Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Mar 3, 2017

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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 ICBC CHINA MOBILE PETROCHINA CCB HSBC BANK OF CHINA SINOPEC CHINA LIFE PING AN Source: Bloomberg GF events Date Event Location 1-3 Mar A-share nonferrous team Hong Kong roadshow 23 Mar Q Tech post-result NDR Hong Kong 31 Mar Li Ning post-result NDR Hong Kong Source: GF Securities (Hong Kong) A-Share Market Investment Strategy: Consumption upgrade in 3rd/4th-tier cities driven by population relocation, income growth and shopping mall popularization The movement of population away from third/fourth-tier cities into first/second-tier cities as part of urbanization has been viewed by many as a cause for concern. However, this trend is now changing as the rural population continues to rise and the number of migrant workers moving into first/secondtier cities decreases. In addition, consumption upgrade tends to be a much more active process when per capita GDP falls in the range of US$3,000-5,000, which is currently the case in China s third/fourth-tier cities. Lastly, shopping malls are now gaining traction in third/fourth-tier cites, a process which typically coincides with consumption upgrade. New Energy Vehicles: Watch investment opportunities from copper foil given strong demand growth The NEV industry landscape will go through significant changes in the short term as a result of the recent subsidy cut, while cobalt and copper foil still present price upsides. Although we believe ongoing cobalt price growth is supported by industry fundamentals, the large amount of inventory needs to be unloaded before the metal s price has any chance of rising above its historical peak. Copper foil production capacity growth is limited by production equipment acquisition difficulties, long capacity development cycles, tough environmental regulation, large amounts of investment needed and high operating costs. We expect copper foil prices to pick up as NEV sales volume increases. Hong Kong Market HK Retail Sector: Jan retail sales in line Retail sales fell 1% YoY in Jan, in line with consensus. The decline remained volume driven (volume down 1.4% YoY), while ASP was up 0.5%. We think the recovery from -2.9% in Dec was mainly due to the early CNY holiday, as evidenced by stronger sales growth for food and supermarkets. Mainland visitor arrivals rose 8% YoY in Jan following 6% growth in Dec, reversing the decline seen in Nov; we expect growth in mainland visitor arrivals in Feb to be softer than in Jan. We expect the recovery in HK retail sales to continue through 1H17. Lenovo (992 HK, Hold): Second property disposal in six months Lenovo has sold two property development projects in Hefei and Wuhan for a total of Rmb1,617m, the group's second disposal of non-core property-related assets in the last six months. The one-off gain from the disposal will help to lift March-quarter earnings to about US$200m, i.e. similar to the same period last year. Nonetheless, in our view, investors will be indifferent, and will continue to scrutinize developments in its loss-making mobile business. Its dividend yield is becoming attractive following the sharp decline in share price in Maintain Hold. 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 Beneficiaries of consumption upgrade in 3 rd /4 th -tier cities Ticker (CH) Company Sector Sources: Wind, GF Securities (HK) Investment Strategy: Consumption upgrade in 3rd/4th-tier cities driven by population relocation, income growth and shopping mall popularization We are positive on ongoing consumption upgrade in China s third/fourth-tier cities based on the following observations. Population relocation The movement of population away from third/fourth-tier cities into first/second-tier cities as part of urbanization has been viewed by many as a cause for concern. However, this trend is now changing as the rural population continues to rise and the number of migrant workers moving into first/second-tier cities decreases. Income threshold for consumption upgrade Based on historical patterns in overseas countries, consumption upgrade tends to be a much more active process when per capita GDP falls in the range of US$3,000-5,000, which is currently the case in China s third/fourth-tier cities. Shopping mall popularization reshaping consumer habits Following robust residential property development over the past few years, shopping malls are now gaining traction in third/fourth-tier cites, a process which typically coincides with consumption upgrade, despite the issue of overdevelopment in some regions. Key fields to see upgrade Unlike first/second-tier cities, where consumption upgrade is driven by new technology, new products and new business models, this upgrade is likely driven by channel development and the popularization of branded goods in third/fourth-tier cities. The considerable volume growth driven by consumption upgrade in third/fourth-tier cities will be most noticeably reflected in the sales performance of supermarkets, restaurants, home appliances, apparel, entertainment services, tourism, healthcare, food and beverages, and early education. 3rd/4th-tier cites revenue mix Ticker (CH) Company Sector 3rd/4th-tier cites revenue mix Aokang Shoes Apparel 33% Wuhan Department Store Commerce 60% Heilan Home Apparel 98% Better Life Comm Chain Commerce 80% Semir Garment Apparel Lao Feng Xiang Commerce 60% Joyoung Home appliances 35% Chongqing Department Store Commerce 80% Supor Home appliances 35% Qingdao Kingking Applied Chemistry Commerce 60% Robam Appliances Home appliances 40% Jason Furniture Light industry Vatti Home appliances 50% Xilinmen Furniture Light industry Swellfun F&B Changshu Rural Coml Bank Banking 80% Shanxi Xinghuacun Fen Wine Factory F&B SAIC Motor Auto Tuopai Shede Wine F&B Jianghuai Automobile Auto Jiugui Liquor F&B Great Wall Motor Auto Lingrui Pharmaceutical Healthcare 30% Changan Auto Auto Mayinglong Pharmaceutical Healthcare 35% Wanliyang Auto New Energy Vehicles: Watch investment opportunities from copper foil given strong demand growth Cobalt and copper foil to maintain volume and price growth The reduction in new energy vehicle subsidies for 2017 is smaller than previously expected. Meanwhile, a scoring system for car makers (based on fuel efficiency and emission levels of models sold) is scheduled to be introduced in 2018, under which NEV sales might amount to 950k, 1.37m and 1.92m units in , while a score/credit trading market worth more than Rmb10bn is also expected to be formed. This should drive increases in both volume and prices along the NEV supply chain, with midstream NEV battery demand likely to reach 48GWh, 69GWh and 92GWh for each of the three years. The industry landscape will go through significant changes in the short term as a result of the subsidy cut, while cobalt and copper foil still present price upsides. Cobalt inventories remain high Tri-element batteries are likely to post structural volume growth on the back of strong passenger vehicle and logistics vehicle sales, with a potential CAGR of above 60%, which would be much higher than the average growth for the NEV battery industry, thus giving a boost to upstream cobalt demand. Assuming cobalt consumption per unit of batteries produced declines by 10% every year given that nickel is replacing cobalt as a raw material used in tri-element batteries, global cobalt demand will amount to 108k tonnes, 118k tonnes and 131k tonnes and 144k Page 2

