Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Nov 30, 2016

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1 Equity Research 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 CHINA LIFE PING AN SINOPEC Source: Bloomberg A-Share Market Investment Strategy: Liquidity-driven market strength unsustainable amid shortage of longterm investment themes Many investors find the current market situation similar to what was seen in 2H14 with improving liquidity, the launch of a cross-border stock connect program, and strength in financial and oldeconomy cyclical stocks. However, we think the major difference between now and 2H14 is that back then, the large amount of liquidity was led by several long-term investment themes such as free trade zone development, SOE reform, the One Road One Belt initiative and brokerage firm leveraging, whereas now, there is a general shortage of attractive investment themes. Most of the random investment stories currently kicking around in the market lack convincing long-term rationale. Building Materials: Property sales deterioration during Nov-April to weigh on cyclical firms The building materials sector will be in the low season between now and next year s CNY, with product prices likely to come down. Considering the comparable base, property sales growth is likely to continue to deteriorate between Nov and April next year, weighing on the mid-term investment outlook for cyclical companies along the property industry chain. Of course, a weakening property market does not necessarily mean an immediate downturn in the building materials sector, and many materials companies are still posting robust earnings performance. We have a neutral view on mainstream cement firms in the medium term. Hong Kong Market Maple Leaf (1317 HK, Buy): Strong FY16 results but main focus is still on policies FY17 net profit beat expectations, rising 50% YoY, mainly due to higher-than-expected other income and lower-than-expected administrative expenses and effective tax rate. Management expects the details of the Revised Law for Promoting Private Education to be released in May 2017, something which could lead the company to change the registration status of some of its schools, and cause a drop in earnings for those schools due to a higher tax bill. We revise up our FY17/18/19 adjusted net profit forecasts by 9%/6%/5% to factor in high profit margins, maintain our Buy rating, but lower our target price from HK$8.00 to HK$6.00. Chow Sang Sang (116 HK, Buy): Formation of JV to provide securities-related financial services Chow Sang Sang announced that it will form a JV with Harvest Fund and other partners that will provide securities-related financial services in China. The JV s application for a securities license is subject to CSRC approval, which we expect to take 3-6 months. We believe the company has sufficient internal financial resources to fund the investment and that the investment amount needed is controllable. The JV should also add value to CSS s existing brokerage business. We maintain our Buy rating and target price of HK$ 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 Investment Strategy: Liquidity-driven market strength unsustainable amid shortage of long-term investment themes Instability of liquidity-driven market Liquidity from the property market, bond market and insurance companies appears to have been flowing into the stock market since Oct. While this abundance of liquidity is likely to support strong share price performance, a market driven purely by liquidity tends to be highly unstable. Based on past experience, liquidity-driven market strength might end with no obvious reasons even when liquidity supply remains high, while the quick rotation of investment focus between sectors in the absence of any prevalent investment themes actually makes it quite difficult for investors to profit. Now vs 2H14 Many investors find the current market situation similar to what was seen in 2H14 in that: 1) back then stock market liquidity was improving on monetary easing, while currently market liquidity is also improving as funds are flowing from other asset classes; 2) the launch of the Shanghai-HK stock connect was a key catalyst back then, and now the Shenzhen-HK stock connect; and 3) financial and old-economy cyclical stocks are posting strong performance both then and now. However, we think the major difference between now and 2H14 is that back then, the large amount of liquidity was led by several long-term investment themes such as free trade zone development, SOE reform, the One Road One Belt initiative and brokerage firm leveraging, whereas now, there is a general shortage of attractive investment themes. Most of the random investment stories currently kicking around in the market lack convincing long-term rationale. Among them are cyclical industry recovery and major stake purchases by insurance companies. Cyclical industry recovery story invalid In view of recent strength in cyclical stocks, many investors now believe that the recovery in cyclical industries and A-share corporate earnings will strengthen further in However, we believe that A-share earnings is likely to peak in 4Q16 and weaken on a quarterly basis next year, given that a large proportion of A-share companies come from cyclical sectors which operate along the property industry chain. Based on historical data, each A-share earnings recovery cycle has coincided with a property market up cycle, while an A-share earnings recovery independent of the property