CEBI Research Market and Investment Outlook

CEBI Research 2019 Market and Investment Outlook

Contents

Global Economic Outlook for 2019: A bumpy road for global economy ...... 2

China Economic Outlook for 2019: Growth deceleration in the wake of trade war ...... 13

China Policy Outlook for 2019 ...... 18

Hong Kong Economic Outlook for 2019 ...... 21

Investment Strategy and Themes for 2019 ...... 25

Sector Outlook ─ China Banks ...... 30

Sector Outlook ─ China Property ...... 39

Sector Outlook ─ HK Property ...... 47

Sector Outlook ─ China Infrastructure ...... 54

Sector Outlook ─ Environment ...... 65

Sector Outlook ─ Technology ...... 72

Sector Outlook ─ Automobile ...... 81

General Disclosures and Disclaimers ...... 88

Contributors

Banny Lam Dominic Chan Head of Research Senior Equity Analyst [email protected] [email protected] (852)2916-9630 (852)2916-9631

Stanley Tang Analyst [email protected] (852)2916-9632 December 17, 2018

2019 Global Economic Outlook for 2018: Global economy to gain more traction

2019 global economic outlook: A bumpy road for global economy

The global economic recovery continues at a decelerating pace with which diverging trends of growth momentum in different economies become more apparent. The trump’s tariffs, mounted geo-political risks, the tightened monetary stance of the U.S. and Eurozone, postponement of Brexit vote by UK Parliament, Italy’s fiscal standoff and turbulence of emerging market (EM) currencies are dragging down market sentiment and weighting on the growth momentum of global economy. Volatilities of global financial markets are skewed to the high side and a clouding global growth outlook comes with elevated economic and political risks. Amid rising interest rates and growing disputes over trade, the International Monetary Fund (IMF) has downgraded the forecasts of global growth for 2018 and 2019 from 3.9% to 3.7% in October 2018. The continued complication of worldwide business environment could make the global economic recovery more challenging. Geo-political risks remain high across the Middle East, Eurozone, the U.K and Korean Peninsula, which add anxiety and confusion to global financial markets. In the face of growth headwinds as well as diverging monetary stance of major economies, the global economy is on the brink of further slowdown in 2019.

For the U.S, protectionism remains as the major economic risks for global recovery. Despite temporary ceasefire of trade war with China for 90 days, the U.S. trade disputes with trading partners continue to stir fears that the global economy will spiral into a full-blown trade war. International trading activities compose of complex supply chain relationships across different countries with which physical trade disruptions driven by tariffs will definitely derail economic growth of different economies, especially those relying on exports. The downside risks are further enhanced by the tightening stance of U.S. monetary policy. As previous tax cuts effects start to fade and the mid-term election results set the stage of fiscal gridlock, U.S growth momentum is likely to face modest slowdown in 2019 but its economic performance still outperforms those of peers in the world.

For Eurozone, economic uncertainties surrounded by Brexit and Italy’s budget dispute become major threats to economic stability in Eurozone. Eurozone faces surging economic and political risks, which are weighting on growth momentum driven by weakening corporate investments and consumer spending. The structural vulnerabilities, financial market fragmentation, weak bank balance sheets, Brexit and weak government finances, remain as the main challenges of Eurozone which will decelerate the growth in 2019.

For Japan, economic relationships with the EU and China have been strengthened to resist the U.S. protectionism. Japan's huge trade surplus with the U.S. has drawn criticism with which Trump's administration aims to raise tariffs to lower the U.S. trade deficit and change unfair trade policies. Trade tariffs on Chinese goods have disrupted the supply chain, becoming a blow to Japan’s major exports of electronics products. In the face of trade war, Japan is stepping up its economic and financial cooperation with China and the EU by opening up and seeking more trade agreements to fight against prevailing protectionism. Japan is likely to maintain stable economic recovery in 2019.

For China, the economy faced slowing momentum in 3Q2018 along with surging downward pressures on economic activities in 4Q2018, mainly driven by Trump’s tariffs and the tightening of U.S. monetary policy. The halting move by the U.S. 2 to keep the tariff rate at 10% on $200 billion worth of Chinese goods for 90 days

will partially alleviate the growth headwind but China’s economy still faces moderation of growth. In recent months, China’s stock market has witnessed volatility and declines, driven by pessimistic investor expectations and sentiment regarding the economic outlook of China. In order to defuse uncertainty of the external environment and stabilize investor confidence, China has launched intensive policy measures to stabilize market, improve the market system, attract long-term capital inflow, deepen reforms of state-owned enterprises and private sectors, and further open up the market, thus ensuring soft-landing of the economy. It is foreseeable that the market will continue to fluctuate in near-term, but China’s policymakers will step up more efforts to revitalize market and ensure the sustainable development of China’s economy. We forecast China’s economy will slow within a reasonable range with the stable growth momentum in 2019.

Table 1: Global economic forecasts

YoY% 2013 2014 2015 2016 2017 2018E 2019E

U.S. 1.8 2.5 2.9 1.6 2.2 2.8 2.6 China 7.8 7.3 6.9 6.7 6.9 6.6 6.3 Euro Area (0.2) 1.4 2.1 1.9 2.4 2.0 1.8 Germany 0.6 2.2 1.5 2.2 2.5 1.9 1.8 France 0.6 1.0 1.0 1.1 2.3 1.7 1.7 Italy (1.7) 0.1 1.0 0.9 1.5 1.0 0.8 Spain (1.7) 1.4 3.6 3.2 3.0 2.5 2.1 Netherlands (0.1) 1.4 2.0 2.2 2.9 2.8 2.6 Greece (3.2) 0.7 (0.3) (0.2) 1.4 2.0 2.2 Portugal (1.1) 0.9 1.8 1.6 2.7 2.3 1.8 Ireland 1.3 8.7 25.0 4.9 7.2 4.7 4.2 UK 2.0 2.9 2.3 1.8 1.7 1.3 1.3 Japan 2.0 0.4 1.4 1.0 1.7 1.3 1.1 Canada 2.5 2.9 1.0 1.4 3.0 2.2 2.1 Australia 2.2 2.6 2.5 2.6 2.2 3.0 2.8 New Zealand 2.2 3.2 4.2 4.1 3.0 3.0 3.0 Mainland China 7.8 7.3 6.9 6.7 6.9 6.6 6.3 Hong Kong SAR 3.1 2.8 2.4 2.2 3.8 3.6 3.0 India 6.4 7.4 8.2 7.1 6.7 7.4 7.6 Singapore 5.1 3.9 2.2 2.4 3.6 2.7 2.4 South Korea 2.9 3.3 2.8 2.9 3.1 2.6 2.4 Taiwan 2.2 4.0 0.8 1.4 2.9 2.6 2.3 Source: IMF, CEBI Forcasts Fig. 1: Global GDP growth Fig. 2: VIX Index 6 5.4 25.0 23.0 5 4.3 21.0 3.6 3.7 3.7 3.7 4 3.5 3.5 3.4 3.3 19.0 3 17.0 15.0 2 13.0 1 11.0 9.0 0 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Jun-16 Jun-17 Jun-18 Oct-16 Oct-17 Oct-18 Apr-16 Apr-17 Apr-18 Feb-16 Sep-16 Feb-17 Sep-17 Feb-18 Sep-18 Dec-16 Dec-17 Aug-16 Aug-17 Aug-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 May-16 May-17 May-18 Dec-18*

*IMF Forcasts *14th December 2018 Source: Bloomberg Source: Bloomberg 3

Fig. 3: JPMorgan/Markit Manufacturing/Service PMI 57.0 55.0 53.0 51.0 49.0 Jul-15 Jul-16 Jul-17 Jul-18 Jan-15 Jan-16 Jan-17 Jan-18 Jun-15 Jun-16 Jun-17 Jun-18 Oct-15 Oct-16 Oct-17 Oct-18 Apr-15 Apr-16 Apr-17 Apr-18 Feb-15 Sep-15 Feb-16 Sep-16 Feb-17 Sep-17 Feb-18 Sep-18 Dec-15 Dec-16 Dec-17 Aug-15 Aug-16 Aug-17 Aug-18 Nov-15 Nov-16 Nov-17 Nov-18 Mar-15 Mar-16 Mar-17 Mar-18 May-15 May-16 May-17 May-18 JPMorgan/Markit_Manufacturing JPMorgan/Markit_Service

Source: Bloomberg

The U.S.: Fading fiscal stimulus and trade war woes pointing to slower growth momentum In 2018, economic recovery of the U.S. economy has been accelerating with the fundamentals improving in varying degrees. The U.S. economy grew at an annualized rate of 4.2% and 3.5% in 2Q2018 and 3Q2018, led by surging personal consumption expenditure and non-residential fixed investment, indicating that the recovery momentum is on track. The unemployment rate continued to trend down to 3.7% in November, the lowest level since 1969 while both headline inflation and core inflation stayed at above 2%. We expect the Fed will lift the benchmark federal funds rate by 25bps in December FOMC meeting and the U.S. GDP will grow 2.8% YoY in 2018E.

Looking forward in 2019, the U.S. economy will slow amid fading impacts of previous fiscal stimulus and uncertainties over the Trump administration's policies remain. The results of mid-term election set the stage of more political and legislative gridlock regarding Trump’s tax cuts and fiscal stimulus as the Democrats may exercise their power in the House to vote against controversial government policies. Possible fiscal standoff will lead to higher risks of an extended government shutdown. With derailed agenda of fiscal policy, the Fed will play a more important role to maintain the rate hike cycle tactfully, thus striking a balance between solid economic growth and surging price level. The Fed’s Chairman Jerome Powell has turned dovish, hinting that current level of interest rate is just below the neutral rate and future tightening decisions are subject to pricing pressures of the U.S economy. His views reflect that correction of equity market and oil prices as well as softening expectation of corporate profit growth have driven the U.S economy settling at a steady growth with stable inflationary pressures. We expect the Fed will adopt two 25bps rate hikes only in 2019, significantly lower than four rate hikes in 2018 and the U.S. economy will continue to demonstrate modest recovery with its GDP growing by 2.6% YoY in 2019E. Fig. 4: U.S. GDP growth YoY% Fig. 5: U.S. Manufacturing PMI (Markit) 3.5 58 3.0 56 2.5 54 2.0 52 1.5 50 1.0 48 0.5 46 0.0 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Sep-16 Sep-17 Sep-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 2012 2013 2014 2015 2016 2017 2018*2019* May-16 May-17 May-18

* CEBI Forecasts *December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg 4

Fig. 6: U.S. Services PMI and Composite PMI Fig. 7: U.S. Unemployment rate (%) (Markit) 66 9.0 64 62 8.0 60 58 7.0 56 54 6.0 52 50 5.0 48 4.0 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Sep-16 Sep-17 Sep-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 May-16 May-17 May-18 3.0 Services Composite 2012 2013 2014 2015 2016 2017 2018*

*December 2018 *November 2018 Source: Bloomberg Source: Bloomberg Fig. 9: U.S. PCE deflator (%) and Core PCE Fig. 8: U.S. headline inflation and core inflation deflator (%) 2.5 2.4

2.2 2 2 1.5 1.8 1 1.6

0.5 1.4

1.2 0 Jul-17 Jul-18 Jan-17 Jan-18 Jun-17 Jun-18 Oct-17 Oct-18 Apr-17 Apr-18 Feb-17 Sep-17 Feb-18 Sep-18

2013 2014 2015 2016 2017 2018* Dec-17 Aug-17 Aug-18 Nov-17 Mar-17 Mar-18 May-17 May-18

Headline inflation (%) Core inflation(%) U.S PCE deflator (%) Core PCE deflator (%)

*Novermber 2018 *October 2018 Source: Bloomberg Source: Bloomberg Fig. 10: U.S. Equity Market Performance YoY % Fig. 11: U.S. dollar index

8000 105 26000

6500 24000 100

22000 95 5000 20000 90 3500 18000 85 2000 16000 80

75 S&P 500 Index(Left) NASDAQ(Left) DJIA(Right) 2012 2013 2014 2015 2016 2017 2018*

*14th December 2018 *14th December 2018 Source: Bloomberg Source: Bloomberg

Eurozone: Bracing domestic and external headwinds Eurozone demonstrated signs of slowdown as GDP’s growth slowed from 2.4% YoY and 2.2% YoY in 1Q2018 and 2Q2018 to 1.6% in 3Q2018. Soft growth of economic indicators in 3Q2018 indicated that strong momentum of 2017 growth, the strongest since the pre-recession year of 2007, may not extend into 2018 and 2019 amid heightened economic and political uncertainties. The moderation of EU growth was, to a large extent, the result of a weaker net trade performance as EU exporters began to experience the negative impact of the slowing global economy. Surrounded by the UK leaving EU, heightened fiscal disputes in Italy and escalating global trade tensions, Eurozone faces slowing growth momentum. In sum, the structural growth weakness, weak balance sheets of financial institutions and fragile government finances, remain as the main challenges faced by Eurozone. The uncertainty about the economic and political outlook of the Eurozone becomes the major headwind against sustainable recovery of Eurozone. Looking ahead, the contribution of net exports to economic growth in Eurozone sets to diminish against the backdrop of trade tensions between the U.S. and its trade counterparts flaring up with a potentially negative impact on global economic growth and international trade. The normalization of monetary policy is foreseen to remain gradual with which low funding costs will continue to support the growth of domestic demand. We forecast Eurozone will grow by 2.0% and 1.8% in 2018 and 2019.

Fig. 12: Eurozone GDP growth YoY% Fig. 13: Eurozone Manufacturing PMI (Markit) 3.0 62 2.5 60 2.0 58 1.5 56 1.0 54 0.5 52 0.0 (0.5) 50 (1.0) 48 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Jun-16 Jun-17 Jun-18 Oct-16 Oct-17 Oct-18 Feb-16 Apr-16 Feb-17 Apr-17 Feb-18 Apr-18 Sep-16 Sep-17 Sep-18 Dec-16 Dec-17 Dec-18 Aug-16 Aug-17 Aug-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 (1.5) May-16 May-17 May-18

*CEBI Forecasts *December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg Fig. 14: Eurozone Service PMI (Markit) Fig. 15: Eurozone Unemployment rate (%) 59 13.0 58 12.0 57 11.0 56 10.0 55 9.0 54 8.0 53 7.0 52 6.0 51 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Jun-16 Jun-17 Jun-18 Oct-16 Oct-17 Oct-18 Feb-16 Apr-16 Feb-17 Apr-17 Feb-18 Apr-18 Sep-16 Sep-17 Sep-18 Dec-16 Dec-17 Dec-18 Aug-16 Aug-17 Aug-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 May-16 May-17 May-18 5.0 2012 2013 2014 2015 2016 2017 2018*

*December 2018 *October 2018 Source: Bloomberg Source: Bloomberg

Fig.16: Eurozone headline inflation and core Fig.17: Euro/USD inflation YoY% 3 1.4 2.5 1.35 2 1.3

1.5 1.25

1 1.2

0.5 1.15 1.1 0 2012 2013 2014 2015 2016 2017 2018* 1.05

Eurozone Inflation (%) Eurozone Core Inflation (%) 1 2012 2013 2014 2015 2016 2017 2018*

*Average January-to-November *14th December 2018 Source: Bloomberg Source: Bloomberg Fig.18: Eurozone Equity Market Performance

14000 12000 10000 8000 6000 4000 2000 0 2011 2012 2013 2014 2015 2016 2017 2018*

FTSE 100 DAX CAC 40

*14th December 2018 Source: Bloomberg

Japan: Strengthening global economic relationships to resist protectionism

Japan’s economy shows signs of modest growth, attributing to the expansionary fiscal and monetary policies of “Abenomics”. Although 3Q2018 GDP growth plunged 2.5% YoY on the temporary disruption of economic activities caused by a series of serious natural disasters, the Japanese economy still enjoyed stable growth momentum with the low unemployment rate of 2.4% in October. The growth was driven by a combination of ongoing improvements in economic activities and corporate profit growth driven by surging domestic and overseas demand. The Bank of Japan (BOJ) has still maintained expansionary monetary stances to fuel the economy with excessive liquidity, buying huge amounts of Japanese government bonds and taking a key interest rate into negative territory. The BOJ’s quantitative easing policy has succeeded to restore and maintain the price level at positive territory with inflation and core inflation (excluding food and energy) reaching 1.4% and 0.4% YoY in October. Looking forward, accommodative financial conditions led by the BOJ’s quantitative easing policy will continue to embrace moderate expansion of Japan's economy. Business fixed investment continues to edge up with corporate profits and projects intended for Olympic Games. Private consumption is also expected to follow a moderate

increasing trend as the employment and income situation continues to improve. The inflation rate stays at low positive level but improvement in the economic and employment conditions will continue to drive up the price level. Despite Japan’s economic momentum pointing to stable path, Trump’s protectionist measures pose risks to economic outlook of Japan’s economy as the U.S. and Japan have deeply rooted bilateral trade relationship. In sum, stepping up financial cooperation and deepening economic and financial stability with other trading partners, namely China and Eurozone, will help counterbalance the protectionist pressures, thus strengthening Japan to sustain healthy recovery of the economy.

Fig.19: Japan GDP growth YoY% Fig.20: Japan Manufacturing PMI (Markit) 4 56.0 55.0 3 54.0 2 53.0 52.0 1 51.0 0 50.0 49.0

-1 2012 2013 2014 2015 48.0 1Q2016 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017 3Q2017 4Q2017 1Q2018 2Q2018 3Q2018 -2 47.0 Jul-17 Jul-18 Jan-17 Jan-18 Jun-17 Jun-18 Oct-17 Oct-18 Apr-17 Apr-18 Feb-17 Sep-17 Feb-18 Sep-18 Dec-17 Dec-18 Aug-17 Aug-18 Nov-17 Nov-18 Mar-17 Mar-18

-3 May-17 May-18

Source: Bloomberg Source: Bloomberg Fig.21: Japan Service PMI (Markit) Fig.22: Japan inflation and core inflationYoY% 54.0 3

53.0 2.5 2 52.0 1.5 51.0 1 50.0 0.5 0 49.0 -0.5 Jul-15 Jul-16 Jul-17 Jul-18 Jan-15 Jan-16 Jan-17 Jan-18 Oct-15 Oct-16 Oct-17 Oct-18 48.0 Apr-15 Apr-16 Apr-17 Apr-18 -1 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Sep-16 Sep-17 Sep-18 Nov-16 Nov-17 Nov-18

Mar-16 Mar-17 Mar-18 CPI Core CPI May-16 May-17 May-18

Source: Bloomberg Source: Bloomberg Fig.23: Japan Unemployment rate (%) Fig.24: Japan’s exports (%) 3.6 20 3.4 3.2 15 3 2.8 10 2.6 2.4 5 2.2 2 0 Jul-17 Jul-18 Jan-17 Jan-18 Jun-17 Jun-18 Oct-17 Oct-18 Apr-17 Apr-18 Feb-17 Sep-17 Feb-18 Sep-18 Dec-17 Aug-17 Aug-18 Nov-17 Mar-17 Mar-18 May-17 May-18 Jul-15 Jul-16 Jul-17 Jul-18 Jan-15 Jan-16 Jan-17 Jan-18 Oct-15 Oct-16 Oct-17 Oct-18 Apr-15 Apr-16 Apr-17 Apr-18 -5

Source: Bloomberg Source: Bloomberg

Fig.25: Japan’s Equity Market Performance YoY % Fig.26: USD/Yen 25000 116

24000 114

23000 112

22000 110

21000 108

20000 106

19000 104

18000 102 Jul-18 Jul-18 Jan-18 Jun-18 Oct-17 Oct-18 Apr-18 Sep-17 Feb-18 Sep-18 Jan-18 Dec-17 Dec-18 Jun-18 Aug-18 Oct-17 Oct-18 Oct-18 Nov-17 Nov-18 Apr-18 Sep-17 Sep-17 Feb-18 Sep-18 Mar-18 Dec-17 Dec-18 Aug-18 Aug-18 May-18 Nov-17 Nov-17 Nov-18 Mar-18 Mar-18 May-18 May-18 Source: Bloomberg Source: Bloomberg

Emerging Asia: Growth to ease further

The prospect of rising interest rate, deterioration of external trade environment, slowdown of developed economies, dollar strength and weakness of currencies have contributed to slower growth of emerging Asia (EA) economies which include ASEAN countries and India. These exogenous factors continues to exert downward pressure on growth momentum by amplifying the existing structural weaknesses. Guarding against the continuous capital outflow and currencies depreciation seen in the recent months is of paramount importance as growth prospects and asset prices in the region demonstrate downtrend, which could hamper domestic demand and trigger a vicious cycle of economic downturn.

Unlike its emerging peers, India’s economy is expected to remain sound in 2019. Even though its economic growth decelerated slightly, the overall GDP growth for 2018 and 2019 is expected to remain at above 7% YoY, supported by various reform packages to open up sectors, reduce red tape, promote continuous capital inflow and maintain a steady investment for infrastructure projects. India will be the bright spot in EA in 2019. The accommodative stance of the Reserve Bank of India (RBI) will help boost consumption, investment, and market confidence. Against the backdrop of an uncertain global outlook, the Indian government would need to initiate proactive measures to maintain its current growth pace and persevere with the revitalization in the manufacturing sector and acceleration of investment in infrastructure projects. We project its overall GDP growth to be 7.4% YoY and 7.6% YoY for 2018E and in 2019E.

ASEAN’s economies are expected to post modest growth in 2019 as the external environment has turned less accommodating. ASEAN’s economic growth decelerates on back of deteriorating external sector driven by rising global trade tensions. Looking forward, the normalization of monetary policy in the U.S. and Eurozone could trigger capital flow volatility, which could interact with and exacerbate balance sheet weaknesses in a number of economies. But most of ASEAN economies appear relatively better positioned to deal with external shocks amid stronger economic fundamentals. By factoring in the positive signs of economic improvement in past several years, we anticipate ASEAN countries will face slower growth rather than economic recession in 2019.

