Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Nov 6, 2014

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1 Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 14E 15E 14E 15E HSI HSCEI MXCN SHSZ SHCOMP SZCOMP INDU SPX CCMP UKX NKY Hong Kong ADRs HK Local Daily ADR Daily ticker Company (HK$) (%) (US$) (%) 941 CHINA MOBILE PETROCHINA ICBC HSBC CCB TENCENT BANK OF CHINA SINOPEC CHINA LIFE INS CNOOC Econ data release China Data Date Period Prior Cons China Trade Balance 8-Nov OCT China Exports YoY 8-Nov OCT China Imports YoY 8-Nov OCT China CPI YoY 9-Nov OCT China PPI YoY 9-Nov OCT Rmb New Loans 10-Nov OCT M0 10-Nov OCT M1 10-Nov OCT M2 10-Nov OCT Total Financing 10-Nov OCT US Data Date Period Prior Cons Initial Jobless Claims 6-Nov 1-Nov Cont Jobless Claims 6-Nov 25-Oct U-3 Unemployment 7-Nov OCT Source: Bloomberg GF events Source: GF Securities A-Share Market Retail: 3Q14 results point to continued weakness Overall consumer demand remained weak in Sep with the brick-and-mortar retail channel still under pressure. Department stores are seeking to capitalize on their prime-location properties, which should help raise their valuations. We expect sector fundamentals to recover slowly in the near term, though the competition from e-commerce players will continue to weigh on traditional retailers. In addition, blue-chip retail stocks are likely to see valuation re-ratings with further progress in SOE reforms and the expected introduction of the SH-HK Stock Connect. OFSE: Operational pressure emerging China will remain highly active in oil & gas extraction, and deregulation in the industry should effectively boost investments from the private sector and overseas, with private-sector firms market shares likely to expand in a more competitive environment. That said, OFSE companies are likely to see earnings under pressure in the short term as a result of recent scandals related to PetroChina. Sector uncertainties are likely to increase in the near term due to oil company reforms and a shift in oil companies preference for suppliers. Building Materials: Cement price momentum to weaken in Nov Cement price growth during Oct in eastern and southern China was mainly a result of coordinated efforts by companies amid weak demand. We expect price momentum to weaken further into Nov with downward pressure to be seen in Dec. Both revenue and earnings growth at building materials companies eased QoQ during 9M14 as sector deleveraging that started in 2H10 continues. We see short-term investment themes driven by the development of the Silk Road Economic Belt and Maritime Silk Road. Hong Kong Market Insurance: Quarterly review; reiterate Positive We believe NBV growth estimates in the life insurance sector may be revised up given the stable individual channel in 9M14. Life insurance stocks are significantly undervalued, and there are positive signs for Ping An and the entire China P&C insurance sector: the underwriting cycle may have bottomed recently. We reiterate our Positive rating on the China insurance sector. We recommend NCI, whose annualized total investment yield is highest among its peers, Ping An, whose shares are trading at a historical low, and China Taiping, which has seen peer-beating life NBV growth. Smartphone Sector: How much is Xiaomi worth? According to Bloomberg, Xiaomi is in discussion for another round of fund raising that values the smartphone maker at US$40-50bn. The US$50bn price tag would price Xiaomi at 4.3x 2014E P/S, which is still higher than the 3.5x P/S of Apple which has a market capitalization of US$641bn and sales of US$183bn for the fiscal year ended Sep 30, 2014, compared with an estimated US$11.5bn for Xiaomi in It is also worth noting that Apple earned US$39bn in net profit in FY2014, whereas Xiaomi is barely profitable at present, according to Bin Lin, co-founder and President of Xiaomi in recent press reports. Property: Oct residential GFA sold recovered in all first-tier cities Oct residential GFA sold in Shenzhen, Guangzhou, Shanghai and Beijing rose 44%, 41%, 18% and 15% MoM respectively on an increase in launches by developers and positive policies. The central government plans to stabilize real-estate related consumption, a positive stance implying more favorable policies in the near future. However, we expect relatively high land prices to drive down developers gross margins in We believe there is a lack of earnings visibility at most Chinese developers. We maintain our Neutral rating on the sector, preferring mass-residential leaders with proven execution, such as Vanke and COLI. Continued on next page Alex Fan, CFA, Head of Research, SFC CE No. ADJ672 alexfan@gfgroup.com.hk Gao Yedong, Editor, SFC CE No. BAI002 yedonggao@gfgroup.com.hk

