Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Jul 22, 2016

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1 Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 15E 16E 15E 16E HSI HSCEI MXCN SHSZ SHCOMP SZCOMP INDU SPX CCMP UKX NKY Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 941 CHINA MOBILE TENCENT ICBC PETROCHINA CCB BANK OF CHINA HSBC SINOPEC PING AN CHINA LIFE Source: Bloomberg GF events Date Event Location Jul Supply-side and SOE reform Taiyuan, thematic co. visits Beijing Source: GF Securities (HK) A-Share Market Internet: Overview of Chinese mobile internet companies business internationalization Distribution channels with high user traffic previously accumulated during the globalization of utility apps should provide opportunities for content operation and internet service companies that are going overseas. We believe Chinese mobile internet companies seeking overseas business development will see opportunities from: 1) emerging markets (e.g. India, Indonesia) where the popularization of smart mobile devices and improvements in network infrastructure will drive consumption demand; and 2) high-arpu markets such as Europe and the US to which Chinese companies can export their leading apps and services. New Energy Vehicles: Fuel cells approaching commercialization Despite the expensive cost of fuel cells which has created a bottleneck for fuel cell vehicle development, several of the components are showing considerable cost downside. In addition, government subsidies are likely to cover the extra cost of fuel cell vehicles, while the economies of scale created by mass production should also further reduce per vehicle cost. The operating cost of fuel cell vehicles has now dropped below that of lithium battery vehicles, leading to enhanced earnings growth potential. We are positive on the fuel cell hybrid system integration and fuel cell key component segments which are likely to achieve commercialization sooner. Sinopharm ( CH): Attractively-valued acquisition of parent company s distribution assets Sinopharm announced that it will acquire four of its parent company Sinopharm Group s (1099 HK, NR) subsidiaries engaged in pharmaceutical distribution in Beijing for about Rmb5.4bn. This will be financed through equity financing at an issue price of Rmb25.1, while the company also plans a private placement to no more than ten parties, also at Rmb25.1/share. The acquisition is valued at 12x the four subsidiaries combined FY15 net profit. We see this as attractive, given Sinopharm s dominant leadership in first-tier cities and the potential synergies in building a more extensive nationwide network. Hong Kong Market Technology: Apple Pay launch implications for FPM manufacturers The Apple Pay service became available in in Hong Kong on July 20. We expect the service to drive mainstream adoption of fingerprint recognition and NFC in smartphones. We reiterate our positive ratings on two HK names with exposure to fingerprint modules (but that do not supply products to Apple). Q Tech targets to ship 20m FPM units in 2016; we estimate the product will account for 20% of its sales (2015: nil). Truly also targets to ship 20m FPM units this year, up 10x from the 2m units sold in IMAX China (1970 HK, Accumulate): Upbeat new IMAX system installation guidance; maintain Accumulate 1H16 revenue increased by 25% YoY, attributed to ongoing IMAX theater network expansion. Net profit came in at US$17.7m, up from a loss of US$67.9m one year ago. Adjusted net profit rose just 1.4% YoY. The company saw a robust 79 new theatre signings in the first half of 2016, up 339% from 18 one year ago, and already exceeding the 74 theatres signed in Management has increased its new IMAX system installation guidance to 115 theatres for 2016, up from 100 theatres. We maintain our Accumulate rating. Daphne (210 HK, Hold): 2Q SSS weakens further; loss recorded in 1H16 SSS dropped from -6% in 1Q16 to -16% in 2Q16 due to sluggish consumer demand as well as frequent rainstorms and flooding. SSS dropped by 12%, and GM dropped significantly as a result of a higher sales mix of aged products. The company had net closures of 274 core brand stores in 2Q16, making a total of 450 net closures in 1H16 (or -17% YoY). We expect the company to continue to close non-performing stores until the SSS decline ends. The company expects to make loss in 1H16. We maintain our Hold rating and TP of HK$1.07. Alex Fan, CFA, Head of Research, SFC CE No. ADJ672 alexfan@gfgroup.com.hk Gao Yedong, Editor, SFC CE No. BAI002 yedonggao@gfgroup.com.hk

