China-Hong Kong Chronicles

Transcription

1 Asia Pacific/China Equity Research Strategy Research Analysts Vincent Chan China/Hong Kong Research Team Peggy Chan, CFA Christiaan Tuntono Victor Wang Sanjay Jain Vineet Thodge Trina Chen Kevin Yin Vivian Zhao Karim P. Salamatian, CFA Rebecca Kwee Isis Wong Iris Wang Arjan van Veen Frances Feng Dick Wei Kenny Lau, CFA Thomas Wong Jinsong Du Duo Chen Joyce Kwock Eva Wang Colin McCallum, CA Timothy Ross Dave Dai Ran Ma Contribution by Grace Chao China-Hong Kong Chronicles ECONOMICS AND STRATEGY 214 outlook: Overweight China, Underweight Hong Kong Figure 1: Potential upside to key China/Hong Kong indices (% upside in 12 months) MSCI China HSCEI Shanghai A Share Hang Seng Index MSCI HK Source: Credit Suisse estimates 16. In this inaugural issue of China-Hong Kong Chronicles, we present the 214 outlook for the China and Hong Kong markets: The China strategy. With more details emerging on the reform measures announced after the third Plenary Session of the 18 th Central Committee Meeting, we believe the market's perception about China's long-term economic growth and financial system risks will improve. This should help boost the Chinese market, particularly sectors such as financials which were badly hit in the past few years due to these concerns. The Hong Kong strategy. Property stocks look inexpensive after the recent correction, but the tapering headwind is still a problem for the sector, in our view. On the other hand, stocks with stronger fundamentals such as Macau gaming and Hong Kong consumer have already enjoyed a very good run this year. Therefore, it could be difficult for Hong Kong stocks to outperform, particularly relative to China stocks. Index targets and sector allocation. Among the key China/Hong Kong indices, we believe the biggest potential upside will be in the HSCEI (31% potential upside from the current level, in the next 12 months), while the biggest potential downside will be in the MSCI HK (-3.3% from the current level). Among sectors, we recommend that investors Overweight banks, diversified financials, insurance, energy and consumer discretionaries, and Underweight consumer staples, industrials, IT, telecoms and utilities (3.3) DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit researchdisclosures or call +1 (877) U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 Focus tables Figure 2: Index targets for major China/Hong Kong indices Index Upside Discount EPS growth assumptions (%) Consensus EPS growth (%) 6 December 213 Implied P/E (x) target (%) rate (%) 213E 214E 215E 213E 214E 215E 213E 214E 215E MSCI China HSCEI 15, Shanghai A Share 2, Hang Seng Index 27, MSCI HK 13, (3.3) Source: Datastream, Credit Suisse estimates Figure 3: Credit Suisse s top buy and sell ideas for China and Hong Kong markets Sector Top buy and sell ideas Sector Top buy and sell ideas China strategy OUTPERFORM: Shenhua, China Pacific, Hong Kong strategy OUTPERFORM: Henderson Land and Banks (China) ICBC, Belle OUTPERFORM: Minsheng Bank, ICBC, CCB, CQRC UNDERPERFORM: BCOM Banks (Hong Kong) Lifestyle OUTPERFORM: BOCHK, Hang Seng Bank, Dah Sing, Wing Hang Health care OUTPERFORM: Sihuan, China Medical Insurance OUTPERFORM: Ping An, China Pacific System, Bloomage Biothech, MicroPort Securities companies OUTPERFORM: Galax Securities Small cap OUTPERFORM: Sinopec Kantons, Sinotrans Shipping Property (China) OUTPERFORM: CR Land, SOHO Property (Hong Kong) OUTPERFORM: Henderson Land, Swire Prop, Hysan Consumer (China) OUTPERFORM: China Mengniu, China Modern Dairy, Anta, Intime, Tsui Wah, Gome, Belle Consumer(Hong Kong) OUTPERFORM: Samsonite, PRADA, Sasa, Chow Tai Fook Textiles OUTPERFORM: Pacific Textile Macau gaming OUTPERFORM: Melco-Crown, SJM Utilities OUTPERFORM: China Everbright, China Resources Gas, Longyuan Power UNDERPERFORM: ENN Energy, China Gas, Huaneng Power Oil and gas OUTPERFORM: CNOOC, Sinopec Kantons Commodities Transportation Source: Credit Suisse estimates OUTPERFORM: CR Cement, Jiangxi Cooper, Shenhua UNDERPERFORM: Zhaojin, Angang, Yanzhou OUTPERFORM: China Southern, Air China Cathy Pacific, Pacific Basin, China Merchants UNDERPERFORM: COSCO, CSCL Telecoms Internet OUTPERFORM: Unicom Figure 4: Credit Suisse China/Hong Kong model portfolio (benchmarking the Hang Seng Index) Weighting (%) CS Hang Seng vs HS Index Recommended stocks OUTPERFORM: Baidu, Sina, Ctrip, Soufun UNDERPERFORM: Changyou, Dangdang, Sohu Consumer discretionary MPEL (2%), Belle (2%), Samsonite (2%), Intime (1%), LifeStyle (1%) Consumer staples. 3.1 (3.1) Energy CNOOC (8%), Shenhua (4%) Financials Banks ICBC (12%), HSBC (12%), BOC HK (8%), Minsheng (4%) Diversified financials HKEX (2%), Galaxy Securities (2%) Insurance AIA (5%), China Pacific (5%), PICC P&C (2%) Real estate (.3) CR Land (4%), Henderson Land (3%), Swire Prop (3%) Industrials (.6) Capital goods (1.) Hutchison (2%) Transportation Cathay Pacific (2%) Information technology (2.4) Tencent (3%), Lenovo (2%) Telecoms services (1.6) China Mobile (6%) Utilities (1.6) CR Gas (3%) Hang Seng Index China stocks Source: Factset, Credit Suisse research China-Hong Kong Chronicles 2

3 214: OW China, UW Hong Kong In this inaugural issue of China-Hong Kong Chronicles, we present the 214 outlook for the China and Hong Kong markets. The China strategy In the past few years, the China market has been de-rated on two concerns: a structural slowdown in economic growth, and rising risks in the financial system. Also, within the China market, sectors that are less geared towards the economic cycle, such as Internet and consumer staples, have been outperforming the big state-owned enterprise (SOE)- dominated sectors such as financials and resources by a wide margin, and valuations of sectors such as Chinese financials are becoming very attractive. We believe the recent comprehensive reform agenda at the third Plenary Session of the 18th Central Committee Meeting have addressed some of these concerns, and if their implementation continues, it could provide a catalyst for the China market; sectors such as banks which are more geared towards the long-term economic health of China should be the biggest beneficiaries, in our view. Our 12-month index targets for MSCI China, HSCEI and Shanghai A Shares are 72, 15, and 2,7, implying 1.3%, 31.% and 16.% upside, respectively. The much bigger upside for the HSCEI than the other two indices is mainly due to the high concentration of depressed state-owned sectors in the index. In our China model portfolio, we Overweight banks, insurance, diversified financials, energy, materials, transportation, consumer discretionary and materials sectors, and Underweight consumer staples, capital goods, IT, telecoms and utilities sectors. Our top picks for China are ICBC, China Pacific Insurance, Shenhua and Belle. The Hong Kong strategy The dynamics of the Hong Kong market is actually quite similar to that of the China market. Due to concerns about rising US interest rates and tightening policy by the Hong Kong government, the property sector has been a big underperformer in the Hong Kong market and its valuation has become very undemanding. However, in the near term, we see limited catalysts for the sector. At the same time, the Hong Kong consumer discretionary sector (which includes both Macau gaming and Hong Kong consumer stocks) have outperformed the market significantly as their fundamentals are more geared towards the Chinese outbound traffic to Hong Kong rather than Hong Kong's own economic fundamentals; however, the valuation of this sector is becoming demanding. Overall, we see limited upside on the Hong Kong stocks, and our 12-month index target for MSCI Hong Kong is 13, potential downside of 3.3% from the current level. Our top picks for Hong Kong are Henderson Land and Lifestyle. China stocks currently account for about 53.8% of the Hang Seng Index weighting; therefore, we expect Hang Seng Index's performance to be better than MSCI HK's similar to MSCI China's, but worse than HSCEI's. Our 12-month index target for the Hang Seng Index is 27,, implying 12.9% upside from the current level. Within the Hang Seng Index, we recommend that investors Overweight China stocks (recommended 62% weighting) versus Hong Kong stocks, and Overweight banks, insurance, diversified financials, energy and consumer discretionary sectors, and Underweight consumer staples, capital goods, IT, telecoms and utilities sectors. China-Hong Kong Chronicles: Monthly update on CS's key views on various sectors China-Hong Kong Chronicles: our monthly series on China and Hong Kong markets will provide updates, including the CS views on all China/Hong Kong sectors, top picks of each sector, key China/Hong Kong index targets and model portfolios, as well as all key data points published in both China and Hong Kong. Economic reforms could trigger a rebound in Chinese stocks Hong Kong domestic stocks look inexpensive but lack catalysts Overweight China vs Hong Kong in a China/Hong Kong portfolio China-Hong Kong Chronicles is a monthly update on CS's key views on these markets, as well as a ready reckoner for important data points China-Hong Kong Chronicles 3

4 Table of contents Focus tables : OW China, UW Hong Kong... 3 The China strategy... 5 The Hong Kong strategy... 8 Index targets, model portfolios and top picks... 1 Recent market developments Chinese Whisper Survey: Nov Chinese Whisper Survey: Nov Sectors... 2 China banks Hong Kong banks Basic materials China consumer Hong Kong consumer China health care Insurance China Internet Macau gaming Oil & gas China property Hong Kong property Securities China small caps Telecoms Textiles Transport Utilities Key research Key charts... 6 China: GDP/output China: Inflation/prices China: Credit and financial market China: Rates China: Fixed asset investment China: Trade China: Income and consumption China: Corporate profitability Hong Kong and Macau P/B of markets... 7 P/B of MSCI China Sectors (I) P/B of MSCI China Sectors (II) P/B of MSCI HK Sectors EPS momentum of markets EPS momentum of MSCI China sectors (I) EPS momentum of MSCI China sectors (II) EPS momentum of MSCI HK sectors IDR of markets China-Hong Kong Chronicles 4

5 The China strategy In the past few years, there have been two key trends that have led to the de-rating of the China market: (1) a structural slowdown of the Chinese economy with no end in sight; and (2) a rising risk of financial crisis, reflected in the sharp rise in credit-to-gdp ratio. This, in turn, is largely due to the problems of surging local government borrowing in the form of local government financing vehicles' (LGFV) debt and a sharp rise in shadow banking activities of which a large amount of non-bank credit has gone to LGFVs. Slowing growth and rising indebtedness triggered market de-rating Figure 5: Slowdown in economic growth 5 Y-Y% Figure 6: Surging credit-to-gdp ratio 2 18 % of GDP Size of shadow banking Mar-93 Sep-96 Mar- Sep-3 Mar-7 Sep-1 Nominal GDP Industrial Sales Credit-to-GDP Loan-to-GDP Given this context, the market has been paying much attention to the recently finished 18 th 3 rd Central Committee Meeting of the Chinese Communist Party, to see whether the new government would launch reforms which could reverse these two above-mentioned trends. To a large extent, it is satisfactory. The reform programmes announced are very comprehensive, probably the most thorough since the massive reform programme announced in late 1993 at the 14 th 3 rd Central Committee Meeting. Most of the current fiscal and financial arrangements were established under that reform programme. The new reform programme could be crucial to China market's valuation Figure 7: Major reform programmes announced in the Central Committee Meeting Reform Agenda Details SOE Reform Rural Land Reform Market vs. Government Fiscal Reform Financial Reform "Hukou" (residentship) Reform One Child Policy Legal system Anti-Corruption Source: Credit Suisse research Emphasis on the co-existence between SOE and private sector. More indirect government control over SOEs. No mention of breaking down the key, state-owned monopolies Clear language endorsing the rights of farmers in their ownership of land and encouraging more freedom of transaction, but implementation details still needed Fewer approvals for projects, more free-trade zones More clarification over the expenditure relationship between central and local government. Early warning system for government debt Interest rate liberalisation and RMB internationalisation still the key direction. Less government control over IPOs. "Hukou" of medium-sized cities will be relaxed while that of mega cities will still be tightly controlled. For urban couples, if either husband or wife (instead of both currently) is a single child, they will be allowed to have two children. Reduction in the influence of local government on law court's judgements. Abolition of labour camp system. Reduction in the influence of local government on anti-corruption investigation China-Hong Kong Chronicles 5

6 There are three key areas in the reform programme which we believe investors should focus on: (1) The role between market and government, particularly local governments In China, local governments have a very big role in driving economic growth. Apart from building infrastructure very aggressively through land sales proceeds and borrowing money, local governments are also very active in choosing which industries/projects to promote, instead of relying on market forces. A very important theme in this reform document is to emphasise the importance of the market in allocating resources, which in other words means downplaying the role of local governments in economic development. More detailed policies include adding other components into the performance matrix of local governments, such as environmental protection and new local government debt, rather than just focusing on economic growth. Also, we expect new control mechanisms will be imposed on local government borrowings and under the rural land reform (discussed further below) the share of gains distributed to local government from land price appreciation is likely to be reduced. Therefore, if these reforms are successfully implemented, the near-term growth of the Chinese economy would probably be negatively affected, as local government investment in infrastructure projects was the major driver of economic growth of the past few years, and the amount could be reduced with a smaller role and less funding from local governments. However, in the long run it would make the Chinese economy healthier and growth more sustainable. Role of local governments in economic development to be reduced (2) Rural land reform Under the new rural land reform program, the rights of farmers to sell their land directly to the final user (instead of going through the local government) are being endorsed. The government also encouraged experiments to use rural land as mortgages for farmers to borrow money for their business. This firm endorsement of farmers having property rights to their land is likely to ensure that rural land reform experiments in cities such as Chengdu and Chonqging in the past few years will be extended to other cities in China. In the long run, it should change substantially the share of gain between farmers and local governments in the land price appreciation process. As mentioned above, this could hinder China's short- to medium-term growth as local governments' ability to fund infrastructure construction would be hindered. However, in the long run, with farmers securing a bigger share of gains from land sales, there would be less opposition to farmland acquisitions and we could expect more sensible and higher return private investment from individual farmers versus local governments. Rural land reform could help to boost long-term private investment (3) SOE reform Frankly, the SOE reform proposal is clearly a compromise. There is no mention of breaking up the state-owned monopolies in key sectors, such as energy, finance and telecommunications. However, there is an idea of creating "Temasek type" investment holding companies for the government to own the SOEs as a passive shareholder and refrain from too much direct involvement in the companies' operations. It seems that tackling the SOEs will only be the agenda of the government in its next term. Cycle and valuations The macroeconomic cycle is another factor determining the market outlook. We expect the economy to stabilise at around the current growth momentum. Among the key demand variables, we expect growth of infrastructure investment, consumption and industrial investment to remain stable, while exports (an expected mild global recovery) and property investment should pick up. This expected pick-up in property investment is mainly due to the inventory of developers having already dropped to a more acceptable level from the extremely high level in early 212. The major reason being that from 2Q12 onwards, property sales were doing well, but developers were very cautious in buying new land and starting new projects. Now, with inventory falling to a more reasonable level, developers' construction activities can expect to pick up. SOE reform a compromise An expected pick-up in export and property construction growth to drive the economy China-Hong Kong Chronicles 6

