Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Aug 10, 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 PING AN SINOPEC CHINA LIFE Source: Bloomberg GF events Date Event Location 22 Aug Yuexiu Property luncheon Hong Kong Source: GF Securities (HK) A-Share Market Macro: July inflation data review; 2H16 policy outlook We believe any talk of deflationary pressure would be irrelevant at present, and we see 1) fiscal policy easing, 2) stable monetary policy, 3) economic restructuring and 4) accelerated reform as the key characteristics of policy making in 2H16. In fact, industrial product price deflation already bottomed in Nov 2015 and is narrowing rapidly. In addition, the government has become highly alert to the prominent issue of asset-based inflation, with its intention to curb asset bubbles likely to put pressure on the formation of monetary policy. Power Equipment: Tri-element battery industry downside limited, upside dependent on policy catalysts Special-purpose new energy vehicles will be the key driver of overall new energy vehicle sales volume growth this year, and we expect relevant policy support to boost new energy logistics vehicle replacement demand, leading to a surge in their output and sales volume in 4Q16. Our worst-case scenario (assuming special-purpose new energy vehicle sales of 80,000 units this year) sees trielement lithium battery demand of 9.5GWh, while a more upbeat assumption of 150,000 units sold would mean battery demand of 12GWh. As such, we believe the downside to the tri-element battery industry is limited while its upside will be dependent on the effect of policy catalysts. Hong Kong Market Aircraft Leasing: A booming market led by strong air transport demand The aircraft leasing industry is expected to expand further over the long term driven by a steady increase in aircraft demand amid continued growth of the international air transport industry. Currently the air transport industry is still going through a boom, and so is the aircraft leasing industry, though it might be approaching a peak based on order backlogs and the ASK-RPK gap. In terms of valuation, we think the market concerns driving the industry valuation of less than 1x P/B in the US stock market are unjustified given leasing companies actual profitability. China Aircraft Leasing (1848 HK, Accumulate): Full-value-chain aircraft solutions provider with strong growth momentum; initiate at Accumulate with TP of HK$9.9 Most of the company s aircraft leases have durations of 12 years, which has locked in cash flows for a long period of time and provides a solid foundation for its stable operating results. The company is likely to report significant revenue and net profit growth in It has been given higher-than-peers P/E and P/B valuations in both the HK and US markets with its strong growth momentum and ROE which is the highest in the industry. We value the company slightly more expensive than the industry average given its growth visibility. Initiate at Accumulate with TP of HK$9.9 based on 10.8x 2016E P/E, representing 2.3x P/B. BOC Aviation (2588 HK, Accumulate): Solid fundamentals but equity return weakened by IPO in the short term, Initiate at Accumulate with TP of HK$41.0 We expect the company to maintain sound lease quality and stable operating results. Its core aircraft leasing business is able to lock in LT cash flows, while high asset quality makes it suitable for risk averse investors amid the current economic weakness. Given the lead time for aircraft delivery and the fact that aircraft prices are no longer at trough levels as they were during the global financial crisis, the company might need to gradually release the pressure on its ROE brought by its IPO over the next three years. Initiate at Accumulate with TP of HK$41.0 based on 10x 2016E P/E and 1.0x P/B. Yuexiu Property (123 HK, Buy): Potential land bank appreciation in Nansha district, Guangzhou According to a media report, the Guangzhou government plans to make the Nansha district a new sub-center to Guangzhou and accelerate the development of its traffic system. We expect this to drive up land and residential property prices in the district. Yuexiu Property has a premium land bank of more than 1m sqm in the Nansha area, and plans to launch Yuexiu International Headquarters Plaza (Nansha District) in mid-aug, which is located near Jinzhou metro station. We reiterate our Buy rating and TP of HK$1.70 on this undervalued asset play. 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 Macro: July inflation data review; 2H16 policy outlook Non-food CPI up significantly on higher property prices YoY CPI growth eased from June to 1.8% in July, while the MoM figure accelerated for the second consecutive month to 0.2%. Food price growth slowed from June to 3.3% YoY, while non-food price growth strengthened for the fourth consecutive month to 1.4% YoY, a new high for the year. Among non-food prices, service prices have continued to rise over the past five months. According to our channel checks, car washes and hair dressers have mostly raised their prices due to higher land and property (rental) prices. Rebounding PPI pointing to earnings improvement The YoY decline in the PPI narrowed considerably from June to -1.7% in July, with positive MoM growth of 0.2%, both beating expectations. Based on past experience, there is a correlation between PPI and industrial profit. The continued rebound in YoY PPI growth over the past seven months is pointing to an improvement in corporate earnings. Contrary to some market views that monetary easing will be needed amid increasing deflationary pressure, we believe the PPI is likely to continue to rebound and that the CPI might