Industrials / China 2357 HK Industrials / China 12 June 2014 AviChina Industry & Technology AviChina Industry & Technology Target (HKD): 5.20 5.00 Upside: 14.9% 2357 HK 12 Jun price (HKD): 4.35 Poised for earnings-growth acceleration in 2015 1 Buy (unchanged) 2 Outperform • Likely upcoming policy reforms would improve AviChina’s 3 Hold margins and encourage more asset injections from its parent 4 Underperform • We expect AviChina to win more orders for its existing and new 5 Sell models, which should drive stronger earnings growth in 2015 • Lowering target price slightly to HKD5.00; reiterating Buy (1) call; catalysts from policy reforms and order-book growth How do we justify our view? new aircraft models this year, disposal gains. Our 2015E EPS is 8% including the Y12F and Z15. For above the consensus as we factor in existing models, we expect the L15 the parent’s planned asset injections. trainer to obtain more orders in 2014, and deliveries of its Legacy Forecast revisions (%) Kelvin Lau 650 business jet to start in 2H14. Year to 31 Dec 14E 15E 16E (852) 2848 4467 Revenue change 10.6 8.9 n.a. [email protected] We raise our 2014-15E revenue by 9- Net profit change (17.4) (17.9) n.a. Core EPS (FD) change (17.4) (17.9) n.a. 11% for new model orders and assets Carrie Yeung injected since 2013. We cut our 2014- Source: Daiwa forecasts (852) 2773 8243 15E EPS by 17-18%, as we reduce our [email protected] Share price performance earnings for subsidiary AVIC Avionics (2014E) and exclude disposal gains (HKD) (%) (2014-15E), but include the parent’s 5.5 135 ■ What's new 5.0 123 We believe AviChina stands to planned asset injections (2015E). Still, 4.5 110 benefit from policy reforms that we we forecast a strong EPS growth pick- 3.9 98 expect the government to announce up to 31% YoY for 2015 and see robust 3.4 85 this year for China’s aerospace and earnings growth continuing in 2016. Jun-13 Sep-13 Dec-13 Mar-14 defence industries, and foresee a Avichina (LHS) Relative to HSI (RHS) boost to orders for its existing and ■ What we recommend new aircraft models, which should We lower our SOTP-based 6-month 12-month range 3.53-5.09 drive higher earnings growth in 2015. target price mildly to HKD5.00 Market cap (USDbn) 3.02 (from HKD5.20), due to a lower 3m avg daily turnover (USDm) 6.80 earnings contribution from AVIC Shares outstanding (m) 5,373 ■ What's the impact Major shareholder AVIC (56.7%) We believe the government will aim Avionics, and a 35% discount to attract more private capital into (formerly 30%) to our SOTP value Financial summary (CNY) China’s national defence and derived from 2015E PERs assigned Year to 31 Dec 14E 15E 16E aerospace-manufacturing sectors, to AviChina’s A-share subsidiaries Revenue (m) 26,148 30,367 35,338 thereby allowing more assets to be and affiliates (formerly 2014E Operating profit (m) 1,947 2,224 2,650 PBRs). We reaffirm our Buy (1) Net profit (m) 723 944 1,145 injected into listed companies, Core EPS (fully-diluted) 0.132 0.172 0.209 including AviChina and its rating, based on strong order-book EPS change (%) 13.9 30.6 21.3 subsidiaries and affiliates. We also growth and positive policy reform. Daiwa vs Cons. EPS (%) (7.7) 7.7 (0.4) expect a reform of industry pricing, The main risk is lower-than- PER (x) 26.5 20.3 16.7 which would help improve expected order-book growth. Dividend yield (%) 0.6 0.8 1.0 DPS 0.022 0.028 0.034 AviChina’s gross-profit margins. PBR (x) 1.8 1.6 1.5 ■ How we differ EV/EBITDA (x) 9.3 9.0 7.6 Meanwhile, we expect AviChina to Our 2014E EPS is 8% below the ROE (%) 6.9 8.4 9.4 obtain licences to sell more of its Bloomberg consensus as we exclude Source: FactSet, Daiwa forecasts See important disclosures, including any required research certifications, beginning on page 21 Industrials / China 2357 HK 12 June 2014 Contents Potential private capital boost from reforms ................................................................................. 6 More private capital expected to enter AviChina’s sector .......................................................... 6 Potential change of pricing system .............................................................................................. 7 Diplomatic considerations ........................................................................................................... 7 2014: contrasting outlook for subsidiaries .................................................................................... 8 Hafei Aviation, Jonhon Optronic: optimistic on earnings ......................................................... 8 Concerns about AVIC Avionics and Hongdu ............................................................................. 10 Other product highlights ............................................................................................................ 