. (M): US$ 149,998.4 models, based on profit growth of 6%/5%/3% in stage 1/2/3, 35% dividend payout, Shares Out. (M): 83,622.3 Float (M): 72,987.3 15.4% sustainable ROE and 13.0% COE. Our PT-implied 2015E P/B is 0.92x. Key risks: 1) Avg. Daily Vol. (M): 415.2 NIM weaker than expected; 2) NPL/provision/opex higher than expected; 3) changes in Source: Bloomberg as of Dec 11, 2014 regulations for global SIBs; 4) capital-raising.
Exhibit 78: BOC loan growth 2012-16E Exhibit 79: BOC NPL and LLR coverage in 2012-16E 12,000 12% 1.7% 250% 1.6% 10,000 10% 1.5% 200% 8,000 8% 1.4% 150% 1.3% 6,000 6% 1.2% 100% 4,000 4% 1.1% 1.0% 50% 2,000 2% 0.9%
0 0% 0.8% 0% 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016E
Gross loans (Rmb'bn) YoY NPL ratio (LHS) Loan loss reserve/NPL (RHS)
Source: Company data, Jefferies Source: Company data, Jefferies
page 43 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 80: BOC’s financial summary Bank of China Limited (3988 HK | 601988 CH) - Summary of Financials Balance Sheet Dupont Analysis Rmb mn 2012 2013 2014E 2015E 2016E % of assets 2012 2013 2014E 2015E 2016E Cash & equivalent 72,475 82,339 77,485 85,500 94,004 Net interest income 2.03 2.04 2.03 1.98 1.91 Interbank assets 6,151,843 6,349,829 7,188,009 8,251,531 9,087,848 Non-interest income 0.86 0.89 0.89 0.88 0.86 Inv. HFT & FV 228,342 227,801 246,301 274,031 301,805 Inv. AFS & HTM 2,138,934 2,328,431 2,401,874 2,650,324 2,913,929 Operating income 2.89 2.94 2.92 2.86 2.77 Gross loans 6,864,696 7,607,791 8,461,561 9,332,943 10,257,095 Operating expense (1.26) (1.24) (1.15) (1.13) (1.11) Loan loss reserve (154,656) (168,049) (199,771) (231,384) (267,754) Other assets 1,016,847 1,205,323 1,362,138 1,510,768 1,661,449 PPOP 1.63 1.70 1.77 1.73 1.66 Total assets 12,680,615 13,874,299 15,513,809 17,101,053 18,784,704 Total provisions (0.15) (0.17) (0.31) (0.34) (0.34) Interest-earning 12,088,325 13,201,356 14,786,310 16,311,924 17,930,216 RWA 7,253,230 9,418,726 10,704,528 12,141,748 13,337,140 Operating profit 1.48 1.53 1.46 1.38 1.32 Non-operating items 0.01 0.01 0.01 0.01 0.01 Customer deposits 9,173,995 10,097,786 11,195,865 12,353,965 13,582,708 Interbank liabilities 1,996,218 2,091,828 2,401,257 2,651,045 2,958,809 Pre-tax profit 1.48 1.53 1.46 1.39 1.32 Debt securities 233,178 254,274 285,571 284,818 241,777 Tax (0.33) (0.35) (0.34) (0.32) (0.30) Other liabilities 755,510 884,616 1,025,731 1,176,474 1,307,121 Minorities & pref. div. (0.05) (0.05) (0.04) (0.04) (0.04) Total liabilities 11,819,073 12,912,822 14,439,490 15,909,505 17,470,739 Interest-bearing 11,403,391 12,443,888 13,882,693 15,289,828 16,783,294 ROA (%) 1.15 1.18 1.12 1.07 1.02 Leverage (x) 15.4 15.0 15.0 14.8 14.7 Minority interests 36,865 37,561 37,561 37,561 37,561 ROE (%) 16.9 17.0 16.2 15.2 14.4 Equity 824,677 923,916 1,036,758 1,153,987 1,276,405 Growth Drivers BVPS (Rmb) 2.95 3.31 3.71 4.13 4.57 % 2012 2013 2014E 2015E 2016E Shares: Period end (mn) 279,147 279,365 279,365 279,365 279,365 Deposit growth 4.0 10.1 10.9 10.3 9.9 Loan growth 8.2 10.8 11.2 10.3 9.9 Income Statement Interest-earning asset growth 6.6 9.2 12.0 10.3 9.9 Rmb mn 2012 2013 2014E 2015E 2016E Net interest income 256,964 283,585 315,017 338,846 359,248 Net interest margin 2.19 2.24 2.25 2.18 2.10 Non-interest income 109,212 123,924 137,766 150,229 161,051 Net interest income growth 12.7 10.4 11.1 7.6 6.0
Operating income 366,176 407,509 452,783 489,075 520,299 Fee income growth 8.1 17.4 16.6 16.1 9.8 Operating expense (159,729) (172,314) (178,111) (194,005) (208,881) Non-interest income growth 9.0 13.5 11.2 9.0 7.2 Non-interest income/Income 29.8 30.4 30.4 30.7 31.0 PPOP 206,447 235,195 274,672 295,070 311,418 Loan loss provision (19,086) (22,938) (48,208) (57,832) (63,668) Operating income growth 11.5 11.3 11.1 8.0 6.4 Other provisions (301) (572) (450) (450) (450) Cost-to-income ratio 37.4 36.4 33.4 33.4 33.5 Opex (core) growth 11.9 8.4 1.9 8.2 6.7 Operating profit 187,060 211,685 226,014 236,788 247,300 Non-operating items 1,129 1,705 1,742 1,300 1,300 PPOP growth 10.1 13.9 16.8 7.4 5.5 LLP/Avg. gross loans 0.29 0.32 0.60 0.65 0.65 Pre-tax profit 187,673 212,777 226,664 237,438 247,950 Tax (41,927) (49,036) (52,236) (54,719) (57,142) Operating profit growth 11.3 13.2 6.8 4.8 4.4 Minorities (6,090) (6,830) (6,830) (6,830) (6,830) Net profit growth 12.4 12.4 6.8 4.9 4.6 EPS growth 12.2 11.5 6.7 4.9 4.6 Net profit 139,656 156,911 167,597 175,889 183,978 DPS growth 12.9 12.0 7.1 4.9 4.6 Dividends 92,119 103,606 113,415 120,220 125,953 Capital, Asset Quality & Liquidity EPS (Rmb) 0.48 0.54 0.57 0.60 0.63 % 2012 2013 2014E 2015E 2016E Effective tax rate (%) 22.3 23.0 23.0 23.0 23.0 Core CAR 10.5 9.7 9.5 9.3 9.4 Total CAR 13.6 12.5 12.0 11.5 11.4 DPS (Rmb) 0.18 0.20 0.21 0.22 0.23 RWA growth 9.0 29.9 13.7 13.4 9.8 Dividend payout (%) 35.0 34.9 35.0 35.0 35.0 RoRWA 2.01 1.74 1.63 1.50 1.43
Business Segments NPL ratio 0.95 0.96 1.24 1.46 1.64 % of operating profit 2009 2010 2011 2012 2013 Loan loss reserve/NPL 236.3 229.4 190.5 169.5 159.4 Corporate banking 70 63 63 61 56 Loan loss reserve/Gross loans 2.25 2.21 2.36 2.48 2.61 Retail banking 27 24 23 22 21 Treasury 7 10 8 11 20 Loan-deposit ratio 74.8 75.3 75.6 75.5 75.5 Investment banking 0 1 1 1 1 Deposits/Total assets 72.3 72.8 72.2 72.2 72.3 Insurance (2) 0 1 1 0 Interbank liabilities/Total assets 15.7 15.1 15.5 15.5 15.8 Debt securities/Total assets 1.8 1.8 1.8 1.7 1.3 Common equity/Total assets 6.5 6.7 6.7 6.7 6.8 Source: Jefferies estimates, Company data
page 44 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
China Everbright Intl. (257 HK, Buy, TP HK$13.2)
Po Wei A Clear Winner in the WTE market Equity Analyst +852 3743 8067 Key Takeaway [email protected] We believe China’s municipal solid waste collection could grow 80% by 2020E, which will pose a serious challenge for local governments who need to process solid waste. Current landfill sites are stretched and local governments Exhibit 81: Price Performance will have to build more WTE plants. We estimate CEI’s capacity will grow >4x
14 by 2020E. We rate CEI as a Buy with a TP of HK$13.2/share.
12 Future growth enormous: We expect China’s MSW collection volume to grow by 80% to 312mt in 2020E, driven by an improvement in MSW collection rate as the 10 municipal government’s collection infrastructure improves and as urban population
8 increases. This will present a formidable challenge for local governments to treat collected MSW, given the current over-reliance on landfills and the increasing scarcity of land. We 6 see WTE as the optimal solution for local governments.
4 CEI’s capacity to grow >4x by 2020E: CEI is a leader in China’s WTE market with market share of ~6% by capacity in 2013. As of 2013, CEI had 12 WTE projects in 2 operation with designed annual waste processing capacity of about 9,650 tons/day. We 0 expect this number to grow four-fold by 2020E given: 1) we believe the total industry Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 capacity should reach about ~300kt/day by 2020E as incineration as a percentage of total Source: Bloomberg as of Dec 11, 2014 solid waste treatment capacity increases to 35% from today’s 25%; and 2) we expect CEI’s market share to increase to 14% in 2020E vs today’s 7%.
Ticker 257 HK Valuation/Risks Market Data Our target price has priced in a scenario where investments ramp up gradually from 52 Week Range: HK$8.80 – HK$12.22 HK$4.1bn in 2014E and reach HK$8.3bn in 2018E. The long-term investment implied by Total Entprs. Value (M): HK$ 53,790.3 our terminal growth rate of 4.5% is about ~HK$2.8bn. Our WACC assumption is at the Market Cap. (M): US$ 6,607.0 high-end of the 7.3%-8.5% WACC range used by the market due the more volatile nature Shares Out. (M): 4,483.7 of the WTE business. We use a 13% ROIC assumption. Downside risk: Near-term Float (M): 2,703.0 volatility of earnings due to uncertainty in timing of M&A and booking of BOT project Avg. Daily Vol. (M): 8.7 revenues. Source: Bloomberg as of Dec 11, 2014
Exhibit 82: Our capex assumption in our EVA valuation Exhibit 83: … and the resulting WTE capacity addition model: we expect capex spending to accelerate in based on this capex assumption 2015/16… 45 45% 50% 9,000 8,252 40 45% 42 8,000 7,427 7,427 35 40% 31% 37 35% 7,000 30 32 30% 6,000 5,422 25 24% 27 25% 5,000 18% kt/day 20 4,100 23 15% 20% HK$ HK$ mn 4,000 15 13% 18 19% 15% 2,791 3,000 10 14 10% 2,000 5 10 5% 1,000 0 0% 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E 0 2014E 2015E 2016E 2017E 2018E LT implied WTE capacity Yo (%) capex
Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates
page 45 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 84: CEI (257 HK) summary financials Income statement Cash flow statement HK$ m 2013 2014E 2015E 2016E HK$ m 2013 2014E 2015E 2016E Revenue 5,320 6,816 8,819 11,410 Profit after tax 1,364 1,697 2,166 2,710 COGS (2,944) (3,825) (4,951) (6,516) D&A 91 112 139 165 Gross profit 2,375 2,990 3,868 4,894 Change in working cap. (2,424) (187) (249) (325) Operating expenses (2,651) (3,342) (4,333) (5,516) Others 605 (2,870) (3,795) (5,199) Operating profit 2,100 2,639 3,403 4,272 CF from operations (364) (1,248) (1,740) (2,649) Other income/expense 0 0 0 0 Capex (302) (750) (750) (750) Interest income 27 26 26 21 Others (648) 0 0 0 Interest expense (316) (411) (553) (694) CF from investing (950) (750) (750) (750) Pre-tax profit 1,812 2,253 2,876 3,599 Equity raised/ (repaid) 3,628 0 0 0 Tax (447) (557) (710) (889) Debt raised/ (repaid) 917 2,100 3,100 3,100 Recurring profit 1,364 1,697 2,166 2,710 Dividends, interest and others (366) (455) (581) (727) Non-recurring profit 0 0 0 0 Others (285) 0 0 0 Minority interest 40 49 63 79 CF from financing 3,894 1,645 2,519 2,373 Net profit 1,325 1,648 2,103 2,632 Net cash flow 2,579 (354) 29 (1,026) Basic EPS (HK$) 0.33 0.37 0.47 0.59 Exchange gain 40 0 0 0 Diluted EPS (HK$) 0.33 0.37 0.47 0.59 Cash at end of year 4,426 4,072 4,101 3,075
Balance sheet Ratio & financial metrics analysis HK$ m 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E Cash 4,426 4,072 4,101 3,075 Revenue Growth 56.0% 28.1% 29.4% 29.4% Inventories 76 98 127 167 EBIT Growth 43.9% 25.7% 29.0% 25.5% Receivables 1,377 1,764 2,282 2,953 EPS Growth 9.9% 12.7% 27.6% 25.1% Other current assets 2,366 2,631 2,985 3,444 EBIT Margin 39.5% 38.7% 38.6% 37.4% Fixed assets 1,587 2,010 2,413 2,796 Net Profit Margin 24.9% 24.2% 23.8% 23.1% Others assets 13,640 16,725 20,729 26,130 Payout Ratio 26.8% 26.8% 26.8% 26.8% Total assets 23,471 27,300 32,637 38,565 Valuation metrics PER (x) 35.1 31.1 24.3 19.5 ST debt 1,780 1,880 1,980 2,080 EV/EBITDA (x) 21.9 18.3 15.1 13.0 Other current liabilities 1,792 2,280 2,932 3,777 Price to Book (x) 3.5 3.2 2.9 2.6 LT debt 5,141 7,141 10,141 13,141 Balance Sheet Ratios Other LT liabilities 979 979 979 979 ROE 9.9% 11.3% 13.0% 14.5% Total liabilities 9,692 12,279 16,032 19,977 ROIC 9.7% 10.0% 10.4% 10.5% Shareholder's equity 13,374 14,616 16,200 18,183 Net debt to equity 8.0% 23.7% 39.9% 57.9% Minority interests 405 405 405 405 Interest coverage (x) 6.9 6.7 6.4 6.4 Total liability & equity 23,471 27,300 32,637 38,565 Book value per share (x) 3.3 3.6 4.0 4.5
Source: Company data, Jefferies estimates, Bloomberg price as of Dec 11, 2014
page 46 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Joseph Fong CGN Power (1816 HK, Buy, TP HK$3.80)
Equity Analyst +852 3743 8074 The Dawn of China’s Atomic Age [email protected] Key Takeaway Nuclear power capacity is set to triple by the end of the decade, increasing its share of power generation to 6% in 2020. CGN Power, China's largest nuclear power operator, is set to be a key beneficiary as the company's nuclear power Exhibit 85: Price Performance capacity doubles in the same period. The build out promises significant
4 economic value added given the higher returns driven by government policy. We rate CGN Power as a Buy with a TP of HK$3.80. 3.5
3 Nuclear to gradually displace coal-fired power as base-load. Nuclear’s track record has proven to be safer and more environmentally friendly than coal-fired power 2.5 and comparable in terms of cost. China is targeting nuclear capacity to reach 58GW by 2 2020, from today's 18.1GW. In the coming decades, we expect nuclear power capacity to
1.5 be the baseload of choice for China. CGN Power, as China's largest nuclear power operator, is set to be a key beneficiary. 1 Deep pipeline of projects. The company's has 13.35GW of nuclear power plants 0.5 currently under construction, leading the company's total installed capacity to reach 0 Dec-14 Dec-14 Dec-14 24.97GW in 2019, from 11.62GW at the end of 1H14. The capacity installation translates
to a 2013-19 NPAT CAGR of 21% and, nearer term, a 2013-16 NPAT CAGR of 23%. In Source: Bloomberg as of Dec 11, 2014 addition, CGN Power's is entitled to acquire or invest in CGNPC's nuclear power plants.
Government policy drives higher returns and building economic value. Nuclear power, like other en vogue infrastructure projects, benefits from government subsidies Ticker 1816 HK Market Data (VAT refunds, tax holidays) to incentivize investment. We estimate nuclear power projects 52 Week Range: HK$ 2.78 – HK$3.64 can yield project IRRs of 9% and higher. Combined with the deep pipeline of projects, Total Entprs. Value (M): Rmb 209,024.9 CGN stands to build substantial economic value. Market Cap. (M): US$ 20,610.6 Shares Out. (M): 9,707.5 Valuation/Risks Float (M): 9,707.5 Our 20-Year DCF-based TP of HK$3.80 assumes the company's consolidated capacity Avg. Daily Vol. (M): NA reaches 39GW in 2035, a WACC of 7.75%, and 4.5% terminal growth rate. Key risks to our Source: Bloomberg as of Dec 11, 2014 estimates and recommendation include nuclear accidents, equity dilutions and a change in the regulatory regime.
Exhibit 86: Market Share of Nuclear Power Plants Exhibit 87: Net Profit Attributable to Shareholders Rmb m Others 16,000 16% 14,000 CLP 3% 12,000 Jiangsu Guoxin 4% CGN 10,000 44% Datang 8,000 5% 6,000 CPIC 10% 4,000
CNNC 2,000 18% 0 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E
Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates
page 47 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 88: CGN (1816 HK) Summary financials Income statement Cash flow Rmb m 2013 2014E 2015E 2016E Rmb m 2013 2014E 2015E 2016E Revenue 17,365 20,457 21,621 29,808 PBT 6,070 7,564 8,284 10,472 Tax surcharge -255 -300 -316 -443 Depreciation & Amortization 2,490 3,071 3,190 4,307 COGS -8,961 -10,458 -11,211 -15,397 Change in working cap. -1,168 -863 615 862 Gross Profit 8,148 9,698 10,094 13,967 Tax paid -580 -1,017 -899 -923 Other income 1,344 1,488 1,188 1,350 Others 2,682 3,058 2,396 4,141 Operating expense -1,207 -1,287 -1,352 -1,455 CF from operations 9,493 11,813 13,585 18,859 Operating profit 8,286 9,899 9,929 13,862 Capex & Acquisitions -12,636 -11,842 -27,408 -14,216 Other gains and losses 133 -166 0 0 Others 8,155 3,297 817 529 Share of results of assoc. & JCE's 292 732 1,556 1,927 CF from investing -4,482 -8,545 -26,591 -13,686 Interest income 162 188 350 223 Equity raised/ (repaid) 876 18,962 0 0 Interest expense -2,804 -3,088 -3,551 -5,540 Debt raised/ (repaid) 428 1,572 405 0 Pre-tax profit 6,070 7,564 8,284 10,472 Dividends, interest and others -5,241 1,328 -5,756 -9,337 Tax -998 -1,017 -899 -923 CF from financing -3,937 21,863 -5,351 -9,337 Minority interest -877 -1,071 -1,111 -1,730 Net cash flow 1,075 25,131 -18,357 -4,164 Net profit 4,195 5,476 6,274 7,819 Cash BOP 5,434 6,640 31,771 13,414 Exchange gain 131 0 0 0 Diluted EPS (Rmb) 0.15 0.15 0.14 0.17 Cash EOP 6,640 31,771 13,414 9,250 Balance sheet Ratio & financial metrics analysis Rmb m 2013 2014E 2015E 2016E 2013 2014E 2015E 2016E Cash & Restricted Desposits 9,400 32,165 13,807 9,644 Revenue Growth -1.2% 17.8% 5.7% 37.9% Inventories 8,384 8,596 8,908 11,812 Operating Profit Growth -2.0% 19.5% 0.3% 39.6% Receivables 2,772 3,717 3,300 2,919 EPS Growth -7.2% 0.0% -9.9% 24.6% Other current assets 1,204 1,215 1,422 1,422 Operating Margin 47.7% 48.4% 45.9% 46.5% Fix assets 87,042 95,538 168,169 178,908 Net Profit Margin 24.2% 26.8% 29.0% 26.2% Others assets 18,872 20,070 23,084 24,983 Payout Ratio 0.0% 0.0% 33.0% 33.0% Total assets 127,675 161,302 218,689 229,688 Valuation metrics PER (x) 18.8 18.8 20.9 16.8 ST debt 13,098 8,291 11,760 11,760 EV/EBITDA (x) 21.6 14.7 19.3 14.3 Other current liabilities 13,365 14,470 15,280 19,099 Price to Book (x) 4.4 2.4 2.2 2.0 LT debt 66,251 72,630 109,291 109,291 Balance Sheet Ratios Other LT liabilities 3,270 3,405 3,566 3,634 ROE 21.3% 14.3% 11.2% 12.8% Total liabilities 95,983 98,796 139,898 143,784 ROA 4.1% 4.5% 3.9% 4.3% Shareholder's equity 23,052 53,524 58,426 64,174 Net debt to Equity 220.7% 78.0% 136.1% 129.7% Minority interests 8,640 8,982 20,366 21,729 Interest coverage (x) 3.9 4.4 4.1 3.6 Total liability & equity 127,675 161,302 218,689 229,688 Book value per share 0.65 1.18 1.29 1.41
Source: Company data, Jefferies estimates, Bloomberg price as of Dec 11, 2014
page 48 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
CITIC Securities (6030 HK, Buy, TP HK$35.6)
Baron Nie, CFA, AIAA Top beneficiaries of capital market reform Equity Analyst +852 3743 8747 Key takeaways: [email protected] CITICS is well positioned for the capital market reform with its investment banking franchise and high-net-worth and institutional customers’ base. We like CITICS’ lead position in the industry and believe it will benefit the most Exhibit 89: Price Performance with good market sentiment and financial reform in China. Maintain Buy.
35 Brokerage business the main driver: CITICS 9M14 net brokerage income surged
30 53% on the back of a strong A-share market (turnover was up 18% YoY for 10M14 and CSI 300 up 34% YTD). With its focus on high-net-worth and institutional customers (AUM 25 with CITICS > Rmb1mn), we believe its commission rate pressure is less than its peers. On the retail customer front, we believe the current rally encouraged a lot of customers with 20 lower AUM to invest in the stock market which should be charged at a higher commission
15 rate, though they are more commission rate sensitive.
10 Resumption of A-share IPO boosted investment banking fees: With its strong investment banking franchise and the resumption of A-share IPO, CITICS investment 5 banking fees surged 190% YoY in 9M14. We believe such trend will continue going into
0 2015 as CSRC will likely implement the registration-based IPO system.
O… O… O… O…
Ju… Ju… Ju…
Fe… Fe… Fe…
Au… Au… Au…
Ap… Ap… Ap…
De… De… De… De… Credit related business: Net interest income was down 30% YoY in 9M14 due to high Source: Bloomberg as of Dec 11, 2014 finance cost, given CITICS’ aggressive leveraging-up, but net interest income actually
recovered QoQ (up 280% QoQ), which may indicate a better trend with the fast growing
margin financing business (margin lending balance up 76% YoY and market share was 7.9% as of October). Ticker 6030 HK Market Data Valuation/Risks 52 Week Range: HK$ 13.72 – HK$ 33.95 Our PT on CITICS-H of HK$35.6 is the average of our 3-stage DDM model and Gordon Total Entprs. Value (M): Rmb 321,254.1 Growth fair P/B model, based on adjusted profit growth of 35%/21%/6% in stage 1/ 2/ 3 Market Cap. (M): US$ 43,420.9 (terminal), dividend pay-out of 40%, sustainable ROE of 17.6%, and COE of 10.3%. Our Shares Out. (M): 1,178.3 PT-implied 2015E P/B is 2.95x. Downside risks: 1) decline in A-shares; 2) less than Float (M): 1,061.2 expected equity and bond financing; 3) slower than expected new business development; Avg. Daily Vol. (M): 15.9 Source: Bloomberg as of Dec 11, 2014 4) commercial banks or other parties with large customer base allowed to enter the capital market; 5) potential losses from overseas business after the acquisition of CLSA.
Exhibit 90: CITICS brokerage volume Exhibit 91: CITICS margin lending balance trend 1,200,000 80% Margin lending (RMB'mn) 1,000,000 60% 70,000 40%
800,000 40% 60,000 30% 50,000 600,000 20% 40,000 20% 400,000 0% 30,000 10% 200,000 -20% 20,000 0% 0 -40% 10,000 0 -10% 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 Nov-14
CITICS brokerage volume (RMB'mn) YoY CITICS QoQ
Source: Jefferies, Wind Source: Jefferies, Wind
page 49 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 92: CITIC’s Financial Summary and Forecast CITIC Securities Company Limited (6030 HK | 600030 CH) - Summary of Financials Income Statement Balance Sheet Rmb mn 2012 2013 2014E 2015E 2016E Rmb mn 2012 2013 2014E 2015E 2016E Fee & commission income 7,090 10,699 17,184 22,518 25,658 Cash 25,836 27,685 29,006 29,469 29,975 Brokerage 3,603 6,493 11,244 14,784 16,499 Customer cash 33,852 40,125 50,157 62,696 81,505 Investment banking 2,754 2,217 3,350 4,739 5,715 Interbank assets 1,612 23,117 25,428 27,971 30,768 Asset management 320 1,489 2,090 2,496 2,943 Inv. AFS & HTM 37,878 35,704 48,510 61,414 83,961 Interest income 2,172 4,090 7,645 11,983 17,885 Inv. HFT & FV 39,231 76,389 96,149 112,108 130,847 Margin financing 461 1,999 4,459 8,335 13,645 Margin fin. & Sec. lending 9,423 34,302 77,179 131,205 209,928 Investment income 3,648 5,259 7,695 11,332 13,396 Other asset 20,676 34,032 37,891 42,001 48,167 Other income 161 231 1,750 250 250 Total asset 168,508 271,354 364,320 466,865 615,150 Total revenue 13,071 20,279 34,273 46,084 57,189 Accounts payable 34,807 45,196 51,160 63,950 83,135 Fee & commission expense 801 1,061 1,800 2,373 2,666 Interbank liabilities 25,734 63,506 127,375 191,156 287,340 Finance cost 948 3,260 5,520 7,425 10,228 Finl. Liabilities at FV 655 20,609 21,153 24,664 28,786 Staff cost 3,786 5,077 8,397 11,060 13,153 Debt securities 1,500 26,177 32,220 35,000 40,000 Other expenses 2,452 3,893 5,926 7,837 9,633 Other liabilities 19,127 26,463 34,954 44,779 57,552 Impairment losses 30 353 228 304 541 Total liabilities 81,823 181,952 266,862 359,549 496,813 Total operation expenses 8,016 13,643 21,871 28,999 36,221 Minority interests 219 1,714 1,714 1,714 1,714 Operation profit 5,055 6,635 12,402 17,085 20,967 Equity 86,465.0 87,688 95,745 105,602 116,623 Profits from asso & JV 432 211 210 220 220 Per share data Pre-tax profit 5,487 6,846 12,612 17,305 21,187 Rmb 2012 2013 2014E 2015E 2016E Tax 1,180 1,538 2,833 3,894 4,760 Shares: Period end (mn) 11,017 11,017 11,017 11,017 11,017 Minorities 69 64 70 70 70 EPS - adjusted 0.38 0.48 0.79 1.21 1.48 DPS 0.30 0.15 0.32 0.48 0.59 Net profit 4,237 5,244 9,709 13,341 16,357 BVPS 7.85 7.96 8.69 9.59 10.59 Adjustments 0 0 (1,000) 0 0 Net profit adjusted 4,237 5,244 8,709 13,341 16,357 Business Segments Dividends 3,305 1,653 3,484 5,336 6,543 % of operating profit 2009 2010 2011 2012 2013 Investment banking 10 7 3 22 10 Effective tax rate (%) 22% 22% 22% 23% 22% Brokerage 59 30 14 24 45 Dividend payout (%) 78% 32% 40% 40% 40% Trading 17 15 (10) 37 33 Asset management 13 8 7 1 10 ROA (exclude customer cash, %) 3.1 2.3 2.8 3.3 3.1 Others 1 40 87 16 3 Leverage (exclude customer cash, x) 1.6 2.6 3.3 3.8 4.6 ROE (%) 4.9 6.0 9.1 12.6 14.0 Capital ROAE (%) 4.9 6.0 10.6 13.3 14.7 Rmb mn 2009 2010 2011 2012 2013 ROAE adjusted (%) 4.9 6.0 9.5 13.3 14.7 Net asset 61,523 73,771 72,593 71,691 Net capital 41,050 50,030 40,472 34,796 Growth Drivers Total risk capital reserves 7,826 8,083 3,096 4,095 % 2012 2013 2014E 2015E 2016E Net capital / total risk capital reserves (%) 525 619 1,307 850 Investment asset growth 35.4 45.4 29.1 20.0 23.8 Margin fin & Sec lending growth 217.6 264.0 125.0 70.0 60.0 Turnover data Total asset growth 13.6 61.0 34.3 28.1 31.8 % 2012 2013 2014E 2015E 2016E Total turnover (Rmb bn) 33,606 48,813 76,255 103,000 118,191 Fee and comm income growth (27.0) 50.9 60.6 31.0 13.9 CSI 300 YoY 7.6 (7.6) 25.5 15.0 15.0 Interest income growth 5.6 88.3 86.9 56.8 49.2 A-share velocity 182 244 323 350 340 Investment income growth (74.7) 44.2 46.3 47.3 18.2 Brokerage market share 5.8 6.2 6.6 6.8 7.0 Net Brokerage comm rate (bps) 7.9 8.4 9.0 8.6 8.1 Revenue growth (50.4) 55.1 69.0 34.5 24.1 Cost-to-income ratio 61.3 67.3 63.8 62.9 63.3 Underwriting data Opex growth (31.8) 70.2 60.3 32.6 24.9 % 2012 2013 2014E 2015E 2016E Total equity financing (Rmb bn) 267 481 659 792 883 Operating profit growth (65.4) 31.3 86.9 37.8 22.7 Euqity market share 12.0 9.1 8.0 8.5 10.0 Net profit growth (66.3) 23.8 85.1 37.4 22.6 Total debt financing (Rmb bn) 5,270 6,421 7,367 8,030 8,752 Net profit adjusted growth 62.6 23.8 66.1 53.2 22.6 Debt market share 5.4 4.0 5.0 5.5 6.0 EPS adjusted growth 50.4 23.8 66.1 53.2 22.6 Underwriting comm rate 0.7 0.7 0.8 0.8 0.8
Source: Company data, Jefferies estimates
page 50 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
COLI (688 HK, Buy, TP HK$27.1)
Venant Chiang Key Takeaway Equity Analyst Despite the prevailing downturn, COLI has already locked in 80% of its sales +852 3743 8013 target with a sell-through rate above 65% and cash collection ratio of 80%. [email protected] Importantly, no massive price cut is needed, given its competitive products. Its active land acquisition should help it reach notable sales growth in 2015. The potential asset injection serves as a key stock catalyst, although this will take time. Reiterate Buy. Exhibit 93: Price performance
30 Asset injection takes time As the asset injection from CSCEC is subject to approval from CSRC and SASAC, we reckon
25 the process will take time and may take place in 2015. Although CSCEC has a land bank of 29.3mn sqm, around half (mainly in tier-3 cities) is held in collaboration with construction bureaus and thus may not be injected into COLI, in our view. The projects that are 20 available to be injected are mainly located in tier-1/2 cities, which will help to enhance COLI’s land bank scale and quality. Holding 53.18% of COLI’s shares, we believe CSCEC 15 will not dilute its shares during the transaction.
10 Strong sales momentum to continue With HK$113.2bn contracted sales recognized as of October, sales in the last two months
5 are expected to improve further thanks to upbeat market sentiment and sufficient new launches (worth cRmb50bn). The sell-through rate for new phase/projects remained high at 75%, with cash collection ratio around 80%. Owing to intensified market competition, 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 the gross profit margin for projects for sale declined moderately to 30-35%. With regard
to 2015, we expect sales to grow 15% to HK$140bn (excluding COGO) on active land Source: Bloomberg as of Dec 11, 2014 acquisition, above the peer average of 8%.
20% growth target unchanged Due to a significant decline in project delivery, COLI’s revenue and operating profit dropped 47.5%/47.3%, respectively in the third quarter. As a result, its operating profit growth edged down to 13.4% yoy as of Sep. Looking into 4Q, the company expects Ticker 688 HK delivery to pick up and reach its annual profit growth target of 20%. Market Data 52 Week Range: HK$17.52 – 24.60 Healthy financial position Total Entprs. Value (M): HK$ 235,172.5 Due to the high land expenditure in 3Q, COLI’s net gearing at the end of September grew Market Cap. (M): US$ 24,205.5 11ppts to 48%. Unlike other peers, COLI was active in supplementing land and it has Shares Out. (M): 8,174.0 purchased 8.4mn sqm land for Rmb32bn as of October, on track for its acquisition target Float (M): 3,816.7 of 10.0mn sqm. We expect the company’s net gearing to decline below 40% by year-end, Avg. Daily Vol. (M): 23.2 within a comfortable zone. Source: Bloomberg as of Dec 11, 2014 Valuation/Risks Our PT of HK$27.1 is based on a 10% discount to our NAV est. of HK$30.1/sh (WACC: 10.2%). Key risks are: 1) macro hard landing and 2) lower-than-expected sales.
Exhibit 94: Monthly sales as of Oct (Rmb bn) Exhibit 95: Presales lock-in as of Oct 15.0 Rmb bn 97.6 120.0 82.9 100.0 10.0 80.0 85% 60.0 104% 5.0 40.0 20.0 0.0 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 2014 2012 2013 2014 As of Oct (Rmb bn) Remaining (Rmb bn)
Source: Company data, Jefferies Source: Company data, Jefferies
page 51 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 96: Financial statement Income statement Cash flow statement HK$ mn 2012 2013 2014E 2015E 2016E HK$ mn 2012 2013 2014E 2015E 2016E Revenues 64,581 82,469 100,880 123,207 161,965 PBT ex. Exceptionals 29,422 33,289 35,679 41,871 48,660 COGS (39,855) (55,647) (66,110) (79,846) (110,060) Change in working cap. (7,946) (24,705) (22,739) (35,581) (27,972) Gross Profit 24,725 26,822 34,770 43,361 51,905 Others (15,854) (20,278) (19,706) (17,355) (19,425) CF from operations 5,622 (11,694) (6,766) (11,065) 1,262 SG&A (2,037) (2,817) (3,635) (6,160) (8,098) EBIT 22,689 24,005 31,135 37,201 43,806 Investment properties (1,703) (4,558) (3,515) (3,163) (2,847) Interest expense (286) (290) (372) (581) (629) Others 2,892 2,838 0 0 0 Associates 2,637 3,773 4,179 4,388 4,607 CF from investing 1,188 (1,720) (3,515) (3,163) (2,847) Other gains/adjustments 3,651 5,435 738 863 875 Free cash flow 6,810 (13,415) (10,281) (14,229) (1,585) PBT 29,422 33,289 35,679 41,871 48,660 Free cash flow per share 0.83 (1.64) (1.26) (1.74) (0.19) Tax (10,590) (10,110) (12,956) (14,703) (18,050) Equity financing 0 0 0 0 0 Minority (110) (135) (133) (158) (179) Debt financing 16,085 13,530 28,349 7,538 10,885 Others (839) (105) (4,576) (5,472) (6,165) Net profit 18,722 23,044 22,590 27,010 30,431 CF from financing 15,228 14,411 23,772 2,066 4,719 Net profit (core) 15,800 18,960 22,590 27,010 30,431 Shares outstanding (weighted) 8,173 8,173 8,173 8,173 8,173 Increase in cash 22,038 996 13,491 (12,162) 3,135 EPS (core) 1.93 2.32 2.76 3.30 3.72 Beginning cash 17,841 39,880 40,876 54,367 42,204 DPS 0.41 0.47 0.56 0.67 0.75 Ending cash (ex.restricted cash) 39,880 40,876 54,367 42,204 45,339
Balance sheet Ratio Analysis (%) HK$ mn 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016E Investment properties 23,657 32,532 36,047 39,210 42,057 Gross Margin 38% 33% 34% 35% 32% Others 3,372 3,982 3,982 3,982 3,982 Operating margin 35% 29% 31% 30% 27% Associates 22,528 18,793 18,793 18,793 18,793 Net profit margin 24% 23% 22% 22% 19% Total fixed assets 49,557 55,307 58,822 61,985 64,832 Property under development 125,893 164,781 218,934 282,502 306,892 Sales growth 33% 28% 22% 22% 31% Debtors & deposits 2,599 7,953 8,070 6,160 8,098 EBIT growth 21% 6% 30% 19% 18% Bank balances & cash 40,880 41,411 54,902 42,740 45,875 Net profit growth 21% 20% 19% 20% 13% Others 10,895 27,071 33,159 34,487 38,577 EPS growth 21% 20% 19% 20% 13% Total assets 229,825 296,522 373,887 427,874 464,274 BVPS 10.7 13.5 15.7 18.3 21.3 Current liabilities 83,975 110,928 163,419 181,478 179,202 Interest coverage (x) 12.4 10.3 10.1 7.7 8.4 Long term debt 53,243 69,397 76,125 90,356 104,588 Net debt to total capital 14% 20% 24% 29% 28% Other long term liabilities 2,018 582 582 582 582 Net debt to equity 20% 29% 37% 44% 43% Deferred income tax 3,031 4,566 4,566 4,566 4,566 Sales/assets 32% 31% 30% 31% 36% Long term liabilities 58,292 74,544 81,272 95,503 109,736 Assets/equity 262% 267% 289% 284% 265% Minority Interests 313 1,080 1,212 1,371 1,549 ROA 8% 8% 6% 6% 7% Shareholders' funds 87,244 109,971 127,984 149,522 173,788 ROE 22% 21% 18% 18% 17% Total liabilities and equity 229,825 296,522 373,887 427,874 464,274 ROCE 13% 12% 11% 11% 11% Source: Company data, Jefferies estimates
page 52 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
CPIC (2601 HK, Buy, TP HK$40) Baron Nie, CFA, AIAA Equity Analyst Key takeaway +852 3743 8747 CPIC’s life business showed another year of solid performance in 2014, with [email protected] NBV expansion potentially reaching 20%. Investment performance was also solid in 2014, with annualized comprehensive yield reaching 6% for 9M14. Its P&C business was hit hard as a result of reserving catch-up. Going into 2015, we maintain our confidence in CPIC’s life operation, forecasting 16% NBV Exhibit 97: Price Performance growth. On its P&C operation, we expect sequential improvements in 40 underwriting margins, as reserving normalizes. We maintain BUY rating on the stock. 35 Life insurance expected to remain stable: 2014 has been another solid year for 30 CPIC’s life operation, with NBV expansion potentially reaching 20%, mainly driven by its 25 improving agency operations. One of the key factors behind CPIC’s strong life operation was its successful reform towards agency driven expansions, which is likely to carry its 20 momentum going into 2015. We are forecasting 16% NBV expansion for its life business
15 for the New Year, driven by both agency business and gradual reform of bancassurance operations (starting to lean towards regular premium bancassurance policies after re- 10 basing).
5 Capital strong, limited impact from Solvency II implementation: CPIC holds one
0 of the strongest capital positions among the listed insurers. With regard to potential Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 implementation of solvency 2 standards, the company still holds some pre-1999 negative Source: Bloomberg as of Dec 11, 2014 spread portfolios, but this is unlikely to have a material impact on overall solvency levels.
Deferred tax pension scheme introduction: On 25 Nov 2014, the Shanghai
government issued a document to accelerate the development of the insurance industry, Ticker 2601 HK referencing the national guidance published by the state council in Aug 2014. The Market Data document explicitly highlights that one of the focus areas will be the “deferred tax 52 Week Range: HK$23.55 - HK$37.25 pension scheme”, targeting implementation by Dec 2015. As one of the leading insurance Total Entprs. Value (M): Rmb 142,599.4 companies in Shanghai, with strong corporate relationships, CPIC is likely to be one of the Market Cap. (M): US$ 36,312.0 first insurers to benefit from the launch of deferred tax pension scheme, in our view. Shares Out. (M): 2,775.3 Float (M): 2,182.6 Valuation/Risks Avg. Daily Vol. (M): 12.9 CPIC-H (2601 HK) is currently trading at 1.3x 15E P/EV, and CPIC-A (601601 CH) is trading Source: Bloomberg as of Dec 11, 2014 at 1.2x 14E/15E P/EV, which compares to the big three average of 1.2x (H shares) and 1.2x (A shares) respectively. Our TP-H of HK$40 implies a 2015E P/EV of 1.53x. Risks: 1) significant slow-down in growth; 2) A-shares decline; 3) pricing competition on traditional products and rising competition.