7 Our index targets for MSCI China, HSCEI and the Shanghai A Share are 72, 15, and 2,7, respectively, implying 1.3%, 31.% and 16.% potential upside. The much higher potential upside for HSCEI compared to MSCI China and the Shanghai A Share is mainly due to differences in sector weightings, with finance and commodities dominating the H- share index with these sectors being the ones that have de-rated the most in the past few years. Apart from the China market being de-rated, another distinct phenomenon of the China market is that big sectors such as banks, financials and commodities are significantly underperforming sectors such as the Internet and consumer staples. This is largely due to the low confidence of investors over the long-term growth and integrity of the financial system, so they put their investment dollars into sectors, such as the Internet and consumer staples, which are more privately owned and less geared towards the economy, particularly the financial system. Larger potential upside for HSCEI than MSCI China and Shanghai A Share Sectors, such as the Internet and consumer staples, outperformed big sectors, such as financials significantly in the past few years Figure 8: P/B of HSCEI P/B (X) Oct-6 Nov-7 Dec-8 Jan-1 Feb-11 Mar-12 Apr-13 Source: Factset, Datastream Figure 9: P/B of China IT, consumer staples and banks 9 P/B (X) Jan-9 Oct-9 Jul-1 Apr-11 Jan-12 Oct-12 Jul-13 Source: Factset, Datastream If our thesis is right, i.e., with more details of the reform programs being released on different sectors, investors are more comfortable about the long-term outlook of the Chinese economy, then: (1) the China market in general should rebound; and (2) those sectors that have de-rated significantly and have a high correlation with the Chinese economy as well as its financial system, would be re-rated and outperform the index. Therefore, apart from Overweight China, within China we Overweight sectors, such as banks, diversified financials, insurance and energy, while Underweight broadly defines consumer sectors. Consumer Staples IT Banks Expected big sectors such as financials to do better in 214 China-Hong Kong Chronicles 7

8 The Hong Kong strategy Hong Kong is expected to face many headwinds in 214. First, there is basically no room for interest rates to fall further, with the US economy continuing to show signs of strengthening. It is only a matter of time before Hong Kong interest rates rise (along with US rates). It may not happen in 214, but the risk will only rise as time passes. Hong Kong's property prices have been stabilising in recent months, largely due to the government's control measures earlier this year, after the large 1-year rise that started in mid-23. Looking ahead, we believe that the most likely scenario is one that is rather stagnant, or a mild decline in, property prices. The potential rise in interest rates is definitely not good news for property prices. However, the administrative control measures adopted by the government earlier this year have resulted in a very substantial decline in transaction volume from 213 onwards. This should create strong pent-up demand for property in Hong Kong should property prices correct more meaningfully. Therefore, it should help protect the downside of Hong Kong property. Interest rate rise remains a threat to the Hong Kong market Property prices stabilising in recent months Figure 1: Centa City Index (Price) 14 July 1997 = Figure 11: Monthly transaction volume 25, No. of units (primary & secondary market) 2, 15, 1, 5, Jan-92 Sep-95 May-99 Jan-3 Sep-6 May-1 Source: Centaline Property Jul-95 Aug-98 Sep-1 Oct-4 Nov-7 Dec-1 Source: Centaline Property The socio-political outlook in Hong Kong is likely to worsen in 214, given the underlying economic problems, i.e., a massive income gap, limited social mobility and high property prices, with little chance of improvement. In addition, with the big political question of the 217 Chief Executive Popular Election moving closer and closer, potential conflicts in Hong Kong are likely to rise and perhaps quite substantially. Indeed, the social tension in Hong Kong is already quite high even though the SAR's unemployment is only around 3.5%, i.e., full employment, and this will only rise further if the economy slows because of rising interest rates. By that time, the risk of social and political conflict will be even greater. This, therefore, is not a positive factor for the Hong Kong market. The China factor for Hong Kong is only a marginal positive. After so many years of opening up with Chinese tourists travelling to Hong Kong, the marginal impact of Chinese tourism on Hong Kong consumption is becoming smaller. Hong Kong's financial system will continue to benefit from trends like renminbi internationalisation, but again the marginal benefits are becoming small. The bottom line is that while the Chinese economy is stabilising, there is no sign that it will rebound strongly, so the impact on Hong Kong would also be limited. Our index targets for MSCI HK and Hang Seng Index will be 13, and 27,, respectively, i.e., -3.3% and 12.9% above current levels. The MSCI HK index is basically flat with the small potential upside of the Hang Seng Index largely driven by China stocks in the index (comprising about 54% of total). Therefore, within a Hong Kong/China Worsening socio-political outlook in Hong Kong Marginal benefits of Chinese tourists to Hong Kong are becoming smaller Hong Kong stocks to perform worse than China stocks China-Hong Kong Chronicles 8

9 portfolio, we recommend investors to Overweight China and Underweight Hong Kong. Within a Hong Kong portfolio, despite us liking the fundamentals of Hong Kong consumer discretionary, which includes Macau gaming and Hong Kong consumer stocks, and benefiting from the secular trend of Chinese tourism and consumption, the valuations of these stocks are generally very stretched and we see very little meaningful upside. Property stocks are the reverse, with their fundamentals not particularly exciting but share prices being quite depressed. Thus, among the big sectors in Hong Kong, we slightly Underweight consumer discretionary, slightly Overweight property and are basically Neutral on financials. Figure 12: P/B of MSCI HK Figure 13: P/B of banks, property and consumer services (Macau) MSCI HK P/B (x) ex-bubble avg. +1SD -1SD Banks Property Consumer Service Source: MSCI Source: MSCI China-Hong Kong Chronicles 9

10 Index targets, model portfolios and top picks A summary of our 12-month index targets for major China and Hong Kong indices is as follows: MSCI HK is expected to have potential downside of -3.3%, while potential upside for the HSCEI is high at 29.9%. Figure 14: Index targets for major China/Hong Kong indices Index Upside Discount EPS growth assumptions (%) Consensus EPS growth (%) Implied P/E (x) target (%) Rate (%) MSCI China HSCEI 15, Shanghai A Share 2, Hang Seng Index 27, MSCI HK 13, (3.3) Source: Datastream, Credit Suisse estimates We have created two model portfolios benchmarking MSCI China and the Hang Seng Index separately. Credit Suisse China Model Portfolio We have run this model portfolio from the beginning of 28 onwards, benchmarking MSCI China. In this almost six-year period from its date of inception, this model was down -2.1%, outperforming MSCI China by 28.%. From the last update, we only make one sector weighting change by cutting the weighting of the property sector by 2 pp and downgrading it from Overweight to Neutral, while increasing the weighting of insurance by 2 pp. The sectors which we Overweight include: consumer discretionary, energy, banks, diversified financials, insurance and materials all these basically being high beta sectors. Our biggest Underweight is in sectors, such as consumer staples, industrials, information technology and utilities. No major change in our portfolio sector weighting We made the following changes in the constituent stocks: (1) Removed Brilliance China and included its weighting in Anta; (2) Replaced China Merchants Bank with Minsheng Bank; (3) Replaced Haitong Securities with Galaxy Securities; (4) Replaced Shimao property with Soho China, and cut Vanke's weighting from 4% to 2%; (5) Removed Zoomlion; (6) Increased the weighting of Daqin Railway and Air China each by 1 pp; and (7) Replaced Huaneng Power with CR Gas. China-Hong Kong Chronicles 1

11 Figure 15: Credit Suisse's China Model Portfolio Weighting (%) CS MSCI vs MSCI Recommended stocks Consumer discretionary Belle (3%), Intime (3%), Anta (2%) Consumer staples. 5.9 (5.9) Energy CNOOC (11%), Shenhua (6%) Financials Banks ICBC (12%), CCB (12%), Minsheng (4%) Diversified financials Galaxy Securities (2%) Insurance China Pacific (6%), PICC P&C (4%) Real estate Vanke A (2%), CR Land (2%), SOHO (2%) Health care (.4) CMS (1%) Industrials (1.4) Capital goods. 4.2 (4.2) Transportation Daqin Railway (3%), Air China (2%) Information technology (3.) Lenovo (2%), Aisino (2%), Baidu (2%),Tencent (1%) Materials Baosteel (2%), Jiangxi Copper (2%) Telecom services (.5) China Mobile (1%) Utilities (1.5) CR Gas (2%) MSCI China Consumer sector* (6.6) * Consumer sector includes consumer discretionary, consumer staples, health care and IT. Source: Factset, Credit Suisse Credit Suisse China/Hong Kong model portfolio We have created a new Credit Suisse China/Hong Kong Model Portfolio, benchmarking the Hang Seng Index. The neutral weighting of China stocks in Hang Seng Index is 53.8%, and in our portfolio it is 62%, so we Overweight China over Hong Kong. Among sectors, we Overweight consumer discretionary, energy, banks, diversified financial and insurance, and Underweight consumer staples, capital goods, IT, telecom services and utilities. The sector and stock selection are both consistent with our China and Hong Kong model portfolios. Overweight China stocks versus Hong Kong stocks Figure 16: Credit Suisse China/Hong Kong Model Portfolio (benchmarking the Hang Seng Index) Weighting (%) CS Hang Seng vs HS Index Recommended stocks Consumer discretionary MPEL (2%), Belle (2%), Samsonite (2%), Intime (1%), LifeStyle (1%) Consumer staples. 3.1 (3.1) Energy CNOOC (8%), Shenhua (4%) Financials Banks ICBC (12%), HSBC (12%), BOC HK (8%), Minsheng (4%) Diversified financials HKEX (2%), Galaxy Securities (2%) Insurance AIA (5%), China Pacific (5%), PICC P&C (2%) Real estate (.2) CR Land (4%), Henderson Land (3%), Swire Prop (3%) Industrials (.6) Capital goods (1.) Hutchison (2%) Transportation Cathay Pacific (2%) Information technology (2.4) Tencent (3%), Lenovo (2%) Telecom services (1.6) China Mobile (6%) Utilities (1.6) CR Gas (3%) Hang Seng Index China stocks Source: Factset, Credit Suisse China-Hong Kong Chronicles 11

12 Top buy and sell ideas from CS analysts Figure 17: Credit Suisse's top buy and sell ideas for China and Hong Kong markets Sector Top buy and sell ideas Sector Top buy and sell ideas China strategy OUTPERFORM: Shenhua, China Pacific, ICBC, Belle Hong Kong strategy OUTPERFORM: Henderson Land and Lifestyle Banks (China) OUTPERFORM: Minsheng Bank, ICBC, CCB, CQRC Banks (Hong Kong) OUTPERFORM: BOCHK, Hang Seng Bank, Dah Sing, Wing Hang UNDERPERFORM: BCOM Health care OUTPERFORM: Sihuan, China Medical Insurance OUTPERFORM: Ping An, China Pacific System, Bloomage Biothech, MicroPort Securities companies OUTPERFORM: Galax Securities Small cap OUTPERFORM: Sinopec Kantons, Sinotrans Shipping Property (China) OUTPERFORM: CR Land, SOHO Property (Hong Kong) OUTPERFORM: Henderson Land, Swire Prop, Hysan Consumer (China) OUTPERFORM: China Mengniu, China Modern Dairy, Anta, Intime, Tsui Wah, Gome, Belle Consumer(Hong Kong) OUTPERFORM: Samsonite, PRADA, Sasa, Chow Tai Fook Textiles OUTPERFORM: Pacific Textile Macau gaming OUTPERFORM: Melco-Crown, SJM Utilities Commodities Transportation Source: Credit Suisse estimates OUTPERFORM: China Everbright, China Resources Gas, Longyuan Power UNDERPERFORM: ENN Energy, China Gas, Huaneng Power OUTPERFORM: CR Cement, Jiangxi Cooper, Shenhua UNDERPERFORM: Zhaojin, Angang, Yanzhou OUTPERFORM: China Southern, Air China Cathy Pacific, Pacific Basin, China Merchants UNDERPERFORM: COSCO, CSCL Oil and gas Telecoms Internet OUTPERFORM: CNOOC, Sinopec Kantons OUTPERFORM: Unicom OUTPERFORM: Baidu, Sina, Ctrip, Soufun UNDERPERFORM: Changyou, Dangdang, Sohu China-Hong Kong Chronicles 12

13 Recent market developments Market performance in November Index and by MSCI sectors MSCI China and Hang Seng H share (HSCEI) were up by 4.8% and 7.7%, respectively. The best performing MSCI sectors were insurance (+18.5%) and health care (+16.1%). On the other hand, retailing (-8.3%) and real estate (-2.2%) were the worst performers. MSCI Hong Kong and Hang Seng Index (HSI) were up.9% and 2.9%, respectively. The best performing MSCI sectors were diversified financials (+7.8%) and consumer discretionary (+3.3%). However, telecoms (-4.8%) and technology (-4.7%) were the worst performers. Insurance is the best performing MSCI China sector Diversified financials doing best in Hong Kong Figure 18: Monthly performance of MSCI China by sector Figure 19: Monthly performance of MSCI HK by sector Source: MSCI, Thomson Financial Datastream Source: MSCI, Thomson Financial Datastream Figure 2: Top and bottom performers China 166.HK Shandong Weigao GP Med H HK Avichina Ind. & Tech. H HK New China Life Insur. H HK BBMG Corp H HK China Taiping Insurance HK Zhaojin Mining Ind. H HK Zhongsheng Group Hldgs HK Belle Int'l Hldgs (CN) HK Daphne Int'l Holdings (CN) HK China Overseas GD Oceans -11 Hong Kong 551.HK Yue Yuen Industrial HK Hong Kong Exch. & Clearing HK Cathay Pacific Airways HK Sands China HK Galaxy Entertainment GRP HK ASM Pacific Technology HK Kerry Properties HK HKT Trust and HKT HK Cheung Kong Infrastructure HK Wheelock and Co -4.7 Source: MSCI Earnings momentum 213 and 214 EPS for MSCI China were up.5% and.3%, respectively, in the past one month. Sectors that saw the biggest EPS upward revisions for 213 were autos (+3.%), utilities (+2.4%) and materials (+2.1%). On the other hand, we saw the biggest EPS downward revisions for transportation (-3.3%) and consumer staples (-1.4%). Upward revisions in Chinese auto, utilities and materials China-Hong Kong Chronicles 13

14 For MSCI Hong Kong, 213 and 214 EPS were up.3% and no change, respectively, in the past one month. Sectors that saw the biggest EPS upward revision for 213 were consumer discretionary (+1.8%). However, we saw the biggest EPS downward revisions for transportation (-3.7%). Upward revision in Hong Kong consumer discretionary Hang Seng Index (HSI) and Hang Seng H share (HSCEI) 213 EPS were up.6% and 1.3% (214 EPS: +.5% and +1.1%), respectively, in the past one month. Figure 21: EPS integers MSCI China Figure 22: EPS integers MSCI Hong Kong Source: IBES aggregates Figure 23: EPS integers one-month change China Autos & Comp Utilities Materials H share Technology Banks Insurance Retailing Health Care MSCI China Real Estate Energy Capital Goods Telecoms Consumer Staples Transportation Source: IBES aggregates Figure 24: EPS integers one-month change Hong Kong Con. Discretionary Capital Goods Hang Seng Index Banks MSCI Hong Kong Real Estate Insurance Telecoms Utilities Div. Financials Transportation -3.7 Technology Source: IBES aggregates Source: IBES aggregates Net upgrades (the number of upgrades less downgrades as a percentage of the total number of estimates) for MSCI China were 3.6% (276 upgrades and 178 downgrades among 2,72 estimates) in November versus -.2% in October. Net upgrades for MSCI Hong Kong were 1.1% (67 upgrades and 6 downgrades among 668 estimates) in November, versus net upgrade of 3.1% in October. Slightly positive net upgrades China-Hong Kong Chronicles 14