11 Forecasts, valuation and recommendation ................................................................................... 12 Earnings-forecast revisions ....................................................................................................... 12 Valuation: new SOTP-based target price of HKD5.00 .............................................................. 12 Major risks ................................................................................................................................. 13 Appendix ........................................................................................................................................ 15 - 2 - Industrials / China 2357 HK 12 June 2014 1 Buy (unchanged) How do we justify our view? 2 Outperform 3 Hold Growth outlook 4 Underperform Valuation 5 Sell Earnings revisions AviChina: net profit and net profit growth (2011-16E) Growth outlook We expect AviChina to resume double-digit 14% YoY net (CNYm) (YoY%) profit growth in 2014, despite reducing our net profit 1,400 40% forecast, as we see strong drivers from its helicopter and 1,200 20% optronics businesses. The profitability of its 44.5%-owned 1,000 subsidiary AVIC Avionics remains a concern as we expect 0% 800 higher R&D and interest expenses than previously for (20%) 600 2014. We forecast AviChina to see strong 31% YoY net (40%) profit growth for 2015, as from that year we now include 400 higher profits from the parent’s planned asset injections 200 (60%) into one of AviChina’s affiliates, Sichuan Chengfei 0 (80%) Integration Technology (CITC). If we exclude the one-off 2011 2012 2013 2014E 2015E 2016E impact from these injections, our 2015E net profit growth Total net profit (LHS) Growth (RHS) would still be solid at 20% YoY, similar to 21% YoY growth Source: Company, Daiwa forecasts we forecast for 2016. AviChina: 1-year forward PER (2011-present) Valuation AviChina is trading at a 2015E PER of 20.3x (on our EPS (PER, x) forecast), below its past-3-year average of 24.3x. We 45 believe its share-price weakness year-to-date reflects 40 35 1 Std concerns in the market about its 2014 profitability 30 (especially from AVIC Avionics), which we think is now 25 average fully priced in. We remain positive on AviChina’s earnings 20 outlook for 2015 and beyond as we expect it to benefit 15 1 Std 10 directly from orders for several new models it plans to 5 launch this year and China’s opening-up of low-altitude 0 airspace potentially from 2015. We expect investor Jul-13 Apr-12 Jun-11 Feb-13 Nov-11 Dec-13 Sep-12 sentiment towards the stock to recover during the next 6 May-14 months, driving a re-rating, as investors are likely to start PER upper lower average focusing more on 2015E earnings. Source: Thomson Reuters, Daiwa forecasts AviChina: consensus EPS-forecast revisions (2014-15E) Earnings revisions Year-to-date, the Bloomberg consensus has revised (HKD) down its 2014 EPS forecast, which we believe reflects 0.22 concerns about a lower earnings contribution from 0.21 AVIC Avionics. As our earnings forecasts exclude disposal gains (whereas the consensus includes them), 0.20 our 2014E EPS is 8% lower than that of the consensus, 0.19 though the consensus still comprises only a few 0.18 analysts. Our 2014E EPS would be in line with that of the consensus if we included disposal gains. Our 2015E 0.17 EPS is 8% above that of the consensus as we include the 0.16 impact from the planned asset injections by AviChina’s Jan-14 Apr-14 parent into affiliate CITC, and we expect the consensus 2014E 2015E to raise its 2015 forecast to factor this in. Our 2015E Source: Bloomberg EPS would be 15% above that of the consensus if we also included disposal gains. - 3 - Industrials / China 2357 HK 12 June 2014 Financial summary Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Revenue growth from helicopters (%) (5.4) 8.3 22.0 160.6 30.0 21.6 20.0 20.0 Revenue growth from trainers (%) (0.6) 8.5 6.3 (51.7) (35.8) 25.0 26.5 26.5 Revenue growth from aviation parts 0.0 117.2 17.7 50.3 18.8 16.4 12.4 12.6 and components (%) Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Aircraft revenue 3,028 5,268 6,555 8,273 10,198 12,187 14,670 17,662 Aviation components and other revenu 2,627 5,705 5,518 10,095 11,995 13,962 15,698 17,676 Other Revenue 238 949 1,199 0 0000 Total Revenue 5,893 11,922 13,271 18,368 22,193 26,148 30,367 35,338 Other income 118 136 132 159 251 195 195 195 COGS (4,285) (8,097) (10,160) (13,803) (17,150) (20,616) (24,182) (28,252) SG&A (786) (1,498) (1,806) (2,533) (2,801) (2,941) (3,238) (3,502) Other op.expenses (182) (390) (459) (641) (735) (839) (918) (1,129) Operating profit 757 2,074 979 1,549 1,758 1,947 2,224 2,650 Net-interest inc./(exp.) (68) (53) (19) (66) (74) (149) (142) (177) Assoc/forex/extraord./others 33 32 92 57 77 100 217 272 Pre-tax profit 722 2,053 1,052 1,540 1,761 1,898 2,300 2,744 Tax (61) (145) (143) (235) (250) (267) (309) (367) Min.