2018 Financial Leasing Sector Outlook

Transcription

1 Equity Research Financials 2018 Financial Leasing Sector Outlook NIS to remain a concern in 2018 Wang Wen SFC CE No. BGL298 wangwen@gfgroup.com.hk GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Sector view Neutral The number of leasing companies continued to grow in 2017, but new lease value dropped for two consecutive quarters, mainly due to a surge in financing costs and strengthened supervision of local government financing and the financial system. Borrowing costs increased significantly in 2017 and are expected to rise steadily in 2018, which will put pressure on leasing companies financing capabilities. The economic recovery improved asset quality for leasing companies and led to a rebound in leasing asset yields in 1H17, resulting in improved NIS in Key themes Market interest rates to continue to rise Given a rise in interest rates globally, neutral monetary policy and continuous financial deleveraging, we expect market interest rates to continue to rise. Leasing companies generally gain a larger NIS amid rising interest rates and mild inflation. However, with the implementation of supply-side policies, the negative consequences on economic growth may prevent a significant increase in leasing asset yields. We expect leasing companies to achieve relatively stable NIS in 1H18. Possible tightening of industry regulation There have been market rumors that the CBRC may replace the MOC in the supervision of leasing companies. Given highly homogeneous business models, we see a trend towards the integration of regulation, against the backdrop of tightening regulation. Possible impacts include leasing businesses becoming subject to more strict regulation to prevent them involving local government financing platforms & channel business. In addition, industry concentration could increase substantially as regulation tightens, and some leading leasing companies may become more competitive. Valuation analysis HK-listed leasing companies are trading below historical average valuations, reflecting market concerns about a deterioration in NIS. The industry is trading at 9.5x 2016E P/E, compared with a 2-year average of 11.5x; industry P/B is at 1.3x, compared with a 2-year average of 1.4x. Investment strategy Under the pressure of narrowing NIS as market interest rates continue to increase while the China economy slows moderately, we remain positive on leasing companies with diversified business operations such as Universal Medical and Far East Horizon. In addition, aircraft leasing is still an attractive sub-sector given its long lease durations, the large proportion of prepaid interest, predictable cash flows, relatively stable lease rates, and given the security deposit aircraft leasing companies hold even if airlines default. We recommend BOC Aviation for long-term investors given its promising fleet expansion, steady earnings growth outlook, and relatively cheap valuation. Top picks Universal Medical (2666 HK, Buy) With China General Technology as its major shareholder and CITIC Capital as its strategic partner, Universal Medical has extensive global resources and medical service experience. We believe the company will maintain steady growth in its leasing business and good asset quality, and we see strong potential in its hospital operation business through PPP projects and active participation in SOE-affiliated hospital reform. We maintain our Buy rating and target price of HK$8.60, based on 10x 2018E P/E and 1.7x 2018E P/B. Risks Upside risks: Stronger-than-expected policy support; sharp fall in financing costs. Downside risks: Surge in non-performing assets at leasing companies on a deteriorating domestic economy; sharper-than-expected rise in borrowing costs.

