STRATEGY NOTE China | Equity Strategy Global 7 January 2014 EQUITY STRATEGY Global Equity Strategy China: A Ticket To Ride And The RMB At 6 Key Takeaway China Offshore NDF 12 Month Forward P r emium/ Discount Despite the recent correction in share prices, the China reform process is very To Spot R MB much intact. The acknowledgement by the authorities that they ought to allow 1.5 prices to be liberalized suggests that some of the immediate beneficiaries from 1.0 the third plenum will be companies whose prices have been regulated. A basket 0.5 0.0 of stocks that are able ‘to re-price’ their ticket items might be a silent winner (0.5) in 2014. (1.0) GLOBAL 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Any upward pressure in domestic prices might create fears over inflation. This suggests Soruce: Bloomberg, Jefferies that the PBOC will continue to maintain tight monetary policy whilst allowing the RMB to China B IS R eal B r oad Effective Exchange R ate Index appreciate as it undertakes reform. We expect the RMB to continue to rise as the central bank 130 is still intervening through FX purchases to curb the rate of appreciation. We would expect 120 the RMB to comfortably break through 6.00 in 2014. We would remain long the currency 110 despite the recent turmoil in Asian FX markets caused by fed tapering. 100 90 One unloved sector that is a play on domestic growth and that we believe might see a 80 70 renaissance in 2014 is the Insurance sector. The stocks are inexpensive, their product range 00 01 02 03 04 05 06 07 08 09 10 11 12 13 is expanding and the competition from wealth-management products has been tightened Source: FactSet, Jefferies by the government bringing down yields. We like Ping An Insurance (2318 HK, Buy, MSCI China vs. MSCI Latin A merica Since Jan. 2013 HK$83.0 PT). We see the company as a clear stand-out on the back of its strong agency ( 2013/ 01/ 01=100) 110 focus and early e-commerce platform attempts. It trades on 1.1x FY14 P/EV. The big three 105 100 insurers are trading at just over book as well based on 2014 P/EV. 95 90 85 “She’s a got a ticket to ride, She’s a got a ticket to ride, but she don’t care”, Ticket to Ride, 80 75 The Beatles 70 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Supply side reforms are generally good for government bond holders. They mean less MSCI China MSCI Latin America government, less spending and less intervention. Furthermore, supply side reform allows Source: FactSet, Jefferies deregulation to occur thereby raising productivity and income per capita. It ought to mean China Cur r ent Account B alance ( in US$ million) also lower inflation over time. The Third Plenum announcements were important because it 1,400.0 saw the political ideological barriers that held back the economy such as Hukou, land rights 1,200.0 1,000.0 and the one child policy being removed. This is very bullish in the long term. 800.0 600.0 The central bank has remained focused on financial reform for the past three years. It is 400.0 200.0 forcing through a liberalization of both interest rates and the capital account (the exchange 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 rate). If the economy is to be able to allocate capital efficiently, businesses need to be able (200.0) to rely on pricing mechanisms being efficient. The recent proposals to address the issue of Source: China State Administration of Foreign Exchange, FactSet, Jefferies domestic pricing ought to mean that in the short-term companies are able to raise prices. In exhibits 1 and 2 we highlight some Chinese companies that offer upside ‘ticket re-pricing’ to their products and services. Our FX teams believe the recent China reform proposals are important and conducive to a Sean Darby * stronger CNH. As the authorities use these reforms to re-orientate the economy away from Chief Global Equity Strategist +852 3743 8073 [email protected] the export/investment model towards stronger private consumption, a firmer CNH will help Christie Ju, CFA * the process. The PBOC reserves rose a further US$350bn in 2013, to US$3.7trn. Our FX Equity Analyst strategy point out that short USDCNH had the best Sharpe ratio in the FX world in 2013. It +852 3743 8012 [email protected] Kenneth Chan * is liquid, carry-positive and volatility is low. The currency is ideal for equity investors to base Quantitative Strategist