COMPANY NOTE Chiho Environmental Group Limited [976.HK; HK$4.61; NOT RATED] Leading metal-recycling Company; Long-awaited earnings recovery in 2017

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1 August 18, 2017 Company: Chiho Environmental Group Limited (CEG) is engaged primarily in the collection, recycling, disassembling, sorting and processing of mixed metal scrap and other resources to recover reusable resources. In 2016, CEG acquired Scholz Holding GmbH (Scholz), one of the world s largest mixed metal recyclers. With more than a century of experience, Scholz has developed several advanced technologies to become one of the few companies in the world capable of handling and recycling multiple types of materials. Hence, CEG has now become a global leader in the metal-recycling and environmental-protection industry. CEG currently operates >300 metalprocessing facilities in >30 countries spanning Europe, Greater China and North America. It sells high-quality scrap metal, scrap PCB boards, and other products to companies like copper refineries, foundries, smelters, steel mills, and aluminum and copper product manufacturers worldwide. Changing controlling shareholder to help business rejuvenation. CEG was in a loss-making situation in , led by 1) falling global commodity prices, and 2) unwise hedging strategies. USUM Investment Group (USUM) came to its rescue in 2015, becoming its single largest controlling shareholder by acquiring over a 60% equity stake in CEG. USUM was initiated by the Chongqing Municipal Government and the Chongqing Federation of Industry and Commerce in It was founded by Loncin Holdings, China Huarong, Longli Real Estate, Excellence Real Estate, and 50 other enterprises in Chongqing. With registered capital of RMB3.42bn, USUM is the largest PE company in Chongqing, focusing on finance, healthcare, natural resources, and some new industries. CEG fits USUM s business strategy in the natural resource and environmental protection segment. With USUM coming aboard, CEG made a big move in 2016, acquiring German metal recycler Scholz. CEG also changed its name from Chiho-Tiande to Chiho Environmental in June 2017 to reflect its business focus on metal recycling and environmental protection. Acquiring Scholz to move up the value chain. The acquisition of Scholz help CEG secure upstream scrap metal supply and accumulate advanced metal-recycling technology. The acquisition was made through a debt restructuring program. CEG paid a total HK$2.4bn to acquire Scholz s debt from its lenders in Germany and the US. The debt restructuring was completed in December Then CEG acquired a 100% equity stake in Scholz for one euro. Scholz is one of the world s largest scrap processing companies. It is the technology leader in the recycling of ferrous and nonferrous metals in the global market. The Company faced a severe overleverage problem in the past. CEG s acquisition helped it reduce its financial leverage and restore normal operations. For CEG, the acquisition provided some revenue and cost synergy, as it helped CEG secure a stable raw material supply, acquire advanced technology to improve its production yield and enhanced its bargaining power to lower its raw material costs. Moreover, the acquisition helped CEG expand its business scope into other metal processing and recycling segments. Global commodity price recovery to drive earnings surge in Global commodity prices started to recover in 2H16 and surged even higher in 1H17. The LME copper spot price YTD has risen 19.8% compared to the average copper spot price in The LME aluminum spot price YTD is 17.7% above the average aluminum spot price in China s hot-rolled coil steel price YTD is up 28.8% compared to the average hot-rolled steel price in The strong commodity price recovery YTD was led by 1) the global economic recovery, and 2) China s stringent supply-side reforms. There might be downside risks to global economic growth in 2018, but we expect China to Chiho Environmental Group Limited Turnover(HK$m, rhs) Market Cap: US$946m; Free Float: 20.89% ROE (%) Dividend yield (%) PER (x) PBR (x) Source: Company data, CGIS Research, Note: using CGIS estimates carry on with its stringent supply-side reforms, which should keep commodity prices at the current high levels in Bloomberg consensus