2 Hong Kong Market (continued) Leju Holdings (LEJU US): Fairly valued major real estate services provider; initiate at Hold The company has strong brand equity and nationwide geographic coverage in China. It is active in three business segments: e-commerce, online advertising, and fee-based online listing for real estate agents. Leju has a strong parent in E-House China and is the exclusive advertising agent for Sina and Baidu. Total net revenue rose 75% YoY to US$196m in 1H14, with its e-commerce segment driving growth. Management has maintained its previous 2014 full-year revenue guidance of US$ m, which would represent a YoY increase of 49%-55%. We see its valuations as fair, and initiate our coverage at Hold, with a target price of US$ E-commerce: Alibaba reported strong GMV growth in 3Q14 Alibaba reported non-gaap net profit of Rmb6.8bn for 3Q14, in line with consensus, spurring a 4.8% move in its share price. 3Q14 gross merchandise volume maintained strong growth, rising 54% YoY, driven mainly by an increase in its user base. We expect strong QoQ GMV growth in 4Q14, which is the traditional peak season in China marked by a) the one-week National Holiday from Oct 1, and b) "Singles Day" on Nov 11 Alibaba recorded Singles Day GMV of Rmb36bn last year. Alibaba is trading at a lofty 48x forward P/E. Page 2

3 Retail: 3Q14 results point to continued weakness Traditional retail channel still under pressure The GF Retail Index (GFRI) rose 10.77% YoY in Sep, easing 3.9pp from growth in Sep 2013 and down 1.4pp from Aug. Sales at the country s top 100 retailers also came off 0.3% YoY in Sep, with the growth figure dropping 7.0pp YoY and 3.6pp MoM. In particular, the sales growth of most products at these retailers was relatively weak except for jewelry (which has become less affected by the high base effect) with food product sales posting the first YoY decline so far this year. Overall, consumer demand remained weak with the brick-andmortar retail channel still under pressure. Sector 3Q14 earnings review: The 30 mainstream department stores we track suffered a 3.47% YoY decline in revenue and an 8.5% YoY drop in net profit (excluding non-recurring items) during the quarter. Though unlikely to see significant improvements business operations, these companies are seeking to capitalize on their prime-location properties through various means including the securitization of rents and renting back properties that they have sold. This should help raise the valuations of traditional department stores. The seven supermarkets tracked achieved revenue growth of 6.04% YoY in 3Q14 with net profit excluding non-recurring items up just slightly by 0.07% YoY. Ongoing supply chain development by these companies might lead to upgrades in overall efficiency across the domestic retail sector. The nine specialty stores tracked posted a revenue decline of 1.6% YoY with net margin (excl. non-recurring items) narrowing by 0.81pp, while the six specialized market operators tracked saw figures of +2.79% YoY and -3.27pp. Sector fundamentals to recover slowly; blue chips to see re-ratings We expect sector fundamentals to recover slowly in the near term as the impact of government spending controls and the high comparable base for jewelry sales fades, though the competition from e-commerce players will continue to weigh on traditional retailers. In addition, blue-chip retail stocks are likely to see valuation re-ratings with further progress in SOE reforms and the expected introduction of the SH- HK Stock Connect. Our top picks are Shanghai Jahwa United ( CH), Lao Feng Xiang ( CH), Dashang ( CH), Hualian Department Store ( CH), Highsun Group ( CH), Wangfujing Department Store ( CH), Beijing Urban-Rural Trade Centre ( CH), Grandbuy ( CH), Silver Plaza Group ( CH), Wuhan Department Store ( CH) and Chongqing Department Store ( CH). OFSE: Operational pressure emerging Substantial growth upside given current energy situation Business conditions in the domestic oil & gas extraction industry should remain strong in the long term given the current energy situation. Despite recent oil price corrections and pressure from oil company reforms, we see substantial growth upside in private-sector OFSE companies given that they have established high technical entry barriers to the industry. Companies under pressure in short term China will remain highly active in oil & gas extraction with the markets for offshore drilling, unconventional energy development and old oilfield secondary recovery to offer great potential. In addition, deregulation in the oil extraction industry should effectively boost investments from the private sector and overseas, with private-sector firms market shares likely to expand in a more competitive environment. That said, oil companies now tend to hire their subordinate OFSE companies following recent scandals related to PetroChina ( CH). As such companies on the oil & gas extraction industry chain, particularly OFSE companies whose costs are less elastic, are likely to see earnings under pressure in the short term. Operational pressure emerging The 15 OFSE listcos we track all posted positive YoY revenue growth in 3Q14, though the pace of growth eased considerably both in YoY and QoQ terms, reflecting short-term fluctuations in sector demand. Gross margins were stable, but net margins varied between companies, with equipment and service companies seeing YoY declines of 36pp and 46pp respectively. Domestic OFSE companies typically face significant limitations in terms of business scale, business scope and key client base as they are mostly at an early stage of development. Furthermore, sector uncertainties are likely to increase in the near term as a result of oil company reforms which were started in 1H14 and a shift in oil companies preference in selecting suppliers as was seen in 2H14. Page 3

4 Building Materials: Cement price momentum to weaken in Nov Cement prices up slightly The national average cement price rose by Rmb2/tonne, or 0.60% WoW last week, with prices in central & southern China up by Rmb7/tonne and northwestern China up by Rmb4/tonne. The average cement inventory as a proportion of storage capacity remained flat WoW. Coal prices at Qinhuangdao port picked up by Rmb5/tonne WoW while prices in other regions were stable. The national average glass price fell by Rmb0.45/heavy box WoW last week with overall inventory increasing by 170,000 heavy boxes WoW to 32.53m heavy boxes on Oct 31 (+17.61% YoY). Cement price momentum to weaken in Nov, downward pressure expected in Dec Cement price growth during Oct in eastern and southern China was mainly a result of coordinated efforts by companies amid weak demand. We expect price momentum to weaken further into Nov with downward pressure to be seen in Dec. Glass prices are likely to decline further in Nov-Dec. Cement companies are likely to see earnings growth slow further in 4Q14 given the high YoY base last year and strong cement price growth in 4Q13. As such we maintain a neutral view on the sector. 3Q14 earnings highlights Both revenue and earnings growth at building materials companies eased QoQ during 9M14 as sector deleveraging that started in 2H10 continues. In addition, despite an overall downward trend in the sector, the performance of individual companies varied significantly with fiberglass names, Huaxin Cement ( CH), Tongli Cement ( CH), Oriental Yuhong Waterproof Technology ( CH), Youpon Integrated Ceiling ( CH) and Beijing Lier High-Temperature Materials ( CH) reporting particularly strong earnings in 3Q14. Short-term opportunities We see short-term investment themes driven by the development of the Silk Road Economic Belt and Maritime Silk Road, with the following beneficiaries: Tianshan Cement ( CH), Qingsong Building Materials and Chemicals ( CH), West Construction ( CH), Ningxia Building Materials ( CH), Qilianshan Cement ( CH), Fujian Cement ( CH). Medium-term opportunities We like blue chips with cheap valuations and strong earnings such as Huaxin Cement ( CH), growth stocks that have seen significant share price corrections this year such as Oriental Yuhong Waterproof Technology ( CH) and Changhai Composite Materials ( CH), and small caps expected to go through reforms such as Fangxing Science & Tech ( CH), Jiayu Door Window & Curtain Wall ( CH), Academy of Building Research Group ( CH) and Jiuding New Material ( CH). Insurance: Quarterly review; reiterate Positive 3Q14 results summary The Chinese insurance sector saw stable individual channels, solid growth in net assets, and positive signs for the P&C sector in 3Q14. For example, Ping An s 9M new business via its individual channel rose 19.9% YoY, compared to 18.8% growth in 1H14, and it consistently saw an improvement in combined ratio in 3Q14. Its 9M combined ratio was 94.9%, lower than the 95.8% in 9M13 (combined ratio is only comparable on a YoY basis). We reiterate our Positive rating for the China insurance sector Based on a stable individual channel in 9M14, we believe NBV growth estimates in the life insurance sector may be revised up. Life insurance stocks are significantly undervalued. For example, Ping An s valuation is at a historical low. There are positive signs for Ping An and the entire China P&C insurance sector: the underwriting cycle may have bottomed recently. We strongly recommend NCI (1336, Buy, TP: HK$38.10) Its 3Q14 net profit beat market expectation, and annualized total investment yield rose further to 5.6% (highest among peers). It is also significantly undervalued at just 1.4x 2014E P/B and less than 1.0x 2014E P/EV (depending on actuarial assumptions). We recommend Ping An (2318 HK, Buy, TP: HK$90.00) Ping An s high-margin FYP accelerated in 3Q14 (19.9% YoY in 9M14 vs 18.8% YoY in 1H14) and its P&C business demonstrated consistent improvement. We also point out that the user base on its internet finance platform continued to expand in 9M14. In addition, Ping An s valuation is at a historical low. Page 4