rise above 2% in 4Q16 based on the following considerations. Both the CRB and Nanhua Industrial Input Indices have continued to pick up. This should drive a continued rebound in the PPI which will pass on to the CPI subsequently. The drag on overall price growth from declining pork prices might be fading as the pork price down cycle is coming to an end and as the YoY comparable base will become relatively low from Sept onwards. The vegetable price down cycle is also coming to an end with the effects of this year s El Nino phenomenon and summer flooding not to be underestimated. Home prices in first and second-tier cities surged across the board during March and April this year, while another round of home price strength has been seen in these cities since the start of July. The gradual increase in the rental CPI over the past few quarters has failed to fully reflect the impact of rising property prices. Asset-based inflation squeezing space for monetary easing We believe any talk of deflationary pressure would be irrelevant at present, and we see 1) fiscal policy easing, 2) stable monetary policy, 3) economic restructuring and 4) accelerated reform as the key characteristics of policy making in 2H16. In fact, industrial product price deflation already bottomed in Nov 2015 and is narrowing rapidly. In addition, the government has become highly alert to the prominent issue of asset-based inflation, with its intention to curb asset bubbles likely to put pressure on the formation of monetary policy. Power Equipment: Tri-element battery industry downside limited, upside dependent on policy catalysts Logistics vehicles to be key driver of new energy vehicle sales volume growth The sales volume of new energy passenger vehicles surged 124% YoY but slid 3% MoM in July; that of new energy buses fell 34% YoY and 49% MoM; the sales volume of special-purpose new energy vehicles dropped 67% YoY and 84% MoM. We have been optimistic that both the output and sales volume of new energy passenger vehicles will double YoY this year, while new energy buses might come down HoH in 2H16 due to the issuance of adjusted subsidy standards. Special-purpose new energy vehicles will be the key driver of overall new energy vehicle sales volume growth this year, and we expect relevant policy support to boost new energy logistics vehicle replacement demand, leading to a surge in their output and sales volume in 4Q16. Limited downside to tri-element lithium battery industry Our worst-case scenario (assuming special-purpose new energy vehicle sales of 80,000 units this year) sees tri-element lithium battery demand of 9.5GWh, while a more upbeat assumption of 150,000 units sold would mean battery demand of 12GWh. As such, we believe the downside to the tri-element battery industry is limited while its upside will be dependent on the effect of policy catalysts. We particularly like battery cell makers Aucksun ( CH), Guoxuan High-Tech ( CH) and Smarter Energy ( CH), and we suggest watching upstream cobalt producers such as Huayou Cobalt ( CH), China Molybdenum Luoyang ( CH) and China Nonferrous Metal ( CH); we also highlight Easpring Material Technology ( CH) and Cangzhou Mingzhu Plastic ( CH). Page 2

3 Aircraft Leasing: A booming market led by strong air transport demand Despite its cyclical nature, the international air transport industry has continued to grow over the past four decades, showing strong resilience to global economic ups and downs. While long-term growth in the international air transport industry has driven the demand of aircrafts, aircraft leasing companies have provided strong support for aircraft financing by leasing aircrafts they bought with funds obtained from the capital markets. Globally, the proportion of aircrafts financed by operating leasing increased gradually from 0.5% in 1970 to 40% in Aircraft leasing and the aviation industry chain Aircraft leasing companies focus on civil aircrafts. The supply of aircrafts mainly comes from Boeing and Airbus, the two major aircraft manufacturers upstream which take a combined market share of more than 80%. Aircraft leasing companies have two main sources of income: lease income collected on a monthly or quarterly basis according to lease agreements signed with airline companies, and aircraft disposal income from the sale of used aircrafts, the conversion of these aircrafts for air cargo transport or aircraft disassembly. The amount of lease income is determined by the size of the leased fleet and the lease rate factor which is mainly driven by the aircraft supply-demand balance, while the net gain from aircraft disposal is determined by the difference between the market value and base value of an aircraft. Aircraft supply and demand Boeing and Airbus, which have formed a duopoly of the aircraft market, arrange aircraft production cautiously to achieve steady growth in overall supply. Meanwhile, the demand of aircrafts, which comprises natural growth, new market and replacement demand, is more volatile as it is the complex outcome of several variables. Historical data indicate a strong correlation between global GDP growth and aircraft demand. Both Boeing and Airbus have released an optimistic outlook for long-term aircraft demand, projecting a ~3.7% CAGR for global fleet size growth over the next 30 years. Aircraft order backlog and the ASK-RPK gap can provide some insight into the supply-demand balance. In particular, the cyclical nature of the industry is mainly caused by the cyclical changes in demand given relatively stable supply. The value of aircrafts The market price of an aircraft is mainly driven by market factors and aircraft specifications. The former include the supply and demand of a