expects global copper, aluminum and steel prices to remain largely flat YoY in 2018 (Fig 5). Base-case earnings estimates and valuation. The commodity price recovery should help CEG return to profit in The acquisition of Scholz will also enlarge its revenue scope and enhance its profitability. The reported China ban on scrap metal imports from 2018 is likely to cause some disturbance to CEG s business, but we believe the financial impact will be limited. The production ramp-up at Scholz s EU and US plants should compensate for potential production cuts at its China plant once the import ban takes effect. We expect CEG s earnings to return to positive territory in 2017 and to grow 67.8% YoY in Based on our base-case forecast, the stock currently trades at 20.6x 2017E and 12.3x 2018E PER. It also trades at 1.7x 2017E and 1.5x 2018E PBR. Its valuation advantage over its global peers seems limited at the moment (Fig 14). We think investors will adopt a wait-and-see attitude in the next few quarters as they require more evidence from CEG about its business turnaround. Given the Company s short track record post-restructuring, we are using relatively conservative assumptions for our projections. We see potential for re-rating if it delivers stronger margin improvement and earnings recovery. Risks: Commodity prices, FX, regulations Price(HK$) HK$ m E 2018E Revenue (m) 5,878 3,137 3,211 16,562 19,238 Gross profit (m) ,319 2,770 GPM (%) Operating profit (m) , ,137 OPM (%) Net profit (m) -1,058-1, NPM (%) EPS

2 Change in controlling shareholder expected to help business rejuvenation CEG s history can be traced back to the 1990s when its founder, Mr. Fang Ankong, started a small-scale metal recycling and trading business in Taizhou, China. Initially CEG only sourced scrap metal locally, but in 1995, it started to import scrap metal from overseas after it got a license from the Ministry of Environmental Protection (MEP) for foreign waste importation. CEG soon became the largest scrap metal recycling and trading company in China in terms of total imported scrap metal volume approved by the MEP and its actual imported scrap metal volume. The Company went through a series of corporate restructurings and was then listed on the Hong Kong Stock Exchange in July But the business didn t perform well after its listing. CEG reported a revenue decline for four consecutive years from 2011 to 2015, and earnings remained on a downward trend starting in It remained in a loss-making situation in The cyclical nature of the metal-recycling business make its earnings highly sensitive to changes in commodity prices. Its poor business performance in the past was due to falling commodity prices, and its unwise hedging strategies caused it to make even larger losses during the period. USUM came to CEG s rescue in CEG placed 456.9m new shares at HK$9.01/share with USUM HK in 1H15. USUM HK also converted its acquired convertible bonds into shares of HK$0.01 each at the conversion price of HK$6.00. Later, in December 2015, USUM paid HK$3.50/share to acquire 389.8m option shares from HWH (Mr. Fang s BVI company). By the end of 2015, USUM HK held a total 899.4m shares in CEG, equivalent to 56.62% of CEG s share capital. In 2016, USUM acquired another m shares from CEG s existing shareholders after it took control of CEG for a total consideration of HK$6.2bn, equivalent to HK$6.12/share. By the end of 2016, USUM held 1,008.9m shares in CEG, representing 62.29% of CEG s issued share capital. Figure 1: USUM s share acquisition in CEG mn shares No of shares Comment ,049.4 Chiho's no of shares at the end of 2014 New share issuance CB conversion 72.6 Option ,588.5 Chiho's no of shares at the end of 2015 USUM Equivalent to 56.62% of Chiho's total share capital 1st round of share issuance Share issuance HK$9.01/share 2nd round of share issuance Share issuance HK$9.01/share CB conversion 52.6 Conversion price at HK$6.0/share Option Transferring price at HK$3.50/share New share issuance 31.0 New share issuance to acquire 100% interest in Dalian New Green Recycle & Resources Corporation, not USUM-related Option ,619.7 Chiho's no of shares at the end of 2016 USUM 1,008.9 Equivalent to 62.29% of Chiho's total share capital USUM acquired new shares Acquisition price at HK$3.50/share Source: Company data, CGIS Research 2