2 Internet: Overview of Chinese mobile internet companies business internationalization Distribution channels with high user traffic to pave way for content and service providers going overseas Growth in the domestic smartphone market has slowed since 2014, with mobile internet user growth hitting a ceiling. As a result, business internationalization has become more common among Chinese mobile internet companies. In fact, leading mobile internet products such as UC Browser and WeChat became available to overseas users back in A larger number of Chinese utility and social media apps were brought to overseas markets during , gaining a fair amount of market shares thanks to the limited number of cultural barriers for this type of products. During , we expect content operation companies (e.g. those in relation to news, videos, live-streaming, games, music, etc.) will become increasingly globalized. Looking further ahead, service-based companies such as those in e-commerce, O2O and internet finance will likely seek business internationalization during Distribution channels with high user traffic previously accumulated during the globalization of utility apps should provide opportunities for content operation and internet service companies that are going overseas. India showing great market potential From a geographical perspective, the global internet industry can be divided into the US, China and emerging markets, with the mature US and China markets being the two key engines of global internet technology development. Among the emerging markets (which lag US/China by 2-5 years in terms of industry development), India has a large young population and a rapidly growing mobile internet user base (up 21% during 1H16) vs low mobile internet penetration of just 28%. The major obstacles for mobile internet development in the country include relatively low per capita income, highly diversified languages and cultures, and strong competition from leading European and US companies. In addition, mid/low-end phones make up the majority of smartphones in India, with ARPU relatively low. Opportunities from emerging and high-arpu markets We believe Chinese mobile internet companies seeking overseas business development will see opportunities from: 1) emerging markets (e.g. India, Indonesia) where the popularization of smart mobile devices and improvements in network infrastructure will drive consumption demand; and 2) high-arpu markets such as Europe and the US to which Chinese companies can export their leading apps and services. New Energy Vehicles: Fuel cells approaching commercialization Fuel cell commercialization about to take off in China Global fuel cell sales have grown at a CAGR of more than 35% over the past five years, mainly driven by strength in the US and Japan. The fuel cell system accounts for 60% of the total cost of a fuel cell vehicle, which represents a bottleneck for the development of these vehicles. That said, several of the components are showing considerable cost downside. In addition, government subsidies are likely to cover the extra cost of fuel cell vehicles, while the economies of scale created by mass production should also further reduce per vehicle cost. In particular, methanol fuel cells will likely become the focus of future development given their great potential for cost reduction and compatibility with existing gas stations. Major bus makers stepping up fuel cell vehicle production Each fuel cell vehicle in China currently receives a subsidy of Rmb200, ,000, which is unlikely to be withdrawn before This subsidy is essentially sufficient to cover the cost of the fuel cell, making it likely for domestic auto companies to make a profit from the production of these vehicles. The operating cost of fuel cell vehicles has now dropped below that of lithium battery vehicles, leading to enhanced earnings growth potential. Beiqi Foton Motor ( CH) has secured a large order for hydrogen fuel-cell buses, while FAW Car ( CH), Yutong Bus ( CH) and King Long Motor ( CH) have also released plans for fuel cell vehicle production: upcoming commercialization of fuel cells in China might exceed current expectations. Prefer system integration and key component segments That said, it is worth noting that the fuel cell industry, as well as listed companies related businesses, are at an early stage of development. We are positive on the fuel cell hybrid system integration and fuel cell key component segments which are likely to achieve commercialization sooner. We like Ye Chiu Metal Recycling ( CH), Advanced Technology & Materials ( CH), Snowman ( CH) and Furui Special Equipment ( CH). Page 2

3 Sinopharm ( CH): Attractively-valued acquisition of parent company s distribution assets What s new? Sinopharm announced that it will acquire its parent company s subsidiaries, Sinopharm Beijing, Beijing Huahong, Beijing Kangchen and Beijing Tianxing, which are engaged in pharmaceutical distribution in Beijing. The total consideration will be about Rmb5.4bn and will be financed through equity financing at an issue price of Rmb25.1. Separately, the company announced that it will raise up to Rmb1.1bn through a private placement to no more than ten parties at a price of Rmb25.1/share. Consolidation of parent company s distribution assets The acquisition is valued at 12x the four subsidiaries combined FY15 net profit. We see this as attractive, given Sinopharm s dominant leadership in first-tier cities such as Beijing and the potential synergies in building a more extensive nationwide network. Accelerated SOE reform progress The move demonstrates China National Pharmaceutical Group Corporation s (CNPGC) determination and commitment to support Sinopharm, the largest distributor in China. CNPGC has been identified by the Chinese government as one of six large SOEs for a pilot program that will attract private investment and improve corporate governance, as the government pushes ahead with reforms aimed at raising economic efficiency through a mixedownership economy. We believe CNPGC will implement more reform initiatives to improve operating efficiency at Sinopharm. Proceeds from the private placement will be used to develop fast-growing platforms These will include hospital supply chain extension programs, community hospital pharmacy hosting projects, hospital cold-chain logistic system projects and IT projects. This will boost overall margin and profitability at the company. (Natalie Chiu, Research Analyst, SFC CE No. AVH029, nataliechiu@gfgroup.com.hk ) Technology: Apple Pay launch implications for FPM manufacturers What's new? The Apple Pay service became available in in Hong Kong on July 20. Rising adoption of NFC and fingerprint recognition technologies in smartphones Apple Pay uses NFC (near field communication) and fingerprint authentication via Touch ID. We expect the service to drive mainstream adoption of fingerprint recognition and NFC in smartphones. Q Tech and Truly are two HK-listed stocks that are engaged in the manufacturing of FPM (fingerprint modules) primarily for mainland smartphone makers (the two companies do not supply products to Apple). Over 70% of smartphones will come with fingerprint recognition by 2018, up from about 20% in 2015, according to Fingerprint Cards (FING-B SS, NR), a Finland based biometric system solutions provider. Reiterate positive ratings on two HK-listed companies with exposure to fingerprint modules Q Tech (1478 HK, Buy): Company targets to ship 20m FPM units in We estimate FPMs will account for 20% of its sales in 2016 (2015: nil). Truly (732 HK, Accumulate): Company also targets to ship 20m FPM units this year, up 10x from the 2m units sold in We estimate the product will account for 2-3% sales in 2016 (2015: negligible). Our positive stance on Truly is more to do with the company s AMOLED display strategy, which has put it in a good position to take advantage of the ramp-up in market demand for AMOLED displays going forward. Octopus business will shrink but not die out Apple Pay will inevitably erode Octopus's lion s share of electronic payments in Hong Kong (handles 13m+ transactions worth over HK$200m on a daily basis). Nonetheless, we do not expect users of Hong Kong s MTR to be able to tap and go in the subway anytime soon, as MTR Corp (66 HK, NR), Octopus s major shareholder, will surely not let this happen. (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) Page 3