15 Figure 25: Net upgrades MSCI China Figure 26: Net upgrades MSCI Hong Kong Dec-95 Dec-97 Dec-99 Dec-1 Dec-3 Dec-5 Dec-7 Dec-9 Dec-11 12M EPS net upgrades (%) - MSCI Hong Kong 3M moving avg. Source: IBES aggregates Source: IBES aggregates Valuations: MSCI China and MSCI Hong Kong EPS growth (%) P/E (x) Trailing Updated as of 29 Nov E 214E E 214E P/B (x) ROE (%) DY (%) MSCI China Consumer discretionary Autos Retailing Consumer staples Energy Financials Banks Insurance Real estate Health care Industrials Capital goods Transportation Information technology Materials Telecoms Utilities MSCI Hong Kong Consumer discretionary Financials Banks Div. financials Insurance Real estate Industrials Capital goods Transportation Telecoms Information technology Utilities Hang Seng Index H share index Source: MSCI, IBES aggregates China-Hong Kong Chronicles 15

16 Figure 27: China Selected economic indicators National accounts, population and unemployment E 214F 215F Real GDP growth (%) Growth in real private consumption (%) (1) Growth in real gross fixed capital formation (%) (2) Fixed investment (% of GDP) Nominal GDP (US$ bn) 3,495 4,514 4,994 5,969 7,295 8,252 9,99 9,899 1,99 Population (mn) 1,321 1,328 1,335 1,342 1,348 1,355 1,362 1,369 1,376 GDP per capita (US$) 2,645 3,399 3,742 4,449 5,41 6,88 6,68 7,23 7,986 Unemployment (% of urban labor force, average year) Prices, interest rates and exchange rates CPI inflation (%, December over December) CPI inflation (% change in average index for the year) Exchange rate (Rmb per USD, end-year) Exchange rate (Rmb per USD, average) REER (% year-on-year change December to December) (3) Nominal wage growth (% year-on-year change, average) year lending rate (%) month interbank rate (%, end-year) Fiscal data General government fiscal balance (% of GDP) General government primary fiscal balance (% of GDP) General government expenditure (% of GDP) Gross general government debt (% of GDP, end-year) (4) Money supply and credit Broad money supply (M2, % of GDP) Broad money supply (M2, % year-on-year change) Domestic credit (% of GDP) Domestic credit (% year-on-year change) Domestic credit to the private sector (% of GDP) Domestic credit to the private sector (% year-on-year change) Balance of payments Exports (goods and non-factor services, % of GDP) Imports (goods and non-factor services, % of GDP) Exports (goods and non-factor services, % increase in $ value)* Imports (goods and non-factor services, % increase in $ value)* Current account balance (US$ bn) Current account (% of GDP) Net FDI (US$ bn) Scheduled external debt amortisation (US$ bn) (5) Foreign debt and reserves Foreign debt (US$ bn, end-year) Public (US$ bn) (6) Private (US$ bn) Foreign debt (% of GDP, end-year) Foreign debt (% of exports of goods and services) Central bank gross FX reserves (US$ bn) 1,528 1,946 2,399 2,847 3,181 3,278 3,419 3,637 3,95 Central bank gross non-gold FX reserves (US$ bn) 1,524 1,942 2,389 2,83 3,159 3,251 3,39 3,66 3,872 (1) Calculated based on annual GDP data released by the NBS. (2) Calculated based on annual GDP data released by the NBS. (3) Real effective exchange rate: increase indicates appreciation. (4) Include Treasury bond and foreign state debt owed by the State Council only. 21F level is estimated to be 5.3%, including local governments affiliated debt. (5) Scheduled and estimated amortizations for medium- and longterm public and private sector debt. (6) Public debt defined as direct loans by government, state banks and SOEs, excluding trade credit. *Exports and imports growth forecasts for 213 and 214 based on figures after the government s policy against carry trades. The above table is taken from the Emerging Markets Quarterly, published on 14 November 213. Please refer to the CS R&A website for more details. Source: National Bureau of Statistics, People s Bank of China, CEIC, Credit Suisse research China-Hong Kong Chronicles 16

17 Figure 28: Hong Kong Selected economic indicators National accounts, population and unemployment E 213E 214F 215F Real GDP growth (%) Growth in real private consumption (%) Growth in real fixed investment (%) Fixed investment (% of GDP) Nominal GDP (US$ bn) Population (mn) GDP per capita (US$) 29,828 31,285 3,277 32,289 35,4 36,84 38,385 4,246 42,4 Unemployment (% of labour force, end-year) Prices, interest rates and exchange rates CPI inflation (%, December over December) CPI inflation (% change in average index for the year) Exchange rate (HK$ per US$, end-year) Exchange rate (HK$ per US$, average) REER (% year-on-year change December to December) (1) Nominal wage growth (% year-on-year change, average) month HIBOR (%, end-year) Fiscal data General government fiscal balance (% of GDP) General government primary fiscal balance (% of GDP) General government expenditure (% of GDP) Gross general government debt (% of GDP, end-year) (2) Money supply and credit Broad money supply (HK$ M2, % of GDP) Broad money supply (HK$ M2, % year-on-year change) Domestic credit (% of GDP) Domestic credit (% year-on-year change) Domestic credit to the private sector (% of GDP) Domestic credit to the private sector (% year-on-year change) Balance of payments Exports (goods and non-factor services, % of GDP) Imports (goods and non-factor services, % of GDP) Exports (goods and non-factor services, % increase in $ value) Imports (goods and non-factor services, % increase in $ value) Current account balance (US$ bn) Current account (% of GDP) Net FDI (US$ bn) Scheduled external debt amortisation (US$ bn) (3) Foreign debt and reserves Foreign debt (US$ bn, end-year) (4) Public (US$ bn) Private (US$ bn) Foreign debt (% of GDP, end-year) Foreign debt (% of exports of goods and services) Central bank gross FX reserves (US$ bn) Central bank gross non-gold FX reserves (US$ bn) (1) Real effective exchange rate, increase indicates appreciation. (2) Also includes debt issued under the Government Bond Program. Excludes debt guaranteed by the government. (3) Scheduled and estimated amortizations for total medium- and long-term public and private sector debt. (4) Non-bank foreign debt to Hong Kong entities. The above table is taken from the Emerging Markets Quarterly, published on 14 November 213. Please refer to the CS R&A website for more details. Source: Census and Statistics Department, Hong Kong Monetary Authority, CEIC China-Hong Kong Chronicles 17

18 Chinese Whisper Survey: Nov-13 People s confidence returns to a 25-month high The Chinese Whispers Economic Outlook Sentiment Index (CWEOSI) increased 4 pp MoM to 61, 6 pp higher than the historical average of 55. This brings the index back to its 25-month high. The index number indicates a further gain in people s confidence. On a closer check, 32% felt safe about their income and jobs, up 2 pp MoM, while 11% were pessimistic, down 5 pp MoM. The remaining 57% held a neutral attitude towards the economic outlook, 3 pp higher MoM. Grouped by income, 35% of higher-income respondents are optimistic, 4 pp and 1 pp higher than the other two income groups, respectively. Some 8% of mid-income respondents felt pessimistic, 9 pp and 2 pp lower than the other two income groups, respectively. Breaking down the results by city tier, the residents of Tier-1 cities are most optimistic about their incomes and jobs. Some 49% in the middle-income group are optimistic, 22 pp and 19 pp higher than those in Tier 2 and Tier 3 cities, respectively. The residents in Tier 3 cities are the most pessimistic 3% are pessimistic about income growth and job security, 14 pp and 4 pp higher than the other two groups respectively. Inflation expectation hits an 8-month high The Chinese Whispers Inflation Sentiment Index (CWISI) was 78 in October, 7 pp above the historical average of 71 and 4 pp higher than the September number, reaching an eight-month high. In further detail, it continued the rise in inflation expectation in September, with even more respondents believing prices will rise soon. Some 58% of all respondents predict prices will go up, 6 pp more MoM, while 2% believe that prices will drop and 4% think they will be flat, 4 pp lower MoM. By age group, more respondents aged expect inflation than from other groups. Some 73% of respondents aged think prices will rise, 19 pp and 18 pp higher than the other two groups, while only 24% of the age group think they will drop, 1 and 14 pp lower than the other two groups. Our thematic topic is a year-end survey after the reform roadmap was released On 12 November, the Third Plenary Session of the 18 th CPC Central Committee was concluded and it approved a document titled Decision on Major Issues Concerning Comprehensively Deepening Reform, which revealed a roadmap embracing a new round of sweeping reforms for the country. According to the reform plan, China will adjust its policies extensively, from the government tax regime and land system to the social security arrangements and family planning policy. Although the specific protocols of the document are yet to be staged, we measured our respondents of different ages and from different industries from all parts of China about their expectations to the new year of 214, especially after the new reform plan was rolled out. We found that 46% believe that China's economy will grow at a higher rate in 214 than in 213. Some 73% believe that the consumer price index will be higher and 64% that property prices will rise. 42% think their best wish for the coming year is a secure job and a pay rise, while 37% chose a worse environment as their least wish. Some 44% believe that it is too early to tell the role of Shanghai Free Trade Zone (FTZ). Some 82% agree to a reform of the family planning policy now and 69% object to postponing retirement, while 52% think that reverse mortgages are unfeasible. In addition, 89% believe that private banks will invigorate banking services while 68% prefer state banks over private banks. Some 59% use online financial services while 32% believe that Internet financing forges new services. Improvement in confidence 8-month high inflation expectation Public's response to reform is positive Some 46% of people expecting stronger GDP growth in 214 China-Hong Kong Chronicles 18

19 Chinese Whisper Survey: Nov-13 Figure 29: People s confidence returns to 25 month high Oct-13 Sep-13 Aug-13 Jul-13 Jun-13 May-13 Apr-13 Mar-13 Feb-13 Jan-13 Dec-12 Nov-12 Oct-12 Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 CWEOSI Source: Credit Suisse Chinese Whispers Survey Average Figure 31: A-share market investment sentiment reaches 8 month high Figure 3: Inflation expectation hits 8 month high Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov CWISI Average CPI (RHS), Credit Suisse Chinese Whispers Survey Figure 32: Property price sentiment drops from historical high 9 4 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct Oct-13 Sep-13 Aug-13 Jul-13 Jun-13 May-13 Apr-13 Mar-13 Feb-13 Jan-13 Dec-12 Nov-12 Oct-12 Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 CSI 3 (RHS) CWAMSI Average Oct-13 Sep-13 Aug-13 Jul-13 Jun-13 May-13 Apr-13 Mar-13 Feb-13 Jan-13 Dec-12 Nov-12 Oct-12 Sep-12 Aug-12 Jul-12 Jun-12 May-12 Apr-12 Mar-12 Feb-12 Jan-12 Dec-11 Nov-11 Oct-11 Sep-11 Aug-11 Jul-11 Jun-11 CWPSI Average SSE Real Estate Index (RHS) Source: Wind, Credit Suisse Chinese Whispers Survey Figure 33: Compared with 213, will Chinese economy grow at a higher, lower or similar rate in 214? Source: Wind, Credit Suisse Chinese Whispers Survey Figure 34: What s the role of private banks? Will you try their services? Invigorates banks, will try its service, 64% Invigorates banks, will not try its service, 25% Hard to regulate, will try its service, 2% C.Similar, 34% A. Higher, 46% Other, 11% B. Lower, 2% Hard to regulate, will not try its service, 9% Source: Credit Suisse Chinese Whispers Survey Source: Credit Suisse Chinese Whispers Survey China-Hong Kong Chronicles 19

20 Sectors China-Hong Kong Chronicles 2

21 China banks Sector view With Victor Wang's assumption of coverage of the China banks sector post a change in primary coverage responsibility, we have turned bullish and recommend investors to reassess their investment case for the sector. The China banking sector's valuation has declined meaningfully, from 1.6x forward P/B in early 29 to around.9x now, despite improving profitability. We attribute such a derating to investors' four key concerns: (1) a slowing economy; (2) the opaque lending and balance sheet structures; (3) concerns about equity-raising; and (4) an unpredictable regulatory environment. However, we see early signs of all four concerns being alleviated this is likely to result in a sizeable valuation recovery, in our view. Recent developments We see the aforementioned four major negative concerns are getting alleviated: (1) a stabilising macroeconomy as recent encouraging PMI and GDP trends suggest; (2) higher visibility on banks' balance sheets, especially in LGFV lending and shadow banking, (3) lower equity-raising possibilities and (4) a more stable regulatory environment. China's recent comprehensive reform plan post the 18 th Third Plenary Session also points to a more sustainable macroeconomic growth model. It will strengthen the long-term economic growth sustainability, given that the government is determined to reduce its direct interference in the economy (hence better usage of resources including capital) and open up more sectors to private capital. We agree that banking sector ROE should decline over time. We forecast banks' ROE will decline from 2.7% in 212 to 17.5% in 215, mainly due to three key challenges: (1) more banking licences are being granted to private capital which will intensify the competition; (2) further interest rate deregulation which will further erode margin; (3) the development of Internet financing also increases competition; and (4) rising NPL formation. We estimate profit growth for the sector will drop from 16% in 212 to 13% in 213, 6% in 214 and 7% in 215. We also expect significant divergence in profitability among banks, as a few could manage to defend their margins and generate strong fee income, while others are likely to witness a sharp slowdown of balance sheet expansion and a significant margin squeeze. Top picks Time to add China banks. We assign OUTPERFORM ratings to seven of the nine H- share banks. Our most preferred banks are MSB, ICBC, CCB and CQRC, and the least preferred is BCOM. Our TPs imply 1.16x 214E sector P/B multiple (vs. current.9x), implying over 27% total return in the next 12 months if we factor in their high dividend yields. If reforms are well executed, a blue-sky valuation scenario with 1.38x sector P/B suggests 43% upside for the sector. Bullish perspective Valuation has declined meaningfully Long-term economic growth sustainability will get strengthened as government direct interference in the economy reduced Banking sector ROE should decline over time Profitability among banks diverges China-Hong Kong Chronicles 21

22 China banks Figure 35: China banks ROE vs P/B Figure 36: A-share aggregated net profit YoY growth (%) Nov-5 Nov-7 Nov-9 Nov-11 Nov-13 1 Nov-15 CN banks P/B (x) CN banks ROE (RHS, %) Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 Source: Factset, Credit Suisse estimates Note: Based on 1,727 A-share companies that have reported quarterly profits since 1Q9. Source: Credit Suisse strategy team, Wind Figure 37: China banks Common equity Tier 1 ratio (%) Figure 38: China banks ROE trend (212A vs 215E) BASEL I data Already based on BASEL III % H13 Note: the red line indicates the minimum CET 1 ratio of 8.5% requirement for domestic SIBs ; Source: Company data ICBC CCB ABC BOC BCOM CMB MINSH CITIC CQRC ROE (212A) ROE (215E) Figure 39: China banks Sensitivity analysis 213E 214E 215E Every 5bp higher NPL ratio Impact on net profit (% of base-case estimate) -7.8% -8.2% -8.4% Every 1bp higher funding cost Impact on net profit (% of base-case estimate) -3.8% -3.9% -4.% Every 1bp higher deposit cost Impact on net profit (% of base-case estimate) -3.4% -3.5% -3.6% Every 5% higher expenses Impact on net profit (% of base-case estimate) -3.2% -3.3% -3.5% Every 1% less fee income Impact on net profit (% of base-case estimate) -3.8% -4.2% -4.5% Figure 4: CS preference for China banks in the key areas Funding Pricing power Flexibility Execution Business restructuring ICBC CCB ABC BOC BCOM CMB Minsheng CITIC CQRC Note: stands for the leading banks in the respective area, stands for the worst banks in the respective area, stands for run-up banks in the respective area and stands for deteriorating banks in the respective area; Source: Credit Suisse estimates China-Hong Kong Chronicles 22