5 We recommend China Taiping (966 HK, Buy, TP: HK$24.00) China Taiping s valuation is attractive (~1.1x P/EV) and it has seen peer-beating growth in life NBV (44% YoY in 1H14 with NBV margin 36.4%). (Felix Luo, Research Analyst, SFC CE No. AQF573, felixluo@gfgroup.com.hk ) Smartphone Sector: How much is Xiaomi worth? What s new? According to a report by Bloomberg, Xiaomi is in discussion for another round of fund raising that values the smartphone maker at US$40-50bn. Valuation increased by up to 200x over past four years Xiaomi was valued at US$250m in its first round of private equity fund raising of US$41m in 2010, and the valuation rose to US$1bn in its second fund raising of US$90m in Dec Six months later, the company s value quadrupled to US$4bn in the third round of fund raising of US$216m in Jun The latest round of fund raising took place in Aug 2013, with the company valued at US$10bn. Xiaomi s key investors include IDG, Morningside Ventures, Temasek, Qiming Venture Partners ( 启 明 创 投 ), and Accel Partners. Its valuation would have increased by 200x in the past four years based on market talks of a new valuation of up to US$50bn. Putting US$50bn into perspective A US$50bn price tag would place Xiaomi ahead of Lenovo which has a market capitalization of US$16bn, and put it at a level comparable to old economy icon Hutchison Whampao (US$53bn). It seems that the price-to-sales ratio is the only feasible metric that could help us arrive at something a little closer to a US$50bn valuation. We estimate that Xiaomi s sales is likely to rise from Rmb32bn in 2013 to Rmb70bn (US$11.5bn) in 2014 on expected smartphone shipments of 60m units, up from 19m units in 2013 (1H14 sales: Rmb33bn). The US$50bn price tag would price Xiaomi at 4.3x 2014E P/S. This is still higher than the 3.5x P/S of Apple which has a market capitalization of US$641bn and sales of US$183bn for the fiscal year ended Sep 30, It is also worth noting that Apple earned US$39bn in net profit in FY2014 (net profit margin 21%), whereas Xiaomi is barely profitable at present, according to Bin Lin, co-founder and President of Xiaomi in recent press reports. Maintain Neutral rating on China smartphone sector Despite strong underlying smartphone volume growth, we are concerned about ongoing margin compression among downstream smartphone brand owners. We maintain our Neutral sector rating, and recommend an investment strategy that focuses on buying a selected group of upstream component makers set to benefit from strong volume growth while avoiding downstream smartphone brand owners given margin contractions in the crowded and competitive market. Our top picks are AAC Tech (2018 HK, Buy), Sunny Optical (2382 HK, Buy), Tongda (698 HK, Buy) and Scud (1399 HK, Buy). (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) Property: Oct residential GFA sold recovered in all first-tier cities Oct residential GFA sold recovered MoM in all four first-tier cities According to China Real Estate Information ( Oct residential GFA sold in Shenzhen, Guangzhou, Shanghai and Beijing rose 44%, 41%, 18% and 15% MoM respectively on an increase in launches by developers and positive policies. Shenzhen primary residential property transaction figures Oct primary residential property transaction volume in Shenzhen rose 43% YoY to 4,783 units; ASP rose 1.7% YoY to Rmb22,198/sqm. Transaction volume in Longgang District rose 113% YoY to 2,783 units. Transaction volume in Nanshan District and Futian District rose 61% and 118% YoY to 224 units and 106 units respectively. Volume in Bao An District dropped 20% YoY to 1,573 units. China Merchants Property ( CH, NR): cooperation with China Merchants Bank to drive sales According to the company s website, from Oct 1 to Dec , home purchasers can receive a Rmb10,000 discount on units at 46 of its residential projects with each lot of 1,000 reward points gained via spending on credit cards issued by China Merchants Bank. The company is set to begin selling the high-end, fully-decorated villas at its residential project Shuang Xi Garden. The project is located in the SheKou Sea World region of Shenzhen, and has Page 5