market is yet to be seen. At the moment, a property market down cycle has started amid strengthening policy tightening, meaning A-share earnings are very likely to come down next year. Insurer stake purchases unable to drive sustainable strength Major stake increases in listcos by insurance companies have taken place at a higher frequency since Oct. Many investors believe that these stake purchases will not only bring continued fund inflows to the stock market, but also influence other investors preferences, drawing more long-term investor funds to blue-chip stocks. Indeed, listed companies typically offer extremely high excess returns during the ten days before and after the announcement of substantial stake purchases by insurance firms; however, such excess returns usually do not persist beyond this period, underlining the lack of long-term investment themes that can attract continued fund inflows. We think this is because insurance firms and other investors have fundamentally different agendas: insurance firms intend to book their share of earnings from companies that they have a major stake in under the equity method, while other investors mainly aim at acquiring capital gains from share price changes. Overall, most participants in the A-share market prefer growth companies or growth-related investment themes, which are quite rare among companies that have been the targets of insurance companies stake increases. Rising interest rates a key risk factor An accelerated rise in domestic interest rates might risk putting an end to the current short-term market rebound driven by the abundance of liquidity. If interest rate growth outpaces the speed of corporate earnings improvement, the positive effect of improving earnings on share prices will be limited by the downward pressure on valuations. In addition, continued increases in interest rates will mean more options of assets available for insurance companies to invest in, making them less inclined to conducting substantial purchases of listed companies shares. Building Materials: Property sales deterioration during Nov-April to weigh on cyclical firms Sector low season during Dec-CNY Cement prices started to stabilize last week, while glass prices continued to decline in WoW terms. Data from the 54 key cities tracked suggest that YoY property sales growth in these cities is very likely to turn negative in Nov. The building materials sector will be in the low season between now and next year s CNY, with product prices likely to come down. Page 2

3 Neutral on cement sector in medium term Tightening measures introduced around the National Day holiday has most definitely thrown the property market into a down cycle. Considering the comparable base, property sales growth is likely to continue to deteriorate between Nov and April next year, weighing on the mid-term investment outlook for cyclical companies along the property industry chain. Of course, a weakening property market does not necessarily mean an immediate downturn in the building materials sector, and many materials companies are still posting robust earnings performance. We have a neutral view on mainstream cement firms in the medium term. That said, due to regional differences, we are positive on Jidong Cement ( CH) given supported demand growth and favorable changes in supply; the arrival of the sector low season will create a good entry point for the stock. Our watch list Among non-cyclical names in the sector, companies from the consumer building materials space such as Oriental Yuhong Waterproof Technology ( CH), TB New Decoration Material ( CH), Weixing New Building Materials ( CH) and Youpon Integrated Ceiling ( CH), which have posted solid share price performance this year with promising mid-term growth potential, are likely to experience share price fluctuations in the coming few quarters as their earnings remain strong but valuations are hurt by recent property policy tightening. These companies have strong enough fundamentals to eventually get through the industry down cycle, but this will be a process. As for companies not engaged in property-related businesses, we remain positive on Shandong Pharmaceutical Glass ( CH) and Jinyuan Cement ( CH) which are expected to see earnings pick up next year. Maple Leaf (1317 HK, Buy): Strong FY16 results but main focus is still on policies FY17 results beat Net profit rose 50% YoY to Rmb308m, stronger than suggested by the positive profit alert guidance of >40% growth. The upbeat results were mainly due to higher-than-expected other income and lower-than-expected administrative expenses and effective tax rate. Maintain Buy but lower TP During the analyst briefing, Maple Leaf s Chief Legal Officer, Ms Fan Guijie, shared her views on market concerns about the Revised Law for Promoting Private Education (RLPPE) including the impact on the PPP light asset model, private school sector development, VIE structure and schools reserve distribution. Although we believe the RLPPE does not affect the company s VIE structure and PPP light asset model, investors appear to demand stronger visibility of reserve distribution capability from ML s schools. This might make the company consider changing the registration status of its high schools, preschools and foreigners schools from schools that do not require a reasonable return to for-profit schools, which allows schools to distribute reserves to shareholders. However, earnings would drop because for-profit schools are required to pay tax. Management expects the