3 tonnes in , representing a CAGR of ~9%. Cobalt supply might grow slowly over the next two years as copper and nickel prices are low at present. Compared with 2007, when the global cobalt price reached its historical peak of Rmb800,000/tonne with a total inventory of just 100 tonnes, global cobalt inventory is currently much higher as a result of overproduction during As such, while we believe ongoing cobalt price growth is supported by industry fundamentals, the large amount of inventory needs to be unloaded before the metal s price has any chance of rising above its historical peak. Robust demand driving copper foil prices The copper foil market is now experiencing structural strength as lithium battery demand is growing rapidly driven by robust NEV demand. We estimate that the demand of copper foil to be used in lithium batteries will reach 55k tonnes, 70k tonnes, 91k tonnes and 114k tonnes in , representing a CAGR of 27%. Copper foil production capacity growth is limited by several factors including production equipment acquisition difficulties, long capacity development cycles, tough environmental regulation, large amounts of investment needed and high operating costs. While copper foil does not demonstrate observable inventory cycles (as cobalt does) due to its short lifespan of just three months, we expect copper foil prices to pick up as NEV sales volume increases. HK Retail Sector: Jan retail sales in line Jan retail sales in line Retail sales fell 1% YoY in Jan, in line with consensus. The decline remained volume driven (volume down 1.4% YoY), while ASP was up 0.5%. We think the recovery from -2.9% in Dec was mainly due to the early CNY holiday, as evidenced by stronger sales growth for food and supermarkets. Hence, retail sales growth for Jan-Feb combined will be a like-for-like comparison to Dec. By category, comparing Jan with Dec, department stores saw the biggest improvement in sales growth (from -3% in Dec to +3% in Jan), followed by food (from +5% to +10%), supermarkets (from +1% to +5%) and consumer durables (from -20% to -18%). In contrast, jewelry saw the biggest weakening in sales (from +2% to -4%) due to the rising gold price, followed by cosmetics (from +5% to +3%). Mainland visitor arrivals growth has been positive since Dec Mainland visitor arrivals rose 8% YoY in Jan following 6% growth in Dec, reversing the decline seen in Nov (-4%). Due to the early CNY holiday (from Feb in 2016 to Jan in 2017), we expect growth in mainland visitor arrivals in Feb to be softer than in Jan. The Hong Kong Tourism Board recently estimated that the number of mainland visitor arrivals will drop by 3.7% in 2017, due to the policy change on HK visas for Shenzhen residents (from multiple-entry to one-visit-per-week), expectations of Rmb depreciation, and competition from other regions. Sector share prices outperformed in Feb Shares across the sector climbed 4% in Feb (vs the HSI s 2% increase). Chow Sang Sang (116 HK, Buy) jumped 16% given its undemanding valuation compared to peers. Bonjour (653 HK, NR) and Trinity (891 HK, NR) also climbed 11% and 7%, respectively. Outlook Most HKRMA members expect a mid single-digit drop in sales during Feb We expect the recovery in HK retail sales to continue through 1H17 given the low base, while declining purchasing power among mainland tourists and the strong US dollar remain challenges. We expect an earnings recovery for retailers that have good growth in China/overseas markets and a stabilizing HK business. We maintain our Buy ratings on I.T (999 HK) and Chow Sang Sang (116 HK), and Hold ratings for Chow Tai Fook (1929 HK) and Luk Fook (590 HK). (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Lenovo (992 HK, Hold): Second property disposal in six months What's new? Lenovo sold two property development projects in Hefei and Wuhan for a total of Rmb1,617m, according to a company announcement issued yesterday. Second property disposal in six months The projects include residential properties, commercial complexes, office buildings and parking spaces, and are the group's second disposal of non-core property-related assets in the last six months. On Sept 30, 2016, Lenovo generated a one-off gain of HK$1.6bn (US$205m) from the sale and lease-back of a commercial property in Beijing. The pretax gain from this latest round of asset disposal is about HK$1.7bn (US$217m), and we estimate an after-tax net profit of about US$184m, assuming a tax rate of 15%. Page 3

4 Earnings boost for the March quarter We currently expect Lenovo to hover around break-even for the March quarter (the usual industry low season), estimating a net profit of US$15m for the period. The one-off gain from the asset disposal will help to lift March-quarter earnings to about US$200m, i.e. similar to the same period last year. Nonetheless, in our view, investors will be indifferent to these one-off gains. The market will continue to scrutinize developments in its lossmaking mobile business (pre-tax loss of US$155m in 4Q16), and whether management can hit its target to turn around the business by 4Q17. Becoming a dividend yield play We maintain our Hold rating given the intense competition in the global smartphone market. Its dividend yield is becoming attractive following the sharp decline in share price in As of yesterday's closing price of HK$4.66, the stock is offering a yield of about 5.7%, assuming an unchanged DPS of HK$0.265 for FYE March 31, 2017 (DPS for FYE March 31, 2016: HK$0.265). (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@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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