Weekly A-Share Picks. Jan 4, A-Share Market. (Note: This is selected translation from the Chinese version of our A-share research notes)

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1 Weekly A-Share Picks Jan 4, 2016 (Note: This is selected translation from the Chinese version of our A-share research notes) (1) Great Transformation and New Growth Annual Strategy Report for A-share in 2016 (P.1) A-Share Market (2) Military Industry - Military Reform Will Continue to Drive the Performance of the Sector (P.2) (3) Electronics Industry - Great Development for Virtual Reality VR/AR Industry: Exists Everywhere (P.3) Great Transformation and New Growth Annual Strategy Report for A-share in 2016 Supply side reform promotes great transformation. Under great pressure from economic downturn and diminishing marginal effect in currency and financial policies, macroeconomic controls will see major changes from managing demand to managing supply, from stimulating terminal demand to investing in production factors and from expanding the volume to improving efficiency and quality. Key direction of supply side reform: following industrial transformation cycles to facilitate development of emerging industries, drive innovation system and formulate new regime for industries. Lifestyle brands localization in industrial chain upgrading developing domestic lifestyle brands will create long-term investment opportunities in consumer stocks. High-end brands and many mass market brands are still dominated by foreign brands. It is important for domestic brands to enhance their brand premium to increase GNP, improve the well-being of public and raise profitability of domestic enterprises, which is also crucial for "improving the quality and efficiency of supply system" required by the supply side reform. Wong Chi Man Head of Research (852) cmwong@chinastock.com.hk "Big Health" in great transformation focused on aging and disease spectrum changes. The structure of Chinese population is about to enter into super aging, and the aging together with income rise will drive demand for medical treatment and public health, bringing investment opportunities in pharmaceutical stocks. In future, winners will be those China pharmaceutical companies with strength in R&D innovation and imitation capability in the following areas: cardiovascular and cerebrovascular disease, cancer, diabetes and subdivided domains of AIDS. Intelligent manufacturing and De-IOE in great transformation: De-IOE is crucial for the localization of industrial chain in science and technology sector. Building a new development system for modern industries is undoubtedly the core of the 13th Five-year Plan, whose underlying objective is to improve the quality and efficiency of the supply system. Science and technology as well as equipment manufacturing are mainly driven by state-owned capital. De-IOE is not only the key to the localization of industrial chain in science and technology sector, but also an important approach to achieve the goal of "Made in China 2025". 1

2 Market strategies for A-share in 2016: sell construction-related stocks and buy emerging industryrelated stocks. Building a new development system for modern industry in supply side reform will characterize the 13th Five-year Plan, while focusing on localization of lifestyle brands, "Big Health", intelligent manufacturing and De-IOE. In 2016, the market will head into rebound following the bull market last year, and the focus will be the opportunities in structural and thematic investment, disposal of construction-related stocks and planning for investment in industries and companies with determined development orientation and earnings support. Specific recommendations: (I) Big Health, pharmaceutical companies with stronger R&D and innovative capability are recommended continuously; (II) Smart devices, benefiting from Made in China 2025 ; (III) Leaders in mobile internet, internet + potential winners are preferred in priority; (IV) Information security, a rather booming industry with determined policy support; and (V) Domestic consumer brands and entertainment brands. Military Industry - Military Reform Will Continue to Drive the Performance of the Sector Core Views: Military reform will continuously drive the sector performance The military reform and military industrial reform resulted therefrom will become one of the most important matters in national defense and military sectors in 2016 and the next two years, which is the main driving force for continuous development of Military Industry. From development perspective, priority is given to military information and equipment for navy and air force. From reform perspective, the restructuring of Scientific Research Institutes and reform of arms producers will accelerate the capitalization process, while the mechanism and efficiency of arms producers will be improved by reforming state-owned enterprises. Aerospace field possesses broad space for strategy development and reconstructing Aerospace field is endowed with strategic development opportunities. Space information, defined as the new commanding height for strategic competition in future, will maintain continuous and rapid development. Meanwhile, the space satellite industry will also possess huge international markets, playing an important role in the One Belt, One Road. In aerospace field, high-thrust rocket and new generation of satellite platform will promote the sustained growth of space satellite industry, and BeiDou Navigation Satellite System sees sustained advance on higher volume. There is a great potential for asset reorganization in aerospace field which will witness the acceleration of capital operation after the reform is facilitated and relevant policies are implemented. In Aviation field, strategic products and small enterprises see broad growth space Overall listing of aero-engine and other key fields are basically completed, with large growth space in the medium and long term. Pay attention to the capital operation of defense sector, avionics sector and basic sector. Some small enterprises will possess larger development space in the future. There is great potential for capital operation in vessel field. Civilian-Military Integration will create favorable situation for individual stock 2