23 Hong Kong banks Earnings growth to slow but still in double digits Hong Kong banks have marginally outperformed the overall market (banks up 13% vs. market up 11%) YTD. All the HK banks beat market expectations in 1H13 driven by betterthan-expected revenue performance (solid loan growth, robust margin expansion and strong fee income). But we expect most of the earnings drivers to soften in 2H13/214. Such strong loan growth in unsustainable and has already slowed marginally. The margin expansion cycle, especially for the smaller banks, could be over as funding cost is increasing and deposit competition could increase given the rise in loan-to-deposit ratios (smaller banks' LDR at 77-88% vs. 7-71% for large banks). Strong trading gains are unlikely to be repeated (as bond markets remain volatile) and trade-related fees could come down. Asset quality continues to remain benign (although some signs of deterioration in China are visible) along with cyclically low credit costs, which could only rise from here. Apart from the softening of earnings drivers, the other risks for HK banks include (1) the impact of rising rates on property/corporate sectors although not a 214 event, rising rates could impact the property sector where prices have doubled since 28 lows; and (2) rising mainland China exposure, which is now one-fifth of HK banks' total assets and growing rapidly (although some portion is covered by guarantees from mainland banks). Recent developments After surprising on the upside for most part of the year, HK banking system loans barely grew in October (+.1% MoM/+15.1% YTD) as (1) trade finance loans (9% of the book) shrunk 4.2% MoM (still up 53% YTD) and (2) partly due to seasonality, October loan growth has been weaker over the past few years, possibly due to Golden Week holiday. Trade finance loan growth was unusually strong until August and as these short-term loans mature, it could drag down the reported overall loan growth for the next few months. HKD funding cost increased by 2 bp MoM to.34% (up 9 bp since April lows) and system net interest margins were down 2 bp QoQ to 1.41% in 3Q13. There has been a lot of action in the family-owned HK banks with Yue Xiu group making an offer for 75% stake in Chong Hing Bank valuing the bank at 2.1x 1H13 P/B (2.35x including the special dividend). Wing Hang is also in talks regarding a potential stake sale by the family and as per media reports (Hong Kong Economic Times), the suitors include Anbang Insurance, Scotiabank, OCBC, UOB, ANZ and ABC (UOB and ANZ have reportedly walked away). WHB is a well-managed bank with conservative management but we do not see the deal multiple to be much higher than 2x given the larger deal size (Yue Xiu group offered US$1.5 bn for a 75% stake in CHB at x). At 2.x P/B, the WHB deal size would be US$5.4 bn. Large banks better on fundamentals, top pick BOCHK With the margin expansion story for the smaller banks over as funding cost has started rising, large banks with superior deposits franchise should be better placed. Among the large banks, BOCHK is our preferred play, mainly on relative valuations (trading at 1.7x 213E P/B for 17-18% core banking ROE and 11.7x 214E P/E) and attractive dividend yield (5.% 213E). Hang Seng Bank enjoys the best deposit franchise but Industrial Bank stake remains a drag on ROEs and capital ratio a sale would be a significant positive. M&A-related newsflow could keep Wing Hang and Dah Sing on the radar of investors. WHB has rallied 5% in three months and in case the deal does not happen, its price could revert to pre M&A multiples of 1.2x. We find the risk-reward more attractive in Dah Sing Bank due to ostensibly cheaper valuations (1.1x P/B FY13E) although it is not in talks yet. BEA is an unlikely M&A candidate, given its fragmented shareholding and the bank's large exposure to China (46% of loan book) remains a key risk. Other risks include potential rise in interest rates and increasing China exposure Loan growth (15.1% YTD) ahead of deposit growth (8.1%) YTD Action in family owned HK banks China-Hong Kong Chronicles 23

24 Hong Kong banks Figure 41: HK banking system loan/deposit growth Figure 42: HKD funding cost of banks vis-à-vis HIBOR (%) 4. Loan growth (YoY) Deposit growth (YoY).6 HK$ funding cost 3M HIBOR Oct-3 Oct-5 Oct-7 Oct-9 Oct-11 Oct-13 Source: HKMA, CEIC, Credit Suisse.1. Oct-9 Apr-1 Oct-1 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Source: HKMA, CEIC, Credit Suisse Figure 43: HK banks Credit cost forecast (bp of loans) Figure 44: Reported vs. core banking ROE (ann, 1H13, %) HSB BoCHK BEA WHB DSB Source: HKMA, CEIC, Credit Suisse E 214E Reported ROE Core banking ROE HSB BOCHK BEA WHB DSB Figure 45: Hong Kong banks key earnings drivers Hang Seng Bank BOC (Hong Kong) Bank of East Asia Wing Hang Bank Dah Sing Bank (%) E 214E E 214E E 214E E 214E E 214E Loan growth Net interest margin Fee income growth Other non-int inc grth Revenue growth Opex growth PPOP growth Credit cost (bp) Core net profit grth* Figure 46: Valuation comparison snapshot Rating Price 12M PT Potential Mkt. cap CoreEPS gth (%) P/E (x) P/B (x) ROE (%) Yield (HK$) upside US$ mn 13E 14E 13E 14E 13E 14E 13E 14E 13E Hang Seng N , BOCHK O , BEA U , WHB N , Dah Sing Bk N , Dah Sing Fin N , Note: Core net profit is ex-associates for HSB and Dah Sing Bank. China-Hong Kong Chronicles 24

25 Basic materials Sector view Steel: Diverging flat and long steel prices It is difficult to explain the divergent pricing of HRC and rebar prices as implied industry unit EBITDA suggests the current level is US$13/t higher MoM for rebar, but US$7/t lower MoM for HRC. Overall industry margins remain depressed, and most private mills suggested a very difficult October in terms of profitability, while production cut remains absent in either self-imposed or pollution-related forms. Coal: Seasonal demand picks up, yet restocking mostly done Power demand is improving MoM seasonally, according to IPPs. Yet upside in coal price seems to have mostly covered by the early winter restocking. As of late October, IPP inventory days were 79 mn t or 23 days, up from 73 mn t or 21 days from early in the month. While we maintain our view of cost support to coal prices, we think much of the winter-restocking related upside is already played out. Cement: Upside risk in southern, central and YZD Cement prices have risen in most regions in recent weeks. On a relative basis, we estimate cement price is Rmb63/t higher than 3Q13 for southern China, Rmb45/t better for eastern and central, while northern regions in the range of +/-Rmb15/t, based on spot prices quoted by the China Cement Association. We see upside risk in earnings for producers with higher exposures to southern, central and eastern China (CR Cement, Conch, CNBM, and TCCI). Our preference remains CR Cement in the sector. Base metals: Export recovery for Al, unusually quiet market for Cu Feedback from Al fabricators suggests that seasonal demand pick-up from exports has been stronger than usual, mainly from Europe, while domestic demand remained flat. Cu fabricators utilisation is stable MoM (mild seasonal pickups in tube but stable for wire/cable). November monthly channel check It is all about construction again. While the order book trend of end-users and basic materials appeared peaking in November, we see signs that construction activities picking up, driven by infrastructure and property, as reflected in improving new project starts (up 17% YoY in September), floor space starts (up 41% in September), and strong cement sales volume in eastern and southern China. In the meantime, industry-related investment remains weak, partly seen in sequential deterioration and disappointment in sales of machine tools. It seems the recovery is all about construction again. Channel checks on demand. Feedback from producers as of early November 213 suggests demand has further softened. (1) The forward order book trend of end-users softened MoM. The percentage of respondents expecting a MoM improvement fell further to 21% in November 213 versus 38% in October, driven mostly by property sales expectations. The respondents expecting a MoM decline widened to 5% from 23% in October, due to auto and property. (2) The forward order book trend for materials remained flat, with 27% of the respondents expecting an improving order book in November 213 (versus 24% in October). Top picks We continue to like CR Cement, Jiangxi Copper and Shenhua. Our least preferred stocks are Zhaojin, Angang and Yanzhou. Still: difficult October in terms of profitability Coal: Seasonal demand picks up Cement: Upside risk in southern, central and YZD Base metals: Export recovery for Al, unusually quiet market for Cu Construction activities picking up, driven by Infrastructure and property Demand has further softened from producers' feedback China-Hong Kong Chronicles 25

26 Basic materials Figure 47: Steel long product warehouse Long product inventory - MYSTEEL (mn tonnes) 12. Figure 48: Thermal coal IPP inventory IPP inventory (mn t) IPP inventory and inventory days 1 IPP inv. days Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Source: Mysteel Figure 49: Al SHFE Inventory (kt) 12 SHFE Al inventory Figure 5: Cu SHFE Inventory (kt) 25 SHFE Cu Inventory Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Figure 51: Iron ore medium mills kt Steel mills iron ore inventory and inventory days (import ore only) Source: Bloomberg, Credit Suisse estimates Figure 52: Coking coal medium mills and coke plants kt Mills/plants coking coal inventory and inventory days Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Small/Med mills IO inv Days (of daily import consumption) Days (of total daily con Mills/plants average coking coal inventory Average inventory d Source: Bloomberg, Credit Suisse estimates China-Hong Kong Chronicles 26

27 China consumer Sector view We remain positive on the long-term outlook of both China consumer staple and discretionary sectors. We believe the demand growth momentum would be driven by: (1) wage increase (re-distribution of wealth); (2) urbanisation and lifestyle change; (3) rising young middle class; (4) relaxation of one-child policy; and (5) consumers' lower financial burden flowing China's reforms in medical insurance, children education and retirement benefit scheme. However, China retailers are facing structural challenges from e- commerce, retail space oversupply, price deflation and labour/rent cost inflation. These negative factors have been gradually factored in a sector multiple de-rating. Within the space, we like the subsectors with a turnaround angle (Anta), stronger performance with proactive e-commerce strategy (Intime and Belle) and lifestyle proxy (Tsui Wah). China staples generally have stronger fundamentals than most discretionary with fewer structural issues. This led to high valuation multiple for years. Within the space, we like the subsectors with more attractive supply/demand dynamics but relatively low multiple (such as dairy and cow farming). Recent developments China retail sales increased 13.3% YoY in October vs. 13.3% YoY in September and 13.4% YoY in August. China consumer confidence index (CCCI) amounted to 12.9 in October vs in September and 97.8 in August. China Bank Card Confidence Index (BCCI) amounted to in October vs in September and in August. Most department stores' SSS YoY growth decelerated in 3Q13 Golden Eagle's 2-4% in 3Q13 vs. 6-8% in 2Q13; Intime's 4-5% in 3Q13 vs % in 2Q13; Parkson's negative.6% in 3Q13 vs. 2% in 2Q13. Footwear's performance was mixed Belle's 1.3% in 3Q13 vs..5% in 2Q13 with inventory level remains steady and healthy; Daphne's negative 18.1 % in 3Q13 vs. negative 13.7% in 2Q13. Hypermarkets: SunArt's less than 1% SSSG in 3Q13 vs. 4% in 1H13; pre-paid card sales declined 1% YoY; CRE's 6-7% SSSG in 3Q13 vs. 5.6% in 1H13; Lianhua's 1.9% SSSG in 3Q13 vs. 2% in 1H13; Springland's 2-4% in 3Q13 vs. 2-4% in 2Q13. Staples: overall demand remains resilient; price war in tissue and noodle segments is gradually eased. Domestic raw milk price (average grade) increased 15.1% YoY in October vs. 1.6% in 3Q13. New Zealand whole milk powder price increased 1.8% YoY in October vs. 63% in 3Q13. Global pulp price increased 13.3% YoY in October vs. 1.2% in 3Q13. Top picks China Mengniu (OP, TP HK$39.5): Promising long-term growth story with margin expansion potential, driven by product mix upgrade, portfolio expansion (team up with Danone, Yashili and Arla Foods), execution improvement. China Modern Dairy (OP, TP HK$4.5): A leading dairy farm operator, benefiting from premium raw milk supply shortage, margin expansion potential (more transparent pricing mechanism, partial self-sufficient of alfalfa, efficiency improvement). Anta (OP, TP HK$12.2): The very first Chinese sportswear play which should see positive order growth (high single digit) in 214; proactive brand building to promote its basketball and peripheral products. Intime (OP, TP HK$11.): Healthy ramp-up of semi-new stores on good execution, uniform multifunctional shopping formats and selective locations; ecommerce should break even in 214 and create opportunity for both offline and online to benefit in tandem. Tsui Wah (OP, TP HK$6.5): HK sales should remain robust through growing delivery coverage. China should see a substantial improvement driven by newly matured young comp stores and up to 1 pp improvement in China s EBIT margin. Gome (OP, TP HK$1.7) had been hated by market for more than two years; both offline and online business started to turn around, likely to further beat consensus earnings estimates; favourable risk/reward profile. Positive long-term outlook with China retailers facing structural challenges Consumer confidence boosted China-Hong Kong Chronicles 27

28 China consumer Figure 53: China Consumer Confidence Index and China monthly retail sales China Consumer Confidence Index (CCI) China Monthly Retail Sales of Consumer Goods, YoY% Figure 54: SSSG of dept stores Golden Week update, 3Q forecast CCI benchmark: Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Figure 55: China raw milk price (Rmb/kg) Jan/6 May/6 Sep/6 Jan/7 May/7 Sep/7 Jan/8 May/8 Sep/8 Jan/9 May/9 Sep/9 Jan/1 May/1 Sep/1 Jan/11 May/11 Sep/11 Jan/12 May/12 Sep/12 Jan/13 May/13 Sep/13 Figure 56: New Zealand milk powder price (US$/metric tonne) 5,5 5, 4,5 4, 3,5 3, 2,5 2, 1,5 Jan/6 May/6 Sep/6 Jan/7 May/7 Sep/7 Jan/8 May/8 Sep/8 Jan/9 May/9 Sep/9 Jan/1 May/1 Sep/1 Jan/11 May/11 Sep/11 Jan/12 May/12 Sep/12 Jan/13 May/13 Sep/13 Source: NBS Source: Bloomberg Figure 57: Valuations Company Ticker Rating Market cap P/E EV/EBITDA P/B ROE CAGR % PEG DivYld (US$ mn) MF Want Want 151.HK N 19, % 37.4% 17.5% % Tingyi 322.HK N 16, % 17.3% 22.7% % Hengan 144.HK N 15, % 28.4% 18.3% % Belle 188.HK O 1, % 17.9% 9.3% % Mengniu Dairy 2319.HK O 8, % 14.2% 29.3%.8.9% Ajisen 538.HK O 5, % 1.% 22.5% % GOME 493.HK O 2, % 7.% 34.2%.5 1.7% Golden Eagle 338.HK U 2, % 2.5% 11.6% % CMD 1117.HK O 2, % 11.8% 72.3%.3.4% Intime 1833.HK O 2, % 13.% 11.9% % Stella 1836.HK N 1, % 13.9% 13.9% % Home Inns HMIN.OQ O 1, % 11.9% 32.7%.6.% Vinda 3331.HK N 1, % 14.5% 18.9% % China Lodging HTHT.OQ O 1, % 11.8% 31.8%.8.% Springland 17.HK O 1, % 15.5% 1.8%.9 5.% Tsui Wah 1314.HK O % 16.2% 37.% % Parkson 3368.HK U % 9.3% 6.6% % Source: Reuters, Credit Suisse estimates China-Hong Kong Chronicles 28