Exhibit 98: CPIC forward P/EV chart Exhibit 99: CPIC NBV growth
25% 2.60 23% 22% 2.40 20% 2.20 2.00 15% 1.80
1.60 10% 10% 1.40 6% 1.20 5% 5% 1.00 0.80 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 0% 2010 2011 2012 2013 2014E
China Pacific Average +1 s.d. -1 s.d. NBV Growth
Source: Bloomberg price as of 11 Dec 2014 Source: Jefferies estimates, company data
page 53 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Exhibit 100: CPIC Financials
Income statement (RMB, mil) 2010 2011 2012 2013 2014E 2015E Profitability measures 2010 2011 2012 2013 2014E 2015E Life insurance premium 87,873 93,203 93,461 95,101 103,869 115,077 New business margin (Life) 11.3% 14.3% 18.9% 22.1% 24.4% 25.7% Non-life insurance premium 51,682 61,755 69,767 81,822 94,095 108,210 RoEV (Life) 24.0% 19.5% 20.0% 20.0% 18.4% 18.0% Total GWP 139,555 154,958 163,228 176,923 197,965 223,286 Loss ratio (P&C) 57.4% 58.5% 61.2% 66.0% 66.5% 65.5% Premium ceded to reinsurers (13,422) (13,384) (11,795) (15,295) (20,272) (23,126) Expense ratio (P&C) 36.3% 34.6% 34.6% 33.5% 34.1% 34.1% Unearned premium reserve chg (6,382) (4,336) (3,594) (2,003) (4,905) (5,627) Combined ratio (P&C) 93.7% 93.1% 95.8% 99.5% 100.6% 99.6% Net earned premium 119,751 137,238 147,839 159,625 172,788 194,533 ROAE 11.0% 10.6% 5.9% 9.5% 11.3% 11.7% Life insurance claims paid (22,832) (28,218) (27,586) (34,470) (38,942) (43,839) ROAA 2.0% 1.6% 0.8% 1.3% 1.6% 1.6% Non-life insurance claims paid (20,136) (27,364) (34,445) (45,657) (49,050) (55,559) Total investment yield 5.2% 3.4% 3.1% 4.8% 5.1% 5.1% Policyholders reserve chg (59,241) (56,063) (58,501) (55,056) (56,252) (61,693) Investment income yield 4.2% 4.4% 4.6% 4.8% 4.9% 4.9% Acq. and general expense (28,063) (33,120) (38,224) (42,365) (50,293) (56,807) Investment income 20,633 16,392 18,060 30,972 36,308 40,372 Other income/expenses 558 1,534 (1,030) (1,135) 666 611 Solvency & liquidity 2010 2011 2012 2013 2014E 2015E Profit before tax 10,670 10,399 6,113 11,914 15,224 17,618 Solvency ratio (Life) 241% 187% 211% 191% 205% 208% Tax (2,005) (2,006) (983) (2,519) (3,071) (3,607) Solvency ratio (P&C) 167% 233% 188% 162% 161% 163% Profit after tax 8,665 8,393 5,130 9,395 12,153 14,011 Gearing ratio 83.1% 86.5% 85.9% 86.3% 86.0% 86.4% Minority interests (108) (80) (53) (134) (173) (200) Cash to insurance liability 5.7% 4.0% 5.7% 3.8% 3.8% 3.8% Profit attributable to shareholders 8,557 8,313 5,077 9,261 11,979 13,811
Balance sheet (RMB, mil) 2010 2011 2012 2013 2014E 2015E Key valuations 2010 2011 2012 2013 2014E 2015E Cash & equivalent 17,560 14,966 24,990 19,335 21,773 24,470 P/EV (Group) 2.02 1.96 1.73 1.62 1.41 1.25 Fixed income investments 344,384 421,855 504,933 529,615 596,395 670,268 P Implied NBVM 18.4 16.2 14.0 12.0 7.3 4.4 Equity Investments 55,516 53,573 62,715 75,129 84,602 95,082 P/E 25.8 26.7 44.9 25.3 19.5 16.9 Other Investments 18,291 32,136 34,690 42,720 48,107 54,065 P/B 2.8 2.9 2.4 2.4 2.1 1.9 Total investment assets 435,751 522,530 627,328 666,799 750,876 843,885 Dividend yield 1.35% 1.35% 1.29% 1.35% 1.75% 2.02% Other Assets 39,960 48,082 54,174 56,734 61,343 60,525 Payout ratio 35% 36% 59% 34% 34% 34% Total Assets 475,711 570,612 681,502 723,533 812,220 904,410 Life insurance liabilities 269,955 327,810 387,674 444,761 501,013 562,706 Non-life insurance liabilities 37,144 47,121 51,213 57,775 65,851 75,313 Business growth (Y/Y %) 2010 2011 2012 2013 2014E 2015E Investment contract liabilities 51,272 47,182 41,754 34,443 36,038 37,706 Life premium 41.7% 6.1% 0.3% 1.8% 9.2% 10.8% Other liabilities 35,789 70,444 103,292 86,168 94,200 103,660 P&C premium 50.5% 19.5% 13.0% 17.3% 15.0% 15.0% Total Liabilities 394,160 492,557 583,933 623,147 697,103 779,385 Total premium 44.9% 11.0% 5.3% 8.4% 11.9% 12.8% Issued Share Capital 8,600 8,600 9,062 9,062 9,062 9,062 Acq. & general expense 30.7% 18.0% 15.4% 10.8% 18.7% 13.0% Retained profit and reserves 71,697 68,196 87,115 89,906 104,464 114,172 Net income 16.3% -2.9% -38.9% 82.4% 29.4% 15.3% Shareholders equity 80,297 76,796 96,177 98,968 113,526 123,234 Investment assets 19.1% 19.9% 20.1% 6.3% 12.6% 12.4% Minority Interests 1,254 1,259 1,392 1,418 1,591 1,791 Insurance liabilities 30.1% 22.1% 17.1% 14.5% 12.8% 12.6% Total equity 81,551 78,055 97,569 100,386 115,117 125,025 Investment liabilities -1.6% -8.0% -11.5% -17.5% 4.6% 4.6% EV (Group) 11.9% 3.2% 19.1% 6.7% 15.3% 12.1% Total Equity & Liabilities 475,711 570,612 681,502 723,533 812,220 904,410 NBV (Life) 22.0% 10.1% 5.2% 6.2% 23.0% 16.1%
Embedded values (RMB, mil) 2010 2011 2012 2013 2014E 2015E Per share data (RMB) 2010 2011 2012 2013 2014E 2015E EV discount rate 11.5% 11.5% 11.5% 11.0% 11.0% 11.0% EPS 1.00 0.97 0.57 1.02 1.32 1.52 Life insurance adjusted NAV 35,836 31,381 35,371 33,791 41,630 50,547 BVPS 9.34 8.93 10.61 10.92 12.53 13.60 Value of inforce business 34,778 41,611 49,896 63,507 77,042 86,509 DPS 0.35 0.35 0.33 0.35 0.45 0.52 Life insurance EV 70,614 72,992 85,267 97,298 118,673 137,055 Embedded Value (Life) 8.21 8.49 9.41 10.74 13.10 15.12 Group EV 110,089 113,564 135,280 144,377 166,497 186,595 Embedded Value (Group) 12.80 13.21 14.93 15.93 18.37 20.59 NBV (Life) 0.71 0.78 0.78 0.83 1.02 1.18 1 year NBV 6,100 6,714 7,060 7,499 9,225 10,709 No. of shares 8,600 8,600 9,062 9,062 9,062 9,062
Source: Jefferies estimates, company data, Bloomberg price as of Dec 11, 2014
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Equity Strategy
China
14 December 2014
Daqin Railway (601006 CH, NC)
Daqin Railway Co., Ltd. is a provider of railway transportation services. The company Johnson Leung primarily provides railway transportation services for coal products in Shanxi and Inner Equity Analyst Mongolia to Qinhuangdao port. It principally transports thermal coal, which is used by +852 3743 8055 IPPs in coastal areas in Southern China. Daqin Railway has a leading position in China’s [email protected] thermal coal shipment with 22% market share up to 1H14. It has also been able to steadily raise freight rate in recent years, while operating at full capacity. The launch of other coal shipment rails in North China, as well as the market’s bearish view of coal consumption Exhibit 101: Price Performance are concerns for the company.
12 Company Background Daqin Railway Company was founded in Oct 2004. It is a subsidiary of Taiyuan Railway 10 Bureau. Daqin operates several railways in China, most famously the Daqin Railway, a 653 km coal-transport railway in north China, linking Datong to Qinhuangdao ports. Daqin 8 Railway was listed on the Shanghai Stock Exchange in July 2006, as the first listed railway operator in China. In 2010, it also conducted a secondary public offering of Rmb1.89bn to 6 acquire transportation facilities under its parents.
4 Top Shareholders Top 10 institutional shareholders hold 71.65% of total shares. 1. Taiyuan Railway Bureau 2 (61.70%); 2. CPIC (3.23%); 3) National Council for Social Security Fund (2.04%); 4. Hebei Port Group (1.07%); 5. China Coal Group (0.94%).
0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Key Products Segment Coal shipment is the key segment. Revenue from freight reached Rmb21bn in 1H14 and Source: Bloomberg as of Dec 11, 2014 accounted for 83% of the company’s total revenue. Out of freight, coal accounted for 92%
of total cargo volume. Daqin also has a small passenger segment, accounting for 9% of revenue in 1H14.
Ticker 601006 CH 9M2014 Results Summary Market Data The company reported 9M14 revenue of Rmb41bn, up 6.9% yoy. Net profit was 52 Week Range: Rmb 6.24 - Rmb 11.14 Rmb11.2bn, up 15.9% yoy. Total gross margin remain stable at 39% as freight rate Total Entprs. Value (M): Rmb 151,186.9 increase has offset cost inflation. Operating cash inflow totalled Rmb15bn, up 26% yoy. Market Cap. (M): US$ 24,665.9 Shares Out. (M): 14,866.8 Management were cautiously optimistic on 2H14 outlook, due to the narrowing of price Float (M): 5,007.6 difference between domestic and import coal, low IPP inventory etc, and expect coal Avg. Daily Vol. (M): 82.8 demand will continue to grow, albeit slowly. 9M14 freight volume increased 2.2% yoy. Source: Bloomberg as of Dec 11, 2014 Consensus Valuation and Rating All 17 brokers rated it “Buy” in Bloomberg. Bloomberg consensus projected Daqin’s EPS in the coming three years to be Rmb1.005, Rmb1.136 and Rmb1.205, respectively, indicating a 12.3% CAGR.
Exhibit 102: Revenue Growth Trend Exhibit 103: Net Income and Margins 60,000.0 15,000.0 45.0 CAGR = 9.2% 49,812.9 40.0 50,000.0 43,497.0 44,833.1 40,643.5 10,000.0 35.0 40,000.0 32,090.3 30.0 30,000.0 5,000.0 25.0 20,000.0 20.0 10,000.0 0.0 15.0 0.0 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Net Income (CNY MN) Gross Margin (%) Net Margin (%) Source: Jefferies, Company data Source: Jefferies, Company data
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Equity Strategy
China
14 December 2014
Exhibit 104: Daqin Railway Financial Summary (RMB Million) FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Income Statement Turnover 32,090.3 40,643.5 43,497.0 44,833.1 49,812.9 COGS 20,060.1 24,218.8 26,420.3 28,478.7 32,306.8 Gross Profit 12,030.1 16,424.7 17,076.7 16,354.4 17,506.1 Operating Profit 10,103.1 14,214.5 14,674.8 13,586.5 14,165.3 EBIT 10,103.1 14,214.5 14,674.8 13,586.5 14,165.3 EBITDA 13,896.8 18,332.3 18,765.2 18,100.6 19,017.3 Pretax Income 9,549.7 13,686.1 15,247.1 14,706.3 16,070.8 Net Income 7,146.7 10,410.8 11,698.6 11,504.0 12,691.5
Balance Sheet Cash and Cash Eqv 9,091.5 10,153.2 4,678.8 7,837.4 8,785.4 Inventory 1,159.9 1,174.0 1,478.4 1,692.6 1,786.8 Current Assets 13,064.4 14,253.7 8,995.6 13,673.0 14,594.2 Long-term Assets 69,624.1 72,049.2 70,815.3 70,399.1 71,275.1 Total Assets 82,997.6 100,146.2 94,120.7 100,567.5 103,955.3 Short-term Borrowings 3,100.0 12,450.0 5,991.6 3,994.2 7,493.6 Current Liabilities 14,644.4 29,228.4 18,617.5 16,443.3 19,649.1 Long-term Borrowings 13,444.4 13,458.1 11,466.0 12,465.4 5,671.2 Long-term Liabilities 29,145.3 43,804.6 31,283.6 30,148.8 26,687.1 Total Liabilities 29,145.3 43,804.6 31,283.6 30,148.8 26,687.1 Total Shareholders' 53,852.3 56,341.7 62,837.1 70,418.8 77,268.2 Shares Outstanding 12,976.8 13,339.0 14,866.8 14,866.8 14,866.8
Cash Flow Statement Net Income 7,146.7 10,410.8 11,698.6 11,504.0 12,691.5 Cash From Operating 8,586.9 16,943.4 13,893.7 13,288.9 15,206.6 Cash from Investing -18,503.4 -36,792.8 -5,577.2 -3,835.0 -4,785.1 Cash from Financing 14,251.4 20,911.0 -13,790.9 -6,330.9 -9,473.7 Net Changes in Cash 4,335.0 1,061.7 -5,474.4 3,123.0 947.7 Free Cash Flow -10,030.9 12,753.3 9,906.2 9,336.7 10,468.5 Cashflow per share 0.3 0.1 -0.4 0.2 0.1
Ratio Analysis and Per Share Data Revenue Growth (%) 46.9 26.7 7.0 3.1 11.1 EBITDA Growth (%) 19.5 31.9 2.4 -3.5 5.1 Net Income Growth (%) 7.0 45.7 12.4 -1.7 10.3
Gross Margin (%) 37.5 40.4 39.3 36.5 35.1 EBITDA Margin (%) 43.3 45.1 43.1 40.4 38.2 Net Margin (%) 22.3 25.6 26.9 25.7 25.5 ROE (%) 15.2 18.9 19.6 17.3 17.2 ROA (%) 9.8 11.4 12.0 11.8 12.4
Debt/Equity Ratio 0.31 0.46 0.28 0.23 0.17 Current Ratio 0.89 0.49 0.48 0.83 0.74 Inventory Turnover 34.98 34.83 32.80 28.28 28.63 Interest coverage ratio 18.10 13.45 13.33 15.77 18.27
EPS 0.55 0.78 0.79 0.77 0.85 BVPS 4.15 3.79 4.23 4.72 5.18 DPS 0.30 0.35 0.39 0.39 0.43 Source: Bloomberg
page 56 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Haitong Securities (6837 HK, Buy, TP HK$24.9) Baron Nie, CFA, AIAA Equity Analyst Leading broker to benefit from positive market +852 3743 8747 [email protected] sentiment Key takeaways HTS should reap the fruits of its leading position in the brokerage industry, Exhibit 105: Price Performance and positive market sentiment should ease their commission rate pressure. We believe margin financing and other capital-based business will continue 25 to be the major earnings growth driver as the company is leveraging up. Maintain Buy. 20 Brokerage commission rate under pressure: HTS’ brokerage commission grew 19% YoY in 9M14 and 33% QoQ in 3Q14 on the back of strong A-share market sentiment 15 (turnover was up 18% YoY for 10M14 and CSI 300 up 34% YTD). The market share of HTS may be shrinking and continuously pressurizing its commission rate (market share down 10 from 4.79% in FY13 to 4.76% in 10M14). However, we believe the strong market sentiment will offset the negative impact from decreasing commission rate.
5 Leverage up for further growth: In order to finance its margin lending business, HTS’ leverage increased from 2.75x as of Dec 13 to 3.70x as of Sep 14, up 0.25x. Thanks to its
0 margin lending balance surging 73% in the same period, net interest income increased
Jun-12 Jun-13 Jun-14
Apr-13 Apr-12 Apr-14
Feb-13 Feb-14
Oct-12 Oct-13 Oct-14
Dec-12 Dec-13
Aug-13 Aug-14 Aug-12 52% YoY in 9M14. We believe this trend will continue and the growth in interest income
will continuously have a meaningful contribution to earnings, though the brokers are now Source: Bloomberg as of Dec 11, 2014 tightening their credit by increasing the margin lending deposit ratio.
Ticker 6837 HK Leasing business made a meaningful contribution: After its acquisition of UT Market Data Capital in Sep 13, leasing business revenue and profit started to kick-in in 2014. It 52 Week Range: Rmb 9.50 - Rmb 23.20 contributed 6% of the company’s total net profit for 1H14. Total Entprs. Value (M): Rmb 198,511.0 Market Cap. (M): US$ 29,097.6 Valuation/Risks Shares Out. (M): 1,492.6 Our PT on HTS-H of HK$24.9 is the average of our 3-stage DDM model and Gordon Float (M): 1,325.8 Growth fair P/B model, based on profit growth of 32%/18%/6% in stage 1/ 2/ 3 (terminal), Avg. Daily Vol. (M): 27.4 dividend pay-out of 40%, sustainable ROE of 16.1% and COE of 9.9%. Our PT-implied Source: Bloomberg as of Dec 11, 2014 2015E P/B is 2.58x. Downside risks: 1) decline in A-shares; 2) less than expected equity and bond financing; 3) slower than expected new business development; 4) commercial banks or other parties with large customer base allowed to enter the capital market.
Exhibit 106: HTS brokerage volume Exhibit 107: HTS margin lending balance trend 800,000 80% Margin lending (RMB'mn) 700,000 60% 50,000 50% 600,000 40% 500,000 40,000 40% 400,000 20% 30,000 30% 300,000 0% 200,000 20,000 20% -20% 100,000 10,000 10% 0 -40% 0 0% 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 Nov-14
HTS brokerage volume (RMB'mn) YoY HTS QoQ
Source: Jefferies, Wind Source: Jefferies, Wind
page 57 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 108: HTS’s Financial Summary and Forecast Haitong Securities Company Limited (6837 HK | 600837 CH) - Summary of Financials Income Statement Balance Sheet Rmb mn 2012 2013 2014E 2015E 2016E Rmb mn 2012 2013 2014E 2015E 2016E Fee & commission income 5,210 6,751 9,328 12,363 14,622 Cash 20,540 18,809 19,079 19,398 19,732 Brokerage 3,361 4,690 6,543 8,328 8,600 Customer cash 31,461 33,778 42,222 57,000 74,100 Investment banking 974 1,309 1,944 3,082 4,692 Interbank assets 9,601 18,831 25,422 34,320 44,616 Asset management 858 731 832 943 1,320 Inv. AFS & HTM 11,286 10,308 14,033 17,776 24,304 Interest income 2,879 3,671 6,564 9,408 11,877 Inv. HFT & FV 32,418 47,590 64,788 82,071 112,209 Margin financing 728 1,430 4,079 6,443 8,136 Margin fin & Sec lending 11,339 27,465 63,170 88,438 114,970 Investment income 2,404 2,150 4,978 6,669 8,822 Other asset 9,838 12,342 15,405 20,152 25,105 Other income 251 231 250 250 250 Total asset 126,482 169,124 244,119 319,155 415,035 Total revenue 10,743 12,803 21,120 28,689 35,570 Accounts payable 36,957 40,430 48,133 64,980 84,474 Fee & commission expense 828 849 1,102 1,370 1,625 Interbank liabilities 26,817 33,364 70,143 116,783 178,817 Finance cost 704 1,484 3,348 4,834 6,558 Finl. Liabilities at FV 135 6,507 8,858 11,221 15,341 Staff cost 2,142 2,621 4,224 5,738 7,114 Debt securities 0 20,940 43,361 44,361 45,361 Other expense 2,166 2,529 3,354 4,467 5,481 Other liabilities 2,143 3,779 4,849 6,609 8,456 Impairment losses 841 (19) 141 353 457 Total liabilities 66,052 105,018 175,343 243,953 332,449 Total operation expenses 6,682 7,465 12,168 16,762 21,234 Minority interests 1,751 2,598 1,600 1,600 1,600 Operating profit 4,061 5,338 8,952 11,927 14,337 Equity 58,680 61,507 67,176 73,602 80,986 Profits from asso & JV 66 117 50 50 50 Per share data Pre-tax profit 4,127 5,455 9,002 11,977 14,387 Rmb 2012 2013 2014E 2015E 2016E Tax 875 1,174 1,937 2,577 3,096 Shares: Period end (mn) 9,585 9,585 9,585 9,585 9,585 Minorities 215 246 246 246 246 EPS 0.33 0.42 0.71 0.96 1.15 DPS 0.12 0.12 0.28 0.38 0.46 Net profit 3,038 4,035 6,819 9,154 11,045 BVPS 6.12 6.42 7.01 7.68 8.45 Adjustments 0 0 0 0 0 Net profit adjusted 3,038 4,035 6,819 9,154 11,045 Business Segments Dividends 1,150 1,150 2,728 3,662 4,418 % of operating profit 2009 2010 2011 2012 2013 Brokerage 76 60 41 38 53 Effective tax rate (%) 21% 22% 22% 22% 22% Asset management 6 7 9 8 2 Dividend payout (%) 38% 29% 40% 40% 40% Proprietary trading 12 14 11 13 36 Investment banking 5 12 12 6 5 ROA (exclude customer cash, %) 3.2 3.0 3.4 3.5 3.2 Directi investmnet 1 2 1 3 6 Leverage (exclude customer cash, x) 1.6 2.2 3.0 3.6 4.2 Headquarters and others (0) 3 23 26 17 ROE (%) 5.2 6.6 10.2 12.4 13.6 Overseas 2 4 3 6 11 ROAE (%) 5.9 6.7 10.6 13.0 14.3 ROAE adjusted (%) 5.9 6.7 10.6 13.0 14.3 Capital Rmb mn 2009 2010 2011 2012 2013 Net asset 43,096 43,864 44,687 57,973 60,311 Growth Drivers Net capital 34,391 32,460 32,441 38,678 39,041 % 2012 2013 2014E 2015E 2016E Total risk capital reserves 4,414 5,678 2,227 2,451 3,047 Investment asset growth 48.8 32.5 36.1 26.7 36.7 Net capital / totla risk capital reserves (%) 779 572 1,457 1,578 1,281 Margin fin & Sec lending growth 75.4 142.2 130.0 40.0 30.0 Total asset growth 27.8 33.7 44.3 30.7 30.0 Turnover data % 2012 2013 2014E 2015E 2016E Fee and comm income growth (20.67) 29.59 38.18 32.53 18.27 Total turnover (Rmb bn) 33,606 48,813 76,255 103,000 118,191 Interest income growth 12.8 27.5 78.8 43.3 26.2 CSI 300 YoY 7.6 (7.6) 25.5 15.0 15.0 Investment income growth 59.6 (10.6) 131.5 34.0 32.3 A-share velocity 182 244 323 350 340 Brokerage market share 5.5 5.5 5.5 5.8 6.1 Revenue growth (1.1) 19.2 65.0 35.8 24.0 Net brokerage comm rate (bps) 8.0 7.9 7.0 6.3 5.4 Cost-to-income ratio 62.2 58.3 57.6 58.4 59.7 Opex growth 0.7 11.7 63.0 37.8 26.7 Underwriting data % 2012 2013 2014E 2015E 2016E Operating profit growth (3.9) 31.4 67.7 33.2 20.2 Total equity financing (Rmb bn) 267 481 659 792 883 Net profit growth (2.1) 32.8 69.0 34.2 20.7 Euqity market share 2.3 6.2 5.0 4.5 5.0 Net profit adjusted growth (2.1) 32.8 69.0 34.2 20.7 Total debt financing (Rmb bn) 5,270 6,421 7,367 8,030 8,752 EPS growth (11.7) 26.4 69.0 34.2 20.7 Debt market share 1.7 1.3 2.0 3.0 4.0 DPS growth (20.0) 0.0 137.2 34.2 20.7 Underwriting comm rate 1.0 1.1 1.1 1.1 1.2
Source: Company data, Jefferies estimates
page 58 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Kweichow Moutai Co. Ltd. (600519 CH, NC)
Kweichow Moutai is a leading high end Chinese liquor producer in China. Its main Jessie Guo, PhD product portfolio includes the Maotai liquor, millesimes liquor series, gift liquor series, Equity Analyst Hanjiang liquors, Maotai Prince liquors and Maotai Yingbin liquor, etc. 852 3743 8036 [email protected] Company Background
Maotai liquor has a very long history in China and is regarded as the country’s top traditional liquor. It is produced in the Maotai village of Guizhou province. The company Exhibit 109: Price Performance was listed in the Shanghai Stock Exchange on Aug.28, 2001 300 Top Shareholders
250 Kweichow Moutai is an SOE with 64.9% shareholding owned by the parentco. Other top institutional shareholders include: 1) E Fund management (1.02%); 2) UBS (0.73%); 3)
200 Temasek Fullerton (0.71%); 4) Bank of Communication E-fund (0.65%) and 5) Sino Life Insurance (0.54%).
150 Key Product Segments The main brand Maotai liquor accounted for 96% of total revenue in 1H14, vs. 94% in 100 2013; while the remaining comes from the sub-brand series liquor. The main brand Maotai liquor enjoys a high GP margin of 94.3% while the sub-brand series liquor has an 50 GP margin of 63.7% in 1H14.
0 9M2014 Results Summary Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 The company continued to be impacted by the government’s anti-corruption and anti- Source: Bloomberg as of Dec 11, 2014 extravagance campaign and saw sales slowdown. 1) Sales (net of tax) grew 0.7% yoy to RMB20.0bn, which implied 2.5% revenue (net of tax) decline in 3Q14. 2) Gross profits dropped by 0.3% to RMB18.6bn; gross margin contracted 0.9ppt yoy to 91.9%. 3) Operating profits declined 3.0% yoy to RMb15.2bn; OP margin contracted 2.8ppt yoy to Ticker 600519 CH 75.4%, mainly due to operating deleverage and GP margin contraction. 4) Excluding Market Data NDRC fine in 1Q13 of RMB247m, core net profit went down 5.5% yoy to RMB10.7bn in 52 Week Range: Rmb 107.3 – Rmb 186.6 9M14, which implied 9% net income decline in 3Q14. It delivered core net margin of Total Entprs. Value (M): Rmb 183,749.2 53.0% in 9M14, contracted 3.5ppt yoy from 56.5% in 9M13, mainly due to OP margin Market Cap. (M): US$ 32,450.1 contraction and lower finance income. Shares Out. (M): 1,142.0 Float (M): 376.3 Consensus Valuation and Rating Avg. Daily Vol. (M): 5.2 Out of the 22 analysts covering the company, 20 rate it a Buy while 2 give it a Hold rating. Source: Bloomberg as of Dec 11, 2014 Bloomberg consensus projected core EPS of RMB13.6, RMB14.9 and RMB16.8 in 14e, 15e, 16e, respectively, indicating CAGR of 8.1%.
Exhibit 110: Revenue Growth Trend Exhibit 111: Net Income and Margins
Source: Jefferies, Company data Source: Jefferies, Company data
page 59 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 112: Kweichow Moutai financial summary (year-end December)
RMB m except per share items FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Income Statement Revenue (net of sales tax) 8,729 10,056 15,925 23,883 28,280 COGS 951 1,053 1,551 2,044 2,194 Gross profit 7,779 9,003 14,374 21,838 26,086 Operating profit 5,941 6,984 11,982 18,407 21,360 EBITDA 6,148 7,269 12,330 18,841 21,917 Pretax Income 6,081 7,162 12,335 18,700 21,432 Net Income 4,312 5,051 8,763 13,308 15,137
Balance Sheet Cash and Cash Eqv 9,743 12,888 18,255 22,062 25,185 Inventory 4,192 5,574 7,187 9,666 11,837 Current Assets 15,656 20,300 27,830 36,225 41,932 Long-term Assets 4,114 5,287 7,071 8,773 13,523 Total Assets 19,770 25,588 34,901 44,998 55,454 Short-term Borrowings 0 0 0 0 2,773 Current Liabilities 5,108 7,028 9,481 9,526 11,307 Long-term Borrowings 0 0 0 0 0 Long-term Liabilities 10 10 17 18 18 Total Liabilities 5,118 7,038 9,497 9,544 11,325 Total Equities 14,652 18,549 25,403 35,454 44,129 Shares Outstanding 1,142 1,142 1,142 1,142 1,142
Cash Flow Statement Net Income 4,312 5,051 8,763 13,308 15,137 Cash From Operating 3,945 5,847 9,979 11,768 11,930 Cash from Investing -1,342 -1,765 -2,123 -4,204 -5,342 Cash from Financing -954 -937 -2,489 -3,758 -6,658 Net Changes in Cash 1,649 3,145 5,366 3,807 -70 Free Cash Flow 2,588 4,115 7,794 7,557 6,524
Ratio Analysis and Per Share Data Revenue Growth (%) 15.5% 15.2% 58.4% 50.0% 18.4% EBITDA Growth (%) 12.8% 18.2% 69.6% 52.8% 16.3% Net Income Growth (%) 13.5% 17.1% 73.5% 51.9% 13.7%
Gross Margin (%) 89.1% 89.5% 90.3% 91.4% 92.2% EBITDA Margin (%) 70.4% 72.3% 77.4% 78.9% 77.5% Net Margin (%) 49.4% 50.2% 55.0% 55.7% 53.5% ROE (%) 33.5% 30.7% 40.4% 45.0% 39.4% ROA (%) 24.3% 22.3% 29.0% 33.3% 30.1%
Debt/Equity Ratio 0.0 0.0 0.0 0.0 0.0 Current Ratio 3.1 2.9 2.9 3.8 3.7 Inventory Turnover Days 1,402.7 1,692.8 1,501.3 1,508.6 1,788.7 Interest coverage ratio NA NA NA NA NA
EPS 3.78 4.42 7.67 11.65 13.25 BVPS 12.83 16.24 22.24 31.05 38.64 DPS 0.98 1.90 3.63 5.84 3.98 Source: Bloomberg
page 60 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Baron Nie, CFA, AIAA Ping An (2318 HK/601318 CH, Buy, TP HK$93 / +852 3743 8747
[email protected] Rmb 73.5) Key takeaway Exhibit 113: Price Performance
2318 HK Ping An had a strong year in 2014, with NBV growth likely to reach 15-20%
100 and improving P&C underwriting margins. Going into 2015, we expect life 90 fundamental expansion to remain solid, around the mid-teens. At the same 80
70 time, we are forecasting strong P&C business performance, thanks to its
60 leading distribution. Potential implementation of Solvency II standards could 50 be a risk for the company due to the pre-1999 portfolio; however, with recent 40
30 successful placement, we see such risk as controllable. Ping An remains our 20 top pick in the China insurance space. 10
0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Life business remains the key driver: Ping An had a strong year in 2014, with life 601318 CH business NBV likely to reach 15-20%, thanks to its outstanding agency operations. Looking 80 into 2015, we expect its agency force to continue to grow by around 5-10%, and 70 productivity to further improve as a result of 1) improving agency quality; 2) rising 60 disposable income; 3) increasing awareness of insurance protections. We expect Ping An 50 to deliver around mid-teens NBV growth again going into 2015. 40
30 Leading P&C operations: Underwriting results in the P&C business were encouraging 20 in 2014, especially in auto-insurance business. P&C combined ratio was recorded at 10 94.9% for 9M14 vs. 95.8% for 9M13; the key reasons cited for the improvement include: 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 1) improvement in business risk selection and 2) tighter control on claims. Going into
Source: Bloomberg as of Dec 11, 2014 2015, we expect Ping An to further differentiate and strengthen its market position after the pricing deregulation. Ticker 2318 HK /601318 CH Solvency 2 could be a drag, but ease with latest placement: Since Ping An still has Market Data 52 Week Range - H: HK$55.60 - HK$77.30 sizable exposure to pre-1999 negative spread portfolio (which was allowed to be
52 Week Range - A: Rmb35.51 – Rmb67.12 discounted at a rate up to 7.5% now), adjustment to market discount rate (according to Total Entprs. Value (M): Rmb816,800.8 local media, one of the key Solvency II changes) implies a decline in solvency ratio. Market Cap. (M) - H: US$ 79,369.0 However, given its latest placements, we believe the company is well prepared for the Market Cap. (M) - A: US$ 79,332.4 potential adjustments. Shares Out. (M) - H: 3,723.8 Shares Out. (M) - A: 4,786.5 Valuation/Risks Float (M) - H: 2,135.1 Ping An-H is trading at 1.0x 15E PEV, which compares to 1.3x for China Life-H and CPIC-H. Float (M) - A: 3,281.0 At the same time, Ping An – A is only trading at 0.97x 15E PEV. Our target price implies Avg. Daily Vol. (M) - H: 24.8 1.24x 15E P/EV, which is in-line with its 3-year average of 1.2x. Risks: 1) Negative A-share Avg. Daily Vol. (M) - A: 90.6 performance; 2) introduction of pricing deregulation for life insurance products, Source: Bloomberg as of Dec 11, 2014 triggering severe pricing competition; 3) Significant slowdown in life insurance growth.
Exhibit 114: Ping An forward P/EV Exhibit 115: Ping An NBV growth
35% 6.0 31% 30% 5.0 25%
4.0 20% 17% 14% 15% 3.0 10% 8% 2.0 5%
1.0 0%
-5% 0.0 -5% Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 -10% 2010 2011 2012 2013 2014E
Ping An Average -1 s.d. +1 s.d. NBV Growth
Source: Bloomberg as of Dec 11, 2014 Source: Jefferies estimates, company data
page 61 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 116: Ping An Group Financials Income statement (Rmb, mil) 2011 2012 2013 2014E 2015E Profitability measures 2011 2012 2013 2014E 2015E Life insurance premium 124,094 134,851 153,377 183,322 215,950 New business margin (Life) 23.7% 26.9% 29.4% 28.8% 29.2% Non-life insurance premium 83,708 99,089 115,674 130,566 147,376 RoEV (Life) 23.7% 20.9% 19.5% 19.8% 19.1% Total gross written premium 207,802 233,940 269,051 313,887 363,326 Loss ratio (P&C) 57.8% 59.4% 60.4% 59.5% 59.5% Premium ceded to reinsurers (10,970) (12,851) (21,034) (19,575) (22,137) Expense ratio (P&C) 35.7% 35.9% 36.8% 37.1% 37.1% Unearned premium reserve change (10,170) (7,945) (7,818) (8,568) (9,685) Combined ratio (P&C) 93.5% 95.3% 97.3% 96.6% 96.6% Net earned premium 186,662 213,144 240,199 285,744 331,504 ROAE 16.0% 13.8% 16.4% 18.9% 17.3% Life insurance claims paid (39,819) (51,592) (54,874) (68,780) (80,964) ROAA 1.3% 1.0% 1.2% 1.3% 1.4% Non-life insurance claims incurred (36,706) (47,009) (55,150) (61,607) (69,539) Total investment yield 3.6% 2.8% 4.8% 5.3% 5.3% Policyholders reserve movement (69,239) (67,393) (87,978) (112,034) (133,117) Investment income yield 4.2% 4.3% 4.7% 5.0% 5.0% Acquisition and general expense (64,686) (84,385) (100,559) (113,944) (128,966) Investment income 29,265 27,370 55,583 72,226 85,874 Banking net interest income 18,882 34,501 42,430 49,360 55,128 Solvency & liquidity 2011 2012 2013 2014E 2015E Other income/expenses 5,667 7,702 6,573 10,923 12,838 Solvency ratio (Life) 156.1% 190.6% 171.9% 211.5% 214.3% Profit before tax 30,026 32,338 46,224 61,887 72,757 Solvency ratio (P&C) 166.1% 178.4% 167.1% 177.2% 199.7% Tax (7,444) (5,588) (10,210) (14,042) (16,419) Gearing ratio 94.3% 94.4% 94.6% 93.9% 92.8% Profit after tax 22,582 26,750 36,014 47,845 56,338 Cash to insurance liability 7.4% 8.3% 6.7% 6.8% 6.8% Minority interests (3,107) (6,700) (7,860) (8,664) (9,058)
Profit attributable to shareholders 19,475 20,050 28,154 39,181 47,279
Balance sheet (Rmb, mil) 2011 2012 2013 2014E 2015E Key valuations 2011 2012 2013 2014E 2015E Cash & equivalent 56,266 73,295 69,142 82,426 97,553 P/EV (Group) 1.96 1.61 1.40 1.16 1.00 Fixed income investments 664,495 801,642 864,106 1,025,050 1,195,802 P Implied NBVM 13.39 11.00 7.23 3.07 -0.04 Equity Investments 99,870 101,470 120,497 143,648 170,010 P/E 23.3 23.0 16.4 11.8 10.1 Other Investments 36,310 60,352 69,221 87,597 121,031 P/B 3.52 2.89 2.52 1.98 1.58 Total investment assets 856,941 1,036,759 1,122,966 1,338,721 1,584,396 Dividend yield 0.7% 0.8% 0.9% 1.3% 1.4% Other Assets 1,428,483 1,807,507 2,237,346 2,488,476 2,753,257 Payout ratio 16% 18% 14% 15% 15% Total Assets 2,285,424 2,844,266 3,360,312 3,827,197 4,337,652 Life insurance liabilities 693,974 804,403 936,629 1,111,562 1,308,621 Non-life insurance liabilities 64,430 78,190 93,583 106,612 121,123 Business growth (Y/Y %) 2011 2012 2013 2014E 2015E Investment contract liabilities 32,811 34,669 54,359 74,300 97,258 Life premium 28.1% 8.7% 13.7% 19.5% 17.8% Other liabilities 1,322,867 1,717,355 2,036,036 2,236,713 2,421,617 P&C premium 33.9% 18.4% 16.7% 12.9% 12.9% Total Liabilities 2,114,082 2,634,617 3,120,607 3,529,187 3,948,619 Total premium 30.4% 12.6% 15.0% 16.7% 15.8% Issued Share Capital 7,916 7,916 7,916 7,916 8,510 Acq. & general expense 39.7% 30.5% 19.2% 13.3% 13.2% Retained profit and reserves 122,951 151,701 174,793 224,433 305,805 Net income 12.5% 3.0% 40.4% 39.2% 20.7% Shareholders equity 130,867 159,617 182,709 232,349 314,315 Investment assets 13.7% 23.9% 14.5% 19.2% 18.4% Minority Interests 40,475 50,032 56,996 65,660 74,719 Insurance liabilities 18.5% 16.4% 16.7% 18.2% 17.4% Total equity 171,342 209,649 239,705 298,010 389,034 Investment liabilities 9.4% 5.7% 56.8% 36.7% 30.9% EV (Group) 13.2% 21.3% 15.3% 20.0% 16.7% Total Equity & Liabilities 2,285,424 2,844,266 3,360,312 3,827,197 4,337,652 NBV (Life) 8.5% -5.4% 14.1% 17.0% 14.9%
Embedded values (Rmb, mil) 2011 2012 2013 2014E 2015E Per share data (Rmb) 2011 2012 2013 2014E 2015E EV discount rate 11.0% 11.0% 11.0% 11.0% 11.0% EPS 2.50 2.53 3.56 4.95 5.76 Life insurance adjusted NAV 48,219 56,973 62,756 84,768 112,908 BVPS 16.53 20.16 23.08 29.35 36.93 Value of inforce business 96,181 120,487 140,282 160,570 171,894 DPS 0.40 0.45 0.50 0.74 0.83 Life insurance EV 144,400 177,460 203,038 245,338 284,802 Embedded Value (Life) 18.24 22.42 25.65 30.99 33.47 Group EV 235,627 285,874 329,653 395,703 496,373 Embedded Value (Group) 29.77 36.11 41.64 49.99 58.33 NBV (Life) 2.12 2.01 2.29 2.68 2.87 1 year NBV 16,821 15,915 18,163 21,249 24,421 No. of shares 7,916 7,916 7,916 7,916 8,510 Source: Jefferies estimates, company data
page 62 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
SAIC Motor (600104 CH, Buy, TP Rmb24.0) Zhi Aik, Yeo Equity Analyst Low valuation, high yield underpin defensiveness 852 3743 8075 [email protected] Key Takeaway We urge investors to align with defensive plays amid slowing sector growth. SAIC has a strong upcoming product cycle within the GM range of brands. In addition, the company is the best proxy to the MPV space, which is currently Exhibit 117: Price Performance the highest growth segment. An SOE reform role model, with high dividend 25 yield and low valuation multiple, SAIC is our top pick.