4 IMAX China (1970 HK, Accumulate): Upbeat new IMAX system installation guidance; maintain Accumulate What s new? IMAX China released its 1H16 results and hosted an analyst briefing yesterday morning. 1H16 bottom line below expectation Revenue increased by 25% YoY to US$55.1m, attributed to ongoing IMAX theater network expansion. Net profit came in at US$17.7m, up from a loss of US$67.9m one year ago. Adjusted net profit rose just 1.4% YoY to US$18.6m. Adj. net margin dropped 8pp to 33.8%, and gross margin also dropped 8pp from 69.6% in 1H15 to 61.6% in 1H16. The key reasons for the margin contraction were the decrease in profitability from its revenue sharing arrangements due to slower box office sales growth compared to IMAX screen number growth, and Rmb depreciation. Trough for IMAX box office sales in 1H16 Total IMAX box office sales in the Greater China region came in at US$180.5m in 1H16, up 3.1% YoY. Excluding the impact from foreign exchange movements, this would have been 10%, still below overall Chinese movie industry sales growth as there was no IMAX version of The Mermaid, 1Q16 s biggest movie, and due to a high base in the same period last year. The company is still confident about 2H16 box office performance given the strong IMAX movie schedule for both Chinese and foreign-language during the period, and the rising contribution from new IMAX theaters opened in 1H16. Strong momentum in theater network expansion, guidance lifted The company saw a robust 79 new theatre signings in the first half of 2016, up 339% from 18 one year ago, and already exceeding the 74 theatres signed in New IMAX system installations increased by 67% YoY to 30 in 1H16, up from 18 one year ago. The total backlog of 264 theatres is an increase of 23% compared to the level at end-fy15. Meanwhile, the company plans to further expand its IMAX theater number with its key customer Wanda during the second half. Management has increased its new IMAX system installation guidance to 115 theatres for 2016, up from 100 theatres. Positive on network expansion We expect box office sales in China to see periodic fluctuations in line with the schedules of top films, and due to the short supply of high-quality Chinese-language films in certain seasons. However, we are still confident in the future growth potential for China s box office sales driven by rising demand and capital investment. For IMAX China, accelerating new theatre signings and new system installations indicate ongoing high demand for IMAX screens and IMAX s strong competitiveness in the Chinese market. The vast IMAX system contract backlog and accelerating new theater signings should support growth over the medium/long term. The stock is now trading at 35x FY16E P/E. We maintain our Accumulate rating. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) Daphne (210 HK, Hold): 2Q SSS weakens further; loss recorded in 1H16 2Q16 SSS weakened again SSS dropped from -6% in 1Q16 to -16% in 2Q16 due to sluggish consumer demand as well as frequent rainstorms and flooding. Street stores accounted for around 60% in FY15 and we expect this ratio to decrease this year. In 1H16, SSS dropped by 12%, and GM dropped significantly as a result of a higher sales mix of aged products, despite 1Q16 GM increasing YoY. The company began to clear its 2015 summer products in May. More store closures in 2Q16 The company had net closures of 274 core brand stores in 2Q16, making a total of 450 net closures in 1H16 (or -17% YoY). We expect the company to continue to close non-performing stores until the SSS decline ends. Loss recorded in 1H16 The company had a net profit of just HK$3m in 1H15. Given the decline of SSS and GM, the company expects to make loss in 1H16. Its overall financial position remains stable. The company is committed to rationalizing its store network and inventory, tightly controlling costs and investing in e-commerce, with the aim of improving FY16 results. We maintain our Hold rating and TP of HK$1.07, still based on 0.4x FY16E P/B. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Page 4

5 Rating Definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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