their stock selection around. +852 3743 8079 [email protected] Vivien Hu * Equity Associate +852 3743 8078 [email protected] * Jefferies Hong Kong Limited Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 5 to 8 of this report. Equity Strategy Global 7 January 2014 The agency distribution will continue to be the key growth driver of the Chinese life insurance industry in the years to come. In 2013, while agency business growth continued to be challenging, there has been visible improvement from 2012, with both Ping An Insurance (2318 HK, BUY, TP: HKD83.0) and China Pacific Insurance (2601 HK, BUY, TP: HKD33.0) delivering 1H13 agency business NBV growth of 15%/7%, respectively. Going into 2014, with broadening product offerings and increasing critical illness protection awareness/needs, we expect agency distribution to deliver moderate growth in the range of 5-8%. Since the CIRC deregulated insurance funds' investment channels in 2012, there has been a prudent and gradual allocation towards alternative investment assets, with small improvements in net yields and less reliance on the volatile A-share markets. In 1H13, the Big 3 life insurers reported comprehensive investment yield in the range of 4.2%-4.6%, despite a 12.8% decline in CSI300. The bottom line is that the markets had run ahead on the back of the better supply side reform news late last year. In the short run, aligning portfolios to an appreciating CNY and domestic ‘re-pricing’ ought to offer a low volatility strategy. At the same time exposure to the China Insurance sector offers a play on improving domestic growth through a wider offering of products. page 2 of 8 Sean Darby, Chief Global Equity Strategist, +852 3743 8073, [email protected] Please see important disclosure information on pages 5 - 8 of this report. Equity Strategy Global 7 January 2014 Exhibit 1: China Stocks Benefit From Supply Side Pricing Reforms Company Name Ticker Price Price Target Rating Sector Positives Natural Gas Pricing Reform Beneficiaries China Petroleum & Chemical - H 386 HK HK$6.01 HK$7.30 BUY Integrated Oil Benefit from rising price Petrochina Co. Ltd - H 857 HK HK$8.14 HK$12.00 BUY Integrated Oil Benefit from rising price Sinopec Shanghai Petrochem - H 338 HK HK$2.21 HK$2.34 BUY Petrochemicals Benefit from rising price Kunlun Energy 135 HK HK$13.40 HK$16.70 BUY Utilities Benefit from rising price China Datang Corp Renewable Power 1798 HK HK$1.66 HK$2.20 BUY Alternative Energy Benefit from alternative demand Xinjiang Goldwind Science & Technology 2208 HK HK$8.89 HK$5.30 BUY Alternative Energy Benefit from alternative demand Electricity Pricing and Water Pricing Reform Beneficiary Guangdong Investment Ltd. 270 HK HK$7.42 HK$8.60 BUY Conglomerates Benefit from rising price Electricity Pricing Reform Beneficiaries Datang International Power Generation 601991 CH Rmb3.94 Rmb5.50 BUY Utilities Benefit from rising price China Power International 2380 HK HK$2.69 HK$3.50 BUY Utilities Benefit from rising price China Resources Power Holdings 836 HK HK$17.50 HK$24.70 BUY Utilities Benefit from rising price Huaneng Power International 902 HK HK$7.08 HK$9.60 BUY Utilities Benefit from rising price Rail Rate Reform Beneficiaries China Railway Group Ltd 601390 CH Rmb2.51 Rmb3.30 BUY Rail Benefit from rising price Zhejiang Expressway Co - H 576 HK HK$7.18 HK$7.30 BUY Expressway Benefit from alternative demand China Eastern Air-H 670 HK HK$2.81 HK$3.30 BUY Aviation Benefit from alternative demand Air China-H 753 HK $5.33 HK$6.20 BUY Aviation Benefit from alternative demand Source: Jefferies page 3 of 8 Sean Darby, Chief Global Equity Strategist, +852 3743 8073, [email protected] Please see important disclosure information on pages 5 - 8 of this report. Equity Strategy Global 7 January 2014 Exhibit 2: China Stocks Benefit From Supply Side Pricing Reforms with DuPont analysis Current Year Forward Revision (%, 4W) Dupont Analysis YTD Return Sustainable Dividend Operating Bloomberg Return Since 2010 % Consensus Growth Rate Cover (3 yr Altman Z Piotroski F- Efficiency Profitability Financial Code Company Name Sector MC (US$mn) (%) (%) PB (x) DY (%) ROE (%) PE EPS PT BUY (3 yr avg, %) avg, x) Score Score (x) (%) Leverage (x) 386 HK China Petroleum & Chemical Corporation Class H Integrated Oil 87168.9 (5.1) 13.1 1.0 5.1 14.0 7.1 0.4 1.0 63.0 7.52 2.44 2.93 5 2.35 2.5 2.37 857 HK PetroChina Co.