2 Sector Outlook Increased competition amid economic recovery Industry competition continues to intensify The number of leasing companies continued to grow in 1H17 The number of financial leasing companies in China continued to increase in 2017, from 7,136 at the end of 2016 to 8,580 at the end of 3Q17. However, QoQ growth slowed to 7%, 8% and 4% respectively in 1Q/2Q/3Q17, the first time it has been below 10% in the past three years. Among the newly established leasing companies, 7 have received a financial leasing license from the China Banking Regulatory Commission (CBRC) as of end-1h17, 19 have been registered as domestic-funded leasing companies, while the rest are registered as foreign-funded leasing companies. The foreign-funded companies accounted for 96% of the total, mainly due to it being easier to obtain this type of license given the less stringent registration requirements. This continued growth means the industry has been filled with new entrants, and has seen intensifying competition and the weakening of the overall bargaining power of leasing companies. Despite continued growth in outstanding lease balance, new lease value dropped in 3Q17 Outstanding lease balance amounted to Rmb5,750bn at the end of 9M17, up 16% YoY. However, quarterly new lease value was reported at Rmb420bn as of end-3q17, down 18% YoY. Specifically, new lease value recorded strong growth in 1Q17 amid a recovery in corporate financing, but dropped for the next two consecutive quarters, mainly due to a surge in financing costs and strengthened supervision of local government financing and the financial system. Figure 1: Number of leasing companies continues to rise Figure 2: Quarterly new lease value (Rmb bn) 10,000 8,000 6,000 60% 50% 40% 30% ,000 2, % 10% 0% -10% Foreign funded leasing companies Domestic funded leasing companies CBRC regulated leasing companies QoQ -100 CBRC regulated leasing companies Foreign funded leasing companies Domestic funded leasing companies Raised borrowing costs Loans and bonds are the main two forms of financing for leasing institutions. Besides this, leasing companies regulated by the CBRC can turn to the interbank financing market for short-term liquidity. Many leasing companies have raised their proportion of direct financing to take advantage of the low interest rates in both onshore and offshore bond markets in the past two years. However, with the Fed rate hike in March and June, interest rates continued to rise for US dollar financing. Meanwhile, with regulation tightening and deleveraging among Chinese financial institutions, financing costs in China also increased substantially. The issuance rate of 1Y bills 2

3 Sector Outlook with AAA ratings increased 215bps from the end of Sept 2016 to the end of Sept Although the PBoC maintained stable benchmark lending rates, stringent regulation has put pressure on credit creation by banks and forced a roll-back in off-balance-sheet financing, resulting in a surge, and volatility, in interbank borrowing costs as well as increasing renminbi loan rates. Raised borrowing costs put pressure on leasing companies financing capabilities and push leasing companies to seek projects with better returns. Figure 3: Declining corporate bond financing vs surge in bill issuance Figure 4: Rmb loan rate rebounded Net financing of corporate bonds (bn) Issuance rate of 1Y Bill (AAA,%) Weighted average RMB loan rate(%) Benchmark lending rate(1-3y,%) Rebound in leasing asset yield and improved asset quality Rebound in leasing asset yield amid economic recovery China posted relatively strong economic growth in the first half, mainly due to: 1) an upward inventory cycle: industrial inventory rebounded from a trough, together with supply side contractions led by regulation, driving the price of industrial products up and promoting corporate earnings to recover, which in turn strengthened this positive cycle by continuing to replenish inventories; 2) the global economy continued to recover which impacted exports positively from 2016; 3) Real estate investment has also recovered since 2016 and supported strong demand for products related to the real estate industry chain; 4) PPI has surged rapidly since 2016, significantly improving the profitability of upstream enterprises. The stronger-than-expected economic recovery helped leasing companies transfer their increased costs to clients in 1H17. As their interim results indicated, Universal Medical, CDB Leasing and Far East Horizon all posted an improved NIS compared with that in Despite GDP growth dropping below 7% to 6.8% in 3Q17, along with decreasing industrial value-added and property sales volume, annual GDP growth of above 6.7% is already a foregone conclusion given GDP growth of 6.9% YoY as of end-9m17. In fact, the IMF raised its GDP forecasts to 6.8% and 6.5% for 2017/18 respectively, indicating a more optimistic expectation. We expect the economic recovery and better profitability at companies to provide support for the annual leasing asset yield and to result in an improved annual NIS for leasing companies compared with