3 Figure 2: CEG s shareholder structure at the end of 2016 USUM Investment Group HK Ltd Mr. Zhang Mingjie China Cinda Asset Management Public investors 62.29% 10.82% 6.00% 20.89% Chiho Environmental Group Limited (976 HK) Chiho Environemntal Greater China 100% 100% Scholz Holding GmbH Scholz: Europe Liberty: North America Source: Company data, CGIS Research USUM s coming aboard helped CEG rejuvenate its metal-recycling business. USUM was initiated by the Chongqing Municipal Government and the Chongqing Federation of Industry and Commerce in It was founded by Loncin Holdings, China Huarong, Longli Real Estate, Excellence Real Estate, and 50 other enterprises in Chongqing. With registered capital of RMB3.42bn, USUM is the largest private equity investment company in Chongqing, focusing on finance, healthcare, natural resources, and some other new industries. CEG fits USUM s vision for business development in the natural resource and environmental protection field. With strong support from USUM, CEG made its first move in 2016, acquiring German metal-recycler Scholz. Since then, CEG has become one of the world s largest metal recycling and trading companies. CEG also changed its name from Chiho-Tiande Group Limited to Chiho Environmental Group Limited in July 2017 to reflect its business focus on metal recycling and environmental protection. Figure 3: CEG s key historical events Date Event Jul-10 IPO listing in HK stock exchange 4Q2010 The establishment of the Shanghai JV 4Q2010 The establishment of the HK JV Jan-11 Proposal to acquire a Beijing company with special licence to handle vehicle scrap Jan-11 Proposal to set up a JV in Tianjin for various scrap processing activities 2011 Acquisition of an industrial site at the Yuen Long Industrial Estate to increase capacity in HK 2011 Investment agreement with Yantai Committee to establish new processing facilities in the development zone in Yantai City 2011 Increase stake in Chiho-Tiande (HK) Recycling from 55% to 70% 2011 Giving up Beijing and Tianjin plan 2012 Sims Metal Mgmt Dragon became strategic partner of the company 2014 Proposal to acquire 80% stake in Yantai Liheng Environmental Protection 2015 Issue of new shares to USUM Investment Group Hong Kong Limited 2015 USUM became controlling shareholder 2016 Acquisition of 60% stake in Yantai Liheng Environmental Protection Technology 2016 Acquisition of entire interest in Dalian New Green Recycle & Resources Corporation 2016 Acuiqisition of the entire equity interest in Scholz Holding GmbH Source: Company data, CGIS Research 3

4 Acquiring Scholz to move up the value chain CEG remains positive on the demand growth outlook of the metal-recycling industry in China, as it expects 1) commodity demand in China to stay firm, and 2) increasing awareness of environmental protection to require a further increase in scrap metal use in China. Given the constraints on fuel and energy supplies, metal production via scrap has grown in attractiveness in China because it is typically less energy intensive, and therefore conserves natural resources in the long run. Eyeing the huge growth opportunity in China s metal recycling industry in the long term, CEG acquired German industry leader Scholz in 2016 to secure good-quality scrap metal supply and accumulate industrial and residential waste processing and recycling technology. The acquisition was made through a debt-restructuring program, as Scholz was severely overleveraged. CEG paid a total HK$2.4bn to acquire Scholz s debt from its lenders in Germany and the US. The debt restructuring was completed in December Then CEG acquired a 100% equity stake in Scholz for one euro. CEG used its own cash to complete the transaction. CEG s cash position stood at HK$3.6bn as at the end of Scholz is one of the world s largest scrap-processing companies in terms of metal-processing volume. Scholz is engaged in all metal -recycling processes, from collecting, gathering, sorting and processing the materials to their sale, utilization and recirculation. It is the technology leader in recycling ferrous and non-ferrous metals in the global market. Scholz was in loss-making situation in 2015 and 1H16 because it was overleveraged. CEG s acquisition should help it reduce its financial leverage and restore normal