Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. May 7, 2015

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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$) (%) (US$) (%) 857 PETROCHINA ICBC CHINA MOBILE CCB BANK OF CHINA TENCENT HSBC CHINA LIFE SINOPEC PING AN Econ data release China Data Date Period Prior Cons China Trade Balance 8-May APR China Export YoY 8-May APR China Import YoY 8-May APR China CPI YoY 8-May APR China PPI YoY 8-May APR Rmb New Loans 10-May APR M0 10-May APR M1 10-May APR M2 10-May APR Total Financing 10-May APR Ind Prod Cum YoY 13-May APR Ind Prod Mthly YoY 13-May APR FAI Growth 13-May APR Retail Sales Cum YoY 13-May APR Retail Sales Mthly YoY 13-May APR US Data Date Period Prior Cons Initial Jobless Claims 7-May 2-May Cont Jobless Claims 7-May 25-Apr U-3 Unemployment 8-May APR Source: Bloomberg GF events Date Event Location 7 May Q-Tech luncheon Hong Kong 11 May BYD Auto site visit Shenzhen 20 May GF overseas Chinese stocks forum Shenzhen Source: GF Securities (HK) A-Share Market Insurance: Comment on health insurance tax discount The State Council has approved a trial to offer an individual income tax discount for health insurance products purchased from insurance companies, which we believe will give a strong boost to sector premiums growth. The health insurance business accounted for % of listed insurers revenue in Assuming a conservative health insurance penetration of 10-30% among individual income tax payers, we calculate additional premiums income of Rmb13.9bn-41.8bn as a result of this trial, representing % of health insurance premiums income in Auto: Comment on replacement of Dongfeng Motor chairman The replacement of Dongfeng Motor s chairman confirms our previous judgment that the key to the Made in China 2025 strategy lies in maintaining the control of Chinese capital in domestic auto companies, and helping these companies survive and compete in the global market. We are confident that going forward M&A and restructuring of an unprecedented scale will be seen in the sector, and that the four large and four smaller domestic auto companies might be consolidated, driving a large number of investment opportunities in the sector. Pharmaceutical: Comment of removal of government pricing guidance The current government guidance price for most drugs will be abolished from Jun 1, 2015, which we believe will not have a substantial impact on the sector. Under the current system, the government only sets a price ceiling for drugs covered by the state medical insurance scheme, while the actual drug price in the end-market is determined based on a bid-winning price which is the result of competition among drug producers. Potential beneficiaries include branded generic drug companies, branded OTC drug makers and blood product companies. Retail: Challenges for sector fundamentals remain in place Sector environment has not improved much with end-market sales recovering only slowly and sector demand still fluctuating. Although most companies did not see 1Q15 operating data pick up from 2014 and despite challenges from easing revenue growth and rising labor/rental costs, the shift towards emerging businesses by companies seeing traditional business bottlenecks should drive sector re-ratings. We see a higher risk of some investment rationales being overturned by sector operating data in the near term, which will put pressure on subsectors that have benefited from high investor expectations. Retail: Weekly views and research recap We are positive on the following themes: 1) three types of companies which are shifting towards supply chain finance development relying on the advantages of their respective industries, 2) traditional retail or industrial companies moving their business online, 3) companies with cheap valuations but high asset value, as well as competitive advantages and reform stories, and 4) leading brands. Please see text below for summaries of key reports issued last week on Lao Feng Xiang ( CH), Light & Textile Industrial City ( CH) and Sliver Plaza ( CH). Hong Kong Market Mengniu (2319 HK, Accumulate): Benefiting from declining raw milk prices; initiate at Accumulate We expect Mengniu to see annual earnings growth of 20-29% during Although its share price has rebounded 27% YTD, we believe the company will continue to benefit from declining raw milk prices in In addition, the market has yet to fully factor in the synergy of its cooperation with Danone and its equity investments in CMD and Yashili. We initiate coverage of the stock at Accumulate, with a target price of HK$45.60, equivalent to 23.5x 2015E P/E (its historical average P/E level). 