Fig.27: India GDP growth YoY% Fig.28: USD/Indian Rupee (INR) 75 11 10 70 9 65 8 7 60 6 55 5 4 50 3 2 45 40 2010 2011 2012 2013 2014 2015 2016 2017 2018*

* CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind

Fig.29: Singapore GDP growth YoY% Fig.30: USD/ Singapore dollar (SGD) 16 1.5 14 12 10 1.4 8 6

4 1.3 2 0

2010 2011 2012 2013 2014 2015 2016 2017 1.2 2018* 2019*

1Q2018 2Q2018 3Q2018 2010 2011 2012 2013 2014 2015 2016 2017 2018*

* CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind Fig.31: Malaysia GDP growth YoY% Fig.32: USD/Malaysian Ringgit (MYR) 8 5.0 7 4.5 6 5 4.0 4 3 3.5 2

1 3.0 0 2.5 2010 2011 2012 2013 2014 2015 2016 2017 2018*

* CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind Fig.33: Thailand GDP growth YoY% Fig.34: USD/ Thai Baht (THB)

8 37 7 36 6 35 5 34 4 33 3 32 2 31 1 30

0 29 28 2010 2011 2012 2013 2014 2015 2016 2017 2018* 2019* 2010 2011 2012 2013 2014 2015 2016 2017 2018* 1Q2018 2Q2018 3Q2018 * CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind

Fig.35: Indonesia GDP growth YoY% Fig.36: USD/ Indonesian Rupiah (IDR) 7 15,000 6.5 14,000 6 5.5 13,000 5 12,000 4.5 4 11,000 3.5 10,000 3 2.5 9,000 2 8,000 2010 2011 2012 2013 2014 2015 2016 2017 2018* 2019* 1Q2018 2Q2018 3Q2018 * CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind Fig.37: Philippines GDP growth YoY% Fig.38: USD/Philippine Peso (PHP) 8 54

7 52

6 50

5 48

4 46

3 44

2 42 40 2010 2011 2012 2013 2014 2015 2016 2017 2018*

* CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind Fig.39: Vietnam GDP growth YoY% Fig.40: USD/Vietnamese Dong (VND) 8 24,000 23,500 7 23,000 6 22,500 22,000 5 21,500 21,000 4 20,500 3 20,000 19,500 2 19,000

* CEBI Forecasts * 14 December 2018 Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind

2019 China Economic Outlook

China: Growth deceleration in the wake of trade war

The second half of 2018 is marked by surging global volatility and cyclical slowdown in economic activities of China. China economic growth has shown decelerating trend as 3Q2018 GDP growth only posted 6.5% YoY, lower than 1H2018’s 6.8%. Surrounded by Trump’s tariffs and heightened geo-political risks that weigh on global growth, China’s economy will continue to face derailed growth momentum, indicated by mixed trend of major economic indicators. In face of unfavorable economic environment, China has launched intensive stimulus measures to revive growth momentum.

The latest economic indicators from China in November 2018 showed that China’s economy is entering the stage of moderating growth.

FAI demonstrated uptrend in November. FAI grew at 5.9% YoY in 11M2018, exceeding consensus estimate of 5.8% and 10M2018’s 5.7%. The rebound of FAI was mainly driven by pick-up of investment in manufacturing activities (+9.5% YTD YoY vs 10M2018’s 9.1%) while investment in infrastructure and real estate stayed unchanged. In general, the government’s recent efforts to implement more infrastructure projects and release more liquidity to support manufacturing industries should help push up the growth of FAI. We believe that acceleration of FAI in different sectors will continue to become major growth driver of China’s economy.

Industrial production softened in November. In November, industrial production expanded by 5.4% YoY, below consensus estimate and October’s 5.9%. General growth of outputs in 11M2018 slowed to 6.3% YoY. Expansion of overall manufacturing activities in most product categories were the major drivers. In particular, the value-added growth of “Computer, Communication Equipment and Other Electronic Equipment”, “Manufacture of Special-Purpose Machinery”, “Production and Supply of Electric Power and Heat Power” and “Manufacture of Medicines” went up significantly by 13.4% YoY, 10.7% YoY, 9.7% YoY and 9.7% YoY in 11M2018. In sum, the growth headwinds from trade war have softened the domestic and external demand, thus decelerating the growth of industrial production.

Retail sales slowed further in November. Retail sales continued to witness a decelerating trend in November as YoY growth dropped to 8.1%, lower than consensus estimate of 8.8% and October’s 8.6% while 11M2018 retail sales decelerated slightly by 9.1% YoY from 10M2018’s 9.2%. National online retail sales reached Rmb8,068.9 bn in 11M2018, posting a YoY growth of 24.1% which was below 10M2018’s 25.5%. Cooling retail sales in November was mainly due to negative market sentiment of trade war and weakening wealth effects from correction of financial markets. In general, retail sales growth for the first eleven months of 2018 was mainly driven by sizeable growth in “Petroleum and Related Products” (November: 8.5%, 11M2018:14.0%), “Commodities” (November: 16.0%, 11M2018:13.4%), “Cosmetics” (November: 4.4%, 11M2018:10.5%), and “Furniture” (November: 8.0%, 11M2018:9.8%). Going forward, retail sales is likely to pursue stable growth path as services consumption will emerge to be the major growth driver.

Consumer inflation softened in November and 11M2018. China's November CPI inflation edged down to 2.2% YoY (-0.3% MoM), lower than consensus estimate of 2.4% and October’s 2.5%. The first eleven months of CPI inflation reached 2.1% YoY. The latest slowdown in general price level was mainly due to a month-on-month decrease in food price by 0.3%, with which price of fresh vegetables dropped 12.3% due to ample supply while price of pork posted negative growth of 0.6% on the outbreak of swine virus in pigs. In general, China’s CPI inflation remained stable at the range between 2% and 2.5%. In addition, China’s producer prices posted a positive growth of 2.7% YoY (-0.2% MoM) in November, standing in line with the consensus estimate but lower than October’s 3.3%. The deceleration of producer prices was mainly attributed to falling prices of oil and related industries under the influence of international oil price change, particularly the producer price index of ‘Extraction of Petroleum and Natural Gas’ dropped by 7.5% MoM (October: +6.3%) and ‘Petroleum, Coking, and Nucleus Fuel Processing’ decreased by 3.3% MoM (October: +3.1%) for November. The rise of factory prices during the eleven months of 2018 reached 3.8%, demonstrating a stable and upward trend. In general, consumer prices and factory-gate prices remained steady, indicating that China’s stable economic momentum is still on track.

11M2018 exports continued to surge on ‘front-loading’ impact of shipments before implementation of new tariffs hikes. China’s external trade has shown year-on-year moderation in November with exports and imports growing at 10.2% YoY and 7.8% YoY, below consensus estimate of 13.8% and 18.3% and October’s 20.0% and 25.7%. Trade surplus reached RMB 306.04bn, larger than the consensus estimate of RMB 226.5bn and October’s 238.76 bn. For the first eleven months of 2018, China’s exports retained the strength to grow 8.2%, exceeding 10M2018’s 7.9% while imports increased by 14.6%, below 10M2018’s 15.4%. China's November exports to the U.S. rose 9.8% YoY while imports dropped 25% YoY, reflecting significant reduction of China’s purchases from the U.S. The trade surplus with the U.S. expanded to USD 293.5 billion for 11M2018, up from USD 251.3 billion during the same period in 2017. In sum, despite the ceasefire of trade war for 90 days, the market still fears of new tariffs hikes. International purchasers rushed out shipments and pushed up total exports of China. The ‘front-loading’ impact is likely to fade in coming months as international demand cools. Waning restocking demand due to slowdown of China’s economy is expected to be offset by China’s pledges to purchase more U.S products, thus stabilizing import demand in coming months. In our view, China's external trade growth is expected to remain on a stable track in 2018.

Monetary indicators demonstrated uptrend in November. November’s monetary indicators showed accelerating trend as the People Bank of China (PBOC) aims to keep ample liquidity in the financial system to cushion the slowing economy. The new loans rebounded to Rmb 1.25tr in November, exceeding consensus estimate of Rmb 1.15tr and October’s Rmb 697bn while M2 growth remained stable at 8% in November, standing in line with consensus estimate and October’s figure. The aggregate financing reached Rmb 1.52tr, exceeding consensus estimate of Rmb 1.35tr and October’s Rmb 743bn. In sum, the fourth RRR cut in October began to unleash the potential credits into the economy while the PBOC’s move to increase the amount of reloans and rediscount to support the financing of small and micro enterprises as well as private companies has revived growth momentum of credits. Prudent and neutral monetary stance of the PBOC remains unchanged, thus cultivating a stable monetary and financial

environment for China’s economy. The PBOC will maintain prudent loosening of liquidity to strengthen growth momentum of China’s economy.

Revitalizing growth momentum in sight

Despite the ceasefire of escalating trade tensions for 90 days, the trade war woes have already demonstrated signs of damages to China, denting growth momentum and triggering substantial volatilities in financial markets. The halting move by the U.S. to keep the tariff rate at 10% on $200 billion worth of Chinese goods for 90 days will partially alleviate the growth headwind against China’s economy. However, China’s economy still faces moderation of growth, exacerbated by existing trade tariffs plan, weak market sentiment and correction of stock market. The latest official manufacturing PMI dropped from 50.2 in October to 50.0 in November, below consensus estimate of 50.2 and the weakest level in over two years, thus reflecting the deceleration of growth momentum. In our view, the temporary ceasefire of trade war along with intensive stimulus measures will help strengthen growth of economic activities, thus ensuring soft- landing of the economy.

Transitioning from a phase of rapid growth to a stage of high-quality economic development, China is leveraging its strong economic fundamentals to promote economic growth through more reliance on domestic demand. Looking into 2019, the major objective of the Chinese government will be to strike a balance between revival of growth momentum against external headwinds and continuation of structural reforms while maintaining proper economic and political stability. Cooling trading activities, mounting geo-political risks, tightening stance of the U.S. monetary policy and dollar strength remain as the major threats to China’s economy but China’s economic fundamentals remain sound and we believe the overall macroeconomic conditions remain stable. Looking forward, ongoing policy stimulus hedging against the global headwinds continues to be the driver of China’s growth momentum with which domestic demand will play a key role to maintain modest growth of China in 2019. The policymakers implement prudent monetary easing and proactive fiscal stimulus, targeting for more sustainable investments in infrastructure, new industries and service sectors and enhancing reform efforts in key policy areas. The stimulus measures could boost domestic demand and efficiency while underpinning and sustaining the economic growth at a reasonable range. We forecast that GDP will grow 6.6% YoY and 6.3% YoY in 2018 and 2019.

Table 2: Economic forecasts for China (YoY %, or otherwise 2014 2015 2016 2017 1Q2018 2Q2018 3Q2018 2018E 2019E specified) Real GDP 7.3 6.9 6.7 6.9 6.8 6.7 6.5 6.6 6.3 FAI (YTD YoY %) 15.7 10.0 8.1 7.2 7.5 6 5.4 6.5 7.3 Retail Sales 12.0 10.7 10.4 10.2 9.8 9.0 9.0 9.2 9.0 Exports (RMB) 4.9 (1.9) (1.9) 10.8 7.4 2.6 10.0 8.9 (5.0) Imports (RMB) (0.6) (13.2) 0.6 18.7 11.7 11.2 19.1 15.4 (6.5) Total trade (RMB) 2.3 (7.0) (0.9) 14.2 9.4 6.4 14.1 11.8 (5.7) CPI 2.0 1.4 2.0 1.6 2.2 1.8 2.3 2.2 2.0 PPI (1.9) (5.2) (1.4) 6.3 3.7 4.1 4.1 3.8 3.0 M2 12.2 13.3 11.3 8.2 8.2 8.0 8.0 8.2 8.5 Exchange Rate 6.2040 6.4936 6.9467 6.5069 6.2745 6.6225 6.8685 6.8973 6.7939 (USD$/CNY)

Source: NBS, Bloomberg , CEBI estimates

Fig. 2: China Exports and Imports (RMB) Fig. 1: China CPI and PPI (YoY %) (YoY %) 8 30 25 6 20 4 15

2 10 5 0 0 -2 -5 -10

-4 2016-01 2016-02 2016-03 2016-04 2016-05 2016-06 2016-07 2016-08 2016-09 2016-10 2016-11 2016-12 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11 -15 -6 CPI PPI Total trades Exports Imports

Source: Wind, Bloomberg Source: Wind, Bloomberg Fig. 3: China’s trade surplus (RMB bn) Fig. 4: China's urban unemployment rate (%)

450 5.2 400 5.1 350 300 5.0 250 4.9 200 150 4.8 100 4.7 50 0 4.6 -50 -100 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11 2016-01 2016-02 2016-03 2016-04 2016-05 2016-06 2016-07 2016-08 2016-09 2016-10 2016-11 2016-12 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

Source: Wind, Bloomberg Source: Wind, Bloomberg Fig. 5: FAI (YTD YoY %) Fig. 6: Real Estate Investment (YoY %) 10 11

9 10

8 9

7 8

6 7

5 6 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

Source: Wind, Bloomberg Source: Wind, Bloomberg

Fig. 7: Industrial Production (YoY %) Fig. 8: Retail sales (YoY %) 17 11.5 16 15 14 11.0 13 12 10.5 11 10 10.0 9 8 7 9.5 6 5 9.0 4 3 8.5 2 1 0 8.0 -1 -2 -3 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11 2016-01 2016-02 2016-03 2016-04 2016-05 2016-06 2016-07 2016-08 2016-09 2016-10 2016-11 2016-12 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

Source: Wind, Bloomberg Source: Wind, Bloomberg Fig. 9: Online Retail Sales (YoY %) Fig.10: China stock market performance 40 25 38 36 15 34 5 32 30 -5 2015 2016 2017 2018* 28 26 -15 24 -25 22 -35 Shanghai Composite Index Shenzhen Component Index CSI300 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

Source: Wind, Bloomberg * 14th Dec 2018 Source: Wind, Bloomberg

2019 China Policy Outlook

China policy outlook for 2019

Surrounded by trade disputes, downward pressures of renminbi and global economic slowdown, China’s economy faces weakening momentum in 3Q18 and forward-looking economic indicators point to a modest deceleration in economic activities in coming quarters. The Politburo, a top decision-making body of China’s Communist Party signaled clearly that China will step up efforts to support growth of the economy. Concurring with the country’s structural rebalancing goals, China’s policy is characterized by prudent monetary easing and aggressive fiscal expansion. The People Bank of China (PBOC) will continue to deploy monetary easing measures to support stable economic growth while keeping inflation in the range of 2%-3%. Meanwhile, both the central and the local governments will put in place more fiscal policies to boost investment and development in infrastructure and new strategic industrial sectors. Regional and rural infrastructure, investment in utilities, as well as subsidized housing construction will continue to be supported by government funding and bank lending. In sum, China will continue to fine-tune its existing accommodative macroeconomic policies to boost growth momentum in 2019.

1. Monetary policy prioritizes prudent and neutral stance in liquidity management Accommodative liquidity management with a prudent and neutral stance will continue to be a priority of monetary policy in 2019. Slowing economic momentum with weakening RMB will exert greater pressure on the PBOC to manage domestic liquidity. With the aim to boost the stable development of the real economy, optimize the liquidity structure of commercial banks and financial markets, lower financing costs, and support small businesses, private enterprise and innovation, the People’s Bank of China (PBOC) have launched four cuts in the required reserve ratio (RRR) in 2018, reducing the RRR for big banks to 14.5 percent and for smaller banks to 12.5 percent, unleashing a net of RMB2.3 trillion for the monetary market and cultivating an appropriate monetary and financial environment for China’s economy. Governor of the PBOC, Yi Gang, pledged an array of policies to widen financing channels for private companies, small- and medium-sized enterprises. China will continue to maintain a prudent and neutral monetary policy environment to support economic growth.

Overall, the escalating trade tensions between the U.S. and China, the U.S. monetary tightening and depreciation of emerging market (EM) currencies are expected to exert pressure on China’s economic outlook. RRR cuts in 2018 along with several monetary easing measures announced in October unleashed trillions of liquidity in the market, helping to strengthen growth momentum of China’s economy. Given the depreciation pressure of RMB and the need to revive economic momentum, PBOC would inject more liquidity into the interbank market through targeted RRR cuts, reverse repo and medium-term lending facility (MLF). RRR cut will be deployed as the principal tool to strengthen the growth momentum of real economy in 2019. We forecast the PBOC would lower more RRR cuts again to revive the growth momentum of real economy in 2019. These monetary easing measures will allow for more flexible responses to accommodate capital demand in 2019. Accordingly, we expect the annual new bank loan target to be between RMB 17.2tr and RMB 17.7tr for 2019E (2018E:

RMB 16.2tr); consequently, 2019E M2 growth would be 8.5% YoY (2018E: +8.2% YoY).

Fig. 1: New loans (RMB bn) and M2 (YoY %) Fig. 2: Aggregate Social Financing (RMB bn) 12 3,500 4,000 10 3,000 3,500 2,500 3,000 8 2,000 2,500 6 1,500 2,000

4 BillionRMB 1,000 1,500 1,000 2 500 500 0 0 0 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

New Loans (RHS) M2 (LHS) 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11

Source: Wind, Bloomberg Source: Wind, Bloomberg

2. Expansionary fiscal policy remains intact to boost domestic demand A proactive fiscal policy stimulating domestic demand will be crucial for stimulating economic growth in 2019. Tax cuts and subsidies can be expected to boost national income and consumption. Public spending on education, healthcare, and poverty relief will also increase. The tax cuts on both enterprises and households will bring significant benefits to boost consumption and increase incentives for private investment. Entering the 2nd last year of China’s 13th FYP (2016-2020), we expect the central government to ramp up agricultural reforms and infrastructure investments, such as highways and railway construction, electricity grid upgrades, and resource development in the central and the western provinces. More public–private partnership (PPP) projects in municipal construction, environmental protection, transportation, traveling, and land development will be launched. Infrastructure investment will rise in 2019. Surging government spending will result in larger fiscal deficit, but room for fiscal stimulus is still ample.

Fig. 3: Fiscal deficit to GDP (%) Fig. 4: Infrastructure investment (YoY%) 4.5 20 4 18 16 3.5 14 3 12 2.5 10 8 2 6 1.5 4 1 2 0.5 0 0 2012 2013 2014 2015 2016 2017

* Source: IMF Source: Bloomberg, Wind

3. Renminbi’s turbulence remains unchanged in 2019 Global foreign exchange (FX) market turbulence driven by U.S. rate hikes, trade disputes and geo-political risks has weakened currencies in the emerging market. The normalization of U.S. monetary policy sends the USD soaring while a host of other currencies tumbling. Mounting global economic uncertainties undermine investor confidence in emerging market assets, triggering a new round of capital outflow. The weakening of emerging market currencies intensifies in 2H18, reducing the momentum of recovery in the emerging economies. Renminbi is of no exception, with year-to-date depreciation against the USD accelerated to 6.2% in December from 1.8% in 1H2018. We believe turbulence in the FX market will continue in 2019.

China’s exchange rate mechanism has undergone major changes in recent years to facilitate the internationalization of renminbi. Notably, the process will be marked by structural adjustments in the economy and reforms in the exchange rate mechanism. Recent weakness of the renminbi has been caused by a slowing global economic momentum, ongoing trade disputes and dollar strength which triggers strong selling pressures. Divergence in monetary policies between the U.S. and other major economies has driven investment to the USD assets, pushing up the USD against other major currencies around the world. Although the bilateral CNY against the USD demonstrates a depreciating trend, RMB remains largely stable against a basket of global currencies. In our view, greater volatility in RMB can be expected due to uncertainties surrounding economic outlook. We forecast RMB per USD for 2018E and 2019E to be 6.8973 and 6.7939.

Fig.5: CNY and CNH Fig.6: CNY Trading Volume (USD mn)

8000 7.5 7000 7 6000 6.5 5000 6 4000

5.5 3000 2012 2013 2014 2015 2016 2017 2018* 2000

CNY CNH Jul-17 Jul-18 Jan-17 Jan-18 Sep-17 Sep-18 Nov-17 Nov-18 Mar-17 Mar-18 May-17 May-18

*14th Dec 2018 Source: Bloomberg Source: Bloomberg Fig.7: China Forex Reserve (USD bn) Fig.8: PBOC Funds Outstanding for Foreign Exchange (RMB bn) 3,250 100 3,200 0 -100

3,150 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Sep-16 Sep-17 Sep-18 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 -200 May-16 May-17 May-18 3,100 -300 3,050 -400 3,000 -500 2,950 -600 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18

Sep-16 Sep-17 Sep-18 -700 Nov-16 Nov-17 Nov-18 Mar-16 Mar-17 Mar-18 May-16 May-17 May-18

Source: Bloomberg Source: Bloomberg

2019 Hong Kong Economic Outlook

2019 HK economic Outlook: Economic momentum to turn softening Echoing global headwinds in the form of on-going trade disputes, interest rate hike, decelerating global growth momentum and escalation of geo-political risks, Hong Kong (HK) economy is seen to face easing of economic activities. Economic activities have only posted growth of 2.9% YoY during 3Q2018, lower than 1Q2018’s 4.6% and 2Q2018’s 3.5% while consumption demonstrated slowing growth momentum at 5.2% YoY, lower than 1H2018’s 7.4%. The deceleration was mainly due to fading asset price-driven wealth effect both from correction of stock market and property market as well as depreciation of renminbi undermining the spending power of mainland tourists. As a small and open economy, HK economic outlook mainly hinges on global economic conditions. Pessimistic sentiment over near-term economic outlook surges as uncertainties in the external environment increased markedly. After a strong performance in 2017 and the first half of 2018, HK economy is projected to ease up in 4Q2018 and 2019 as correction of housing market and stock market point to more negative wealth effects while hiking downside risks of global economy affect growth of trading and financial activities. For domestic environment, the theme for 2019 outlook will be the shift to the balance of growth drivers, with consumption and investment rather than external trade contributing more to economic growth. For external environment, gradual U.S. rate hikes and slowing China’s economic growth remain as the key threats to HK economy. In general, with strong fiscal position and low unemployment rate, HK medium-term outlook remains resilient. The recent openings of the Guangzhou-Shenzhen-Hong Kong Express Rail Link and Hong Kong-Zhuhai-Macau mega bridge enhance economic links with China which will spur HK economic benefits. Also, HK is destined to play an important role in the development of “Belt and Road” and “The Greater Bay Area” initiative. The strengths and unique position as the gateway connecting overseas businesses with their Mainland counterparts have strengthened HK as the key player of the initiatives. With potential strengths and threats on the economy, we remain positive towards HK economic growth on the back of balanced and solid economic fundamentals. For 2018 and 2019, we forecast HK economy to grow modestly by 3.6% and 3.0%.

The U.S.-China trade war weakens HK external trade sector. The U.S. trade conflicts with China is weighting on global economic sentiment as well as trade and investment activities. HK, which has served as the re-export hub between the two nations for decades, and whose biggest trade partner is China, is inevitably affected. Despite the temporary ceasefire of trade war, the existing tariff plan has damaged the growth momentum of HK’s external merchandise trade. As most of Hong Kong’s exports are re-export of products produced by mainland manufacturers, the external trade sector will be hit by the slowdown of global trade.

Consumption growth remains as the key driver of HK economy, contributing 69% of HK GDP. HK unemployment rate reached a 20-year record low of 2.8%, indicating that the domestic labor market remains tight which supports the growth of household income and maintains growth momentum of consumer spending. However, sharp correction of stock market over 21% since January 2018 and dipping property prices are generating heavy negative wealth effects, which decelerate the consumption momentum. In addition, retail sales from mainland

visitors have provided support for consumption as number of mainland visitors grew strongly at 13.0% YoY in the first ten months of 2018 but the year-to-date depreciation of renminbi around 5.7% undermines the purchasing power of mainland visitors which will soften growth of retail sales. In sum, decreasing expenditures of household and tourists will result in further slowdown in consumption growth.

The property market gathers gloom amid surging mortgage rates. HK residential property market demonstrates slowing signs, driven by rate hikes and uncertain economic conditions. The private home prices have declined since August with October’s drop extending to 2.4% YoY, indicating more correction ahead. In sum, Hong Kong has high population with shortage of land with which resilient demand for housing keeps pushing up property prices. With low interest rates and unemployment rate, Hong Kong citizens have demonstrated strong affordability to purchase properties both for living and investment. With outlook for the property market deteriorating amid rising interest rates and unstable economic environment, property market is set to experience correction of 5% to 10% in the next three months.