29 Hong Kong consumer Visitation trends back to basics and look global Hong Kong retail sales had grown at 11.9% YoY year-to-october. Stripping out the jewellery and watch sales which saw exceptional growth during April-July 13 as a result of a sharp decline in gold price, Hong Kong retail sales would have grown at 8% YoY during the same time period. Mainland Chinese visitation spending remains the key driver of the Hong Kong retail sector. While the visitation growth remains robust (+18% YoY), the shift is from visitors from Tier 1 or 2 cities to lower tier cities and day trippers, who in general possess lower spending power and target mainly daily/personal necessities. We remain positive on global luxury trends with 1% growth forecast for 214 and this to be led by NJA at 12%, a pick-up from 1% in 213. That being said, the risk to the downside remains in mainland China and Hong Kong where more traveling overseas and weaker visitation could lead to the leakage of luxury sales to other markets. Recent developments Chow Tai Fook (1929.HK, HK$12.4, OUTPERFORM, TP HK$14.5) and Luk Fook (59.HK, HK$28.65, NEUTRAL, TP HK$29.7), the top two Hong Kong jewellery retailers, both reported record 1H FY14 net profits in late Nov-13 which rose 73% and 92% YoY, respectively, as a result of gold rush during the period. 2H will be less exciting. Sa Sa (178.HK, HK$9.3, OUTPERFORM, TP HK$9.7), one of the leading cosmetics and skincare products retailers in Asia with 16 stores in Hong Kong and Macau, registered a decent recovery of same-store-sales growth (SSSG) in Hong Kong from 6% during the National Day Golden Week (1-7 October 213) to 21% post-golden week (up to 14 November 213) driven by intensive promotions and discount offering. This is in line with our view that consumers are more price sensitive. For international brands, Samsonite (191.HK, HK$23.45, OUTPERFORM, TP HK$25) was the only company to record a positive surprise, as 3Q13 sales growth of 17% beat our estimate by 4bp. Market share gains in most markets more than offset disappointing China sales. Esprit s (33.HK, HK$16.34, UNDERPERFORM, TP HK$6.9) 1Q FY14 revenue decline of 1% was in line as positive retail sales growth in Europe (first time since 21) was more than offset by worsening sales trends in Asia. On a 2-3-year view, Esprit s underlying earnings cannot deliver what the market is implicitly pricing in. L Occitane s (973.HK, HK$17.8, UNDERPERFORM, TP $14) 1H14 operating income missed our estimates by 5%. Earnings risk remains high for 2H FY14. PRADA will report 3Q FY15 trading update on 2 December 213 where we expect 7% SSSG. Top picks Samsonite, Sa Sa, PRADA and CTF With 214 outlook still uncertain and our CS economist expecting private consumption expenditure momentum to be negative in Hong Kong next year, we prefer international names such as Samsonite and PRADA which have diversified portfolios to offset any HK/China weakness, strong brand momentum, rising market share, rising FCF generation and forward ROIC expansion. We also prefer general retailers such as Sa Sa which should continue to see resilient sales momentum in Hong Kong and Macau given demand for cosmetics and skincare products are in general inert to economic cycles. Among the jewellery retailers, we believe the normalising sales growth momentum and soft 2H FY14 outlook are likely to impose pressure on share prices in the short run. Over a longer time horizon, Chow Tai Fook remains our top pick in the sector because its 2H earnings momentum will be strongest given its more extensive retail exposure in mainland China, especially in lower tier cities which are likely to experience stronger growth. Mainland Chinese visitation spending remains the key driver of the Hong Kong retail sector Top jewellery retailers both reported record 1H FY14E net profits as a result of gold rush Sa Sa's SSSG grow from 6% to 21% Positive surprise in Samsonite China-Hong Kong Chronicles 29

30 Hong Kong consumer Figure 58: Hong Kong monthly retail sales (HK$) (HK$mn) (%) 6, 25 5, 2 4, 15 3, 1 2, 1, 5 Figure 59: YTM retail sales growth of key segments Motor Vehicles and Parts Department stores Medicines, Cosmetics Jewellery, Watches, Clocks & Valuable Gift Supermarket Clothing, Footwear and Allied Products (CF) Total Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Total retail sales - LHS YoY % chg - RHS Furniture and Fixtures Electrical Goods, Photographic Equipment Oct 13 - YoY % chg YoY % chg (YTM) Source: Hong Kong Census and Statistics Department Figure 6: Mainland Chinese visitation Visitation (Person) 4,5, 4,, 3,5, 3,, 2,5, 2,, 1,5, 1,, 5, Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 (%) Source: Hong Kong Census and Statistics Department Figure 61: Mainland Chinese visitation growth trend YoY 5 % chg Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13-1 Overall Mainland Chinese visitations - LHS YoY% chg - RHS Overnight Mainland Chinese - RHS Sameday Mainland Chinese - LHS Source: Hong Kong Tourism Board Source: Hong Kong Tourism Board Figure 62: Luxury sales momentum in Non-Japan Asia NJA aggregate constant FX sales growth YoY of luxury companies 4% 4% Figure 63: Hong Kong retail sales growth vs rental growth YoY chg (%) % 26% 27% 6% 5% 3% 27% 26% 24% 25% 23% 8% 28% 22% 15% 1% 11% 11% 12% 9% 9% 1% 1% 11% 5% Q2 4Q2 3Q3 2Q4 1Q5 4Q5 3Q6 2Q7 1Q8 4Q8 3Q9 2Q1 1Q11 4Q11 3Q12 2Q13-1 (1%) -2 1Q8 2Q8 3Q8 4Q8 1Q9 2Q9 3Q9 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E Overall prime Premium prime High-street Retail sales growth Source: Hong Kong Census and Statistics Department, Jones Lane LaSalle China-Hong Kong Chronicles 3

31 China health care Downside from anti-corruption priced in After the GSK bribery investigation and the harsh Guangdong tender measure finalisation, we believe the bad news is almost over as the market has believed that this round of the anti-corruption campaign has spilled over to the whole sector and a steep drug price cut in the near term is inevitable. We also see good news emerging: (1) Shandong province initiated EDL drug tender with more moderate measures than the Guangdong tender; (2) the Chinese government will increase the annual funding for the New Rural Cooperative Medical Scheme to Rmb28 bn (up 16.7% YoY); and (3) our channel checks indicate that the Guangdong non-edl drug tender may be further delayed to 214 July/August and is less likely to follow the other provinces. The MSCI China Healthcare Index was down 5.3% during 1-3Q13, and has then rebounded by 26.6% since the start of 4Q. We believe the risks from the policy headwinds have already been priced in. Although there remains earnings downside in 4Q13, the market now seems to be able to look through the short-term earnings volatility. Less policy headwinds in 214 We believe the China healthcare sector will continue to outperform the market in 214 given: (1) growth drivers are intact; (2) valuation is attractive; (3) leaders are better off; and (4) drug tender measures are more moderate. Another ~15 provinces/cities are expected to run non-edl drug tenders in 214 and pharma companies which have new drugs will have the opportunity to expand their hospital penetration if they can win the tenders. The recent Third Plenary Session reiterated removing drug mark-up, optimising medical insurance system, enhancing grassroots healthcare services in healthcare reform, and focused more on improving operational efficiencies. We believe private hospitals will benefit the most, and the government is open for more market-oriented behaviour in the healthcare system, probably because the reform on public hospital itself has proved to be quite difficult to implement given a lot of incumbent stakeholders' interests involved. Top picks We reiterate Sihuan (46.HK) as our top pick in the China pharma sector and believe the stock should outperform other healthcare stocks over the next six months driven by strong FY13E results with 4%+ net profit growth. Moreover, this round of high growth momentum should continue in 214/15 because Sihuan s three new blockbusters will penetrate into additional hospitals if they manage to win tenders in the other 15 provinces which will run non-edl drug tenders in 214. We also like China Medical System (867.HK) for its immunity from the anti-corruption investigation and the high visibility and low volatility of its earnings. Bloomage BioTech (963.HK) is our top pick in the China medical supplies sector. The new CEO has over 2 years of experience in sales and marketing of medical instruments, and he is now actively recruiting for Bloomage s sales and marketing team; we believe his appointment largely reduces the execution risk of Bloomage s dermal filler business. Bloomage is also an indirect play in the China private hospital sector because most of its fillers are sold to private plastic surgery hospitals. MicroPort (853.HK) will have good chance to get a re-rating in 214 for its new product launches (next generation of drug eluting stents and electrophysiology products) and potential earnings accretion from the recently acquired OrthoRecon business. Bad news over Good news came Continue to outperform China-Hong Kong Chronicles 31

32 China health care Figure 64: Shandong EDL drug tender measures are more moderate than Guangdong Guangdong Shandong Price premium for innovation and better quality No Bidding frequency Monthly Yearly Price cap Yes No Quality vs price Quality accounts only 1% in the total valuation Quality valuation first to qualify bidders, then compete on price No. of winner per drug specification Only the lowest bidder Two winners, both the lowest bidder and highest quality evaluation bidder Source: Shandong and Guangdong drug tender administration Yes Figure 65: The increase in government NRCMS premium subsidy has been accelerating in recent years Figure 66: MSCI China Healthcare rebounded recently 17% NRCMS premium subsidy by the government (RMB per head) Source: The National Health and Family Planning Commission 8 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 MXCN Index MXCNHC Index Source: Bloomberg, Credit Suisse Estimates Figure 67: China healthcare stocks comp set ROE (%) Mkt cap Price TP CS P/E (x) EV/EBITDA (x) EPS Company Ticker (US$ mn) (local) (local) rating CAGR Shanghai Pharma 267.HK 6, N % Sinopharm 199.HK 2, N % Sihuan 46.HK 4, O % CMS 867.HK 2, O % Sino Biopharm 1177.HK 3, N % Mindray MR.N 5, U % Shandong Weigao 166.HK 5, N % MicroPort Scientific 853.HK 1, O % Bloomage BioTech 963.HK O % Average % Source: Credit Suisse estimates China-Hong Kong Chronicles 32

33 Insurance Sector view We are positive on the medium-term outlook of the Chinese insurance sector given low insurance penetration, growing GDP and personal wealth and ageing population. We believe the agency channel, which now accounts for 8-9% of the value, will be key to the long-term sustainable growth and value creation for Chinese life insurers. Hence we like insurance companies with better agency quality and growth momentum. We also like the P&C sector and we believe the medium-term growth fundamentals remain very strong. We also think there are structural reasons for margin sustainability for the three largest listed insurers given their scale advantage which is difficult to replicate. Recent developments The growth for the life insurers slowed materially recently due mainly to more attractive yields from shorter-term competing products, i.e. wealth management products at the bancassurance channel and the slower agency channel growth due to rising labour cost and low agency management quality. However, we think the worst is behind us and we are going to see better agency momentum. We also highlight several initiatives from the regulators to focus on the insurance protection which is key to the healthy development: (1) the lift of guarantee rate of traditional product to 3.5% from 2.5%; (2) the potential launch of tax deferred pension and health insurance products; and (3) new bancassurance regulation to encourage more insurance protection sales and allow insurance sales inside bank branches. The P&C sector growth remained very strong this year. However, the profitability for the main segment, auto insurance, continued to deteriorate given claims inflation and heightened competition. Going into 214, we expect more regulatory intervention to restore the underwriting profitability and the introduction of auto insurance pricing liberalisation on both commercial and mandatory segments. Top picks We prefer the large cap insurers with a strong agency growth momentum such as Ping An and China Pacific. We highlight that Ping An's agency momentum has been the best among its peers so far this year with double-digit growth and it is trading at a 1% discount to China Life on its pure life division. The recently completed Rmb2 bn convertible bond issuance and the capital injection into its banking division would alleviate investor concerns about its relatively weak capital position and bank. We also prefer China Pacific given its steady results in both life and P&C divisions and the strongest capital position. China Taiping could be a dark horse as the smallest listed insurer with the cheapest valuation. Its recent results have been quite volatile given its ambitious growth target, but the recently announced bancassurance new regulation would benefit the company and lead to a more stable growth outlook. Insurance companies will better agency quality and growth momentum Growth for the life insurers slowed as a result of more attractive yields from shorter-term competing products Better agency momentum going forward More regulatory intervention expected China-Hong Kong Chronicles 33

34 Insurance Figure 68: Value of new business started to grow again Value of new business growth % Figure 69: Trading at a considerable discount to AIA P/EV x 6% 5% F'casts 2.x 1.75x P/EV (x) P/EV (x)* H-shares A-share discount (%) 4% China Life 1.5x 8% VNB growth (% p.a.) 3% 2% 1% % Ping An China Pacific China Taiping 1.25x 1.x.75x.5x -19% -28% -24% -1% -2% Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 New China Life PICC Group Jun-14F Dec-13F Jun-13 Dec-12.25x.x China Life (H) Ping An (H) China Pacific (H) New China Life (H) China Taiping PICC Group (H) AIA China Life (A) Ping An (A) China Pacific (A) New China Life (A) Figure 7: Big discount still ascribed to Ping An Bank Ping An sum-of-the-part implied valuation of bank Ping An - SOTP valuation (HK$) - implied bank valuation Figure 71: with life co still trading in discount to China Life Ping An Life implied valuation vs. China Life (P/EV x) 5% 4% Life insurance x EV China Life multiple Property & Casualty x book PICC P&C at 2.1x Bank x book Mid tier banks trade.8-1.1x Securities x book Peers trading on x Corporate / other x book Price to Embedded Value (premium / discount) 3% 2% 1% % -1% -2% sd +1 sd -1 Average Current price (HK$) % Jul-9 Nov-9 Mar-1 Jul-1 Nov-1 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 Figure 72: PICC P&C loss ratio improving Figure 73: with scale advantage Loss ratio, % 85.% 8.% F'casts ----> Expense ratio, % 5.% 45.% China Taiping F'casts ----> 75.% 4.% Ping An Loss ratio (%) 7.% 65.% 6.% 55.% China Pacific Ping An PICC Expense ratio (%) 35.% 3.% 25.% 2.% China Pacific PICC 5.% China Taiping 15.% 45.% 1.% 1H14F 2H13F 1H13 2H12 1H12 2H11 1H11 2H1 1H1 2H9 1H9 2H8 1H8 2H7 1H7 2H6 1H6 2H5 1H5 2H4 1H4 1H14F 2H13F 1H13 2H12 1H12 2H11 1H11 2H1 1H1 2H9 1H9 2H8 1H8 2H7 1H7 2H6 1H6 2H5 1H5 2H4 1H4 China-Hong Kong Chronicles 34

35 China Internet Sector view Despite sector-wide multiple expansion and strong share price performance over the past few months, we still see ample investment opportunities. Position in China Internet economy expansion. As Internet becomes much more engaging in daily consumer life, value creation from Internet-based businesses is taking a more important role in the overall economy. Beyond traditional advertising and games, monetisation has ramped up rapidly in travel, tangible-goods ecommerce, local life services, and emerged in frontier markets of Internet finance and online-to-offline (O2O) applications. We believe 214 key investment themes are: (1) digitalisation of local services; (2) ecommerce sees strong growth; (3) online travel penetration driven by smartphone adoption; (4) emergence of Internet finance; and (5) mobile monetisation: Games, O2O, e-commerce payment Recent developments China structure population change propelling online real estate demand. In the next 5-1 years, the bulk of China internet population (post 8s and 9s) will be entering the age group of home ownership (age 25-5). People in this age group tend to use more online tools and information to find products and services. We believe the demographic tailwind will propel increasing online usage in the real estate segment in the coming years. The usage shift shall gradually migrate real estate marketing, sales and consumer spending dollars from offline to online. Other diversified local services providers like 58.com and Dianping should benefit from these demographic changes as well. Online travel: Increasing leisure travel demand and better user experience to drive penetration: China s online travel market reached Rmb bn in 212 with an annual growth rate of 32%, accounting for 7% of the total travel market in China, according to iresearch. We believe the main catalysts come from users moving online, travelling abroad and using more packaged tour. Everything mobile: The growth of mobile Internet has been quite pronounced and much talked about over the past several years. What has changed significantly since 1Q13 is that revenue contribution has become meaningful and been ramping up quickly. We are entering a stage when mobile has become ubiquitous in every segment of China Internet. In the next two years, we believe that mobile Internet will no longer be a separate concept or topic, as mobile usage becomes indispensable to all Internet services. Top picks Our OUTPERFORM stocks are based on the following points. 1) Leading beneficiaries of Internet economy expansion and mobile monetisation: Baidu Sina Ctrip and SouFun 2) Undervalued evolving business with potential catalysts: Changyou, Dangdang and Sohu. Internet-based businesses taking more important role in overall economy Real estate marketing expected to shift from offline to online Increasing travelling use Mobile Internet expected to merge with Internet services China-Hong Kong Chronicles 35