SAIC-VW to continue share gain, SAIC-GM product cycle coming. We believe 20 SAIC-VW would gain share next year due to strong brand equity. Meanwhile, the next to see robust product cycles are the GM joint ventures: SAIC-GM and SAIC-GM-Wuling. 15 SAIC-GM had been losing share in the past, specifically 1H14 was up only 8% y/y vs. the sector up 11%, mainly due to an aging line-up. But we believe intense launches of new products in 2H14 and 2015 will refresh the overall portfolio. Key new models for GM 10 include the Buick Envision SUV (2H14), Cadillac ATS-L (2H14), new Chevrolet Cruze (2H14), new Chevrolet Sail (2015), new Buck Excelle GT (2015), new Chevrolet Malibu
5 (2015), Baojun SUV (2015) etc.
Best MPV proxy in the space. Among the listed OEMs, SAIC has the largest exposure 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 to the explosive MPV segment i.e. at 15% of overall volume in 2013. The MPV segment was up 46% y/y in 8M14, even stronger than SUV 34%. MPV production for SAIC is Source: Bloomberg as of Dec 11, 2014 mainly done at SAIC-GM-Wuling. The JV is China's largest Minibus and MPV manufacturer. The OEM is also due to introduce a new Wuling MPV (2H14), and a low- priced SUV in 2015, which we believe would provide good volume uplift due to its Ticker 600104 CH extensive dealership network. Market Data 52 Week Range: Rmb 12.22 – Rmb 24.30 Low valuation, high dividend yield underpin defensiveness. SAIC remains at a Total Entprs. Value (M): Rmb 245,102.0 discounted valuation vs. HK-listed peers, trading at 7.6x 2015 PER vs. HK peers of 8x, Market Cap. (M): US$ 40,023.3 despite benefitting from the stock connect. Though the largest OEM with 5.7mn units of Shares Out. (M): 11,025.6 expected volume in 2014, we expect SAIC to continue delivering steady volume and Float (M): 1,911.7 earnings growth. We expect net profit to grow 16%/14% to Rmb29bn/Rmb33bn in Avg. Daily Vol. (M): 33.0 2014/15E, respectively. Another positive is the generous dividend. SAIC has proposed to Source: Bloomberg as of Dec 11, 2014 distribute dividend of Rmb1.2 per share, which would translate to yield of 6% for 2014E.
Valuation/Risks We rate SAIC “Buy”, TP of Rmb24.0 based on 8x (in-line with sector average) 2015 EPS of Rmb2.96. Risk is weaker-than-expected volumes for new launches.
Exhibit 118: SAIC net profit trend (2011-1H14) Exhibit 119: SAIC sales volume mix(2013) Rmb m Sunwin Bus SIH NAVECO 30,000 0% 1% 3% 24,804 SAIC CV 25,000 22,270 0% SAIC-VW 20,222 20,752 30% 20,000 14,718 13,938 SGMWL 15,000 13,573 11,931 31%
10,000
5,000 SAIC-GM 31% SAIC PV 0 4% 2011 2012 2013 1H14 Net profit to shareholders Share profit from JVs/Asso.
Source: Jefferies, company data Source: Jefferies, company data
page 63 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 120: SAIC financials Income statement Cash flow statement RMB mn 2012 2013 2014E 2015E 2016E RMB mn 2012 2013 2014E 2015E 2016E Revenue 480,980 565,807 648,665 723,770 788,600 Profit before tax 40,156 41,493 46,171 50,778 53,583 Business Tax -7,975 -3,439 -4,541 -5,066 -5,520 Change in working cap. -5,110 5,661 -4,930 1,193 -4,330 Cost of sales -400,564 -490,988 -561,468 -626,959 -684,210 Tax paid -6,628 -5,909 -6,243 -6,747 -6,815 Gross profit 72,441 71,379 82,656 91,745 98,870 Others -8,827 -20,643 -20,657 -22,654 -24,360 CF from operations 19,591 20,603 14,341 22,569 18,079 Operating expense -45,743 -53,075 -60,848 -68,311 -75,218 Dividend received 11,469 20,920 19,620 21,784 23,662 Operating profit 26,698 18,304 21,808 23,434 23,651 Capex -16,009 -15,659 -15,000 -15,000 -15,000 Other gains, net -1,375 664 -1,923 -1,923 -1,923 Others -12,484 17,449 1,255 1,255 1,255 Share of results of ass. 14,718 22,270 26,031 29,012 31,600 CF from investing -17,023 22,710 5,875 8,038 9,916 Interest income (expense) 115 255 255 255 255 Debt movement -1,632 -2,432 0 0 0 Pre-tax profit 40,156 41,493 46,171 50,778 53,583 Dividends -14,988 -13,339 -9,475 -10,758 -11,639 Others 1,342 89 0 0 0 Tax -6,628 -5,909 -6,243 -6,747 -6,815 CF from financing -15,277 -15,682 -9,475 -10,758 -11,639 Minority interest 12,776 10,780 11,217 11,431 11,498 Net profit 20,752 24,804 28,711 32,600 35,270 Fx rate impact (20) (151) - - - Basic EPS (Rmb) 1.88 2.25 2.60 2.96 3.20 Net cash flow -12,729 27,480 10,741 19,849 16,356
Balance sheet Ratio & financial metrics analysis RMB mn 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016E Cash 60,846 89,098 99,838 119,688 136,044 Revenue Growth 10.6% 17.6% 14.6% 11.6% 9.0% Inventories 24,951 30,915 33,077 38,379 39,603 Gross margin 15.3% 12.7% 12.8% 12.8% 12.6% Receivables 40,371 48,483 53,526 60,294 63,721 EBIT Margin 8.5% 7.3% 7.1% 7.0% 6.8% Other current assets 62,987 63,689 63,689 63,689 63,689 Net Profit Margin 4.4% 4.4% 4.5% 4.5% 4.5% Fix assets 32,826 38,131 47,620 56,125 63,748 EPS growth 2.6% 19.5% 15.8% 13.5% 8.2% Others assets 95,222 103,326 108,619 114,730 121,550 Payout Ratio 31.9% 53.3% 33.0% 33.0% 33.0% Total assets 317,203 373,641 406,370 452,905 488,355 Valuation metrics PER (x) 11.9 10.0 8.6 7.6 7.0 ST debt 5,799 5,252 5,252 5,252 5,252 EV/EBITDA (x) 4.4 3.7 3.3 2.9 2.6 Other ST liabilities 150,553 181,088 183,364 196,626 196,948 Price to Book (x) 2.0 1.8 1.6 1.4 1.2 LT debt 947 6,264 6,264 6,264 6,264 Balance Sheet Ratios Other non-current liabilities 14,898 19,305 19,305 19,305 19,305 ROE 17.0% 18.0% 18.3% 18.2% 17.4% Total liabilities 172,197 211,909 214,185 227,447 227,768 ROA 6.5% 6.6% 7.1% 7.2% 7.2% Shareholder's equity 122,337 137,757 156,994 178,836 202,466 Net debt to Equity -37.3% -48.0% -46.0% -48.0% -47.8% Minority interests 22,669 23,975 35,192 46,622 58,120 Interest coverage (x) -347.5 -161.9 -180.3 -198.4 -209.4 Total liability & equity 317,203 373,641 406,370 452,905 488,355 Book value per share 11.10 12.49 14.24 16.22 18.36
Source: Jefferies estimates, company data, Priced as of Dec 11, 2014
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Equity Strategy
China
14 December 2014
Sinopharm (1099 HK, Buy, TP HK$31)
Key takeaway Jessica Li We expect upside surprises from Sinopharm in 2015 and are becoming more Equity Analyst positive on the company’s growth outlook, due to the potential approval of 852 3743 8010 incentive plan under SOE reforms, reduced financial costs and potential [email protected] acquisitions in the pharmacy business. Sinopharm remains our top pick. Reiterate BUY.
Exhibit 1: Price performance Expect to maintain above-industry growth. We remain confident that Sinopharm,
45 China’s largest pharmaceutical distributor, will continue to sustain organic growth 3~5% above the industry average, given its scale advantage and its being the most 40 comprehensive national network to tap into attractive lower-tier markets. We forecast that 35 the company will deliver 3-year earnings CAGR of 21%.
30 Incentive scheme to be approved in 2015. We believe Sinopharm, chosen by 25 CNPGC as a major platform for the CSOE pilot mix-ownership reforms, will most likely
20 adopt stock-based compensation plans for senior management. That, together with better corporate governance and strengthened supervision, should lead to improving 15 productivity, efficiency and faster pace of consolidation. The company has submitted a 10 comprehensive reform plan to the SASAC. We anticipate an approval from the SASAC with
5 detailed agenda in 2015.
0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Reduced financial costs. We expect financial costs for Sinopharm to stay high in 2015,
as the company has relatively high debt levels. However, we expect the company to Source: Bloomberg as of Dec 11, 2014 reduce its finance costs via optimizing/reducing effective borrowing rates. On November 21st, 2014, the People's Bank of China cut its benchmark one-year loan rate by 40bps to 5.6%. We estimate that Sinopharm would save borrowing costs of nearly Rmb100mn in 2015, or ~3% accretive to its 2015 net profit.
Ticker 1099 HK Potential acquisitions in pharmacy business. Sinopharm will continue to boost the Market Data development of its less visible retail pharmacy business, currently contributing a mere 4% 52 Week Range: HK$19.72-34.50 to its total profit. Sinopharm will speed up its M&A pace in retail pharmacy. The company Total Entprs. Value (M): Rmb 94,283.0 is negotiating with Fosun Pharma to acquire Fosun’s Shanghai For Me Pharmacy and Market Cap. (M): US$ 10,033.0 Beijing Golden Elephant Pharmacy. The transaction, if implemented, should enhance Shares Out. (M): 1,192.8 Sinopharm’s market position in Beijing and Shanghai, the two largest pharma retail Float (M): 1,088.8 markets in China. There is room for significant margin improvement in the segment. Avg. Daily Vol. (M): 6.0 Source: Bloomberg as of Dec 11, 2014 Valuation/Risks Maintain BUY and TP of HK$31, based on a PEG of 1.05, 3-year EPS CAGR of 21% and 2014e EPS of Rmb1.12. Risks include slower economic growth in China; more severe price cuts; stiffer competition; rapidly rising interest rate.
Exhibit 121: Revenue Growth Trend Exhibit 122: Net Income and Margins
180,000.0 2,500.0 9.0 166,866 2,250.0 8.4 8.4 160,000.0 8.2 8.0 8.0 8.0 2009-2013 CAGR = 33.4% 1,979.4 136,502 2,000.0 140,000.0 7.0
120,000.0 1,560.6 6.0 102,225 1,500.0 100,000.0 5.0 1,208.8
80,000.0 69,234 967.2 4.0 1,000.0 60,000.0 52,668 3.0 2.7 2.6 2.4 2.3 40,000.0 2.1 2.0 500.0
20,000.0 1.0
0.0 0.0 0.0 FY2009 FY2010 FY2011 FY2012 FY2013 FY2009 FY2010 FY2011 FY2012 FY2013
Total revenue (CNY MN) Net income (CNY MN) Gross margin (%) Net margin (%)
Source: Company data, Jefferies, Bloomberg Source: Company data, Jefferies, Bloomberg
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Equity Strategy
China
14 December 2014
Exhibit 123: Financial Summary Profit & Loss Cash Flow (RMB Million) 2011 2012 2013 2014E 2015E (RMB Million) 2011 2012 2013 2014E 2015E Turnover 102,225 136,502 166,866 200,346 239,172 Net Income 2,403 3,086 3,580 4,596 5,440 Gross Profit 8,355 10,988 13,379 16,128 19,200 D&A 309 388 477 565 650 Change in working capital -2,327 -615 -8,574 -12,038 5,290 Operating Profit 3,636 4,869 6,102 7,992 9,651 Cash From Operating 1,019 3,856 4,941 -4,860 13,966 EBIT 3,946 5,291 6,281 8,197 9,890 EBITDA 4,255 5,679 6,758 8,762 10,540 Capex -848 -1,296 -1,375 -1,512 -1,739 Pretax Income 3,128 4,022 4,621 5,976 7,065 Free Cash Flow 171 2,560 3,566 -6,372 12,227 Net Income 1,561 1,979 2,250 2,884 3,428 Equity raised - net 2,899 0 0 0 0 EPS (reported) 0.66 0.82 0.89 1.12 1.33 Debt raised - net 10,414 2,291 9,002 4,100 200 Ending cash 13,091 9,802 14,002 8,233 16,386
Balance Sheet Ratio Analysis (RMB Million) 2011 2012 2013 2014E 2015E % 2011 2012 2013 2014E 2015E Cash and Cash Eqv 13,091 9,802 14,002 8,233 16,386 Revenue Growth (%) 47.7 33.5 22.2 20.1 19.4 Inventory 12,214 13,865 16,702 19,797 23,950 EBITDA Growth (%) 47.5 33.5 19.0 29.7 20.3 Current Assets 56,233 67,266 89,713 100,853 122,109 Net Income Growth (%) 29.1 26.8 13.7 28.2 18.8 Long-term Assets 11,395 13,861 15,740 17,570 19,641 Total Assets 67,628 81,127 105,453 118,423 141,750 Gross Margin (%) 8.2 8.0 8.0 8.0 8.0 EBITDA Margin (%) 4.2 4.2 4.0 4.4 4.4 Short-term Borrowings 8,667 10,948 21,007 21,107 21,207 Net Margin (%) 1.5 1.5 1.3 1.4 1.4 Current Liabilities 40,292 51,155 70,841 75,759 94,200 Long-term Borrowings 5,182 5,192 4,134 8,134 8,234 Debt/Equity Ratio 67.9 70.3 87.9 90.6 80.4 Long-term Liabilities 6,948 7,023 6,001 10,375 10,909 Current Ratio 83.2 82.9 85.1 85.2 86.1 Total Liabilities 47,240 58,179 76,842 86,134 105,109 Inventory Turnover 8.4 9.8 10.0 10.1 10.0
Total Equity 20,388 22,949 28,611 32,288 36,641 ROE (%) 11.8 13.4 12.5 14.2 14.8 Shares Outstanding 2,403 2,403 2,568 2,568 2,568 ROA (%) 3.6 3.8 3.4 3.9 3.8 Source: Jefferies estimates, company data
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Equity Strategy
China
14 December 2014
Tongrentang (600085 CH, NC)
Jessica Li Company Background Equity Analyst Beijing Tongrentang is a leading Chinese traditional medicine manufacturer. Established in 852 3743 8010 1669, the Tongrentang brand has a long history of over 343 years in China. Beijing Tongrentang is an SOE company owned by Beijing SASAC. Its major products include [email protected] LiuWei DiHuang pill for the health of kidney, TongRen DaHuoLuo pill for treating rheumatism, WuJi BaiFeng pill for treating gynecopathy, TongRen NiuHuang PingXin pill Exhibit 124: Price Performance and AnGong NiuHuang pill for clearing away heat, GuoGong liquor for easing aches in
30 loins and legs, as well as ZaiZaoWan for treating apoplexy, among others.
Top Shareholders 25 The top 10 institutional shareholders hold 55.7% of total shares: 1. Kangmei Industrial (30.4%); 2. China Asset Management (6.4%); 3. Harvest Fund Management (4.2%); 4. 20 Dacheng Fund Management (2.9%); 5. Yihua Fund Management (2.3%).
15 Key Segments Beijing Tongrentang is primarily engaged in two major areas: pharmaceutical 10 manufacturing with a portfolio of well-known TCM products under the brand of Tongrentang, accounting for 60% of total sales in 2013; and Tongrentang drug stores 5 business (40% of total sales in 2013). Over 90% of Tonrentang’s revenue comes from China market. 0 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 9M2014 Results Summary Source: Bloomberg as of Dec 11, 2014 The company reported 1-3Q14 revenue of Rmb 7.2bn, up 9% yoy. Net profit was Rmb579mn, up 14% yoy. Total gross margin remained stable in 1-3Q14, while operating margin and net margin increased slightly, due to better control on selling expenses. Ticker 600085 CH
Market Data Key Events 52 Week Range: Rmb 16.35 - Rmb 22.95 1) Potential rollout of SOE reforms by Beijing SASAC; 2) Potential incentive scheme; 3) Total Entprs. Value (M): Rmb 28,571.0 Progress in pipeline products; and 4) Potential price increase of low-priced drugs. Market Cap. (M): US$ 4,685.4 Shares Out. (M): 1,311.1 Consensus Valuation and Rating Float (M): 539.4 9 out of 10 brokers rated it “Buy”. Bloomberg consensus projected Tongrentang’s EPS in Avg. Daily Vol. (M): 13.5 Source: Bloomberg as of Dec 11, 2014 2014-2016 to be Rmb0.59, 0.70 and 0.84, respectively, indicating a 19% CAGR.
Exhibit 125: Revenue Growth Trend Exhibit 126: Net Income and Margins 10,000.0 700.0 656 50.0 2009-2013 CAGR 28% 8,715 600.0 44.2 570 42.7 42.9 41.9 8,000.0 7,504 40.0 40.0 500.0 6,108 438 6,000.0 30.0 400.0 343 286 300.0 3,824 20.0 4,000.0 3,250 200.0 10.0 2,000.0 8.8 9.0 100.0 7.2 7.6 7.5
0.0 0.0 0.0 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 Revenue (Rmb mn) Net income (Rmb mn) Gross margin (%) Net margin (%)
Source: Jefferies, Company data Source: Jefferies, Company data
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14 December 2014
Exhibit 127: Beijing Tongrentang financial summary (RMB Million) FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Income Statement Turnover 3,250.2 3,824.5 6,108.4 7,504.0 8,714.7 COGS 1,861.5 2,134.9 3,663.0 4,284.0 5,064.8 Gross Profit 1,388.7 1,689.5 2,445.4 3,220.0 3,649.8 Operating Profit 453.3 552.8 789.5 1,049.3 1,263.6 EBIT 445.2 547.9 819.0 1,083.5 1,286.2 EBITDA 549.1 646.5 939.5 1,212.6 1,429.4 Pretax Income 460.4 561.7 801.6 1,076.5 1,295.8 Net Income 285.6 343.2 438.1 570.1 656.0
Balance Sheet Cash and Cash Eqv 1,600.0 1,790.2 2,079.0 3,640.1 4,938.3 Inventory 1,815.1 2,048.5 3,166.8 3,679.8 4,180.3 Current Assets 3,798.9 4,410.3 5,950.0 8,080.3 9,997.3 Long-term Assets 1,123.4 1,079.0 1,379.9 1,587.6 1,914.6 Total Assets 4,922.3 5,489.3 7,329.9 9,667.9 11,911.9 Short-term Borrowings 173.0 173.0 231.0 231.0 261.0 Current Liabilities 974.7 1,214.3 2,420.0 2,898.8 2,984.6 Long-term Borrowings 39.3 Long-term Liabilities 34.6 53.7 98.9 1,164.8 1,089.9 Total Liabilities 1,009.3 1,268.0 2,518.8 4,063.6 4,074.5 Total Shareholders' 3,913.0 4,221.3 4,811.1 5,604.4 7,837.4 Shares Outstanding 520.8 520.8 1,302.1 1,302.1 1,311.1
Cash Flow Statement Net Income 388.3 471.1 654.7 878.6 1066.7 Cash From Operating 627.7 492.0 544.9 874.0 676.4 Cash from Investing -47.6 -156.9 -237.5 -237.4 -431.4 Cash from Financing -158.6 -166.9 -232.3 927.8 1034.3 Net Changes in Cash 419.6 167.4 68.5 1561.1 1247.1 Free Cash Flow 569.6 399.8 115.0 585.1 249.1 Cash flow per share 1.2 0.9 0.4 0.7 0.5
Ratio Analysis and Per Share Data Revenue Growth (%) 10.6 17.7 59.7 22.8 16.1 EBITDA Growth (%) 6.8 17.7 45.3 29.1 17.9 Net Income Growth (%) 10.3 20.2 27.6 30.1 15.1
Gross Margin (%) 42.7 44.2 40.0 42.9 41.9 EBITDA Margin (%) 16.9 16.9 15.4 16.2 16.4 Net Margin (%) 8.8 9.0 7.2 7.6 7.5 ROE (%) 9.4 10.5 12.6 14.3 13.1 ROA (%) 8.2 9.1 10.2 10.3 9.9
Debt/Equity Ratio 0.3 0.4 0.7 1.0 0.8 Current Ratio 3.9 3.6 2.5 2.8 3.3 Inventory Turnover 1.0 1.1 1.4 1.2 1.3 Interest coverage ratio 71.0 63.6 53.7 47.3 10.3
EPS 0.55 0.66 0.34 0.44 0.49 BVPS 5.83 6.25 2.67 3.06 3.83 DPS 0.23 0.35 0.00 0.00 0.00 Source: Wind
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Equity Strategy
China
14 December 2014
Vanke (000002 CH, Buy, TP Rmb13.8) Key Takeaway Venant Chiang As the top Chinese developer, Vanke is the pioneer in changing itself during Equity Analyst the market transition by 1) delivering strong sales, 2) reinforcing its financial +852 3743 8013 strength, 3) sharpening its operational efficiency and 4) exploring an “asset- [email protected] light model”. We are optimistic about its leadership position backed by sustainable long-term growth. Buy with PT of Rmb13.8.
Exhibit 128: Price performance Outstanding sales performance As Vanke registered its second highest historical sales of Rmb22.1 in Oct, its sales in the 14 first 10 months have increased 17% yoy to Rmb171bn, notching up 82% of its Rmb210bn
12 sales target. The excellent sales performance is thanks to its ample saleable resource (8mn sqm inventory added 2mn sqm monthly launch), end-user market focus (90% below 144 10 sqm), strong marketing and pricing flexibility. We forecast its strong sales momentum to continue and reach Rmb220bn by year-end, implying 28% YoY growth. 8 Sound earnings growth with solid financial strength 6 As of Sep, Vanke’s net profit grew 4.8% to Rmb6.5bn, with net profit margin up 0.5ppts to 10.2%, mainly thanks to lowered financing costs (-27% yoy) and increased profit in 4 associate investments (+218% yoy). Impressively, the debt profile improved notably, with
2 net gearing declining 10ppts to 26%, the lowest level in the industry. The proportion of short-term borrowing shrank to 26% from 43% at the end of 2013. In our view, Vanke is 0 well positioned to reinforce its leadership in the market down cycle, underpinned by its Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 financial war chest. Source: Bloomberg as of Dec 11, 2014 Sales scale not a focus Despite strong sales momentum continuing, there is no improvement in the sell-through rate for new launches; it still remains at 57%, lower than the company’s expectation of 60%. As the completed-but-unsold inventory increased 30% in 3Q to Rmb25bn, Vanke may slow down new commencements to c21mn sqm (vs. target of 22.3mn), similar to Ticker 000002 CH last year, implying 2015 sales may remain largely stable. As the largest developer in China, Market Data Vanke would not pursue the growth of scale in sales in the long run, but will focus more 52 Week Range: Rmb 6.52 – Rmb 13.20 on operation efficiency and profitability, in our view. Total Entprs. Value (M): Rmb 211,077.6 Market Cap. (M): US$ 21,683.8 “Asset-light model” underway Shares Out. (M): 9,700.1 As non-residential projects account for 15% of the total portfolio, Vanke targets to Float (M): 7,591.3 monetize all shopping malls under operation. For instance, it sold 90% of shares in a Avg. Daily Vol. (M): 124.1 Shanghai office building to GIC for Rmb1.65bn, and will establish a JV company (Vanke Source: Bloomberg as of Dec 11, 2014 accounts for 20% stake) with Carlyle Group for nine shopping malls. As the ‘asset-light’ business model will enhance the company’s asset turnover meaningfully, we expect Vanke’s ROE to improve from 20%.
Exhibit 129: Monthly sales as of Oct (Rmb bn) Exhibit 130: Presales lock-in as of Oct 30.0 Rmb bn 210.0 250.0 160.0 25.0 200.0 20.0
15.0 150.0 91% 100% 10.0 100.0
5.0 50.0
0.0 0.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 2014 2012 2013 2014 As of Nov (Rmb bn) Remaining (Rmb bn)
Source: Company data, Jefferies Source: Company data, Jefferies
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14 December 2014
Exhibit 131: Financial statement Profit and Loss statement Cash flow statement Rmb mn 2012 2013 2014E 2015E 2016E Rmb mn 2012 2013 2014E 2015E 2016E Revenues 103,116 135,419 149,976 167,139 171,248 PBT ex. Exceptionals 25,730 27,871 29,192 32,257 33,436 COGS (71,678) (100,763) (116,080) (130,691) (135,220) Change in working cap. (5,539) (10,670) (27,607) (22,739) (26,371) Gross Profit 31,438 34,656 33,896 36,448 36,028 Others (15,911) (15,277) (10,314) (15,274) (16,637) CF from operations 4,280 1,924 (8,729) (5,757) (9,573) SG&A (5,837) (6,868) (7,074) (7,343) (7,325) EBIT 25,602 27,789 26,821 29,106 28,703 Investment properties (149) (6,906) (347) (172) (34) Interest expense (1,746) (1,496) (1,283) (1,452) (1,605) Others (2,858) (1,049) 0 0 0 Associates 890 999 1,652 2,663 4,361 CF from investing (3,007) (7,954) (347) (172) (34) Other gains/adjustments 985 579 2,002 1,940 1,976 Free cash flow 1,273 (6,031) (9,076) (5,929) (9,607) PBT 25,730 27,871 29,192 32,257 33,436 Free cash flow per share 0.12 (0.55) (0.82) (0.54) (0.87) Tax (10,068) (9,573) (9,425) (10,233) (10,173) Equity financing 0 0 0 0 0 Minority (3,111) (3,179) (3,434) (3,826) (4,042) Debt financing 20,613 3,514 17,642 10,200 20,163 Others (4,379) (5,600) (4,892) (5,450) (5,757) Net profit 12,551 15,119 16,333 18,197 19,221 CF from financing 16,234 (2,086) 12,750 4,750 14,406 Net profit (core) 12,493 15,119 16,333 18,197 19,221 Shares outstanding (weighted) 10,995 11,013 11,013 11,013 11,013 Increase in cash and cash equivalents 17,506 (8,116) 3,675 (1,179) 4,799 EPS (core) 1.14 1.37 1.48 1.65 1.75 Beginning cash 33,614 51,120 43,004 46,679 45,500 DPS 0.18 0.41 0.44 0.50 0.52 Ending cash (Ex. Restriced cash) 51,120 43,004 46,679 45,500 50,299
Balance sheet Ratio Analysis (%) Rmb mn 2012 2013 2014E 2015E 2016E 2012 2013 2014E 2015E 2016E Investment properties 2,375 11,710 12,057 12,230 12,264 Gross Margin 30% 26% 23% 22% 21% Others 6,612 14,811 14,811 14,811 14,811 Operating margin 25% 21% 18% 17% 17% Associates 7,040 10,637 10,637 10,637 10,637 Net profit margin 12% 11% 11% 11% 11% Total fixed assets 16,028 37,159 37,506 37,678 37,712 Property under development 239,170 313,416 426,902 519,051 614,319 Sales growth 44% 31% 11% 11% 2% Completed properties for sale 15,994 17,717 17,717 17,717 17,717 EBIT growth 31% 9% -3% 9% -1% Debtors & deposits 35,260 37,894 41,993 50,142 51,374 Net profit growth 30% 21% 8% 11% 6% Bank balances & cash 52,292 44,365 48,040 46,861 51,660 EPS growth 30% 21% 8% 11% 6% Others 20,058 28,654 28,654 28,654 28,654 Total assets 378,802 479,205 600,812 700,103 801,437 BVPS 5.80 6.98 8.02 9.18 10.40 Interest coverage (x) 5.4 5.2 5.6 5.4 5.2 Current liabilities 259,834 328,922 428,985 481,578 534,890 Net debt to total capital 16% 22% 27% 26% 27% Long term debt 36,036 44,082 50,749 80,874 111,390 Net debt to equity 23% 31% 38% 42% 47% Other long term liabilities 60 90 90 90 90 Sales/assets 31% 32% 28% 26% 23% Deferred income tax 734 673 673 673 673 Assets/equity 593% 623% 680% 693% 700% Long term liabilities 36,830 44,844 51,512 81,637 112,153 Minority Interests 18,313 28,543 31,978 35,804 39,846 ROA 3% 3% 3% 3% 2% Shareholders' funds 63,826 76,896 88,337 101,084 114,548 ROE 20% 20% 18% 18% 17% Total liabilities and equity 378,802 479,205 600,812 700,103 801,437 ROCE 12% 11% 10% 9% 8%
Source: Company data, Jefferies estimates
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Equity Strategy
China
14 December 2014
The Year of the Ram: Stars Are Aligned
China Stock Market - Massive Untapped Potential 4
The Third Plenum: A Roadmap for Future Prosperity 8
2015: Keeping Growth Steady a Top Priority 11
The Bull Case for China A Shares 13
Our Journey Begins with China 2025 16
China Macro: Monetary Relaxation 26
Jefferies Sector Allocation & Top Picks
2014 Sector Performance 33
Summary of Sector Views 35
2015 Sector Allocation & Top Picks 37
China 2015 Sector View
Autos & Machinery 72
Consumer 76
Conglomerate & Gaming 81
Energy (Oil & Gas, Coal) 87
Financials (Banks, Insurance & Brokers) 92
Healthcare 95
IPPs, Clean Tech & Environmental Services 101
Metals & Mining (Cement, Steel & Gold) 113
Property 126
TMT (Telecom, Internet & Tech) 131
Transportation (Airlines, Ports & Shipping) 139
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Equity Strategy
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14 December 2014
2015 Autos Sector: NEUTRAL Passenger Vehicles (PV) We believe Auto sector growth will slow to 7% in 2015, from expected growth of 10% in Zhi Aik Yeo 2014. Recall in 2013, growth was at a high 16%, and in 1H14, it was at 11%. From the Equity Analyst recent monthly sales figures, in September, growth decelerated to 7.1% and further +852 3743 8075 slowed in October to 6.6%. Our reasons for believing that growth will continue to [email protected] decelerate next year include:
Charles Cheng i. Pre-buying in anticipation of quota restrictions has just started having an Equity Associate impact. According to our calculations, 913,000 units were pre-bought in +852 3743 8056 2013-1H14, which is reducing current market demand. [email protected] ii. More cities will be subjected to license restrictions in 2015, in addition to
the six existing. Even though the pace of introducing quotas has seemingly
slowed in recent days, our thesis remains that many tier 2 cities are prone to
quota risk, and we are expecting four cities to implement quotas in 2015:
Shenzhen, Wuhan, Qingdao, and Shenyang.
iii. The traditional engines of growth, tier 3-4 markets, are seeing waning demand strength, due to weakness in their respective commodities and property markets, which are their key economic drivers.
Competition intensifying and capacity utilization falling At the same time, we believe consensus expectation is running way too high, still expecting 22% earnings growth on average in 2015 for the HK/China OEM space, which is bound for disappointment, in our view. Supporting that argument is our thesis that industry margin will come under pressure in the next 2 years, due to:
I. Competition intensifying across all segments; SUV will no longer be a comfort zone. Competition will not only be in the form of lower prices but also intensive release of new models to flood the system. By adding up the model launches expected, we found that the system would see a staggering 38% growth in the number of car models by end-2016 vs. end-2014. In particular, Luxury (segment C) and SUV will see 50% and 76% expansion in new models, respectively, greatly exceeding volume growth over the same period.
Exhibit 132: Number of car model additions Aug 2014 vs. 2016E
Aug 14 Est end of 2016 % growth A00 16 17 6% A0 44 50 14% A 112 134 20% B 49 70 43% C 8 12 50% SUV 89 157 76% MPV 41 54 32% 359 494 38% Source: Jefferies, company data
II. Capacity utilization will fall due to aggressive capacity additions in 2015-16. We would expect the industry utilization level to drop from 104% (2013) to 89% (2015) and further decline to 86% by end-2016. Please refer to Table 14 for our detailed capacity utilization projections.
Identifying the winners Given the slower growth and intensified competition, we urge investors to align with companies with i) proxies to strong foreign brands; ii) strong new product pipelines and
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14 December 2014
iii) high capacity utilization. The environment is expected to get tough, but having the first two strengths will help OEMs stay ahead of competition and gain share. And having strong capacity utilization would help OEMs avoid the need to cut prices and issue bigger discounts to compete.
Buy recommendations. We like SAIC (600104 CH, Buy) and Changan (000625 CH/ 200625 CH, Buy) for their strong underlying brands, upcoming product cycles, high utilization and undemanding valuations of 7.6x and 8.8x/6.5x (A/B), respectively in 2015E. Meanwhile, we maintain Buy on Great Wall (2333 HK) as we believe the strong pipeline of new products will defend against the competitive pressure from the foreign brands in 2015.
Hold recommendations. Dongfeng (489 HK) and GAC (2238 HK) similarly benefit from a convincing product cycle. But Dongfeng remains haunted by inventory issues at Nissan/Honda JVs and sell-through volume is still weak. Meanwhile, GAC faces product mix deterioration concerns, and valuation at 8.0x is still rich, despite the recent pullback in stock price. Separately we are concerned that Geely’s recent strong volumes of EC7/XDH are not sustainable going into 2015, and the company does not have a competitive product in the pipeline beyond this vehicle.
Underperform recommendation. We see an abrupt drop in 2H profitability for Brilliance (1114 HK), due to back-end loaded R&D, selling expenses, personnel costs, and dealer incentives. We are also expecting low volume growth for 2015 due to excessive inventory cited by many dealers, which may come as a disappointment to consensus. Heavy-Duty Trucks (HDT) Flat growth for 2015. We are expecting 0% growth in HDT volume for 2015, similar to the expected growth in 2014. From our channel checks, most OEMs have indicated that half of their current HDT orders are in Euro 4 trucks. This signals a relatively smooth transition to the new emission standard vs. 2008, and 1H15 may not see a huge y/y drop in growth. Moreover, this is on the back of an expected 12% y/y decline in HDT volume in 2H14, so part of the pre-buying in 2013-1H14 may have been repaid. Although pre- buying is not that big an issue anymore, we are still concerned that the HDT volume in 2015 remains plagued by structural weakening of FAI growth, a lackluster property construction market, and substitution of HDT by LDT for last mile delivery.
Indicators of HDT utilization still muted. While HDT do not have utilization data similar to excavator operating hours, we find the Yiwu cargo price index and average daily highway freight tonnage growth useful proxies. In the recent months of Yiwu cargo price data, the trend had been flattish and muted. Meanwhile, the average highway freight tonnage had declined for 5 consecutive months y/ y. Although there is a sequential uptick in growth, the 2% y/y decline in September indicates the daily amount of goods carried by trucks remains weak in the month.
Diesel engine to continue underperformance in Sept. Weichai engine sales (including Yangchai) continued to underperform the HDT industry, down 30% y/y in Sep (latest figure) vs. a 15% decline for HDT in the same month, underperforming by a massive 15ppt. In 3Q, the pace of decline of 20% has become more severe vs. 16% drop in 2Q. Currently many engine customers are destocking the Euro 3 engine inventory as the Euro 4 transition date nears i.e. 1 Jan 2015.
Stock recommendations. Weichai (2338 HK, Unpf) the largest HDT engine manufacturer, remains affected by the OEMs’ engine destocking cycle. Production in recent months has mainly been of Euro 4 engines; hence we expect the destocking phase to at least continue until 1H15. Meanwhile, Sinotruk (3808 HK, Unpf) faces the issue of mix deterioration. Traditional Euro 4 trucks are of lower margin vs. Euro 3 trucks, hence we believe the complete replacement of Euro 3 production by Euro 4 trucks by 1 Jan 2015 will cause a surprise margin downside.
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Equity Strategy
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14 December 2014
2015 Machinery Sector: POSITIVE Glimpse of Hope Key Takeaway Johnson Leung We close our 3-year long bearish positions in the Chinese construction Equity Analyst machinery space as continuous infrastructure investment may start to +852 3743 8055 turnaround machinery sales in 2015. Despite the long term overhang, we find [email protected] safety in our conviction of 2014 being a cycle trough and investors’ expectations being low in this space. We pick Lonking as our top Buy through Zhi Aik Yeo this L-shaped recovery. Equity Analyst +852 3743 8075 Infrastructure FAI may be more effective than real estate development FAI in [email protected] driving construction machinery demand. Recent lending rate cut suggests that the government may be in a renewed stimulating mode, which could coincide with more Charles Cheng spending in infrastructure in 2015. Construction machinery sales, which are 95% Equity Analyst correlated with infrastructure spending and 60% with real estate development, should +852 3743 8056 benefit from further emphasis in the infrastructure development. [email protected] While we believe the emphasis in FAI for growth may risk an eventual hard
landing, construction machinery may offer relatively the best risk-reward ratio in a 12-month view.
First, 2014 may be the trough for the company earnings. Three consecutive years of decline in sales have resulted in excavator sales in 2014 being only 50% of their peak in 2011. Total machinery fleet will drop while demand driven by infrastructure projects will rise as soon as 2015, in our view, to improve machine utilization to a level that can bring back growth in machinery sales and hence earnings for the companies.
Second, expectation is low in this space. Neither a sharp YoY decline in earnings nor continuous deceleration in overall FAI has been effective in driving share prices in the past 6 months. If the worst of bad news could not drive these stocks down, the least of good news could lift them. We think the market sentiment for this space is between despondency and depression. Beginning of machine sales growth could be a positive catalyst in 2015.
Constructively positioned in a likely L-shaped recovery. We pick Lonking as top Buy on its higher exposure to infrastructure construction, lower valuation and least impairment risks compared to other construction machinery peers. We also recently upgrade XCMG and Zoomlion to Buy while we downgraded Sany to Underperform on a relative basis to navigate through the L-shaped recovery.
Exhibit 133: Revenue for the 4 machinery companies combined (Rmb mn) 2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e Concrete 11,792 17,025 32,946 49,233 53,981 39,631 30,757 30,141 33,156 38,129 Crane 18,612 24,009 29,442 37,100 32,603 26,457 21,482 21,267 22,968 26,414 Road 2,639 3,286 5,184 6,207 4,761 5,044 4,615 4,799 5,279 6,071 Earth moving 9,684 11,646 20,814 27,755 23,280 20,107 16,957 17,433 19,176 21,094 Other 2,239 5,828 9,415 15,003 12,363 14,068 14,101 14,702 16,074 18,194 Non machinery 4,295 5,414 5,362 7,114 7,674 5,351 5,243 5,346 5,764 6,416 Total 49,261 67,208 103,163 142,411 134,662 110,657 93,154 93,689 102,418 116,318 (YoY) Concrete 44% 94% 49% 10% -27% -22% -2% 10% 15% Crane 29% 23% 26% -12% -19% -19% -1% 8% 15% Road 25% 58% 20% -23% 6% -9% 4% 10% 15% Earth moving 20% 79% 33% -16% -14% -16% 3% 10% 10% Other 160% 62% 59% -18% 14% 0% 4% 9% 13% Non machinery 26% -1% 33% 8% -30% -2% 2% 8% 11% Total 36% 53% 38% -5% -18% -16% 1% 9% 14% Source: Jefferies estimates, company data. Note: The four machinery companies are Zoomlion, Sany, XCMG and Lonking
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Equity Strategy
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14 December 2014
I. Rate cut positive for demand for construction machinery. First, the 40bps cut
Exhibit 134: Combined revenue in lending rate on Nov 21 2014 may again coincide with growth in infrastructure FAI. We and GPM of machinery makers think the lending rate may not be a driver to the infrastructure FAI but just an indication of under our coverage: the willingness of the government to stimulate the economy. Second, infrastructure FAI Both revenue and margin may could be bigger than real estate FAI as a driver for construction machinery demand. have bottomed in 2014 II. Yet, recovery may be L-shaped. Recovery of annual machinery sales may be L- shaped because the accumulative fleet of machinery has yet to see correction, which is required in our view for utilization to rise and the company earnings to sustainably turnaround. We think the rebound in machinery share price could be volatile, mixed with overshoot and undershoot to a magnitude of 30-50% on a secular uptrend.