Tighter liquidity conditions triggers more rate hikes in Hong Kong. The U.S. Federal Reserve has conducted eight 25bps rate hikes since the end of 2015. As HK dollar has been pegged with U.S dollar since 1983, Hong Kong interest rate should follow U.S to rise to avoid liquidity outflow. However, in the past, due to ample liquidity flow into HK economy, the interest spread has not triggered substantial outflow of liquidity and Hong Kong interest rates still stay at low level. However, the continued outflow of liquidity within HK banking system reflected by falling aggregate balance from HK 179.7 bn in January 2018 to HKD 76.3 bn in November 2018 signals the end of ‘low interest rate’ environment. The uptrend of HK interest rate hikes will derail HK economic growth momentum.

“Belt and Road” and “The Greater Bay Area” initiative to extend medium-term growth momentum of HK economy. HK is one of the world’s most open economics with friendly business and investment environment characterized by free trade, free flow of capital and information as well as transparent regulatory regimes. HK economy is exposed to global economic conditions with which near- term economic growth may be affected by global economic turbulence. To further provide solid base for the economy to maintain sustainable growth, HK will play a greater role in the “Belt and Road” initiative and the “The Greater Bay Area” initiative. HK’s strength in human resources, financing, and connections with other countries could help the mainland enterprises explore overseas opportunities arising from these initiatives. Being an international financial center, Hong Kong is ready to act as a fundraising hub with its rich experience, talents and global networks. In addition, the recent openings of the Guangzhou- Shenzhen-Hong Kong Express Rail Link and Hong Kong-Zhuhai-Macau mega bridge further support HK’s integration into China’s trade and economic strategies. In sum, Hong Kong will work actively to modernize its regulatory framework, strengthen investor protection, and promote the diversification of services and products, thus enhancing growth strength of the economy.

Table 3: Economic forecasts for HK (YoY %, or otherwise specified) 2013 2014 2015 2016 2017 2018E 2019E Real GDP 3.1 2.8 2.4 2.2 3.8 3.6 3.0 Consumption 4.6 3.3 4.8 2.0 5.5 5.9 2.8 Investment 2.6 (0.1) (3.2) (0.3) 4 4.9 4.9 Government expenditure 2.7 3.1 3.4 3.3 3.4 3.7 3.5 Exports 7.8 1.0 (1.4) 0.7 5.5 4.9 3.6 Imports 8.3 1 (1.8) 0.9 6.3 5.9 3.6 Unemployment rate (%) 3.4 3.3 3.3 3.3 3 2.8 3.2 CPI 4.3 4.4 3 2.4 1.5 2.3 2.0

Source: Hong Kong Census, CEBI estimates

Fig. 1: HK GDP Growth YoY% Fig. 2: Unemployment rate (%)

5.0 3.5 4.5 3.4 4.0 3.3 3.5 3.2 3.0 3.1 2.5 3 2.0 1.5 2.9 1.0 2.8 0.5 2.7 0.0 2.6 2.5 2012 2013 2014 2015 2016 2017 2018*

* CEBI Forecasts * August to October Source: Bloomberg, Wind and CEBI Source: Bloomberg, Wind Fig. 3: HK Composite Consumer Price Index Fig. 4: HK's external merchandise trade YoY% (CPI) (%)

4.5 20 30 25 4 15 20 3.5 10 15 3 5 10 2.5 5 2 0 0 1.5 -5 Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18 Oct-16 Oct-17 Oct-18 Apr-16 Apr-17 Apr-18 -5 1 -10 -10 0.5 -15 -15 0 Exports Imports 2012 2013 2014 2015 2016 2017 2018*

* January to October Source: Bloomberg, Wind Source: Bloomberg, Wind

Fig. 5: Volumn of Total Retail Sales YoY% Fig. 6: Private Domestic - Price Indices by Grade (All District) 420 12.0 400 10.0 380 8.0 360 6.0 340 4.0 320 2.0 300 0.0 280 2012 2013 2014 2015 2016 2017 2018* (2.0) 260 (4.0) 240 (6.0) (8.0) 2016-01 2016-02 2016-03 2016-04 2016-05 2016-06 2016-07 2016-08 2016-09 2016-10 2016-11 2016-12 2017-01 2017-02 2017-03 2017-04 2017-05 2017-06 2017-07 2017-08 2017-09 2017-10 2017-11 2017-12 2018-01 2018-02 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10

* January to October * October Source: Bloomberg, Wind Source: Bloomberg, Wind Fig. 7: HK Aggregate Balance (HKD Million) Fig. 8: Total Visitors Arrival (YoY %) 200,000 25 180,000 160,000 20 140,000 15 120,000 100,000 10 80,000 60,000 5 40,000 0 20,000 2012 2013 2014 2015 2016 2017 2018* 0 -5

-10 Total Visitors Arrival (YoY %) Visitors Arrival From Mainland (YoY %) * 14th December 2018 * January to October Source: Bloomberg, Wind Source: Bloomberg, Wind

Investment strategy and themes for 2019 tment strategy and themes for 2018

2019 Investment Outlook: Entering a new era of investment cycle after correction in 2018 Derailed worldwide economic recovery halts the growth momentum of output and income. Stock markets across the globe have been on the downswing with heightened volatilities during 2018, which have been mainly driven by surging risk premium amid escalation of trade tensions, slowing global economic growth, rising interest rates and growing geo-political tensions. The economic and political uncertainties have intensified the stock market fluctuations. From a valuation perspective, the price-to-earnings (PER) of the U.S. is close to its historical average. As developed market shares become more expensive, emerging market stocks laggards, which have been faced substantial correction in 2018, are becoming more attractive to investors, and are expected to provide higher expected returns in 2019.

The world and China will confront with a series of challenges in 2019. Impact of tighter U.S. monetary policy as well as trade protectionism will continue to toughen the global business conditions. The Politburo statement in October laid out the clear signals to the market that China is facing downward pressures and policymakers are stepping out strong policy support to withstand global headwinds. China’s policy stance has turned to more accommodative in the face of trade war, slow-motion global growth and correction of China’s stock market. Measures for economic stabilization have launched intensively in 4Q2018, brightening near-term economic outlook of China in 2019. As such, optimism over a continued economic stabilization has been growing with which market sentiment begins to turn more positive. In general, we remain cautiously bullish on China and Hong Kong’s equity markets in 2019 and expect the following trends to occur:

• China will strengthen stabilization measures to ensure soft-landing of the economy • Renminbi will stabilize with a reasonable trading range • Cheap valuation and humble relative performance of equity market remain intact after correction in 2018 • Equity valuation will be revised upward on market sentiment.

Our sector and stock picks are based on the forward valuation and growth potential driven by the company’s earnings growth and their particular business environment.

Targets of HSI and HSCEI

The Hong Kong stock market has been downgraded partly on slower EPS growth in 2018E and 2019E due to slower global growth and depreciation of renminbi. The correction of Hong Kong’s stock market in 2018 is still considered as a potential laggard, with the HSI currently trading on 2018 forward PER multiples of 10, which is 20% lower than their respective 12-year average while Dow Jones industrial index and S&P 500 index are currently trading on 2018 forward PER multiples of 16.08x and 17.75x, which are closer to their respective 12-year average. The Hong Kong stock market has now become one of the investment hotspots again for potential rotation of investors’ portfolio investment. Since

global economic uncertainties remain intact in 2019, attractive equity returns in Hong Kong equity market should draw buying interest and it takes times for investors to restore investment confidence as they are still cautious about China and global economic outlook. After discounting for the uncertainties that have been priced-in in 2018 as well as the market concerns diminishing and corporate earnings improving in the coming year, we forecast that the HSI and HSCEI will slowly recover to reach 28,600 and 12,500, with PER multiples of 10.5x and 8.5x respectively by end-2019.

Eight Investment themes for 2019

1. China’s economic slowdown prompting infrastructure investment stimulus Infrastructure funding has suffered severely due to deleveraging efforts in 1H2018 with which infrastructure investment only grew at 3.7% in the first eleven months of 2018, significantly lower than 2017’s 19%. China’s recent measures for economic stabilization will boost investment in infrastructure projects that help enhance the income and welfare of households. These projects include water irrigation, agriculture, advanced equipment manufacturing, social housing, local airports in 2nd/3rd-tier cities, railways, and other large-scale projects. Investment in high value-added infrastructure projects will have an increasing impact on economic growth. Major infrastructure projects in railways, roads, energy, information technology, and industrial parks will commence in the coming years, favoring companies such as China Communications Construction Co Ltd (1800 HK), China Railway Construction Corp.(1186 HK) and China Railway Group (390 HK). Surging demand for construction services and materials will bring opportunities to China State Construction (3311 HK), Angang Steel (347 HK), CHALCO (2600 HK), CNBM (3323 HK) and CR Cement (1313 HK).

2. Consumption as the key growth driver China will leverage the fundamental role of consumption in promoting economic growth and enhance the framework of regulation underpinned by monetary policy and macro-prudential policy. China’s policymakers will strengthen efforts to transition China into a consumption- and services-driven economy, thus encouraging medium-high end consumption. Maintaining a stable economic growth and enlarging contribution of consumption to the economy are crucial in developing a prosperous society. Consumer discretionary sector such as auto will benefit from surging consumption. We favor Geely Auto (175 HK) and GAC Group (2238 HK). In addition, services sectors for consumers such as e- commerce, medical and health, insurance, tourism, and entertainment will gain from various policy changes and outperform China's overall growth. We believe companies including Tencent (700 HK), Ping An Insurance (2318 HK), Ping An Good Doctor (1833 HK), Shanghai Jin Jiang (2006 HK), Haichang Ocean Park (2255 HK) and Alibaba Pictures (1060 HK) will benefit.

3. “New economy” sector to enhance global competitiveness of China

China’s “New economy” sector will become the key to promote greater sophistication in the industrial sector. China will further implement the “Internet+” action plan, upgrading manufacturing capabilities by incorporating Internet and automation technologies into manufacturing and businesses. The initiative entails the integration of mobile Internet, cloud computing, big data, and automation with

modern manufacturing to foster new industries and business development in e- commerce, industrial Internet and Internet finance. Stocks including Tencent (700 HK), SMIC (981 HK), Ping An Good Doctor (1833 HK), Kingsoft (3888 HK), ZhongAn Online P&C Insurance (6060 HK) and China Literature (772 HK) will benefit from such initiative.

4. Pushing forward “Belt and Road” and “The Greater Bay Area” initiative The Belt and Road Initiative is the major infrastructure and investment schemes to grow China’s global economic connections. Major infrastructure projects in railways, roads, energy, information technology and industrial parks will commence in the coming years, favoring companies such as China Communications Construction Co Ltd (1800 HK), China Railway Group (390 HK) and China Machinery Engineering Corp. (1829 HK). Project financing for The Belt and Road projects favor HK banks including HSBC (5 HK), HangSeng Bank (11 HK), and BOCHK (2388 HK). In addition, the Greater Bay Area, which includes Guangdong, Hong Kong and Macau, generates around 12% of China’s GDP. Being China’s most affluent and dense region, the area’s development can link up city clusters with capabilities across sectors. Given its great potential, the Greater Bay Area is poised to be a landmark in China's economic reform. Major beneficiaries include property stocks include Country Garden (2007 HK), Agile (3383 HK), Logan (3380 HK), Shenzhen Investment (604 HK); logistics stocks include Guangshen Railway (525 HK), China Travel (308 HK) and Kerry Logistics (636 HK); infrastructure stocks include Guangdong Investment (270 HK) and Shenzhen Express (548 HK); consumption discretionary stocks Chow Tai Fook (1929 HK) and Sa Sa (178 HK).

5. Strengthening environmental initiatives China demonstrates great efforts to ensure sustainable development. It is expected that China will further implement more efficient environmental protection systems in coming years by accelerating the development of renewable energy, water treatment, and solid waste treatment. For water treatment and solid waste sectors, we prefer China Everbright International (257 HK), China Everbright Greentech Ltd (1257 HK) and Beijing Enterprises Water (371 HK). For the renewable energy sector, we favor CGN Power (1816 HK), China Singyes Solar (750 HK), Huaneng Renewables (958 HK), and Longyuan Power (916 HK). For new energy auto market, we prefer BYD Company (1211 HK).

6. China’s property market under restructuring China’s property market continues to see signs of stabilization with curbs on house purchases and tightening mortgage rules. Deceleration in home prices growth largely reflects the mismatch between demand and supply. Amid slowing growth prospects of residential property sales, growing inventory levels and tightening onshore liquidity, the downside risks of the sector are surging with further price correction around the corner. We expect that the existing tightening measures in the sector may remain in force as China is seeking stable development in property market in 2019, and measures will be implemented to prevent price surges in metropolises and growing inventories in small cities.

Property developers with focus on top-tier cities and those with commercial or luxury property exposure would be winners. Despite industry-wide growth, valuation of some developers with focus on first-tier cities is still attractive. Developers focusing on first-tier and second-tier cities, and those with

commercial or luxury property exposure would stand to benefit from current environment of property market. Beneficiaries will be COLI (688 HK), CR Land (1109 HK), and Shenzhen Investment (604 HK).

7. Slowdown of HK property sector on rising interest rate HKSAR government has launched announced several rounds of aggressive measures targeting to avoid the rapid increase in property prices. Surging interest rates along with strong policy move are expected to suppress investment demand that is believed to have driven up the property prices. We expect a reasonable correction in overall property prices is likely in near-term. Office and shopping malls landlords will outperform as strong rental demand are driving up rental yield. For property developers, we favor SHK Property (16 HK), CK Property (1113 HK), Wharf REIC (1997 HK), SWIRE Property (1972 HK) and REIT such as LINK REIT (823 HK) and Champion (2778 HK).

8. U.S rate hikes benefiting Hong Kong banks The U.S. Federal Reserve has conducted eight 25bps rate hikes since the end of 2015. Banks and the financial sector will enjoy the traditional benefits of higher interest rates as their profits are expected to increase after rate hikes because of the enormous cash reserves benefiting from higher yields. Also, customer accounts are paid less than the short-term rates, allowing banks to profit from the difference. This spread tends to rise throughout the rate hike cycle, increasing profits that go directly into the banks’ bottom line. In additional, rate hikes also tend to occur during strong economic expansion and periods of rising bond yields. These elements favor increased lending and capital utilization, with a surge in business and consumer loans adding to bank profits. Hong Kong banking sector is expected to benefit from U.S rate hikes as the U.S-HK currency peg will drive up the city’s interest rates. HK banks with high level of customer deposits will benefit from the increased rates and we prefer HSBC (5 HK), Hang Seng Bank (11 HK), Standard Chartered Bank (2888 HK) and BOC HK (2388 HK).

2019 Sector Outlook

Sector Outlook ─ China Banks

High dividend yield and low valuation, NPL is the key issue

Banks are having stable fundamentals Dominic Chan Mainland continues to step up regulations on banks, but on the Senior Equity Analyst other hand it improves the transparency of banks’ balance sheets [email protected] Banks are having high dividend and low valuation. Large banks (852) 2916-9631 are expected to outperform for 2 reasons. 1) Large banks have more channels to replenish capital，2) Pressures on capital are 17 Dec 2018 relatively lower Prefer CCB (939 HK) and ABC (1288 HK)

Risk resilience of banks increases: The macroeconomic growth of mainland slowed down, and RMB depreciated. Nevertheless, risk resilience of banks remains high. In 2018, loan amounts continued to rise while net interest margin widened, which led to a single digit growth in sector profit. At the same time, NPL is still under control, provision coverage has risen, and Key Data banks raised capital through various channels. Avg.18E P/E (x) 5.5 Avg.18E P/B (x) 0.72 China’s overall monetary policy is still relatively stable: The current Avg.18E Dividend Yield (%) 5.1 monetary policy is relatively stable. In Nov2018, new loans was Rmb1.25tn Source: Bloomberg, CEBI and M2 recorded 8% YoY growth. Throughout 2018, the required reserve ratio was lowered from 16% to 14.5% for large banks while that of small and medium-sized banks was lowered from 14% to 12.5%. At the same time, it is Sector Performance (%) expected that PBOC will continue to use monetary tools including SLF, MLF, 1-mth 0.3 SLO and PSL to release capital to the banking industry in 2019. 3-mth 1.4 YTD -3.9 Regulations on the financial industry launched: Mainland continuously Source: Bloomberg step up regulations on the banking sector, which includes 1) Implementing stricter IFRS 9 guidelines, 2) launching new financing policies, etc. We expect tighter regulations can improve the risk management as well as the transparency of banks’ balance sheets, which is beneficial to the industry in the long run. CEBI’s Stock Pick CCB (939 HK) “One two five” goal leads to uncertainties: According to the “One two five” ABC (1288 HK) goal set by China Banking and Insurance Regulatory Commission(CBIRC), in order to support private enterprises, the proportion of corporate loans to private enterprises has to be increased in the future. As the credit risks of private enterprises are higher, the goal is likely to increase the non-performing

loans of banks, causing uncertainties to the bank sector

Sector performance is expected to synchronize with the market: The Sector Performance sector fluctuated tremendously in 2018, we expect that earnings growth will Absolute Relative be around 7.9% this year, and that in 2019 will sightly slow down to 7.2%. 1-mth Looking forward to 2019, the sector performance is expected to go in line with the market. We prefer large banks, mainly because 1) Large banks have more channels to replenish capital, 2) Large banks face lower pressure when capital cost increases Prefer CCB (939 HK) and ABC (1288 HK): CCB is trading at 5.1x 2019E P/E, with 5.5% 2018E dividend yield. ABC is trading 5.0x 2019E P/E, with 6.0% 2018E dividend yield.

Risks: 1) RMB continues to weaken, 2) Banks raise rates asymmetrically, 3) Higher than expected NPL.

2018 China Banks results are keeping momentum

1) 3Q18 results showed that China Banks are having solid fundamentals.

In 3Q2018, total loan amount recorded a high single digit YoY growth, net interest margin widened, leading to revenue and profit growth. Among big 4 banks, ABC had the fastest growth in its net profits, followed by CCB.

CCB’s (939 HK) 3Q2018 revenue was Rmb 479.07bn, up 6.86% YoY, net profit was Rmb214.11 bn, up 6.4% YoY. During the period, the total amount of loans was Rmb13.77 tn, up 6.68% from the end of 2017, net interest margin was 2.34%, up 0.18 pp.

ABC’s (1288 HK) 3Q2018 revenue was Rmb457.49 bn, up 12.01% YoY, net profit was Rmb171.61 bn, up 7.3% YoY. During the period, the total amount of loans was Rmb11.30 tn, up 9.49% from the end of 2017, net interest margin was 2.35%, up 0.11 pp.

ICBC’s (1398 HK) 3Q2018 revenue was Rmb539.88 bn, up 6.64% YoY, net profit was Rmb240.12 bn, up 4.82% YoY. During the period, the total amount of loans was Rmb15.26 tn, up 7.24% from the end of 2017, net interest margin was 2.3%, up 0.13 pp.

BOC’s (3988 HK) 3Q2018 revenue was Rmb375.86 n, up 3.22% YoY, net profit was Rmb153.27 bn, up 5.34% YoY. During the period, the total amount of loans was Rmb11.70 tn, up 7.35% from the end of 2017, net interest margin was 1.89%, up 0.04 pp.

Fig 1: Changes in the amount of bank loans in Fig 2: Net Profit Margin in China Banks (%) the mainland

1,600,000 35,000 2.90

1,400,000 30,000 2.70 1,200,000 25,000 1,000,000 20,000 2.50 800,000 15,000 600,000 2.30 400,000 10,000 2.10 200,000 5,000 1.90 0 0

1.70

2013-01 2013-08 2014-03 2014-10 2015-05 2015-12 2016-07 2017-02 2017-09 2018-04 1.50

Financial institutions: loans balance

Financial institutions: new loans 2013-03 2013-09 2014-03 2014-09 2015-03 2015-09 2016-03 2016-09 2017-03 2017-09 2018-03 2018-09

Source: Wind Source: Wind

2) Loan distribution has changed- The proportion of retail loan increased.

In response to the current changes in economic environment, banks have put increased efforts on personal loans since the past few years. The proportion of personal loans increased year by year, and we expect the trend to continue.

3) Provision coverage has risen to cope with increases in bad debts.

In 3Q2018, the ratio of non-performing loans (NPL) slightly increases, but it is still in the controllable range. While the profit in 2018 increases, banks are also increasing impairment provision to improve their risk resilience, the overall provision coverage of banks is high.

Fig 3: Non-performing loan ratio of China Banks Fig 4: Provision coverage in China Bank (%) (%)

2.10 310.00 1.90 290.00 1.70 1.50 270.00 1.30

1.10 250.00 0.90 0.70 230.00 0.50 210.00

190.00

2013-03 2013-08 2014-01 2014-06 2014-11 2015-04 2015-09 2016-02 2016-07 2016-12 2017-05 2017-10 2018-03 2018-08 170.00 NPL : Commercial banks 150.00

NPL : State-owned banks

NPL : joint equity commercial banks

2013-03 2013-09 2014-03 2014-09 2015-03 2015-09 2016-03 2016-09 2017-03 2017-09 2018-03 2018-09

Source: Wind Source: Wind

4) Capital situation is improving steadily.

China banks are raising capital through various channels in 2018, the aggregate amount of funds raised in between banks increased. The capital adequacy ratio of banks is improving, and the funding plans of big 4 banks include:

1) BOC announced the issuance of Rmb 120 bn convertible bonds on Oct 2018.

2) CCB announced on 29Oct that it has completed the issuance of the second phase of the tier-2 capital bonds with an amount of Rmb40 bn. The bond is a 10- year fixed rate bond with a redemption right at the end of the fifth year with a coupon rate of 4.7%.

3) ICBC plans to issue no more than 1 billion preferred shares domestically, and raise Rmb 100 bn to supplement its capital. The plan is still subject to approval by regulatory authorities such as CBIRC and CSRC.

4) ABC announced the non-public issuance of A shares in July 2018, in order to raise Rmb 100 bn.

Fig 6: Wealth management product balance of Fig 5: Capital adequacy ratio of China Banks (%) China Banks (Rmb 100mn)

15.00 35.00 60.0%

14.00 30.00 50.0% 13.00 25.00 40.0% 12.00 20.00 30.0% 11.00 15.00 20.0% 10.00 10.00 9.00 5.00 10.0%

0.00 0.0%

2013-03 2013-08 2014-01 2014-06 2014-11 2015-04 2015-09 2016-02 2016-07 2016-12 2017-05 2017-10 2018-03 2018-08

Commercial bank: Capital adequacy ratio 2015-01 2015-05 2015-09 2016-01 2016-05 2016-09 2017-01 2017-05 2017-09

Commercial bank: Tier 1 capital adequacy ratio1 Wealth management product balance

Commercial bank: CET 1 capital adequacy ratio YoY (%)

Source: Wind Source: Wind

Authorities keep launching new regulatory measures

1) Authorities keep launching new regulatory measures on banks.