36 China Internet Figure 74: China Internet sector forward P/E Figure 75: China internet user breakdown by age group (mn) Fastest growing demographics *Stock universe includes Baidu, Tencent, Sohu, Ctrip, Netease, Qihoo, Shanda Games, Changyou; Source: Companies, Credit Suisse research Figure 76: China online classified market size forecast Source: CNNIC Figure 77: China s online travel to reach 12% of total travel market in 15E % e 214e 215e Total travel market (Rmb bn) Online travel market % of total travel market 12% 1% 8% 6% 4% 2% % Source: iresearch Source: China National Tourism Administration, iresearch, Credit Suisse estimates Figure 78: Closing the monetisation gap: Still in progress 9% 8% 7% 6% 5% 4% 3% 2% 1% % Gap: 49% traffic vs. 18% revenue on average 35% 1% 5% 25% 17% 15% 67% 41% 77% 34% 5% 4% 4% 5% Baidu Naver Google Facebook Sina Weibo Youku Dangdan Mobile Traffic Mobile Revenue Figure 79: China outgrows rest of Asia-Pac in B2C ecommerce in the coming years 1% 6.6% 1.6% Source: Company data, Credit Suisse research Source: emarketer, Jun 213 9% 8% 7% 6% 5% 4% 3% 2% 1% 14.9% 19.% 21.7% 23.6% % E 214E 215E 216E Japan China Australia South Korea India Indonesia Other China-Hong Kong Chronicles 36

37 Macau gaming Sector view 213 is the fifth consecutive year when the Macau gaming sector has outperformed the broader market since 29. It has risen 73% year-to-date to an estimated record 214E EV/EBITDA of 15.5x. The sector has underperformed the Hang Seng Index by 6% in the past 1.5 months, as market interest is shifting to some heavyweight China sectors. Macau gaming stocks' share prices have also become seemingly immune to positive news flow. In the absence of exciting gaming industry data or developments in Macau, we believe this widely owned sector will extend the past month's underperformance against the market to the next two to three months until there are new catalysts or its valuation differentials against the market contract notably. We do not believe the sector is due for a deep correction similar to those seen in 3Q11 and 2Q12, which were triggered by the unanticipated slowdown of the Chinese economy. Our view is supported by our Macau Gaming Research Sentiment Indicator, which indicates that the current market sentiment towards Macau gaming stocks is not overheated. We believe the Macau gaming sector will extend the past month's underperformance against the market to the next two to three months Recent developments The market should start to pay attention to two major developments related to Macau in 214: (1) The opening of Chimelong Ocean Resort in Hengqin, China, which some investors believe will drive visitation growth in Macau. However, as the resort is opening in phases, investors should not expect it to significantly drive visitor flow to Macau before 1H14, in our view. (2) The openings of three new casinos by Galaxy, MPEL and Sands China in 215, due to which the market anticipates an increase in Macau visitations and an acceleration in GGR growth in 215 and 216. Based on historical trading patterns, the market starts to factor in the impact of a new casino on the operator's share prices about seven months before the opening. Therefore, the share prices of Galaxy and MPEL should see an impact from 4Q14; 2Q15 for Sands China. Hence, we do not expect the market to be excited by the 215 new casino openings before 1H14. Two major developments related to Macau: the opening of Chimelong Ocean Resort in Hengqin, China, and the openings of three new casinos by Galaxy, MPEL and Sands China in 215 Top picks Melco-Crown: Our long-term buy which we like its growing premium-mass exposure, expansion projects both in Macau (Studio City and the Tower 2 in Cotai Strip) and overseas (City of Dreams Manila in the Philippines), and favourable valuation discount of 15% to the sector average. SJM: Its series of initiatives implemented in Grand Lisboa to drive table efficiency, which should be felt from 4Q13. At a 32% discount to 214E sector valuation with a dividend yield of 4.8%, we expect SJM to be a sector outperformer in the next six months. Figure 8: Valuation comparison of the Macau gaming stocks Mkt Credit Pot. P/E EV/EBITDA Dividend yield cap Price Suisse TP upside (x) (x) (%) Company Ticker (US$ mn) (l.c.) rating (l.c.) (%) 13E 14E 15E 13E 14E 15E 13E 14E 15E Galaxy 27.HK 33, N MPEL MPEL.OQ 19, O MGM China 2282.HK 13, N Sands China 1928.HK 6, N SJM 88.HK 17, O Wynn 1128.HK 19, O Sector avg Note: Priced as of 29 November 213; O = Outperform; N = Neutral. China-Hong Kong Chronicles 37

38 Macau gaming Figure 81: CS Macau Gaming Index vs. Hang Seng Index (Rel. perf) Macau gaming sector underperforms Figure 82: Sectorial EV/EBITDA band chart 2,3 16.x ,8 13.5x ,3 11.x 9.x x 7 Jan 13 Mar 13 May 13 Jul 13 Sep 13 Nov 13 CS Macau Gaming Index Hang Seng Index MGI rel. to HSI (RHS) 7 3 Jan-1 Jan-11 Jan-12 Jan-13 Source: DataStream, Credit Suisse Figure 83: Annual GGR forecast US$mn 75, 6, 45, 3, 15, 13,574 14,896 23,53 33,427 37,974 44,731 5,691 58, E 214E 215E Mass-market VIP Slot Source: DICJ, Credit Suisse estimates Figure 85: Mainland Chinese visitations to Macau Person (%) 2,, 45 1,8, 1,6, 1,4, 1,2, 1,, 8, 6, 4, 2, Source: DSEC Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Mainland Chinese YoY % chg (5) (1) Source: Datastream, Credit Suisse estimates Figure 84: Monthly GGR trend MOPmn YoY % 4, 6. 35, 3, 25, 2, 15, 1, 5, - Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Mass-market VIP Slot YoY % chg Source: DICJ Figure 86: Gaming table supply (subject to DICJ approval) No. of table 8, 7, 6, 5, 4, 3, 2, 1, - 1,388 2,762 5,32 5,485 5,748 5,826 4,77 4,791 4,375 4,17 6, E214E215E Source: DICJ, Credit Suisse estimates China-Hong Kong Chronicles 38

39 Oil & gas Sector view The Chinese Communist Party announced a series of reform packages across all sectors following the conclusion of the Third Plenum Session in November. Specifically for Oil & Gas there are two key reforms announced: (1) energy pricing reform and (2) open-up of the domestic downstream business. Energy pricing reform is already under way following the refined product price reform in March and natural gas price reform in July, hence we do not expect any substantial reforms to be announced. However, opening up of the downstream business is not well flagged by the street and could spur a negative surprise to the market. Recent developments On 27 November, China Securities Journal reported that Ministry of Commerce is close to finalising the policy documents for opening up crude and oil product imports, and is likely to publish by 1Q14. This is consistent with our comments post the conclusion of the Third Plenum Session, which highlighted the likely opening up of the marketing/retail segment. If there is free import of crude and products, it implies the new market entrants do not need to rely on the SOEs to supply their products. Coupled with the intense competition, we believe some international oil majors and private enterprises will be very keen to get into the Chinese market. Sinopec and PetroChina are clearly superior to them in terms of logistics and infrastructure; however, these new entrants might be more sophisticated in non-oil retail format and cost control. We are likely to see margin squeeze for a period of time once the market opens up. The marketing segment has been a stable earnings contributor for Sinopec and PetroChina, given their dominant market shares. For example, Sinopec's marketing segment is consistently delivering US$5-6/boe operating profit even during the 28/9 downcycle. The two SOEs combined make up 95% of China's domestic retail market share. PetroChina has been aggressively expanding into the retail market, doubling its marketing sales volume from 85 mn t to 153 mn t over the past few years. While Sinopec s market share has been dropping steadily, its returns are a lot more superior to PetroChina's. PetroChina s marketing business might be more vulnerable to the new entrants, thanks to its weaker logistics and infrastructure set-up and higher cost structure compared to Sinopec. In terms of earnings contribution (9% to PetroChina and 42% to Sinopec), Sinopec might be worse hit. Top picks CNOOC (883.HK, OUTPERFORM, TP HK$21): CNOOC is on the cusp of a two-year production spurt starting 214 where the market has not fully factored in, in our view. After three years of flat production we forecast CNOOC will record 15% production growth p.a. in both 214 and 215, bringing 215 volumes to the low end of their 6-1% five-year production target. The next catalyst comes through the end of January where CNOOC hosts its annual strategy presentation. Over the presentation the company will disclose to the market its 214 production guidance and new projects, which should give the street more confidence on their production spurt. Sinopec Kantons (934.HK, OUTPERFORM, TP HK$9): Sinopec Kantons is the logistics and trading arm for Sinopec, and Sinopec holds 6% of the company. We like Kantons for two key reasons: (1) asset injection from Sinopec parent as part of Sinopec s strong commitment to shape it into a world-class logistic and storage company; and (2) strong organic 2% EPS CAGR in E. Our HK$9 target price has factored in a Rmb7 bn asset injection (valued at 8x P/E and financed with 5% equity and 5% debt). We expect the asset injection to come through in 1Q14. Two key reforms: 1) energy pricing reform and 2) openup of domestic downstream business Opening up of crude and oil product imports under way Margin will squeeze as the market opens up China-Hong Kong Chronicles 39

40 Oil & gas Figure 87: Sinopec & PetroChina marketing OP/barrel stable earnings contribution throughout cycles (US$/boe) Figure 88: Sinopec and PetroChina retail marketing domestic market share 7% 6% 5% 4% 3% % Sinopec PetroChina Sinopec PetroChina Source: Company data, Credit Suisse Source: Company data, Credit Suisse Figure 89: China total oil demand growth vs CS Li Figure 9: China diesel demand growth vs. IP growth Keqiang Momentum Index (lagged by 3M) 25% 2.5% 3% 2% 2% 15% 1% 5% % -5% 2.% 1.5% 1.%.5%.% 25% 2% 15% 1% 5% % -5% -1% -15% 18% 16% 14% 12% 1% 8% 6% 4% -1% -.5% China Total oil demand growth (YoY 3MMA) - LHS CS Li Keqiang Momentum Index (%mm 3MMA) - RHS Source: China OGP, CEIC, Credit Suisse Economics Research -2% China Diesel demand growth (YoY 3MMA) - LHS China IP growth (YoY) - RHS Source: China OGP, CEIC, Credit Suisse estimates 2% Figure 91: Chinese Oil & Gas Sector valuation comps Up/(down) Mkt cap P/E (x) EV/EBITDA (x) P/B (x) ROE (%) Net D/E (%) Company Ticker FX Rat. Price TP vs TP (US$ mn) 13E 14E 13E 14E 13E 13E 14E 13E PetroChina 857.HK HK$ U % 217, % 11.7% 4% Sinopec 386.HK HK$ N % 99, % 12.% 43% CNOOC 883.HK HK$ O % 92, % 19.6% Net cash COSL 2883.HK HK$ O % 13, % 18.% 54% Sinopec Kantons 934.HK HK$ O % 2, % 11.8% Net cash Anton Oil 3337.HK HK$ U % 1, % 13.7% 5% Hilong 1623.HK HK$ O % 1, % 2.4% 22% SPT Energy 1251.HK HK$ N % 1, % 15.8% Net cash China-Hong Kong Chronicles 4

41 China property Commercial property to outperform housing in 214E Housing stocks as early-cycle plays dominated investors focus in late 212 and 213. With the economy stabilising and credit gradually getting tightened, we expect commercial properties to outperform housing in terms of earnings growth. Pent-up demand should have already been largely absorbed during the past 18 months bull housing market, which was triggered by the significant credit loosening starting from June 212. With developers more aggressive land banking in 213, and the pick-up of housing construction new-starts in 2H13, we expect housing supply to increase further in 214. This does not bode well for the housing supply / demand dynamics in 214E. On the other hand, we expect central government s current structural reforms to boost the growth of service industries in major cities, creating rising demand for offices and shopping malls there. The China office market is indeed in oversupply, especially when taking into consideration the upcoming supply in the next few years. However, the supply/demand dynamics are very different among different cities and within different submarkets in the same city. For example, Beijing Grade A offices currently have an average vacancy rate of 4%, while it is 37% in Chengdu. Shanghai Pudong area s Grade A offices has a vacancy rate similar to Beijing s average, but Shanghai s Puxi area has a vacancy rate of more than 1%. The supply pipeline also varies significantly between cities and submarkets in the same city. Therefore, we believe many high-quality offices located in the right locations may be severely undervalued by investors, given the consensus bearish view on China s office markets. Office projects IRR and execution risk vs. malls' While the IRRs for shopping malls depend on operational execution as well as location and land cost, the latter two are more important for offices, which in general have lower execution risks. Our proprietary analysis on office markets in major cities their submarkets, the dynamics between Grade A and B offices, and rental vs. resale strategies leads to the revaluation of key commercial property players NAVs. High-speed rails reduce demand for regional offices while benefiting hubs We believe the high speed rail build-up should have a major impact on office demand in different Chinese cities similar to what happened in the UK, Europe and Japan. That is, the hub cities of the high-speed rail network such as Beijing and Wuhan would benefit more from the high speed rail. As a matter of fact, just like what happened in other countries, many companies (especially those in the service industry) may downsize or eliminate small regional offices in the cities within a few hours' reach from hub cities, and consolidate the office space to Beijing and Wuhan, etc. Stocks with commercial properties exposure look more attractive than some homebuilders We expect CR Land to continue to obtain higher commercial property IRR than many of its peers, due to CR Land s established MixC brand name and good project locations at relatively low costs. We believe SOHO China, a pure Tier 1 city office play, should get a boost in valuation from locking in some of the land appreciation gain in Shanghai soon. Franshion s planned spin-off should help realise the valuation of its undervalued office assets. SHKP, with its exposure mainly in Tier 1 cities that have better demand supply dynamics, is trading at an attractive valuation currently. 6 December 213 Commercial property to outperform housing in 214E Housing supply expected to increase further Rising demand for offices and shopping malls as the government boosts the growth of service industries High-speed rails reduce demand for regional offices while benefiting hubs China-Hong Kong Chronicles 41

42 China property Figure 92: China national housing sales YoY growth 1% Housing sales value YoY change Figure 93: Housing sales volume and ASP YoY change trend 8% 6% 4% 2% % Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13-2% -4% Source: NBS, Credit Suisse estimates Figure 94: Grade A offices' vacancy and pipeline the big difference among cities, and among different submarkets within the same city Source: Soufun, Credit Suisse estimates Figure 95: The dynamics between Grade A and B offices how much cheaper are the Grade B office rents vs. Grade A? 6% 57% 54% 5% 48% 4% 41% 37% 3% 31% 2% 1% % Shanghai Pudong Shangahi Puxi Beijing Shenyang Chengdu Wuhan (Hankou) Note: the existing stock for Tier 2 cities (Chengdu, Wuhan and Shenyang) includes both Grade A and B offices, as the Grade A office there (unlike Tier 1 cities) is not significant enough. Source: Jongs Lang LaSalle, Credit Suisse Figure 96: Due to differences in costs and asset turnover, CR Land s IRR (assuming no leverage) stands out among major mall owners in China CR Land Shenzhen MixC 26.7% Source: Jongs Lang LaSalle, Credit Suisse Figure 97: NAV of office properties & commercial properties in China as % of total NAV NAV of office property in China as % of total GAV NAV of commercial property in China as % of total GAV CR Land Hangzhou MixC 21.% 1% CR Land Shenyang MixC 15.9% CR Land Chengdu MixC Hang Lung Shenyang Forum % 12.8% 76% 56% 48% 42% 42% 4% 32% 2% CapitaMallAsia average 11.% 12% 15% 19% 25% 15% 18% 9% 8% 5% Wharf Chengdu IFC 9.4% % 5% 1% 15% 2% 25% 3% China-Hong Kong Chronicles 42