details of the RLPPE to be released in May We revise up our overall FY17/18/19 adjusted net profit forecasts by 9%/6%/5% to factor in high profit margins, partly offset by expectations of a stronger Canadian dollar. We lower our target price from HK$8.00 to HK$6.00, based on 17.5x FY18E P/E, at 0.9x PEG on a 19.4% EPS CAGR during FY17-19 (previously 1.1x). We lower the valuation basis because of the potential earnings impact from switching to for-profit schools. Will the law discourage private schools? Management does not think the RLPPE will restrict the development of private schools. Given that parents are now more willing to send their children abroad to study, demand for private schools with better English-language teaching and strong academic results is also increasing. Management believes the law would encourage the development of private schools with special features, such as the company s bilingual, dualcurriculum and dual-diploma education, to meet market demand. Is the VIE structure restricted by the RLPPE? Profit from ML s schools is currently transferred to the listed company through transactions between schools and the management company. The management company owns the Maple Leaf trademark, as well as the intellectual property rights for the programs and evaluation systems of the BC program, Chinese program and ESL program adopted by the schools. The schools are required to pay the management company for the use of this intellectual property. According to management, as these transactions are genuine and fairly priced, and there have been no laws or court cases in China that have overruled the validity of the VIE structure, management believes its VIE structure remains intact. Going forward, the company will continue to upgrade the quality of the programs so it can charge higher intellectual property fees. Is the PPP light asset model sustainable? Most of the company s school properties under the light asset model are provided and owned by local governments. According to management, the Page 3

4 RLPPE allows local governments to receive profit-sharing fees as a form of rental for the use of state-owned assets. Therefore, the RLPPE does not affect ML s existing PPP light asset model. FY17 trading update As of Aug 31, 2016, deferred revenue was up 22% YoY to Rmb803m. Given the total number of students enrolled is up 15% YoY to 20,581 as at Sept 30, 2016, we estimate average tuition fee growth of 6%. Results highlights Revenue jumped 27% YoY, driven by 20.3% growth in student enrollment and a 4.7% tuition fee increase. GPM expanded 2.7pp to 48.4% due to the increase in tuition fee and utilization rate (from 61.6% to 64.4%). GPM was below our estimate of 50.3% due to a one-off share-based payment of HK$18.5m to give share awards to certain teachers. Operating profit surged 47% as the SG&A expenses ratio fell 1.2pp to 17.8%. Adjusted net profit rose 64% (1H/2HFY16: +70%/+60%). (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Chow Sang Sang (116 HK, Buy): Formation of JV to provide securitiesrelated financial services What s new? Chow Sang Sang announced that it will form a JV, Harvest Securities ( 嘉实证券有限责任公司 ), with Harvest Fund and other partners, under Chapter 10 of the Mainland and Hong Kong CEPA framework, to provide securities-related financial services in China. Harvest Fund will hold a majority equity stake in the JV, while CSS will hold a 27% stake. Subject to regulatory approval The JV s application for a securities license is subject to CSRC approval, which we believe will take 3-6 months. CSS is the only JV investor from Hong Kong. The company s Hong Kong securities brokerage business has been consistently profitable and has not been found to be in violation of any regulations. We believe its sound record may help it to get approval. Funded with internal resources Given this was a voluntary announcement, we estimate CSS s capital contribution should be within 5% of its net asset value of HK$8.9bn, as of June 30, 2016, (or <HK$447m). As at June 30, 2016, CSS had a cash balance of HK$1.2bn and a net gearing ratio of 5%. The company also holds 4,061,800 shares in HKEX (388 HK, NR), worth HK$832m. We believe the company has sufficient internal financial resources to fund the investment and that the investment amount is controllable. JV should add value to existing brokerage business According to management, no new securities firm has been granted a license by the CSRC for ten years. Applications for securities firm licenses through the CEPA framework could be a door for new entrants to the industry. For example, the approval of the establishment of 申港证券股份有限公司 earlier this year, was the first case since the adoption of Chapter 10 of the Mainland and HK CEPA framework in Aug There are around 20 JV applications currently pending at the CSRC and we do not expect all these applications to be approved. We therefore believe a securities firm license in China could enhance the value of CSS s securities brokerage business. Other synergies are potential client referrals and securities trading volume from Harvest Fund. Nov trading update SSS has been slightly softer in Nov so far, compared to Oct, mainly due to weaker gold product sales. Gem-set SSS momentum has continued in both its HK and China markets. We maintain our Buy rating and target price of HK$19.30, still based on 15x FY17E P/E. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@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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