Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Aug 12, 2014

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1 Equity Research Dim Sum Express Alex Fan, CFA Head of Research SFC CE No. ADJ Albert Yip, CFA Research Analyst SFC CE No. ADT Ryan Zhu Research Analyst SFC CE No. BDK Gao Yedong Editor SFC CE No. BAI GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong A-Share Market Property: Fujian policy relaxation favoring first-time buyers/upgraders Fujian was the first provincial government to relax property policies during this round of sector policy easing. Key measures include HPR relaxation, tax discounts and easier access to household registration for non-locals. It is worth noting that the definition of first-home buyers has been relaxed under the government guidelines, which means first-time upgraders will benefit from more favorable mortgage borrowing terms, though a decline in mortgage rates is unlikely. We expect listed developers based in Fujian to benefit the most from these guidelines in the short term. Environmental: Water pollution control plan key catalyst for 2H14 There have been media reports that a water pollution control plan with total investment of Rmb2trn will be issued soon. This plan is said to encourage the introduction of private capital into the water pollution control space as well as financing based on water pollution permits. This plan will be the most important policy for the environmental sector in 2H14. Although the market has more or less been expecting the issuance of this plan, we believe policy strength for water treatment plant technical upgrades, water recycling and sewage treatment might exceed expectations. Non-Ferrous: Loss in WTO appeal to lead to tougher rare earth regulations Base metals that posted strength recently weakened last week as the political situation in Russia deteriorated; however nickel, aluminum and zinc should remain strong going forward. Crack downs on illegal rare earth mining is a key factor to watch following China s loss in its WTO appeal. The MIIT has started to accept applications for electric vehicles to be included in its catalogue for purchase tax exemption which is likely to be released by the end of this month. Higher raw material prices for neodymium magnets is favorable for companies seeking to raise product prices. Hong Kong Market IGG (8002 HK): Re-rating to continue on mobile game strength IGG s share price surged ~30% yesterday on solid earnings growth in 1H14. Revenue from mobile games increased significantly from US$4.7m in 1H13 to US$74.8m in 1H14, mainly driven by the continued strength of its flagship game Castle Clash. Management is confident that monthly revenue from Castle Clash will improve further in 2H14. The company is also seeing momentum in its new games, with Clash of Lords II, released in Mar, generating 11% of overall revenue; the company has guided that five other mobile games will be launched in 2H14. We expect the re-rating of the stock to continue. China Lilang (1234 HK): 1H14 earnings miss expectation 1H14 net profit came in 5% below consensus on lower-than-expected revenue (3% below consensus) and a higher-than-expected effective tax rate (up from 20.2% to 26.6%). Revenue from its core Lilanz brand dropped 2%, while its L2 brand saw revenue grow 20%. E-commerce development is lagging peers, with revenue contributing just 1%. Consensus sees 9% revenue growth in FY15. The stock is trading at 9.0x FY14E P/E, close to the average forward P/E of 9.6x over the past three years. We believe this valuation is fair given the menswear sector remains tough on aggressive discounts.

2 Property: Fujian policy relaxation favoring first-time buyers/upgraders First provincial-level property easing The guidelines for local property market development recently rolled out in Fujian are the first set of similar guidelines issued by a provincial government during this round of property policy easing. Key highlights of the guidelines are as follows. HPR adjustments According to the guidelines, HPRs in Fuzhou and Xiamen are allowed to be relaxed. We believe that speculative demand has been pushed out of the local property markets as a result of HPRs which have been in place over the past three years, and that a HPR relaxation will mainly benefit prospective buyers of owner-occupied homes such as non-locals who are currently required to provide one-year tax payment or social security contribution records to become qualified home buyers. Tax discounts The deed tax rate for first-homes smaller than 90sqm has been lowered from 1.5% to 1%, with further tax cuts for green homes and houses with refined decoration. Household registration Non-local residents (as well as their parents and minor children) can obtain household registration in the places where they have bought a house. Lower-level governments to offer preferential policies In addition, the provincial government also encourages city and county governments to offer preferential policies for first-home buyers of properties smaller than 144 sqm. As such we expect these lower-level governments to issue favorable polices in the near term. Local property names to benefit most It is worth noting that the definition of first-home buyers has been relaxed under the guidelines. 1) Only homes bought from developers (as opposed to existing homes) will be taken into consideration when assessing whether an individual is a firsthome buyer. 2) First-time upgraders will be treated as first-home buyers. 3) Mortgage applicants that have fully repaid any mortgages previously borrowed will receive the same treatment as firsttime mortgage borrowers. Under these new rules, first-time upgraders will benefit from more favorable mortgage borrowing terms (e.g. down payment ratio lowered from 60% to 30%), though a decline in mortgage rates is unlikely. We expect listed developers based in Fujian to benefit the most from these guidelines in the short term, including Yango Group ( CH), Thaihot Group ( CH), Xiamen C&D ( CH) and Xiamen ITG ( CH). Environmental: Water pollution control plan key catalyst for 2H14 Water pollution control plan to include Rmb2trn investment There have been media reports that a water pollution control plan will be issued soon. According to people familiar with the matter, this plan will likely involve total investment of Rmb2trn, and it is also said to encourage the introduction of private capital into the water pollution control space as well as financing based on water pollution permits. Key catalyst for 2H14 As we have previously pointed out, this water pollution control plan will be the most important policy for the environmental sector in 2H14. Although the market has more or less been expecting the issuance of this plan, we believe policy strength for water treatment plant technical upgrades, water recycling and sewage treatment might exceed expectations. Historically share price strength in the environmental sector has typically been driven by major policy support. We believe detailed rules for key subsectors and regions will be rolled out following the issuance of this plan and that significant improvements will be seen in the orders received by companies and sector expectations. Stricter water treatment plans to be issued in key regions In addition, stricter water treatment plans are likely to be issued in cities with sever water scarcity and water pollution as well as economically developed regions. We expect the bio-film treatment method to be more widely adopted and the sewage treatment market to grow significantly. Positive on market leaders and smaller-caps We like market leaders such as Originwater Technology ( CH), Tianjin Motimo Membrane Technology ( CH) and Water Business Doctor ( CH) given attractive valuations following recent share price corrections. We are also optimistic on smaller-cap companies which are sensitive to positive sector changes such as CEC Environmental Protection ( CH), Safbon Water Service ( CH) and Inter China Water Treatment ( CH). Page 2

3 Non-Ferrous: Loss in WTO appeal to lead to tougher rare earth regulations Metal prices mixed Base metals that posted strength recently weakened last week as the political situation in Russia deteriorated. The LME price of zinc led the decline, down 1.84% (domestic %). Changes in the LME prices of copper (-1.12%), aluminum (+2.48%), lead (+0.9%), nickel (+0.84%) and tin (-0.22%) varied with changes in their domestic prices also mixed at -1.33%, 0.28%, -0.12%, 0.89% and -0.7%. Nickel, aluminum and zinc prices to remain strong The non-ferrous sector is now at the bottom following a long period of declining product prices and share prices which are likely to rebound significantly on improvements in supply-demand dynamics. In particular, the supply shortage of nickel and aluminum is unlikely to be resolved any time soon with Indonesia limiting raw material exports, while zinc is likely to post continued strength with global production capacity set to be reduced. We like Yintai Resources ( CH), Zhongjin Lingnan Nonfemet ( CH), Ji En Nickel ( CH), Xingye Mining ( CH), Chengtun Mining ( CH), Jianxin Mining ( CH), Yunnan Aluminium ( CH), Yuguang Gold & Lead ( CH). Russian situation driving gold prices Gold prices rebounded last week also due to tensions in Russia. The international spot gold price picked up 2.21% with the domestic price up 1.28%, while the international silver price dropped 2.46%. The world s largest gold ETF SPDR lowered its gold position further by 5.98 tonnes to tonnes. We like Chifeng Jilong Gold Mining ( CH), Shandong Gold Mining ( CH) and Zhongjin Gold ( CH). Rare earth regulations to strengthen as China loses WTO appeal The prices of light and heavy rare earth oxides rose 0.36% and 1.28% respectively last week. The WTO has announced that China lost the appeal against the recent rare earth trade dispute and has required China to relax restrictions related to its export quotas and duties. This should force the Chinese government to issue new policies for the sector. In particular, we see crack downs on illegal rare earth mining as a key factor to watch. The MIIT has started to accept applications for electric vehicles to be included in its catalogue of models exempt from the levy of purchase tax which is likely to be released by the end of this month. We are positive on Tianqi Lithium Industries ( CH), Luxiang ( CH), Zhonghe ( CH), Yahua Industrial Group ( CH) and Jiangxi Special Electric Motor ( CH) given continued policy support for electric vehicles. Raw material price increases to help manufacturers raise product prices The resource recycling industry is offering substantial room for growth, and we are particularly positive on China Recycling Development, which is the major shareholder of Qinling Cement ( CH) given its waste collection channels and business expansion potential. The price of H35 neodymium magnets remained stable last week with raw material prices up slightly by 1.27%. The mild increase in raw material prices is favorable for magnet processing companies which are seeking to raise product prices. We like Zhong Ke San Huan Hi-Tech ( CH), Zhenghai Magnetic Material ( CH), Ningbo Yunsheng ( CH) and Galaxy Magnets ( CH). IGG (8002 HK): Re-rating to continue on mobile game strength Strong performance for mobile games IGG s share price surged ~30% yesterday on solid earnings growth in 1H14. Revenue from mobile games increased significantly from US$4.7m in 1H13 to US$74.8m in 1H14, with its proportion of overall revenue rising from 16.5% in 1H13 to 82% in 1H14. Mobile game strength was mainly driven by the continued popularity of its flagship game Castle Clash, which generated revenue of US$60m in 1H14, compared with US$29m in 2H13. Monthly revenue from Castle Clash in overseas markets grew from an average of US$10m during 1Q14 to US$13m in Jun and US$15m in Jul as the company shifted its main resources away from the Tencent platform to overseas markets in 2Q14. Management is confident that monthly revenue from Castle Clash will improve further in 2H14. Growth momentum strong on new games Clash of Lords II, a new mobile game launched in Mar 2014, generated US$5.3m in revenue in 2Q14, 11% of overall revenue. Management indicated that monthly revenue from this game rose considerably from US$2.3m in Jun to US$3m in Jul and is expected to reach US$5m in 2H14. In addition, the company previously guided that it will launch five other mobile games during 2H14, including Clash of Gangs and Brave Trials. The initial performance of Brave Trials appears encouraging with daily revenue reaching US$10,000 on the fifth day after its launch. Page 3

4 Revenue from Tencent platform rising Gross revenue from Castle Clash on the Tencent platform increased steadily to US$3.2m in Jul. Management expects monthly net profit from the Tencent platform to remain stable at around US$1m during 2H14. We expect the re-rating of the stock to continue. (Analysts: Ryan Zhu, China Lilang (1234 HK): 1H14 earnings miss expectation 1H14 net profit 5% below consensus Net profit rose 2% to Rmb248.1m, 5% below consensus. The miss was mainly due to lower-than-expected revenue (3% below consensus) and a higherthan-expected effective tax rate. The company announced an interim dividend of HK$0.12 and special dividend of HK$0.05, the same as in 1H13, meaning a payout ratio of ~65%. Revenue remained flat Revenue from its core Lilanz brand dropped 2% due to the net closure of 158 stores during the period (-5% YTD), in line with order book growth. The company s L2 brand saw revenue growth of 20%, better than the corresponding high-single-digit order book growth. L2 saw a net increase of 18 stores (+7% YTD). Effective tax rate increase The company s effective tax rate rose from 20.2% to 26.6% following the expiry of one subsidiary s tax concession for advanced and new technology enterprises. The application for the extension of this concession for is pending approval. Net cash stable Working capital management improved, driven by the drop in average trade receivables turnover to 76 days, down 14 days compared with 1H13. Net cash remained at Rmb1.7bn (vs Rmb1.6bn at end-fy13). E-commerce development lagging peers E-commerce revenue contributed just 1% of revenue in 1H14. Lilanz is currently only available online at Tmall.com, while L2 products are available on Tmall.com, JD.com and VIP.com. Outlook Management is targeting low-mid single-digit SSSG for 2H14 (vs low single-digit in 1H14). It also expects continued order book growth at the 2015 Spring and Summer sales fair being held in late Aug. Our view Consensus sees 9% revenue growth in FY15, which we believe factors in high-singledigit order book growth for Lilanz in FY15 (vs also high-single-digit growth at the 2014 Winter sales fair). The stock is trading at 9.0x FY14E P/E, close to the average forward P/E of 9.6x over the past three years. Given the menswear sector remains tough on aggressive discounts (some A-share peers revised down 1H14 net profit guidance in July), we think the company s valuation is fair. (Analyst: Albert Yip, albertyip@gfgroup.com.hk) Page 4

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