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) Great Wall Motors (2333 HK, NR): April sees steady growth after strong 1Q15 results GWM s total sales volume rose by a steady 32.0% YoY in April, with SUV sales rising 57.4% YoY but sedans declining 32.1% YoY. The Haval series continued to be the star product, with sales up 78.2% YoY and total sales volume for Jan-Apr up 93.5% YoY. The H6 continued to be a top seller, with April sales up 16.7% YoY and Jan-Apr sales up 25.7% YoY. The H6 s sales growth has stabilized and accounts for 39.6% of total sales volume. The first results for the H8 didn t surprise, with 252 units sold in April. Brilliance China (1114 HK, NR): 1Q results likely to be ugly given BMW's results Brilliance China s 1Q15 results are likely to be ugly given the 43% YoY in profit at its JV with BMW, from which it gets the bulk of its earnings. The poor 1Q15 results from the BMW JV are likely to significantly affect its full year earnings and lead to meaningful analyst downgrades. BCA s share price has been weak over the last few weeks and was down 7% yesterday. Unless there are signs of a pickup in car sales in the coming months, BCA s shares are likely to remain under pressure. IGG (8002 HK, Buy): Outlook remains intact with strong catalysts from M&A and new hit games 1Q15 adjusted net profit rose 7.2% YoY, in line with our expectation. The company also announced its planned acquisition of an overseas game company. We believe the planned M&A and new hit mobile games will be strong catalysts for the company this year. Despite the QoQ revenue decline in 1Q15, we believe the company could see a recovery in growth in the next few quarters with stable performance for its core games and strong momentum in new games even without considering the contribution from upcoming M&A. Page 2

3 Insurance: Comment on health insurance tax discount The State Council has approved a trial to offer an individual income tax discount for health insurance products purchased from insurance companies. We believe this will give a strong boost to sector premiums growth. Overall health insurance premiums rose 42% YoY to Rmb158.7bn in 2014, with the business accounting for % of listed insurers revenue. Both Ping An Insurance ( CH) and CPIC ( CH) have set up a health insurance subsidiary. Assuming a conservative health insurance penetration of 10-30% among individual income tax payers, we calculate additional premiums income of Rmb13.9bn-41.8bn as a result of this trial, representing % of health insurance premiums income in Auto: Comment on replacement of Dongfeng Motor chairman It was announced yesterday that Zhu Yanfeng has been appointed as the new chairman of Dongfeng Motor Group (489 HK). This confirms our previous judgment that the key to the Made in China 2025 strategy lies in maintaining the control of Chinese capital in domestic auto companies, and helping these companies survive and compete in the global market. We are confident that going forward M&A and restructuring of an unprecedented scale will be seen in the auto sector, and that we might see consolidation among the four large domestic auto companies (FAW, Dongfeng, Changan, SAIC) and the four smaller ones (Chery, CNHTC, Guangzhou Auto, BAIC), which would drive a large number of investment opportunities in the sector. We are positive on the following four types of companies: A-share listcos from the FAW and Dongfeng families; Other companies expected to undergo consolidation such as Beiqi Foton Motor ( CH), Jianghuai Automobile ( CH), CNHTC Jinan Truck ( CH), Shanghai Diesel Engine ( CH) and Ankai Automobile ( CH); Whole-vehicle and auto part companies with cheap valuations such as Great Wall Motor ( CH), SAIC Motor ( CH), HUAYU Automotive Systems ( CH), Beiqi Foton Motor ( CH), Chongqing Changan Automobile ( CH), and Jiangling Motors ( CH); Auto part companies with strong performance that are in line with the Made in China 2025 plan. Such as Fulin Precision Machining ( CH), Beijing WKW Automotive Parts ( CH), Tianrun Crankshaft ( CH), Yunnei Power ( CH) and Weifu High-Technology ( CH). Pharmaceutical: Comment of removal of government pricing guidance The current government guidance price for most drugs will be abolished from Jun 1, 2015, which we believe will not have a substantial impact on the sector. Under the current system, the government only sets a price ceiling for drugs covered by the state medical insurance scheme, while the actual drug price in the end-market is determined based on a bid-winning price which is the result of competition among drug producers. That said, we believe the removal of the government guidance price will benefit the following pharmaceutical companies: Branded generic drug companies, especially those whose main products have been properly certified, such as Jiangsu Hengrui Medicine ( CH), Huahai Pharmaceutical ( CH) and Huadong Medicine ( CH); Branded OTC drug makers whose products have price upside such as Jiangzhong Pharmaceutical ( CH), China Resources Sanjiu Medical & Pharmaceutical ( CH) and Beijing Tongrentang ( CH); Blood product companies such as Hualan Biological Engineering ( CH), Shanghai RAAS Blood Products ( CH), Boya Bio-Pharmaceutical ( CH), Tiantan Biological Products ( CH). Page 3