Starting from 1Jan, 2018, IFRS 9 was formally implemented to increase the provision requirements on banks. On 28Sep 2018, CBIRC issued “Measures for the Supervision and Management of Commercial Banks’ Financial Management Business, after issuing “Guidance on Regulating the Asset Management Business of Financial Institutions” on 27Apr, 2018. The key points include

1) Wealth management business has to get rid of “rigid payment”, and it cannot promise income and capital protection.

2) To strictly increase the investment requirements of non-standardized debt assets, prohibit the pool of funds, and prevent shadow banking risks and liquidity risks.

3) To classify unified liabilities and hierarchical leverage requirements, eliminate multiple levels of nesting, and suppress channel services.

4) To strengthen supervision and coordination, strengthen macro-prudential management and functional supervision. Following the new regulations on capital management, the mainland launched new financing policies, which helps eliminate the uncertainties of industry supervision.

“One two five” goal leads to uncertainties The “One two five” goal set by CBIRC worries the market. According to the goal, as of the end of Sep 2018, loans to private enterprises only account for 25% of total loans outstanding. On 7Nov, 2018, CBIRC proposed the “One two five” goal, stating that large banks have to lend no less than one third of their loans to private enterprises, small and medium sized banks have to lend no less than two third of their loans to private enterprises, and after three years, banks’ loans to private enterprises should account for no less than 50% of new corporate loans. Besides increasing the lending to private enterprises, there were other measures to lower the funding costs of private enterprises. As of the end of Sep 2018, 18 major commercial banks were lending to small and medium enterprises at an average interest rate of 6.23%, which was 0.7 pp lower than that in the first quarter, in order to provide support to private enterprises.

If the “One two five” goal is being implemented, the proportion of loans to private enterprises will increase. As the interest rate is not high enough while the credit risks are relatively high, this may increase the non-performing loans of banks.

Growth of new loans and M2 slowing down New loans in Nov2018 was Rmb1.25tn in China, while M2 grew by 8% YoY in Nov2018.

Fig 7: China’s new loan growth (%) Fig 8: China monthly M2 growth (%)

2,000,000 18.0% 35000 100.00% 1,800,000 16.0% 80.00% 30000 1,600,000 14.0% 60.00% 1,400,000 25000 12.0% 1,200,000 40.00% 10.0% 20000 1,000,000 20.00% 8.0% 15000 800,000 0.00% 600,000 6.0% 10000 4.0% -20.00% 400,000 5000 -40.00% 200,000 2.0% 0 0.0% 0 -60.00%

Jul-16 Jul-17 Jul-18 Jan-16 Jan-17 Jan-18

Oct-16 Oct-17 Oct-18 Apr-16 Apr-17 Apr-18 2013-01 2013-08 2014-03 2014-10 2015-05 2015-12 2016-07 2017-02 2017-09 2018-04

Amount (Rmb 100 mn) YoY(%) M2 YoY(%)

Source: Wind Source: Wind

2018 marked the start of a new cycle of lowering the required reserve ratio. As of the end of Nov2018, PBOC lowered the ratio three times. The ratio was lowered from 16% to 14.5% for large banks while that of small and medium-sized banks was lowered from 14% to 12.5%. In addition to lowering the required reserve ratio, the PBOC is using various measures to release funds to the market, which include SLF, MLF, SLO and PSL, of which MLF is the main tool. As at 5Nov, 2018, the MLF balance is about Rmb 4.9 tn.

The required reserve ratio of banks has dropped to a relatively low level. We believe that the PBOC will tend to use monetary policy tools to release funds to the market in 2019.

Fig 9: Reserve ratio of China Banks Fig 10: China’s MLF

60,000 450% 25.00 400% 20.00 50,000 350%

15.00 40,000 300% 250% 10.00 30,000 200% 150% 5.00 20,000 100%

0.00 10,000 50% 0% 0 -50%

Required reserve ratio : mid and small banks 2016-01 2016-04 2016-07 2016-10 2017-01 2017-04 2017-07 2017-10 2018-01 2018-04 2018-07 2018-10

Required reserve ratio :Large banks MLF balance YoY (%)

Source: Wind Source: Wind

Earnings growth will slightly slow down in 2019 After experiencing the earnings decline cycle in 2016 and 2017, the sector regained its growth momentum in 2018, and the full-year EPS growth is expected to be 7.9%. Looking forward to 2019, market expects the EPS growth of the sector will be 7.2%, meaning that the growth rate will slow down next year. For loans growth, the growth rate is expected to be slow down from 7.4% in 2018 to 6.1% in 2019.

Fig 11: China Banks’s EPS growth rate in Fig 12: China Banks’s loans growth rate in 2018/2019 2018/2019

12% 16% 2018E 2019E 2018E 2019E 10% 14% 8% 12% 6% 10% 4% 8% 2% 6% 0% 4% -2% 2% -4% 0% -6%

Source: Wind, CEBI Source: Wind, CEBI

Low valuation and high dividend yield

Fig 13: China Bank P/B and ROE comparison Fig 14: Core capital ratio for China Banks

15 (%) 16.00% CCB 14 14.00% ICBC 14 12.00% ABC 13 10.00%

13 8.00% PSBC 12 6.00% BOC CITIC 4.00% 12 2.00% 11 Bocom 0.00% 11 (x) 10

0.5 0.6 0.7 0.8 0.9 Source: Wind Source: Wind

Slowing global economic growth has increased uncertainties in the markets. We have selected stocks based on factors such as valuation, interest rate, earnings growth, ROE, and net interest margin.

Banks are currently trading at 2019E P/E 5.1X, 2019E P/B 0.65X with 5.1% 2018E dividend yield, valuation is undemanding. Looking forward to 2019, the macro- economy iis mixed, and there is still a lack of incentives for revaluation. Earnings growth of the sector is expected to be 3% and sector performance is expected to synchronize with the market.

Recommend CCB and ABC We prefer large banks, mainly because 1) Large banks have more channels to replenish capital, 2) Large banks face lower pressure when capital costs increase. Based on P/B and ROE comparison, we recommend CCB (939 HK) and ABC (1288 HK).

Fig 15: 1- year share price performance (major stocks) (%)

130

110

China Banks Hang Seng Index

Source: Bloomberg

Fig 16: CCB revenue and growth rate (%) Fig 17: CCB net profits and growth rate (%)

300,000 45.6% 50.0% 700,000 8.0% 45.0% 600,000 6.0% 250,000 41.5% 41.0% 45.6% 39.0% 40.0% 500,000 4.0% 35.0% 200,000 30.0% 400,000 2.0% 150,000 25.0% 300,000 0.0% 20.0% 100,000 200,000 -2.0% 15.0% 10.0% 100,000 -4.0% 50,000 5.0%

0 -6.0% 0 0.0% 2015 2016 2017 1H2017 1H2018 2015 2016 2017 1H20171H2018

Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Fig 18: ABC revenue and growth rate (%) Fig 19: ABC net profits and growth rate (%)

600,000 12.0% 250,000 45.0% 10.0% 38.9% 36.4% 40.0% 500,000 8.0% 200,000 35.9% 35.0% 6.0% 33.7% 37.6% 400,000 30.0% 4.0% 150,000 300,000 2.0% 25.0% 20.0% 0.0% 100,000 200,000 15.0% -2.0% -4.0% 10.0% 100,000 50,000 -6.0% 5.0%

0 -8.0% 0 0.0% 2015 2016 2017 1H2017 1H2018 2015 2016 2017 1H20171H2018

Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Risks Risks include 1) RMB continues to weaken, 2) Banks raise rates asymmetrically, 3) NPL increases faster than expected.

Fig.20：Comparable table (Data as of December 14, 2018) EPS EPS CAGR P/E ratio P/B ratio Dividend yield ROE Ticker Company Name Price 2017 2018E 2019E 2017 2018E 2019E 2017 2018E 2019E 2018E 2018E Market Cap (HKD m) HK peers 1398 HK EQUITYIND & COMM BK OF CHINA-H 5.52 0.91 0.96 1.03 6% 6.05 5.76 5.34 0.80 0.77 0.70 5.25 13.57 5.25 939 HK Equity CHINA CONSTRUCTION BANK-H 6.44 1.11 1.17 1.27 7% 5.81 5.49 5.08 0.77 0.76 0.69 5.51 14.02 5.51 3988 HK Equity BANK OF CHINA LTD-H 3.31 0.65 0.68 0.73 6% 5.12 4.85 4.53 0.58 0.57 0.52 6.40 11.90 6.40 1288 HK EQUITYAGRICULTURAL BANK OF CHINA-H 3.42 0.67 0.69 0.73 4% 5.11 4.96 4.68 0.68 0.66 0.60 5.96 13.16 5.96 3968 Hk EQUITYCHINA MERCHANTS BANK-H 32.05 3.21 3.60 4.10 13% 9.99 8.90 7.82 1.45 1.38 1.22 3.40 16.69 3.40 3328 HK Equity BANK OF COMMUNICATIONS CO-H 5.79 1.05 1.08 1.15 4% 5.51 5.39 5.05 0.61 0.58 0.53 5.73 10.72 5.73 1658 Hk EQUITYPOSTAL SAVINGS BANK OF CHI-H 4.45 0.68 0.77 0.86 12% 6.53 5.80 5.16 0.83 0.74 0.66 3.74 13.65 3.74 1988 HK EQUITYCHINA MINSHENG BANKING COR-H 5.54 1.30 1.44 1.45 6% 4.27 3.85 3.82 0.53 0.49 0.44 3.50 12.24 3.50 998 HK Equity CHINA CITIC BANK CORP LTD-H 4.79 1.00 1.01 1.08 4% 4.77 4.72 4.42 0.53 0.51 0.47 6.06 11.10 6.06 Average 5.91 5.53 5.10 0.75 0.72 0.65 5.06 13.01

Source: Bloomberg

Sector Outlook ─ China Property

Be cautious on credit risks, expect softer

home sales in 2019

Debt repayment to soar during the period of 2019 to 2021 Stanley Tang Restrictive measures increased tremendously, housing policies remain tightened Equity Analyst Sales volume shows signs of slowing down, expect weaker home [email protected] sales in 2019 Major infrastructure began operation, driving up property prices (852)2916-9632 in the Greater Bay Area, recommend Logan Property (3380 HK)

Prefer COLI (688 HK) for its solid balance sheet Dominic Chan RMB depreciation increases the credit risks of property Senior Equity Analyst developers: As developers are having a high level of foreign- [email protected] denominated debt, RMB depreciation will weigh on their (852) 2916-9631 profitabilities and cash flows. USD/CNH has increased from

6.2635 in March to 6.8810 as at 13Dec, representing a 9.86% depreciation of offshore RMB. At the same time, debt repayment 17 Dec 2018 will soar from 2019 to 2021, investors should pay attention to the credit risks of developers in the coming 3 years.

Housing curbs continue to be tightened: In 2018, restrictive measures remain tightened, and“houses are for living in, not for speculation” remains as the guiding principle of housing policies. Restrictive measures increased 82% YoY in the first three Key Data quarters of the year. In addition to stepping up restrictions on Avg.18 E P/E (x) 5.88 home purchases and sales, the Ministry of Housing and Urban- Avg.1817 DecE 2018P/B (x) 1.09 Avg.18E Dividend Yield (%) 6.89 Rural Development have ramped up the crackdown on illegal Sourc e: Bloomberg, CEBI activities, and the three-year shantytown redevelopment projects

started this year as well. On the other hand, property destocking

has been effective. As inventory keeps dropping, destocking Sector Performance (%) policy may be adjusted in the near future. 1 -mth 14.4 Relatively strong in property prices in the Greater Bay Area: 3-mth -0.2 Hong Kong high-speed rail and the Hong Kong-Zhuhai-Macau YTD -5.1 Bridge began operation this year while other major infrastructure Source: Bloomberg, CEBI will be completed within a few years. With strong support from the government, we expect the property prices in the area to increase, benefiting developers with significant landbank in the GBA. We recommend Logan Property as 18.69 million sqm, 53% of its total landbank, is located at the GBA. As Logan has the most sizeable GBA landbank, as well as better net gearing and net margin, t make Logan our top pick among GBA developers. CEBI’s Stock Pick Prefer COLI for its solid balance sheet: COLI’s net gearing Logan Property (3380 HK) was just 27.04%, the lowest among listed developers. This gives COLI (688 HK) COLI an advantage to acquire land given the liquidity strain in the industry. Also, COLI has a higher profitability than its peers in recent years. As new start and area under construction increased significantly compared to that in the previous year, this will drive COLI’s sales and profit growth in 2019. Sector Performance Absolute Relative 1-mth 39

RMB depreciation increases the credit risks of property developers

Offshore RMB has been depreciating since March this year as USD/CNH dropped from 6.2635 to 6.8810 as at 13Dec, representing a 9.86% depreciation. As Chinese property developers are having a high level of foreign-denominated debt, RMB depreciation will weigh on their profitabilities and cash flows. Moreover, according to Wind, Chinese property developers had issued Rmb 484.38 bn of corporate bonds this year as at 12Oct, which was 29.25% higher than the value for the whole year of 2017. As Chinese property developers have built up their debt loads rapidly in recent years, debt repayment will surge significantly in the following 3 years, with repayment amounts of Rmb 417.27 bn, Rmb 462.15 bn and Rmb 671.34 bn from 2019 to 2021.

Fig 1: Debt level and the percentage of foreign debt of property developers

180,000 (Rmb mn) （%） 90

160,000 80

140,000 70

120,000 60

100,000 50

80,000 40

60,000 30

40,000 20 20,000 10

0 0

CNY debt USD debt HKD debt

Debt in other currencies Percentage of foreign debt

Source: Bloomberg

In 10M2018, Evergrande, Vanke and Country Garden had the most outstanding sales performance among their peers while other property developers are on track to meet their 2018 contracted sales target. However, because of liquidity strain in addition to tightening housing curbs, the sales performance of property developers in 2019 may be adversely affected.

Fig 2: Sales performance of major property developers in 2018

Aggregate contracted sales amount in the first Full year contracted sales target Percentage 10 months of 2018 completed Vanke Rmb 485.62 bn N/A N/A COLI Hkd 250.90 bn Hkd 290 bn 86.52% CR Land Rmb 176.99 bn Rmb 183 bn 96.72% Country Garden Rmb 455.99 bn N/A N/A Longfor Rmb 164.12 bn Rmb 200 bn 82.06% Shimao Rmb 136.03 bn Rmb 140 bn 97.16% Sunac Rmb 374.54 bn Rmb 450 bn 83.23% Evergrande Rmb 501.14 bn Rmb 550 bn 91.12% Source: Company data

Housing curbs continue to be tightened

In 2018, “houses are for living in, not for speculation” remains as the guiding principle of housing policies in China and restrictive measures are tightening. According to Centaline Property Research Centre, 385 restrictive measures were issued in the first three quarters of 2018, representing an 82% YoY growth. Throughout the year, various cities have launched or stepped up restrictions on home purchases and home sales while the Ministry of Housing and Urban-Rural Development have ramped up the crackdown on illegal activities in the housing market. The Ministrty also proposed to raise the proportion of residential land and the supply of public rental land. Furthermore, the three-year shantytown redevelopment projects started this year and policies will be modified according to the situations of different cities.

Fig. 3： Major housing policies

Cities that launched or stepped up restrictions on home purchases include: Launching or stepping up restrictions on home Chengdu, Xi’an, Dalian, Shenyang, Qingdao, Hainan, Taiyuan, etc. purchases and sales Cities that launched or stepped up restrictions on home sales include: Chengdu, Xi’an, Dalian, Chongqing, Qingdao, Hainan, Harbin, Shenyang, etc. From July to December, 2018, actions were taken to regulate the housing markets in 30 cities “Notice on Launching Special Actions to Combat the including Beijing, Shanghai, Guangzhou and Shenzhen. Actions were taken to target: Infringement of Public Interests by Illegal Activities Speculative behavior in the housing market and Governing the Housing Market in Selected Illegal activities of intermediaries Cities” Illegal activities of property developers False advertising Raising the proportion of residential land in targeted cities The proportion of residential land to urban construction land is recommended to be at least 25% “Notice on Further Improving the Work Related to the Regulation and Control of the Housing Market” To significantly increase rental housing and the land supply of shared housing, and to ensure public rental land supply. In 3 to 5 years, the proportion of public rental housing, rented housing and shared housing in the new housing supply has to be greater than 50% Policies will be modified according to the housing development situations of different cities Cash compensation has to be cancelled in cities with insufficient inventory in commercial properties and high pressure of property price inflation Starting the three-year shantytown redevelopment projects 5.8 million flats will be constrcted in 2018, 15 million flats will be renovated in shantytowns from 2018 to 2020, and the protection of public rental housing will be increased Continuing to implement differentiated regulation and control, establishing sound mechanisms to foster the stable development of the housing market Source: The State Council of the People’s Republic of China

According to NBS’s 70-city price index, overall home prices MoM came down a bit in recent months, while the price movement in tier-1 cities was almost flat. In November, new home prices in tier-1 cities slightly increased 0.3% MoM, while secondary home prices dropped 0.4% MoM.

Fig 4: MoM change of 70-city price index (new Fig 5: MoM change of 70-city price index home) (secondary home)

6.00 Tier-1 4.00 Tier-1 Tier-2 5.00 Tier-2 3.00 Tier-3 4.00 Tier-3 Overall Overall 2.00 3.00

2.00 1.00 1.00

0.00 0.00

-1.00 -1.00 2015-01 2015-05 2015-09 2016-01 2016-05 2016-09 2017-01 2017-05 2017-09 2018-01 2018-05 2018-09 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 2016-07 2016-10 2017-01 2017-04 2017-07 2017-10 2018-01 2018-04 2018-07 2018-10 Source: NBS Source: NBS 41

In terms of nationwide contracted sales, residential property sales volume and sales value both showed signs of slowing down lately. Residential property sales volume dropped by 1.32% and 3.71% YoY in October and November respectively during which residential property sales value increased 9.91% and 13.32% YoY. If contracted sales growth remain sluggish, it will put pressure on the cash flows and profitabilities of property developers in 2019. On the other hand, completed and unsold residential property came down after hitting its peak in 2016, meaning that property destocking has been effective. As inventory keeps dropping, destocking policy may be adjusted in the near future.

Fig 6: Residential property sales volume Fig 7: Residential property sales value

200 (million sqm) (%) 50 1,800 (Rmbbn) (%) 80 70 180 40 1,600 160 60 30 1,400 140 50 1,200 40 120 20 1,000 30 100 10 800 20 80 0 600 10 60 0 -10 400 40 -10 20 -20 200 -20 0 -30 0 -30

2015-02 2015-07 2015-12 2016-05 2016-10 2017-03 2017-08 2018-01 2018-06 2018-11 2015-02 2015-07 2015-12 2016-05 2016-10 2017-03 2017-08 2018-01 2018-06 2018-11

Monthly sales volume YoY change Monthly sales value YoY change

Source: NBS Source: NBS

Fig 8: Selling price of commercial properties Fig 9: Completed and unsold residential (Rmb per sqm) property (mn sqm)

10,000 80,000 9,000 70,000 8,000 60,000 7,000 6,000 50,000

5,000 40,000

4,000 30,000 3,000 20,000 2,000 10,000 1,000 0 0

2013-02 2013-06 2013-10 2014-02 2014-06 2014-10 2015-02 2015-06 2015-10 2016-02 2016-06 2016-10 2017-02 2017-06 2017-10 2018-02 2018-06 2018-10 2008-02 2008-10 2009-06 2010-02 2010-10 2011-06 2012-02 2012-10 2013-06 2014-02 2014-10 2015-06 2016-02 2016-10 2017-06 2018-02 2018-10

Source: NBS Source: NBS

In 11M2018, Real Estate Investment, GFA under construction and GFA started recorded 9.7%, 4.7% and 16.8% YoY growth respectively, whereas GFA completed fell 12.3% YoY. As housing curbs remain tightened and contracted sales growth slowed down, the YoY of Real Estate Investment dropped slightly when compared to that in the previous month. Because of the US-China trade dispute, it is expected that China’s export will slide in 2019. We expect that the growth of Real Estate Investment will remain steady in the next year in order to drive economic growth. Fig 10: Real Estate Investment Fig 11: GFA under construction

120,000 12 900,000 (10,000 sqm) (%) 9 (100 mn) (%) 800,000 8 100,000 10 700,000 7

80,000 8 600,000 6 500,000 5 60,000 6 400,000 4

40,000 4 300,000 3 200,000 2 20,000 2 100,000 1 0 0 0 0

2015-02 2015-06 2015-10 2016-02 2016-06 2016-10 2017-02 2017-06 2017-10 2018-02 2018-06 2018-10 2015-02 2015-06 2015-10 2016-02 2016-06 2016-10 2017-02 2017-06 2017-10 2018-02 2018-06 2018-10

Real Estate Investment YoY change GFA under construction YoY change

Source: NBS Source: NBS

Fig 12: GFA started Fig 13: GFA completed

200,000 25 120,000 (10,000 sqm) (%) 35 (10,000 sqm) (%) 180,000 20 30 160,000 15 100,000 25 140,000 10 20 80,000 120,000 5 15 10 100,000 0 60,000 5 80,000 -5 0 60,000 -10 40,000 -5 40,000 -15 20,000 -10 20,000 -20 -15 0 -25 0 -20

2015-02 2015-06 2015-10 2016-02 2016-06 2016-10 2017-02 2017-06 2017-10 2018-02 2018-06 2018-10 2015-02 2015-07 2015-12 2016-05 2016-10 2017-03 2017-08 2018-01 2018-06 2018-11

GFA started YoY change GFA completed YoY change

Source: NBS Source: NBS

Relatively strong in property prices in the Greater Bay Area

The Greater Bay Area has been one of the key development strategies of the government in recent years. While the Hong Kong high-speed rail and the Hong Kong-Zhuhai-Macau Bridge began operation this year, Humen No.2 Bridge and Shenzhen-Zhongshan Bridge are still under construction. These infrastructure projects improve the connectivity between different cities, which can foster the economic cooperation within the Greater Bay Area. As the development of the Greater Bay Area receives strong support from the government, we expect the property prices in the area may be stronger, which in turn benefits the developers with significant landbank in the GBA.

We recommend Logan Property as 18.69 mn sqm of its landbank is located at the Greater Bay Area, which accounts for 53% of the group’s total landbank. As Logan has a much sizeable GBA landbank compared to its peers, this gives the company a relative advantage over its peers. At the same time, the net gearing of Logan was 52.51% at 1H18, the lowest among GBA developers, and its net margin was 22.64%, only second to KWG. Thus, Logan is our top pick among GBA developers.