operations. For CEG, the acquisition provides some revenue and cost synergy with its existing business in terms of securing metal scrap import volume, acquiring advanced technology to improve its metal scrap processing yield, and enhancing its bargaining power to lower the cost of its scrap metal imports. More importantly, CEG is able to improve its technology, which should help it expand its product offerings to the other scrap metal processing and recycling segments. Figure 4: Financial impact of CEG s acquisition of Scholz on CEG s balance sheet and P&L (HK$ m) Balance sheet Change CEG (after consolidation of Scholz) Cash 3,586 1,657-1,929 Borrowings 1,360 5,034 3,674 P&L* H16 Scholz Revenue 11,540 4,566 Gross profit 1, Gross profit margin 11.6% 14.2% Net profit -1, Net profit margin na na CEG Revenue 3,137 1,513 Gross profit Gross profit margin na 4.3% Net profit -1, Net profit margin na na % of CEG Revenue 370% % 3.0 Gross profit na 980% 9.8 Net profit na na Source: Company data, CGIS Research 4

5 Commodity price hike expected to help earnings recover in The commodity price recovery should boost CEG s earnings in Global commodity prices started to recover in 2H16 and surged even higher in 1H17. The LME copper spot price YTD has risen 19.2% as compared to the average copper spot price in The LME aluminum spot price YTD is 17.3% above the average aluminum spot price in China s hot-rolled coil steel price YTD has risen 27.8% compared to the average hot-rolled steel price in Global economic growth has been strong in 2017 and has been one of the key drivers of the recovery in commodities in China s supply-side reforms have also contributed to the strong commodity price recovery. The World Bank expects global growth to accelerate from 2.7% in 2017 to 2.9% in But it also expects the world economy to continue to face a number of downside risks, such as increasing protectionism, heightened policy uncertainty, the possibility of financial market turbulence, and in the long run, weaker potential growth. But we expect China s strict supply-side reforms to keep commodity prices at least at the current level. Bloomberg consensus estimates expect global copper, aluminum and steel prices to stay largely flat YoY in Figure 5: Bloomberg consensus estimates for global copper, aluminum and steel prices in Source: Bloomberg, CGIS Research Spot Aluminum $/mt 2,030 2,028 2,058 2,101 2,143 Copper $/mt 6,480 6,476 6,530 6,564 6,575 Steel-Hot R. $/ST na na On top of the commodity price recovery, the acquisition of Scholz has expanded CEG s revenue scope and enhanced its profitability. The Company will consolidate Scholz into its financial statements from 2017 onwards. Scholz should gradually move back to normal operations with CEG s financial support to replenish working capital. In addition, the reduction in financial leverage should help Scholz return to profit in The acquisition of Scholz will help CEG s existing business secure good-quality scrap metal supply at lower cost. With the consolidation of Scholz, we estimate CEG s total revenue in 2017 will grow 415.8% YoY in 2017 and 16.2% YoY in We estimate that CEG s existing China business revenue will grow 26.5% YoY in 2017 and 10.3% YoY in Its China business revenue growth will be driven mainly by rising commodity prices. Scholz s EU and US metal-recycling business revenue growth, on the other hand, will be driven mainly by improving capacity utilization. We expect Scholz to gradually return to normal operations from 2017 onwards. The commodity price recovery will also help improve the gross profit margins of the metal-recycling business of both CEG and Scholz. Moreover, the improvement in utilization will further enhance Scholz s gross profit margin in If Scholz returns to normal production, its revenue is 5-6x CEG s existing business revenue. Hence, we expect CEG to have more stable gross profit margins in with the consolidation of Scholz. Having said that, we use rather conservative margin assumptions to provide the base-case earnings estimates for CEG (Fig 6). We expect CEG s gross profit margin to expand from 6.8% in 2016 to 14.0% in 2017 and 14.4% in 2018, roughly the same level as Scholz s gross profit margin in 1H16. We expect its SG&A cost as a percentage of total sales to decline slightly from 9.6% in 2016 to 8.5% in 2017 and 8.0% in 2018 because we still expect the Company to have one-time expenses related to its business integration after the acquisition of Scholz in We expect its net financing cost to remain high, related to Scholz s EU debt. We expect CEG to return to profit in 2017, and we estimate that its earnings will grow 67.8% YoY in In addition to our base-case earnings forecast for CEG, we ran an earning sensitivity test for the Company in 2017 and Our earnings sensitivity analysis shows that every 0.5ppt increase in our base-case gross profit margin assumption will boost our earnings forecast for the Company in by 10-16% (Fig 7). 5