specific model, a particular aircraft s position in its life cycle and the financing environment. The market value of an aircraft cyclically fluctuates around the base value which declines gradually over time; this fluctuation can be measured by the CMV-to-BV ratio. The aircraft leasing industry cycle and valuation The aircraft leasing industry is expected to expand further over the long term driven by a steady increase in aircraft demand amid continued growth of the international air transport industry. Currently the air transport industry is still going through a boom, and so is the aircraft leasing industry, though it might be approaching a peak based on order backlogs and the ASK-RPK gap. In terms of valuation, we think the market concerns driving the industry valuation of less than 1x P/B in the US stock market are unjustified given leasing companies actual profitability. Key risks include weaker-than-expected global air transport demand; the increase in aircraft production exceeding demand growth; sharp growth in new products from aircraft manufacturers other than Boeing and Airbus; deterioration in the aircraft financing environment caused by financial market volatility; aircraft-related black swan events triggered by frequent occurrences of terrorist attacks and political tensions. (Wang Wen, Research Analyst, SFC CE No. BGL298, wangwen@gfgroup.com.hk ) China Aircraft Leasing (1848 HK, Accumulate): Full-value-chain aircraft solutions provider with strong growth momentum; initiate at Accumulate with TP of HK$9.9 Full-value-chain aircraft solutions provider with strong growth momentum CALC positions itself as a full-industry-chain aircraft solutions provider covering operating leasing, sale-andleaseback, structured finance, aircraft replacement, asset management and aircraft disassembly (to be launched). The company ranked fourth among Asian aircraft leasing companies by fleet size (including order backlog) at end Since it was acquired by China Everbright Limited in 2011, the company has maintained high growth in fleet size, total assets and net profit, as well as an industry-leading ROE of around 20%. Page 3

4 A young and continuously growing fleet CALC owned a fleet of 63 aircrafts with an average age of 3.5 years (weighted by net book value) as of end Its fleet size is expected to grow at a CAGR of more than 15% over the next seven years to 172 in Continued fleet expansion is key to the company s core revenue growth, and also helps it maintain a young and competitive fleet. Aircrafts from the Airbus A320 family account for 86% of the company s fleet. The market value of the model, which is one of the most popular narrow-body aircrafts in the world, is supported by strong demand, while its high penetration rate also means a highly liquid secondary market. Longest remaining lease term and active global business development CALC has an average remaining lease term of ten years, the longest among peers. Long lease terms ensure stable cash flows over an extended period of time, which helps minimize operational risk. The company focused on the mainland market prior to 2015, with regional airlines making up its most important client base thanks to the rapid development of local airline companies in China. The company began to actively explore the global market in 2015, delivering seven aircrafts to overseas customers during the year, which accounted for 37% of annual new aircraft deliveries. Full-industry-chain offering through China Aircraft Disassembly Center (CADC) project The company has reduced its stake in the CADC project to 48% by introducing other strategic investors including: 1) China Aero (18%), which is controlled by Friedmann Pacific Asset Management and provides business support such as the purchase and leasing of used aircrafts, and the sales and distribution of components from used aircrafts; 2) Neo Modern (14%), which is controlled by China Everbright and provides financing support; and 3) an independent third-party Sky Cheer (20%), which manages government relations for the acquisition of permits, licenses and preferential treatments from local governments. The CADC project should be brought on line in 2018 as scheduled. It will be the first of its kind to be carried out in China, and should give CALC a unique competitive edge by extending its industry chain coverage. Initiate at Accumulate with TP of HK$9.9 CALC is still going through rapid expansion with its fleet size expected to grow at a CAGR of more than 15% over the next seven years through Most of the aircraft leases the company has entered into have durations of 12 years, which has locked in cash flows for a long period of time and provides a solid foundation for its stable operating results. The company is likely to report significant revenue and net profit growth in 2016 mainly driven by the large amount of net finance lease receivables at end In addition, gains from the sale of finance lease receivables through ABS are also expected to reach a record high this year. The company has been given higher-than-peers P/E and P/B valuations in both the Hong Kong and US markets with its strong growth momentum and ROE which is the highest in the industry. We value the company slightly more expensive than the industry average given its growth visibility. We initiate coverage with an Accumulate rating and target price of HK$9.9 based on 10.8x 2016E P/E, representing 2.3x 2016E P/B. A turnaround in global market sentiment which currently anticipates a discount in the value of aircraft assets could lead to a re-rating in the aircraft leasing industry and hence share price upside for the company. Key risks include the company s fleet expansion falling short