Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Feb 23, 2016

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1 Equity Research 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 ICBC PETROCHINA TENCENT CCB BANK OF CHINA HSBC CHINA LIFE PING AN SINOPEC Source: Bloomberg GF events Date Event Location 23 Feb Yechiu Metal Recycling co. visit Jiangsu Source: GF Securities (HK) A-Share Market Property: Upgraders in second-tier cities to be key beneficiaries of tax break Primary area sold during last week came down substantially from the week before Chinese New Year, though transactions actually picked up from last year s post-cny week. It is worth noting that the residential property inventory depletion period across first-tier cities (esp. Shanghai) has declined to a low level, meaning significant upward pressure on home prices. We believe upgraders in secondtier cities will be the main beneficiaries of the recently introduced tax discounts for home purchases, with inventories to come down and home prices to be driven higher. Construction: Home purchase tax break and document on urban development both positives We expect the recently introduced preferential deed tax and business tax policies for home purchases to improve conditions in the construction sector, with the decoration, landscaping and structural steel subsectors most likely to benefit. In addition, in its recently released opinions on strengthening the management of urban planning and development, the State Council set out a timetable for the promotion of prefabricated buildings, which should be a positive catalyst for the structural steel subsector. We expect the construction sector to continue to yield excess returns on strengthening policy support. Hong Kong Market IGG (799 HK, Hold): New game sales performance disappoints; downgrade to Hold Our channel checks indicate that sales of the company s new games will come in below our previous forecasts. We expect revenue from the company s core games to have declined in 3Q15, but see a slight improvement in 4Q15. We expect net margin to have narrowed further in 2H15, compared to the first half. IGG shares have rebounded 16% in the last three months. We believe the stock is fairly valued and that upside potential has narrowed. We downgrade our rating from Buy to Hold and leave our target price unchanged at HK$3.75. Maple Leaf (1317 HK, NR): Takeaways from investor meeting Maple Leaf targets to increase its student number from 16,078 at the end of FY15 to 40,000 in five years, through increases in students at existing schools and the addition of new schools. In M&A, the company is looking for opportunities in Canada and HK. The company has signed MOUs with over 50 overseas universities, including about 10 universities of the world s top 100 universities. Management believes the company could maintain a pretty stable net profit margin going forward. Maple Leaf s shares have risen 19% YTD, outperforming the HSI s 11% decline. KWG (1813 HK, Hold): Results in line, but not impressive; maintain Hold 2015 revenue dropped 20% YoY, booked GFA dropped 35% YoY and booked ASP rose 18% YoY net profit rose 3% YoY to Rmb3.4bn due to the decrease in other costs and increase in profit from associates. These results were in line with consensus but not impressive, in our view. Management is confident it can achieve its 2016 contract sales target, but is still cautious on the outlook for the China property market in 2016 and its earnings visibility. The company lacks earnings visibility for 2016, in our view. 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 Property: Upgraders in second-tier cities to be key beneficiaries of tax break Weekly property transactions down on CNY Primary area sold during last week came down substantially from the week before Chinese New Year, with first- and second-tier cities tracked posting drop-offs of 59% and 46% respectively. That said, transactions actually picked up from last year s post-cny week. Upward pressure on first-tier home prices New project launches declined to a relative low level last week due to the sector low season and the CNY holiday. Our index tracking property inventories in 15 large cities remained stable at a high level. It is worth noting that the residential property inventory depletion period across first-tier cities (esp. Shanghai) has declined to a low level, meaning significant upward pressure on home prices. Upgraders in second-tier cities key beneficiaries of tax break Shortly after the minimum down payment requirement for non-hpr cities was lowered prior to CNY, the central government has now introduced preferential deed tax and business tax policies related to home purchases. While such tax discounts have been expected by the market, the timing of their issuance was slightly earlier than expected. These new policies, which should mainly encourage upgrading demand, do not distinguish between ordinary and luxury housing, and are not applicable to first-tier cities. We believe first-tier cities will hardly be affected by the new policies, while the impact on third/fourth-tier cities should also be limited as similar tax reductions