6 Figure 6: CGIS earnings estimates for CEG in HK$ m E 2018E China 5,878 3,137 3,211 4,062 4,478 % YoY chg -18.6% -46.6% 2.4% 26.5% 10.3% Scholz ,500 14,760 % YoY chg 18.1% Total revenue 5,878 3,137 3,211 16,562 19,238 % YoY chg -18.6% -46.6% 2.4% 415.7% 16.2% COGS -5,895-3,182-2,993-14,243-16,468 Gross profit ,319 2,770 Gross profit margin -0.3% -1.4% 6.8% 14.0% 14.4% SG&A ,403-1,534 as % of sales -2.6% -4.9% -9.6% -8.5% -8.0% Other gains and losses EBIT , ,137 EBIT margin -15.7% -33.1% -12.8% 4.9% 5.9% Net financing cost Profit contribution from JV and associates PBT -1,068-1, Tax Effective tax rate -0.3% 0.0% 0.1% 30.0% 30.0% PAT -1,071-1, Minority interest Profit attributable to common shareholders -1,058-1, % YoY chg na na na na 67.8% EPS(HK$) Source: Company data, CGIS Research Figure 7: CEG earnings sensitivity to gross profit margins HK$ m 2017E Change from base case 2016 % YoY chg na 15.5% % na 15.0% % na 14.5% % na 14.0% % na 13.5% % na 13.0% % na 12.5% % na Source: Company data, CGIS Research HK$ m 2018E Change from base case 2017E % YoY chg % 15.9% % 122.6% 15.4% % 104.3% 14.9% % 86.0% 14.4% % 67.8% 13.9% % 49.5% 13.4% % 31.2% 12.9% % 13.0% 6

7 Figure 8: CEG 2016 share price performance 20.0% 10.0% 0.0% -10.0% Figure 9: CEG 2017YTD share price performance 30.0% 20.0% 10.0% 0.0% Jan % Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug % -30.0% -40.0% 976 HK HSI Index -20.0% -30.0% -40.0% -50.0% 976 HK HSI Index Source: Bloomberg, CGIS Research Source: Bloomberg, CGIS Research Figure 10: CEG 12-mth forward PBR band Figure 11: CEG share price correlation with copper price Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 7,000 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3, mth forward PBR Average +1 Std -1 Std Copper (US$/mt) 976 HK (HK$, rhs) Source: Bloomberg, Company data, CGIS Research Source: Bloomberg, CGIS Research 7

8 Figure 12: CEG share price correlation with aluminum price Figure 13: CEG share price correlation with steel price 3,000 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1, ,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Aluminum (US$/mt) 976 HK (HK$, rhs) Hot roiled steel (Rmb/ST) 976 HK (HK$, rhs) Source: Bloomberg, CGIS Research Source: Bloomberg, CGIS Research Figure 14: Peer comparison Ticker Mkt cap Price PER EPS growth PEG P/Bk Dividend yield ROE US$ m (lc) E 2018E E 2018E 2017E E 2018E E 2018E E 2018E Chiho Environmental Group 976 HK na na 67.8% na % 0.7% 1.2% -10.7% 8.2% 12.3% A-share peers GEM Co Ltd CH 3, % 151.3% 47.7% % 0.3% 0.5% 3.8% 8.0% 10.6% Dongjiang Environmental CH 1, % -1.0% 22.0% % 0.7% 0.9% 16.4% 14.5% 15.4% Yechiu Metal Recycling China CH 1, % % 45.0% % na na 0.9% 15.8% 18.9% Chengdu Techcent Environment CH 1, % 112.9% 47.7% % 0.8% 1.1% 7.4% 12.4% 15.8% Overseas peers Sims Metal Management SGM AU 2, % 14.3% 17.8% % 3.0% 3.4% 6.8% 7.4% 8.3% Schnitzer Steel Industries SCHN US % % 6.0% % 2.9% 2.9% -3.8% 7.4% 7.5% Commercial Metals CMC US 2, % 87.1% 54.7% % 2.6% 2.7% 4.0% 7.5% 10.6% Derichebourg SA DBG FP 1, % 317.0% 12.7% 0.1 na na 0.5% 0.6% na 16.9% 16.6% Steel Dynamics Inc STLD US 8, % 79.1% 6.6% % 1.7% 1.8% 13.1% 20.1% 17.8% Alba SE ABA GR na na 165.7% na na na 4.2 na na 5.2% na na 19.2% na na Source: Bloomberg, Company data, CGIS Research, Note: based on closing prices on 17 August