4 Retail: Challenges for sector fundamentals remain in place End market recovery slow, demand fluctuating The Mar reading of the GFRI (GF Retail Index) rose 15.82% YoY, strengthening 6.13pp YoY and 5.04pp MoM. In addition, the top 100 retail companies nationwide saw sales growth of 3.1% YoY during the month, up 1.8pp YoY and 4.1pp MoM, driven by strength in food and jewelry sales, though home appliance sales continued to decline YoY due to the competition from e-commerce and a weak property market. Overall, sector environment has not improved much with end-market sales recovering only at a slow pace and sector demand still fluctuating earnings highlights The 30 A-share listed department stores saw revenue fell 3.2% YoY in 2014, compared with positive growth of 8.12% one year ago; net profit (excluding non-recurring items, same in this paragraph) declined 1.25% YoY, deteriorating from -0.95% in The seven listed supermarkets also posted poorer revenue and net profit growth of 2.94% and -2.43%, compared with 2013 figures of 6.67% and 6.00% respectively. The seven A-share jewelry retailers suffered a revenue decline of 6.7% YoY in 2014, compared with positive growth of 21.3% in 2013, while net profit growth of 4.3% YoY was much weaker than the 2013 figure of 31.8%. Weakness continued into 1Q15 Most companies did not see 1Q15 operating data pick up from That said, despite challenges from easing revenue growth and rising labor & rental costs, the shift towards emerging businesses by companies struggling with traditional business bottlenecks should provide opportunities for sector re-ratings. Potential downward pressure on share prices in near term We see a higher risk of some investment rationales being overturned by sector operating data in the near term, which will put pressure on subsectors that have benefited from high investor expectations. We highlight opportunities from: 1) market leaders that have seen minimal share price growth recently, 2) companies on track to carrying out SOE reforms but have seen minimal share price growth recently, and 3) investment themes such as those related to gold supply chain finance and financial leasing. Our top picks for the month are Haining China Leather Market ( CH), Light &Textile Industrial ( CH), Silver Plaza ( CH), Lao Feng Xiang ( CH) and Hualian Department Store ( CH). Retail: Weekly views and research recap Investment themes We are positive on the following themes: 1) Three types of companies which are shifting towards supply chain finance development relying on the advantages of their respective industries: a) specialized market operators such as Light & Textile Industrial City ( CH), Haining China Leather ( CH), Shenzhen Huaqiang ( CH) and Guangdong Highsun ( CH); b) jewelry companies such as Shanghai Yuyuan ( CH), Eastern Gold Jade ( CH) and Beijing Kingee ( CH); c) distribution platforms such as Better Life ( CH). 2) Traditional retail or industrial companies moving their business online such as Gansu Gangtai ( CH). 3) Companies with cheap valuations but high asset value, as well as competitive advantages and reform stories such as Silver Plaza ( CH), Beijing Hualian ( CH), Chongqing Dept Store ( CH), Dashang Group ( CH), Central Emporium ( CH), Wuhan Dept Store ( CH), Changchun Eurasia ( CH) and Beijing Wangfujing ( CH). 4) Leading brands such as Shanghai Jahwa ( CH) and Lao Feng Xiang ( CH). Summary of key reports issued last week: Lao Feng Xiang ( CH): Strong brand competitiveness despite gold price downturn FY14 results were in line. 1Q15 revenue growth of 19% YoY was better than total retail jewelry sales growth of 3.6% and CTF s 3% decline. Market share has increased despite the current gold price down cycle. With a three-year development plan focused on raising market share and profitability, LFX will accelerate penetration into 3rd/4th-tier cities and the HK/overseas markets, increase the sales mix of high-gm products, and explore an O2O business model. Page 4

5 We see LFX as a long-standing national brand with a strong market position, well-defined business transformation plan and efficient incentive mechanism Light & Textile Industrial City ( CH): Core growth stable; supply chain finance, SOE reform and online business future growth drivers Supply chain finance: The company s priority rent renewal evaluation system is now an important reference for third-party financial institutions when issuing loans. In addition, Shaoxing s new CPC secretary has accumulated considerable experienced from the financial reform in Wenzhou. Top-down financial reform is expected. SOE reform: One of the three listed Shaoxing SOEs has kicked off reforms. We expect the company to follow suit. Its investment in the platform makes it a target for the Internet Plus theme. Sliver Plaza ( CH): Growth at regional retail leader fueled by finalization of SOE reform plan The reform plan includes the acquisition of parent company s entire retail business and an employee share scheme. The acquisition is valued at 14.9x FY14 P/E, undemanding compared to the company s 49.4x FY14 P/E. "Silver Plaza Cloud Living" next strategic move: We believe the company is likely to grow into an omni-channel operator and become a leading provider of services that cover various aspects of local residents everyday life by leveraging on the Etone Pay platform and the Shandong City Card. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Mengniu (2319 HK, Accumulate): Benefiting from declining raw milk prices; initiate at Accumulate A volume-driven dairy leader Mengniu, which manufactures and distributes dairy products in China along with its subsidiaries, is the second largest dairy company in China with a 24% liquid milk market share. It has an asset-light model as it does not operate directly in dairy farming which requires considerable investment in farm construction and cow raising. As a downstream player, Mengniu s NPM ranges between 4-6%, with its earnings mainly driven by volume growth. Long-term outlook positive China s dairy industry has grown substantially over the past 15 years, with dairy product sales volume growing at a CAGR of 26.49%. Mengniu has been an industry leader with revenue growth higher than industry average for the most part of the past decade. Although sector expansion has slowed down, we still have a positive outlook on the industry, one main reason being that per capita milk consumption in China is much lower than levels in developed countries. We expect the domestic dairy industry to maintain steady growth in the long run as Chinese residents disposable income increases. Mengniu, in particular, is making great efforts to increase its market share and improve its operational efficiency. Ambitious cooperation with Danone Danone has a 20% stake in its JV with Mengniu, which focuses on low-temp products including yogurt and lactic acid fungus beverage. Danone has also acquired a 25% stake in Yashili through an HK$4.39bn private placement. Mengniu has introduced Danone into the picture to leverage on the latter s management team to help pull Yashili out of its current difficulties. Danone s infant milk formula business ranked No.1 in mainland China by revenue in In fact, it has been a consistent pattern for Danone to expand its presence in China through M&A with a strategic focus on maintaining the highest market shares for its different products. In view of this pattern, we expect to see aggressive growth in the Mengniu-Danone JV as well as Yashili. Controlling shareholder with fully integrated value chain to provide support COFCO, which is controlled by the central government, is Mengniu s biggest shareholder with a 31.62% stake. COFCO operates businesses along a fully integrated value chain covering grain distribution, agricultural product processing, breeding and slaughtering, branded consumer goods manufacturing and distribution, property development, financial services and e-commerce. Mengniu benefits from its connection with COFCO in terms of forage and packaging materials supply, cash management and COFCO s e-commerce platform. Growth driven by declining costs and synergy; initiate at Accumulate We expect Mengniu to see annual earnings growth of 20-29% during The stock is trading at 21.1x 2015E P/E, or 2.5x 2015E P/B. Although its share price has rebounded 27% YTD, we believe the company will Page 5

6 continue to benefit from declining raw milk prices in In addition, the market has yet to fully factor in the synergy of its cooperation with Danone and its equity investments in CMD and Yashili. We initiate coverage of the stock at Accumulate, with a target price of HK$45.60, equivalent to 23.5x 2015E P/E (its historical average P/E level). Risks Increasing raw milk prices, tougher competition downstream, food safety issues, and stronger-than-expected impact of imported products. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Yang Ke, Research Analyst, SFC CE No. BEZ121, yangke@gfgroup.com.hk ) Great Wall Motors (2333 HK, NR): April sees steady growth after strong 1Q15 results Total sales volume rose steadily in April GWM s total sales volume rose by a steady 32.0% YoY in April to 78,258 units, with SUV sales rising 57.4% YoY to 62,098 units but sedans declining 32.1% YoY to 5,658 units. The Haval series continued to be the star product, with sales up 78.2% YoY to 56,193 units and the total sales volume for Jan-Apr up 93.5% YoY. Pickup sales volume continued to decline during the month, with sales down 8.6% YoY to 10,499 units, meaning a 11.1% YoY decline in Jan-Apr sales volume to 38,872 units. H6 continues to be a top seller Following on from the good performance in 1Q15 sales, GWM posted steady growth in SUV sales in April, taking Jan-Apr units sold to 237,607, up 54.8% YoY. In particular, its Haval series saw sales rise 93.5% YoY to 218,463 units during the four months, indicating strong market demand so far this year. The H6 continued to be a top seller, with 30,767 units sold in April, up 16.7% YoY, meaning total Jan-Apr sales volume of 118,516 units, up 25.7% YoY. The H6 s sales growth has stabilized and accounts for 39.6% of total sales volume. The first results for the H8 didn t surprise, with 252 units sold in April; however, we expect this to climb in the coming months. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Chongjing Deng, Research Analyst, SFC CE No. BEY953, dengchongjing@gfgroup.com.hk ) Brilliance China (1114 HK, NR): 1Q results likely to be ugly given BMW's results What s new? Brilliance China s (BCA) 1Q15 results are likely to be ugly given the 43% YoY decline in BMW s 1Q15 JV profit. BMW s 1Q15 net profit rose 4% YoY to EUR1,516m, driven by strong sales in the US and Europe as well as SUV sales. However, its results from equity accounted investments, which include its share of the results of the JV with BCA, and two DriveNow equity investments, fell by 43% YoY to EUR128m (equivalent to ~16% of BCA-BMW JV s 2014 full year profit). This was mainly attributable to the lower contribution from the BCA JV reflecting a range of factors including the impact of preparing for production start-ups for new vehicles, capacity expansion measures and increased competition, according the company. During 1Q15, BCA-BMW JV s sales rose 15.5% YoY to 72,185 units. Shares likely to remain under pressure Given the bulk of BCA s earnings come from the BCA- BMW JV, we see a significant earnings decline in BCA s 1Q15 results. Although BCA does not report quarterly, the upcoming interim results will reflect this earnings decline. According to current market analyst forecasts, BCA s 2015 earnings are expected to grow 11% YoY to Rmb6,002m. The poor 1Q15 results from the BMW JV are likely to significantly affect its full year earnings and lead to meaningful analyst downgrades. BCA s share price has been weak over the last few weeks and was down 7% yesterday, which may have partly reflected this market concern. However, unless there are signs of a pickup in car sales in the coming months, BCA s shares are likely to remain under pressure, probably coming closer to the HK$12 seen at the beginning of the year. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) Page 6

7 IGG (8002 HK, Buy): Outlook remains intact with strong catalysts from M&A and new hit games What s new? 1Q15 adjusted net profit rose 7.2% YoY to US$14.8m, in line with our expectation. The company also announced its planned acquisition of an overseas game company. Below are our key takeaways from the analyst briefing. QoQ revenue decline in 1Q15 1Q15 revenue came in at US$53.6m, up 22% YoY but down 11% QoQ. The QoQ decline was mainly attributable to: 1) seasonal factors (4Q is its traditional peak season); 2) the change in Europe s value-added tax policy led to a reduction of revenue recognized in Europe while overall turnover remained stable ; 3) the devaluation of Russian Ruble. The European VAT policy change and Russian Ruble devaluation might have caused a total reduction of US$5m in revenue recognition in related regions. Without this, the company s overall turnover remained stable in 1Q15. Strong momentum on new games The company plans to launch over 30 mobile games this year, including four hit products Game of Kings, Brave Quest, Final Fable and Age of Kingdoms. Game of Kings is developed by the same team as Castle Clash, and is expected to be formally launched in June. The other three games are expected to be released in 3Q15. The company indicates that the four games are of high quality and innovation. Meanwhile, Nerd Kingdom, the American game developer acquired by the company at the end of 2014 has seen performance. Its self-developed client-based sandbox game TUG, similar to the well-known Minecraft game is now at the testing stage. The company has significant hope for this game and expects to launch a mobile version of TUG in 1-2 years to be a year of M&A The just announced acquisition of gaming companies has confirmed our view that the company will realize its business expansion through M&A given its strong financial resources. The company indicates that it will continue to seek M&A targets this year. Benefiting from the company s strong game operation capability in global markets, we believe M&A should bring about strong synergy and consolidate its market position in global markets. Strong catalysts in M&A and new hit games We believe the planned M&A and new hit mobile games will be strong catalysts for the company this year. Despite the QoQ revenue decline in 1Q15, we believe the company could see a recovery in growth in the next few quarters with stable performance for its core games and strong momentum in new games even without considering the contribution from upcoming M&A. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) Page 7

8 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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The recipients should be aware of relevant disclosures of interests (if any) when reading this report. Copyright GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. GF Securities (Hong Kong) Brokerage Limited. All rights reserved /F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: Fax: Website: Page 8