of expectations; lease agreement defaults resulting from funding difficulties at certain client airline companies; aircraft-related black swan events triggered by frequent occurrences of terrorist attacks and political tensions. (Wang Wen, Research Analyst, SFC CE No. BGL298, wangwen@gfgroup.com.hk ) BOC Aviation (2588 HK, Accumulate): Solid fundamentals but equity return weakened by IPO in the short term, Initiate at Accumulate with TP of HK$41.0 Largest aircraft leasing company in Asia BOC Aviation ranked fifth globally and first in Asia among aviation leasing firms with a fleet of 511 aircrafts at end-2015 (including order backlog). As a subsidiary of the BOC Group, the company has maintained independence in its business management and operations, with a strong track record of fleet and lease quality management. A young fleet that continues to grow and focuses on popular narrow-body models BOC Aviation s average fleet age of 3.3 years (weighted by net book value) is one of the youngest across the industry. A younger fleet means higher lease income, more attractive selling prices, and lower operating and sales risks. Meanwhile, narrow-body aircrafts represent 87% of company s selfowned fleet, with the Airbus A320 family and Boeing 737 family accounting for 48% and 34% respectively. A fleet of popular aircraft models has higher market penetration and a more liquid secondary market. Page 4

5 Sound lease quality The company has a highly diversified customer base, serving 64 airline companies across 31 countries as of mid-2016 with its self-owned and managed aircrafts. Globalized operations help makes its aircraft deployment more flexible. In addition, the average remaining lease term for the company s self-owned aircrafts stood at 7.4 years at end-2015, which was one of the longest in the industry. Advantageous access to financing BOC Aviation benefits from one of the cheapest debt financing costs among aircraft operating leasing companies in the world, with an average cost of funds of 1.9%, 1.9% and 2.0% in 2013, 2014 and 2015 respectively. This has resulted from the ability of the company s management to gain access to a wide range of financing channels, as well as the strong and committed support from Bank of China. Initiate at Accumuate with TP of HK$41.0 We expect BOC Aviation to maintain sound lease quality and stable operating results. Its core aircraft leasing business is able to lock in long-term cash flows, while its high asset quality makes it suitable for risk averse investors amid the current economic weakness. That said, it might be difficult for the company to bring its leverage ratio back to levels prior to its listing within a short period of time, given the lead time for aircraft delivery and the fact that aircraft prices are no longer at trough levels as they were during the global financial crisis. Instead, the company might need to gradually release the pressure on its ROE brought by its IPO over the next three years. For the purpose of valuation analysis, Air Lease is a good comparable for the company in terms of total assets, net assets, revenue and net profit, though BOC Aviation demonstrates a long-term competitive edge given its lower financing cost and higher leverage ratio (in a normal state of business operations). We initiate coverage of the company with an Accumulate rating and target price of HK$41.0 based on 10x 2016E P/E, slightly above Air Lease, and 1.0x 2016E P/B, which is flat with Air Lease. A turnaround in global market sentiment which currently anticipates a discount in the value of aircraft assets could lead to a re-rating in the aircraft leasing industry and hence share price upside for the company. Key risks include the company s fleet expansion falling short of expectations; a decline in the aircraft lease rate factor due to intensified competition; a rise in the company s financing cost due to the cessation of low-cost financing support from Bank of China; aircraft-related black swan events triggered by frequent occurrences of terrorist attacks and political tensions. (Wang Wen, Research Analyst, SFC CE No. BGL298, wangwen@gfgroup.com.hk ) Yuexiu Property (123 HK, Buy): Potential land bank appreciation in Nansha district, Guangzhou What s new? According to a report on guandian.cn, the Guangzhou government plans to make the Nansha district a new sub-center to Guangzhou and accelerate the development of its traffic system. We expect this to drive up land and residential property prices in the district. Premium land bank in Nansha Yuexiu Property has a premium land bank of more than 1m sqm in the Nansha area. The company plans to launch Yuexiu International Headquarters Plaza (Nansha District) in mid-aug, which is located near Jinzhou metro station. It will have a total GFA of 0.9m sqm, comprising ten high-rise commercial apartment buildings, four office buildings and a large shopping mall. The development will be a landmark project in the Nansha Free Trade Zone, following its completion at the end of The commercial apartment units that will go on sale this year will have an average size of sqm. Yuexiu Property has also built a solid brand name in Nansha through its Southern Le Sand project. Maintain Buy The stock is currently trading at 0.3x 2016E NBV, suggesting the company is an undervalued asset play. We reiterate our Buy rating and target price of HK$1.70, equal to 0.6x 2016E NBV. We will hold a post-interim results NDR for the company on Aug 22. Yuexiu Property s CEO and CFO will be present. (Dennis Yao, Research Analyst, SFC CE No. ALK994, dennisyao@gfgroup.com.hk ) Page 5

6 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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