Fig 14: Landbank situation of GBA developers Fig 15: GBA Landbank distribution of Logan

(%) 20,000,000 (sqm) 70 Hong Kong, Shenzhen, 11.20% 60 0.38%

15,000,000 50 Zhuhai/ 40 Zhongshan, 10,000,000 30 19.17%

5,000,000 20 Huizhou/ 10 Dongguan, Guangzhou/ 0 0 Foshan/ 33.40%

Zhaoqing, 35.86%

Greater Bay Area Landbank

Greater Bay Area Landbank as a percentage of total (RHS) Source: Company data Source: Company data

Fig 16: Logan’s revenue and growth rate (%) Fig 17: Logan’s net profits and growth rate (%)

30,000 100.0% 7,000 200.0%

90.0% 6,000 25,000 80.0% 150.0% 70.0% 5,000 21.8% 20,000 60.0% 4,000 22.6% 15,000 50.0% 100.0% 3,000 18.2% 40.0% 10,000 2,000 30.0% 23.6% 50.0%

5,000 20.0% 1,000 27.5% 10.0% 0 0.0% 0 0.0% 2015 2016 2017 1H20171H2018 2015 2016 2017 1H2017 1H2018

Revenue (Rmb mn) YoY (%) Net profits (Rmb mn) YoY (%) NPM (%)

Source: Company data Source: Company data 44

Prefer COLI for its solid balance sheet

We recommend COLI in the property sector as its credit risk is significantly lower than that of its peers. In 1H18, its net gearing was just 27.04%, which was the lowest among listed developers. This gives COLI an advantage to acquire land when opportunities arise given the liquidity strain in the property development industry. Besides, the net margin of COLI was 26.55% at 1H18, and the company has been outperforming its peers in terms of profitability in recent years. As new start and area under construction increased significantly compared to that in the previous year, this will drive COLI’s sales and profit growth in 2019.

Fig 18: Net debt to Equity (%)

250 2017 1H2018 200

150

100

Source: Bloomberg

Fig 19: COLI’s revenue and growth rate (%) Fig 20: COLI’s net profits and growth rate (%)

180,000 4.0% 50,000 30.0% 24.6% 24.8% 160,000 3.0% 22.6% 25.0% 40,000 20.4% 26.2% 140,000 2.0% 120,000 20.0% 30,000 1.0% 100,000 15.0% 0.0% 80,000 20,000 -1.0% 10.0% 60,000 10,000 40,000 -2.0% 5.0%

20,000 -3.0% 0 0.0% 0 -4.0% 2015 2016 2017 1H2017 1H2018 2015 2016 2017 1H2017 1H2018

Revenue (Rmb mn) YoY (%) Net profits (Rmb mn) YoY (%) NPM (%)

Source: Company data Source: Company data

China property sector outperformed the market in 2018.

Fig 21: 1- year share price performance (major stocks) (%)

140

130

120

110

100

China Property Hang Seng Index

Source: Bloomberg

Risks

Risk factors include 1) RMB continues to weaken, 2) Weaker-than-expected sales growth, 3) Changes in housing policy.

Fig 22: Comparable table (Data as of December 14, 2018) EPS EPS CAGR P/E ratio P/B ratio Dividend yield ROE Price Ticker Company Name 2017 2018E 2019E 2017 2018E 2019E 2017 2018E 2019E 2018E 2018E Market Cap (hkd m) (Local Currency) China Property 2202 HK EQUITY CHINA VANKE CO LTD-H 28.20 2.93 3.58 4.29 21% 9.62 7.87 6.57 2.04 1.76 1.50 4.52 24.32 328351.98 688 HK EQUITY CHINA OVERSEAS LAND & INVEST 27.20 3.72 3.73 4.39 9% 7.31 7.30 6.20 1.08 1.00 0.89 3.49 15.36 298008.68 1109 HK EQUITY CHINA RESOURCES LAND LTD 31.05 3.32 3.61 4.21 13% 9.35 8.61 7.38 1.54 1.39 1.23 3.91 17.44 215205.67 2007 HK EQUITY COUNTRY GARDEN HOLDINGS CO 9.60 1.42 1.83 2.35 29% 6.77 5.24 4.09 1.76 1.49 1.18 6.49 30.84 207792.07 960 HK EQUITY LONGFOR GROUP HOLDINGS LTD 22.70 2.51 2.48 3.12 12% 9.06 9.15 7.28 1.63 1.49 1.30 4.42 19.41 134707.43 813 HK EQUITY SHIMAO PROPERTY HOLDINGS LTD 21.15 2.68 3.13 3.98 22% 7.88 6.76 5.32 1.09 0.96 0.85 5.67 16.82 69872.22 2777 HK EQUITY GUANGZHOU R&F PROPERTIES - H 12.24 7.59 3.61 4.34 -24% 1.61 3.39 2.82 0.54 0.51 0.46 11.75 17.48 39441.78 3377 HK EQUITY SINO-OCEAN GROUP HOLDING LTD 3.54 0.79 0.76 0.90 7% 4.51 4.65 3.92 0.48 0.45 0.42 8.83 10.84 26960.62 1918 HK EQUITY SUNAC CHINA HOLDINGS LTD 27.30 3.19 3.54 5.56 32% 8.57 7.72 4.91 2.23 1.95 1.49 3.01 31.71 120262.98 3383 HK EQUITY AGILE GROUP HOLDINGS LTD 10.14 1.79 2.20 2.61 21% 5.66 4.60 3.89 0.89 0.77 0.69 10.33 18.42 39718.86 3333 HK EQUITY CHINA EVERGRANDE GROUP 24.90 2.12 3.82 4.55 47% 11.77 6.52 5.47 1.99 2.03 1.70 10.20 32.67 326499.98 1233 HK EQUITY TIMES CHINA HOLDINGS LTD 7.30 1.74 2.11 2.63 23% 4.19 3.45 2.77 0.75 0.65 0.55 8.39 21.73 13386.87 123 HK EQUITY YUEXIU PROPERTY CO LTD 1.44 0.21 0.24 0.26 12% 6.84 6.10 5.45 0.48 0.46 0.44 6.29 7.95 17857.88 3883 HK EQUITY CHINA AOYUAN GROUP LTD 4.96 0.71 0.99 1.40 41% 7.00 5.01 3.54 1.09 0.97 0.80 7.81 25.34 13282.30 1813 HK EQUITY KWG GROUP HOLDINGS LTD 6.96 1.35 1.68 2.11 25% 5.15 4.16 3.30 0.68 0.60 0.53 8.67 16.88 22081.66 1638 HK EQUITY KAISA GROUP HOLDINGS LTD 2.35 0.70 0.79 0.89 13% 3.38 2.99 2.64 0.61 0.36 0.33 - 12.88 14264.67 3380 HK EQUITY LOGAN PROPERTY HOLDINGS CO L 9.49 1.35 1.47 1.97 21% 7.02 6.48 4.81 1.90 1.70 1.38 6.55 31.07 52083.63 Average 6.81 5.88 4.73 1.22 1.09 0.93 6.89 20.66

Source: Bloomberg

Sector Outlook ─ HK Property

Rising rates, uncertain market conditions, home prices face higher downward pressure in 2019

Hong Kong house prices grew by 6.41% YTD Stanley Tang Banks to raise rates for the first time in 12 years, the repayment liability of homebuyers will further increase if rates Equity Analyst continue to rise [email protected] Uncertain market conditions and lowered demand caused property prices to drop (852)2916-9632

The government announced 6 new housing policies, and will focus on increasing land supply and public housing as mentioned in 2018 Policy Address Dominic Chan Surging office rent and the commencement of infrastructure Senior Equity Analyst projects will support landlords and REITs, recommend [email protected] Champion REIT (2778 HK) (852) 2916-9631

Hong Kong’s low interest rate environment comes to an end: Since 2015, the Fed has raised rates by 8 times but banks in Hong 17 Dec 2018 Kong have not followed. On 27Sep, following the Fed rate hike by 0.25%, banks in Hong Kong raised their Prime rates between 0.125% and 0.25%, for the first time in 12 years. If banks continue to raise

rates in 2019, this will further increase the repayment liability of

homebuyers. 18 Dec 2018 Investment sentiment weakens amid market uncertainties: The Centaline City Leading Index, an indicator of property prices in Hong Kong, dropped 6.92% after hitting its peak on 17Aug, and it has been Key Data dropping for 11 consecutive weeks since September, which is the Avg.18E P/E (x) 14.3 longest drop since Nov2008. Furthermore, second hand transaction Avg.18E P/B (x) 0.57 Avg.18E Dividend Yield (%) 4.2 has remained low since July, and the number of mortgage Source: Bloomberg applications dropped below 10,000 in September, showing a

lowering demand for property investment.

Government to tighten housing policies and boost land supply: Sector Performance (%) The government announced 6 new initiatives in June, which include 1-mth 6.1 3-mth -1.2 adjusting the selling price of SSFs and launching Special Rates on YTD -6.9 vacant first-hand private flats. In 2018 Policy Address, the Source: Bloomberg government proposed the “Lantau Tomorrow Vision” and the development of brownfield sites in the New Territories to boost land supply in the future, and 70% of the land will be used for public

housing. However, the impacts on home prices are limited in the shot run as the policies are long term measures. CEBI’s Stock Pick Champion REIT (2778 HK) Landlords and REITs supported by new infrastructure and surging office rent: The commencement of new infrastructure will attract more tourists to Hong Kong and shopping malls can be benefited. On the other hand, office rents stay high as vacancy rate remains low. We like Champion REIT as the rent of its office building in Central is increasing significantly. As tenants occupying 45.6% of Sector Performance

office space are renewing their lease contracts next year, this will Absolute Relative significantly increase the rental income of Champion REIT in the 1-mth coming years. 47

Hong Kong’s low interest rate environment comes to an end

Following the Fed rate hike by 0.25% on 27Sep, banks in Hong Kong followed to raise their benchmark lending rates (Prime rates) with a range between 0.125% and 0.25%, which was the first time for banks to raise interest rates in 12 years, marking the start of the normalization cycle of interest rates. As HIBOR (1- month HIBOR) is now hovering around its highest level over the past decade, HIBOR-based Morgages reached the interest rate cap for most of the time in 2018. Thus, raising Prime rates will increase the monthly repayment of homebuyers. However, as most banks only raised their prime rates by 0.125%, which were lower than the 0.25% rate hike by the Fed, the repayment ability of homebuyers will be minimally affected, limiting the effect on property prices in the short run. In 2Q2018 and 3Q2018, the index of home purchase affordability worsened to 74%, which is significantly higher than the long term average of 44% between 1998 and 2017. From the long term perspective, the market expects the Fed to continue to raise interest rates in 1H2019, meaning that banks in Hong Kong are likely to raise their Prime rates again, and this will increase the risks of investing in the housing market and put pressure on home prices. Fig 2: Index of home purchase affordability Fig 1: 1 month HIBOR (%)

2.5 80

2 70 65

1.5 60 55

1 50

45 0.5 40

35 0 30

Jul-16 Jan-13 Jun-12 Oct-14 Apr-18 Feb-17 Sep-17 Dec-15 Aug-13 Nov-18 Mar-14 May-15 1Q2010 4Q2010 3Q2011 2Q2012 1Q2013 4Q2013 3Q2014 2Q2015 1Q2016 4Q2016 3Q2017 2Q2018

Source: Bloomberg Source: HKSAR government

Investment sentiment weakens amid market uncertainties

Investment sentiment weakens amid market uncertainties, causing property prices to drop. According to Centaline City Leading Index (CCL), home prices have dropped 6.92% after hitting its peak on 17Aug, from 188.64 to 175.59 as at 14Dec, and the index has been dropping for 11 consecutive weeks since September, which is the first time on since Nov2008, showing that Hong Kong’s property market is cooling down. At the same time, the official data from Rating and Valuation Department showed that the average price and rent of HK residential properties have soared 7.83% and 5.12% respectively in 10M2018. However, average price has been dropping for 3 consecutive months, and it declined 2.36% in October, the largest decline in a single month since Dec 2015.

Fig 3: Centaline City Leading Index (Jul 97 = 100) Fig 4: Average price and rental indices

200.00 450 Rental Index 190.00 400 Price Index 180.00 350 170.00 300 160.00 250 150.00 200 140.00 150 130.00 100 120.00 110.00 50

100.00 0

Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jun-10 Jun-15 Oct-13 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Oct-08 Oct-13 Oct-18 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 Apr-11 Apr-16 Feb-07 Feb-12 Feb-17

Dec-07 Dec-12 Dec-17 Aug-09 Aug-14 Source: Bloomberg, Centaline Source: Rating and Valuation Department

In terms of transaction volume, according to the data from Midland Realty, weekly resale transactions of 35 major estates has stayed low since July, signaling a waning demand from property investors in the second hand market. At the same time, according to HKMA, the number of mortgage applications dropped below 10,000 in September for the first time in 13 months, showing that the demand for property investment has weakened, causing property prices to drop.

Fig 5: Midland Realty 35 Major Secondary Fig 6: Number of mortgage applications Estates Transaction

140 20,000 18,000 120 16,000 100 14,000

80 12,000 10,000 60 8,000

40 6,000 4,000 20 2,000 0 0

Jul-18 Jan-18 Jun-18 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Oct-18 Apr-18 Feb-18 Sep-18 Aug-18 Nov-18 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Mar-18 Oct-14 Oct-15 Oct-16 Oct-17 Oct-18 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 May-18

Source: Bloomberg, Midland Realty Source: HKMA

Government to tighten housing policies and boost land supply

The government announced six new initiatives in June to regulate the housing market. Under the new pricing policy for Subsidised Sale Flats (SSFs), the selling price of SSFs will be adjusted from 70% of the assessed market value to 52% of the assessed market value, making subsidised housing more affordable. We expect this policy will lower the demand of private housing as subsidized flats become cheaper. At the same time, the government launched Special Rates on vacant first-hand private flats in order to incentivize developers to accelerate the sale of first-hand property, which can increase the supply of first-hand private flats.

In 2018 Policy Address, the government proposed the “Lantau Tomorrow Vision” and the development of brownfield sites in the New Territories in order to boost

land supply in the future. The government intends to allocate more land to public housing, and suggests that the ratio of public housing will be increased to 70% on newly developed land, which will lower the land supply for private housing in the long term.

Fig. 7： Major housing policies

Revising the affordability test of the pricing mechanism for the Home Ownership Scheme Revising the pricing policy for Subsidised Sale Ensuring the affordability ratio of subsidised flats will increase from 50% to 75% Flats (SSFs) Delinking the selling prices of SSFs from private property prices, the selling price of SSFs will be adjusted from 70% to 52% of the assessed market value. Non-joint venture project at Ma Tau Wai Road will Providing 450 Starter Homes units with Occupation Permit to be issued in 2Q2019 be assigned as a Starter Homes pilot project 9 private housing sites in Kai Tak and Anderson Road will be allocated to public Reallocating private housing sites for public housing housing 10,600 flats can be provided for sale or rental purposes Owners of private flats with Occupation Permit issued for at least 12 months are Introducing Special Rates on vacant first-hand required to file annual returns to the government on the occupancy status of the flats private flats Flats that are vacant for more than 6 months are subject to Special Rates Constructing artificial islands with an area of about 1700 hectares near Kau Yi Chau and Hei Ling Chau Lantau Tomorrow 260,000 to 400,000 residential units will be provided to accommodate 700,000 to 1,100,000 residents First phase of intake will start in 2032 Planning and implementing the development of 340 hectares of brownfield sites in Development of Brownfield Sites in the New Kwu Tung North, Fanling North, Hung Shui Kiu and Yuen Long South Territories Investigating on the development of 200 hectares of brownfield sites in New Territories North Source: HKSAR Government

As the housing policies mentioned in the Policy Address are long term measures, they pose limited impact on private housing supply in the short run. According to the data provided by the Transport and Housing Bureau, the number of private residential units under construction reached 80,000 in September, a relatively high level in recent years, and the actual completion of private residential units in the first 9 months were 12,700. At the same time, units available for the coming three to four years remain steady, showing that the impact of the housing policies on the property market is limited in the short run.

Fig 8: Number of private residential units under Fig 9: Actual completion of private residential construction units

90,000 30,000

85,000 80,000 25,000 75,000 20,000 70,000 65,000 15,000 60,000

55,000 10,000 50,000 45,000 5,000 40,000 0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Jun-07 Jun-10 Jun-13 Jun-16 Sep-06 Sep-09 Sep-12 Sep-15 Sep-18 Dec-05 Dec-08 Dec-11 Dec-14 Dec-17 9M17 9M18 Mar-05 Mar-08 Mar-11 Mar-14 Mar-17

Source: Transport and Housing Bureau Source: Transport and Housing Bureau

Fig 10: Units available for the coming three to four years

90,000

85,000 80,000 75,000

70,000 65,000 60,000

55,000 50,000 45,000

40,000

Jun-07 Jun-10 Jun-13 Jun-16 Sep-06 Sep-09 Sep-12 Sep-15 Sep-18 Dec-05 Dec-08 Dec-11 Dec-14 Dec-17 Mar-05 Mar-08 Mar-11 Mar-14 Mar-17

Source: Transport and Housing Bureau

Landlords and REITs supported by new infrastructure and surging office rent

As Hong Kong high-speed rail and the Hong Kong-Zhuhai-Macau Bridge began operation this year, transportation between Hong Kong and other mainland cities becomes more convenient, and this attracts more tourists to visit Hong Kong. The Hong Kong government predicted that the high-speed rail can carry 80,000 passengers to Hong Kong per day, which in turn benefits the shopping malls in Hong Kong. On the other hand, office rents in Hong Kong stand high and the office space in Central is having a robust demand. In 1H2018, the vacancy rate of prime office buildings in Central was only 1.1%. We expect that the tight vacancy rate in Central will further drive up office rents, and this is beneficial to the profit growth of landlords and REITs.

REITs outperformed the market in 2018. As of 14Dec, the sector was up by 9.3% YoY, while developers and landlords performed in line with the market.

Fig 11: 1- year share price performance (major stocks) (%)

120

115

110 105

100 95

85 80

75 70

Hang Seng Index Developers Landlords REITs

Source: Bloomberg

We like Champion REIT as it will probably benefit from the climbing rent in Central. Passing rents at Three Garden Road, Central was HKD 95.87 per sq. ft. at end-June 2017, but the spot rent as at October jumped to HKD 140 per sq. ft., representing a 46.03% difference between passing and spot rents. As tenants occupying 45.6% of office space in Three Garden Road, Central are renewing their lease contracts next year, this will significantly increase the rental income of Champion REIT in the coming years.

Fig 12: Rental rates of landlords and REITs (%)

100

Office 80 Retail 75

Source: Company data

Fig 13: Champion REIT’s revenue and growth Fig 14: Champion REIT’s net profits and rate (%) growth rate (%)

3,000 14.0% 1,400 51.5% 60.0% 46.7% 47.6% 1,200 49.3% 50.0% 2,500 12.0% 50.5% 1,000 40.0% 10.0% 2,000 800 30.0% 8.0% 600 20.0% 1,500 400 10.0% 6.0% 1,000 200 0.0% 4.0% 0 -10.0% 500 2.0% 2015 2016 2017 1H20171H2018

0 0.0% Net profits ex-revaluation (Hkd mn) 2015 2016 2017 1H2017 1H2018 YoY (%)

Revenue (Hkd mn) YoY (%) NPM (%)

Source: Company data Source: Company data

Risks Risk factors include 1) Interest rate hike, 2) Slower-than-expected retail sales growth in Hong Kong, 3) Higher than expected vacancy rates of office buildings.

Fig 15: Comparable table (Data as of December 14, 2018)

EPS EPS CAGR P/E ratio P/B ratio Dividend yield ROE Price Ticker Company Name 2017 2018E 2019E 2017 2018E 2019E 2017 2018E 2019E 2018E 2018E Market Cap (hkd m) (Local Currency) Developers 16 HK EQUITY SUN HUNG KAI PROPERTIES 113.50 17.24 11.35 12.10 -16% 6.58 10.00 9.38 0.61 0.59 0.56 4.40 6.19 328827.58 1113 HK EQUITY CK ASSET HOLDINGS LTD 57.45 8.07 6.76 7.10 -6% 7.12 8.49 8.09 0.68 0.66 0.63 3.44 7.80 212185.86 12 HK EQUITY HENDERSON LAND DEVELOPMENT 39.85 6.92 2.91 3.65 -27% 5.76 13.69 10.92 0.58 0.58 0.57 4.37 5.47 175390.25 20 HK EQUITY WHEELOCK & CO LTD 45.35 10.09 6.27 7.07 -16% 4.49 7.23 6.42 0.37 0.38 0.36 3.38 5.78 92874.50 17 HK EQUITY NEW WORLD DEVELOPMENT 10.76 2.34 0.94 0.93 -37% 4.60 11.50 11.61 0.51 0.51 0.49 4.73 4.30 109760.94 83 HK EQUITY SINO LAND CO 13.78 2.18 0.79 0.83 -38% 6.32 17.38 16.66 0.65 0.62 0.61 3.92 3.76 93154.25 683 HK EQUITY KERRY PROPERTIES LTD 28.30 6.40 3.61 4.15 -19% 4.42 7.84 6.82 0.42 0.42 0.41 4.63 6.14 41181.97 Average 5.61 10.88 9.99 0.55 0.54 0.52 4.12 5.63 Landlords 1997 HK EQUITY WHARF REAL ESTATE INVESTMENT 48.85 5.67 3.18 3.36 -23% 8.62 15.38 14.56 0.69 0.70 0.69 4.21 4.63 148319.70 1972 HK EQUITY SWIRE PROPERTIES LTD 28.60 5.80 1.51 1.43 -50% 4.93 18.89 20.03 0.61 0.63 0.61 2.84 4.77 167310.00 HKL SP EQUITY HONGKONG LAND HOLDINGS LTD 6.66 18.50 3.37 3.53 -56% 0.36 1.98 1.89 0.42 0.42 0.42 3.17 2.84 122076.84 101 HK EQUITY HANG LUNG PROPERTIES LTD 15.90 1.81 1.07 1.02 -25% 8.78 14.82 15.60 0.52 0.52 0.51 4.74 3.42 71513.73 Average 5.67 12.76 13.02 0.56 0.57 0.56 3.74 3.92 REITs 823 HK EQUITY LINK REIT 78.85 21.71 2.67 2.96 -63% 3.63 29.50 26.68 0.92 0.92 0.90 3.42 3.40 166530.16 2778 HK EQUITY CHAMPION REIT 5.42 1.92 0.26 0.28 -62% 2.82 20.53 19.22 0.49 0.51 0.50 4.74 2.50 31691.24 778 HK EQUITY FORTUNE REIT 9.17 1.68 0.51 0.53 -44% 5.47 17.88 17.40 0.57 0.61 0.60 5.69 3.28 17646.74 435 HK EQUITY SUNLIGHT REAL ESTATE INVEST 5.00 0.88 0.25 0.27 -45% 5.68 20.00 18.52 0.55 0.55 0.54 5.50 2.85 8235.70 Average 4.40 21.98 20.46 0.63 0.65 0.64 4.84 3.01

Source: Bloomberg

Sector Outlook ─ China Infrastructure

Infrastructure investment supports China economic growth

Growth rate of Infrastructure FAI bottomed out since Aug 2018, Dominic Chan the local government debt issuance increase to provide financial Senior Equity Analyst support to infrastructure projects. [email protected] Railway construction need to speed up to meet 13th Five year plan. (852) 2916-9631 Rail freight volume will increase based on NDRC target.

CRC (390 HK) and CRRC (1766 HK) are our top-picks, thanks to 17 Dec 2018 increasing infrastructure investment.