43 Hong Kong property Strong momentum in residential market in Oct/Nov The re-launch of The Cullinan in late September by SHKP was a key breakthrough in the physical market, with the well-calculated incentives that has managed to unlock the interests of the cautious but cash-rich investors in the market. Our analysis shows that HK$11.6 bn of primary residential sales were achieved in October 213, most of which were driven from high-end projects, including The Cullinan (HK$3.4 bn), The Austin (HK$2.1 bn), The Graces (HK$1.5 bn) and Yoo Residence (HK$8 mn). The HK$11.6 bn of primary residential sales in October 213 was one of the highest monthly records in the last 24 months. November has been another strong month in primary residential market, with an estimated HK$14.6 bn of contracted sales achieved, mainly from The Austin (HK$6.3 bn), The Avenue II (HK$2.4 bn), The Long Beach (HK$2.2 bn) and Imperial Kennedy (HK$1.2 bn). Strong momentum to last until early January We expect developers to actively launch projects (in different segments, locations and asset types) from now until early January. We expect the upcoming key launches to include Century Gateway II (by SHKP), The Avenue II (by Sino / Hopewell), The Visionary (by Nan Fung), and Double Cove II (by Henderson Land / NWD). Starting from mid-january, the three events that might put the launches on pause until March 214 are: (1) Policy Address scheduled on 15 January 214; (2) Chinese New Year starting on 31 January 214; and (3) Budget Speech scheduled on 26 February 214. Therefore, the strong momentum in the primary residential market might last for three months, from October 213 to January 214, in our view. Top picks: Henderson Land, Swire Prop, Hysan As we approach 1Q14, we suggest a switch from developers to landlords. Among landlords, we prefer the cyclical landlords that may deliver higher rental growth to offset any potential cap rate expansion. We prefer Swire Prop (41% discount to NAV) as a prime Central office landlord. We also like Hysan (4% discount to NAV), as a retail landlord with a significant ramp-up of its marketing campaigns for its Lee Gardens portfolio, which might lead to an outperformance of the retail sales performance in its retail portfolio than its peers. The full-year impact of the recently filled-up Hysan Place office will also be reflected in FY14E and be one of the key revenue growth drivers for Hysan. Among developers, we prefer Henderson Land (49% discount to NAV) for its continuous launch of urban, low-cost projects. The upcoming launches in the near term include 39 Conduit Road, Double Cove II (mainly comprises two-bedroom units), The Highpark Grand (a redevelopment project launch at Boundary Street), 8 Minden Avenue (a serviced apartment launch not subject to First Hang Sales Ordinance), and Wing Hong Street project (a commercial strata-title launch). More projects are expected to launch till early Jan China-Hong Kong Chronicles 43

44 Hong Kong property Figure 98: Potential launches expected from now till mid-january Est. Attrib Stake Gross Proceeds Developer District Project name units GFA (sq ft) % ASP (HK$/sf) (HK$ mn) SHKP Tuen Mun Century Gateway II , 1% 7,6 5,89 SHKP Western District Imperial Kennedy , 92% 17, 2,23 SHKP HK Island Shouson Peak 24 7,7 1% 39,277 3,33 Nan Fung Tung Chung The Visionary 1,139 1,15,4 1% 6,5 8,973 Henderson Land Mid-levels 39 Conduit Road 38 43,329 6% 45, 2,34 Henderson Land Ma On Shan Double Cove P ,791 59% 1,4 4,72 Henderson Land North Point The Hemispheres ,27 1% 16, 1,79 Cheung Kong North Point Electric Road project ,86 1% 16, 1,379 Sino Land / URA Wan Chai The Avenue P1 1, ,499 5% 19,3 7,284 New World Dev Yuen Long Park Signature ,74 1% 5,2 3,293 New World Dev Western District Eight South Lane 94 41,134 1% 16, 79 Kowloon Dev Mongkok MacPherson ,42 1% 12, 1,23 Kerry Prop Mid-levels The Summa ,1 71% 15,5 2,269 TOTAL 5,766 3,51,983 43,726 Figure 99: Estimated monthly transaction value in Hong Kong primary residential market Figure 1: Swire Properties discount to NAV chart Figure 11: Henderson Land discount to NAV chart Figure 12: Hysan discount to NAV chart China-Hong Kong Chronicles 44

45 Securities Sector view We like the Chinese brokers given its structural high growth potential underpinned by the favourable regulatory environment and underdevelopment of the capital market in China. Currently the total stock market capitalisation to GDP is quite low at just 45% with very little derivatives products available on the market, i.e. margin finance started only three years ago. The investment banking activities have been on hold for more than a year since last October given the regulator's concern about the market irregularities and fraud. Hence we see clear growth potential for the brokers and think the investment banking business and margin finance would be the two key growth drivers for the sector next year. The brokers could also further leverage up to capture the growth of the capital-intensive businesses for better returns. We would also expect the sector to further consolidate given the fragmented market with 114 brokers in China which would benefit the big listed brokers with abundant capital. Recent developments In 213, the brokerage business was very strong with average daily trading volume up more than 5% compared with that in 212. The brokerage commission remained quite stable in China as the competition relaxes and the brokers increase client stickiness by providing value add products and services. All the three listed brokers had strong earnings growth with Galaxy the most leveraged to improving markets. The investment banking business has been weak so far this year as CSRC put a stop on IPO activities since last October which impacted Citic's earnings the most. However, we expect the IPO activities to resume after the CSRC published the new official rules on 3 November 213. Volumes should be strong given the 7+ companies in the pipeline and the more favourable regulations The new business development has been quite rapid with margin finance almost tripled so far this year and rapid development of other derivatives products including stock repo and stock pledged repo. The new business now accounts for 15-3% of brokers earnings compared to close to nothing three years ago. However, stock lending business didn't grow much which in our view still need some time for the market and investors to grow. Top picks We prefer brokers with strong earnings growth potential and attractive valuation. Galaxy Securities is our top pick with strong earnings growth outlook in 214 underpinned by strong brokerage franchise, high new business growth. Its capital position is also strong with low leverage and improving potential. We highlight that the Galaxy Securities is also the best play in terms of industry consolidation given its strong background and government support as well as strong capital position. We like Citic on a fundamental basis but highlight its rich valuation with low ROE, i.e. 5%. We are also a little concerned about its recent acquisition of CLSA which presents execution risks. Clear growth potential mainly driven by investment banking business and margin finance Strong brokerage business IPO activities expected to resume New business development has been quite rapid in margin finance and derivatives products China-Hong Kong Chronicles 45

46 Securities Figure 13: SHCOMP index down slightly this year Shanghai Composite Index, ,2 3, 2,8 Figure 14: ADT was Rmb2 bn in 213, up 5% YoY Daily trading turnover, Rmb bn 35, CS forecast 3, 25, 2,6 2, 2,4 15, 2,2 1, 5, 2, 1,8 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-7 May-7 Sep-7 Jan-8 May-8 Sep-8 Jan-9 Stock t/o May-9 Sep-9 Jan-1 May-1 Sep-1 Jan-11 May-11 Sep-11 Jan-12 May-12 Annual average daily turnover Sep-12 Jan-13 May-13 Sep-13 Figure 15: We expect strong IPO volume next year Equity issuance Rmb bn / growth 1,2 1, IPO Placement Rights issue Growth Figure 17: Citic is trading at a 25x P/E (213) H share and A share P/E 8% 7% 6% 5% 4% 3% 2% 1% % -1 Figure 16: Margin trading to continue to grow strongly Margin trading outstanding balance (Rmb mn), % of mkt cap Rmb mn 35, 1.4% 3, 1.2% 25, 1.% 2,.8% 15,.6% 1,.4% 5,.2%.% Sep-13 Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Mar-12 Dec-11 Sep-11 Jun-11 Mar-11 Dec-1 Sep-1 Jun-1 Mar-1 Margin trading % of market cap Figure 18: Haitong is trading at a 18x P/E (213) H share and A share P/E x 28.x A share 3. H share 26.x 25. sd x 22.x sd +1 PE (x) 2. PE (x) 2.x Average sd -1 A share 18.x 16.x 14.x sd -1 H share Average 12.x 5. Oct-13 Aug-13 Jun-13 Apr-13 Feb-13 Dec-12 Oct-12 Aug-12 Jun-12 Apr-12 Feb-12 Dec-11 Oct-11 Aug-11 Jun-11 Apr-11 Feb-11 Dec-1 Oct-1 Aug-1 Jun-1 Apr-1 Feb-1 Dec-9 Oct-9 Aug-9 Jun-9 Apr-9 Feb-9 Dec-8 Oct-8 Aug-8 Jun-8 Apr-8 Feb-8 Dec-7 1.x May-12 May-12 Jun-12 Jul-12 Jul-12 Aug-12 Sep-12 Sep-12 Oct-12 Nov-12 Nov-12 Dec-12 Jan-13 Jan-13 Feb-13 Mar-13 Apr-13 Apr-13 May-13 Jun-13 Jun-13 Jul-13 Aug-13 Aug-13 Sep-13 Oct-13 Oct-13 Nov-13 China-Hong Kong Chronicles 46

47 China small caps Sector view China small cap companies have had a good year in 213, with MSCI China Small Cap Index outperforming MSCI China Index by 12% YTD, mainly driven by the stabilisation of the Chinese economy and the low base effect, in our view. (Recall that consensus EPS growth in 212 was revised down significantly from +2% to -26% YoY.) As China s economic activities gradually improved, with headline GDP growth accelerating to 7.8% YoY in 3Q13 and the official PMI released by NBS rising to an 18-month high of 51.4 in October, we believe the steady growth in China can be sustained. However, we also noticed that the stabilisation in the economy largely depends on infrastructure investment and the housing market, while private sector investment is still missing. China small caps are now trading at 9.4x forward P/E, at a 1% premium to MSCI China s 9.3x, based on consensus estimates (13-year average +5% premium). The P/B ratio of China small caps is.9x, at a deep 33% discount to MSCI China s 1.3x. Given its least expensive valuation in the region, we are OVERWEIGHT China small-cap sector among the Asia ex Japan small-cap universe. We believe reform and structural adjustment will be the themes for China small caps in 214. Recent developments As the Chinese economy has gradually stabilised over the past year, the current investor sentiment has become more positive towards China. Although there is a lack of strong growth catalysts in sight, the stabilisation has made investors believe that the worst is over in China, and slow but steady improvement may be achievable. We believe the market will continue to seek bottom fishing opportunities and recovery players in the coming year; for instance, in the materials and industrial sector, which have underperformed year-todate. One of the China small caps we are recommending belongs to the industrial sector, which has been trading at a deep discount to both peers and asset values, but may start to deploy its cash more effectively by acquiring new assets at bargain pricings. Reform and structural adjustment will continue to be the main theme in China with more detailed measures coming out following the Third Plenary Session of the 18 th CCPCC. We hope the structural adjustment under steady economic growth can trigger potential increase in private sector investment. Therefore, we still like stocks with exposure to restructuring or M&A opportunities. Top picks Good year in 213 mainly driven by the stabilisation of the Chinese economy and the low base effect Stabilisation in the economy largely depends on infrastructure investment and the housing market Reform and structural adjustment will be the themes for China small caps in 214 Slow but steady improvement may be achievable Steady economic growth can trigger potential increase in private sector investment Sinopec Kantons (934.HK, 18% potential upside). We like Sinopec Kantons for potential asset injection and strong organic growth. We are convinced that Sinopec has a strong commitment to transform Kantons into a world-class logistics and storage company. Our analysis shows that Sinopec has a long list of viable assets, with total investment well over Rmb1 bn, but our target price factored in only a Rmb7 bn asset injection, which we expect to come through later in 213 or early 214. Sinotrans Shipping (368.HK, 14% potential upside). The restart of its fleet expansion plan (since October 213) and progress in liquidating its sister companies are key catalysts to reducing the valuation discount. The company is in discussions with the yards about new orders and reviewing proposals from western ship financiers eager to offload their shipping assets at bargain prices. With US$85 mn cash (46% of total net asset value) on hand, it could potentially double its profit by expanding its fleet size from 2.9 mn dwt today to 5.8 mn dwt. China-Hong Kong Chronicles 47

48 China small caps Figure 19: China small caps have outperformed MSCI China by 12% year-to-date Figure 11: Changes in China small caps' consensus earnings growth estimates (%) 3 26% Jan-13 Apr-13 Jul-13 Oct-13 MSCI China MSCI China Small Cap Index 15 1 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov EPS YoY growth 214 EPS YoY growth 15% Figure 111: China small caps are trading at 9.4x fwd P/E 19x 15 15x 12 12x 9 9x 6 5x Figure 113: China small caps is trading a 1% premium to the prospective P/E of MSCI China (LT average 5% premium) Rel. Premium/ 12M Fwd P/E Premium/Discount (RHS) performance discount 22 MSCI China 5 MSCI China SC Figure 112: and one standard deviation below longterm average of 12.2x P/E (x) Avg. P/E STD+1 STD-1 Figure 114: China small caps is trading at undemanding.9x fwd P/B, versus long-term average 1.1x 1.9x x x x 1 (25) 3.5x (5) China-Hong Kong Chronicles 48

49 Telecoms Sector view After the initial disruption caused by the entry of China Telecom as a new player into the cellular space in 28, the China cellular market has enjoyed fairly stable competitive dynamics since 21. With no additional entrants, a relatively benign three-player market has been established, with all three players delivering revenue and EBITDA growth. There are relatively sensible data pricing plans in place for 2G and 3G services across all three China operators, and this resulted in an industry revenue growth rate of 9.2% in 3Q13 (and a double-digit growth rate in the ten quarters from 1Q11 through 2Q13). Smartphone penetration is also still relatively low (at around 22.1%), suggesting that there is further growth to come. While we acknowledge that the market is sub-optimal given the ongoing presence of both handset subsidies and China Mobile s Wi-Fi offering (with an average yield of only US$.3/MB), valuations of both China Mobile and China Unicom look attractive versus our DCF-based target prices. Our view is that the 4G investment phase, which is now commencing, will be somewhat less disruptive than the shift to 3G, particularly because no additional players are being introduced for 4G. Recent developments The China telecoms operators have reported October 213 subscriber statistics. Total market net additions decreased by 1.5% MoM to mn, while the number of 3G net additions dropped 24.5% MoM to mn. China Mobile s numbers have been most susceptible to the pace of handset upgrades and therefore most volatile; we were therefore not overly surprised to see its 3G net add number decrease by 39.7% MoM to mn. Unicom s 3G net adds declined by only 1.2% to mn for October 213, while China Telecom s 3G net add rate increased by.3% MoM to 3.1 mn. We note a much clearer correlation between 3G net add number trends and the cellular revenue trajectory in the case of Unicom than in the case of China Mobile. China Unicom s 3G net add rate records the number of subscribers actually taking 3G data plans, while China Mobile s 3G numbers records the number TD-SCDMA-enabled handsets on its network, rather than the number of customers actually subscribing to data plans. Top picks Unicom remains our top pick within the China telecoms space. The fact that Unicom has added mn 3G net adds to date, bodes well for rising revenue market share. Sure enough, for 9M13 as a whole Unicom delivered 2.2% YoY growth in cellular service revenue, and Unicom s revenue market share rose from 15.6% in 4Q12 to 18.1% by 3Q13. Importantly, Unicom continued to enjoy operational gearing, with the EBITDA margin on service revenue rising by.9% YoY into 3Q13, consolidated EBITDA rising 16.8% YoY, and headline net profit grew by 51.5% YoY. Our DCF-based target price implies 47.5% potential upside for Unicom. We also rate China Mobile OUTPERFORM. We believe that the poor monetisation of data and commensurate decline in both revenue market share and headline net profit is fully in the price, as is the significant 4G capex burden. However, the market is not factoring in the prospect of improved monetisation of data under 4G. China Telecom remains our least favourite of the three operators and we rate it NEUTRAL; we expect China Telecom a material capex burden for 4G, and China Telecom s fixed line cash flows would be vulnerable to new entrants such as China Mobile. 4G investment phase will be somewhat less disruptive than the shift to 3G as no additional players are being introduced for 4G Clearer correlation between 3G net add number trends and the cellular revenue trajectory in the case of Unicom than in the case of China Mobile China-Hong Kong Chronicles 49