III. Risk-reward interesting despite long-term overhang. We think the FAI driven growth in China is not sustainable. Already nearly 50% of China’s GDP depends on capital
Source: Jefferies estimates, company data. formation, which makes further emphasis in FAI for growth a risk for hard landing. While Note: The construction machinery makers under an imminent hard landing is not visible, construction machinery offers the most our coverage are Zoomlion, Sany, XCMG and Lonking interesting risk-reward ratio in our industry space to play till this FAI bubble busts, particularly given the above mentioned positive potential catalyst in 2015.
Exhibit 135: Growth rate of FAI and lending rate: pick up in Exhibit 136: Accumulative excavator fleet (1,000 units): … infrastructure FAI coincided with lending rate cut in both because the installed excavator fleet has only peaked in 2008 and 2012 2013-14
Source: WIND, CEIC, NBS, Jefferies research Source: Jefferies estimates, Industry Year Book. Note: The accumulative amount is 5-year
Exhibit 137: YoY Growth of Total FAI Exhibit 138: Infrastructure FAI Growth Exhibit 139: Real Estate FAI Growth versus Retail sales: gap narrowing YoY: Accelerate and sustained around YoY: slowing down 20%
Source: NBS Source: NBS Source: NBS
We expect the earnings to bottom out as from 2014, stay low in 2015 before meaningfully picking up in 2016, driven primarily by the volume growth. But the earnings may stay far from the peak levels in 2011 and 2012 on our L- shaped recovery view.
page 75 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015 Consumer Key Takeaway We have long argued that the consumer sector will face growth slowdown Staples: POSITIVE and intensifying competition hence a gradual de-rating is inevitable in the Retailers: NEUTRAL long run. For the forthcoming 2015, we take a positive view on consumer Sportswear: NEUTRAL staples since favourable agri-supply/prices and weak gasoline prices could Jewellery: NEUTRAL benefit their margins. A number of heavily de-rated stocks have a chance of Electronics goods retailer: NEUTRAL re-rating. We are neural on department stores, electronic goods distributors Apparel: NEGATIVE and jewellery. We remain negative on apparel and footwear due to fierce competition and threat from E-commerce; on restaurants due to weak growth Restaurants: NEGATIVE and rising operating costs. Top Picks: Tingyi (322 HK), CRE (291 HK),
Biostime (1112 HK), CMD (1117 HK), Gome (493 HK) and Intime (1833 HK).
Top Sells: Want Want (151 HK), Parkson (3368 HK), Giordano (709 HK),
Ajisen (538 HK) and Sasa (178 HK). Jessie Guo, PhD Equity Analyst Persistent low inflation +852 3743 8036 [email protected] China CPI remained low at 1.4% in November 2014 vs. 1.6% in October 2014. Non-food CPI dropped to 1.0% from 1.2% in October; food CPI reached 2.3% in November 2014 vs. Edwin Fan, CFA 2.5% in October. In terms of PPI, food PPI reached -0.2% in November 2014, vs. +0.2% in Equity Analyst October. We believe inflation will stay at low single digits in 2015. +852 3743 8037 [email protected] Volatile consumer sentiment
All three leading indicators for consumer sentiment have been very volatile since 2011. All Kevin Chee, CFA three sentiment indices dropped in October 2014 after a short rebound in September. 1) Equity Analyst +852 3743 8022 The consumer confidence index dropped 2.0 to 103.4 in October 2014. 2) The consumer [email protected] expectation index dropped 1.2 to 107.2. 3) The consumer satisfaction index dropped 3.1 to 97.8. We do not expect meaningful upwards trends of the sentiment in the near term. Jeffrey Zeng Equity Associate Favourable Agri-supply and pricing +852 3743 8009 Prices of most major agri-products pulled back in 2H14 compared with 1H14 and 2H13. [email protected] Most agri-products, including wheat, corn, palm oil, have sufficient inventory with rising
or stable stock-to-use ratios. We expect the prices of these major agri-products to drop or at most rise mildly in 2015. It should help gross margin expansion or at least ease margin pressure on F&B companies in 1H15. A heated debate recently is about raw milk powder: the global raw milk powder price has dropped substantially since April 2014 due to high inventory and ample supply in New Zealand in that production season. We expect the New Zealand raw milk powder price to recover in 2015 as the inventory normalises. This should ease pressure for a sharp price drop of domestic raw milk, and hence benefit upstream dairy farms and dairy companies with integrated value chains. We expect domestic raw milk price to drop mildly at single digit in 2015. Another important agri- commodity with meaningful impact on F&B companies is sugar: we expect domestic sugar price to rebound by high single digits to low teens due to a declining inventory and lower production. Favourable agri-pricing should benefit most F&B companies. Weak property market eases rental cost pressure Fast rising store rental has been adding margin pressure to retailers in the past 2-3 years. However rental hike has moderated in recent months due to the lacklustre property market. The private retail rental index in Hong Kong reached 174.1 (+4% yoy) in Oct.2014, vs. 175 (+4% yoy) in Sep.2014 and 167.5 (+7% yoy) in Oct.2013, according to Hong Kong Rating and Valuation Department. Retail rental hike in China has slowed down in 2014 due to lacklustre retail market and increasing property supply. According to Knight Frank, rents in prime shopping centres rose only 3% yoy in 3Q14 in Metropolitan cities (Beijing, Shanghai and Guangzhou), compared to 6% yoy increase in 2013. This should benefit department stores and speciality retailers and even consumer brands having their products sold in department stores and shopping malls.
page 76 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Soft gasoline price lowers transportation cost
Global crude oil price has been softening since July 2014. It reached average of USD76/barrel in November 2014, down 10% mom and down 19% yoy. It has dropped 28% since July 2014. Crude oil price could continue to remain soft, with Bloomberg consensus forecasts of USD86/barrel in 2015 while Jefferies energy team projects crude oil price of USD67.5/barrel in 2015. The soft gasoline price could potentially benefit consumer goods producers by lowering their transportation costs, which account for c4% of sales for the leading players such as Want Want (151 HK), Hengan (1044 HK) and Vinda (3331 HK). …Yet competition remains fierce In the face of weak economic backdrop, slowdown in demand growth and high base factor, the consumer sector has become a highly competitive battlefield amongst existing players and from newcomers. In particular, competition in the tissue paper, soft drinks, liquid milk, infant formula, beers, shoes and apparel intensified meaningfully in 2014, as indicated by increasing discounts and promotional expenses for major players. We expect competition to remain tight in 2015. This suggests the gross margin expansion and lower transportation and rental costs mentioned above could be offset by high marketing costs for many consumer companies. E-commerce a threat to traditional retailers In our report entitled “Hard Choices: The Impact of Ecommerce” published on July 9, 2014 and “Beyond Singles Day: The Impact of E-commerce” published on November 10, 2014, we discussed in detail how e-commerce has posed a serious threat to most traditional retailers, particularly department stores and domestic apparel/footwear brands. We found that leading global apparel brands seem to leverage it to enhance branding recognition; sportswear uses it as an effective tool for cleaning up inventory; and restaurants and jewellers have held up relatively well.
Most department store operators tend to open shopping malls with more floor space for entertainment and leisure but they have not found a clear and effective path to battle against E-commerce. Intime (1833 HK) is at the vanguard amongst department stores to introduce O2O integration but it is at an early stage and it’s hard to tell if it will make a success in the medium term. We believe E-commerce will unavoidably dilute traffic to department stores. Many apparel, sportswear and footwear brands have to face online competition and price cannibalization to their offline retail channels. Traditional electric goods distributors such as Gome (493 HK) and Suning (002024 CH) are struggling to integrate their O2O platforms but price wars with pure E-tailers such as JD.com (JD US) and Tmall.com (BABA US) are hurting their margins.
Due to macro headwinds, over-expansion in the past and competition from E-commerce, the department stores, apparel and footwear sectors faced poor SSSG YTD and many delivered negative SSSG in the recent months. However, we believe the worst might be over and expect SSSG to recover mildly in 2015 to low single digits for department stores and apparel. Sector preference We are positive on consumer staples in near term. As mentioned earlier, a favourable agri-backdrop and low transportation costs should benefit consumer staples companies’ margins or at least ease margin pressure in the next two quarters. Ongoing urbanization is set to bring a consumption upgrade, which will become the new growth engine for many F&B companies. However, due to a slowing economy and rising base, the industry growth for consumer staples (e.g. noodles, beverages, tissues, dairy) is decelerating and competition remains intense. A number of leading staples companies have de-rated substantially in 2014. We expect a re-rating opportunity for them in 2015.
page 77 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
Key catalysts: lower-than-expected agri-prices, stable macro backdrop, favourable weather.
Key risks: higher than expected agri-prices, slow implementation of policies, poor weather; tight competition; food safety issue.
We are neutral on department stores/retailers. Department stores delivered poor SSSG of -1 to -9% in 1H14 mainly due to competition from shopping malls, from E- commerce and among department stores operators. The performance was also negatively impacted by government’s anti-corruption and anti-extravagance campaign. We do not expect a quick rebound in sales growth as fundamentals remain challenging, but expect a slow recovery in 2015 mainly driven by: 1) Government’s effort to rejuvenate the economy; 2) Retailers’ own efforts to adjust their business models to attractive customers; 3) Lower rental cost pressure; 4) A low base for 2015. We believe the worst might be behind us and expect SSSG to recover mildly in 2015 to low single digits. The sector has been heavily de-rated but a substantial re-rating is unlikely.
Key catalysts: Faster than expected M&As; better consumer sentiment; capacity reduction; favourable policies to boost consumption.
Key risks: Irrational fast expansion; tight competition; faster than expected rise of labour and rental costs; Competition from ecommerce.
We are neutral on electronics goods retailers. The key issue facing traditional electronic goods distributors is traffic taken away by pure E-tailers such as JD.com and Alibaba. As such, we expect mild revenue growth of 9% in 2015 vs 8% in 2014. However, Gome and Suning have the advantages of multi sales channel development, inventory/logistics management as well as after-sales service. Those advantages are not easy for pure e-commerce platforms to replicate in the short term. We expect Gome and Suning to become more cost efficient on rental, staff and advertising due to improvement in supply chain. Thus Gome is expected to enjoy a core NPM of 2.1-2.2% in 14-15e, up from 1.6% in 2013; Suning’s NPM is expected to improve to 0.2% in 15e from -1% in 14e. Electronic goods retailers experienced a de-rating in 2014, we expect a mild re-rating opportunity in 2015.
Key catalyst: 2014 results announcement in Feb-Mar15; further expansion of online channels for non-electronics goods retailing, including apparel and jewellery.
Key risks: Slowdown in demand for electrical appliances; competition from pure e- retailers; less than expected cost saving from supply chain development.
We are neutral on Jewellery. Gold price movement is a major driver of this sector. Jefferies’ house view holds that gold price could drop 5% yoy to USD1,200/ounce in 2015/16 from USD1,265/ounce in 2014, driven by the following factors: 1) producers’ short-covering activities may remain low; 2) higher interest rates raise the opportunity cost for investors to hold a non-interest bearing asset such as gold; 3) central banks are under pressure to manage real returns and may continue to be net sellers of gold.
We expect a low SSSG at 4% and sales growth at 9% for the jewellers in 2015e, vs -12% in 2014. Albeit a normalized business cycle with low base, we do not expect a meaningful sequential pick-up on jewellery demand in 2015. We believe demand for gem-set jewellery will outperform gold in 2015, as jewellers offer support to franchisees to boost gem-set sales in lower tier cities. We expect non-gold jewellery’s contribution to revenue to increase from the current 40% to 43% in 2015e for the whole sector. This suggests margin expansion, bear in mind gold delivers merely 11% gross margin whereas non-gold delivers 40% gross margin. We expect jewellers GPM to grow by 0.6ppt and NPM to grow by 0.3ppt in 2015e.
During 2014, CTF (1929 HK) traded between 15-20x 1-year forward PE, while Luk Fook traded between 7-10x. We believe jewellers are unlikely to see meaningful re-rating in 2015, in the face of weak gold price movements in medium term.
page 78 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
Key catalysts: 4Q14 operations update in Jan-Feb 2015; sharp movements in gold price.
Key risks: Gold price volatility; weak traffic, aggressive store expansion resulting in operating deleverage.
We are neutral on sportswear. This sector experienced a rebound in 2013-14 after suffering from a multi-year down cycle but we foresee risks in 2015. 1) We expect overall sales growth to slow down from 15%/10% in 2013/14e to 8%/7% in 2015e/16e; and SSSG to slow down from 10% in 14e to 6%/5% in 15e/16e. 2) International brands will enjoy revenue growth of 10% vs local brands at 7% in 15e, indicating a worsening competitive landscape led by international brands; 3) Retail inventory of domestic sportswear brands may gradually increase from 4.5 months in 2014 to 5 months by 2015e; 4) Domestic sportswear ASP may only grow by 0-1% in 15e while gross margin and operating margin are expected to stabilize. Sportswear sector enjoyed a re-rating in 2014 and we believe the sector is unlikely to see further re-rating in 2015.
Key catalysts. Better-than-expected 2014e results to be announced in Feb-Mar15; new sports events sponsorships.
Key risks. Softening demand, domestic brands lose market share to international peers; faster than expected growth of staff and rental costs.
We remain negative on apparel and footwear. The sector has faced weak fundamentals in the past 2 years but is unlikely to turnaround in 1H15, in our view. 1) E- commerce continues to become a serious challenge to local apparel and footwear brands. Leading companies are not yet successful in operating their self-developed e-platforms. 2) Inventory remains high. We expect SSSG to remain weak at 0-3% and revenue to grow by 2-6% during 2015. 3) Despite a lower cotton price forecast according to Bloomberg consensus (to USD0.61/lb in 2015 vs USD0.77/lb in 2014), we do not expect meaningful gross margin expansion, as any gains will offset by rising labour costs and lower ASP as a result of heavy promotions (20-30% on apparel, 30-50% on footwear). 4) We expect net margins to diverge as smaller brands impose measures to control rental and retail staff costs, while large brands have lower flexibility on cost control. The margins of large local brands including Belle may decline by 0.2ppt while small local brands such as Daphne and Lilang may expand by 0.7-0.8ppt. During 2014, apparel and footwear names have de-rated heavily but a further de-rating is likely for a number of stocks.
Key catalysts: 4Q14 operational update in Jan-Feb 2015, M&As.
Key risks: SSSG recovery earlier than our expectation; lower-than-expected competition from e-commerce.
We are negative on restaurants. We expect lacklustre restaurant industry growth in Hong Kong and mainland China to continue amid fierce competition. We see rising operating costs adding pressure to margins. We prefer restaurants with strong brands and operations to withstand competition in a challenging operational environment. While the sector has underperformed in 2014, we expect further earnings downside and a mild de- rating in 2015e as fundamentals remain challenging while consensus is too optimistic, in our view.
1) Hong Kong’s restaurant industry grew at 4% CAGR in the past 5 years, driven entirely by ASP, while volume growth was flattish. We believe the slowing tourist arrivals could add pressure; we expect low-mid single digit growth in HK.
2) China’s restaurant industry experienced meaningful slowdown in the recent two years mainly due to consumption contraction in the high-end market. We do not expect a meaningful turnaround in the high-end segment as the anti-extravagance campaign continues; whereas the mass market segment continues to face intense competition. We expect high single digit to 10% industry growth in mainland China.
page 79 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
3) We expect rising operating costs (particularly staff cost) to add pressure to margins. The minimum wage in mainland China has been rising in low to mid teens in recent years, while the minimum wage in Hong Kong is expected to increase by c8% next year. These could suppress the margin levels amid fierce competition and a tight labour market.
Key catalysts: Intensifying competition; deteriorating SSSG; sharp hike in staff cost and rental expenses.
Key risks: Competition eases; quick rebound in SSSG; slowdown in staff cost and rental hike. Sector valuation and stock picks Staples trade at 17x 15e PE, vs. historical median of 24x. Retailers trade at 12x 15e PE vs. historical median of 17x; whereas apparels trade at 12x 15e PE, vs. historical median of 18- 20x. Staples underperformed HSCEI by 17% in the past three months, while retailers underperformed by 7%, apparels underperformed by 16%, and restaurants underperformed by 16%.
Top Picks: Tingyi (322 HK), CRE (291 HK), Biostime (1112 HK), CMD (1117 HK), Gome (493 HK), Intime (1833 HK)
Top Sells: Want Want (151 HK), Parkson (3368 HK), Giordano (709 HK), Ajisen (538 HK) and Sasa (178 HK)
page 80 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015 Conglomerates Sector: POSITIVE Benefit from Policy Easing and SOE reforms Key Takeaway Christie Ju Rate cut and monetary easing will benefit conglomerates with high exposure Equity Analyst to property and financial services sectors. SOE reform should accelerate, we +852 3743 8012 see more M&A and restructuring in 2015. Mix-ownership and profitability [email protected] improvement will be the key focus, we expect listed conglomerates to benefit. Valuation is undemanding at 1.0x 2015 P/B, compared with historical Moses Ma average of 1.2x P/B. Our Top Buy is CITIC Limited (267 HK). Equity Analyst +852 3743 8792 Recent rate cut benefits Chinese conglomerates [email protected] We see some conglomerate names are beneficiaries of the interest rate cut, such as CITIC (267 HK), thanks to its significant exposure to property, resource and financial services sectors. The weighted average share prices of CITIC Bank (A/H) and CITIC Securities (A/H) jumped 41%/86% since September 1, 2014. Benefiting from rate cut, Fosun (656 HK) eases the financial cost, given high financial leverage (~82% net gearing). Its secondary market investment in banking and financial services sectors (Mingshen Bank, Xinhua Insurance etc.) also benefited from rate cut and should see increases in investment profit in 2014 and beyond.
More consolidations ahead; infrastructure, utilities and property key focus China has accelerated SOE reforms, following the roadmap highlighted at the Third Plenum. Many SOEs and conglomerates are actively involved in functional/public service enterprises, especially infrastructure and utilities businesses. A significant amount of infrastructure and utilities assets are in the hands of local governments and related entities. In particularly, environmental services may experience further development in 2015. The upcoming new environmental law and “Water Ten Clauses” is expected to bring Rmb2 trillion investment. As China promotes mixed-ownership and securitization of state-owned assets, we believe local governments may spin off these businesses to the capital market.
Many SOEs are involved in the real estate business, including residential development, investment properties and hotel operations. Consolidation of state-owned property assets may be another area of interests. Consumer sector is very diverse and highly competitive. Conglomerates’ exposure to consumer are also diverse, ranging from brewery, winery, department store, tobacco and packaging, to retail travel agency, etc.
Exhibit 140: China Conglomerates – key sector exposure & consolidation focus Infrastructure Natural Company Sector Property Consumer Industrial Healthcare Financial Utilities Resources Engineering Residential & CITIC Ltd Iron Ore, Steel Securities, Banking Contracting Investment Property Toll Road, Water Residential & Tobacco, Package Shanghai Industrial Treatment Investment Property Printing Natural Gas, Water Beijing Enterprise Brewery Treatment SOEs Water Supply, Toll Guangdong Investment Investment Property Department Store Road, Power Utility Transmission, Tianjin Development Winery Elevator Port Residential & Theme Park, Resort, China Travel Power Tourism Property Travel Agency Residential & Iron Ore, Steel, Insurance, PE and Private Fosun International Fosun Pharma Stock Market Investment Property Crude Oil Investment
SOE Consolidation Focus
Source: Jefferies, Companies
page 81 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Conglomerates the preferred platform for asset injection Going forward, SOEs are likely to focus investments in sectors that either provide public services or are critical to national security. Those operating in natural monopoly industries would be run like private companies.
Chinese government owns a huge amount of assets including infrastructure, utilities and land. To advance diverse forms of ownership and support SOEs to enhance vigour, control and influence, we believe privatizations through M&A or injections will accelerate.
Listed SOEs that can leverage the capital market will gain advantages over non-listed ones. For China Conglomerates under our coverage, we expect future consolidation to occur mostly in infrastructure utilities and real estate.
Transparency to improve, incentive plan to be introduced Exhibit 141: SOE’s average ROE is lower Chinese SOEs, in particular industry leaders in strategic industries, enjoy privileges, both with high gearing explicit and implicit, in doing business in China. The privileges come in the form of 20 185 cheaper and easier credits, priority access to business opportunities and certain protection 15 175 against competition.
10 165 The connections paralyze the invisible hand of the market, misallocating valuable 5 155 resources, dampening competition, undermining efficiency gains and creating room for corruption and bribery. The mechanism is also in part responsible for China’s investment- 0 145 2008 2009 2010 2011 2012 2013 led economy supported by ever increasing debt, which is unbalanced and unsustainable.
SOE's Debt-Equity Ratio (RHS) Average ROE - SOE Average ROE - All Listco In this context, separating state ownership from management will eradicate the channels
for vested interests in the government or their offshoots at SOEs to profit via economic Source: Wind, Jefferies privileges. Only when SASACs or future SAMCs act as shareholders rather than government superiors, will the SOEs truly begin to follow modern corporate practises.
Only then can the board of directors, general meeting of shareholders and senior managers each serve their proper functions in a balanced way. Otherwise, despite the existence of the corporate organs, SASAC appointed senior management is unlikely to truly act in the full interests of the shareholders. Management incentive plans in SOEs are rare. Among listed SOEs, only a small percentage has stock options plans for senior management. We expect incentive plans to be implemented on a wider basis, and align shareholder/management interests.
CITIC (267 HK) is our top pick. CITIC is the largest (in revenue, asset and market cap) and most profitable Chinese conglomerate in Hong Kong market, with estimated 34% of revenue and 77% of its EBIT contribution from financial services sector. We see CITIC a good proxy to Chinese economy and a core holding for investors who are long China.
CITIC is a key beneficiary of the interest rate cut, thanks to its significant exposure to property, resource and financial services sectors. The weight average share prices of CITIC Bank (A/H) and CITIC Securities (A/H) jumped 41%/86% since September 1, 2014, while SHCOMP surged ~30% and HSI decreased ~5%. On the other hand, the share price of CITIC declined 10% in the same period of time. Besides, CITIC became the poster child for SOE reform, it completed the US$37bn acquisition of its parent company at August 2014. The company recently entered a JV with KKR to acquire United Envirotech Ltd. (UNIT.SI) for S$1.65/share. CITIC will invest ~S$1.3bn and control at least 51% of the company. We see the acquisition a positive given the high growth of China environmental market, and the stable cash generation from BOT/TOT business model.
Trading at 5.7x 2015P/E and 0.7x P/B with strong prospect, we believe valuation is undemanding. We estimate the mark to market value of CITIC Bank and CITIC Securities could add HK$2.43/share upside. We expect CITIC to catch up on improving fundamentals, reiterate Buy with HK$17 target price.
page 82 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015 Macau Gaming Sector: NEUTRAL Darkness before Dawn; Pick the Proven Winners Key Takeaway Leon Liao While short term pain may linger, we believe stocks may have bottomed, and Equity Analyst see sentiment improving on positive catalysts. Rate cut bodes well for VIP +852 3743 8021 recovery, mass demand should resume after political unrest settles. The [email protected] Anniversary of Portugal handover is ideal for President Xi to showcase the success of "One Country, Two Systems". We believe golden days are still ahead. Top Picks: Galaxy and Sands China.
Short term pain may last longer. With both VIP and mass market under severe pressure, 2014 has been a painful year for investors. We expect GGR to remain under pressure in the next 3-4 months, given 1) tough comparison vs. high base in 4Q13/1Q14; 2) continuation of anti-corruption caps VIP growth; 3) political unrest in Hong Kong dampens mass market demand; and 4) lack of big resort launches. While there might be some bright spots around Chinese New Year, sector recovery may not happen until March 2015 at the earliest.
Stocks may have bottomed; sentiment improving on positive catalysts. Gaming stocks declined 34% from their recent highs, and were quite stable amid poor GGR results. We believe the bad news was largely priced in. On the other hand, we see sentiment improving with emerging positive catalysts: 1) China’s surprise rate cut signals it has entered a monetary easing cycle, which bodes well for a potential VIP recovery; 2) mass growth should resume after “Occupy Hong Kong” settles; 3) 24 hours border crossing starts from Dec 18; and 4) the removal of daily limit on HKD to RMB conversion.
Macau to showcase the success of “One Country, Two Systems”. President Xi will be the guest of honor at the 15th anniversary of Portugal’s handover in Dec; we believe the event will be an ideal platform to showcase the success of the One Country, Two Systems policy. It is critically important for China to ensure the long term prosperity of Macau. We expect more supportive measures to drive tourism, infrastructure development, and investment in non-gaming activities to follow.
Long term growth model still intact. While the fast growth phase cannot last forever, we believe the golden days for Macau are still ahead. China will not legalize gambling, regional competition is not an issue in the midterm, in our view. The HK-ZH-MC Bridge will improve ease of access, high-speed rail in central and west China will significantly increase the three/five hour radius around Macau. World class non-gaming development in Hengqin Island will help enhance the attractiveness of Macau to general public, we expect solid growth to resume in 2H2015, strong profitability and good return to shareholders should follow
Top Picks. Our 2015/16 GGR growth estimates are 3%/12%, respectively. We like operators with high table yield, cost efficiency and diversified business model, and prefer companies will clear longer term strategy, sustainable competitive advantage and sharp focus on investors returns. Our top picks are Galaxy (27 HK, Buy) and Sands China (1928 HK, Buy).
Key Risks Key risks are 1) Domestic liquidity is the key 2) Anti-corruption and labor shortages are risks to watch and 3) Competition between Cotai players may drag down margins.
page 83 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Short term pain may last longer
Gross Gaming Revenue (GGR) started to drop in June 2014, dragged mainly by weak VIP initially. The market continues to deteriorate as premium mass is affected by the policy headwind. GGR experienced the first quarterly decline in five years in 3Q14. The market continued to deteriorate in Oct registered negative growth in mass revenue. Nov GGR also dropped 19.6% yoy.
Feb 2014 reached a record monthly GGR of MOP38bn (boosted by CNY holiday), and 1Q14 GGR reached MOP102bn. We believe this will be hard to surpass in 1Q15. VIP weakness may continue while mass decline in Oct triggered a marketwide downgrade (in GGR). We expect a stock rebound as early as Jan 2015 because of a low base and play for the Chinese New Year (CNY) in Feb.
Exhibit 142: GGR may turnaround in 2Q15E
yoy % growth
100% 80% 60% 40% 20% 0% -20%
-40%
2Q12 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14
4Q14 E 4Q14 E 1Q15 E 2Q15 E 3Q15 E 4Q15
Source: DICJ, Jefferies
Sentiment improving on positive catalysts Interest rate cut might be the start of new monetary easing cycle China cut 1 year benchmark lending rates to 5.6% (-40bps) and 1 year benchmark deposit rates to 2.75% (-25bps) on Nov 21, 2014. Previously, the central bank had focused on fiscal spending, targeted mini-stimulus and open market operations to drive a balanced economy. These measures were not potent enough to make a real difference, as weak industry output, bank lending and lacklustre property market added more pressures to a slowdown. This rate cut, China’s first in over 2 years, is a clear “step up” in the government’s stimulus policy. We see it as the beginning of sustained supportive monetary policies which will help drive broad-based demand recovery, and expect more RRR and interest rate cuts to follow in the coming months. China’s liquidity conditions will gradually improve from here on.
Exhibit 143: VIP GGR is highly correlated with China’s liquidity
Source: DICJ Bloomberg, Jefferies page 84 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Anti-corruption will still be enforced but the peak has passed The campaign to check misbehavior by party officials may be ending, according to a statement issued after the Politburo meeting on Sep 30. It said the “mass line” campaign has reached its goals. It is likely that the anti-corruption campaign may ease.
The number of officials being publicized on the CCDI (Central Commission for Discipline Inspections) website has slowed down in recent months. Mr. Wang Qishan, a member of the Politburo Standing Committee who launched the anti-corruption campaign concluded that the anti-corruption work was bearing fruit, during the 2nd session of the Standing Committee of CPPCC National Committee’s 7th meeting, held on Aug 25.
Exhibit 144: Number of senior officials being investigated by CCDI is declining
200 178 180 168 160 140 114 120 100 80 63 68 60 33 40
20 1 5 4 0 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4QTD
Source: CCDI, Jefferies
Long term growth model intact Macau’s GDP reached US$51.7bn in 2013 from US$5.9bn in 1999 when it was handed over to mainland China. The central government supported the liberalization of gaming in 2000-02 and introduced international players to the industry. It also opened the Individual Visit Scheme (IVS) in 2003 when SARS hit the region. IVS eligibility expanded to 49 cities in mainland China, covering the richest population in south-eastern and coastal cities. Gross gaming revenue (GGR) reached US$45bn in 2013, 7x that of Las Vegas Strip.
Exhibit 145: GGR estimated to grow by 3%/12% in 2015/16E 450,000
350,000
250,000
150,000
50,000 2009 2010 2011 2012 2013 2014E 2015E 2016E
Sands China Galaxy Wynn Macau SJM MPEL MGM China
Source: Jefferies estimates
Construction boom will boost demand & supply Infrastructure development in Macau and Pearl River Delta area can improve both Macau’s capacity to accommodate visitors and demand for its gaming business. More infrastructure is under development, which will boost demand and increase capacity. The Hong Kong – Zhuhai – Macau Bridge will accelerate the connection within the Pearl-River- Delta area. A High Speed Rail connecting more cities to Zhuhai will bring more visitors to
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Equity Strategy
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14 December 2014
Macau. The development of Hengqin is targeted to support Macau’s long-term growth after construction in Cotai ends. A third airport runway is also under discussion, which will bring more visitors from other parts of the world.
Regional competition is not an issue in medium term We don’t think China will legalize gambling although underground gambling exists in the country. The only legal gaming is in the form of lotteries and online entertainment using credit points (not real money). The media has exposed illegal casinos in Shanya, Hainan province. Whenever such activities have come into the light, the government has shut them down. Based on our understanding, we don’t see any possibility of loosening these restrictions in this term or even the second term under Xi Jinping’s presidency.
Pick the proven winners We conducted a set of tests comprising 6 performance indicators and ranked each item from 1-6. The total score reflects how each operator performs compared with competitors in general. Sands China has the lowest score and leads the test as it is best positioned on strong EBITDA margin, advantage in Mass business and higher contribution from non- gaming. Galaxy ranks the second with outstanding performance in mixed table yield and first-mover advantage in new property launches.
Exhibit 146: Score card in current running business (*1 – best, 6 – worst) Sands Galaxy MPEL Wynn MGM SJM China Macau China Table efficiency 6 1 5 4 2 3 (Revenue/table) Cost efficiency (EBITDA 1 3 2 4 5 6 margin) VIP/Mass split 1 3 2 5 4 6 non-gaming 1 4 3 2 5 6 contribution ROI (EBITDA/Inv) 4 5 6 2 3 1 New launch schedule 3 1 2 4 5 6 Total 16 17 20 21 24 28 Source: Jefferies estimates
New property value has not yet been priced in We used the 3-year average trading multiple to value the current business as 1) historical long-term valuation is more relevant to its own business if there is no significant change in fundamentals; 2) 2-year and 1-year average are higher than 3-years because the sector has been re-rated in the past two years, which is exaggerated by market sentiment.
The current market value for the new properties is not in the price. Sands China, SJM and MPEL have negatively priced the value of its new property, while Galaxy Macau, Wynn Palace and MGM Cotai only priced in 53%, 12% and 17% of the NAV in current price.
Exhibit 147: New property NAV not yet priced in (HK$ bn) 500 Current market value 400 Current properties Value Implied new properties Value 300
200
100
-
(100) Sands Melco SJM Galaxy Wynn MGM China Crown Macau China
Source: Jefferies, Bloomberg, priced as of Dec 1, 2014
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Equity Strategy
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14 December 2014
2015 Energy - Oil & Gas Sector: POSITIVE Key Takeaway Celebrations/dirges for the new normal of lower oil prices are premature, in
our view. The recent slowdown in China's oil demand growth was not Laban Yu unexpected. Likewise, we believe China's oil demand will recover with a Equity Analyst vengeance. While industrial oil demand is flat/falling, consumption demand +852 3743 8047 rises exponentially. Investors with longer time horizons should be overweight [email protected] oil and gas. Before China really starts driving.
The rout in the oil markets is the most severe since the financial crisis of 2008, with the
January 2015 contract down 38% and the 2015 price strip down 33% since the beginning
of the third quarter.
OPEC/Saudi Arabia’s acceptance of letting market forces (of all things) set the oil price has spawned numerous conspiracy theories. We believe that a less inflammatory explanation to Saudi/OPEC inaction is also possible: the market is temporarily oversupplied; economic growth and lower industry capital spending will correct the imbalance; and the price correction while steep is not yet long-lived. We do not necessarily believe that the Saudis have abrogated their role as swing producer, or that strategically they desire prices below $100 over the medium term. Tactically however an oil price downturn is conducive to spreading the burden of production cuts both politically to other large exporters and economically to numerous small-scale producers.
Exhibit 148: Jefferies oil price forecast ($/bbl) Strip 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Brent 69.43 71.27 72.90 74.13 75.25 76.41 77.38 78.14 78.88 79.58 80.11 80.63 WTI 65.74 66.25 66.76 67.46 68.19 68.87 69.49 70.25 70.75 71.26 71.68 72.25 Differential (3.69) (5.02) (6.14) (6.67) (7.06) (7.54) (7.89) (7.89) (8.13) (8.32) (8.44) (8.37)
Jefferies forecast Brent - current 68.00 70.00 74.00 77.00 80.00 82.00 84.00 86.00 88.00 90.00 90.00 92.00 Brent - previous 87.00 89.00 91.00 93.00 95.00 97.00 99.00 101.00 105.00 105.00 105.00 105.00 Current % versus strip -2.1% -1.8% 1.5% 3.9% 6.3% 7.3% 8.6% 10.1% 11.6% 13.1% 12.3% 14.1%
WTI - current 64.00 65.00 69.00 72.00 75.00 77.00 79.00 81.00 83.00 85.00 85.00 87.00 WTI - previous 81.00 83.00 85.00 87.00 89.00 91.00 93.00 95.00 95.00 95.00 95.00 95.00 Current % versus strip -2.6% -1.9% 3.4% 6.7% 10.0% 11.8% 13.7% 15.3% 17.3% 19.3% 18.6% 20.4%
Strip 2015 2016 2017 LT Brent 71.93 76.79 79.80 WTI 66.55 69.20 71.48 Differential (5.38) (7.59) (8.31)
Jefferies forecast Brent - current 72.25 83.00 90.00 100.00 Brent - previous 90.00 98.00 105.00 105.00 Current % versus strip 0.4% 8.1% 12.8%
WTI - current 67.50 78.00 85.00 95.00 WTI - previous 84.00 92.00 95.00 95.00 Current % versus strip 1.4% 12.7% 18.9% Source: Bloomberg, Jefferies estimates
We believe that the plunge in oil price has multiple causes:
. Weak demand growth. Global demand is on track for a 0.7% increase in 2014, which would be the weakest annual growth experienced since the 1% decline in demand in 2009. Chinese demand for refined products, the primary engine of oil demand growth over the last decade, is up a meagre 1.4% through October.
. US production gains. Non-OPEC supply is set to rise by 1.9 mbd in 2014; since 1984 the next highest level of growth in non-OPEC supply was 1.2 mbd (4 times, most recently in 2013). The US is the clear driver of this growth and is set to increase 2014 output by 1.4 mbd.
. Financial market drivers. The surging US$ since the beginning of 3Q14 has been highly correlated with the fall in the oil price. We do not believe that the
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Equity Strategy
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14 December 2014
US$ and the price of oil need to be highly correlated over longer periods of time, but in periods of volatility they do tend to correlate strongly. Over 1H14, the r2 between the US$ and the Brent oil price was 7%; since the beginning of 3Q14, the r2 has been 85%. In addition, record non-commercial net length in both the Brent and WTI contracts at the beginning of 3Q14 has been substantially liquidated, adding further selling pressure. China to drive oil demand in medium term Industrial flat, consumption exponential To us, China's weak oil demand growth is not unexpected. Industrial demand for oil (~75% of total) has been flat to mildly declining as a result of 1) natural gas substitution, 2) economic rebalancing and 3) efficiency gains from new infrastructure (i.e. rail and roads, refiners). This has been offset, just barely, by consumption demand for oil (~25% of total), which has been growing exponentially.
Exhibit 149: China industrial petroleum demand Exhibit 150: China consumption petroleum demand mmbbl/d mmbbl/d 9 3.0 8 2.5 7
6 2.0 Kerosene Other & losses 5 (Jet fuel) 1.5 4 Lubricant
3 Fuel Oil 1.0
2 Gasoline Diesel 0.5 1
0 0.0
Jul-06 Jul-14 Jul-04 Jul-05 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13
Jul-05 Jul-10 Jul-04 Jul-06 Jul-07 Jul-08 Jul-09 Jul-11 Jul-12 Jul-13 Jul-14
Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-04 Source: China NBS, China OGP, Jefferies Source: China NBS, China OGP, Jefferies
The inflection We believe the inflection point for China's car penetration will occur 2016-17, at which point oil demand growth will accelerate. We believe China will reach car saturation (oil demand plateau) in 10-20 years. Over this time, China will have to add or find substitutes for 24-38 mmboe/d of transportation energy demand (~125-200% of current US oil consumption), according to our calculations. That amounts to an average annual increase of 1.2-3.8 mmboe/d over the next 10-20 years.
Exhibit 151: Oil demand intensity vs. per capita GDP
bbl/head/yr 1978 peak 35
30 US 25 1997 peak 1973 peak 20 S. Korea 1973 peak 15 Japan
10 EU
5 China India 0 - 5 10 15 20 25 30 35 40 45 50 55 Real PPP GDP/head (2011 US$) Source: BP, World Bank, Jefferies
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Equity Strategy
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14 December 2014
Short-term oversupply, long term irrelevance OPEC is currently bent out of shape over a measly 1 mmbbl/d production cut. Do they cut? Do they not? Does it matter when China's demand growth starts up again? We believe investors with a longer time horizon (+3 years) do not need to worry about OPEC meetings and shale oil production — just buy upstream oil and gas and hold tight. China demand drove the investment commodity (e.g. coal, iron ore, aluminum etc.) super-cycle over the past decade. It will drive the consumption commodity (oil and gas) boom in the next decade.
page 89 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Energy - Coal Sector: NEGATIVE Key Takeaway Heading into 2015, we believe coal demand in China is at best flat. While
economic rebalancing has been slower than expected, substitution and Laban Yu efficiency gains have exceeded our expectations. We believe China is now Equity Analyst trying to soft-land the coal industry which some in the market have +852 3743 8047 misinterpreted as an industry rescue. We reiterate our Underperform rating [email protected] on all three coal stocks.