Infrastructure investment supports China economic growth: Due to the uncertainty of China-US trade war, export growth may slow down in 2019. Meanwhile, domestic demand weakened too. As such, fixed asset investment is an important factor to drive China economy. Thanks to financial supports from local government, infrastructure Key Data investment has been rebounded since 3Q18, we believe it will Avg.18E P/E (x) 5.6 maintain momentum in 2019. Avg.18E P/B (x) 0.65 Avg.18E Dividend Yield (%) 3.8 Several policies launched to stimulate infrastructure investment: Source: Bloomberg, CEBI China issued several policies to stimulate infrastructure investment, especially some polices regarding to remedy shortcomings in infrastructure field. Sector Performance (%) 1-mth 2.9 Local government raised debt financing to support infrastructure 3-mth 7.7 projects: Financial shortage and tight control on PPP projects are the YTD 12.7 key reasons that infrastructure growth slowdown in 1H18. We believe these two factors are over, especially local government started to Source:Bloomberg

raise debt financing to support infrastructure projects.

13th Five Year Plan target is yet to meet: According to 13th Five Year Plan, the length of railways in operation is targeted to increase from 127k km in 2017 to 150k km in 2020. We believe construction of railway network will pick up in order to meet the 13th Fiver year plan CEBI’s Stock Pick target. CRC (390 HK) CRCC (1186 HK) Rail equipment demand will increase: We expect rail equipment CRRC (1766 HK)

demand to rebound, mainly due to two reasons, 1) more railway line will start operation during 2018-2020, 2) National Development And Reform Commission (NDRC) issued “Three-Year Action Plan to Win

the Blue Sky Defense War”, of which target to increase rail freight volume by 30% in 2020, comparing with that of 2017. As such, we Sector Performance expect orders of freight wagons, locomotives and EMUs will pick up. Absolute Relative CRC (390 HK) and CRRC (1766 HK) are our top picks: CRC is our 1-mth top pick under infrastructure sector, while CRRC is our top picks under rail equipment sector. Rise in raw material price is one of the sector

risk.

Infrastructure growth to support China economy

Chinese economy are mainly driven by fixed asset investment (FAI), domestic demand, and export. Due to the uncertainty of China-US trade war, export growth may slow down in 2019. Meanwhile, domestic demand weakened too. As such, fixed asset investment is an important factor to drive China economy.

We believe fixed asset investment growth rate started to recover. The reason why fixed asset investment slowed down in 1H18, mainly due to , 1) Tight budget for FAI projects in 1H18, 2) tight control on PPP projects. However, we saw such negative impacts fade out. More importantly, China implemented some infrastructure policy to bolster areas of weakness.

The growth rate of China FAI has bottomed out since Aug 2018, with the growth rate of China FAI saw 5.9% YoY growth during 11M18, compare with 5.3% YoY growth in 8M18, reflecting China speed up the infrastructure.

Fig 1: China monthly FAI growth rate(2015-11M2018)

11 10.7 10.5 10 10.2 9.6 9.2 9 9 8.9 8.9 8.38.3 8.3 8 8.18.18.2 8.1 7.8 7.9 7.5 7.5 7.3 7 7.27.2 7

6.1 6.1 6 6 6 5.9 5.7 5.5 5.4 5.3 5 2016 2016 2016 2016 2016 2016 2017 2017 2017 2017 2017 2018 2018 2018 2018 2018 Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan

to to to to to to to to to Jul to to to to to to to Feb Apr June Aug Oct Dec Mar May Sep Nov Feb Apr June Aug Oct

Source: NBSC, Wind

During the CPC Central Committee Political Bureau meeting held on 31Jul, there were four key tasks for infrastructure investment in 2H18: 1) Maintaining stable and healthy economic growth, adhering to a proactive fiscal policy and a prudent monetary policy; 2) Remedying shortcomings is a key task of deepening the supply- side structural reform, 3) better combine the prevention and mitigation of financial risks and the service of the real economy, and firmly do de-leverage work; 4) Promote reform and the development of "One Belt, One Road".

Afterwards, China implement several policies to bolster areas of weakness, and to deepen supply-side structural reform. Those policies include 《关于加大交通基础设施补短板力度的工作方案(2018-2020) 》，and 《乡村振兴战略规划（2018- 2022）》, which is targeted to push transportation and urban area development. Meanwhile, market expect the infrastructure investment during 2018 to 2020 in urban area would reach Rmb 4.52 tn.

On 31Oct, NDRC issued “Guiding Option on Maintaining Efforts to Remedy Shortcomings in Infrastructure Field”. Basic principles shall focus on effective precision poverty alleviation and pollution prevention and control, and make remedy

shortcomings in railways, highways, waterways, airports, water conservancy, energy, agriculture and rural affairs, ecological and environmental protection, public services, urban and rural infrastructure, shantytown renovation, and other fields. Then key tasks, include 1) Increase projects reserve, 2) accelerate front-end work of each projects, 3) ensure projects under construction shall be satisfied in an overall manner, and avoid abandoned unfinished projects, 4) Better regulation on local governments’ debt financing, 5) More financial support on under construction projects, 6) ensure proper financial need, 7) Attract capital from private segment, 8) Push PPP projects steadily, 9) Deepen reform in investment segment, 10) Prevent debt financing risk from local government.

Meanwhile, China Banking and Insurance Regulatory Commission (CBIRC) has issued 「中国银保监会办公厅关于商业银行承销地方政府债券有关事项的通知」. According to the new circular, bank that underwrite local government bond will no longer face restriction on the amount of the debt they can buy themselves, the 20% ceiling has been scrapped, and Banks will now able to buy up any portion of a bond sale that has not been fully subscribed, reducing the risk that local governments will fail to get all the money they want to raise. The latest move to help raise funds of infrastructure investment.

Fig 2: Yearly Debt Raising amount from local Fig 3: Monthly Debt Raising amount from local government (2014-10M2018) government

70,000 10,000 8,830 60,428 9,000 7,570 60,000 8,000 7,485

50,000 43,581 7,000 38,351 40,524 6,000 5,343 40,000 5,000 3,523 4,000 3,018 30,000 2,560 3,000 1,910 20,000 2,000 1,000 286 10,000 4,000 0 0

0 2014 2015 2016 2017 10M2018

Source: Ministry of Finance Source: Ministry of Finance

Actually, the debt financing amount from local government is increasing throughout 2018, especially after Jul 2018. We believe local government debt financing would increase to support infrastructure investment, which can help to accelerate the progress of under construction projects and new projects.

On 24Oct, the National Development and Reform Commission (NDRC) publicly expressed its support for private capital investment in (PPP) projects, with a focus on meeting economic and social development needs. In the first three quarters of 2018 the amount of private investment in China increased by 8.7% YoY, with an increment of 2.7 pp YoY, and 3.3 pp higher than national investment.

Meanwhile, NDRC said that in order to promote private investment, most important thing is to establish and improve the working mechanism for promoting the healthy development of private investment, guide and urge relevant parties. The second is to issue a long-term mechanism for promoting private capital projects.

In order to further promote the enthusiasm of private investment and maintain the momentum of private investment, the requirements of the State Council executive

meeting, the recent committee of State Council has introduced a number of national industrial policies in line with the national capital in the fields of transportation energy, ecological environmental protection and social undertakings. The preliminary work includes a total of 1,222 projects, with a total investment of more than Rmb 2.5 tn. At present, some of these projects have already signed contracts.

China government make remedy shortcomings though several infrastructure projects, including railways, subway, highways and waterways investment.

1) Rail Investment

The China Railway Corporation (CRC) held its 2018 work conference on 2Jan 2018. At the meeting, it stated that a total investment of Rmb 730 bn for rail investment has set for this year, representing a 8% YoY decline. However, in July this year, CRC raised the railway investment target to Rmb 800 bn this year, including railway equipment investment of Rmb 120 bn. In 9M2018, the total investment in railway construction was Rmb 572.3 bn, include Rmb 110 bn in September.

According to 13th Five Year Plan, the operating length of railway will reach 150K km in 2020. As of the end of 2017, the operating length was 127K km. As such, 23K km of new railways will need to be operational during 2018-2020. Meanwhile, we expect the total investment for railway industry will maintain Rmb 800 bn per year during 2018-2020.

Fig 4: Total railway sector FAI (Rmb bn) Fig 5: Total operational length of railways (km)

9,000 8,238 8,010 8,000 160,000 150,038 8,088 8,015 8,000 8,000 140,538 8,000 132,038 140,000 127,038 6,657 120,970124,000 7,000 6,340 120,000 111,821 5,906 103,145 6,000 97,625 100,000 93,250 5,000 80,000 4,000 60,000 3,000 40,000 2,000 20,000 1,000 0 0

Source: Wind, CEBI Source: Wind, CEBI

In a long run, China still need to expand its railway network. According to “Mid-long term railway network plan(2025) issued by NDRC, operating mileage of railway network will reach 175K km in 2025, including 38K of high speed train.

In order to meet the demand, “Eight vertical and eight horizontal” key railway network will be built, based on the foundation of “Four vertical and four horizontal” railway network.

2) Subway Investment

After the Baotou Metro project was suspended last year, China government re- examined the planning of urban transit development, and suspended the approval of the new urban rail project. In Jul 2018, NDRC issued the "Opinions on Further Strengthening the Management of Urban Rail Transit Planning and Construction", by tightening the examination and approval of the application for the construction of rail transit cities, key restrictions include 1) the revenue of the construction of rail transit cities should meet Rmb 30 bn, 2) The revenue of cities which plan to build light rail should more than Rmb 15 bn.

However, NDRC recently restarted the approval of new urban transit projects, including 1) The third phase of urban transit project in Changchun, 2) The third phase of urban transit project in Suzhou, etc. We believe the approval of new urban transit projects will be accelerated.

According the 13th Five Year Plan, China targets to expand urban transit network by 3,000 km. As of the end of 2017, there were 165 urban transit lines in operation, with operating length of 5,021km. The potential of China Urban transit market was huge. 1) By the end of 2017, a total of 254 urban transit lines in 56 cities are under construction. The length of pipeline was 6,246km, with total investment of Rmb 3875.6 bn. 2) As of 2017, a total of 7,427km of new urban transit projects approved, which indicates that the urban transit construction is still in a high growth stage in the next few years.

Fig 6: Total railway sector FAI (Rmb bn) Fig 7: Total operational length of railways (km)

7,000 6,338 9,000 1,200 7,661 5,762 8,000 6,000 5,238 1,000 7,000 6,617 4,762 5,000 5,899 6,000 800 5,022 3,6833,847 4,000 5,000 4,153 600 2,899 4,000 3,618 3,000 3,173 2,165 3,000 2,539 400 1,914 2,064 2,000 1,628 1,713 2,000 1,455 200 1,000 1,000

0 0 0

Rapid transit in operation

Source: Wind, CEBI Source: Wind, CEBI

3) Highways and Waterways

Total Highways sector FAI saw robust growth in past 5 years, with a CAGR of 11.4% during 2013-2017. Total Waterways sector FAI maintained steadily at Rmb 800 bn in past five years.

According to the 13th Five-Year Plan, the construction of the national expressway network will be accelerated. It is planned to build a new expressway with a mileage of about 30,000km, including 7 metrology radiation lines, 11 north-south vertical lines, 18 east-west horizontal lines, and regional loop lines. National highway network construction consisting of parallel lines and tie lines.

Fig 8: Total highways sector FAI (Rmb bn) Fig 9: Total waterways sector FAI (Rmb bn)

25,000 18.5%20.0% 10,000 25.0% 21,100 8,100 8,200 8,000 8,000 20.9% 20.0% 20,000 17,800 8,000 6,700 15,500 16,500 15.0% 13.1% 15.0% 15,000 13,700 6,000 10.0% 10.0% 10,000 7.9% 4,000 6.5% 5.0% 5.0% 0.0% 5,000 2,000 1.2% 0.0% -2.4% 0 0.0% 0 -5.0% 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017

Highways FAI Highways FAI YoY (%) Waterways FAI Waterways FAI YoY(%)

Source: Wind Source: Wind

Railway equipment segment see a steady growth

The passenger traffic volume of railways recorded 10% YoY growth in past few years. In 2017, the passenger traffic volume grew by 11%. In 9M18, China’s railway network carried a total of 2.57bn passenger trips, up 9.3% YoY.

Rail freight volume rebounded in 2017, with a 10.1% YoY growth. In 9M2018, rail freight volume was 2.97bn tonnes, up by 7.9%.

We expect that the construction of the railway network will meet the target of 13th Five-Year Plan. Thanks to the new railway line to start into operation, the demand for railway equipment is expected to rise steadily, mainly for EMUs, locomotives and freight wagons. Wait. At the same time, according to the NDRC “Three-Year Action Plan to Win the Blue Sky Defense War” 「打赢蓝天保卫战三年行动计划」issued in Jul 2018, it plans to increase rail freight usage by 30% in 2020 compared with 2017.

We estimate China's railway passenger traffic to increase by ~9% YoY in 2019 and 2020, while rail freight volume is expected to increase by 9% and 10% respectively in 2019 and 2020. As the demand for rail freight increases, it will drive demand for freight wagons. Overall, there will be stable demand for railway equipment from 2019 to 2020.

Fig 10: Rail passenger volume in China Fig 11: Rail freight volume in China

4,500 12.0% 4,000 15.0%

4,000 10.7% 11.0% 3,500 10.0% 9.9% 9.7% 10.0% 10.1% 9.0%10% 3,500 9.5% 3,000 8.5% 8.8% 9.0%9.0%9.0% 6.5% 3,000 8.0% 5.0% 2,500 2,500 6.0% 2,000 -0.4% 0.0% 2,000 -1.8% -2.3% 4.6% 1,500 1,500 4.0% -4.7% -5.0% 1,000 1,000 2.0% -10.0% 500 500 -11.6%

0 0.0% 0 -15.0%

Rail passenger volume (mn trips) YoY % Rail freight volume (mn tonnes) YoY %

Source: Wind, CEBI Source: Wind, CEBI

Total Rail Equipment sector FAI is highly correlated with length of newly operating railways, mainly due to additional vehicles required for new railway. We expect more new railways will start into operation from 2019 to 2020 to achieve the 13th Five- Year Plan target. As such, the total amount is expected to rise from Rmb 120 bn in 2018 to Rmb 140 bn in 2020.

Fig 12: Length of newly operational railway (km) Fig 13: Railway equipment FAI in China 12,000 160.0 146.5 20.0% 140.0 140 130 9,531 140.0 10,000 9,500 120 8,500 120.0 15.0% 8,427 104.9 103.8 100.0 8,000 100.0 90.0 92.0

5,586 80.0 10.0% 6,000 5,389 5,000 60.0 4,000 3,281 40.0 5.0% 3,038 2,174 20.0 2,000 0.0 0.0% 0

Rolling stock investment in China (Rmb Bn) As % of railway sector FAI Source: Wind, CEBI Source: Wind, CEBI

China Railway Corporation procure rail vehicles from time to time. On 17Oct, 2018, CRC procured a batch of orders, including a total of 1,455 EMUs. The details of the orders are,

110 units of 350 km "Fuxing" EMU (8 vehicles) is 110, 15 units of 350 km "Fuxing" EMU (17 vehicles), 5 units of the speed of 350 km/h "Fuxing" EMU, and the number of tenders for the 350-kilometer "Revival" high-altitude EMU (8 vehicles) was 30. At the same time, China Railway has also tendered 143 electric locomotives, including 78 six-axis 7200KW freight electric locomotives and 65 eight-axle 9,600kw freight electric locomotives.

On the other hand, China Railway stated that it plans to purchase 216,000 new freight wagons and 3,756 locomotives in the next three years. Among them, 40,000 freight wagons and 188 locomotives were purchased in 2018; 78,000 trucks and 1,564 locomotives were purchased in 2019; 98,000 freight wagons and 2004 locomotives were purchased in 2020. The purchase amount of these rolling stocks exceeded Rmb 150 bn.

Below shows the procurement volume by CRC from 2013 to 2018 YTD.

Fig 14: Procurement of MUs (units) Fig 15: Procurement of locomotives (units)

500 473 467 1600 1480 450 1400 377 400 357 1200 350 325 300 1000 790 759 250 800 686 200 600 150 105 100 400 225 263 200 50 0 0 2013 2014 2015 2016 2017 2018YTD 2013 2014 2015 2016 2017 2018 YTD Source: Wind Source: Wind

Fig 16: Procurement of freight wagons Fig 17: Procurement of passenger cars

70,000 3,000 2,840 57,940 60,000 2,500 50,000 43,177 2,000 40,000 29,900 1,500 1,372 30,000 25,279 1,226

20,000 1,000 10,980 11,315 682 10,000 500 263.00

0 14 2013 2014 2015 2016 2017 2018 0 YTD 2013 2014 2015 2016 2017 2018

Source: Wind Source: Wind

The urban transit market is in a growth stage. In 2017, the number of urban rail passengers in China was 18.48 billion, up by 14.8% YoY. It is expected that the number of urban rail passengers in China will see double digit growth from 2018 to 2020.

By the end of 2017, there were a total of 31,888 urban transit vehicles in operation in China. We expect the vehicles to see a CAGR of 16% from 2017 to 2020.

Fig 18: Urban transit passenger volume during Fig 19: Number of urban transit vehicles in 2011-2020E in China (million) China (units)

30,000 60,000 25,961 49,795 25,000 23,388 50,000 20,882 42,678 18,480 37,752 20,000 40,000 16,090 31,888 13,800 15,000 12,666 30,000 26,163

10,919 19,941 8,729 17,300 10,000 7,134 20,000 14,366 12,611 8,2859,945 5,000 10,000

0 0

Source: Wind, CEBI Source: Wind, CEBI

CRC and CRRC are our top picks Infrastructure sector outperformed the market in 2018. As of 14th Dec, infrastructure sector was up by 12% YoY, compare with 12.8% decline in Hang Seng index. Within infrastructure sector, CRC is the best performer, with share price rose by 27.9%, CRCC is the next, with the share price rose by 20.3%, CCCC is the worst performer, with share price declined by 14.6% ytd.

Fig 20: 1- year share price performance (major stocks) (%)

120

100

China infra China rail equip Hang Seng Index

Source: Bloomberg

Fig 21: Infrastructure sector performance in 2018 (%)

YTD C 1M -14.6 C C 2.16 C

C 20.1 R C 8.58

C 27.5 R 4.39 C

-20.0 -10.0 0.0 10.0 20.0 30.0

Source: Bloomberg

In Short, we believe China will increase infrastructure investment to boost economic growth, we are bullish on infrastructure sector. Maintain buy rating on CRC (390 HK), with target price of Hk$ 8.6, representing 9.4x 2018E PE. (Average PE level in past 10 years)

More new railway lines will start operation during 2019 to 2020, under the theme of higher demand on railway equipment, CRRC (1766 HK) is worthy to watch.

Fig 22: CRC revenue and growth rate (%) Fig 23: CRC net profits and growth rate (%)

800000 12.0% 18000 45.0%

700000 16000 40.0% 10.0% 600000 14000 35.0% 8.0% 12000 30.0% 500000 10000 25.0% 400000 6.0% 8000 20.0% 300000 4.0% 6000 15.0% 200000 4000 10.0% 2.0% 100000 2000 5.0% 2.0% 2.0% 2.3% 2.6% 3.0% 0 0.0% 0 0.0% 2015 2016 2017 1H20171H2018 2015 2016 2017 1H2017 1H2018

Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Fig 24: CRRC revenue and growth rate (%) Fig 25: CRRC net profits and growth rate (%)

250,000 10.0% 14,000 10.0%

8.0% 200,000 12,000 5.0% 6.0% 10,000 5.0% 5.0% 5.2% 150,000 4.3% 4.4%4.0% 0.0% 8,000 100,000 2.0% 6,000 -5.0% 0.0% 50,000 4,000 -2.0%

0 -10.0% 2,000 -4.0%

0 -6.0% 2015 2016 2017 1H2017 1H2018

Revenue (Rmb m) YoY (%) Net profits (Rmb m NPM (%) NPM (%)

Source: Company data Source: Company data

Risks Risk factors include 1) increase in raw material (such as cement and steel) price may bring negative impact on GPM, 2) Slower-than-expected investment in infrastructure in China, 3) Financial shortage on particular infrastructure projects.

Fig 26: Cement price index Fig 27: Steel price index

180.00 140.00

160.00 120.00 140.00 120.00 100.00 100.00 80.00 80.00 60.00 60.00 40.00 40.00 20.00 20.00 0.00 0.00

Source: Wind Source: Wind

Fig 28: Comparable table (Data as of December 14, 2018) EPS EPS CAGR P/E ratio P/B ratio Dividend yield ROE Ticker Company Name Price (local currency) 2017 2018E 2019E 2017 2018E 2019E 2017 2018E 2019E 2018E 2018E Market Cap (USD m) HK peers 390 HK EQUITY CHINA RAILWAY GROUP LTD-H 7.37 0.80 0.89 1.03 13% 8.05 7.23 6.25 0.98 0.88 0.80 1.98 11.89 23916.92 1186 HK EQUITY CHINA RAILWAY CONSTRUCTION-H 10.88 1.34 1.55 1.75 14% 8.12 7.03 6.21 0.81 0.79 0.71 2.22 12.39 22628.02 1800 HK Equity CHINA COMMUNICATIONS CONST-H 7.58 1.49 1.41 1.57 2% 5.07 5.38 4.84 0.60 0.55 0.50 3.63 10.95 25370.90 3311 HK Equity CHINA STATE CONSTRUCTION INT 6.44 1.19 1.18 1.37 7% 5.42 5.48 4.71 0.83 0.76 0.68 5.50 15.04 4162.28 3996 HK EQUITY CHINA ENERGY ENGINEERING C-H 1.01 0.21 0.22 0.24 6% 4.86 4.59 4.30 0.55 0.50 0.46 3.93 11.33 3886.62 Average A shares 601390 CH Equity CHINA RAILWAY GROUP LTD-A 7.38 0.81 0.88 1.03 13% 9.63 9.55 8.10 1.07 1.00 0.92 1.98 11.82 23916.77 601186 CH Equity CHINA RAILWAY CONSTRUCTION-A 11.83 1.34 1.56 1.79 16% 8.92 8.62 7.52 0.98 0.98 0.89 1.80 12.56 22627.87 601668 CH Equity CHINA STATE CONSTRUCTION -A 6.17 0.88 0.98 1.10 12% 7.48 7.14 6.37 1.20 1.05 0.93 3.95 14.91 37569.94 601669 CH Equity POWER CONSTRUCTION CORP OF-A 4.95 0.55 0.60 0.68 11% 9.93 9.34 8.25 0.97 0.96 0.87 2.02 11.02 10983.19 Average 0.90 1.01 1.15 8.99 8.66 7.56 1.06 1.00 0.90 Overseas names DG FP equity VINCI SA 73.54 43.58 48.27 51.95 9% 13.53 13.48 12.53 2.47 2.19 1.99 3.64 16.19 49844.82 EN FP equity BOUYGUES SA 32.9 26.68 22.11 25.91 -1% 10.49 13.22 11.29 1.34 1.32 1.25 5.18 11.46 13698.29 1812 JP equity KAJIMA CORP 1512 17.22 13.79 13.24 -12% 6.71 7.57 7.88 1.10 1.06 0.96 3.26 12.38 7037.58 1801 JP equity TAISEI CORP 4950 39.57 32.33 34.74 -6% 9.38 10.56 9.83 1.63 1.54 1.40 2.54 14.75 9785.87 Average 31.76 29.12 31.46 10.03 11.21 10.38 1.63 1.53 1.40 Source: Bloomberg

Sector Outlook ─ Environment ector Outlook ─ Environmen

Chasing 13th Five Year Plan Target

The three-year action plan for the Blue Sky Defence War Dominic Chan established the importance the Mainland attaches to the Senior Equity Analyst environmental protection industry. [email protected] The growth rate of waste-to-energy investment and the (852) 2916-9631 development potential of the water treatment industry is still large. Gas demand continues, and natural gas accounts for 10% of total 17 Dec 2018 energy consumption by 2020. Pay attention on China Everbright International and China Gas.