9 Company profile Chiho Environmental Group Limited is a global leader in the metal recycling and environmental protection industry, engaged primarily in the collection, recycling, disassembling, sorting and processing of mixed metal scraps and other resources to recover reusable resources, including ferrous and nonferrous metals, precious metals, plastic, paper and spare parts. CEG processes industrial scrap metal, including steel, iron, copper, aluminum and other scrap metal from manufacturing, end-of-life vehicles ( ELV ) and appliances, factory and building demolition, household and industrial E-waste, and municipal waste. It currently has a presence in over 30 countries and regions spanning Europe, Greater China and North America, operating more than 300 sites, including metalprocessing facilities equipped with a one-stop system for collecting, gathering, sorting and processing. Additionally, CEG sells highquality scrap metal, scrap PCB boards, and other products to various end users, including copper refineries, foundries, smelters, steel mills, and aluminum and copper product manufacturers worldwide. At the end of 2016, CEG completed the acquisition of Scholz Holding GmbH ( Scholz ), one of the world s largest mixed metal recyclers, with advanced ELV processing capability. With more than a century of experience, Scholz has developed several advanced technologies to become one of the few companies in the world capable of handling and recycling multiple types of materials. China and the global metal-recycling industry The metal-recycling industry plays a vital role in the production and supply of ferrous and nonferrous metals. It contributes significantly to the protection of the environment and to the preservation of valuable natural resources, including energy, which are consumed in large quantities during the metal production processes. The growth drivers for China and the world s metal-recycling industry are 1) metal consumption growth from economic growth and industrial activity, 2) movement in commodity/metal prices and price expectations, 3) environmental factors and collection systems, 4) the drive to reduce energy consumption, and 5) technological advances. The global metal-recycling industry is cyclical in nature, as demand for metal recycling hinges on global economic growth and metal price volatility. ISRI (Institute of Scrap Recycling Industries) data shows that global ferrous scrap, copper scrap and aluminum scrap trading volume had a volatile growth pattern in (Fig 15). In China, the metal-recycling industry relies heavily on foreign imports of raw materials, especially industrial and residential scrap metal because waste sorting and collection in China is still in the early stage of development. It is much more common for waste to be thrown away unsorted. Hence, leading metal recyclers in China have been using foreign imports to ensure high quality scrap metal; otherwise, the recycling yield wouldn t be high enough to cover the production cost for the recyclers. But the recycling of imported mixed scrap metal in China is highly regulated, as it is subject to licensing requirements under the Provisional Regulations on Environmental Protection in relation to waste importation. CEG is a licensed metal recycler for waste importation in China. Based on data from the Ministry of Commerce (MOC), China imported around 7.4m tons of ferrous and non-ferrous scrap metal in CEG s China business handles about 400k tons of metal scrap on a yearly basis. Its acquisition, Scholz, handled about 4m tons of scrap metal in 2016 in the EU and US markets, compared to global scrap metal trading volume of around 101m tons. 9

10 Figure 15: Global ferrous and non-ferrous metal scrap trading data in th tons Global imports of ferrous scrap China 10,144 5,383 3,365 3,516 13,621 5,766 6,692 4,935 4,439 2,524 2,284 % YoY chg -46.9% -37.5% 4.5% 287.3% -57.7% 16.1% -26.3% -10.0% -43.1% -9.5% World total 90,814 97,344 97, ,111 94, , , , , ,132 88,051 % YoY chg 7.2% 0.1% 5.8% -8.2% 7.3% 9.2% -1.2% -8.5% 0.9% -12.9% as % of total 11.2% 5.5% 3.5% 3.4% 14.4% 5.7% 6.0% 4.5% 4.4% 2.5% 2.6% Global exports of ferrous scrap World total 91,803 96,078 97, ,254 94, , , ,812 99,112 97,916 87,117 % YoY chg 4.7% 1.1% 3.2% -5.5% 8.6% 9.4% -3.3% -8.9% -1.2% -11.0% Global imports of copper scrap China 4,821 4,943 5,585 5,577 3,997 4,363 4,686 4,859 4,372 3,873 3,657 % YoY chg 2.5% 13.0% -0.1% -28.3% 9.2% 7.4% 3.7% -10.0% -11.4% -5.6% World total 7,237 7,650 8,556 8,293 6,293 7,202 7,786 8,127 7,499 7,061 6,731 % YoY chg 5.7% 11.8% -3.1% -24.1% 14.4% 8.1% 4.4% -7.7% -5.8% -4.7% as % of total 66.6% 64.6% 65.3% 67.2% 63.5% 60.6% 