50 Telecoms Figure 115: Share of total net adds Figure 116: Share of 3G net adds Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 - Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 CM CT CU CM CT CU Figure 117: China s cellular market revenue growth FY8A-15E Rmb mn FY8A FY9A FY1A FY11A FY12A FY13E FY14E FY15E China Mobile 55,384 39,76 33,128 42,768 32,414 3,526 36,771 44,238 China Unicom 2,157 5,317 12,356 2,93 22,729 25,662 17,972 16,717 China Telecom 488 1,785 17,719 2,526 24,555 22,875 23,569 17,22 Market 58,29 46,862 63,23 84,224 79,698 79,62 78,312 78,156 Growth % China Mobile China Unicom China Telecom Market Figure 118: China s cellular market revenue and revenue market share FY8A-FY15E Rmb mn FY8A FY9A FY1A FY11A FY12A FY13E FY14E FY15E China Mobile 412, ,13 485, ,999 56,413 59, ,71 671,948 China Unicom 64,74 7,21 82,377 13,37 126,36 151, ,67 186,387 China Telecom 28,218 3,3 47,722 68,248 92,83 115, , ,449 % market share China Mobile China Unicom China Telecom Figure 119: China telecoms sector comparative multiples Close Target Upside P/E(x) EV/EBITDA(x) FCF yield (%) Div yield (%) Price (HK$) Price(HK$) (%) 14E 15E 14E 15E 14E 15E 14E 15E China Mobile China Unicom China Telecom VNET NJA - integrated NJA - telecoms China-Hong Kong Chronicles 5

51 Textiles Sector view The textile production data in China has softened in recent months, with production volume growth for yarns, clothes and garments falling to 6.7%, 3.7% and -4.2% YoY in 3Q13. While the export market is still relatively stable, the growth rate of domestic retail sales of textiles and garments continued to decline. Our recent channel checks confirmed softening of the textile sector. Among leading fabric and dyeing manufacturers, some started to see utilisation fall slightly in recent months to 8%+ versus 9%+ earlier this year. The capex expansion cycle will be delayed. However, raw material costs may remain positive for the sector in the near future as China s cotton inventory level remains relatively high compared with the global average. In addition, the widening discount of international cotton price to China cotton price is beneficial to fabric manufacturers, like Texhong Textile, which have manufacturing bases in Southeast Asia, to help them expand margins. However, we believe such advantage is short term and unlikely to sustain beyond March 214, as it is unreasonable for the Chinese government to continue the direct cotton purchasing plan with fixed prices next year after it finishes the current one from September 213 to March 214. The key driver will be strong end-demand, which is yet to be seen. We will monitor any potential demand drivers closely. Recent developments On the company level, Texhong released a positive profit alert for FY13 on 8 November, stating that the full-year earnings will double YoY. We believe the strong growth is well in expectation, given a low earnings base in 1H12, an 84% capacity increase in 213, and the margin expansion due to the China/international cotton price premium. However, Texhong has achieved a lower-than-expected sales volume YTD, due to its product mix strategy (with a focus on higher-margin products) and possibly slower-than-expected new capacity ramp-up. We now project a 21% YoY 214 capacity increase from the 28% originally targeted. Texwinca and Pacific Textile posted their 1H FY3/13 interim results on 22 November. Texwinca reported disappointing results with revenue down 15% YoY but net earnings up 64% YoY on low base effect. Both textile and retail segments missed expectations. Sales volume of textile dropped unexpectedly by 2% YoY on weak US orders, though partly offset by ASP and margin increase. The retail part disappointed again with negative 12.7% SSSG, store closures and operating losses. Despite a weak recovery potential, Texwinca's price should be cushioned by its strong cash position (4% net cash-to-equity ratio) and attractive dividend yield (6.4%/8.1% CY13/14E yield), in our view. Pacific Textiles interim revenue was up 24% YoY and earnings up 39% YoY, 2% higher than our estimates. The upside surprise mainly came from gross margin expansion (+1.4 pp YoY) and partly due to stable ASP, while the strong volume growth (+24% YoY) is in line with expectation. Top picks Our top pick in the Chinese textile sector is Pacific Textile, given its (1) robust sales volume growth and stable ASP; (2) capacity expansion, with a 1% capacity increase in Panyu to start operation after 214 CNY (earlier than expected), and the Vietnam project to commence production in late CY14 (on track); (3) management's commitment to further improve its operating efficiency, and (4) attractive dividend yield. Our target price of HK$12.4 is based on 14x CY214E P/E, or a target dividend yield of 6.4%. Softened textile production in recent months Raw material costs may remain positive China s cotton inventory level remains relatively high Strong growth is well in expectation for Texhong Texwinca and Pacific Textile and retail segments missed expectations Pacific Textiles interim revenue and earnings higher than our estimates China-Hong Kong Chronicles 51

52 Textiles Figure 12: Production volume growth of the textile sector in China has decelerated in recent quarters % 2Q7 3Q7 4Q7 1Q8 2Q8 3Q8 4Q8 1Q9 2Q9 3Q9 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 Yarn Cloth Garment Figure 122: China textile and garment retail sales growth became weaker 4% Figure 121: Export market is relatively stable, with 11.8% YoY textile export growth in 3Q13 5% 4% 3% 2% 1% % -1% -2% -3% 1Q97 1Q98 1Q99 1Q 1Q1 1Q2 Average 13.9%YoY since Q3 1Q4 Figure 123: China cotton inventory increased significantly since 211 due to government s direct purchase policy 8 1Q5 1Q6 1Q7 1Q8 1Q9 1Q1 1Q11 1Q12 1Q % 2% 1% mn bales (48 lbs) % % Textile & Garment Retail Sales YoY 3mma 2 6-1% -2% Mar-98 Apr-99 May- Jun-1 Jul-2 Aug-3 China Retail Sales YoY 3mma Sep-4 Oct-5 Nov-6 Dec-7 Jan-9 Feb-1 Mar-11 Apr-12 May-13 /1 1/2 2/3 3/4 4/5 5/6 6/7 7/8 8/9 9/1 1/11 11/12 12/13 13/14 Ending stock (calculated) Stock/use ratio (rhs) 2 Figure 124: Supply over demand global cotton inventory remains high 13 1 mn bales (48 lbs) /1 1/2 2/3 3/4 4/5 5/6 6/7 7/8 8/9 9/1 1/11 11/12 12/13 13/14 Production Consumption Stock/use ratio (rhs) Source: USDA (year-end in July), Credit Suisse estimates % Source: USDA (year-end in July), Credit Suisse estimates Figure 125: China cotton is trading at a 5%+ premium over int l cotton China vs. Int'l diff (LHS) 6 Int'l px (Cotlook A Index)* China Cotton Index China price prem (+) / disct (-) % May-7 Aug-7 Nov-7 Feb-8 May-8 Aug-8 Nov-8 Feb-9 May-9 Aug-9 Nov-9 Feb-1 May-1 Aug-1 Nov-1 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Source: Bloomberg, Credit Suisse estimates Prices (' Rmb per ton) China-Hong Kong Chronicles 52

53 Transport Sector view Our sector preferences remain with dry bulk, where we see a multi-year theme continuing to play out. This started with the summer's capesize rally where a degree of inventory restocking coincided with a substitution of higher grade foreign ore for its local equivalent sparked demand for ore-carrying vessels, which we see as enduring for the next two years. The other end of the size spectrum is also performing well with a shrinking handysize fleet and rising minor bulk imports into the PRC seeing rates at multi-year highs. Airlines should do well from any reduction in jet fuel prices as a consequence of Iran's sanction removals and its effect on crude prices, although currency pressures, weak freight volumes and excess LCC supply is generally working against the groups. We like full service carriers with a premium focus (where we feel accelerating corporate travel is providing some impetus) and PRC players on account of the volume side of the business and diminished barriers to international business. Ports, in our view, are the best way to play any recovery in Western Hemisphere consumption and hence container volumes from the East, with liner companies still overwhelmed by capacity increases and the negative impact that these have on freight rates. Only those with substantial and prolonged cost-out focuses are likely to reward investors, when indeed some stability to the volatile pricing environment returns. Recent developments While we are heading into the traditional end 4Q/beginning 1Q decline in dry bulk shipping rates (which typically persists up until the end of the Lunar New Year), any vessel class exposed to the grain trade has continued to outperform. While capes and panamaxes have taken a breather, supramax, handymax and handysize vessels rates continue to hit multi-year highs, with the larger vessels still ahead double digits YoY. The International Energy Agency is now seeing crude and jet kero prices off 6% in 214 which works well for our airline universe, where passenger demand (especially in the front cabins) is expanding. Association of Asia-Pacific Airlines' demand growth is sustaining a >6% rate, with Greater China players running ahead of this. Port throughput is also expanding even off 2H12 volumes that were widely considered to be inflated on account of PRC overinvoicing. We see O&D (gateway) players as generally doing better, given our view of rising Western Hemisphere demand as employment improves and the impact of any P3 alliance remains uncertain. Port throughput increases and their impact on sector earnings remains in stark contrast to liner companies (who might usually be assumed to have a direct drive from rising volumes) where oversupply means that rate increases have failed to gain traction and 1st/15th November increases on both Asia-Europe and Transpacific lanes have continued to give up ground, suggesting another quarter where the (APAC) players likely lose money as a group. Top picks Within the HKG/PRC universe, our strongest calls are cantered on the airline and dry bulk shipping sectors. China Southern is our top pick in terms of upside to current target price, given its leverage to recovering yields and continuous domestic demand growth, with Air China also favoured on account of its exposure to rising China-outbound demand. Cathay Pacific is also on our focus list on account of its product development, costs focus and exposure to rising premium cabin demand. Pacific Basin is also a perennial favourite and not just because of its transparency, financial prudence and managerial oversight but because handy size freight rates are at two year highs and should continue to trend higher given the increasing scarcity of the global handysize fleet. In the ports sector we favour China Merchants on account of its gateway focus, with liner operators only finding themselves in the short category COSCO and CSCL the most overvalued in our opinion. Sector preferences remain with dry bulk Airlines should do well from any reduction in jet fuel prices Vessel class exposed to the grain trade has continued to outperform Crude and jet kero prices reduction works well for airline universe China-Hong Kong Chronicles 53

54 Transport Figure 126: SCFI and BDI YoY% 2% 15% 1% 5% % -5% -1% Oct-1 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 SCFI YoY% BDI YoY% Figure 128: PRC exports YoY% 4.% 35.% 3.% 25.% 2.% 15.% 1.% 5.%.% -5.% -1.% Feb-11 Jul-11 Dec-11 May-12 Oct-12 Mar-13 Aug-13 Figure 13: PRC iron ore imports (YoY% Chg.) 8 8% 7% 7 6% 6 5% 5 4% 3% 4 2% 3 1% % 2-1% 1-2% Jan-4 Jul-5 Jan-7 Jul-8 Jan-1 Jul-11 Jan-13 China Iron ore import vol (mn ton) YoY (%) Figure 127: PRC fare indices 5% 4% 3% 2% 1% % -1% -2% -3% Dec-7 Feb-9 Apr-1 Jun-11 Aug-12 China international China regional China domestic Figure 129: Hong Kong and China traffic growth by airline 7.% 6.% 5.% 4.% 3.% 2.% 1.%.% -1.% -2.% -3.% Jan-8 Sep-8 May-9 Jan-1 Sep-1 May-11 Jan-12 Sep-12 May-13 CX CA CZ MU Figure 131: Drybulk vessel time charter rates (US$/day) 14, 12, 1, 8, 6, 4, 2, - Jan-4 Jan-6 Jan-8 Jan-1 Jan-12 3k dwt 45k dwt 75k dwt 17k dwt China-Hong Kong Chronicles 54

55 Utilities Sector view We see various fundamental industry risks that could lead to a divergence in earnings growth across sub-sectors and our pecking order on a 12-month basis is: waste-to-energy (WTE), wind, gas and IPPs. We see plenty of earnings opportunity with a longer-term positive view on the WTE industry. While wind power capacity growth is expected, we cherry pick those that would be less impacted by the exponential acceleration of maintenance costs. City gas distributors could face demand and margin challenges due to rising gas prices and uncertainties associated with the new trend of coal-to-gas conversion. We prefer distributors exposed to bigger cities such as Beijing and Tianjin as they offer more visibility. After the recent tariff cut to fund environment-related subsidies, IPPs could see another cut with subsidising gas-fired power as an option and companies need to grow capacity to offset earnings decline. Recent developments October power generation was 43.5 bn kwh, 8.4% YoY, in which thermal power generation was 339.7bn kwh, 1.5% YoY, hydro power generation was 69.4 bn kwh, 6.9% YoY M power generation was bn kwh, 7.% YoY, in which thermal power generation was bn kwh, 6.9% YoY, hydro power generation was bn kwh, 3.1% YoY. Power tariff cut in Sep-25 of Rmb.14/kWh on average will provide funding for the increase in China s renewable energy surcharge (applicable to all end-users except residential and agriculture) by Rmb.7/kWh and fund incremental subsidies for denitration (de-nox) and dust removals (de-dust) of Rmb.2/kWh each. Effective 1 July 213, China introduced a new pricing mechanism for city-gate gas (costs paid by city gas distributors). The average increase of ~15% (from Rmb1.69/cm to Rmb1.95/cm on a blended basis) was a result of the Rmb.4/cm increase on base volume and incremental volume priced at 85% of alternative fuel prices. Also, the price increase this time excluded the volume designed to serve household customers and left out Guangdong and Guangxi, which had their prices set in December 211 as a pilot programme. Top picks Our pecking order on a 12-month basis is: waste-to-energy (WTE), wind, gas and IPPs. Our top buys are: China Everbright, China Resources Gas and Longyuan Power. We also like China Resources Power despite our cautious view on IPPs. Our top sells are: ENN Energy, China Gas and Huaneng Power. Distributors exposed to bigger cities preferred Power tariff cut in Sep-25 provides funding for the increase in China s renewable energy surcharge New pricing mechanism for city-gate cause a gas average increase of ~15% China-Hong Kong Chronicles 55

56 Utilities Figure 132: Average EPS growth trend by sub-sector Figure 133: 12-month forward P/E history of China utilities WTE* Wind** Gas IPPs Current P/E (x) x SD Mean x SD Avg EPS grth (past 5 yrs) 25% 5% 16% 73% E CAGR 32% 29% 16% 2% * WTE: measured by China Everbright International; ** Wind: measured by Longyuan Power. Figure 134: Projections of total waste-to-energy (WTE) capacity for the next ten years * WTE: measured by China Everbright International; ** Wind: measured by Longyuan Power. Source: Bloomberg, Credit Suisse estimates Figure 135: Time needed to complete oil-to-gas switch for industrial customers under different energy demand growth assumptions Source: NDRC, World Bank, Credit Suisse estimates, Credit Suisse estimates Figure 136: China utilities Credit Suisse top buys and sells Ticker Company Rating TP Up/downside P/E (x) P/B (x) ROE (%) Yield (%) EPS CAGR(%) Top buys 14E 15E 14E 15E 14E 15E 14E 15E 13-15E 257.HK CEI O % HK CRG O % HK Longyuan O % Top sells 2688.HK ENN U 4. -2% HK CGH U % HK HNP U % Based on the stock price of Nov.25 China-Hong Kong Chronicles 56