Exhibit 152: QHD benchmark prices Exhibit 153: Mine mouth to QHD coal prices Rmb/ton Premium blend 5800kcal Rmb/ton 1,100 Premium blend 5500kcal 1,100 Premium blend 5500kcal Blend 5000kcal 1,000 1,000 Blend 5000kcal Ordinary blend 4500kcal Ordinary blend 4500kcal 900 900
800 800
700 700
600 600
500 500
400 400
300 300
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Jan-12 Jan-14 Jan-08 Jan-09 Jan-10 Jan-11 Jan-13
Apr-09 Apr-08 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14
Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14
Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
May-09 May-10 May-11 May-12 May-13 May-14 May-08 Source: SXCoal, Jefferies Source: SXCoal, Jefferies
Coal demand is peaking In recent months, thermal coal power generation has been declining by over 5% YoY. The collapse in coal demand has occurred concurrently with the production restrictions. However, the effect of production restrictions on prices, especially at the mine mouth, has been negligible. Going forward, we believe coal demand growth will be lower than thermal power production growth, which will be lower than power production growth, which will be lower than GDP growth, due to:
. Economic rebalancing: We have previously calculated that a GDP unit of services (tertiary industry) uses a quarter the energy of manufacturing and construction (secondary industry). With China rebalancing towards services, energy consumption growth should be much lower than in the previous decade of fixed asset investment-led growth.
. Efficiency gains: China is upgrading its coal-fired power plants to more efficient, large power plants, using super-critical steam technology. The most efficient plants generate ~26% more electricity from the same amount of coal.
. Direct gas substitution: We believe more natural gas is displacing coal than expected. Despite gas being 2-4x more expensive on a calorific content basis, industrial coal furnaces are large, inefficient, dirty and unwieldy, resulting in higher equipment, maintenance and manpower costs.
. Electrification: Coal furnaces can also be replaced by electric furnaces. In China, only ~50% of coal is used by power plants to produce electricity compared to 93% in the US. A portion of power production growth will be used to displace direct coal burn application.
. Alternative energy: While we project total energy demand in China to grow below 4% per annum in the next 3-5 years (and declining), wind, nuclear, solar and hydro — direct coal substitutes for power generation — are growing ~5- 30% per annum.
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14 December 2014
Exhibit 154: China power generation Exhibit 155: China thermal power generation Bn Kwh/day Bn Kwh/day 18 Other 14 16 12 14 Nuclear 10 12
10 8
8 6 6 Thermal 4 Thermal 4 2 2 Hydro
- -
Jul-10 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-11 Jul-12 Jul-13 Jul-14
Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-14 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13
Jan-04 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-05 Source: China NBS, Bloomberg, Jefferies Source: China NBS, Bloomberg, Jefferies
Policy support? Help has been sent in the form of import tariffs, production restrictions, and domestic tax relief. We believe they are short term measures designed to soft land the industry rather than a reason for investors to bottom-fish. We do not believe supporting coal prices is a rational long term policy. Whatever support the industry may be getting now, will disappear in the medium term, in our view.
Imports are tiny China has implemented a 3-6% import tariff on imported coal (with Indonesia exempt due to a free trade agreement). We estimate imports to be less than 6% of China’s total supply in 2015. Some of this capacity may be uneconomic with the tariff but, with a flattened supply curve and collapsing demand, the capacity that does drop out will have a negligible effect on prices, in our view.
Exhibit 156: China coal supply Exhibit 157: China coal supply mtons 100% 5,000 90% 4,500 80% 4,000 Other 70% 3,500 Other 60% Net imports 3,000 Net imports 50% Shaanxi 2,500 Shaanxi 2,000 40% Inner Mongolia 1,500 30% Inner Mongolia 1,000 20% Shanxi 500 Shanxi 10%
- 0%
2000 2005 1995 2010
1995 2000 2005 2010
2015E 2020E 2025E
2020E 2025E 2015E Source: China NBS, Bloomberg, SXCoal, Jefferies Source: China NBS, Bloomberg, SXCoal, Jefferies
Production restrictions temporary In what we believe will be a replay of 2012's temporary production restrictions, China National Coal Association has called for a 10% production cut from 2H14. We believe China has no interest in supporting coal prices in the long term, current production restrictions are temporary measures designed to buy time (liquidity) rather than the solvency of coal companies.
page 91 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
2015 Financials - Banks Sector: NEUTRAL Neutral Amidst Cross-Currents Key Takeaway Will Hong We expect the implementation of the Third Plenum plans to drive long-term Equity Associate re-rating of H-share banks, with near-term pressures from growth +852 3743 8750 deceleration, asset quality deterioration & deposit rate deregulation likely to [email protected] be offset by accommodative monetary & regulatory policies. Given these cross currents, we are Neutral on the sector (though valuation provides strong Baron Nie, CFA, AIAA downside support as capital risk recedes), and prefer the Big 4 banks for their Equity Analyst high dividend yield. Top pick BOC (3988 HK). +852 3743 8747 [email protected] Reform is slow but commitment is strong; 2015 may prove bears wrong: China developers’ bonds outperformed stocks in 2014 despite refinancing concerns amidst changing price expectations. With the refinancing pressure of offshore debt in 2015-16 falling to <25% of 2013-14 levels, we believe 2015 may prove China bears wrong. Asset quality risk is high but resides largely with the government (e.g. LGFVs & inefficient SOEs), and is being addressed by reform initiatives in the Third Plenum plan (e.g. KPI changes to drive real behavioural improvements, greater transfers from central to local governments, rural reforms to boost demand in over-built/supplied regions), in our view. We thus see credit deterioration at the margin from growth deceleration, and not a credit crisis.
We are Neutral as negative under-currents meet positive buffers: With growth decelerating in China, we expect the banks to face 1) provisioning pressure, especially as loan-loss reserves fall amidst credit deterioration & quicker NPL recognition; and 2) NIM pressure from weak loan demand, as well as deposit rate deregulation, which is on an ever shorter timetable. However, we believe China has levers to cushion the impact via accommodative policies, including 1) monetary measures like system-wide RRR & interest rate cuts to stimulate lending & demand while lowering refinancing risk & cost; and 2) regulatory reforms such as LDR loosening to reduce deposit gathering pressure and thus funding cost, as well as mortgage securitization to boost the banks’ lending capacity and fee income.
Valuation provides strong downside support as capital risk recedes: As we do not expect a credit crisis to materialize in China, the banks’ sub-1x P/B valuation provides strong downside support, especially in light of their still-high ROEs and receding common equity issuance risks (given successful placements of their preferred shares at lower-than- expected yields, suggesting strong demand), in our view.
Prefer big banks on dividend yield, top pick BOC: Given our Neutral stance, we prefer the Big 4 banks for their high dividend yield (7% on average). Our top pick remains BOC (3988 HK, Buy) we expect the bank to benefit more from greater RMB internationalization, and is less susceptible to RMB interest rate deregulation as it has the highest proportion of non-interest income & overseas business.
page 92 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Financials - Insurance Sector: POSITIVE Remain Positive; Expect Performance to Catch Up with Fundamentals Baron Nie, CFA, AIAA Key Takeaway Equity Analyst Going into 2015, we maintain our positive outlook on the China insurance +852 3743 8747 sector. On life business, we expect the sector to benefit from 1) supportive [email protected] policies; 2) stable fundamental growth; and 3) solid investment performance.
On P&C insurance, we expect auto-insurance margin to be stable, or Will Hong potentially improve, despite the upcoming pricing deregulations. We prefer Equity Associate the larger cap insurers going into the New Year. Top picks: Ping An (H); Ping +852 3743 8750 An (A); CPIC (H). [email protected]
Policy framework supportive: 2015 is likely to be another busy year with important
policy developments, including 1) pricing deregulation on participating / universal life
products; 2) development and introduction of solvency 2 framework; 3) introduction of deferred tax policies for pension products. We see overall policy direction as supportive, and likely to drive further growth for the industry.
Expect fundamental growth to remain solid: Post a strong recovery in 2014, we are expecting average New Business Value growth of 10-15% for the listed insurers going into 2015. In particular, we believe agency business will continue to be the key growth driver, amid 1) stable growth of agency headcount and improving agency quality; 2) broadening product offerings (especially given potential pricing deregulation and introduction of pension supportive policies); and 3) improving investment yields; 4) strong preparation of 2015 opening campaign. Bancassurance volume is likely to decline further, as a result of control on high-cash-value product sales, but with limited NBV impact.
Investment expected to be stable: Post the rapid allocation towards alternative assets in the past 2 years, we expect overall allocation towards alternative investments to be more stable for the industry in 2015. Investment yields will remain at a relatively high level, which will continue to support interest margins for the insurers.
Lower interest rate environment offers a mixed bag of impacts: Long-term bond yield has declined lately, together with the return on some WMPs. In our view, gradual changes in the interest rate environment do not lead to clear-cut advantages/disadvantages for the insurers. On the one hand, sales could be boosted as a result of improving liquidity and relatively stronger yields; but on the other hand, re- investment of assets could be negatively dragged.
P&C outlook positive: We also maintain a positive view on the P&C industry going into 2015. We expect: 1) growth of around 12-15%, mainly driven by auto-insurance business; 2) underwriting margin stable, supporting 18-20% ROE for the top players; and 3) limited impact from the auto-insurance deregulation (for larger P&C insurers).
Stock picks: We prefer the larger cap insurers going into 2015, and believe share price performance will start to catch up with the improving fundamentals post the digestion of SH/HK connect. Ping An-A (601318 CH; BUY) and Ping An-H (2318 HK; BUY) are our top picks in the sector, despite its near term capital overhang, followed by CPIC-A (601601 CH; BUY) and CPIC-H (2601 HK; BUY). We also like PICC (2328 HK; BUY), as a leader in the P&C field.
page 93 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
2015 Financials - Brokers, Asset Mgrs & Exchanges Sector: POSITIVE Positive Reforms Continue Key Takeaway Baron Nie, CFA, AIAA With Third-Plenum plans to promote a registration-based IPO system gaining Equity Analyst impetus, we believe 2015 will be a positive year for Chinese brokers. The +852 3743 8747 lacklustre start for the Shanghai-Hong Kong Stock Connect (SC) has tamed [email protected] our enthusiasm for HKEx & the HK brokers, but we believe it is too early to dismiss the SC (especially as admin uncertainties & unfamiliarity get sorted Will Hong out in the next few months) and will be looking for attractive entry points. At Equity Associate the same time, we expect Cinda to benefit from the easing liquidity +852 3743 8750 environment, accelerating its asset disposal process. Top pick CITICS. [email protected] Prefer China brokers as reform momentum increases: As China grapples with funding issues for smaller companies, there is increased momentum to push through Third-Plenum plans to promote a registration-based IPO system, which we believe will be the key highlight for the sector in 2015, alongside other prior initiatives (e.g. margin lending) as well as new ones (e.g. stock options and market making) that will drive the Chinese brokers’ strong earnings growth. While brokerage commission rate pressure is likely to remain, we believe this may be offset by market share expansion, and thus prefer the big Chinese brokers given their stronger franchise, better facilities & product/service offerings, as well as capital position.
Bargain-hunting SC beneficiaries, especially HKEx given LME angle: Whilst the SC was off to a slow start relative to unrealistic expectations (considering the admin uncertainties & unfamiliarity), we believe it is too early to dismiss the scheme and will be looking for attractive entry points for HKEx & the HK brokers as issues such as pre-checks get sorted out; a custodian pre-check solution to address long-only investors’ concern with regard to premature transfer of securities to brokers is expected to be implemented in the next six months. HKEx, in particular, will see LME contributions increase significantly in 2015 with LME Clear’s successful launch and Asia Commodities due in December 2014 (notwithstanding some fine-tuning in LME trading fees).
Cinda will benefit from easing liquidity: Cinda’s net balance of traditional assets and restructured assets jumped 36%/61% respectively in 1H14, as a result of proactive growth strategy amid economy slowdown and fast NPL formation. Going into 2015, we expect a more appropriate and sustainable asset growth rate, together with accelerating asset disposals amid the easing liquidity environment. We believe its unique distressed asset investment model will be gradually appreciated by more investors, via improving communications and disclosures. With potential 2015E ROE of around 17%, we believe Cinda’s current valuation remains attractive.
Top pick CITICS: We like CITICS’ strong revenue generation and innovation capability, given its strong investment banking franchise, diversified revenue base, and overseas expansion opportunities.
page 94 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Healthcare Sector: POSITIVE Robust demand growth; Pricing reforms favour marketization Jessica Li, Ph.D, MBA Key Takeaway Equity Analyst We remain positive on the outlook for the Chinese pharmaceutical industry, +852 3743 8010 and believe it capable of sustaining mid-teen% growth, given the robust [email protected] demand growth trend. The government aims to introduce more market
mechanisms into the sector, which should favour leading innovative players. Lilian Wan Drug tenders will progress faster in 2015, and overall pricing risk is Equity Associate manageable. Sinopharm remains our top pick in the sector. +852 3743 8084 [email protected] Robust demand drives mid-teens% growth of China’s pharmaceutical market. We forecast that the Chinese pharmaceutical market will sustain mid-teens% growth in 2015, primarily driven by rigid demand, although the growth has decelerated from twenties% in 2011-2013. Major drivers include favourable demographics; improving insurance coverage; rising prevalence of severe chronic disorders, treatment of which relies much on drugs; increasing disease diagnosis; and the development of E-commerce for prescription drugs and involvement of commercial health insurance.
Drug pricing reforms to introduce more market mechanisms; full implementation a long way to go. The NDRC has been consulting on the new guidelines for drug pricing in China this year, and is pushing for the new guidelines to be released in January 2015. We expect more drug pricing policies to be issued in the next few months. According to the latest draft, the medical insurance department would set benchmark prices, instead of NDRC, which set maximum retail prices for generic drugs covered by government reimbursement. Medical insurance payers will also negotiate directly with drug manufacturers on prices of under-patent and exclusive drugs. Under the new pricing mechanism, innovative drugs and low-priced drugs would be favourably priced, while off-patent originator drugs and independently-priced generic drugs of domestic companies could face more pricing pressure. We believe that the government is not ready for full implementation yet and would likely conduct pilot reforms in trial regions first.
Drug tendering process to speed up; pricing pressure manageable. Drug tenders are expected to speed up in 2015. According to the latest draft of the new tendering guidelines, all provinces are required to complete the new round of drug tenders by June 2015. We expect the new guidelines to be officially released in early 2015 and the tender pace to speed up in 2015. So far, 13 provinces have started the purchase of low-priced drugs, 18 provinces have started the new EDL tenders and 9 provinces have started the new non-EDL tenders. We believe the pricing risk is manageable, as the new guidelines put more emphasis on drug quality.
Major policy events in 2015. 1) Release of guidelines on online sales of prescription drugs; 2) Progress of provincial drug tenders; 3) New guidelines on drug pricing mechanisms and tendering rules; and 4) Rollout of central SOE reforms.
Top pick - Sinopharm (1099 HK; BUY; TP HK$31), China’s No. 1 pharmaceutical distributor and the major consolidator in the space. Significant opportunities lie in its retail pharmacy business. Interest rate cut could reduce financial costs in 2015. Being chosen for the CSOE pilot reform should invigorate the company’s future development.
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Equity Strategy
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14 December 2014
Demand growth remains robust
The growth prospects of the Chinese healthcare industry remain healthy, as we see key growth drivers staying intact: increasing government spending, improving insurance coverage/continuous rollout of critical illness insurance, and robust demand increase on favourable demographic trends. The development of E-commerce for prescription drugs and involvement of commercial health insurance should add more growth to the sector. Pricing pressure should remain manageable, as the new tender rules trend towards more rational pricing.
Exhibit 158: Chinese pharmaceutical industry sales/profit and growth trends
Sales of pharmaceutical industry Total profit of pharmaceutical industry Rmb bn 1,600 Sales YoY growth Total profit YoY growth 60%
1,400 50%
1,200
40% 1,000
800 30%
600 20%
400
10% 200
0 0%
Jul-12 Jul-13 Jul-14
Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-12 Jun-13 Jun-14
Apr-12 Apr-13 Apr-14
Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14
Oct-12 Oct-13
Sep-12 Sep-13 Sep-14
Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
Mar-12 Mar-13 Mar-14
Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14
Nov-12 Nov-13
May-07 May-08 May-09 May-10 May-11 May-12 May-13 May-14 Note: Accumulated sales and profit data Source: National Bureau of Statistics of China, Jefferies
Increasing government spending continues We believe increasing fiscal spending on the healthcare sector, and government subsidies will continue to drive the growth of China’s healthcare industry until 2020. The 2014 government budget for healthcare expenditure implies a 13% increase from the same period last year, slightly below a 14% YoY increase in 2013. Government per capita subsidies for the New Rural Cooperative Medical Insurance (NRCMI) and Urban Resident Basic Medical Insurance (URBMI) increased 14% to Rmb320 in 2014 from RMB280 in 2013, and are expected to reach over Rmb360 in 2015. The reimbursement rates for NRCMI outpatients and in-patients also increased to 50% and 75% from previous 40-60% and 35- 45%, respectively.
Exhibit 159: Government spending on healthcare remains Exhibit 160: Government subsidies for medical insurance healthy continue to increase
Government healthcare spending YoY growth% Government annual subsidy Individual payment
Rmb bn Rmb YoY growth of per capita spending 1,000 40% 500 60% 2009-2015E CAGR 26% 900 35% 50% 800 400 30% 700 40% 25% 300 600 30%
500 20% (Rmb) 200
400 20% (%) growth YoY 15% 300 100 10% 10% 200 5% 0 0% 100 2009 2010 2011 2012 2013 2014 2015E 0 0% Note: Govenment subsidies to >Rmb360 per capita in 2015. 2000 2005 2010 2011 2012 2013 2014 Budget NRCMI = New Rural Cooperative Medical Insurance Source: National Bureau of Statistics, Jefferies Source: National Health and Family Planning Commission
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14 December 2014
Private hospitals continue to expand The Chinese government is committed to accelerate progress and solve the difficulties facing the private hospital sector, aiming to triple the number of beds per thousand population in private hospitals to 1.5 by 2020 from the current 0.5, implying a 7-year 17% CAGR in total private hospital beds, while the growth in public hospitals would be merely 2% during the same period. Private capital is encouraged to participate in the privatization of public hospitals in areas where public hospital resources are plentiful. Going into 2015, we expect more detailed favourable policies on private hospitals. We expect the private hospital sector to grow rapidly at a CAGR of ~20% over the next three years, fuelled by policy incentives and increasing medical demand from the growing middle class.
Involvement of commercial health insurance Involving commercial medical insurance is crucial to release medical demand in China. Commercial insurance companies are encouraged to develop an enriched portfolio of commercial health insurance products targeting different market segments, as a supplement to basic medical insurance. Health services such as check-up, management of chronic diseases, disease prevention, endowment services, rehabilitation services, etc, will be supported. The diverse and multi-level commercial health insurance services, if successfully implemented, should lead to long-term sustainable growth for healthcare sub-sectors including speciality drugs, medical devices, vaccine products, diagnostic products, TCM, and premium health services.
Development of online sales of prescription drugs It has become increasingly evident that the E-commerce prescription drug market may open up in early 2015 at the least, according to an internet company symposium held in Guangdong. The market potential of online prescription drugs, estimated at Rmb300bn (or US$49bn), would account for 30% of the overall prescription drug market. Nonetheless, we are cautiously optimistic given the lack of prescriptions and pharmacists.
Price reform to introduce more marketization mechanisms The Chinese government is exploring new drug pricing mechanisms to establish a more reasonable price system in China. In June 2014, the State Council required a new guideline of drug pricing mechanism be completed by the end of December 2014. The NDRC has been consulting on the new guidelines to reform drug pricing in China.
Based on the latest draft on drug pricing reforms, the NDRC would likely cancel maximum retail prices of most drugs whose prices are regulated, except the Class I psychotropic and anaesthesia drugs. Medical insurance department will set benchmark prices of common drugs and negotiate with manufacturers on prices of patent and exclusive drugs. Under the new pricing mechanism, innovative drugs and low-priced drugs would be favourably priced, while MNCs’ off-patent originator drugs and independently-priced generic drugs of domestic companies could face more pricing pressure.
Although NDRC is pushing forward and trying to release the official guidelines by January 2015, we believe the government is not ready for full implementation yet, as the supporting measures in terms of drug tendering and payment methods of medical insurance are far away from being established. Furthermore, the mechanisms to determine the benchmark prices of medical insurance are still under discussion. Pilot reforms in trial regions would likely be conducted first.
page 97 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 161: Potential direction of reform on drug pricing mechanism Max. retail prices Benchmark prices
• Set by NDRC • Set by MHRSS • Some high-priced drugs are • Fixed amount paid by medical exposed to price reduction insurance funds • MHRSS to negotiate directly with pharma manufacturers
Prices in hospitals < Hospitals make profits Benchmark prices
The amount above payment of Prices in hospitals > medical insurance will be paid Benchmark prices out of pocket
To establish a more reasonable pricing system
Note: NDRC- National Development & Reform Committee MHRSS-Ministry of Human Resources and Social Security of China Source: SFDA Southern Medicine Economic Institute; Jefferies Drug tenders to speed up in 2015; Pricing pressure manageable New guidelines to improve tendering rules The provincial drug tendering rules in China are still evolving. The NHFPC has been consulting on the new guidelines for provincial drug tendering, including both EDL drugs and non-EDL drugs. Previously, old guidelines adopted a “double-envelope” system for EDL tenders and a comprehensive evaluation methodology for non-EDL tenders. The double-envelope model, which was originally introduced by Anhui, placed much emphasis on drug prices and resulted in severe price cuts during the last round of EDL tenders. The new guidelines, however, will introduce an improved version of the double- envelop system and will apply it for both EDL and non-EDL tenders. The new version will favour drugs with better quality, with less emphasis on low prices.
The new guidelines will implement different tendering/purchasing rules for different categories of drugs, based on their clinical needs, status of patent, number of suppliers and related regulatory policies.
Drug tenders to speed up According to the latest draft of the new guidelines, all provinces are required to complete the new round of drug tenders by June 2015. We expect the new guidelines to be officially released in early 2015 and the tender pace to speed up in 2015. So far, 13 provinces have started the purchase of low-priced drugs, 18 provinces have started the new EDL tenders and 9 provinces have started the new non-EDL tenders.
As the new guidelines provide similar tendering rules for both EDL drugs and non-EDL drugs, we forecast that more provinces could combine the two tendering schemes, and therefore speed up the tendering pace. We believe the pricing risk is manageable, as the new guidelines put more emphasis on drug quality.
Exhibit 162: Rolling out the tender process for low-priced drugs Low-priced drugs Hubei Heilongjiang Hebei Shanxi Ningxia Jiangsu Inner Mongolia Guangdong Release of Zhejiang Yunnan Low-priced Anhui Gansu Drug list Liaoning Qinghai Jiangxi Xinjiang Guangxi Others Henan Sichuan Shaanxi
2014 2015E
Started Low-priced drugs purchase Low-priced drugs purchase to start in 2015 Source: Province tender offices, Jefferies page 98 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 163: Rolling out the tender process for new EDL and non-EDL EDL Hunan Beijing Ningxia Gansu Non-EDL Shanghai Anhui Jilin Hebei New EDL Hubei Guangdong Chongqing Fujian releases Hainan Jilin Fujian Zhejiang Qinghai Jiangxi Shanghai Shandong Shaanxi Sichuan Sichuan Hunan Others Guangdong Jiangsu, Yunnan, Shanxi, Henan Heilongjiang 2013 2014 2015 2013 2014
EDL tender with new guideline EDL tender expected to start in 2014 Started non-EDL tender Non-EDL tender expected to start in 2014 and beyond Source: Province tender offices, Jefferies
Increasing M&A activity We continue to see a trend towards gradual consolidation of the Chinese pharmaceutical industry, driven by stricter government policies to enforce higher standards and raise entry barriers, as well as an increasingly marketized hospital sector. Increasing M&A activities are seen among domestic companies, as leading players aim to broaden and optimize their product portfolios. Year to date, there were 130 transactions with aggregated deal value of Rmb24bn (or US$3.9bn). Among major subsectors, pharmaceuticals and medical devices saw the largest numbers of transactions and deal value, namely 89/15 transactions with deal value of Rmb19bn (US$3.1bn)/ Rmb2bn (US$328mn), respectively. The consolidation trend is expected to continue with rising industry standards and companies seeking new growth engines.
Exhibit 164: M&A trend of the Chinese healthcare industry (since 2009)
Total Chinese healthcare sector Pharmaceuticals
8,000 Total consideration of acquisitions # of M&A transactions 160 5,000 Total consideration of acquisitions # of M&A transactions 120
7,000 140 100 4,000 6,000 120 80 5,000 100 3,000
4,000 80 60
2,000 3,000 60
40 Number of transactions of Number
2,000 40 transactions of Number Transaction amount (US$ mn) (US$ amount Transaction Transaction amount (US$ mn) (US$ amount Transaction 1,000 20 1,000 20
0 0 0 0 2009 2010 2011 2012 2013 2014 YTD 2009 2010 2011 2012 2013 2014 YTD Medical devices Health services Total consideration of acquisitions # of M&A transactions 1,800 16 300 Total consideration of acquisitions # of M&A transactions 16
1,500 250 12 12 1,200 200
900 8 150 8
600 100 Number of transactions of Number
4 4 transactions of Number Transaction amount (US$ mn) (US$ amount Transaction 300 mn) (US$ amount Transaction 50
0 0 0 0 2009 2010 2011 2012 2013 2014 YTD 2009 2010 2011 2012 2013 2014 YTD Source: Wind, Jefferies
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14 December 2014
Key events and catalysts in 2015
Exhibit 165: Key catalysts in 2015 Time Government body Key catalysts Potential sector impact Late 2014/2015 Provincial tender Outcome of EDL tender in Jiangsu, Yunnan, Shanxi, Henan and High/short term offices Heilongjiang, etc Late 2014/2015 NHFPC Release of new guidelines on drug tendering Mid-high/short term January 2015 NDRC Release of new guidelines on drug pricing High/short term Early 2015 CFDA Release of guidelines for online sales of prescription drugs High/short term March 2015 NHFPC Detailed policies to support private hospitals Low/long term 2015 SASAC Rollout of central SOE reforms Low/long term 2015 NHFPC Release of the Planning on the National Health Service System Low/long term (2015-2020) 2015 NHFPC Release of official guidelines on easing physicians’ multi-sited Low/long term license 2015 MOHRSS Rollout of commerical health insurance Low/long term 2015 CFDA Release of new regulation on drug registration Med/long term 2015 NHFPC Release of guidelines on cost control of medical insurance Med/long term 2015 NHFPC Selection of the 2nd batch of domestic medical equipment, Low/long term instruments and consumables, for public hospitals reference of purchasing in the future Late 2015/2016 NHFPC Release of new National Drug Reimbursement List (NRDL) Med/long term Note: CFDA = China Food & Drug Administration; MOHRSS = Ministry of Human Resources and Social Security NDRC= National Development & Reform Committee; NDRL= National Drug Reimbursement List; NHFPC= National Health and Family Planning Commission; SASAC = State-owned Assets Supervision and Administration Commission of the State Council Source: Jefferies
Exhibit 166: Key industry conferences in 2015 Time Upcoming events Related companies April 16-18, 2015 The 18th China International Medical Equipment Exhibition Mindray, Weigao, Fosun Pharma May 15-18, 2015 The 73rd China International Medical Equipment Fair (CMEF Mindray, Weigao, Fosun Pharma Spring 2015) May 15-17, 2015 The 73rd National Drug Fair Guangzhou BYS Pharma, Shanghai Pharma July 30-Aug 1, 2015 The 50th China National New & Special Drugs Fair CMS, CSPC, Fosun Pharma, Sihuan, Sino Biopharm Sep 3-5, 2015 The All China Biotech Conference & Exhibition Fosun Pharma Nov. 2015 The 27th National Medical Economic Information Conference CMS, CSPC, Fosun Pharma, Sihuan, Sino Biopharm, Sinopharm, Shanghai Pharm, Guangzhou BYS Pharma Nov. 2015 The 10th International Congress of Chinese Orthopedic Weigao, Microport, PW Medtech Association (COA 2015) Nov. 2015 The 74th China International Medical Equipment Fair (CMEF Mindray, Weigao, Fosun Pharma Autum 2015) Source: Jefferies
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Equity Strategy
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14 December 2014
2015 IPPs Sector: POSITIVE Key Takeaway While a significant earnings recovery should taper off with slowing decline of
coal prices, we believe China’s ongoing power reform will transform China Jack Lu IPPs from a cyclical sector into real defensive utilities. During the transition, Equity Analyst the industry should be allowed to get proper returns before the deeper +852 3743 8020 nationwide reform. As such, we believe, in 2015, the industry profitability [email protected] will remain intact, and tariff cuts, if any, will be just a reflection of falling coal
prices. We like China Resources Power (836 HK, Buy) and Huaneng (902, Joseph Fong Buy) in our universe. Equity Analyst
+852 3743 8074 Moving to a market-oriented power market [email protected] Utilities should be a defensive yield play given stable returns while China IPPs are viewed
as a cyclical sector due to high policy risk. Nonetheless, we believe power sector reform is
an essential part of China’s 13th five-year plan and will translate China IPPs from a cyclical
sector into real defensive utilities. We expect the reform will allow IPPs to bid for on-grid at respective marginal cost; meanwhile regulating transmission and distribution tariff via a cost-plus mechanism model. We believe this reform will significantly lower industry risk or required cost of capital of China IPPs.
Shenzhen pilot reform a great move The implementation of Shenzhen pilot reform proves China’s strong desire for power reform, in our view. In particular, the pilot is seen as unprecedented in taking the grid companies – the monopoly of China’s power industry – head on. We believe grid companies will be forced to transit from powerful dealers to mere electricity transporters, a precondition for implementing a market pricing system at a wholesale level.
Allow them to gain a proper return before the reform We have seen that the government allowed oil refiners to get a decent refining margin when implementing fuel pricing reform. They are likely to take a similar stance toward the power sector, in our view. Looking at our calculations, we expect the investment return of the thermal power industry to stay within a reasonable range, covering interest cost and 10-year country treasury yield.
An intact 2015 We believe the market will continue to maintain industry return in 2015. We expect coal prices to remain weak and the interest rate cut to enhance IPPs’ probability significantly, given their highly levered balance sheets. We believe tariff cuts, if any, will merely reflect falling coal prices.
Exhibit 167: Peers comparison: EV/EBITDA vs. ROIC Exhibit 168: Peers comparison: EV/EBITDA vs. Yield China US HK China US HK 11 11 NEE CLP DUK CLP 10 10 SO SO Datang 9 XEL CMS 9 CMS XEL Datang AEP DTE DTE AEP 8 EXC ETR 8 EXC ETR CPI PCG CPI
7 CRP 7 EV/EBITDA PCG EV/EBITDA CRP Huadian Huadian 6 Huaneng 6 Huaneng 5 5
4 4 4 5 6 7 8 9 10 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 ROIC Yield % Source: Bloomberg, Jefferies Source: Bloomberg, Jefferies
page 101 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Transiting into Real Utilities
We believe China power reform is an essential part of the 13th five-year plan and will transform China IPPs from a cyclical sector into real defensive utilities. In the transition, China IPPs are likely to be allowed to get a proper return before a deeper nationwide reform. As such, we believe, in 2015, the market will see continuing decent returns for China IPPs; tariff cuts, if any, will merely be a reflection of falling coal prices.
China IPPs are not real utilities Utilities are a defensive yield play in developed countries, given their stable operation and returns, with asset value related to interest rate. In the US, with a current 10-year country treasury rate of 2.2%, electricity stocks are trading at ~3.5% of dividend yield on average.
Investors did not treat China IPPs as “real utilities” stocks, as “industry risk” is almost the same as other volatile sectors. In the past, the Chinese government, based on inflation concerns, has often pressured on-grid tariff, even though IPPs suffered from high cost inflation. Historically, the five IPP names in our coverage have seen volatile cash flow and ROIC under this unstable power system.
Exhibit 169: Return on invested capital
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-2.0%
Huaneng Huadian CRP CPI Datang
Source: company reports, Jefferies
Where are China IPPs valued now? EV/EBITDA vs. ROIC: From an asset quality perspective, we believe CRP, Huaneng and Huadian have strong returns on their projects while they are valued at low EV/EBITDA levels compared to US and HK power utilities. The selected US power utilities are mostly trading at more than 8x 2015E EV/EBITDA with ROIC around 5%.
EV/EBITDA vs. Yield: In terms of yield play, we believe Huaneng, CPI and Huadian should be investable given high dividend yield base with sound dividend payout ratio.
Reform to lower industry risk of China IPPs Under a market pricing system, China IPPs should bid for on-grid at their respective marginal cost. On-grid tariff should be set by marginal generators. As such, return on an electricity project should be justified by a proper investment decision. We believe power wholesale reform will significantly lower the industry risk or required cost of capital of China IPPs.
US listed power companies’ required cost of capital was just 4.5%-5.5% as they are yield play names with stable return of assets. We assume China IPP’s required cost of capital in the deregulation market should be about 6.5% for a risk-averse yield play, given China’s 10-year country treasury rate is 1.3% above US.
page 102 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 170: US power utilities’ WACC vs. ROIC
6 PCG DTE NEE 5 AEP XEL DUK SO CMS ETR EXC 4
3 WACC WACC % 2
1
- - 1 2 3 4 5 6 7 8 5-yr Avg. ROIC % Source: Bloomberg
Profitability of China’s overall thermal IPPs National Bureau of Statistics of China (NBS) publishes financials of over 1,000 thermal IPPs on a monthly basis. We assume the Chinese government uses this data to monitor thermal power industry. In order to calculate the average ROIC of those IPPs, we have also made some assumptions on financial ratios, based on the five listcos’ ratios. According to our calculations, the average ROIC of those IPPs was 6.2% in 2013.
Exhibit 171: Financials of over 1,000 IPPs
PBT Asset Liability Equity ROA ROE Liab/Eq. Cash/Debt Debt/Liab. Interest rate EBIT ROIC Rmb mn act. act. act. act. act. act. act. JEF est. JEF est. JEF est. JEF est. JEF est. 2003 45,843 953,634 581,595 372,040 3.6% 9.2% 156.3% 11% 82% 4.8% 48,157 4.6% 2004 44,822 1,088,978 702,393 386,585 3.3% 8.9% 181.7% 11% 82% 4.8% 47,085 4.2% 2005 46,230 1,187,698 780,159 407,539 3.0% 8.7% 191.4% 11% 82% 4.8% 48,564 3.9% 2006 66,642 1,470,893 989,280 481,613 3.8% 11.2% 205.4% 11% 82% 4.8% 70,006 4.8% 2007 64,957 1,814,941 1,254,209 560,731 3.0% 9.3% 223.7% 12% 79% 4.9% 68,308 3.9% 2008 -39,202 2,023,382 1,505,613 517,769 -1.5% -5.5% 290.8% 8% 82% 6.0% -41,692 -2.0% 2009 46,489 2,147,979 1,561,882 586,097 1.7% 6.3% 266.5% 5% 84% 4.7% 48,762 2.1% 2010 27,977 2,259,981 1,679,514 580,467 1.0% 3.6% 289.3% 5% 84% 4.5% 29,295 1.2% 2011 20,594 2,526,033 1,867,063 658,970 0.6% 2.5% 283.3% 4% 82% 5.6% 21,810 0.8% 2012 84,570 2,614,655 1,913,471 701,184 2.5% 9.3% 272.9% 4% 82% 5.7% 89,689 3.1% 2013 175,601 2,766,081 1,937,808 828,272 4.9% 17.2% 234.0% 5% 78% 5.1% 185,092 6.2% Source: NBS, Jefferies
Allow IPPs to generate sufficient return before the reform We think the Chinese government will likely allow thermal power IPPs to generate a proper return before implementing deeper reforms, as it has done in the past on fuel pricing reform. The Chinese government squeezed refiners because of inflation concerns, when oil price was high in 2010-2012, but allowed them to recover as oil prices pulled back in 2013 when the new leadership pushed hard for fuel pricing reform. We believe a 6.2-6.5% ROIC for China thermal IPPs is rational in the deregulation market, considering ~5% interest cost and 3.5% 10-year CT rate.
page 103 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 172: Average investment returns of over 1,000 China thermal IPPs
25% ROIC 20%
15% ROE
10%
5%
ROA 0%
-5%
-10% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Source: NBS, Jefferies
An intact 2015 We believe the industry will maintain current returns in 2015. We expect coal prices to remain weak and the interest rate cut to enhance IPPs’ probability significantly given their highly levered balance sheets. We expect tariff cuts, if any, to merely reflect falling coal prices.
UHV not a threat Mega projects of ultra-high voltage (UHV) bulk power transmission have been planned to transmit power at mine mouths to load centers. We believe this will likely benefit IPPs at mine mouths but should not threaten load centres in terms of either utilization or tariffs, in our view.
Based on our calculations, we do not expect on-grid tariff at load bases to be significantly depressed by UHV projects. Despite the large tariff spread between mine mouth and load centers at ~Rmb150/MWh, a substantial transmission tariff is also required, with cost-plus pricing along UHV lines. With a 10% IRR, we estimate the required transmission tariff at ~Rmb136.5/MWh.
Exhibit 173: Required transmission tariff analysis
Required transmission tariff @ 8% IRR Required transmission tariff @ 10% IRR
Transmission tariff (Rmb/MWh) 120.3 Transmission tariff (Rmb/MWh) 136.5 Sales (Rmb/MWh) 120.3 Sales (Rmb/MWh) 136.5
Non-capital costs (Rmb/MWh) Non-capital costs (Rmb/MWh) Transmission loss (17.5) Transmission loss (17.5) O&M costs (36.1) O&M costs (40.9) Tax expense (16.7) Tax expense (19.5) Tax rate 25% Tax rate 25% Cash flow 50.0 Cash flow 58.5 Cash margin 42% Cash margin 43%
Capital costs (Rmb mn) 23,400 Capital costs (Rmb mn) 23,400 Rated power capacity (MW) 8,000 Rated power capacity (MW) 8,000 Utilization hours 5,500 Utilization hours 5,500 Annual electricity transmission (GWh) 44,000 Annual electricity transmission (GWh) 44,000 Unit capital costs (Rmb/MWh) 532 Unit capital costs (Rmb/MWh) 532
IRR 8.0% IRR 10.0% Asset life (years) 25 Asset life (years) 25 Source: State Grid, Jefferies
page 104 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Clean Energy Sector: POSITIVE Key Takeaway Heading into 2015, we are positive on clean energy in China. The Energy
Development Strategy Action Plan (2014-20) highlights China’s intent to Joseph Fong tackle air pollution, climate change, habitat and other environmental Equity Analyst challenges head on. We expect policy support to remain firmly in place for +852 3743 8074 natural gas, wind, nuclear and solar infrastructure. We remain positive on the [email protected] natural gas distributors and renewable project developers. Within the value
chain, we prefer downstream plays as we believe returns are more Howard Lau sustainable. Equity Associate
+852 3743 8082 Our top picks are Kunlun Energy, Beijing Enterprises and JinkoSolar. [email protected]
Gas Outlook: Natural gas consumption to grow even as oil prices fall Laban Yu The natural gas distributors have struggled in 2014 as company-specific issues and falling Equity Analyst energy prices have raised questions about the sustainability of earnings growth. However, +852 3743 8047 we believe energy substitution driven growth will remain healthy in the next few years. In [email protected] 2015, we expect shares to recover, as the natural gas story is intact and the sector delivers
on earnings growth.
We are positive on the whole sector and our top picks in the space are Kunlun Energy and Beijing Enterprises.
Energy substitution driving natural gas sales volume We believe natural gas demand growth is driven by energy substitution. In the near-to- medium term, natural gas demand is driven by residential users switching from LPG and coal to natural gas, and industrial users switching from fuel oil and, to a lesser extent, coal to natural gas. The switch from LPG and fuel oil to natural gas has been driven by economics as natural gas is cheaper than either fuel. Coal to natural gas substitution is in part driven by policy.
Exhibit 174: Natural Gas Market with Price Controls Exhibit 175: Industrial use of energy, excl. for feedstock P m TCE S 250
200
150 Natural Gas Market equilibrium P2 Price reform will 100 encourage production
P1 Cost plus pricing leads 50 Oil Excess demand to supply shortages
0
D
2009 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2010 2011 2012 Q Q2 Q 1 Source: Jefferies Source: NBS, Jefferies
Oil to gas energy substitution will happen despite the fall in energy prices The arbitrage between retail price of natural gas and fuel oil has come off considerably given the dramatic fall in oil price. In certain cities, the incremental volume price of natural gas is likely higher than the prevailing fuel oil price. Even with the narrowing arbitrage we expect industrial customers to switch from fuel oil to natural gas. It is not clear what the market price of natural gas should be – what is the proper discount, or perhaps premium, to the substitutes. The discount implied by incremental volume pricing is a somewhat arbitrary NDRC formula. If the natural gas price is meant to be at a premium or parity, then switching should still be happening.
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14 December 2014
Fuel oil to natural gas switching will still occur even if the market price of natural gas is meant to be at a discount to oil. We believe there are at least two routes whereby the natural gas price can be lowered: 1) PetroChina can potentially lower its price to increase volumes sold (the city gate prices set by the NDRC are ceilings and trading can happen below these levels), 2) the NDRC can adjust the oil price in its formula. In the interim, we would expect industrial customers to make the investment in natural gas. The natural gas market has historically been rationed and the natural gas price is unlikely to be static if the oil price remains low, especially given China’s policy outlook. Industrial customers may not save money from switching to natural gas this year, but they stand to recognize energy savings in the long run as the market price of natural gas is discovered. Industrial customers can finally receive their allocation of natural gas in a historically rationed market.
Natural gas a beneficiary of stricter environmental regulations Demand for natural gas will be driven by the substitution of coal by natural gas for environmental and economic reasons. We’ve seen national and local policies aimed at improving air quality through phasing out and outright banning new industrial coal-fired steam boilers. Industrial users of coal will be pressured to switch to a non-coal alternative or relocate. The substitution directly from coal to natural gas will be accelerated by these stricter environmental regulations.
Government policy to remain supportive China’s gas distribution network could face two decades of further investment. China’s gas distribution network spans ~343,000km, just 1/10 the size of the US’ gas distribution network and smaller than even Germany’s gas distribution network. If we look at the distribution network density (length of distribution network ÷ country size), China’s distribution network density is lower than Netherlands, the UK, Italy, Japan, France and Spain. We believe there’s a positive relationship between the distribution network density and population density.
China’s distribution network density of 35m per km2 varies considerably from province to province. Major cities such as Beijing and Shanghai have a distribution network density of ~1,110m per km2 and ~3,360m per km2 , respectively, considerably higher than the national average. In comparison, Inner Mongolia has 5m per km2 of distribution pipelines. China’s cities, excluding Beijing, Shanghai and Tianjin, have a distribution network density of 154m per km2 which we believe is considerably underinvested given its population density of 350 people per km2. The United Kingdom and Germany have a population density of 263 and 226 people per km2, respectively, and a distribution network density of ~1,130m and ~1,320m per km2, respectively.
Exhibit 176: Distribution Network Density in Select Exhibit 177: Distribution and Population Density by Countries Province 2.50 Population Density 1,500 2.00 1,250 Beijing
1.50 1,000 Tianjin
1.00 750 Jiangsu Shandong 0.50 500 Zhejiang Urban China
0.00 250 US
UK China
Italy
Japan
China Spain
France 0
Germany 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3
Netherlands Pipeline Density
Source: IEA, Jefferies Source: IEA, Jefferies
If we assume that China’s cities, excluding Beijing, Shanghai and Tianjin, eventually reach a distribution network density of 600m per km2, China would need to construct an
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14 December 2014
additional ~840,000km of pipelines. 600m per km2 is roughly half the distribution network density of Beijing. We believe even further upside to distribution pipeline construction is conceivable. In 2012, China added ~44,000km of pipelines, which translates to 19 years of additional pipelines. With decades of investment left to complete, we believe concerns over the sustainability of the returns of gas distributors is misplaced, especially given the role of private capital. Valuation Shares of the pure-play natural gas distributors are trading at 7x-16x 2015 P/E, below their historical trading range. We believe shares will recover as the companies execute on earnings growth, and as multiples recover.
Renewable Outlook: Resetting expectations after a difficult year 2014 has been a difficult year for renewable companies, as they were unable to meet high expectations. Strong wind speeds in 2013 set the bar high for wind farm operators. Instead of just normalizing, wind speeds have been particularly weak in 2014. Solar installments in 4Q13 surged in China as companies rushed to complete projects to qualify for higher tariffs, and set the stage for China to become the new engine of growth of PV installments in 2014. Although we believed the solar distribution generation target of 8GW was a red herring, utility scale projects have not been able to fully offset it. We believe solar installments will be in the lower end of the NEA’s solar installation target of 10-14GW. Downstream execution has been lacking with GCL Energy likely to miss its original guidance. WTG equipment and component manufacturers have been a bright spot as Goldwind and CHST saw gross margins improve.
Policy support for renewable energy remains intact We believe the investment in alternative energy will be sustained as the sector will continue to benefit from policy support. China is in the long process of weaning itself of its addiction to coal and China is striving to meets its 2015 and 2020 target of non-fossil fuels accounting for 11.4% and 15% of total primary energy demand, respectively.
Our top picks in the segment are JinkoSolar and Huaneng Renewable.
Utilization hours should recover as wind speeds are expected to normalize Unusually weak wind speeds and difficult compares have led to disappointing power generation growth. Wind power utilization hours YTD October declined by 11% YoY compared to the same period a year ago despite the improvement in curtailment. In 2015, we believe wind farm operators’ earnings growth will resume as curtailment continues to gradually improve, and new capacity is built. We expect ROE to bounce back to ~12-13% in 2015-16 with a sustainable growth outlook and strong policy support.
Wind installation capacity to be front-end loaded We expect wind capacity to increase by 17-18GW in 2015. A key difference will be that projects are likely to be front end loaded as on-grid tariffs may be lowered in the second half to reflect the decline in WTG prices.
Distribution Generation to gain more traction in 2015 Despite lofty NEA targets, distributed generation has disappointed in 2014. In our discussion with solar companies, there has been an increased interest in developing distributed generation solar projects in 2015, compared to 2014. In addition, the NEA is now encouraging local government to promote distributed generation on railways stations, airport terminals and other public infrastructure. We expect a modest increase in distributed generation projects in 2015, but we believe distributed generation will fall far short of 8GW. In 2015, we expect solar installments of 12-14GW in 2015, mostly driven by utility scale projects.
Within the solar value chain, we prefer downstream Within the solar value chain, we believe the downstream business, or solar farms, is where we continue to believe investors can find the most long-term sustainable value in the solar value chain. The sustainable value is driven by FiT and other government subsidies that help projects lock in returns. The challenge is execution. The module business lies on the
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Equity Strategy
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14 December 2014
other end of the spectrum and are a commoditized product with immense competitive pressures. The module cost curve is constantly getting flatter and lower, making it difficult for margins to expand.
The production of polysilicon has proven difficult and the polysilicon market is an oligopoly with the top 5 players accounting for ~80% of 2013 production. The cost curve is also steeper than the other parts of the supply chain. However, we believe the polysilicon cost curve is facing downward pressure as established players look to add new capacity in the coming years.
JinkoSolar looking to unlock value in its downstream business next year Execution has proven to be challenging for solar farm companies with United PV and GCL New Energy unable to meet their original guidance. We believe Jinko will be able to connect new 600MW of downstream project by year end, bringing its total to 813MW. The company is seen by the market as a module company as modules contribute the majority of the company’s earnings in 2015. The company will look to spin off its downstream business next year to unlock value and to raise new capital to build more projects.
Nuclear’s Growing Role in Power Nuclear’s global track record has proven to be safer and more environmentally friendly than coal-fired power, and comparable in terms of cost. China is targeting nuclear capacity to reach 58GW by 2020, from today’s 18.1GW. We are forecasting nuclear power generation to increase more than threefold, helping it account for 6% of total power generation from 2% in 2013. In the coming decades, we expect nuclear power capacity to be the baseload of choice for China. CGN Power as China's largest nuclear power operator is set to be a key beneficiary.
Superior earnings visibility to renewables Renewable power, like nuclear, benefits from higher returns owing to subsidies. However, a nuclear power plant's earnings visibility, once a project is completed, is superior to its renewable counterparts as it is not subject to nature's whims (low wind speeds, cloudy days, drought). The superior earnings visibility justifies a valuation premium compared to renewable power companies.
An industry dominated by CGN Group and CNNC Nuclear power is a strictly regulated industry with CGN Power, and its parent company, CGNPC, and China National Nuclear Corporation (CNNC) having dominant market positions. Only CGNPC, CNNC and China Power Investment Corporation (CPIC) are allowed to own a majority stake in a nuclear power plant. Even the remaining of the Big Five power plants (Huaneng, Datang, Guodian and Huadian) only have minority stakes in nuclear power plants.
Exhibit 178: Power Generation – China Exhibit 179: Power Generation – China bn kwH 10,000 100% Solar 9,000 90% Wind Solar Nuclear 8,000 Wind 80% Hydropower 7,000 70% Nuclear Gas-fired 6,000 Hydropower 60%
5,000 Gas-fired 50% 4,000 40% Coal-fired 3,000 Coal-fired 30% 2,000 20%
1,000 10% 0%
0
2010 2023 2024 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2025
2012 2015 2011 2013 2014 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2010 Source: NBS, Jefferies estimates Source: NBS, Jefferies estimates
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14 December 2014
Rapid growth out till 2016 before reassuming in 2020 We are forecasting 25GW of nuclear power plants to commence operation in the next few years, raising China’s nuclear capacity to 43GW in 2016. Nuclear power plants require a long lead time. As a result of the suspension of new nuclear project approvals following the Fukushima disaster, we believe relatively few nuclear power plants will be able to commence operation in 2017-2020. Given the number of projects that are expected to commence operation in the next 12 months, we expect China’s nuclear capacity to reach 60GW in 2020.
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Equity Strategy
China
14 December 2014
2015 Environmental Services Sector: POSITIVE Key Takeaway China’s environmental services industry has the most positive LT outlook
among our coverage universe. As China’s focus on cleaning up the Po Wei environment intensifies in 2015, we believe there is plenty of growth ahead Equity Analyst for the wastewater treatment and solid waste treatment sectors. Our long- +852 3743 8067 term view is that capacity for both markets should more than double within [email protected] the next 5-10 years in order to keep up with demand. China’s Public Private
Partnership model means there will be ample room for rapid growth for WWT Brian Lam and waste treatment private companies. Equity Associate +852 3743 8083 Wastewater treatment capacity to double: We believe China’s wastewater [email protected] discharged as a percentage of total water usage is too low, currently 11% vs c.30% for Japan and Korea, mainly due to its lax discharge standards. If the Chinese government is serious about cleaning up the environment, it must raise the discharge standards. If we assume that China’s wastewater generated as % of total water usage will reach 17% in the long run, China will need ~317mcm/day of wastewater treatment capacity in the long run, more than double its current amount.
Municipal solid waste treatment to grow significantly: We predict that municipal solid waste collection volumes in China will grow by >80% from 2012 to 2020E, reaching 312mt. This will be driven by an improvement in the MSW collection rate as the municipal government’s collection infrastructure improves and the urban population increases. We think China will have no choice but to push for more incineration plants, and forecast that by 2020E China will have around 108mt/year of incineration capacity (vs 45mt/year in 2012) to treat the 146mt MSW that is suitable for WTE purposes.
Pursuit of the PPP model: China has been following the French model of Public Private Partnership in order to alleviate its financial burden, given the local governments’ stretched balance sheets. In France, 70%/55% of the population’s water/wastewater services is now provided by one of the three major operators. Ultimately, we expect China’s waste water and waste treatment markets to end up similar to France’s, where a few top players will dominate the majority of the market. BEW (371 HK, Buy) and SIIC (SIIC SP, Buy) should be the LT winners for WWT, while CEI (257 HK, Buy) will be a market leader for waste treatment.
MoF Support and PBOC rate cut: In September, the Ministry of Finance published an ordinance advocating for further implementation of the PPP model for waste water and solid waste treatment projects, among other infrastructure and public service projects. Going forward, more and more greenfield projects are likely to use the PPP model. The government will also be selecting more and more existing government run projects to convert to PPP. BEW, SIIC and CEI should benefit from increased government commitment and support for PPP projects. We believe the recent interest rate cuts are also a positive for the sector given the potential pick up in wastewater/solid waste treatment investments and lower WACCs.
Our top pick is SIIC Environment with a TP of S$0.23/sh, ~35% upside. We believe that SIIC, just like BEW, has all the key ingredients (aggressive M&A strategy, good safety track record, SOE backing, etc) to be a long-term winner. At just 1.4x forward PB (vs BEW’s 2.6x), SIIC presents good value for its long-term outlook. SIIC’s current share price is cheapest in our coverage given projected investment up to 2016 accounts for c.90% of current market EV.
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14 December 2014
Exhibit 180: China’s wastewater treatment capacity: still needs to grow by >50% even after achieving the aggressive 12th FYP target
Source: China Environmental Yearbook, Jefferies
Exhibit 181: Forecast # of incinerators in China: Based on Exhibit 182: … and annual incineration capacity should current run rate, should reach about 230 in 2015E and 334 reach 75mt in 2015E and 108mt in 2020E in 2020E 160 146 140
120 108 103 100 80 74 75 80
60 45
mn tons mntons peryear 40 31
20
0 2010 … 2012 … 2015E … 2020E
Annual capacity MSW usable for WTE
Source: China Environmental Yearbook, Jefferies Source: China Environmental Yearbook, Jefferies
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14 December 2014
Exhibit 183: Water services market share in France: Veolia, Exhibit 184: Wastewater market share in France: Veolia and Suez and Saur together account for ~70% market share Suez together account for ~55% market share
Public Operators, 27% Veolia, 28%
Veolia, 39% Public Operators, 44% SEM, 3%
Others, 1%
Saur, 11% Lyonnaise des Eaux (Suez), Lyonnaise des SEM, 1% 18% Eaux (Suez), Others, 1% Saur, 8% 19%
Source: Veolia company presentation, Jefferies Source: Veolia company presentation, Jefferies Note: Market share based on population served Note: Market share based on population served
Exhibit 185: Waste landfill facilities Exhibit 186: Incineration of municipal Exhibit 187: Treatment of Hazardous market share in France waste market share in France Waste market share in France
Veolia, Veolia, 27% 29% Veolia, 36%
Others, Others, Others, 64% 71% 73%
Source: Veolia company presentation, Source: Veolia company presentation, Source: Veolia company presentation, Jefferies Jefferies Jefferies Note: market share calculated by tonnages, Note: market share calculated by tonnages, Note: market share calculated by tonnages, private contracts private contracts private contracts
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14 December 2014
2015 Metals & Mining - Cement Sector: NEUTRAL Key Takeaway After strong growth in 2014, we expect cement companies’ earnings growth
will be much slower in 2015, with earnings decline potential for some Po Wei companies in the first half. East China will continue to see the least capacity Equity Analyst additions, benefiting Conch and CNBM. Additions in southwest are likely to +852 3743 8067 be strong. After growing by <4%, we don’t expect demand to rebound [email protected] strongly in 2015. Our top pick of the sector is Conch-A due to cheap valuation
at just about 8x 2015PE. Least preferred is Shanshui due to relatively higher Brian Lam new capacity growth in its region of operation and expensive relative Equity Associate valuation vs Conch. +852 3743 8083
[email protected] We look at cement FAI in order to gauge what next year’s supply situation will look like. In
general, overall cement industry capex has been decreasing since 2011, but some regions
have outperformed others.
Exhibit 188: China total cement FAI has been decreasing since 2011
200 101% 120% 180 100% 160 75% 80% 140 61% 62% 60% 120 40% 31% 100 40%
Rmb bn 80 3% 20% 60 -5% -6% -3% -4% -15% 0% 40 -18% 20 -20% 0 -40% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD* Cement FAI YoY %
Source: Digital Cement, Jefferies * January through October
Similar to this year, East China will see the least new capacity added next year with only two new lines (combined 9kt/d) ramping up in Shandong next year, implying yoy new capacity growth of about 3% in Shandong.
South China is also looking good, but Conch’s 12kt/day line could be a near term risk: especially for the Guangdong/Guangxi markets where only Conch and CR Cement will have new lines in 2015, also implying a growth rate of just below 3% yoy. We however note that Conch’s 12kt could be a near-term disruption to the market in 1H15 given its large size.
Southwest China should continue to struggle with overcapacity, especially Guizhou and Yunnan, two provinces where capex remained high in 2014. Typically capex investments made in one year will show up as new capacity in the next year.
Little chance for a rebound in Liaoning and Jilin. Both provinces saw big investments being made in the last few years and Shanshui will be adding another line in Jilin after 1Q15.
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14 December 2014
North China should be stable but Shaxi will remain depressed. Shanshui will add two new lines. The company also expects part of this year’s 8mt capacity additions to be pushed to 2015.
Despite most cement names reporting strong GP/ton expansion in 2014, many are trading at near trough valuation levels. Conch-A (600585 CH, TP Rmb24.6) is our top Buy due to cheap valuation and positive 2015 outlook. Conch should be the big winner next year due to extremely limited new supply coming online next year in its core markets in East China. The A-share is trading at a 8% discount to the H-share, and is at 7.9x forward PE, Conch-A is cheaper than CR Cement and Shanshui’s valuations of ~8.5x. We believe the main reason was industry leader Conch’s low H-share valuation acting as a glass ceiling for other names.
Exhibit 189: East China cement FAI: East China should see Exhibit 190: South & Central China cement FAI: With only CR relatively little new capacity coming online next year. Cement and Conch adding new lines in Guangdong in 2015, Shandong’s large investments in recent years have led to the province’s investment level for 2014 is low depressed prices Rmb bn Rmb bn 10.0 14.0 9.0 12.0 8.0 7.0 10.0
6.0 8.0 5.0 6.0 4.0
3.0 4.0 2.0 2.0 1.0 0.0 0.0 Jiangsu Zhejiang Anhui Fujian Jiangxi Shandong Henan Hubei Hunan Guangdong Guangxi Hainan 2008 2009 2010 2011 2012 2013 2014 YTD 2008 2009 2010 2011 2012 2013 2014 YTD
Source: Digital Cement, Jefferies Source: Digital Cement, Jefferies
East China East China should see relatively little supply added in 2015. With the exception of Shandong, where CNBM will ramp up one 5kt/d line and Shanshui will add one 4kt/d line, the other provinces will have no new supply. Shandong is still suffering from the massive investments made in 2012 and 2013. Shandong ASP remains depressed. Excluding Shandong, FAI across the region has also come down significantly from the 2009/2010 peak. We think cement companies’ GP/ton in the region should remain stable next year.
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14 December 2014
Exhibit 191: Benchmark Shandong cement ASPs: prices are depressed after overinvestment in the past few years leading to oversupply
500
450
400 RMB/ton
350
300 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2011 2012 2013 2014
Source: Digital Cement, Jefferies
South China South China will also see limited new capacity new year as FAI has slowed. In Guangdong, only CR Cement and Conch will add new lines. CR Cement’s 155mpta clinker line in Fengkai will be completed by 2015YE, while Conch’s 12kt/d line in will commence operations in 1H15. Conch will also add one 5kt/d line in Hunan, while CNBM will add one new 5kt/d line in Henan. CR Cement’s project in Hepu, Guangxi will come online in 2016.
Exhibit 192: Southwest China cement FAI: Yunnan and Exhibit 193: Northwest China cement FAI Guizhou should see significant new capacity ramping up in 2015 due to relatively high investment levels in 2014 Rmb bn Rmb bn 25.0 14.0
12.0 20.0 10.0
15.0 8.0
6.0 10.0
4.0 5.0 2.0
0.0 0.0 Chongqing Sichuan Guizhou Yunnan Tibet Shaanxi Gansu Qinghai Ningxia Xinjiang 2008 2009 2010 2011 2012 2013 2014 YTD 2008 2009 2010 2011 2012 2013 2014 YTD
Source: Digital Cement, Jefferies Source: Digital Cement, Jefferies
Southwest China According to CR Cement and Conch, expect to see a lot of new capacity in Guizhou and Yunnan. FAI investments in both provinces in 2014 remained high, and typically investments made in one year will show up as new capacity in the next year. In fact, Guizhou has already begun suffering from overcapacity this year. Prices are near the historical trough. Conch will also be ramping up 5kt/d lines in Sichuan, Chongqing and Yunnan next year.
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14 December 2014
Exhibit 194: Benchmark Guizhou cement ASPs: prices have fallen dramatically this year due to oversupply
450
400
350 RMB/ton
300
250 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2011 2012 2013 2014
Source: Digital Cement, Jefferies
Exhibit 195: North China cement FAI: Shanxi’s investment Exhibit 196: Northeast China cement FAI: Jilin’s investment has slowed this year but part of the 8mt of new supply remains high but Liaoning is now suffering from depressed added in 2014 will likely be pushed to 2015 profitability due to overinvestment in the last few years Rmb bn Rmb bn 16.0 8.0
14.0 7.0
12.0 6.0
10.0 5.0 8.0 4.0 6.0 3.0 4.0 2.0 2.0 1.0 0.0 Beijing Tianjin Hebei Shanxi Inner 0.0 Mongolia Liaoning Jilin Heilongjiang 2008 2009 2010 2011 2012 2013 2014 YTD 2008 2009 2010 2011 2012 2013 2014 YTD
Source: Digital Cement, Jefferies Source: Digital Cement, Jefferies
North China BBMG does not have any new lines for 2015 and confirmed supply will be relatively stable next year in Beijing, Tianjin and Hebei. In Shanxi, Shanshui has two lines (one 4kt/d and one 4.5kt/d) coming online after 1Q15. Shanshui also expects part of the 8mt ramping up in Shanxi in 2014 to be pushed to 2015.
Northeast China Shanshui has one 4kt/d line in Jilin coming online after 1Q15. They expect 2-3mt of new capacity to come online next year in Northeast China. Liaoning is still suffering from massive overinvestment over the past few years and ASP remains depressed.
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14 December 2014
Exhibit 197: Benchmark Liaoning cement ASPs: Liaoning is also suffering from overcapacity and prices are at an all-time low
500
450
400
350 RMB/ton
300
250 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2011 2012 2013 2014
Source: Digital Cement, Jefferies
Exhibit 198: Conch GP/ton expanded significantly in 1H14 Exhibit 199: BBMG GP/ton contracted slightly in 1H14
140 70 66 122 61 120 60
100 88 88 90 50 42 80 79 38 80 40 35 36 35 67 64 32
60 30
Rmb/ton Rmb/ton
40 20
20 10
0 0 2010 2011 2012 2013 2014E 2015E 1H13 1H14 2010 2011 2012 2013 2014E 2015E 1H13 1H14
Source: Company data, Jefferies Source: Company data, Jefferies
Exhibit 200: CNBM GP/ton expanded in 1H14 Exhibit 201: CR Cement GP/ton expanded significantly in 1H14
120 140 126 100 119 113 100 120 110 110
100 93 80 69 70 71 68 65 63 80 74 72 57 60
60
HK$/ton Rmb/ton 40 40
20 20
0 0 2010 2011 2012 2013 2014E 2015E 1H13 1H14 2010 2011 2012 2013 2014E 2015E 1H13 1H14
Source: Company data, Jefferies Source: Company data, Jefferies
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14 December 2014
Exhibit 202: Shanshui GP/ton contracted slightly in 1H14 Exhibit 203: Asia Cement GP/ton expanded significantly in 1H14
100 94 100 94 90 90 80 80 69 70 70 63 65 60 62 57 58 56 60 52 52 60 47 48 50 46 50 45
40 40
Rmb/ton Rmb/ton 30 30 20 20 10 10 0 0 2010 2011 2012 2013 2014E 2015E 1H13 1H14 2010 2011 2012 2013 2014E 2015E 1H13 1H14
Source: Company data, Jefferies Source: Company data, Jefferies
Exhibit 204: Relative forward PE vs Conch H-shares Exhibit 2052014 January-October cement demand by region 15% 9.4% 1.3 10% 6.9% 6.1% Premium 3.7% 1.1 5% 3.3%
0.9 0% -1.5% 0.7 -5%
-10% 0.5 YoY YTD Growth (%) -9.3% Average: 0.5x Discount -15%
0.3
East
North
Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
Mar-10 Mar-11 Mar-12 Mar-13 Mar-14
Nov-10 Nov-11 Nov-12 Nov-13 Nov-14
May-10 May-11 May-12 May-13 May-14
Northeast
Northwest Southwest
CNBM CR Cement Shanshui Sinoma National avg
BBMG Asia Cement Average South& Central Source: Bloomberg, Jefferies Source: Digital Cement, Jefferies
Exhibit 206: YTD YoY growth in FAI Exhibit 207: Rolling 3M YoY growth in FAI
45% 45%
40% 40% 35% 35% 30%
30% 25%
25% 20%
15%
20% YTD YTD growth YoY (%) 10% 15%
5% 3m 3m moving average growth YoY (%)
10% 0%
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jul-13 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-14
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Overall FAI Secondary industry Tertiary industry Overall FAI Secondary industry Tertiary industry
Source: CEIC, Jefferies Source: CEIC, Jefferies
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14 December 2014
2015 Metals & Mining - Steel Sector: NEGATIVE A New Lower Input Cost Environment Key Takeaway Po Wei Iron ore price fell off the cliff in 2014 to ~US$70/ton from US$130/ton at the Equity Analyst beginning of 2014. Our global team expects iron ore prices to stay at a +852 3743 8067 depressed level of about US$75/ton in 2015/16 due to the continued strong [email protected] seaborne supply and slowdown in demand in China. We believe the lower input costs will benefit Baosteel (600019 CH, Buy, TP RMB5.8/shr) the most Brian Lam given its strong focus on higher margin auto and machinery customers and Equity Associate attractive valuation vs lower quality Maanshan and Angang A shares. +852 3743 8083 [email protected] Strong iron ore supply growth an incremental positive: Seaborne iron ore supply growth should be strong in 2014/15. Our global team expects seaborne supply to grow by 123mt/83mt in 2014/15. China remains the biggest seaborne iron ore buyer, accounting for ~66% of volumes. Assuming China’s steel production increases by 4.7% in 2015 (Jan-Oct is up 4.7% yoy), we estimate China’s demand will amount to only an additional c.50mt this year (assuming China will source 80% of its demand from seaborne stock). Hence, iron ore price has been weak this year, marginally benefiting the steel mills.
However, most of the benefit of lower iron ore price escapes the steel mills: The steel mills suffer from the “middle squeeze” problem. Currently there are over 230 steel mills in China. They lack bargaining power vs. the big 4 iron ore suppliers. Also, commoditized steel product producers like Angang also lack bargaining power vs. end customers. Hence, falling iron ore price always goes hand in hand with falling steel ASPs. Margins rarely expand for steel mills.
Baosteel (600019 CH, Buy) is our top pick. We continue to believe the only way to generate industry leading profitability in the Chinese steel industry is by focusing on the right customer segments. We believe Baosteel’s dominant market share in the autos and machinery businesses is highly defensible and it will maintain industry leading margins.
Exhibit 208: Seaborne iron ore supply will increase by 123mt and 83mt in 2014 and 2015, respectively mt 1,450 21 7 1,400 54
1,350 32 (31) 1,300 47 27 (1) 1,250 38 1,200 10 1,380 1,150 1,297 1,100 1,175 +123mt / 10% YoY +83mt / 6% YoY 1,050
1,000 2013 Vale Rio BHP FMG Others 2014E Vale Rio BHP FMG Others 2015E Source: Company data, Jefferies
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14 December 2014
Exhibit 209: China as a % of total seaborne iron ore Exhibit 210: Rio, BHP, FMG and Vale as % of total seaborne demand iron ore supply
80% 80% 72% 66% 66% 70% 70% 63%
60% 60%
50% 50%
40% 40%
30% 30% 20% 20% 20%
10% 10%
0% 0%
2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013
2007 2010 2001 2002 2003 2004 2005 2006 2008 2009 2011 2012 2013
Source: CEIC, Jefferies Source: Company data, CEIC, Jefferies
Exhibit 211: China imported iron ore prices have been declining since 2013 Rmb/ton
1,200
1,000
800
600
400
200
0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2012 2013 2014
Source: Bloomberg, Jefferies
Exhibit 212: Relative forward PE vs Baosteel
1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
Angang-H Angang-A Maashan-H Maashan-A
Source: Bloomberg, Jefferies
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14 December 2014
Exhibit 213: Number of steel mills in China Exhibit 214: China’s iron ore inventory
450 mtons 418 400 120
350 110 108 300 100
250 90 80 200 233 150 70
100 60
50 50
0 40
2006 2007 2008 2009 2010 2011 2012 2013 2014
Sep-10 Sep-11 Sep-12 Sep-13 Sep-14
Mar-13 Mar-11 Mar-12 Mar-14 Mar-10 Source: CEIC, Jefferies Source: Bloomberg, Jefferies
Exhibit 215: Iron ore prices Exhibit 216: China steel prices US$/ton Rmb/ton 170 4,500 4,300 150 4,100 3,900 130 3,700 3,500 3,300 110 3,100 2,900 90 2,700 2,500 70
69.25
Jul-14
Jan-14
Jun-14
Apr-14
Feb-14
Oct-14
Sep-14
Mar-14
Aug-14 Nov-14 50 May-14 HRC CRC Rebar Wire Rod Plate Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Source: Platts, Jefferies Source: Steelease, Jefferies
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14 December 2014
2015 Metals & Mining - Gold Sector: NEGATIVE Key Takeaway Our global team’s long term gold price forecast is $1,200/ounce. We believe the
risks to this forecast are modestly to the downside given a potentially Po Wei stronger dollar and ultimately rising interest rates. While Zijin’s earnings Equity Analyst could beat consensus by ~10% in 2014E due to a lower than expected cost +852 3743 8067 inflation, we believe the depletion of Zijinshan and the production mix shift [email protected] towards higher costs mines will result in cost pressure again in 2015. Our
least preferred stock in the gold sector is Zijin’s A-share which is currently Brian Lam valued at 25x and 1.9x 2015 PE and PB. A demanding valuation for a Equity Associate company with sub-10% ROE. +852 3743 8083 [email protected] Cost inflation: Our main concern for gold equities was cost inflation. However, Zijin’s mined gold cost came down 5% and 3% sequentially in 1H14 and 3Q14 for the first time in its history. Gross margins of mined gold, silver and zinc all improved yoy due to lower production costs. Assuming a relatively stable gold price in 4Q14 and the company does not book a huge one-time gain/loss on its future/hedging position, we estimate the company’s full year net profit could reach ~RMB2.6bn, almost 10% higher than consensus.
Huge A-share premium: Zijin’s A-share is trading at ~70% premium over H-share, and A-shares’ average daily trading volume is over 5x that of H-shares. We believe in the long term the gap will narrow given the A-H connect. A-share’s current valuation of 25x and 1.9x 2015 PE and PB are much too high given the QE driven gold price bull run is over, and our expectation of sub-10% ROE in the next few years.
We think valuation for Zijin H-shares (Hold) is full; our TP of HK$1.9 implies 1x forward PB, in-line with peers. A-shares (UNPF) are much more expensive, trading at 29x/2.2x forward PE/PB. Our TP of Rmb1.65/sh uses the same 1x forward PB as H- shares and implies ~40% downside. Upside risk: Continued decline in unit costs. Downside risk: Further decline in gold price.
page 122 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
Exhibit 217: Our global team’s LT gold price forecast is Exhibit 218: Zijin’s unit mine gold production cost: US$1,200/oz declining since the beginning of 2014
1,800 170 1,669 158 1,700 160 1,572 1,600 149 150 146 145 1,500 1,411 140 131 1,400 1,225 1,265 130 1,300 1,200 1,200
RMB/g 120
US$/oz 1,200 107 110 1,100 100 1,000 90 900 80 800 1H12 2H12 1H13 2H13 1H14 3Q14 2010 2011 2012 2013 2014E 2015E 2016E Source: GFMS, Jefferies Source: Company data, Jefferies
Exhibit 219: Zijin’s gross margins for mined gold, silver and zinc all improved yoy due to lower production costs.
80% 75% 67% 70% 60% 56% 60% 54% 52% 50% 39% 39% 40% 35% 30% 27% 20% 20% 15% 11% 7% 10% 0%1% 0% 2%
0%
Overall
MinedZinc
MinedGold
RefinedZinc
MinedSilver
RefinedGold
MinedCopper
RefinedCopper Iron Iron concentrates
3Q14 3Q13
Source: Company data, Jefferies
page 123 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
2015 Packaging Paper Sector: NEGATIVE Key Takeaway China’s packaging paper capacity growth is likely to be strong in 2015.
Despite the slowdown in ramp up in leading players such as NDP (2689 HK, Po Wei Hold, TP HK$5.7/sh) & LMP (2314 HK, UNPF, TP HK$3.4/sh), there are still Equity Analyst plenty of new lines coming from smaller players. We still don’t see an +852 3743 8067 inflexion point for demand. We expect industry supply to outgrow demand in [email protected] 2015, leading to decline in GP/ton for both LMP and NDP. We prefer NDP
over LMP as we expect LMP’s effective interest rate/tax rate could rise leading Brian Lam to decline in earnings. Equity Associate +852 3743 8083 Demand weaker than expected: 4Q is traditionally the peak demand season for paper. [email protected] However, the YoY rate of decline in waste paper import volumes (a good proxy for monthly paper production in China) has accelerated since July. Furthermore, we have yet to see any meaningful price hikes in 2H, and LMP indicated they expect 2H prices to remain flat compared to 1H’s average level in October despite suggesting in their 1H14 briefing they may raise prices in 4Q.
Supply outlook: Both LMP and NDP management were upbeat on next year’s supply outlook based on the government’s plan to eliminate ~4mt of backwards capacity in Dongguan region by the end of 2015. We are sceptical about whether the capacity cuts will be pushed through given the government's previous failed attempts at reining in backwards cement capacity. We expect another ~6.3mt of new capacity to come online in 2015 and beyond. Net net, we expect supply to continue to outgrow demand in the next few years, just as it has since 2011.
Prefer NDP over LMP: We expect LMP’s (2314 HK, UNPF, TP HK$3.4/sh) effective interest and tax rates to increase going forward, putting further pressure on its bottom- line. LMP’s interest capitalisation rate has fallen from 50% in FY13 to just over 30% in 1H14 and will continue to decline to 25-30% going forward. Its effective interest rate should also creep upwards to 13-14% in 2H14 (vs 11% and 12% in FY13 and 1H14). For NDP (2689 HK, Hold, TP HK$5.7/sh), we expect earnings to grow due to further cost reductions and a lower effective tax rate of ~17% (vs 21% in FY13) as it takes advantage of preferential tax rates for high-tech plants.
Exhibit 220: Waste paper import volumes Exhibit 221: Supply/demand in paper industry: supply outgrew demand since 2011 and will likely to continue to
5.0 50% do so going forward
40% 4.0 30%
2.8 3.0 2.7 2.5 2.62.7 2.5 20% 2.6 2.4 2.42.5 2.4 2.2 2.32.3 2.2 2.1 2.2 2.1 2.0 mtons 10% 2.0 1.8 4% 4% -1% 1% 0% -9% 1.0 -11% -11% -10% -15% -10% -17%
0.0 -20% Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14
2013 2013 Series2
Source: CEIC, Jefferies Source: RISI, CEIC, Jefferies
page 124 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 222: Paper industry capex: still growing by about Exhibit 223: LMP and NDP’s GP/ton forecasts 9% in 2014E
Source: CEIC, Jefferies Source: Company data, Jefferies
Exhibit 224: China’s new paper capacity pipeline: ~2.8mtpa ramped up in 2014, with another 6.3mtpa to come in the 2015 and beyond Company Type of paper Capacity (kton) Location Note Nine Dragon Corrugating medium 300 Sichuan Commenced production in January 2014 Nine Dragon Containerboard 350 Shengyang Commenced production in September 2014 Shanying Paper Containerboard 490 Anhui Commenced production in October 2014 Shanying Paper Corrugating medium 550 Anhui Commenced production in July 2014 Lee & Man Containerboard 300 Chongqing Commenced production in July 2014 Zhejiang Jingxing Paper Corrugating medium 300 Zhejiang Undergoing trial production run Henan Sheng Yuan Paper Containerboard 300 Henan Scheduled to commence production in 2014 Sihai Paper Corrugating medium and T-paper 200 Jiangxi Scheduled to commence production in 2Q14 Hebei Changtai Paper Containerboard & corrugating medium 1,200 Hebei Scheduled to commence production in 2015 Zhejiang Chuancheng Paper Containerboard & corrugating medium 500 Zhejiang Scheduled to commence production in 2H15 Zhongfeng Paper High-performance corrugating medium 150 Henan Scheduled to commence production in July 2015 Huifeng Paper Containerboard 300 Zhejiang Scheduled to commence production in 2015 Huifeng Paper Corrugating medium 300 Zhejiang Scheduled to commence production in 2015 Anan Paper Containerboard 300 Liaoning Scheduled to commence production in 2015 Ruifeng Paper Corrugating medium 100 Shandong Approval received Ruifeng Paper Linderboard 300 Shandong Approval received Jianshi Paper Containerboard 300 Chongqing Scheduled to commence production in 2017 Youyi Reyuan Paper Corrugating medium 600 Jilin Phase I scheduled to commence production in 2017, other phases by 2017 Jiangsu Lucheng Paper High-performance corrugating medium 250 Jiangsu Qiangwei Paper Plaster paper 200 Shandong Yongxin Paper High-performance corrugating medium 400 Hebei Yongxin Paper Plaster paper 400 Hebei Baishan Paper High-performance corrugating medium 200 Jilin Taiyang Honghe Paper Containerboard 500 Shandong Jianshi Paper Corrugating medium 250 Chongqing
Total under planning 9,040 2014 ramp up 2,790 2015 and beyond total 6,250 Source: UMPaper, Jefferies
page 125 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
2015 Property Sector: POSITIVE Winter Getting Warmer; Reshuffling In Progress Key Takeaway Venant Chiang With the Golden Age fading out, future growth will likely be steady. We Equity Analyst expect the sector to perform better in 2015 than in 2014 on demand & +852 3743 8013 supply rebalancing, favorable policy and improving company credit. Still, [email protected] no sharp rebound is expected but opportunities will emerge for select developers that manage to acquire market share as a result of enhanced
capital structure. Top Picks: COLI, CR Land and Vanke. Longfor and Sunac
have potential for re-rating. Please refer to our 2015 outlook report for details.
Better credit, better equities: China property stocks have begun to perform (+27%, 25/24ppts over HSI/MSCI China) since 2H14 owing to policy relaxation especially after earlier-than-expected rate cut. Later phases of valuation improvement would need to be justified by sustained sales recovery and improving credit conditions, unless macro easing triggers a broad-based sector rally again. In 2014, developers' bonds outperformed stocks despite refinancing concerns. Even Agile recovered from its credit crisis. In 2015 and 2016, the refinancing pressure of offshore debt should be insignificant, equivalent to est. <25% of the raising size in 2013 or 2014. We believe restored investor confidence in company credit will enhance stock valuations.
Sales on moderate growth: High growth expectations should be discounted on stocks. Since demand driven by user/upgrader will gradually release on improved affordability, moderate sales growth is achievable in 2015 on policy support and stable price. We expect Tier-1/2 cities to deliver 8% vol growth, over the 5% national forecast. ASP at earliest may rise in 1H after destocking. We forecast a mild price recovery of 2%/3%/1% for country/Tier-1/2 cities/Tier-3 cities. Our base case suggests developers' presales grow 13% YoY in 2015E (vs. 8% in 2014E).
Screening winners: Sales growth does not necessarily translate into outperformance, regardless of scale/market cap. On the one hand, market consolidation will accelerate (from 22% in 2013 to 30% in 2015E for Top 30 developers by market share). Only a few in the market will climb up the ranking, and it will be especially difficult for those (e.g. Evergrande, Agile and R&F) struggling to fix legacy issues (e.g. high inventory & leverage). Developers owning better-quality land reserves are poised to capture sales/acquisition growth.
Stock picking strategy: Many developers will be in search of a new strategy in an attempt to perform better. Before they are proven, we focus on several parameters as summarized in the comparison in Exhibit 97. While capital structure enhancement is our key concern to find an outperformer, we believe select big/mid-sized developers of middle to top credit rank will stand out as more investor return will be preserved by capital cost savings. Our Top Picks are COLI, CR Land and Vanke, and we see re-rating potential for Longfor and Sunac. Key risks: Poor sales, deteriorating credit and unexpected economic turmoil.
page 126 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
Favorable policy environment likely to continue
Policy in China still plays a significant role in the property market. Favorable policy environment is a critical driver for the recovery since September, in our view. Our China Property Policy Index (JCPPI) has edged up 4.0 from June to November 2014, driven by a series of easing policies. Only five cities remained HPR (four Tier-1 cities and Sanya in Hainan Province) after this round of policy easing. PBoC also stepped up twice, with a mortgage relaxation before National Day and a 40bps rate cut recently.
We believe a favourable environment will sustain in the near term given the pressure to meet GDP growth target. Transaction volume should recover gradually on stable ASP when inventory remains high for developers.
Exhibit 225: China Property Policy Index (JCPPI) 6.0 Loose 4.0
2.0
0.0
-2.0
-4.0 -7.0 -6.0
-8.0 Tight -10.0
-12.0
Jul Jul 10 Jul Jul 07 Jul 08 Jul 09 Jul 11 Jul 12 Jul 13 Jul 14
Jan Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14
Apr08 Apr07 Apr09 Apr10 Apr11 Apr12 Apr13 Apr14
Oct 12Oct Oct08 Oct09 Oct10 Oct11 Oct13 Oct14 Oct07 Source: Jefferies estimates
Residential sales moderately better in 2015 On the back of a revival in home purchase sentiment facilitated by government relaxation, we believe 2015 will be a better market for home sales than 2014 as demand and supply should rebalance, although it may take more than a year to arrive at a normalized level (from 16 months today to 10-12 months for major 35 cities). Most sales will continue to be driven by Tier 1/2 cities while most Tier 3 cities are under prolonged oversupply pressure.
On our base case, we forecast national sales volumes to grow 5%, within the range of 2% for Tier 3 cities and 8% for Tier 1/2 cities. In respect of ASP, on average throughout 2015, we forecast a mild increase of 2%, 1% and 3%, respectively, for the overall nation, Tier 3 cities and Tier 1/2 cities.
Exhibit 226: 2015 national transaction forecast National Tier 1/2 cities Tier 3 cities Volume Bull Case Significant credit loosening and political support 10% 12% 7% Base Case Credit environment improves modestly with stable home price 5% 8% 2% Bear Case Tighter-than-expected credit environment -6% -8% -4%
ASP Bull Case Undersupply, developers' financial position improves notably 7% 10% 3% Base Case A balanced supply and demand 2% 3% 1% Bear Case Oversupply, developers' financial position deteriorates -5% -3% -6% Source: Jefferies estimates
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Equity Strategy
China
14 December 2014
2015 developers’ sales growth to pick up
As inventory levels are still high, left behind by intense new launches in 2014, new launches in 2015 should slow down and account for 54% of total saleable resource in 2015, vs. 64% in 2014, implying a slower run-rate. In our base case analysis, average sell- through rate may improve slightly to c55% in 2015, supported by credit and policy loosening. With regard to saleable resource, we forecast 8% growth as developers decelerate new construction generally. Taking into account saleable resource and sell- through rate, we forecast a 13% contraction in sales growth on average for developers in 2015.
Exhibit 227: Developers’ presales yoy change
40%
35% 34% 30% 27% 23% 25% Bull case: 21% 20%
15% 16% Base case:13% 10%
5% 8% Bear case: 3% 0% 2010 2011 2012 2013 2014E 2015E
Source: Jefferies estimates Picking the market winners Many mid-sized to large players such as Agile, Country Garden, Evergrande and R&F have de-rated with no clear signs of re-rating potential in the near term. Their trading performance is uninspiring, attributed to a continued decline in stock beta.
We can no longer pick stocks based on tier by size or market capitalization. In our view, a company that can stand out when China property’s Golden Period is fading should have the strength to take up more market share with an effective business model and prudent financial management as developers will not benefit from lenient lending. Size is not completely relevant, whereas developers with lesser leverage or an inventory problem (either unsold but completed properties or land) may find it easier to capture the growth opportunity. These are the stocks we like.
Exhibit 228: Comparison metrics for major developers
Credit Sales growth Financial Valuation loosening position impact Agile High Low Weak Demanding China Merchant Prop High High Strong Attractive China Vanke High Medium Strong Attractive COGO High Medium Healthy Attractive COLI High Medium Strong Attractive Country Garden Medium Medium Healthy Fair CR Land High Medium Strong Attractive Evergrande Medium Low Weak Fair Greentown Medium Low Healthy Fair Longfor High Medium Healthy Attractive R&F High Medium Weak Demanding Shenzhen Investment High High Healthy Attractive Shimao High Medium Healthy Fair Sunac High Medium Healthy Attractive KWG High High Healthy Attractive Source: Jefferies
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Equity Strategy
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14 December 2014
Gradual fundamental improvement to support sector valuation We expect the improving industry backdrop will provide a foundation to support valuation enhancement as policy stance should still be a major swing factor to compel investor interest in China property.
From a company perspective, improvement in fundamentals will also be a solid reason to lift valuation from currently trading at a 41% disc to NAV, still near -1SD, as are the Price- to-book ratio (0.9x) and Price-to-earnings ratio (6.9x).
Exhibit 229: Weighted sector NAV discount chart 10% 4.8% Peak 0%
-10%
-20% -22.3% +1stdev
-30% -35.3% Avg -41.0% -40%
-50% -48.2% -1stdev -60% -66.3% Trough
-70%
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14
Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14
Source: Jefferies estimates, Bloomberg as of Dec 11, 2014
Exhibit 230: Weighted sector PE band Exhibit 231: Weighted sector PB band
25.0 25.0 Max 45.0x Max 3.7x 20.0 20.0 Avg 10.7x Avg 1.4x 15.0 +1stdev 16.9x 15.0 +1stdev 1.8x 6.9 0.9 10.0 10.0
-1stdev 4.4x Min 5.6x -1stdev 0.8x Min 0.7x 5.0 5.0
0.0 0.0 Jan/08 Jan/09 Jan/10 Jan/11 Jan/12 Jan/13 Jan/14 Jan/08 Jan/09 Jan/10 Jan/11 Jan/12 Jan/13 Jan/14
Source: Jefferies estimates, Bloomberg as of Dec 11, 2014 Source: Jefferies estimates, Bloomberg as of Dec 11, 2014
page 129 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015 China Property Top Buys
Top Buy COLI (688 HK, Buy, PT HK$27.1) As a China property proxy, COLI’s upside is not limited thanks to the macro support, credit loosening and sales improvement. Its solid landbank and financial foundation will help it to secure more market share when market consolidation is accelerating. In the near term, its active land acquisitions should help it to reach notable sales growth in 2015. The potential asset injection serves as a key stock catalyst, although this may still takes time.
CR Land (1109 HK, Buy, PT HK$23.6) Despite the chairman’s resignation leading to near-term share price pressure, we see an insignificant impact on its solid fundamentals. Asset injection is still on track, and sales performance is continuing to improve. We like its financial discipline, growth certainty in sales/recurring income and the asset injection. An improvement in sector outlook should mitigate downside risks for the stock.
Vanke (000002 CH/2202 HK, Buy, PT Rmb13.8/HK$17.2) As the top Chinese developer, Vanke is the pioneer in improving itself during market transition by 1) delivering strong sales, 2) reinforcing its financial strength, 3) sharpening its operational efficiency and 4) exploring an “asset-light model”. We expect it to reinforce its leadership position backed by sustainable LT growth path and out-of-the-box-thinking.
Exhibit 232: Valuation table Company Ticker Price Mkt Rating Target Upside NAV Disc PE PB DY Cap * * US$ mn Price* /Down /prem. 13 14E 15E 13 14E 15E 13 14E 15E CMP A 000024 CH 20.00 7,856 Buy 16.2 -19% 24.9 -20% 12.3 11.6 11.2 1.9 1.7 1.5 1.6 1.7 1.8 CMP B 200024 CH 17.90 7,856 Buy 18.6 4% 31.0 -42% 8.8 8.3 8.0 1.4 1.2 1.1 2.2 2.4 2.5 COGO 81 HK 3.92 1,154 Buy 7.6 94% 12.7 -69% 3.6 4.3 4.2 0.8 0.7 0.6 2.8 2.3 2.3 COLI 688 HK 22.95 24,199 Buy 27.1 18% 30.1 -24% 9.9 8.3 7.0 1.7 1.5 1.3 2.0 2.4 2.9 CR Land 1109 HK 19.66 14,789 Buy 23.6 20% 26.2 -25% 12.1 9.9 8.9 1.4 1.2 1.1 2.2 2.7 3.1 Franshion 817 HK 2.17 2,565 Buy 2.9 34% 5.2 -58% 8.0 7.0 6.8 0.6 0.6 0.5 4.4 5.1 5.1 KWG 1813 HK 5.45 2,071 Buy 6.9 27% 12.6 -57% 5.4 4.4 3.8 0.7 0.6 0.6 6.7 8.0 9.4 Longfor 960 HK 9.63 6,761 Buy 12.3 28% 20.5 -53% 6.8 6.6 6.2 1.1 1.0 0.9 3.0 3.1 3.3 SZI 604 HK 2.17 1,863 Buy 4.0 84% 7.3 -70% 5.7 5.9 3.4 0.4 0.4 0.4 8.8 12.0 19.4 Vanke A 000002 CH 12.03 21,689 Buy 13.8 15% 18.4 -35% 8.8 8.1 7.3 1.7 1.5 1.3 3.4 3.7 4.2 Vanke H 2202 HK 16.70 21,689 Buy 17.2 3% 23.1 -28% 9.7 9.0 8.1 1.9 1.7 1.5 3.1 3.3 3.8 Sunac 1918 HK 6.74 2,940 Buy 8.1 20% 14.9 -55% 5.1 4.5 3.8 1.3 1.1 0.9 3.5 4.1 4.8 Evergrande 3333 HK 3.16 5,947 Hold 3.3 4% 8.2 -61% 4.3 4.5 4.2 0.8 0.8 0.7 17.0 11.1 11.9 CGH 2007 HK 3.02 7,929 Hold 3.6 19% 7.2 -58% 5.1 4.7 3.8 1.0 0.9 0.8 7.1 7.9 9.5 Soho 410 HK 5.53 3,709 Hold 6.5 18% 9.2 -40% 5.4 10.8 20.1 0.6 0.6 0.6 5.7 5.4 4.1 Greentown 3900 HK 7.40 2,063 Hold 8.8 19% 21.3 -65% 2.9 4.7 4.4 0.5 0.5 0.4 7.3 8.1 8.5 Hopson 754 HK 6.85 1,983 Hold 8.0 17% 26.7 -74% 6.1 7.4 6.5 0.2 0.3 0.3 0.0 0.0 0.0 Poly Property 119 HK 3.02 1,423 Hold 3.3 9% 8.3 -64% 5.4 5.5 5.0 0.4 0.4 0.3 7.4 7.4 7.4 Powerlong 1238 HK 1.08 557 Hold 1.2 11% 3.1 -65% 3.4 3.2 3.0 0.2 0.2 0.2 0.0 5.8 7.0 Shimao 813 HK 17.46 7,821 Hold 15.9 -9% 29.0 -40% 6.6 5.2 5.3 1.2 1.0 0.9 4.6 5.8 5.7 Sino Ocean 3377 HK 4.45 4,292 Hold 4.4 -1% 9.8 -55% 7.1 6.2 6.5 0.6 0.5 0.5 5.2 5.2 5.2 R&F 2777 HK 9.21 3,828 U/P 7.1 -23% 17.7 -48% 4.0 6.7 7.7 0.7 0.7 0.7 8.4 5.4 5.4 Gemdale 600383 CH 9.16 6,648 U/P 7.1 -22% 11.8 -22% 17.3 16.4 13.7 1.4 1.3 1.2 1.7 1.9 1.9 Agile 3383 HK 4.06 2,051 U/P 3.9 -4% 13.1 -69% 2.5 3.2 3.9 0.4 0.3 0.3 11.7 3.7 0.0 Renhe 1387 HK 0.36 1,473 U/P 0.4 11% 0.7 -49% N/A N/A N/A 0.3 0.3 N/A 0.0 0.0 0.0 Yanlord YLLG SP 1.06 1,572 U/P 0.99 -7% 2.2 -52% 8.5 8.2 8.0 0.5 0.5 0.5 1.2 1.4 1.4 Average 14% -50% 7.0 7.0 6.8 0.9 0.8 0.8 4.7 4.6 5.0 Source: Jefferies estimates, Bloomberg as of Dec 11, 2014, *trading currency
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Equity Strategy
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14 December 2014
2015 Telecom
Sector: NEUTRAL Mobile voice revenue decline to continue China’s overall telecom service revenue reached RMB976bn In the first 10 months of Cynthia Meng 2014, +4.7% YoY excluding VAT tax consideration. If including VAT tax impact, total Equity Analyst industry telecom service revenue growth would have been 0.4% YoY in the first 10 month +852 3743 8033 of 2014. We are estimating FY14 growth to be 1.9% YoY factoring in VAT tax impact. YTD [email protected] mobile voice service and SMS revenue declined 3.8% YoY and 14.6% YoY respectively excluding VAT tax consideration due to continued pressure from OTT cannibalization.
We estimate total industry telecom services revenue to grow 4.8% YoY to RMB1,189bn in Exhibit 233: Telecom Services FY15. We estimate VAS revenue, which is mainly composed of revenue from wireless data Revenue Growth traffic, to grow 18.4% YoY. However, facing competition from OTT, total industry YoY % 2013A 2014E 2015E traditional mobile voice revenue is estimated to decline 4.7% YoY in 2015, following 7.6% CM 5.4% 0.9% 5.1% YoY decline in 2014. CT 10.0% 2.2% 3.7% CU 13.5% 4.0% 5.3% Telcos to focus on 4G migration as wireless penetration peaks Total 8.2% 1.9% 4.8% Source: Jefferies, company data According to the MIIT, total wireless penetration reached 93.5% by Oct 2014. 3G/4G Note: YoY growth is not adjusted for VAT monthly net adds exceeded total subs monthly net adds since Dec 2012. We estimate reform impact. wireless penetration to further increase to 99.4% by YE15. As penetration peaks, we
believe the Chinese teclos will focus on migrating 2G users into 4G with less incremental Exhibit 234: VAS Revenue Growth new users for subscriber development. We think that the wide availability of affordable 4G YoY % 2013A 2014E 2015E handsets should help to attract 2G users to migrate into 3G/4G plans. CM 24.4% 22.2% 20.6% CT 26.9% 11.3% 13.8% We estimate total industry subs will reach 1.37bn by YE15 with 76mn net adds and CU 30.5% 15.8% 14.9% 163.8mn users migrating from 2G to 3G/4G. CM’s total subs is estimated to reach 851mn Total 26.0% 19.1% 18.4% by YE15, with 130mn 4G subs net adds, 51mn 3G subs net adds and 137mn 2G subs loss. Source: Jefferies, company data 3G/4G penetration is estimated to reach 58.5% (23% penetration rate for 4G) in FY15. We
estimate CT’s total users to reach 202mn by YE15, with 32mn 3G/4G subs net adds and
15.6mn 2G subs loss. 3G/4G penetration is estimated to reach 76% in FY15. We estimate Exhibit 235: Mobile Voice Revenue CU’s total users to reach 317mn by YE15, with 28mn 3G/4G subs net adds and 11mn 2G YoY % 2013A 2014E 2015E subs loss. 3G/4G penetration is estimated to reach 57% in FY15. CM -3.4% -9.7% -7.0% CT 18.4% 0.3% 2.3% As of Sep 2014, 628 TD-LTE models have been awarded with Network Access License (NAL) CU 11.9% -3.6% -0.4% by MIIT. 36% of newly-launched models in the first 10 months were 4G and the 4G model Total 1.1% -7.6% -4.7% penetration went up to 60% in Oct 2014. We expect more 4G LTE handsets, especially Source: Jefferies, company data sub-RMB1,000 models, to be launched in FY15. This will benefit ZTE, Huawei and Lenovo as major low-end 4G handset suppliers, in our view.
4G capex remains high; D&A growth exceeds revenue growth We forecast LTE Capex to grow 22.6% YoY to be RMB151bn in FY15, accounting for 36.4% of total Chinese Telco Capex of RMB415bn. CM will spend the most on LTE network building given its 300-400K LTE BTS target in FY15, accounting for 60% of industry total LTE Capex. CU will spend the least since it will continue to expand the 3G network, accounting for 7% of industry total.
With rigorous capex plans, we expect D&A expense to weigh on margins and D&A expense growth will exceed service revenue growth in FY14-16. We forecast the D&A expenses will grow at 6.9-7.5% in FY14-16 while service revenue will grow at 4.1-4.8%.
Telecom equipment vendors are the direct beneficiary of LTE deployment. ZTE in our view is the dominant player in the 4G equipment space as it supplies 25-32% of LTE equipment to three Telco operators.
page 131 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 236: 4G LTE Capex Forecast 2014E 2015E 2016E China Mobile 74.9 90.1 79.3 YoY% 141.6% 20.2% -11.9% China Telecom 40.2 50.8 45.4 YoY% 204.4% 26.5% -10.7% China Unicom 8.0 10.0 10.0 YoY% 25.0% 0.0% Total 4G LTE Capex 123.1 150.9 134.7 YoY% 178.5% 22.6% -10.7% Source: Jefferies estimates, company data
Exhibit 237: 4G LTE Capex Forecast China Mobile Capex - Total Listco + Parentco 0 2012A 2013A 2014E 2015E 2016E China Mobile Capex - Total Listco + Parentco 184.3 234.9 264.1 243.5 191.1 YoY 10.7% 27.5% 12.4% -7.8% -21.5% China Mobile Capex - Listco - 2G+4G from 2013, only 2G before0.0 0.0 0 0 0 0 2012A 2013A 2014E 2015E 2016E Total Capex (RMB bn) 127.4 184.9 225.2 223.5 181.1 YoY% -0.9% 45.1% 21.8% -0.8% -19.0% China Mobile Capex - Parentco - TD (3G) 0 0 0 0 0 0 2012A 2013A 2014E 2015E 2016E TD-SCDMA Capex (RMB bn) 23.9 20.0 13.9 0.0 0.0 YoY% 83.8% -16.3% -30.5% -100.0% NM China Mobile Capex - Parentco - Railcom (Wireline) 0 0 0 0 0 0 2012A 2013A 2014E 2015E 2016E Total Capex (Railcom) (RMB bn) 33.0 30.0 25.0 20.0 10.0 YoY% 32% -9% -17% -20% -50% China Unicom Capex - Listco - Wireless +Wireline 0 0 0 0 0 0 2012A 2013A 2014E 2015E 2016E China Unicom Capex (RMB bn) 99.8 73.5 79.9 83.4 85.3 YoY% 30.2% -26.4% 8.7% 4.4% 2.3% China Telecom Capex - Total Listco + Parentco 0 0 0 0 0 0 2012A 2013A 2014E 2015E 2016E China Telecom Capex - Total Listco + Parentco 72.5 80.0 80.3 90.1 83.2 YoY 1.4% 10.3% 0.4% 12.3% -7.7% 0 - - - - - Total Industry Capex 2012A 2013A 2014E 2015E 2016E Total Capex (Industry) (RMB bn) 356.6 388.4 424.3 417.0 359.5 YoY% 13.3% 8.9% 9.3% -1.7% -13.8% 0 0.0% 0.0% 0.0% Total 4G LTE Capex - 44.2 123.1 150.9 133.6 Source: Jefferies estimates, company data
4G battle accelerates; FDD-LTE Licensing expected 1H15 FDD is being trialled in 40 cities as of Aug 2014, up from 16 cities in Jun 2014. CT and CU are applying for additional 237 FDD-LTE trial cities. We expect FDD commercial license to be issued in 1H15. FDD is being trialed in 40 cities. Expect FDD commercial licenses in 1H15 CM has accomplished its full-year BTS target of 570K, covering over 300 cities by Sep 2014 and it is planning to bring forward its LTE Phase III. CM is looking to have 600- CM is looking to complete development 700mn LTE BTS by YE14 and 1mn by YE15. During Phase III, half of the BTSs will be of 600-700K LTE BTS by YE14 and 1mn utilized for the 4G network coverage in rural areas. According to MIIT, to reach the same by YE15. In Phase III, CM will focus on network coverage as GSM in rural areas, CM will need to add 20-30% LTE BTS in addition the LTE coverage in rural areas. to transferring existing GSM sites into hybrid GSM/LTE BTS.
CT’s no. of LTE BTS will reach 140K BTS by YE14. By finishing its LTE Phase II by 2015, we expect the no. of BTS to reach 280K by 2015. In FY15, CT will mainly focus on 100 key cities for LTE coverage, which generated over 75-80% of total traffic during 3G era.
page 132 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
CT’s no. of LTE BTS will reach 140K by CU has started FDD-LTE preparation work in 300 cities although trial license was granted YE14, doubling to 280K by YE15, mainly for only 40 cities, which will enable CU to launch FDD-LTE services in key cities as soon as focusing on covering 100 key 4G LTE commercial FDD-LTE license is issued. Different from CM and CT, CU will continue cities leveraging on its 3G HSPA+42M network in FY15. CU’s no. of BTS is expected to reach 70K by YE14, and 270K by YE15 respectively. CU has started FDD-LTE preparation We expect the asset injection into Tower Company will commerce in late 2015. CT is likely work in 300 cities. No. of LTE BTS will to benefit the most from tower sharing given it has the least number of towers among reach 100K by YE14 and 270K by YE15, three Telco operators. respectively MVNO licenses: introducing new mobile service distributor
MIIT issued a fourth batch of MVNO licenses on Nov 20, 2014 to increase its no. of MVNO operators to 33, including Alibaba, JD.com, Haier, Xiaomi etc. CM has made the first move to sell 4G service to MVNOs. We expect CU and CT to follow as soon as FDD-LTE commercial license is issued.
MVNOs who usually get a basket of services at wholesale prices (40-70% of retail prices) from telco operators, are offering more flexible tariff packages and more promotions. However, we hold the view that MVNOs are resellers of telecom services and cannot pose meaningful competition to the telcos who mandate the wholesale prices. As of September 2014, three months after the commencement of virtual services, only 200K subs were developed by MVNOs, according to stats disclosed by MIIT.
Top pick: ZTE ZTE (Buy) is our top pick, benefiting from rigorous 4G capex plans in FY15 as a dominant equipment vendor in China (4G market share of 28% at CM, 32% at CT and estimated 25% at CU). In addition, ZTE enjoys better GPMs in the 4G era based on higher pricing power. GPM for newly-added overseas contracts is estimated to be 35% compared with 32% in the past. Moreover, increasing demand for affordable 4G handsets will drive topline growth (70-75mn handset unit sales is estimated for FY15 with 2-3% market share)
Valuations ZTE: Reiterate Buy. Our PT of HK$21 implies 16.4x FY15E PE, slightly below the mid-point of the historical range of 9x - 25x PE. ZTE is currently trading at 14.3x FY15E PE, with 14.7% upside. ZTE will directly benefit from Chinese telcos’ LTE capex peak in FY14-15, and potentially 2016. Risks include mgmt. execution as ZTE increases global expansion & builds its handset brand.
page 133 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Internet Sector: POSITIVE Key Takeaway We maintain overweight on China’s Internet sector based on multiple secular
trends: 1) long-term Internet demographic shifts to more mature population Cynthia Meng with higher consumption power; 2) proliferation of affordable smartphones Equity Analyst +852 3743 8033 and data plans as well as improving 3G/4G coverage drives mobile [email protected] monetization, including mobile commerce, advertising and games, which is still at a nascent stage; 3) low Internet penetration in rural areas implies huge potential for e-Commerce growth. Our top picks are Tencent, Baidu, JD.com and Vipshop.
Changing demographics and mobile support e-Commerce in the next decade As discussed in our sector note, “A Taste of Domestic Consumption: The Unleashing of China’s E-Commerce Power” published on Sept 19, 2014, China’s e-Commerce growth for the next decade should benefit from: 1) changing Internet user demographics towards 30+ year old age groups; 2) accelerating structural shift to online from traditional retail; 3) the Chinese government’s massive support for urbanization and domestic consumption; 4) proliferation of affordable smart devices; 5) improving wireless and transport infrastructures in lower tier and rural markets, and 6) rising consumer demand for better quality, design & fashion, authenticity and timely delivery.
Exhibit 238: China Online Retail Sales Market Size by GMV Exhibit 239: China Online Shopper Penetration
Source: iResearch as of July 2014 (2007A-2017E), Jefferies estimates Source: CNNIC as of Jan 2014, Jefferies estimates (2018E)
Majority of new Internet users are in the older, 30+ year old age group Our analysis shows that China’s Internet users aged 30+ will account for 54% of total Internet users by 2018, up from 33% in 2008, and 81% of the 240mn new incremental Internet users will be 30+ years old. These users with higher consumption power will fuel the growth of both PC and mobile e-Commerce, in our view.
Capturing emerging growth opportunities in m-Commerce Mobile has developed much faster than expected in the past three years, but is far from hitting the saturation point. As more and more time spent shifts to mobile, top players start to embrace emerging growth opportunities in m-Commerce. Benefiting from the proliferation of affordable smartphones, users in lower tier cities and rural China directly take up mobile shopping, skipping PC-based e-Commerce. Difficult access to physical shopping facilities in these markets makes online shopping an attractive option.
M-Commerce accounted for 33.4% of total online sales in 3Q14, +19.1pcpt YoY, according to iResearch. We currently estimate m-Commerce penetration of online sales to reach 34.3% in FY14, up from 14.5% in FY13. Mobile accounted for 35.8% of Alibaba’s GMV in CY3Q14, +3pcpt QoQ, +21.2pcpt YoY, and 42.6% of total GMV transacted on Nov 11th Singles Day promotion. Mobile contributed 30% of JD’s total orders in 3Q14, +6pcpt QoQ, and 40% on Nov 11th.
page 134 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 240: China Internet Users by Age Group Exhibit 241: China M-Commerce Market Size by GMV
Source: CNNIC as of Jan 2014, Jefferies estimates Source: iResearch as of July 2014, Jefferies estimates
Accelerating structural shift to online from traditional retail According to linkshop.cn’s 1H14 survey, revenues of 73 surveyed Chinese offline retailers showed only moderate YoY growth. In the department store category, 35 out of the 54 surveyed stores posted revenue declines, with average sales down by 2% YoY in 1H14. For example, we expect to see increasing telco dependence on leading e-Commerce channels such as JD.com for marketing cost savings.
Low Internet penetration in rural areas implies upside for rural e-Commerce Internet penetration gap between urban and rural areas in China remains huge with an urban penetration of 62% compared to 27.5% in the rural areas in 2013. According to Alibaba, 34% of urban residents are online shoppers compared to 9% in the rural areas where e-Commerce development is still at early stage. During the last Nov 11th Singles Day promotion, rural consumers accounted for approximately 10% of Alibaba’s total GMV of USD9.3bn. JD also recorded 145% YoY growth in no. of orders from outside of top 52 cities.
Growing disposable income and fragmented offline retail infrastructure drives potential upside for rural e-Commerce penetration. China’s rural e-Commerce market is expected to reach RMB460bn in 2016, 2.6x that of RMB180bn in 2014, according to AliResearch. Alibaba plans to expand into rural areas through enhancing logistics and delivery services, enabling farmers to sell agricultural produce to urban residents and global consumers while making affordable purchases on Taobao.
Exhibit 242: Urban vs. Rural Internet Penetration Exhibit 243: China’s Rural E-Commerce Market Size Estimates
Source: CNNIC as of Jan 2014, Jefferies Source: AliResearch as of Oct 2014, Jefferies
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14 December 2014
Expanding into new verticals, services and overseas market The competitive landscape of the B2C market is polarized with dominant players and vertical pure plays. High potential growth and expansion opportunities exist in entering new verticals, new markets geographically, new industries and local lifestyle services. Top Internet players including Alibaba, Tencent and Baidu are making inroads into new areas such as healthcare, digital entertainment, Internet finance and O2O services.
Growing consumer demand for quality goods, insufficient purchasing channels and lack of promotional discounts of foreign brands in China gives rise to a rapidly growing cross- border online shopping market, which is expected to grow at a 2013-18 CAGR of 36% to RMB1trn by 2018, according to Nielsen. E-commerce players, such as Alibaba, Amazon China, Vipshop, Suning and Jumei, have launched their respective global sales channels to satisfy the growing appetite for foreign brands among Chinese and lower the cost, time and language barriers in overseas online shopping. We expect to see increasing efforts to be deployed, including partnership with the government, in promoting cross-border online shopping going into 2015 as e-Commerce players compete for this greenfield opportunity.
B2B is quietly back on the horizon B2B platforms facilitate the matching of supply and demand of SME business needs by introducing sub-suppliers to potential SME buyers. Driven by the growth on the B2C side, as well as increasing Internet and online shopping adoption, a large and growing base of SMEs is moving businesses online. The business models of B2B players are evolving from advertising based on information-oriented services to transaction-based.
Mobile search and performance-based social ads to see acceleration
Mobile opens up opportunities for connecting users with services According to iResearch, China’s search market grew 55% YoY for the first 9 months of 2014, up from 40.6% in 2013, driven by increasing time spent on mobile, broadening mobile search scenarios and optimizing mobile search technology pioneered by Baidu. Baidu, the leading mobile search engine in China, had a mobile search traffic market share of 75.2% in 2Q14. Mobile search already accounted for 50% of its overall search traffic and 36% of revenue in 3Q14, up from 20% in 4Q13.
Looking into 2015, we expect more mobile search queries will be done through formats beyond text, such as voice and visual search, while users will increasingly search on mobile for services, in addition to information, that can be completed within a few clicks on an easy-to-use interface. We expect Baidu’s advertising customer base expansion to continue, particularly SME merchants, leveraging on its product portfolios including city- level bidding, LightApp, group-buy and Baidu Connect.
Exhibit 244: China Search Market Size Exhibit 245: Baidu’s Mobile Search Traffic Market Share
Source: iResearch as of Nov 2014, Jefferies Source: Analysys International as of Jul 2014, Jefferies
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Equity Strategy
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14 December 2014
Performance-based social ads still in a nascent stage Advertisers increasingly prefer performance-based ads over displays ads in order to optimize their advertising dollars particularly in times of macro uncertainties. Tencent’s performance-based ad platform Guangdiantong (GDT) is able to provide targeted ad services for advertisers leveraging on Tencent’s large social properties and traffic across Qzone and Weixin.
Our benchmarking analysis of domestic and international Internet SNS platforms implies upside potential for Tencent’s performance-based ad revenue from current low base. Advertising only accounted for 12.3% of Tencent’s total revenue in 3Q14, compared to 92% of Facebook’s and 89% of Twitter’s. Performance-based ads represented 4.6% of Tencent’s revenue, 45% of which was contributed by mobile, up from 30% in 2Q14. We expect to see further upside to this, as mobile GDT monetization on Weixin official accounts is still at a nascent stage.
page 137 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
2015 Technology Sector: NEUTRAL Conservative on China tech in 2015 Overall we are conservative on China tech in 2015. Following the iPhone 6 launch this Ken Hui year, there is a lack of exciting new products driving growth next year. China macro Equity Analyst uncertainty is also unfavourable for domestic demand. +852 3743 8061 [email protected] China smartphone growth to slow further As we expected late last year, China’s smartphone market has been experiencing slower growth this year. According to Gartner, growth in China smartphone shipments slowed from 86% y/y in 2013 to 25% y/y in 9M14. The growth was particularly weak at 11% y/y in 3Q14. With the China smartphone market already saturated with smartphones accounting for 92% of handset shipments in 3Q14, the highest level in the world, we expect the market growth to further slow to below 10% in 2015. The weaker growth will lead a challenging environment for both handset makers and component suppliers for China smartphones in 2015.
Prefer upstream to downstream but wait for better entry points The Chinese government is strengthening both policy and financial support for the semiconductor industry. Recently the government published a blueprint to support the domestic semiconductor industry, with the ultimate goal to become a global leader by 2030. To achieve that, the blueprint suggests eight measures including the setting up of a government committee to coordinate ecosystem development, and establishment of an investment fund to support the industry.
In addition to government policy, we see several fundamental supports for Chinese semiconductor industry. First, we expect slowing Moore’s Law to allow Chinese semiconductor foundries to gain share from second-tier global competitors. Second, we expect a more competitive Chinese fabless industry to spur demand for semiconductor foundry and equipment. Third, new trends such as smart devices and Internet of Things will drive secular demand for semiconductors. However, we believe the semiconductors sector is fairly valued currently, this suggesting better entry points.
Top Buy: FIH Mobile Downside support. The stock has been down due to concerns on weakness at key customers, particularly Sony. Historically, BV was a strong support when FIH was profitable. Therefore, with net losses unlikely in the foreseeable future given lighter assets and more diversified customers compared to 2012 and before, we see strong downside support at current stock prices close to BV. Diluted BVPS was HK$3.84 with net cash (including short-term investments) per share of HK$2.54 as of June 30.
Share gain at Chinese customers. Xiaomi reported 20% q/q growth in C3Q shipments, implying 18mn for the quarter. We believe Redmi strength offset high-end weakness. With Xiaomi developing more Redmi models in-house, FIH has gained assembly share in overall volume. We estimate FIH is shipping 3-4mn units per month to Xiaomi. We believe FIH is also seeing positive momentum with Meizu. First, Meizu has scaled down in-house manufacturing and increased outsourcing to FIH. Second, demand is strong for MX4, an attractively priced five-mode 4G smartphone with high specifications. With Chinese operators shifting direct handset subsidies to tariff rebates, smartphone makers focusing on open channels should gain share, thus benefiting both Xiaomi and Meizu. We believe FIH is negotiating a new contract to resume assembly services for Huawei with trial production having started, thus we see upside potential.
Valuation/Risks. Our HK$5 PT implies 1.2x our 2015E year-end diluted BVPS of HK$4.1. We expect FIH to earn 5% ROE in 2015, the highest level since 2009. Therefore, our target PB appears justified, with the stock trading at a 1.5x avg since 2009. Peer average is 1.5x. The main downside risk is share loss at major customers.
page 138 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
2015 Transportation - Airlines Sector: POSITIVE Positive Earnings Momentum to Continue Key Takeaway Boyong Liu, CFA We reiterate our positive view on the airline sector into 2015, due to 1) Equity Analyst structural improvement on supply/demand balance, 2) lower fuel cost, which +852 3743 8015 is yet to be fully factored in, 3) cargo earnings recovery. We prefer Chinese [email protected] airlines names to regional ones on their zero fuel hedges, and more significant improvement in supply & demand. CEA-H and CSA-H are our 2 top picks for 2015.
Chronic oversupply has seen signs of improvement. Slowdown in demand growth, and excessive booking of aircraft have led to persistent overcapacity in Asian airline industry. The situation is particularly challenging for the SE Asian short haul segment but is also seen in the Chinese domestic segment. We believe the Chinese airline market should be the first to restore demand/supply balance, given its oligopolistic market structure and smaller order backlog. In 2014, Big 3 Chinese airlines have already stabilized their domestic yield in a rather weak demand environment, and they plan to further slowdown the capacity growth.
Expect demand to be a tailwind for earnings recovery. We expect government’s pro-growth policies in China should help air travel to regain strength in 1H15 against a very low base. Chinese airlines in the past have been early cycle beneficiaries, given their high exposure to business travelers, and we expect the phenomenon to continue in 2015. A similar situation should also emerge in emerging Asian airlines, as the revival of regional economies could potentially help absorb some of the severe overcapacity in the short-haul segment.
Falling fuel price yet to be fully priced in, in our view. We prefer Chinese airline names in this falling fuel price environment, given their lack of fuel hedging. Under a conservative assumption (Chinese airlines won’t lift base fare to offset domestic fuel surcharge) and Brent $90/barrel for 2015, Chinese airlines could achieve 12% to 18% ROE, and current 0.7-1.2x 2015 PB still looks undemanding, and current price of $72 per barrel Brent should support further upside on their 2015 ROE and share price.
Cargo has finally seen signs of normalization. After 3 years of painful capacity adjustment, the spot air freight market has started to show signs of improvement, starting in 4Q13. The positive trend has been further boosted by a strong east-west trade and new tech product launches. We believe cargo earnings recovery may continue into 2015 on the back of falling fuel cost, and continuing cargo shift from high cost freighter to low cost bellyhold. While cargo recovery is positive to earnings for all airlines, we don’t qualify it as our main criteria for stock picking given airlines’ much higher revenue exposure to the passenger business.
Our pecking order for 2015. China Eastern-H (CEA) and China Southern-H (CSA) are our two top picks, given their higher earnings sensitivity to fuel and undemanding valuation, and favorable company-specific stories. We also rate Air China as Buy. On the regional airlines, we prefer SIA to Cathay, as we are still concerned that Cathay’s rapid capacity addition in long haul will continue to dilute its passenger yield. SIA, on the other hand, may see pressure from LCCs begins to ease, and Tigers’ earnings should also begin to recover since CY3Q14 as it terminates all loss making overseas JVs.
page 139 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Chronic over-supply sees signs of improvement
Excessive booking of aircraft combined with slow economic growth have led to overcapacity in Asian airline sectors since 2H12. The situation is particularly challenging for ASEAN short haul markets, due to the explosive expansion of LCCs, but also has been seen in the Chinese domestic market. Both markets have seen a meaningful slowdown in economy and thus effective air travel demand, and airlines have to lower the ticket price to support load factors.
Exhibit 246: Passenger load factor in Asian airlines sector Exhibit 247: GDP growth in the past 3 years has been has been declining yoy since 1H13 sharply slowing down in emerging Asian countries
7.0 20% 14 5.0 12 10 3.0 10% 8 1.0 0% 6 -1.0 4 -3.0 -10% 2 -5.0 0
-7.0 -20% -2
Jul-11 Jul-12 Jul-13 Jul-14
Jan-11 Jan-12 Jan-13 Jan-14
Apr-11 Apr-12 Apr-13 Apr-14
Oct-11 Oct-12 Oct-13 Oct-14 China India Malaysia PAX LF yoy ASK yoy Indonesia Thailand Singapore Source: IATA Source: Bloomberg
While we have seen some consolidation in the LCCs segment, and some airlines have also begun to scale down their capacity plans, the process is still slow in most markets (except for Singapore), and aircraft order backlog remains large in years to come, thus we expect the positive impact will take some time to filter through. Fragmented market structure also results in significant “Prisoner’s Dilemma” among the airlines in cutting their existing capacity.
However, we expect Chinese airlines should be the first to benefit from restored demand/supply balance, given its oligopolistic market structure, and much smaller order backlog. In 2014, the Big 3 Chinese airlines have already stabilized their domestic yield (positive on average) in a rather weak demand environment, but intentionally lower their domestic capacity growth during the off-peak season.
Exhibit 248: Domestic ticket has been stabilized in 2014 Exhibit 249: Big 3 airlines’ domestic ASK growth have
40% been much slower in 10M14 vs. 2013 15% 30% 2013 13% 20% 2012 11% 10% 9% 2014 0% 7% -10% 5% -20% 3% 2011 -30% 1%
-1%
Jul-09 Jul-14
Jan-07 Jan-12
Jun-07 Jun-12
Apr-08 Apr-13
Feb-09 Feb-14
Oct-10
Sep-08 Sep-13
Dec-09
Mar-11
Aug-11
Nov-07 Nov-12
May-10 1 2 3 4 5 6 7 8 9 10 11 12
Source: Jefferies estimates Source: Company data
Looking into 2015 and onwards, we expect a slow growth in domestic capacity to continue, as Big 3 airlines have all passed their aircraft delivery peak in 2014, which should significantly ease their pressure to grow capacity.