60.2% 59.8% 58.3% 54.9% 54.3% Global exports of copper scrap World total 4,652 5,233 5,329 5,082 4,757 5,557 5,988 6,009 7,980 9,798 6,206 % YoY chg 12.5% 1.8% -4.6% -6.4% 16.8% 7.8% 0.4% 32.8% 22.8% -36.7% Global imports of aluminum scrap China 1,687 1,765 2,091 2,155 2,626 2,854 2,686 2,593 2,504 2,306 2,087 % YoY chg 4.6% 18.4% 3.1% 21.9% 8.7% -5.9% -3.5% -3.4% -7.9% -9.5% World total 5,615 6,555 7,087 7,049 6,510 8,046 8,478 8,556 8,486 8,906 8,853 % YoY chg 16.7% 8.1% -0.5% -7.6% 23.6% 5.4% 0.9% -0.8% 5.0% -0.6% as % of total 30.1% 26.9% 29.5% 30.6% 40.3% 35.5% 31.7% 30.3% 29.5% 25.9% 23.6% Global exports of aluminum scrap World total 5,186 6,208 6,923 8,270 6,212 7,400 8,788 8,323 7,834 8,070 7,834 % YoY chg 19.7% 11.5% 19.5% -24.9% 19.1% 18.8% -5.3% -5.9% 3.0% -2.9% Source: ISRI data, CGIS Research Risk factors Commodity price risk CEG s metal-recycling business is subject to huge commodity price volatility, which makes its earnings cyclical in nature. The prices of its raw materials and recycled metal products are volatile, and its operating results have therefore historically been cyclical and are expected to remain highly cyclical in nature. During an environment of increasing prices, CEG s margins generally expand, as the difference in timing between buying unprocessed scrap metal and selling recycled metal products normally leads to higher margins. Conversely, decreasing prices of mixed scrap metal generally has the opposite effect on its margins and profitability. The fall in commodity prices in the past led to CEG s revenue decline and loss-making due to provisions made for inventories. Even in an increasing price environment for raw materials, competitive conditions may limit its ability to pass on price increases to its customers. The Company therefore needs to constantly monitor its raw material and end-product prices to apply appropriate hedging strategies. Depending on the price environment, the Company will adjust its hedging strategies to ensure effective hedging and stable margins. But there are still occasions when CEG cannot fully hedge positions in certain commodities. As a result, its sales and inventory positions will be vulnerable to adverse changes in commodity prices, which will adversely impact its margins and profitability. 10

11 FX risk CEG reports its financial results in HK$. But the majority of its products are sold in the EU and China markets. Its purchases of raw materials are principally denominated in US$ and Euros. Hence, its liabilities and earnings are exposed to fluctuations in exchange rates between these currencies and the HK$. Currency exchange rates can be quite volatile, which also leads to some uncertainty in its earnings. Regulation risk CEG s metal-recycling business is subject to a variety of domestic and overseas regulations. In China, CEG needs to have the required permits from MEP to run its metal-recycling business. The EU and US markets have even higher standards and stricter regulations for the metal-recycling industry to comply with. We think the environmental laws and regulations in China will become more stringent in the future. For instance, the central government is likely to ban imports of certain scrap metal into China from 2018 onwards. This policy might have a negative earnings impact on CEG s existing business in the short term. But eventually this policy should drive industry consolidation by forcing importers and enterprises with unsound environmental protection practices and less sophisticated processing technology out of the market. So in the longer term, leading industry players like CEG should benefit from such policy changes. 11

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Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the securities covered in this research report three business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong-listed companies covered in this report; and (4) have any financial interests in the Hong Kong-listed companies covered in this report. Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >20% within 12 months in absolute terms share price will decrease by >20% within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 Room , 35/F, Cosco Tower, Grand Millennium Plaza, 183 Queen s Road Central, Sheung Wan, Hong Kong. General line: