Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Sep 8, 2016

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1 Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 16E 17E 16E 17E HSI HSCEI MXCN SHSZ SHCOMP SZCOMP INDU SPX CCMP UKX NKY Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 700 TENCENT CHINA MOBILE ICBC PETROCHINA CCB HSBC BANK OF CHINA PING AN SINOPEC CHINA LIFE Source: Bloomberg GF events Date Event Location Sep Purapharm co. visit - Source: GF Securities (HK) A-Share Market Retail: 1H16 sector earnings review; earnings recovery a long way away The sector experienced a re-rating during Aug driven by a general lack of profitable investment targets and insurance companies major stake increases in listed retail companies. However, the rally ended prematurely due to rumors of tougher regulation being imposed on insurers investments. The sector revenue and net profit declines enlarged in 1H16. Although some companies achieved positive earnings growth through M&A, cost control and accounting treatments of land parcels/properties, any sector valuation upside is limited by weak revenue growth. Auto: 1H16 sector earnings review; both passenger and commercial vehicle segments recovering Sector revenue picked up 11.3% YoY in 1H16; net profit growth came in at 15.0% YoY, with auto making and auto part companies rising 16.3% and 11.7% respectively. Auto making companies saw investment gains come down substantially as a proportion of total net profit during 1H16 as the sales growth of JV brands slowed. The sector net profit margin increased 0.2pp from a year ago to 6.5% in 1H16, but edged down 0.1pp to 5.7% when non-operating gains and losses are excluded. The net margin of the commercial bus and passenger vehicle segments both increased YoY. Hong Kong Market Pharmaceutical: Drug manufacturer sales slowed to 8.3% YoY in July NBS data show that sales at drug manufacturers slowed in July to 8.3% YoY, from 10.2% YoY in 2Q16. We attribute the slowdown to the high base in July last year. We expect full-year sales growth to be in line with the two-year trend of 9-10%. Large-caps appeared to widen the growth gap with their smaller counterparts. We expect price cuts in tenders to continue to put pressure on growth, but believe upcoming national reimbursement list revisions may drive volume. China Resources Pharma s upcoming IPO could also be a near-term catalyst for share prices in the sector. New Energy Vehicles: Shenzhen adjusts new energy vehicle purchase subsidies Shenzhen has lowered the subsidy available for private pure-electric vehicles with a mileage range of less than 250 km, but maintained the same subsidy for vehicles with a larger range. The subsidy will also drop for hybrid vehicles. The biggest subsidy cut is for vehicles with a range of less than 150 km. We believe the revision is aimed at preventing fraud and encouraging NEV tech development. We do not expect the adjustment to have a big impact on large auto companies. The policy could deter buyers away from low-range vehicles, potentially boosting mileage range technology across the industry. 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 Retail: 1H16 sector earnings review; earnings recovery a long way away Department stores on the decline but consolidation yet to take place The 24 A-share listed key department store companies saw revenue decline 4.5% YoY in 1H16, extending the trend of negative revenue growth since 2015 (-0.4% YoY). Gross margin widened further on a shift of business focus towards self-operated business, direct procurement of branded products from manufacturers and strengthened promotion control. However, expense ratios increased at an even faster pace, leading to an 11.1% YoY decline in average net profit and a 0.6pp contraction in net margin to 3.3%. Despite industry-wide weakness, a fundamental industry consolidation is yet to be seen as department store operations are highly regional-based and some companies with poor business performance have managed to earn a lease spread by sub-leasing their floor space. Supermarket leaders likely to stand out in industry consolidation The seven key listed supermarket companies reported revenue growth of 1.9% YoY in 1H16, strengthening by 0.4pp from However, the performance of individual companies diverged significantly. Compared with department stores, supermarket operators are less restricted by an asset intensive business model, and are mostly hovering around breakeven with increasing divergence between peers. Leading players have already started the process of industry consolidation relying on their supply chain and operational advantages. Monthly sector outlook The sector experienced a re-rating during Aug driven by a general lack of profitable investment targets and insurance companies major stake increases in listed retail companies. However, the rally ended prematurely due to rumors of tougher regulation being imposed on insurers investments. The sector revenue and net profit declines enlarged in 1H16. Although some companies achieved positive earnings growth through M&A, cost control and accounting treatments of land parcels/properties, any sector valuation upside is limited by weak revenue growth. The market will refocus on sector earnings performance following 1H16 result announcements, and we like subsector leaders such as NanJi E Commerce ( CH), Yonghui Superstores ( CH) and Jiangsu Guotai International Group Guomao ( CH). We also highlight the asset revaluation potential at some of the traditional retail companies such as Light &Textile Industrial ( CH). Separately, we remain positive on companies driven by business transformation such as Hemei Group ( CH) and Hualian Department Store ( CH), as well as Materials Development ( CH) which is driven by SOE reform. Our stock picks for Sept are Hemei Group ( CH), Materials Development ( CH), NanJi E Commerce ( CH), Light &Textile Industrial ( CH) and Hualian Department Store ( CH). Auto: 1H16 sector earnings review; both passenger and commercial vehicle segments recovering Sector net profit up 15.0% Sector revenue picked up 11.3% YoY in 1H16; net profit growth came in at 15.0% YoY, with auto making and auto part companies rising 16.3% and 11.7% respectively. Auto making companies saw investment gains come down substantially as a proportion of total net profit during 1H16 as the sales growth of JV brands slowed. Bus and PV net margin widened The sector net profit margin increased 0.2pp from a year ago to 6.5% in 1H16, but edged down 0.1pp to 5.7% when non-operating gains and losses are excluded. The net margin of the commercial bus segment widened by 1.1pp thanks to stabilizing bus sales volume and strong sales growth of new energy vehicles. The recovery in the passenger vehicle market led to a 0.3pp increase in segment net margin. Meanwhile, the net margin of the core component segment narrowed 4.9pp to 18.8%. Adjusted sector net operating cash flow (the sum of net operating cash flow and additional bills receivable) dropped 134% YoY to an outflow of Rmb9.31bn, mainly due to a significant drop in bills receivable growth. Our stock picks In our view, the end of a down cycle coupled with relatively cheap valuations typically point to a buying point for a cyclical sector. Some of the blue-chip auto stocks are trading at relatively low valuation levels, while declining interest rates, improving sector conditions and rising dividend yields are set to drive re-ratings in these stocks. Our sector stocks are as follows. In the heavy duty truck industry: CNHTC Jinan Truck ( CH), Weifu High- Technology ( CH) and Beiqi Foton Motor ( CH); Among other blue-chip stocks: Huayu Automotive Systems ( CH), SAIC Motor ( CH), Great Wall Motor ( CH), Jiangling Motors ( CH) and Chongqing Changan Automobile ( CH); Page 2

3 Among new energy vehicle names: Fulin Precision Machining ( CH), Beijing WKW Automotive Parts ( CH), Jianghuai Automobile ( CH) and Corun New Energy ( CH); Among smart car players: Wanliyang ( CH), Tuopu Group ( CH), Shuanglin Auto Parts ( CH), Huayu Automotive Systems ( CH), Ningbo Gaofa Automotive Control System ( CH) and China Automotive Engineering Research Institute ( CH); Other auto part companies: Kunming Yunnei Power ( CH) and FAWER Automotive Parts ( CH). Pharmaceutical: Drug manufacturer sales slowed to 8.3% YoY in July What s new? NBS data show that sales at drug manufacturers slowed in July to 8.3% YoY, from 10.2% YoY in 2Q16, and are up 10.0% YTD. We attribute the slowdown to the high base in July last year following drug price deregulation in May, and comes despite fewer policy uncertainties. We expect full-year sales growth to be in line with the two-year trend of 9-10%. TCM decoction and medical devices driving growth The TCM decoction pieces and medical devices segments led industry sales growth in 1H16, with growth of 13.03% and 12.6% YoY respectively. Growth is more prominent in these two subsectors given the favorable policy environment (e.g. technical requirements for concentrated TCM granules) and higher capital spending on hospital construction, which should help to support above-average growth. Finished TCM products (+8.16% YoY) and biopharmaceuticals (+9.32%) trailed other segments as more stringent regulation has limited short-term sales growth. Large companies more resilient Large-cap companies appeared to widen the growth gap with their smaller counterparts in 1H16. CSPC Pharma (1093 HK, Buy), Fosun Pharma (2196 HK, NR) and Sino Biopharm (1177 HK, NR) posted average revenue growth of 12.6% and net profit growth of 21.7% YoY, meaning profit growth has clearly outpaced revenue. It should be noted, however, that a number of smaller companies had specific issues that affected growth, such as supply disruptions and sales model adjustments. Less uncertainty improves 2H16 visibility We expect price cuts in tenders to continue to put pressure on growth, but believe upcoming national reimbursement list revisions may drive volume. In addition, the upcoming IPO by China Resources Pharma could be a near-term catalyst for share prices in the sector. (Natalie Chiu, Research Analyst, SFC CE No. AVH029, nataliechiu@gfgroup.com.hk ) New Energy Vehicles: Shenzhen adjusts new energy vehicle purchase subsidies Shenzhen updates NEV financial support policy Shenzhen s Development and Reform Commission has updated its financial support policy for new energy vehicles (NEVs), which will take effect from Sept 17. The policy gives subsidy guidance for purchases, recharging, recharge station construction and auto battery recycling. Reduced subsidy for private NEVs with a range less than 250 km The new policy lowers the subsidy available for private pure-electric vehicles with a mileage range of less than 250 km, but maintains the same subsidy for vehicles with a larger range. The subsidy will also drop for hybrid vehicles. Please see details in the following table. Policy further differentiates subsidies by mileage range The biggest subsidy cut is for vehicles with a range of less than 150 km. We believe the revision is aimed at preventing fraud and encouraging NEV tech development. Most large auto companies that produce NEVs can manufacture vehicles with a range of more than 250 km (a standard for everyday practicality), while some can produce vehicles with a range of km. We therefore do not expect the update to have much of an impact on them. However, the policy will deter buyers away from low-range vehicles, potentially boosting mileage range technology across the industry. Companies that rely on low-range vehicle sales volume to earn a large amount of subsidies should also be negatively affected. Page 3

4 Subsidies for new energy vehicle purchases before and after Sept 17 Vehicle Designed mileage Subsidy from Sep 17 (R, km) (Rmb `000) Previous Change Change % EV-PV 100 R< % 150 R< % R % Hybrids- PV R % Sources: GF Securities (HK) (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Chongjing Deng, Research Analyst, SFC CE No. BEY953, dengchongjing@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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