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14 December 2014
Based on our delivery data and company guidance, we estimate CA, CEA and CSA will add 35, 28 and 35 aircraft (net of retirement) and account for about 6% growth at each of the Big 3 from their existing fleet by the end of 2014.
Exhibit 250: CA’s aircraft delivery Exhibit 251: CEA aircraft delivery Exhibit 252: CSA aircraft delivery plan plan plan
700 15% 700 14% 700 15% 12% 600 600 10% 600 10% 10% 8% 500 500 500 6% 5% 5% 400 400 4% 400 2% 300 0% 300 0% 300 0%
CA Fleet Net Addition YoY CEA Fleet Net Addition YoY CSA Fleet Net Addition YoY
Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates
Based on our discussion with management, we believe big 3 airlines have also reached a consensus that growth during the 13th 5-year plan (FYP) should be much lower than the 11% growth during the 12th FYP. They will also be more prudent in placing aircraft orders going forward, and be more focused on opportunities on fast growing international routes rather than domestic market.
Expect demand to be a tailwind for earnings recovery
Business travel demand has been particularly weak since 1H12, and has been the main drag for airlines’ earnings in the past 3 years. On the other hand, leisure travel demand remains quite resilient, as reflected by still high airlines earnings during 3Q travel season.
We expect government’s pro-growth policies, including interest cuts, speed-up of FAI, and loosening restriction on property market, to help stimulate business travel demand growth in 1H14. Chinese airlines in the past have been early cycle beneficiaries, as business travel is also very sensitive to the economic cycle. A similar situation has also happened in ASEAN countries, and India, and could potentially help absorb some of the severe overcapacity in the short haul segment.
page 141 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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14 December 2014
Exhibit 253: 3Q EBIT has been very resilient in the past 5 Exhibit 254: Historically airline demand began to pick up years. Off -peak season is the main earnings delta for full ahead of economy year Rmb bn 30 300%
21 20 16 200% 13 12 11 11 9 9 10 100% 3
0 0% 2010 2011 2012 2013 2014 3Q EBIT Full Year EBIT 3Q as % of full year EBIT
Source: Company data, Jefferies estimates Source: CAAC, Bloomberg, Jefferies
Exhibit 255: Chinese airlines at zero Falling fuel price yet to be fully priced in hedge vs. peers Investors began to turn cautious on Chinese airlines, due to their 21% to 49% share price
70% 65% rally in the past 3 month. We argue, however, that the rally has yet to fully price in our 60% assumption of Brent at $90/barrel (12% yoy decline). 60% 50% Even under our conservative assumption that reduction in fuel surcharge will cancel 50% 40% of cost savings, the 12% yoy fuel price decline to $90 Brent/barrel could still bring in near 30% 60% earnings growth for Air China and near 200% yoy earnings growth for China 20% Southern, and the 3 airlines can deliver an ROE between 11.9% and 18.4% in 2015. 10% Current price of below $70 per barrel could provide further upside to ROE. 0% 0% 0% 0% On top of that, we also see an improving supply/demand environment, due to slowdown in aircraft deliveries and potential uptick in demand, which have also not been reflected in price rally in our view.
Source: Jefferies estimates, company data
Exhibit 256: Sensitivity Analysis for Fuel Fuel cost savings on 1% Earnings Implied earnings 3-month Share Current PB ROE Implied 15E ROE if fuel decline of fuel price 2014E growth in 2015 Performance 2015E 2015E price declines 33% CA* Rmb 124mn 2,708 5% 20.9% 1.0x 11.9% 21.0% CEA* Rmb 110mn 1,507 7% 49.1% 1.2x 18.4% 33.8% CSA* Rmb 135mn 831 16% 39.0% 0.7x 13.1% 28.4% Cathay§ HK$135mn 4,070 3% 24.3% 1.0x 10.0% -- SIA† SG$18mn 751 2% 8.1% 0.9x 8.8% -- Source: Jefferies estimates, company data Note: *Chinese airlines are 50% covered by fuel surcharge on domestic flights. §Cathay is 60% hedged against Brent at $100/barrel. †SIA is 65% hedged against jet fuel at $116/gallon and 2015 growth is based on operating profit.
page 142 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
Cargo has finally seen signs of normalization
After 3 years of painful capacity adjustment, spot air freight market started to show signs of improvement starting 4Q13. The positive trend has been further boosted by a strong east-west trade and new tech product launches. We believe cargo earnings recovery may continue into 2015 on the back of falling fuel cost (accounts for over 50% of total operating cost for freighters), and continuing cargo shift from high cost freighter to low cost bellyhold.
While cargo recovery is positive to earnings for all airlines, we don’t qualify it as our main criteria for stock picking given airlines’ much higher revenue exposure to the passenger business.
Exhibit 257: Cargo yield on an Exhibit 258: Cargo cost breakdown - Exhibit 259: Cargo revenue exposure improving trend fuel accounts for over half of across APAC airlines 15% freighter’s operating cost 10% Aircraft maintenance ANA 5% 8% 6% Depreciation 5% EVA 0% 15% Fuel SIA -5% CSA -10% Personnel 15% CA -15% Handling, landing 0% 10% 20% 30% 40% and overflying 51% Others Cargo Rev as % of Total Rev EVA China Airlines SIA
Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates Source: Company data, Jefferies estimates
Our pecking order for 2015 China Eastern-H (CEA) and China Southern-H (CSA) are our two top picks, given their higher earnings sensitivity to fuel and undemanding valuation, and favorable company specific stories. We also rate Air China as Buy.
On the regional airlines, we prefer SIA to Cathay, as we still concerned that Cathay’s rapid capacity addition in long haul will continue to dilute its passenger yield. SIA on the other hand, may see pressure from LCCs begin to ease, and the Tigers’ earnings should also begin to recover since CY3Q14 as it terminates all loss making overseas JVs.
Exhibit 260: Valuation Comparison Table Company Rating Price Market Cap EV PB ROE EV/EBITDA ($mn) (US$mn) 2013 2014 2015 2013 2014 2015 2014 2015 Air China - H Buy 5.9 10,003.0 26,366 1.1x 1.1x 1.0x 6.3% 5.0% 11.9% 9.1x 6.7x China Southern - H Buy 3.6 4,608.4 13,367 0.8x 0.8x 0.7x 5.9% 2.4% 13.1% 6.3x 4.4x China Eastern - H Buy 3.9 6,309.1 17,763 1.4x 1.4x 1.2x 9.5% 5.5% 18.4% 8.2x 5.5x Air China - A Buy 6.3 13,442.9 29,679 1.6x 1.5x 1.5x 6.3% 4.9% 11.8% 10.3x 7.6x China Southern - A Hold 4.9 7,742.7 22,423 1.5x 1.4x 1.4x 5.7% 2.4% 13.2% 10.6x 7.3x China Eastern - A Hold 5.9 12,139.3 24,275 2.8x 3.0x 2.9x 9.9% 6.0% 21.0% 11.2x 7.4x Cathay Pacific Hold 17.4 8,826.5 14,304 1.1x 1.0x 1.0x 4.4% 6.3% 10.0% 8.0x 6.8x SIA Buy 10.9 9,738.9 6,629 1.0x 1.0x 0.9x 2.7% 6.2% 8.8% 3.5x 3.0x Average 1.4x 1.4x 1.3x 6.3% 4.8% 13.5% 8.4x 6.1x Source: Jefferies estimates, company data, Bloomberg. Price as of close on Dec 11, 2014.
page 143 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.
Equity Strategy
China
14 December 2014
2015 Transportation - Shipping Sector: POSITIVE Benefit from lower oil in more than one way 2015 positioning – prefer tanker and container over dry bulk Bonnie Chan We believe tankers and containers would continue to outperform dry bulk in 2015. Equity Analyst +852 3743 8754 . Tanker is our most preferred sector as we see limited supply while seaborne [email protected] trade may grow if OPEC successfully pushes some US tight oil producers out of the market.
. Container is our second preferred sector. Although supply-demand dynamics may be less favourable than 2014, falling oil price would cushion freight rate weakness.
. Dry bulk is our least preferred sector. Falling iron price is a risk to the competitiveness of Brazilian iron ore.
Exhibit 261: Bunker costs fell 25% since September 2014 US$/ton
800
700
600
500
400
300
200
100
0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: Jefferies, Bloomberg
Most preferred: Japan shipping companies, Orient Overseas, China Cosco-H For Asia including Japan investors, we prefer Japanese shipping companies over their Asia- ex counterparts. We believe the current share price has not fully discounted the benefit of a weaker Japanese Yen, which has depreciated over 18% since September.
Exhibit 262: Consensus has not yet factored in impact of Yen depreciation
JPY bn Yen Sensitivity: RP FY 3/2016 earnings increase Consensus increase per 1 JPY/USD from Yen depreciation earnings growth move NYK +1.8bn +27bn +20.0bn MOL +2.0bn +30bn +11.6bn KL +0.8bn +12bn +9.0bn Source: Jefferies
Within Hong Kong/China, we prefer Orient Overseas (OOIL) and China Cosco. At 0.7x PB 2015, we believe the market has not priced in a much lower cost base at OOIL in 2015, coming from lower bunker costs. We believe OOIL can save up to US$275m on bunker cost alone in 2015. For China Cosco, we believe the company is in the midst of a turnaround and would continue to benefit into 2015 with a much lower bunker costs.
page 144 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
Tanker –beneficiary of OPEC supply
Tanker segment is now firmly in recovery territory. VLCC has been averaging higher than last year. Year-to-date, VLCC time charter rates averaged US$22,403/day (vs. US$9,252/day in 2013) while product tanker time charter rates averaged US$10,116 /day (vs. US$7,576/day in 2013). YTD, only 22 VLCC have been delivered and 10 VLCC have been scrapped. Global fleet has only increased by 1.9% in 2014.
We believe that this trend will continue into 2015. We forecast supply will grow at 1.6% yoy, with only 17.8m dwt to be delivered in 2015. Supply will start picking up in 2016 and we expect fleet growth to accelerate to 4%.
Exhibit 263: Tanker supply remains subdued - 2015 fleet growth at 1.6% m dwt 40.0 9.0%
30.0 7.0% 5.0% 20.0 3.0% 10.0 1.0% 0.0 -1.0% (10.0) -3.0%
(20.0) -5.0%
(30.0) -7.0% 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E Actual delivery (m dwt) Scrapped Fleet growth
Source: Jefferies estimates
Exhibit 264: VLCC TC rates - Middle East to Japan Exhibit 265: Product Tanker TC rates
Source: Jefferies Source: Jefferies
Demand upside if low oil price pushes out US shale oil production Demand for tanker has been weak due to a decline in US crude import, which was offset partially by China demand growth. While next year demand growth from China may be weak due to slow down in the industrial sector, it could be offset by US seaborne crude oil import. US seaborne crude oil import has declined by over 37% since 2010 as North America oil production has pushed out import. However, a low oil price environment may force out some North American producers who have a higher breakeven point than US$ 70/bbl.
In addition to this long term picture, we now see short term drivers for oil tanker as well going into 2015. For the first time in four years, the oil market is in contango, i.e. the
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Equity Strategy
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14 December 2014
forward price of oil is higher than spot price. This implies that traders can make a profit by buying oil at spot and sell forward contracts at a higher price, storing the oil in tankers until delivery. This should tighten the supply-demand balance for oil tankers further.
Exhibit 266: Oil storage trade is viable for the first time Exhibit 267: US Seaborne crude import has declined by since Jan 2011 37% since 2010
Source: Jefferies, Bloomberg Source: Jefferies, EIA Container – benefit of oil underestimated Container shipping has outperformed market expectations in 2014. We believe investors have not yet factored in the impact of lower bunker price on the cost base, which could reduce cost by US$200-300m in 2015. This savings could be 4-5x current forecasted net profit.
Exhibit 268: Drop in bunker price will have a large impact on shipping companies’ net profit USD m 700 700
600 600
500 500
400 400
300 300
200 200
100 100
0 0
-100 -100 OOIL CSCL CSD NOL K-Line MOL NYK
2H14 Bunker Cost Savings 2015 Bunker Cost Savings 2H14 NP JEFe 2015 NP JEFe
Source: Jefferies estimates, company data
Demand growth may slow from 6%+ to around 5% We forecast a global demand growth of around 5% next year vs. 6%+ in 2015. The key driver is Asia-Europe slowing from 8% yoy growth to 3-4% next year as inventory restocking cycle is now over. Demand remains well supported in Transpacific, where we forecast 5% volume growth in 2015. Intra-Asia should also benefit from the US recovery, which would aid intra-regional trade of semi-finished goods.
page 146 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 269: EU inventory has normalised Exhibit 270: Retail sales growth yoy%
30 4.0%
25 2.0%
0.0% 20
-2.0% 15 -4.0% 10 -6.0%
5
Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-05 Jul-06 Jul-07
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Retail sales growth yoy%
Source: Jefferies, Eurostat Source: Jefferies, Eurostat Supply to accelerate but 2015 may be the last year of container over-supply Supply growth will accelerate from 6% in 2015 to 7.2% in 2015 based on our forecast. However, we believe this large supply is well known. Furthermore, there is room for container operator to manage their capacity increase on individual trade lanes through idling or returning charter vessels to non-operating owners. As long as there is no large negative demand surprise, we believe average rates may just be flat or slightly down in 2015.
Exhibit 271: Container supply to accelerate in 2015 but started to slow down in 2016 2009 2010 2011 2012 2013 2014E 2015E 2016E Beginning 12,367,592 13,060,177 14,282,499 15,415,201 16,341,329 17,285,952 18,317,591 19,643,735 Actual Addition 4250 or above 839,709 1,201,683 1,128,412 1,151,296 1,201,594 1,288,008 1,606,499 854,704 Below 4250 234,046 184,254 100,717 112,260 176,012 243,631 232,100 174,881 Slippage -100,000 -112,455 89,964 Scrapping -381,169 -183,799 -107,181 -351,566 -461,298 -400,000 -400,000 -250,000 Ending 13,060,177 14,282,499 15,415,201 16,341,329 17,285,952 18,317,591 19,643,735 20,513,284 Capacity 5.5% 9.4% 7.9% 6.0% 5.8% 6.0% 7.2% 4.4% growth % Source: Jefferies estimates, Alphaliner
Exhibit 272: Asia-Europe - volume has started to slow in Exhibit 273: Transpacific - volume growth remained strong September into September
30%
20%
10%
0%
-10%
-20%
Jul-11 Jul-12 Jul-13 Jul-14
Jan-11 Jan-12 Jan-13 Jan-14
Apr-12 Apr-11 Apr-13 Apr-14
Oct-12 Oct-11 Oct-13 Oct-14
Demand growth yoy% Capacity growth yoy%
Source: Jefferies, CTS, Alphaliner Source: Jefferies, Journal of Commerce, Alphaliner
page 147 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Dry bulk – another year at the valley
Although dry bulk supply has slowed from 12% in 2012 to 6.6%in 2013 and 2014, and China iron ore imports has increased by 16% yoy, the dry bulk recovery remains sluggish with Panamax, Handymax and Handysize all seeing lower rates than 2013.
We see 2015 as being another sluggish year in dry bulk with demand headwinds. Low iron ore price will put the Brazilian iron ore export story at risk.
Exhibit 274: China iron ore imports – up 16% YTD Exhibit 275: China coal imports – down 13% YTD
60% 120% 50% 80% 40% 30% 40% 20% 0% 10%
0% -40% -10% -80%
-20%
Jul-12 Jul-13 Jul-14
-30% Jul-11
Jan-11 Jan-12 Jan-13 Jan-14
Apr-13 Apr-11 Apr-12 Apr-14
Oct-11 Oct-12 Oct-13 Oct-14
Jul-12 Jul-11 Jul-13 Jul-14
Jul-10 3MMA YoY%
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Apr-10 Apr-11 Apr-12 Apr-13 Apr-14
Oct-10 Oct-11 Oct-12 Oct-13 Oct-14
Source: Jefferies, CEIC Source: Jefferies, company data
We believe that China steel production per capita may have peaked earlier than expected. Although crude steel production is still posting 3-4% growth yoy, the marginal increase in production is now being exported rather than consumed domestically. YTD, China crude steel production has increased by 30.5 m tonnes while net export has increased by 21.6m. China now exports around 9% of its total production vs. just 6% in 2013. We believe that this trend is not sustainable in the medium term as China is already the largest steel producer in the world with total market share of 50%.
Chinese coal imports dropping is another risk for 2015. Coal import decline has accelerated to 27% yoy decline in September and October.
Exhibit 276: China FAI has slowed sharply Exhibit 277: Steel production growth may stop if China
40% export no longer profitable
35% 30% 25% 30% 20% 25% 15% 20% 10% 15% 5% 10% 0% 5% -5%
0% -10%
Source: Jefferies, CEIC Source: Jefferies, CEIC
page 148 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
2015 Transportation - Ports Sector: NEUTRAL Selectively Optimistic for Chinese Ports Key Takeaway Boyong Liu, CFA We would position selectively on ports stocks into 2015. Despite a stable Equity Analyst earnings growth outlook, we expect that tamed volume growth may limit the +852 3743 8015 sectors’ valuation upside, and the small ports’ free trade zone fad should [email protected] quickly fade. On the other hand, large ports may leverage up for overseas M&A, the pace and quality of which should be a key criterion for stock
selection. Our top pick is CMHI (144 HK, Buy) for 2015 from that angle.
Volume growth should remain in single digits. Our base case forecasts 5.5% container volume growth in China, a touch slower than 5.9% in 2014, given 1) the 8% volume growth to the U.S. and Europe recorded in 2014 is already very high in a post- outsourcing environment, and was supported by a much lower base in 2013; 2) weakening volume on Europe routes has become increasingly evident since 4Q14, and may weigh on the growth outlook into 2015. In our view, the volume outlook will continue to be a dominating factor for the sector valuation cycles; therefore we stay Neutral on the sector.
The pace and quality of re-leveraging may set winners and losers. Chinese ports generally lack capex needs, and increasingly rely on M&A to fuel earnings growth. Both CMHI and CP (1199 HK, Hold) are at unreasonably low gearing levels, due to equity raising (CMHI) and assets disposals (CP) in 2013-14. Therefore the pace and quality of their investment will be a main theme to watch into 2015. Large A-share listed ports also face a similar situation, including CMHI’s 24% owned associate, SIPG (600018 CH, NC). From an investor perspective, we prefer the acquisition of mature port projects to non- port assets (leasing) or greenfield port projects.
Tariff will continue to trend up but at a slower pace. Ports operators have been enjoying an average 3-5% growth in container ASP thanks to rising tariff and rapid box mix improvement. While we believe their ASP/box will continue to trend up into 2015, as selective ports have already revealed their tariff hike plans, we believe the impact on earnings will be relatively smaller than 2014, as the large ASP boost from box mix improvement in 2014 will be difficult to repeat.
The smaller ports’ free trade zone fad difficult to sustain in 2015; large ports may play catch-up. During 2H14, smaller port stocks became highly speculative on news related to free trade zones and they were in high valuation, except the laggard Qingdao Port (6198 HK, NC). Thus we see limited chance for this fad to repeat in 2015, though in the near term, large cap port names may play catch up.
Our pecking order for 2015. CMHI remains our top pick for its solid earnings growth, good track record on overseas M&A, and undemanding valuation. We also rate HPHT (HPHT SP, Buy) as Buy from a stable dividend prospective. We rate CP Hold given its leasing business has yet to reach the bottom. We also rate two small ports Dalian and Tianjin as Hold, on their stretched valuation.
page 149 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Volume growth unlikely to accelerate
Our base case assumption forecasts a 5.5% container volume growth for 2015 in China, slightly below the 5.9% of 2014. Specifically we forecast 5.1% volume growth for foreign trade and 7.0% growth for domestic. Company-wise, we expect the three large container ports, CMHI, CP and HPHT to achieve organic volume growth of 5.8%, 8.8% and 5.5%, respectively.
Exhibit 278: Container port volume growth forecasts Trade 2013 2014E 2015E China US 5.7% 8.0% 8.0% China EU 6.0% 7.5% 5.0% Intra-Asia & Others 4.2% 5.4% 6.5% Foreign Trade 4.9% 6.4% 5.1% Domestic 13.1% 4.2% 7.0% Total 6.6% 5.9% 5.5% Source: Jefferies, company data
We see limited chance for volume growth to further accelerate from 2014’s level given 5.9% growth was already high in our view, without help from outsourcing. China’s Exhibit 279: China container container port throughput growth as a multiple of global GDP growth has been trending throughput growth as multiple of GDP down to 2-3x in the past 3 years from an average of over 6x before the GFC, due to growth has been falling since 2008 slowing down of production outsourcing. We believe this low GDP multiplier should 14.0x continue in coming years and form a structural headwind on port volume growth. 12.0x Secondly, we expect some cyclical headwinds from European routes to begin to mount. 10.0x The volume on Europe routes has begun to soften quickly since late Sept 14, as macro 8.0x conditions in core European countries began to deteriorate, which should likely drag 6.0x down overall volume growth, in our view, in 1H15 in particular. While volume to the U.S. 4.0x remains healthy, it has remained at 8% YTD. However, we haven’t seen a meaningful 2.0x recovery in housing related products since March. For 2015, we are not expecting any 0.0x growth acceleration on the U.S. routes either.
Lastly, we believe high volume growth in 1H14 was partially due to the very low base in 1H13, as in 2013 the peak season was very short and started in late June. However in Source: Jefferies estimates, IMF, Ministry of 2014, the peak season is more normal and started in late April. Volume growth for 2015 Transport China could also slow from a normalized base in 2014.
Exhibit 280: Europe volume growth has been slowing Exhibit 281: YoY change in vessel load factors to US and down since 1Q14; our recent channel checks suggest it EU began to decline since 2H14 due to high base continues to deteriorate while US routes remain stable 40% 30.0% 30% 20.0% 20% 10.0% 10% 0.0% 0%
-10.0% -10%
-20.0%
Jul-12 Jul-13 Jul-14
Jan-12 Jan-13 Jan-14
Apr-12 Apr-13 Apr-14
Oct-12 Oct-13 Vessel LF chg yoy AE route Vessel LF chg yoy TP routes AE yoy TP yoy
Source: Jefferies estimates, JOC, CTS Source: Jefferies estimates, Chineseshipping.com.cn
page 150 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Tariff will continue to trend up, but may be at slower pace
Port operators have been enjoying an average of 4% growth in container ASP in 2014 based on our estimates, compared to a stable ASP in 2012-13.
The ASP improvement has come from mix improvement, as 1) volume growth has been primarily driven by high-priced foreign trade boxes, 2) some Bohai Bay ports have stopped counting their internal trans-shipment throughput, which cannot generate revenues. Select ports, such as Qingdao, Shanghai, Ningbo and Xiamen, have raised tariff by 3-12%.
We believe ports ASP/box will continue to trend up into 2015, as a couple of ports have already revealed their tariff hike plans, and container liners’ improving profitability in 2014 has also made the tariff increase easier to push through. However, in the near term, we believe the impact on port earnings will be milder than 2014, as the large ASP boost from box mix improvement in 2014 will be difficult to repeat.
Exhibit 282: In 2014, high priced foreign trade container Exhibit 283: Tariff increases at select ports boxes have exceeded low priced domestic boxes Region Tariff Increase in 2014 40% Shanghai 5% Qingdao 3% 30% Xiamen 12-15% 20% Ningbo 3%
10% Region Planned Tariff Increase in 2015 0% Shanghai 2% -10% Qingdao 3%
Xiamen high single digit
Jun-12 Jun-13 Jun-14
Feb-12 Apr-12 Feb-13 Apr-13 Feb-14 Apr-14
Oct-12 Oct-13 Oct-14
Dec-11 Dec-12 Dec-13
Aug-13 Aug-14 Aug-12 Yantian high single digit (with raise volume rebate) Foreign Trade (YoY) Domestic Trade (YoY) Hong Kong (HIT) high single digit to 10% Source: Jefferies estimates, Chineseport.cn Source: Jefferies estimates
We see the trend as encouraging, particularly for long term infrastructure investors, as Chinese port operators have not been able to properly pass through the fast labor cost inflation between 2011-13. Their less business oriented mentality (focus on cargo volume instead of profitability) has also eroded their bargaining power against container carriers. Following Qingdao Port’s IPO, the central government’s push for SOE reform and some Exhibit 284: Net Gearing at CHMI and changes in ports top management, we felt a subtle change in the industry’s business CP strategy, becoming more profitability focused. The tariff increase in 2014-15 may have been a good sign, in our view. 45%
40% 35% The pace and quality of re-leveraging may 30% 28% determine winners and losers 25% Most Chinese ports have passed the peak for capex spending, now yielding a stable FCF. 20% They will also increasingly rely on M&A’s to fuel earnings growth. Local stevedores, such 15% 15% as SIPG have become more aggressive in expanding into non-port business, such as 10% property, while ports with overseas investment expertise such as CMHI and CP, overseas M&A’s will be the main area for future investment in our view.
In addition, both CMHI and CP’s gearing is currently at an unreasonable low level, due to CMHI CP recent equity raising at CMHI and asset disposal at CP, which has led investors to focus on their re-leveraging process. Thus we believe the pace and quality of M&A will be an Source: Jefferies estimates, company data important company-specific price driver into 2015.
page 151 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
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14 December 2014
From an investor perspective, we prefer acquisition of mature port projects at reasonable valuation. It would be ideal for the M&A target to have at least the same level of ROE as the existing portfolio, and be debt financed. We do not like large capex spending on non- port businesses, such as container leasing, we also don’t like large greenfield projects.
Exhibit 285: Recent and future acquisitions by COSCO Pac and CMHI Year Target Stake PE IRR COSCO Pac 2013 Taicang 39.04% 14.3x - 2014 ACT 40% 49.8x - CMHI 2010 TICT 29% - 15% 2012 LCT 50% - 12% 2013 PDSA 23.50% - >12% 2013 Terminal Link 49% - >8% 2013 CICT 85% - <11% Future project Asciano Majority TBD Source: Jefferies estimates, company data
Both CMHI and CP have a solid recent track record on M&A projects, particularly CMHI, which has been able to gain 8-15% IRR from its overseas projects. CP’s investment in Piraeus ports have also achieved faster than expected turnaround, though the upfront investment and ramp up costs seemed to be aggressive at the time. And its investment into ACT may also take longer time to achieve the similar return as other mature Chinese ports. We give the benefit of doubt to both managements that their future M&A will continue to be value accretive to the investors.
Smaller ports’ free trade zone fad difficult to sustain in 2015
From 2H13, ports stocks became highly speculative on news related to free trade zones and new trade agreements (i.e. free trade agreement with Korea, and new silkroad “Yi Dai Yi Lu”). A share ports led the rally, and also lead the rally of small ports in the Hong Kong market.
A-share ports stocks rallied with an average rise of 104% YTD. We see limited fundamental support for the rally, as both earnings and volume growth are stable at best.
However, those ports’ undemanding valuation, very low institutional ownership, and favorable news flow make them ideal targets for hot money. During the rally, the top five largest transactions of those stocks were also done by retail accounts according to Stock Exchange Data, rather than institutional accounts, which reconfirms our doubts.
Exhibit 286: Earnings growth is far less exciting than the share price Iron ore YTD yoy Coal YTD yoy Crude Oil YTD yoy Container YTD yoy Total YTD yoy 1H results yoy Share price YTD SIPG 80,730 2% 77,320 -14% 1,860 -20% 26,447 5% 570,990 -2% 2,932 15% 10% Tianjin Port Dev 86,190 11% 60,280 22% 32,330 2% 10,577 8% 397,790 5% 402 -5% 28% Tianjin Port A 601 6% 82% Ningbo A 75,980 18% 55,270 -8% 46,470 1% 14,252 12% 395,660 7% 1,637 11% 64% Tangshan Port A 161,100 26% 135,000 0% 10,650 10% 751 50% 372,700 14% 508 11% 182% Qingdao 142,448 1% 9,380 63% 12,525 5% 352,410 4% 855 10% 0% Dalian Port A 12,620 -26% 11,260 -5% 25,720 12% 7,395 3% 321,540 4% 284 -27% 72% Dalian Port H 284 -26% 37% Yingkou Port 30,270 4% 15,830 -30% 8,560 1% 4,320 7% 261,600 5% 364 20% 292% Rizhao 110,980 -5% 19,470 -17% 25,660 8% 1,827 19% 254,080 7% 401 -2% 64% Lianyungang 72,970 9% 15,740 -9% 3,788 -8% 158,240 5% 52 -47% 86% Xiamen Int'l 7,030 21% 19,180 13% 6,284 8% 150,539 7% 191 41% 88% Xiamen Port Dev A 90 1% 85% CMHI 54,305 3% 2,149 11% -8% CP 55,980 10% 147 2% 2% HPHT 17,988 7% 637 -15% 1% Source: company data, Chineseport.cn, Bloomberg
page 152 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Exhibit 287: The reasons for the share price rally Share price Reasons beyond Share price Companies peformance 2013 fundamental performance YTD Rally started Reasons beyond fundamental SIPG 101% Shanghai FTZ 10% Employee share scheme, and potential asset injection Tianjin Port Dev 21% Tianjin FTZ 28% Sept Tianjin FTZ Tianjin Port A 42% Tianjin FTZ 82% Sept Tianjin FTZ Ningbo -5% N.A. 64% Sept New Silkroad Tangshan Port -8% 182% April Jing-Jin-Ji (Beijing-Tianjin-Hebei) Qingdao NA 0% N.A. Dalian Port A -6% 72% July FTZ with Korea, Mongolia, Jinpu New District, and discount to A share Dalian Port H 8% 37% July FTZ with Korea, Mongolia, Jinpu New District, and discount to A share Yingkou Port -5% 292% April Large share bonus, FTZ with Korea Rizhao -12% 64% July FTZ with Korea Lianyungang 9% 86% Sept FTZ with Korea, Yi Dai Yi Lu, New Silkroad Xiamen Int'l 9% 88% July New Silkroad, Xiamen FTZ, Tariff increase Xiamen Port Dev A 29% 85% July New Silkroad, Xiamen FTZ, Tariff increase CMHI 14% FTZ, Qianhai -8% CP -4% 2% HPHT -15% 1% Source: Jefferies
Our pecking order for 2015
Our stock picks for 2015 are mainly based on corporate specifics and valuations, given our less bullish view on the container volume.
CMHI remains our top pick for its solid earnings growth (on interest savings), good track record on overseas M&A’s, undemanding valuation and underweight positions at institutional investors.
We rate CP as Hold given its leasing business has yet to reach the bottom, and valuation is not yet attractive enough to offset the further deterioration in leasing. Stabilization of leasing business or value accretive M&A’s may potentially change our view.
We also rated two small ports Dalian and Tianjin as Hold, on their stretched valuation. We also rated HPHT as buy from a stable dividend prospective, as we believe tariff increase could help it to maintain current dividend level over our forecast period.
Exhibit 288: Valuation Comparison Table Company Rating Mkt cap Price PE PB ROE Dividend Yield $mn LC$ 2013 2014 2015 2013 2014 2015 2014 2015 2014 2015 China Merchants Buy 8,743 26.45 15.8 14.8 12.8 1.4 1.3 1.2 8% 8% 4% 4% Cosco Pacific Hold 3,990 10.52 5.4 12.6 11.7 0.8 0.8 0.8 7% 7% 3% 3% Hutchison Port Buy 5,924 0.680 27.4 24.2 25.7 0.7 0.7 0.7 3% 3% 8% 8% Tianjin Port Dev. Hold 1,533 1.93 14.6 13.8 14.8 1.0 0.9 0.8 7% 6% 3% 3% Dalian Port - H Hold 3,268 2.87 15.3 14.2 13.7 0.8 0.7 0.7 5% 5% 3% 3% Average 15.7x 15.9x 15.7x 0.9x 0.9x 0.9x 6% 6% 4% 4% Source: Jefferies estimates, company data. Price as of close on Dec 11, 2014.
page 153 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
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Equity Strategy
China
14 December 2014
Analyst Certification: I, Christie Ju, CFA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Laban Yu, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Venant Chiang, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Sean Darby, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Jessie Guo, PhD, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Johnson Leung, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Jessica Li, Ph.D., certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Leon Liao, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Cynthia Meng, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Baron Nie, CFA, AIAA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. I, Po Wei, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. Registration of non-US analysts: Christie Ju, CFA is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Laban Yu is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Venant Chiang is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Sean Darby is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Jessie Guo, PhD is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Johnson Leung is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Jessica Li, Ph.D. is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Leon Liao is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst. page 154 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report. Equity Strategy
China
14 December 2014
Registration of non-US analysts: Cynthia Meng is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Baron Nie, CFA, AIAA is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
Registration of non-US analysts: Po Wei is employed by Jefferies Hong Kong Limited, a non-US affiliate of Jefferies LLC and is not registered/ qualified as a research analyst with FINRA. This analyst(s) may not be an associated person of Jefferies LLC, a FINRA member firm, and therefore may not be subject to the NASD Rule 2711 and Incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst.
As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receives compensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's judgement. Company Specific Disclosures For Important Disclosure information on companies recommended in this report, please visit our website at https://javatar.bluematrix.com/sellside/ Disclosures.action or call 212.284.2300.
Meanings of Jefferies Ratings Buy - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period. Hold - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period. Underperform - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 10% or more within a 12-month period. The expected total return (price appreciation plus yield) for Buy rated stocks with an average stock price consistently below $10 is 20% or more within a 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. For Underperform rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is minus 20% within a 12- month period. NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/ or Jefferies policies. CS - Coverage Suspended. Jefferies has suspended coverage of this company. NC - Not covered. Jefferies does not cover this company. Restricted - Describes issuers where, in conjunction with Jefferies engagement in certain transactions, company policy or applicable securities regulations prohibit certain types of communications, including investment recommendations. Monitor - Describes stocks whose company fundamentals and financials are being monitored, and for which no financial projections or opinions on the investment merits of the company are provided. Valuation Methodology Jefferies' methodology for assigning ratings may include the following: market capitalization, maturity, growth/value, volatility and expected total return over the next 12 months. The price targets are based on several methodologies, which may include, but are not restricted to, analyses of market risk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF, P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns, and return on equity (ROE) over the next 12 months.
Jefferies Franchise Picks Jefferies Franchise Picks include stock selections from among the best stock ideas from our equity analysts over a 12 month period. Stock selection is based on fundamental analysis and may take into account other factors such as analyst conviction, differentiated analysis, a favorable risk/reward ratio and investment themes that Jefferies analysts are recommending. Jefferies Franchise Picks will include only Buy rated stocks and the number can vary depending on analyst recommendations for inclusion. Stocks will be added as new opportunities arise and removed when the reason for inclusion changes, the stock has met its desired return, if it is no longer rated Buy and/or if it underperforms the S&P by 15% or more since inclusion. Franchise Picks are not intended to represent a recommended portfolio of stocks and is not sector based, but we may note where we believe a Pick falls within an investment style such as growth or value.
Risk which may impede the achievement of our Price Target This report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, the financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of the financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, and income from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financial and political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates may adversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities such as ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk.
page 155 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report. Equity Strategy
China
14 December 2014
Other Companies Mentioned in This Report • Agile Property Holdings Ltd. (3383 HK: HK$4.06, UNDERPERFORM) • Anhui Conch Cement Co. (914 HK: HK$27.35, BUY) • Asia Cement (China) Holdings Corp (743 HK: HK$4.50, HOLD) • ASM Pacific Technology Limited (522 HK: HK$75.65, HOLD) • Baidu Inc. (BIDU: $229.32, BUY) • Bank of China Limited (3988 HK: HK$4.11, BUY) • Beijing Enterprises (392 HK: HK$59.10, BUY) • Beijing Enterprises Water Group Ltd. (371 HK: HK$5.29, BUY) • Belle International (1880 HK: HK$8.22, UNDERPERFORM) • Biostime International Holdings (1112 HK: HK$15.42, BUY) • China Biologic Products Inc. (CBPO: $65.00, BUY) • China Coal Energy (1898 HK: HK$4.97, UNDERPERFORM) • China Cosco Holdings - H (1919 HK: HK$3.83, BUY) • China Life Insurance Company Limited (2628 HK: HK$26.75, HOLD) • China National Building Material Company Ltd. (3323 HK: HK$7.37, HOLD) • China Overseas Grand Oceans (81 HK: HK$3.96, BUY) • China Pacific Insurance (Group) Co., Ltd. (2601 HK: HK$32.50, BUY) • China Resources Cement Holdings Ltd (1313 HK: HK$5.06, BUY) • China Resources Enterprise, Limited (291 HK: HK$15.52, BUY) • China Shanshui Cement Group (691 HK: HK$3.27, HOLD) • Chow Tai Fook Jewellery Co. Ltd (1929 HK: HK$10.12, BUY) • CITIC Securities Company Limited (6030 HK: HK$28.30, BUY) • CMS (867 HK: HK$13.10, BUY) • CSPC (1093 HK: HK$6.90, BUY) • Dongfeng Motor Group Co Ltd (489 HK: HK$11.22, HOLD) • Fosun Pharma (2196 HK: HK$27.85, BUY) • Galaxy Entertainment (27 HK: HK$48.05, BUY) • Guangdong Investment Ltd. (270 HK: HK$10.68, HOLD) • Hengdeli Holdings (3389 HK: CNY1.49, HOLD) • Huaneng Renewable Corp (958 HK: HK$2.57, BUY) • Intime Department Store (Group) Co. Ltd. (1833 HK: HK$5.91, BUY) • Longfor Properties (960 HK: HK$9.55, BUY) • Luk Fook Holdings (Intl) Ltd (590 HK: HK$26.60, HOLD) • Petrochina Co. Ltd. - A (601857 CH: CNY9.35, HOLD) • Petrochina Co. Ltd - H (857 HK: HK$8.09, BUY) • PICC Group (1339 HK: HK$3.57, HOLD) • Ping An Insurance (Group) Company of China, Ltd. (2318 HK: HK$74.00, BUY) • SAIC (SAIC: $50.38, HOLD) • Sihuan Pharma (460 HK: HK$5.22, BUY) • Sino Biopharm (1177 HK: HK$7.24, BUY) • Sinopharm (1099 HK: HK$27.80, BUY) • Springland International Holdings Ltd. (1700 HK: HK$2.97, BUY) • Tencent Holdings Ltd. (700 HK: HK$113.70, BUY) • Tingyi Holdings Corp. (322 HK: HK$17.60, BUY) • Yanzhou Coal Mining (1171 HK: HK$6.45, UNDERPERFORM) • Zhaojin Mining Industry Company Limited (1818 HK: HK$3.98, UNDERPERFORM) • Zijin Mining Group Co Limited (2899 HK: HK$2.10, HOLD) Distribution of Ratings IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY 1040 52.26% 276 26.54% HOLD 804 40.40% 141 17.54% UNDERPERFORM 146 7.34% 5 3.42%
page 156 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report. Equity Strategy
China
14 December 2014
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page 157 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report. Equity Strategy
China
14 December 2014 to the publication of a research report containing such rating, recommendation or investment thesis. Any comments or statements made herein are those of the author(s) and may differ from the views of Jefferies. This report may contain information obtained from third parties, including ratings from credit ratings agencies such as Standard & Poor’s. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. Third party content providers give no express or implied warranties, including, but not limited to, any warranties of merchantability or fitness for a particular purpose or use. Third party content providers shall not be liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or profits and opportunity costs) in connection with any use of their content, including ratings. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase, hold or sell securities. They do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice. Jefferies research reports are disseminated and available primarily electronically, and, in some cases, in printed form. Electronic research is simultaneously available to all clients. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Jefferies. Neither Jefferies nor any officer nor employee of Jefferies accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. For Important Disclosure information, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 1.888.JEFFERIES
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page 158 of 158 Christie Ju, CFA, Equity Analyst, +852 3743 8012, [email protected]
Please see important disclosure information on pages 154 - 158 of this report.