Important position of the environmental protection industry: In Jul 2018, the State Council issued the "Notice on the Three-Year Action Plan for the Fight against Blue Sky". After three years of efforts, it will significantly reduce the total emissions of major air pollutants, synergistically reduce greenhouse gases, and significantly reduce the number of days of heavy pollution.

Support environmental companies: According to the content of the battle against the blue sky, the mainland would like to support r the Key Data environmental protection industry is not diminished. However, from Avg.18E P/E (x) 10.4 the actual figures, the amount of environmental protection investment Avg.18E P/B (x) 1.64 was only Rmb 932 bn in 2016. Although it increased by 4.7% YoY, Avg.18E Dividend Yield (%) 2.9 the proportion of domestic GDP did not rise, and even fel, from 1.28% Source: Bloomberg in 2015 to 1.24% in 2016. In the next five years, it is necessary to

increase relevant investment to catch up with the planning goals.

Promising outlook of the waste-to-energy industry: According to Sector Performance (%) the 13th Five-Year Plan, by the end of 2020, the national municipal 1-mth 1.7 solid waste incineration treatment accounts for 50% of the total waste 3-mth -6.0 disposal capacity, while at the end of 2016, the ratio is 37%. It is YTD -8.1 expected the capacity will increase from 235,000 tons per day in 2015 Source: Bloomberg

to 591,000 tons per day in 2020, with a CAGR of 20.2%. Optimistic view on the water treatment industry: We believe that CEBI’s Stock Pick sludge disposal is expected to have a large room for growth. At the China Everbright International (257 HK) end of 2015, the size of the sludge decontamination facility was 37,400 China Gas (384 HK) tons per day. It is expected that by 2020, the treatment capacity of

inland sludge decontamination equipment will increase to 97,500 tons

per day in 2020, with a CAGR of 21.1%, and the sludge disposal rate will increase to 75%.

Gas Industry worthy to watch：It is expected that gas consumption Sector Performance accounted for 10% of total energy consumption by 2020. As of the end of 2017, natural gas accounted for only 7% of energy consumption, an Absolute Relative increase of 0.8 pp from 2016. 1-mth

Pay attention on CEI (257 HK) and China Gas (384 HK) We can pay attention on CEI (257 HK) and China Gas (384 HK). They are trading at 7.4x 2019E P/E and 15.5x 2019E P/E respectively.

Steady growth on waste to energy investment

The demand for waste-to-energy in the Mainland is still strong. First, the harmless treatment of domestic garbage in the Mainland continues to rise, from 457,000 tons per day in 2010 to 758,000 tons per day in 2015, a CAGR of 10%. According to the 13th Five-Year Plan, it is expected that the national plan to increase the harmless treatment capacity of domestic garbage will increase by 510,000 tons per day, to 1.268 million tons per day, with a CAGR of 10%.

Furthermore, the proportion of waste incineration has also increased year by year. The proportion of landfill disposal has decreased from 81% in 2007 to 60% in 2016, while the proportion of incineration increased from 15% to 37%. According to the 13th Five-Year Plan, it is estimated that the proportion of waste incineration will increase to over 50% by 2020. It is estimated that the scale of national waste-to- energy facilities will increase from 235,000 tons per day in 2015 to 591,000 tons per day in 2020 with a CAGR of 20.2%. As the proportion of waste incineration still has not reached the target, it is expected that waste incineration in 2019 and 2020 to maintain rapid growth.

In terms of the overall investment, the total investment amount of the national waste innocuous treatment facilities during the 13th Five-Year Plan period is estimated to be Rmb251.84 bn, 1.42 times higher than that of the 12th Five-Year Plan period. The total investment in environmental pollution control in the country has not increased significantly in 2016, and it is expected that the total investment will increase in 2019-2020.

Fig 1: Municipal waste disposal volume Fig 2: Harmless treatment of domestic garbage (10,000 tons / day) (10,000 tons / day)

25,000 8.0% 100.00 8.0%

20,000 95.00 6.0% 6.0% 90.00 15,000 4.0% 4.0% 85.00 10,000 2.0% 80.00 2.0% 5,000 75.00 0.0% 0 0.0% 2012 2013 2014 2015 2016 2017 Harmless treatment of domestic garbage (10,000 tons / 2012 2013 2014 2015 2016 2017 day) Municipal solid waste disposal volume (10,000 tons) YoY (%) YoY (%) Source: China Statisticial Yearbook on Environment Source: China Statisticial Yearbook on Environment

Fig 3: Distribution of domestic waste treatment Fig 4: Investment in environmental pollution methods in 2016 control (Rmb 100 mn)

10,000.00 20.0% 2%

9,000.00 10.0%

38% 8,000.00 0.0%

60% 7,000.00 -10.0%

2012 2013 2014 2015 2016 Investment in environmental pollution control (100 million yuan) YoY (%)

Sanitary landfill Incineration Others Investment in environmental pollution to GDP ratio

Source: China Statisticial Yearbook on Environment Source: China Statisticial Yearbook on Environment

Sludge treatment see a faster growth

The water treatment industry includes sewage treatment, sludge treatment and reclaimed water treatment. During the 12th Five-Year Plan period, the degree of infiltration of sewage treatment in the Mainland has reached a high level. At the end of 2015, the national urban sewage treatment capacity reached 217 million cubic meters per day, the urban sewage treatment rate was 91.9%, and the county sewage treatment rate was 85%. By 2020, the sewage treatment capacity will reach 268 million cubic meters per day, with a CAGR of 4.3%, urban sewage treatment rate of 95%, and county sewage treatment rate will rise to over 85%.

The harmless disposal of sludge is expected to have a larger room for growth. At the end of 2015, the size of the sludge decontamination facility in the Mainland was 37,400 tons per day, and the innocent disposal rate of urban sludge was 53%, while that in the county was 24.3%. It is expected that by 2020, the treatment capacity of inland sludge decontamination equipment will increase to 97,500 tons per day in 2020, with a compound annual growth of 21.1%, and the sludge disposal rate will increase to 75%, the disposal rate has increased to 60%.

The recycling treatment is also planned to be improved. At the end of 2015, the size of reclaimed water production will be 26.53 million cubic meters per day. It is expected to increase to 41.58 million cubic meters by 2020, with a CAGR of 9.4%. At the same time, the processing rate has also increased. Among them, the utilization rate of recycled water in Beijing is expected to increase from 65.9% in 2015 to 68% in 2020, and the number of water-scarce cities will increase from 12.1% in 2015 to 20% in 2020, while other cities and counties will increase from 4.4% in 2015 to 15% in 2020.

In addition, the Mainland also plans to newly renovate the sewage pipe network during the 13th Five-Year Plan period. During the period, the newly added sewage pipe network will be 125,900 kilometers and the old sewage pipe network will be 27,700 kilometers. Overall, during the 13th Five-Year Plan period, a total investment of about 564.4 billion yuan was expected for the construction of urban sewage treatment and recycling facilities. Among them, the investment in new and renovated

sewage treatment facilities was 193.8 billion yuan, which was 65% higher than the total investment during the 12th Five-Year Plan period.

Fig 5: Urban sewage treatment capacity (100 mn Fig 6: Sewage treatment investment (Rmb 100 cubic meters) mn)

500 6.0% 160 4.0%

480 5.0% 140 2.0% 120 0.0% 460 4.0% 100 -2.0% 440 3.0% 80 -4.0%

420 2.0% 60 -6.0%

400 1.0% 40 -8.0% 20 -10.0% 380 0.0% 2012 2013 2014 2015 2016 0 -12.0% 2012 2013 2014 2015 2016 Urban sewage treatment capacity (100 million

cubic meters) Sewage treatment investment (Rmb 100m)

YoY (%) YoY (%)

Source: China Statisticial Yearbook on Environment Source: China Statisticial Yearbook on Environment

Gas Industry worthy to watch According to the "Three-Year Action Plan for the Blue Sky Defence War" issued by State Council in Jul 2018, the goal is to reduce the total emissions of major air pollutants, includes greenhouse gas emissions, and significantly reduce the number of days of heavy pollution after three years of efforts. Improve ambient air quality. Among them, the reference to the mainland strives to achieve 10% of total energy consumption by 2020. The amount of new natural gas is preferentially used for urban residents and areas with severe atmospheric pollution and replacement of coal in winter, with a focus on supporting Beijing-Tianjin-Hebei and in the surrounding areas, the realization of “increasing gas and reducing coal” is conducive to the stable development of natural gas enterprises.

In addition, according to the “13th Five-Year Plan” for natural gas development, the average annual growth rate of natural gas consumption during the 12th Five-Year Plan period was 12.4%. During the 13th Five-Year Plan period, the gasification rate of urban population will increase from 42.8% in 2015 to 57% in 2020, and the compound annual growth rate of gasification population will be 10.3%.

As of the end of 2017, natural gas accounted for only 7% of energy consumption, an increase of 0.8 percentage points from 2016. It is expected that by 2020, natural gas consumption will reach 360 billion cubic meters, an increase of 167 billion cubic meters from 2015, and consumption will grow at a compound annual growth rate of 13.3%. It is expected that the natural gas industry will have a rapid growth to reach the national target.

Gas company revenue comes from gas connection installation fees and sales of natural gas. The increase in gasification population is expected to drive the gas company's gas connection installation fee income, while the increase in natural gas sales will increase the company's sales revenue. In the first three quarters of 2018, the sales volume of natural gas in the Mainland was 203.7 billion cubic meters, a YoY increase of 17.4%.

Fig 7: Natural gas consumption (100 million Fig 8: Natural gas consumption as a percentage cubic meters) of total energy sales (%)

2,500.00 20.0%

2,000.00 15.0% 5.2 16.8 1,500.00 10.0% 1,000.00 8.2

500.00 5.0%

0.00 0.0% 69.8 2012 2013 2014 2015 2016

Natural gas consumption (100 million cubic

meters)

YoY (%) Natural gas coal crude oil others

Source: Wind Source: Wind

Pay attention on China Everbright Internatinal (257 HK) and China Gas (384 HK)

Fig 9: 1- year share price performance (major stocks) (%)

140

120

100

China WTE China Sewage China Gas Hang Seng Index

Source: Bloomberg

Fig 10: CEI revenue and growth rate (%) Fig 11: CEI net profits and growth rate (%)

25,000 80.0% 4,000 60.0% 70.0% 3,500 20,000 50.0% 60.0% 3,000 40.0% 15,000 50.0% 2,500 40.0% 2,000 30.0% 10,000 30.0% 1,500 24.4% 20.0% 19.9% 19.6% 20.0% 5,000 17.5% 18.7% 10.0% 1,000 10.0% 500 0 0.0% 2015 2016 2017 1H2017 1H2018 0 0.0%

2015 2016 2017 1H2017 1H2018 Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%) Source: Company data Source: Company data

Fig 13: China Gas net profits and growth rate Fig 12: China Gas revenue and growth rate (%) (%)

60,000 70.0% 7,000 120.0% 60.0% 50,000 6,000 100.0% 50.0% 5,000 40,000 80.0% 40.0% 30,000 4,000 30.0% 60.0% 20,000 3,000 20.0% 40.0% 2,000 10,000 10.0% 1,000 20.0% 0 0.0% 13.0% 16.3% 14.6% 7.7% 11.5% 2015 2016 2017 1H2017 1H2018 0 0.0% 2015 2016 2017 1H2017 1H2018 Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Risks Risks include: 1) Mainland investment in environmental protection industry is lower than expected, 2) Capital shortages make construction time of new environmental protection projects longer than expected.

Fig 14: Comparable table (Data as of December 14, 2018)

EPS EPS CAGR P/E ratio P/B ratio Dividend yield ROE Ticker Company Name Price 2016 2017E 2018E 2016 2017E 2018E 2016 2017E 2018E 2018E 2018E Market Cap (HKD m) Waste Treatment 257 hk equity CHINA EVERBRIGHT INTL LTD 6.82 0.76 0.86 0.92 10% 8.00 7.89 7.38 1.25 1.12 1.06 3.72 15.02 41895.09 895 hk equity DONGJIANG ENVIRONMENTAL-H 8.42 0.62 0.70 0.84 - 12.62 11.99 9.97 1.66 1.44 1.23 2.18 13.76 10496.32 1330 hk equity DYNAGREEN ENVIRONMENTAL PR-H 3.23 0.23 0.30 0.37 27% 13.08 10.84 8.56 1.21 1.15 1.05 2.49 12.31 12745.76 1381 hk equity CANVEST ENVIRONMENTAL PROTEC 4.06 0.24 0.30 0.35 20% 15.17 13.53 11.67 1.96 1.80 1.59 1.13 13.96 9968.65 3989 HK equity CAPITAL ENVIRONMENT HOLDINGS 0.176 0.01 0.02 0.02 - 14.03 11.10 7.77 0.68 0.69 0.66 - 8.20 2515.87 Average Sweage Treatment 257 hk equity CHINA EVERBRIGHT INTL LTD 6.83 0.76 0.86 0.92 - 8.00 7.89 7.38 1.25 1.12 1.06 3.72 15.02 41895.09 270 hk equity GUANGDONG INVESTMENT LTD 14.96 0.88 0.76 0.82 -4% 21.40 19.63 18.29 2.42 2.34 2.26 3.64 12.52 97805.81 371 hk equity BEIJING ENTERPRISES WATER GR 4.26 0.42 0.50 0.56 15% 9.51 8.52 7.58 1.56 1.52 1.36 4.08 18.06 40099.33 807 hk equity SIIC ENVIRONMENT HOLDINGS LT 1.59 - 0.24 0.26 - - 6.59 6.15 - 0.45 0.42 3.78 6.28 4144.48 855 hk equity CHINA WATER AFFAIRS GROUP 8.56 0.73 0.84 0.96 - 11.01 10.15 8.92 1.91 1.82 1.55 3.20 19.03 13772.19 1065 hk equity TIANJIN CAPITAL ENVIRON-H 3.11 0.42 0.42 0.44 3% 7.69 7.42 7.04 0.68 0.70 0.65 2.55 9.70 12440.13 1363 HK equity CT ENVIRONMENTAL GROUP LTD 0.315 0.11 0.11 0.09 - 3.00 2.79 3.50 0.44 0.35 0.31 1989.79 Average Gas 384 hk equity CHINA GAS HOLDINGS LTD 28 1.23 1.54 1.81 21% 20.18 18.18 15.47 4.81 4.10 3.48 1.66 24.02 142001.11 2688 hk equity ENN ENERGY HOLDINGS LTD 72.2 2.99 4.37 5.15 31% 23.55 16.53 14.03 4.00 3.45 2.95 1.97 22.65 81153.01 1193 hk equity CHINA RESOURCES GAS GROUP LT 32.65 1.68 2.03 2.28 17% 16.95 16.09 14.31 3.06 2.83 2.50 2.16 19.11 72614.02 392 hk equity BEIJING ENTERPRISES HLDGS 44.75 5.45 5.89 6.50 9% 7.66 7.60 6.89 0.80 0.77 0.70 2.69 10.62 56476.88 1083 hk equity TOWNGAS CHINA CO LTD 5.85 0.50 0.51 0.58 7% 11.34 11.40 10.17 1.02 0.96 0.90 2.85 9.08 16438.66 3633 hk equity ZHONGYU GAS HOLDINGS LTD 5.53 0.22 551.50 0.41 36% 16.82 0.01 13.49 3.83 3.59 2.99 1.45 24.20 14038.20 1600 hk equity CHINA TIAN LUN GAS HOLDINGS 6.64 0.47 0.72 1.12 54% 13.33 9.27 5.97 1.95 1.74 1.41 2.27 19.62 6571.04 Average 15.69 11.30 11.48 2.78 2.49 2.13

Source: Bloomberg

Sector Outlook ─ Technology ctor Outlook ─ Internet

High growth era ended

High growth of tech passed and sector valuation under pressure Dominic Chan Software sector: mainland strengthened supervision of mobile Senior Equity Analyst games, making growth rate slowed down [email protected] Hardware sector: smartphone market is saturated, the outlook of (852) 2916-9631 component suppliers are full of uncertainty Telecom equipment sector: It is expected that China will speed up 17 Dec 2018 the commercialization of 5G. We can pay attention to telecom equipment sector

China strengthened supervision on mobile games: China implemented several measures to strengthen the supervision of the mobile game industry, including real-name system, time limits for underage children, and even suspending approval for new-handed games. The upgrade of the mainland's supervision may result in a lower- than-expected growth rate in 2018 and 2019. Key Data Third-party payment market is still at a high growth: The size of third- Avg.18E P/E (x) 22.7 party payment transactions in China reached Rmb 120.3 trn in 2017, a Avg.18E P/B (x) 2.66 YoY increase of 104.7%. With the continued popularity of Internet finance, Avg.18E Dividend Yield (%) 2.2 China's third-party mobile payment market will continue to maintain rapid Source: Bloomberg growth

Online advertising market grew steadily: The size of China's online advertising market in 2017 was Rmb 375.01 bn, a YoY increase of 30%. Sector Performance (%) Online advertising is expected to grow steadily, with a 31% growth in -0.5 online advertising in 2018 1-mth 3-mth -9.8 Saturation of smartphone market affects supply chain: The saturation YTD -28.9 of the smartphone market has a deeper impact on parts companies, Source: Bloomberg

including mobile phone lenses and acoustic products. At the same time,

the Sino-US trade war has also increased the cost of raw materials.

Speed up commercialization of 5G in China: It is expected that the 5G CEBI’s Stock Pick will be formally commercialized by 2020, and the “National Infiltration” will Tencent (700 HK) be completed in five years in China. Before commercialization, the China Tower (788 HK) construction of 5G networks, including the demand for base stations and optical cables will continue to increase, which is beneficial to telecommunications equipment companies.

Pay attention to telecom equipment sector: Outlook for software sector is mixed, hardware sector became worst, we suggest to pay attention to telecom equipment sector, includes China Tower (788 HK). The stock is currently trading at 37x 2019E P/E. Sector Performance Absolute Relative Risk: 1) Policy risk, 2) smartphone shipments are weaker-than-expected, 1-mth 3) global implementation of 5G is slower-than-expected.

High growth rate in mobile game ended According to a report released by iResearch in Jul 2018, the size of China's mobile game market in 2018 is predicted to be Rmb193.71 bn, a YoY increase of 30.1%, but the growth rate is slowing down year by year. In the meantime, iResearch predicts the growth rate in 2019 will slow down to 20%.

Fig 2: Size of mobile games industry in China in Fig 1: China mobile game industry in 2014-2019E 2014-2019E

3000 120.0% 7 18.0%

16.0% 2500 100.0% 6 14.0% 5 2000 80.0% 12.0% 4 10.0% 1500 60.0% 8.0% 3 1000 40.0% 6.0% 2 4.0% 500 20.0% 1 2.0%

0 0.0% 0 0.0% 2014 2015 2016 2017 2018E2019E2020E 2014 2015 2016 2017 2018E

Amount (Rmb 100m) YoY (%) Amount (Rmb 100m) YoY (%)

Source: iResearch, CEBI Source: iResearch, CEBI

Chinese mobile game market become more concentrated. Tencent is the market leader, with market share in 2017 was 43.7%, increased by 5.9 pp. The second is NetEase, accounting for 18.1% of the market.

Fig 3: China Mobile game market in 2017 Fig 4: China Mobile game market by age group

others, kingnet, over 40 0.8% 26.2%

36-40 ztgame, Tecncent, 1.0% 43.7% 31-35

changyou, 25-30 1.0% Ourpalm, 1.1% Netease under 24 Youzu, game, 1.5% 37wan, 0.0% 10.0% 20.0% 30.0% 40.0% 18.1% kunlun, 2.2%Perfect 2017 2016 2.1% World, 2.4% Source: iResearch Source: iResearch

According to age group of Chinese mobile game market, the proportion of young users increased in 2017, the proportion of below 24 years old users increased from 24.7% in 2016 to 31.3% in 2017

However, Chinese mobile game market is facing several unfavorable factors, the first one is the upgrading of the mainland supervision. Recently, the mainland has introduced a number of regulatory measures. On Aug 30, 2018, the Ministry of Education and the National Health and Health Committee jointly issued the

“Integrated Myopia Prevention and Control Program for Children”. The details are, 1) implementation of the total regulation of online games, 2) control Increase the number of online games online games, and 3) Explore the age-adjusted system that meets national conditions and take measures to limit the use time of minors. Although the program is mainly aimed at preventing the myopia rate of children, its indirectly regulates online game and mobile games market.

Meanwhile, the overall penetration rate of China’s mobile game has continued to decline. In addition, the mainland has suspended the approval of new game tours. It is expected that the growth rate of mobile game growth in 2018 will be lower than expected, and the growth of the mobile game market in 2019 may not be optimistic.

China's third-party payment market continues to grow explosively

The third-party payment market is still at a high growth stage. According to a report released by iResearch in November 2018, the size of third-party payment transactions in China reached 120.3 trillion yuan in 2017, a YoY increase of 104.7%. Among them, 40% of the transaction size comes from internet finance, and 27.4% comes from personal business. With the continued popularity of Internet finance, China's third-party mobile payment market will continue to maintain rapid growth.

Fig 5: The market size of China’s third party Fig 6: The market share of China’s third party payment market in 2013-2017 payment market in 2017

140 450.0% Others 8% 120 400.0% 350.0% 100 300.0%

80 250.0% 200.0% 60 150.0% 40 100.0% 20 50.0%

0 0.0% Tenpay Alipay 2013 2014 2015 2016 2017 39% 53%

Amount (Rmb 100m) YoY (%)

Source: iResearch Source: iResearch

Stable growth in online advertising market According to the annual monitoring report of China's online advertising market released by iResearch in September 2018, the size of China's online advertising market in 2017 was Rmb 375.01 bn, a YoY increase of 30%. Online advertising is expected to grow steadily, with a 31% growth in online advertising in 2018.

Among them, the proportion of China Mobile Advertising over online advertising has increased year by year. In 2017, China Mobile Advertising accounted for 68% of online advertising, and it is expected that the proportion will increase to 84.3% by 2020. At the same time, China's emerging social network advertising market grew at a faster rate, becoming one of the driving forces for online advertising.

Fig 8: China online advertising market in 2013- Fig 7: China advertising market in 2013-2017 2020

8000 14.0% 9000 45.0% 8000 40.0% 7000 12.0% 7000 35.0% 6000 10.0% 6000 30.0% 5000 8.0% 5000 25.0% 4000 4000 20.0% 6.0% 3000 3000 15.0% 2000 10.0% 2000 4.0% 1000 5.0% 1000 2.0% 0 0.0%

0 0.0% 2013 2014 2015 2016 2017

Amount (Rmb 100m) YoY (%) Amount (Rmb 100m) YoY (%)

Source: iResearch Source: iResearch, CEBI

Fig 9: China mobile advertising market in 2013- Fig 10: China online social network advertising 2020 market in 2013-2020

8000 200.0% 1400 90.0%

1200 80.0% 6000 150.0% 70.0% 1000 60.0% 84.3% 4000 100.0% 800 77.6%82.8% 50.0% 60.7%68.0% 40.0% 2000 45.7% 50.0% 600 30.0% 24.3% 400 0 12.1% 0.0% 20.0% 200 10.0% 0 0.0%

Amount of online advertising market (Rmb 100m)

YoY (%)

% mobile advertising to online advertising Amount (Rmb 100m) YoY (%)

Source: iResearch, CEBI Source: iResearch, CEBI

Cloud services maintain rapid growth in China

The size of China's cloud service market is relatively small, and the market growth rate has remained stable after the rapid growth in the previous period.

Among them, the growth rate of China's public cloud market is faster than that of the private cloud market. It is expected that the size of China's public cloud market will increase by 34.7% in 2019, while the private cloud market will increase by 21.4%.

Fig 11: China public cloud market in 2014-2020 Fig 12: China private cloud market in 2014-2020 (Rmb 100mn) (Rmb 100mn)

700 70.0% 900 30.0% 800 600 60.0% 25.0% 700 500 50.0% 600 20.0% 400 40.0% 500 15.0% 300 30.0% 400

300 10.0% 200 20.0% 200 5.0% 100 10.0% 100

0 0.0% 0 0.0% 2014 2015 2016 2017 2018E 2019E 2020E 2014 2015 2016 2017 2018E 2019E 2020E

Amount (Rmb 100m) YoY (%) Amount (Rmb 100m) YoY (%)

Source: iResearch, CEBI Source: iResearch, CEBI

The global smartphone market weakened Global smartphone shipments slowed down after a sharp increase in the past few years. According to IDC data, global smartphone shipments in the third quarter were 355 million, down 6% YoY. Based on the brand, Samsung is the number one brand in the world, with shipments of 72.2 million during the period, but down 13.4% YoY, and the market share fell to 20.3%. The second place was Huawei, with shipments of 52 million units, up 32.9% YoY, with a market share of 14.6%. Apple's shipments were 46.9 million units, a slight increase of 0.5% YoY and a market share of 13.2%.

Fig 13: Smartphone shipment in the world Fig 14: Smartphone market share 2017 2017 2017 2017 2018 2018 2018 500.00 100.0% 450.00 Q1 Q2 Q3 Q4 Q1 Q2 Q3 80.0% 400.00 Samsung 23.2% 22.9% 22.1% 18.9% 23.5% 21.0% 20.3% 350.00 60.0% 300.00 Huyawei 10.0% 11.0% 10.4% 10.7% 11.8% 15.9% 14.6% 250.00 40.0% 200.00 20.0% 150.00 Apple 14.7% 11.8% 12.4% 19.6% 15.7% 12.1% 13.2% 100.00 0.0% 50.00 4.3% 6.2% 7.5% 7.1% 8.4% 9.5% 9.7% 0.00 -20.0% Mi

OPPO 7.5% 8.0% 8.1% 6.9% 7.4% 8.6% 8.4%

2011-03 2011-12 2012-09 2013-06 2014-03 2014-12 2015-09 2016-06 2017-03 2017-12 2018-09 Others 40.3% 40.1% 39.5% 36.8% 33.2% 32.9% 33.8% shippments ( m units) YoY (%)

Source: IDC Source: iResearch

According to IDC estimates, global smartphone shipments will reach 1.454 billion units in 2018, down 0.7% YoY. It is expected to increase to 1.646 billion units by 2022, with a CAGR of 2.4% from 2017 to 2022. . However, IDC pre-estimated 5G will not be popularized until 2021, saying that smartphone shipments are still not optimistic in the next two years. This will affect the demands of related components, including optical products and acoustic products.

Capex to increase in telecom equipment sector

In line with the development of “Broadband China”, the optical cable market accelerated. From 2015 to 2017, the total length of China's optical cables has increased by an average of 20% per year. By 2017, the total length of optical cable lines is 37.47 million kilometers.

On the other hand, the growth rate of 3G/4G base station construction in the Mainland slowed down. As of 2017, the number of 3G/4G base stations in China was 4.62 million, an increase of 14.1% YoY. Although the 3G/4G base growth rate is slowing, it is expected that the future 5G will soon enter commercialization, and the capital investment of related telecommunications equipment will continue to increase.

Fig 16: China’s 3G/4G base number in 2012- Fig 15: China optical cable length in 2012-2017 2017

4000 25.0% 500 462 120.0%

3500 405 20.0% 400 100.0% 3000 320 80.0% 2500 15.0% 300 2000 213 60.0% 1500 10.0% 200 109 40.0% 1000 82 5.0% 100 20.0% 500

0 0.0% 0 0.0% 2012 2013 2014 2015 2016 2017 2012 2013 2014 2015 2016 2017

Total length (km) YoY (%) No of base (10k) YoY (%)

Source: iResearch Source: iResearch

Higher earning visibility for 5G related sector

In the past two years, the 5G technology has passed two stages, namely 5G related technology test and 5G technical solution verification. At present, the development of 5G in the Mainland has entered the third stage of work. The Ministry of Industry and Information Technology indicated that it is necessary to speed up the deployment of 5G and all-optical networks, and establish the third phase of the results of the 5G technology R&D test in the Mainland. It is expected that after the establishment of 5G spectrum, operators are expected to invest in R&D projects. We estimate that the 5G commercial network will be launched in 2020.

According to a report released by iResearch in November 2018, it is expected that 5G users will start with 42.13 million people from 2020, and complete the "national penetration" in five years. By 2025, the user scale will reach 1.28 billion. The scale of China's 5G market is estimated to increase by 0.6 million yuan in 2020 and 3.8 trillion yuan in 2025.

Fig 17: Number of users in China 5G market in Fig 18: China 5G market in 2020-2030 (Rmb tn) 2020-2030 (million users)

160000 350.0% 7 120.0%

140000 300.0% 6 120000 100.0% 250.0% 100000 5 200.0% 80.0% 80000 4 150.0% 60000 60.0% 3 40000 100.0% 40.0% 50.0% 20000 2 0 0.0% 20.0% 1

0 0.0%

2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E

size ( million users) YoY (%)

Source: iResearch, CEBI Source: iResearch, CEBI

According to the 5G market size structure, infrastructure investment still accounts for 18.9% of the total in 2020, but it has been decreasing year by year. 5G smart phone devices are expected to start explosive growth by 2022. By 2022, 5G smart phones account for 26.9% of China's 5G market, while in 2023, they account for 34.4%.

Before 2020, during the 5G test period, we expect network equipment companies to benefit more than operators. In fact, the Mainland has announced that it will focus on supporting 5G scale networking construction and application demonstration projects this year, and launching 5G network construction in no less than five cities. Therefore, we believe that in the next year and the following year, we can pay more attention to telecommunications equipment companies, because their profitability will be relatively higher.

Fig 19: China 5G market structure in 2020-2030

100.0%

90.0%

80.0%

70.0% 60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 2020E 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E

FAI 5G smartphone Flow rates internet service fee

Source: iResearch, CEBI

China Tower is worthy to watch Both Software, hardware and telecom equipment sectors are underperformed market.

Fig 20: 1-Year performance of tech sector (major stocks) (%)

140

120

100

China software China hardware China telecom equip Hang Seng Index

Source: Bloomberg

China Tower is the world’s largest telecommunications tower infrastructure service provider. Thanks to the demand from 5G network construction, demand for telecom infrastructure service will increase. The stock is trading at 34X 2019E PE.

Fig 22: China Tower net profit and growth rate Fig 21: China Tower revenue and growth rate (%) (%)

80,000 600.0% 3,000 3000.0%

70,000 2,000 2500.0% 500.0% 60,000 400.0% 1,000 2000.0% 50,000 0 1500.0% 40,000 300.0% 2015 2016 2017 1H2017 1H2018 30,000 -1,000 1000.0% 200.0% 20,000 -2,000 500.0% 100.0% 10,000 -3,000 -40.9% 0.1% 2.8% 3.4% 3.4%0.0% 0 0.0% 2015 2016 2017 1H2017 1H2018 -4,000 -500.0%

Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Risks Risks: 1) Policy risk, 2) smartphone shipments are weaker-than-expected, 3) global implementation of 5G is slower-than-expected.

Fig 23: Comparable table (Data as of December 14, 2018)

EPS EPS CAGR P/E ratio P/B ratio Dividend Yield ROE Ticker Company Name Price 2017 2018E 2019E 2017 2018E 2019E 2017 2018E 2019E 2018E 2018E Market Cap (HKD m) Software sector 700 HK EQUITY TENCENT HOLDINGS LTD 308.80 8.77 9.53 11.34 14% 30.75 28.30 23.80 8.26 7.69 6.10 0.33 24.18 2939857.07 777 HK Equity NETDRAGON WEBSOFT HOLDINGS L 12.68 - 0.37 0.61 - - 34.74 20.72 1.31 1.24 1.19 1.29 6.10 6734.93 354 HK Equity CHINASOFT INTERNATIONAL LTD 4.02 0.27 0.33 0.41 23% 14.76 12.22 9.83 1.55 1.51 1.30 0.48 14.79 9773.88 434 HK EQUITY BOYAA INTERACTIVE INTERNATIO 1.37 0.41 - - - 3.35 - - 0.38 - - - - 992.68 799 Hk EQUITY IGG INC 10.14 0.91 1.22 1.35 22% 11.10 8.34 7.51 6.49 4.43 3.26 5.55 52.13 12996.54 1980 HK Equity TIAN GE INTERACTIVE HOLDINGS 3.24 0.29 0.34 0.34 9% 11.18 9.47 9.47 1.24 - - - - 4107.90 2280 Hk EQUITY HC GROUP INC 4.19 0.31 0.37 0.50 28% 13.69 11.42 8.36 1.04 0.93 0.82 0.22 7.70 4694.49 400 HK EQUITY COGOBUY GROUP 2.9 0.24 - - - 12.13 - - 0.96 - - - - 4254.13 3888 HK Equity KINGSOFT CORP LTD 12.26 2.84 0.26 0.80 -47% 4.32 47.52 15.38 1.13 1.18 1.12 0.81 5.91 16829.65 Average 12.66 21.72 13.58 2.48 2.83 2.30 1.44 18.47 Hardware sector 1810 HK EQUITY XIAOMI CORP-CLASS B 13.52 - 0.51 0.66 - 9.69 26.72 20.52 - 3.77 3.32 - 11.99 305249.38 2018 HK Equity AAC TECHNOLOGIES HOLDINGS IN 48.65 5.02 3.94 4.51 -5% 9.69 12.35 10.78 2.98 2.60 2.25 3.37 22.02 59255.70 6088 HK Equity FIT HON TENG LTD 3.4 0.23 0.27 0.30 - 14.79 12.64 11.18 1.55 1.40 1.28 2.07 12.47 22927.68 2382 HK EQUITY SUNNY OPTICAL TECH 70.8 3.08 3.21 4.54 - 22.99 22.07 15.58 8.60 6.91 5.13 1.18 36.89 77656.96 Average 14.29 18.45 14.52 4.37 3.67 3.00 2.21 20.84 Telecom equipment 788 HK EQUITY CHINA TOWER CORP LTD-H 1.36 - 0.02 0.04 - 11.74 75.56 37.78 1.22 1.10 0.98 0.58 2.95 239371.52 552 HK Equity CHINA COMMUNICATIONS SERVI-H 5.85 0.45 0.49 0.55 11% 12.93 11.87 10.56 1.15 1.18 1.10 3.00 10.80 40517.21 763 HK Equity ZTE CORP-H 14.78 1.26 - 1.11 -6% 11.74 - 13.27 2.48 1.69 1.54 - 13.19 87665.73 6869 HK EQUITY YANGTZE OPTICAL FIBRE AND-H 22.25 2.15 2.59 2.90 16% 10.36 8.58 7.66 2.23 1.99 1.71 3.72 22.30 24777.53 1617 HK EQUITY NANFANG COMMUNICATION HOLDIN 4.64 0.14 0.29 0.37 64% 33.49 16.06 12.41 5.87 - - 2.93 35.00 5196.80 Average 16.05 28.01 16.33 2.59 1.49 1.33

Source: Bloomberg

Sector Outlook ─ China Autos

tor Outlook ─ Environmen Consolidation persists; leader remains strong

Passenger vehicle (“PV”) sales may have negative growth in 2018, Dominic Chan and sluggish in 2019, due to car purchase tax discount policy Senior Equity Analyst expired [email protected] NEV will maintain a faster growth in 2019 (852) 2916-9631 Competition will be more intense, resulting a leader to remain strong 17 Dec 2018 Inventory level increase is the key risk for the industry Auto sector return to reasonable valuation, of which Geely Autos (175.HK) is our top pick

PV sales may remain sluggish in 2019: PV sales will face several challenges in 2019, including economic slowdown, car purchase tax discount expired, NEV subsidiary policy changed, higher competition from overseas brand vehicles, and high base after high growth in previous years. Even though NEV sales may remain strong, PV sales outlook most likely be sluggish in 2019.

NEV will become more popular: Due a significant increase in the Key Data number of new model, sales of NEV boomed in 2018, with NEV sales Avg.18E P/E (x) 11.2 grew by 81.1% to 731k units in 9M2018. In addition, China has also Avg.18E P/B (x) 1.2 introduced different policies to support the development of NEV, Avg.18E Dividend Yield (%) 3.7 those policies include, “Regulation on Investment Management of Source: Bloomberg

Automobile Industry” issued by NDRC in May 2018; “Three-Year Action Plan to win the Blue Sky Defense War” by State Council in July 2018. We believe NEV will continue to be popularized in 2019. Sector Performance (%) -0.7 Leader remains strong: Passengers car growth rate continue to 1-mth 3-mth -8.5 slow down, and full share cap restrictions on auto industry will be YTD -43.1 abolished by 2022, resulting a more competitive market. We expect Source: Bloomberg competition continue to be intense and leader will remains strong going forward.

Increase in inventory level is the key risk: According to the data CEBI’s Stock Pick from the China Automobile Dealers Association, inventory level Geely Autos (175 HK) continue to increase thought out 2018, with the inventory coefficient increase from 1.6 in early this year to 1.88 in Oct 2018, and up 50% YoY, reflecting higher inventory level in retail market.

Reasonable valuation; Geely (175 HK) is our top pick: Auto sector has been declined to a reasonable valuation, of which trading at 6.9x Sector Performance 2019E PE. Within auto sector, we like Geely Autos (175 HK) because

of its higher competitiveness of its products. Absolute Relative 1-mth

Auto sales expects to remain sluggish in 2019

China auto industry faced many challenges in 2019, including macroeconomic growth slowed down, car purchase tax discount soon expire, NEV purchase tax exemption policy adjusted, opening of China auto market, etc. Meanwhile, base is high after strong growth in the past few years. According to data from the China Association of Automobile Manufacturers (CAAM), auto sales in China totaled 22.87m, down 0.1% YoY, of which auto sales in China declined by 11.7% in Oct 2018. We believe auto sales in China likely to see negative growth in 2019.

Fig 2: Retained number of passengers car in Fig 1: Passengers car sales in China (10K units) China (10K units)

3500 0.16 25000 16% 2802.8 2887.9 21743 3000 0.14 14% 19440 14% 2459.76 17228 2349.19 0.12 20000 12% 13% 2500 2198.41 12% 12% 12% 0.1 15447 2000 15000 13741 10% 0.08 8% 1500 0.06 10000 6% 1000 0.04 4% 500 5000 0.02 2% 0 0 0 0% 2013 2014 2015 2016 2017 2013 2014 2015 2016 2017

Passenger car sales in China YoY (%) Retained number of NEV in China YoY (%)

Source: CAAM Source: CAAM

Due to the slowdown in Marco economy and domestic consumption, high base in passenger cars, and no further car purchase tax discount, we expect auto sales will be sluggish in 2019.

PV sales weakened but different model saw different growth in 2018. Based on 10M2018 data, sales volume of SUV came at 8.1m, up by 1.6% YoY. Sedan sales volume remained steadily at 9.4m, sales volume of MPV and crossover dropped by 14.1% and 19.1% YoY.

Fig 3: 10M2018 Auto Sales volume breakdown by Fig 4: Auto Sales volume based on Model Country 100.0 Korean France 6.8 5.2 2.8 2.2 8.9 5% 1% 90.0 20.7 80.0 29.4 37.1 41.5 US 70.0 39.0 9.7 11% 60.0 10.0 10.2 50.0 8.4 Chinese 6.8 42% 40.0 German 30.0 62.8 55.4 49.8 21% 20.0 47.9 45.4

10.0 0.0 2014 2015 2016 2017 9M2018

Japanese Sedan MPV SUV Crossover 20% Source: CAAM Source: CAAM

According to the breakdown by country, own brand accounted for 42%, Deutsch series accounted for 21% while Japanese series accounted for 20%.

10M2018, sales volume of SAIC group accounted for 25%, DongFeng group accounted for 13%, Geely Group rose to 6% after a strong growth.

Fig 5: Top 10 auto manufacturers based on sales volume in 10M2018

Chery Brilliance auto 3% SAIC 3% Others 25% 11% Greatwall 3%

Geely 6%

GAC 8% Dongfeng 13% CCAG 8% BAIC 8% China FAW 12%

Source: CAAM

NEV continued to see significant growth, with the sales volume grew by 75.6% YoY to 860K. Market originally expect sales volume of NEV can come to 1.1m in 2018.

NEV become more popular in China. As of the end of June 20128, retained number of NEV was 1.99m in China, compared with 4m in the world, retained number of NEV was about 50% worldwhile.

Fig 6: NEV sales volume from 2016-2018 Fig 7: NEV breakdown by country (thousands)

18 Korean France 16 5% 1%

14 US 12 11% 10 8 Chinese 42% 6 German 21% 4

2 Japanese 0 20% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2016 2017 2018

Source: CAAM Source: CAAM

Within China market, BAIC group sold the most NEV in Oct2018, BYD group is the next.

Fig 8: 10M2018NEV Sales breakdown

Zotye 2867

Brilliance 2961

SGMW 3126

JAC 4804

Jiangling 5002 Geely 5971 Chery 7297

SAIC 8077

BYD 26069

BAIC 27814

0 5000 10000 15000 20000 25000 30000

Source: CAAM

Uncertainty on NEV purchase tax exemption policy

NEV purchase tax exemption policy is the key uncertainty for NEV sales in next few years. There is a rumor that the amount of subsidy will be cut by 30% compared with 2018. We do not know whether rumor is correct or not, but we believe subsidy may decrease gradually, and end the tax exemption policy until 2020.

Regarding to the tax exemption policy in 2018, different model get different subsidy, mainly depends on the durability of NEV. Below shows NEV subsidy schedule in 2018.

Fig 9: NEV subsidy schedule in 2018 Amount of subsidy

EV maximum range 2015 2016 2017 2018

80-100km 31500

100-150km 31500 25000 20000

150-200km 45000 45000 36000 15000

200-250km 45000 45000 36000 24000

250-300km 54000 55000 44000 34000

300-400km 54000 55000 44000 45000

over 400km 54000 55000 44000 50000

Hybrid EV 31500 30000 24000 22000

Source: CAAM

Abolish full share cap restrictions on auto industry by 2022

On April 2018, NDRC announced a five year transition period to abolish full share cap restrictions on the auto industry. The details include 1) abolish restrictions on specialist and NEV by the end of this year, 2) abolish restrictions on commercial cars and passengers car by 2020 and 2022 respectively. By the end of 2022, cancel the rules that JV cannot be formed by 2 companies.

We believe it will bring greater impact on those brands which are rely on joint ventures, due to the reduction on income contributable from joint venture. Leaders remain outperform

Based on 1H18 sales figure, auto segment performance are mixed, of which leaders remained outperform.

Fig 10: 1H2018 results for major auto manufacturer

90,000

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0 Geely GAC BAIC Brilliance DFM BYD Great Wall

1H17 1H18

Source: CAAM

Rise in inventory is the key risk

According to the data from the China Automobile Dealers Association, inventory level continue to increase thought out 2018, with the inventory coefficient increase from 1.6 in early this year to 1.88 in Oct 2018. Meanwhile, coefficient increased compare with 2017 too.

Based on industry norm, inventory coefficient is normal within 0.8-1.2, inventory coefficient larger than 1.5 reflects inventory enter an alert level. If the coefficient is higher than 2.5, its mean that inventory is too high. We believe increasing inventory level is negatively affect auto manufacturers and auto dealers.

Fig 11: Monthly inventory coefficient from 2016-2018

2.5

1.5

0.5

0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct

2016 2017 2018

Source: CABA

Valuation becomes reasonable

Auto sector is volatile and declined by 37% in 1-year horizon.

Fig 12: 1-Year sector performance (major stocks) (%)

120

100

Hang Seng Index China Auto

Source: Bloomberg

Geely Auto is our top pick

Even though China Auto market is mixed in 2019. Due to the industry consolidation, leader will remains outperform. Geely Auto is our top pick, given that its competitiveness on its own brand, and higher market shares in NEV segments. The stock is trading at 6.9x 2019E P/E.

Fig 14: Geely Auto net profits and growth rate Fig 13: Geely Auto revenue and growth rate (%) (%)

100,000 140.0% 12,000 140.0%

120.0% 10,000 120.0% 80,000 100.0% 100.0% 8,000 60,000 80.0% 80.0% 6,000

40,000 60.0% 60.0% 4,000 40.0% 40.0% 20,000 2,000 20.0% 20.0% 7.5% 9.5% 11.5% 11.0% 12.4% 0 0.0% 0 0.0% 2015 2016 2017 1H20171H2018 2015 2016 2017 1H2017 1H2018

Revenue (Rmb m) YoY (%) Net profits (Rmb m YoY (%) NPM (%)

Source: Company data Source: Company data

Risks

Risk factors include 1) weaker-than-expected retail sales in China, 2) greater-than- expected competition in NEV field, 3) changes in NEV subsidy policy.

Fig 15: Comparable table (Data as of December 14, 2018)

Source: Bloomberg

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We, LAM Chiu Kei, Banny (C.E. No.:AGH217), Chan Wai Kit (C.E. No.: APP 609) and Tang Yat Sing (C.E. No.:BNS762) are SFC licensed persons, primarily responsible for the content of this research report, in whole or in part, hereby certify that all of the views expressed in this report accurately reflect our personal view about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. We and/or our associate(s)/connected person(s) have no financial interests in relation to any listed company (ies) covered in this report, and we and/or our associate(s)/connected person(s) do not serve as officer(s) of any listed company (ies) covered in this report.

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