6 so far seen an ASP of over Rmb95,000 per sqm. The apartments in the project have been available to buy since July, and had almost sold out as of end-oct. Favorable policy environment; declining gross margin an overhang Premier Li Keqiang recently said that the central government plans to stabilize real-estate related consumption. This positive stance implies more favorable policies in the near future, in our view. However, we expect relatively high land prices to drive down developers gross margins in We believe there is a lack of earnings visibility at most Chinese developers. We maintain our Neutral rating on the sector, preferring mass-residential leaders with proven execution, such as Vanke (2202 HK, NR) and COLI (688 HK). (Dennis Yao, Research Analyst, SFC CE No. ALK994, dennisyao@gfgroup.com.hk ) Leju Holdings (LEJU US): Fairly valued major real estate services provider; initiate at Hold Major real estate services provider in China The company has strong brand equity and nationwide geographic coverage in China (over 250 cities). It is active in three business segments: e-commerce (selling discount coupons to property buyers in China), online advertising, and feebased online listing for real estate agents. The company listed on the NYSE in Apr In the online discount coupons sales segment, it mainly competes with SouFun (SFUN US, NR), while in real estate related online advertising, it mainly competes with SouFun and Sohu Focus. Strong parent, exclusive advertising agent for Sina and Baidu The company is 76% owned by E-House China (EJ US, NR), a leading Chinese real estate services provider. Tencent (700 HK, NR) also holds a 16% stake as a way of providing property-related content and WeChat-based solutions to its users. The company is an exclusive advertising agent for SINA s real estate & home decoration related advertising, and an exclusive advertising agent for Baidu s Brand-Link product. 1H14 results review: e-commerce segment driving growth Total net revenue rose 75% YoY to US$196m. E-commerce revenue grew 188% YoY to US$118m, contributing 60% of total revenue. Online advertising revenue grew 12% YoY to US$69m, 35% of total net revenue. Listing revenue remained flat. Non-GAAP net income rose 290% YoY to US$28m. Management has maintained its previous 2014 full-year revenue guidance of US$ m, which would represent a YoY increase of 49%-55%. First/second-tier cities the main drivers The company s e-commerce and advertising businesses are active in about 73 cities in China. According to management, revenue from first/second-tier cities accounts for 40%/53% of total e-commerce revenue respectively, and 36%/50% of advertising revenue respectively. Fair valuation; initiate at Hold We expect 2014/15 net earnings to grow 4%/40% YoY to US$44/62m respectively. The stock is trading at 34.6x 2015E P/E. We see its valuations as fair, and initiate our coverage at Hold, with a target price of US$16.00, equal to 35.0x 2015E P/E. Future earnings catalyst: profit margin expansion given more efficient expenses control. Key risks: Entry barriers in Chinese online advertising are quite low, which may lead to more intense completion and profit margin shrinkage for the company. (Dennis Yao, Research Analyst, SFC CE No. ALK994, dennisyao@gfgroup.com.hk ) E-commerce: Alibaba reported strong GMV growth in 3Q14 What's new? Alibaba (BABA US, NR) reported non-gaap net profit of Rmb6.8bn for 3Q14, in line with Bloomberg consensus, spurring a 4.8% move in its share price. Strong GMV/user growth; flattish average spending by users 3Q14 GMV (Gross Merchandise Volume) maintained strong growth, increasing by 54% YoY to Rmb556bn, driven mainly by an increase in its user base. Annual active buyers reached 307m for the quarter (+52% YoY), while average spending per user was largely flat at Rmb1,810 for the quarter. 4Q14 outlook: strong QoQ growth Management has not offered any financial guidance. Nonetheless, we expect strong QoQ GMV growth in 4Q14, which is the traditional peak season in Page 6

7 China marked by a) the one-week National Holiday from Oct 1, and b) "Singles Day" on Nov 11 Alibaba recorded Singles Day GMV of Rmb36bn last year. Lofty valuation Alibaba is trading at 48x forward P/E (for fiscal year ending March ) based on Bloomberg consensus. Its market capitalization now represents 69% of Google s (GOOG US) and 1.9x that of Amazon (AMZN US). (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) Page 7

8 Hong Kong Equity Rating Definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited ( GF Securities (Hong Kong) ) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies did not have any investment banking relationships with the companies mentioned in this research report in the past 12 months. (3) All of the views expressed in this research report accurately reflect the independent views of the analyst(s). Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the companies mentioned in this report, or has any financial interests in or holds any shares of the securities mentioned in this report. Disclaimer This report is prepared by GF Securities (Hong Kong). 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