offered in these cities in 2015 have not boosted demand considerably and as the secondary property markets in these cities are not particularly active. As such, we believe upgraders in second-tier cities will be the main beneficiaries, with inventories to come down and home prices to be driven higher. That said, the marginal effect of these supportive policies might not be as strong as generally imagined as they are issued at a time of relatively good sector conditions. We remain positive on short-term investment opportunities from mainstream developers on a combination of policy support and fundamental improvements, while also highlighting stocks driven by the property finance, business diversification and SOE reform themes. Our top picks for the week are Zhongnan Construction ( CH), Jiabao Industry & Commerce ( CH), Haide Industry ( CH), Guangdong Mingzhu ( CH) and Metro Land ( CH). Construction: Home purchase tax break and document on urban development both positives Sector conditions to improve on tax break for home buyers We expect the recently introduced preferential deed tax and business tax policies for home purchases to improve conditions in the construction sector, with the decoration, landscaping and structural steel subsectors most likely to benefit. Promotion of prefabricated buildings positive for structural steel In addition, in its recently released opinions on strengthening the management of urban planning and development, the State Council set out a timetable for the promotion of prefabricated buildings, which should be a positive catalyst for the structural steel subsector. Sector outperformance to continue on policy support The rapid deceleration in FAI growth has moderated recently, and we expect investment to remain strong amid downward pressure on the economy. The latest issuance of supportive policies such as those targeting lending supply, fiscal policy easing, infrastructure development and the property market all signal that the government is taking measures on all fronts to maintain stable economic growth. We expect the construction sector to continue to yield excess returns on strengthening policy support. IGG (799 HK, Hold): New game sales performance disappoints; downgrade to Hold What s new? Our channel checks indicate that sales of the company s new games will come in below our previous forecasts. The share price has rebounded 16% in the last three months. Currently trading at 12.7x 2016E P/E or 8.6x 2016E ex-cash P/E, we believe the stock is fairly valued and that upside potential has narrowed. We downgrade our rating from Buy to Hold. Page 2

3 Lower-than-expected sales of new games IGG launched three key new games last year, but their sales performance has come in below our expectation, according to our channel checks. Final Fable, launched in Jun, delivered average performance in 3Q15. Game of Kings performed poorly and was subsequently relaunched. Meanwhile, the launch of Age of Kingdoms was also delayed from Sep to Dec. Core games have matured Gross revenue from core games Castle Clash and Clash of Lords continued to decline in 3Q15, mainly due to their maturity. We expect monthly gross revenue from these two games to decrease from US$10m and US$3m in 2Q15 to around US$9m and US$1.5m in 3Q15, respectively. 4Q15 is the traditional peak season for the overseas game market. With increased effort in content updates and promotion, we expect the company to see a slight improvement in gross revenue from core games in 4Q15. Margin contraction on increased promotional efforts for Link The company increased its marketing efforts to promote its mobile instant messenger app Link in 3Q15. As such, we expect net margin to have narrowed further in 2H15, compared to the first half. Earnings forecasts cut Given the weak performance in both existing core games and new games as well as increased marketing expenses for Link, we expect adjusted net profit to decline by 60% and 20% YoY in 3Q15 and 4Q15 respectively. We revise down our earnings forecasts by 10%, 25% and 31% to US$47m, US$53m and US$59m for 2015/16/17. Downgrade from Buy to Hold The share price has rebounded 16% in the last three months. Currently trading at 12.7x 2016E P/E or 8.6x 2016E ex-cash P/E, we believe the stock is fairly valued and that upside potential has narrowed. We downgrade our rating from Buy to Hold and leave our target price unchanged at HK$3.75, based on 9x ex-cash 2016E P/E and a cash value of HK$1.17 per share as of end Risks Downside risks include a continuation of the declining trend in its existing core games and greater uncertainty in new games over the next few quarters. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) Maple Leaf (1317 HK, NR): Takeaways from investor meeting What s new? At the investor meeting we held yesterday, key areas of interest included the growth outlook, cooperation with overseas universities, tuition fee regulation, margin trend, number of students and profit margin breakdown by school. Growth outlook For organic growth, the company targets to increase its student number from 16,078 at the end of FY15 to 40,000 in five years, representing an increase of 4,000-5,000 students per year, through increases in students at existing schools and the addition of new schools. In M&A, the company is looking for opportunities in Canada and HK. In addition, the company has purchased a 1.9% stake in G8 Education (GEM AU), an Australian developmental and educational childcare service provider, and may seek business co-operation with this company. Cooperation with overseas universities The company has signed MOUs with over 50 overseas universities, including about 10 universities of the world s top 100 universities. We believe the MOUs with top universities could enhance the ratio of the company s high school graduates that are admitted to top universities. This ratio is one of the key performance indicators through which parents rate a school. In FY15, 51% of its high school graduates entered the top 100 universities. Tuition fee regulation A school tuition fee increase requires the approval of local government pricing authorities. In general, each private school can only raise tuition fees once every three years and the tuition fee increase cannot be greater than 25%. Number of students and profit margin breakdown by school Around 40%, 20%, 30%, 9% and 1% of students come from high schools, middle schools, elementary schools, preschools and foreign national schools, respectively. High schools net profit margin is 3-5pp above the group average. While the profit margins of middle and elementary schools are broadly in line with the group average, profit margin from preschools is lower than the group average. Margin trend Management believes the company could maintain a pretty stable net profit margin going forward. In our view, the positive factors are 1) tuition fee increases: the company plans to Page 3

4 increase tuition fees in Tianjin schools in FY17; 2) increases in facility utilization rate; 3) increases in student-to-teacher ratio: teachers salaries are the largest item in cost of sales, representing 62% of cost of sales in FY15. Overall student-to-teacher ratio was 10.2 in FY15. Currently, the studentto-teacher ratio in elementary and middle schools was lower than in high schools. By expanding the number of elementary and middle school students, the company aims to gradually raise the overall student-to-teacher ratio to 15. On the other hand, we believe the negative factors are 1) a rising effective tax rate: the company s PRC subsidiary, Beipeng Software, enjoyed 50% tax rate reduction in FY15. The effective tax rate will go up when the preferential tax treatment ends. 2) More assetlight approach: The company is adopting a more asset-light approach to accelerate expansion, which requires less capex (Rmb20m vs the asset-heavy approach of Rmb m per school). However, the company may pay up to 50% of school profit to its landlord. When the profits from this fledgling asset-light approach in schools matures, the company plans to re-negotiate with landlords for better lease terms such as fixed rental instead of profit-sharing. Valuation Maple Leaf s shares have risen 19% YTD, outperforming the HSI s 11% decline. According to Bloomberg estimates, the stock is trading at 21.5x FY16E P/E, and adjusted net profit should grow at a CAGR of 22% in FY (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) KWG (1813 HK, Hold): Results in line, but not impressive; maintain Hold Key takeaways from yesterday s analyst meeting: 2016 contract sales target to be increased 10% YoY to Rmb22bn. 60% of its projects available for sale are located in first/second-tier cities in China. Management said it is likely to achieve moderate growth in booked GFA and net profit in 2016, but gave no specific targets. Gross margin may remain flat in Management plans to acquire more land banks in 2016 through cooperation with local land owners. Management is bullish on the prospects of its investment property portfolio in first-tier cities. The new supportive policy from the Chinese government to cut residential property transaction taxes may boost property sales. Management will continue to cut its exposure to loans denominated in USD/HKD going forward to avoid currency risks. Results in line, but not impressive 2015 revenue dropped 20% YoY to Rmb8.3bn; booked GFA dropped 35% YoY to 552k sqm, while booked ASP rose 18% YoY to Rmb13,713 per sqm net profit rose 3% YoY to Rmb3.4bn due to the decrease in other costs and increase in profit from associates. These results were in line with consensus but not impressive, in our view. Management is confident it can achieve its 2016 contract sales target, but is still cautious on the outlook for the China property market in 2016 and its earnings visibility. Given rising land costs in first/second-tier cities, we believe the company s gross margin may decline in Maintain Hold The company lacks earnings visibility for 2016, in our view. The stock is trading at 5.0x2015E P/E and a 30% discount to its 2015 NBV, which already factors in most negative issues, in our view. We maintain our Hold rating. (Dennis Yao, Research Analyst, SFC CE No. ALK994, dennisyao@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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