3 Investment opportunities from Civilian-Military Integration: 1. Priority is given to military information-related civilian enterprises entering the military industry with high technical contents; 2. From the perspective of enterprise strategy, priority is given to enterprises with good and continuous operation capacity that position Military Industry as the focus of strategy; 3. Small and medium-sized enterprises with better main businesses and some correlations with the Military Industry may bring more investment opportunities. Sector rating and key enterprises It is estimated that the military industry will see good investment opportunities in 2016 driven by the reform and restructuring and development, so maintain "Recommend". It is believed that aerospace, aviation, vessel and civilian enterprises entering military industry possess great investment opportunities, so Baosheng Group ( CH), Aerospace Changfeng ( CH), CSSC ( CH) and Shandong Zhanggu ( CH) are highly recommended. Electronics Industry - Great Development for Virtual Reality VR/AR Industry: Exists Everywhere VR/AR industry will boom and enjoy continuous investment opportunities in the next three to five years. Great technical progress has been achieved in chips, display, micro-projection and sensing technology and killer hardware may be developed. Facebook, Google, Microsoft, Apple, Tencent and other large enterprises will pay more and more attention to VR/AR. Demands for game and entertainment appear, and application scenario is taking shape. VR hardware terminal shall be supported by content and industrial chain; therefore, micro-ecology vendors are of great potential for development. In short term, it is more reasonable to invest in hardware vendors which are capable of involving in microecology, such as Baofeng Science and Technology ( CH), LETV ( CH), Alpha Animation ( CH) and Shunwang Technology ( CH). Vendors manufacturing cheap VR hardware, e.g. Hangzhou Liaison Interactive Information Technology Co. Ltd. ( CH) (holding shares in Avegant), China Communication Technology Co., Ltd. ( CH), Huawen Media ( CH) (holding shares in Shanghai Deepoon Science and Technology Co., Ltd.), will have more potential in VR market penetration and better sales, with event-driven investment opportunities in short term. Chip, AMOLED, micro-projection and other core components enjoy great development potential. Chip is the core component to ensure VR computing power and fluency: Allwinner Technology Co., Ltd. ( CH) is recommended. AMOLED screen eases dizziness by shortening delay: Tianma Microelectronics Co., Ltd. A ( CH) is recommended. 3

4 Micro-projection is the most core component enabling reality augmenting: ZQCOT ( CH) and YCIG ( CH) are recommended. Laser radar is the core basic component of VR/AR position sensor and the camera is used for motion capture, both of which are the basis for depth sensing. Game and animation will become the breakout of VR content production. There will be great booming for VR game. The cooperation between Hangzhou Shunwang Technology ( CH) and HTC will become an important model. Traditional client game companies may follow VR game model. New development teams of VR game will constantly emerge, and capital cooperation, mergers and acquisitions in game will be intensified. Seamless docking of VR/AR and animation industry can be achieved. Animation production and distribution companies like Guangdong Alpha Animation and Culture Co., Ltd. ( CH) and Great Wall Animation ( CH) are recommended. Due to the limitation on technology, investment, shooting mode etc., the development of VR video takes another 3-5 years or even longer. VR technology can be allied to live broadcast, tourism, online education, health care, real estate, aerospace and military fields. With the development of technology, virtual reality video conference and personal communication will be possible in the future. Ecosystem manufacturers and online-offline experience models enjoy more opportunities. Hardware + content + app store distribution+ SNS, Oculus has successfully built macro ecosystem, and Microsoft and Apple may follow the trend. Vendors who cooperate with Oculus, Microsoft and Apple will enjoy growth potential. GoerTek Inc. ( CH) is the original equipment manufacturer (OEM) of Oculus. Theme parks, experience store and other offline experience models enjoy stronger vitality and unforgettable experience and have the ability of repeated monetization. It is predicted that this will become an integral part of VR content distribution. Domestic participants include Lingnan Landscape ( CH). In vertical distribution field, models similar to iqiyi content distribution + complete industry chain service + operation revenue-sharing model are more likely to build an ecological circle. 4

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