4 Sector Outlook Figure 5: Quarterly GDP & PMI Figure 6: NIS of listed leasing companies rebounded in 1H % 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% H H17 NIS: Universal Medical NIS: CDB Leasing PMI Quarterly GDP YoY(RHS,%) NIS: Far East Horizon Pace of NPA formation slowing Based on quarterly data on commercial banks released by the CBRC, NPL ratios at commercial banks in China remained at 1.74% for 3 consecutive quarters. Meanwhile, special mention loans have significantly decreased since 3Q16 and pass loans continued to increase, indicating overall asset quality improvements. Based on the data released by listed banks, the overall NPL ratio for listed banks was 1.64% as of end-sept, down by 2bps from end-june. The pace of NPL formation slowed significantly as the proportion of newly generated NPLs (write-offs added back) decreased by 27bps QoQ to 0.47%. Based on the interim results from Far East Horizon, Universal Medical and CDB Leasing, there are signs of the NPA ratio at leasing companies leveling off, as the ratio edged down from 0.99% at end-2016 to 0.95% at end-1h17 for Far East Horizon, and 0.81% to 0.78% for Universal Medical. The ratio for CDB Leasing increased slightly from 0.98% to 1.11%, but if write-offs are added back, the newly generated NPA decreased as well. Given the NPA at listed (equipment) leasing companies is typically lower than the average NPL ratio for commercial banks, we expect the pace of NPA formation to continue to slow in the second half of Figure 7: NPL ratio and proportion of loans labeled as special mention at commercial banks Figure 8: Leasing companies NPA ratio % 1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% NPL ratio (%) "Special mention" loans (%) "Pass" loans (%) 0.00% H H17 NPA ratio: Far East Horizon NPA ratio: CDB Leasing NPA ratio: Universal Medical 4

5 Sector Outlook Aircraft leasing market maintains steady growth The fundamentals and outlook for the aircraft leasing industry remain stable. Growth in the air transport industry is the key driver of aircraft leasing demand, and fleet expansion at listed aircraft leasing companies is quite promising as aircraft deliveries typically lag orders by 1-3 years. Furthermore, aircraft leasers have stronger pricing power over the leasing yields of operating leases than other equipment leases as a result of higher entry barriers. Despite weakness in the global economy, the air transport industry has maintained relatively strong performance. YoY available seat kilometers (ASK) and revenue passenger kilometers (RPK) growth have remained stable at around 6%, with the ASK-RPK gap implying a supplydemand equilibrium. The market value of an aircraft cyclically fluctuates around its base value which declines gradually over time. The ratios of market value to basic value for the best-selling 737 and A320 models have recovered from their lows and remained at a prospering range, indicating strong aircraft demand and suggesting that leasing companies can sell their aircrafts at favorable prices. In China s air transport market, steady growth in passenger volume and turnover (calculated as passenger volume multiplied by traveling distance) have provided strong support for the domestic aircraft leasing business. Air passenger volume totaled 409.5m in 9M17, up 12.5% YoY, while passenger turnover totaled 705.6bn passenger-kilometers in the same period, up 13%. Figure 9: Stable YoY growth in ASK and RPK Figure 10: Aircraft market value to base value ratio at cyclically high level % 110% 105% 100% 95% 90% 85% 80% ASK YoY (%) RPK YoY (%) 737 NG-800 A

6 Sector Outlook Figure 11: YoY passenger volume and turnover growth in China Passenger volume (YoY) Turnover YoY Long-term prospects Leasing penetration rate will continue to increase According to the Global Leasing Report issued by White Clarke Group, annual leasing volume in China has surpassed Germany, the UK and Japan to become the world s second largest leasing market, with the US remaining the largest. However, the leasing penetration rate of 4% in China in 2015 is still far below those of developed countries, which range from 9.6% to 40%. The leasing penetration rate was calculated in the report based on total new leasing business volume divided by total investment, excluding real estate. If we take newly-added leasing contract amount divided by equipment purchasing in fixed assets investment ( 固定资产投资完成额 : 设备工器具购置 ), the penetration rate was 8% in 2016, meaning there is still potential for a continuous rise. Figure 12: Leasing penetration rates by country (%) China US Japan UK France Australia 6

7 Direct lease and operating lease mix to improve Financial leasing accounts for the majority of leasing business in China at the moment with operating leases accounting for less than 10% (according to media reports). Furthermore, salesand-leaseback makes up over 85% while direct leases less than 15% in the financial leasing business. As the number of leasing companies continues to increase, price competition has intensified in the sales and leaseback business with a similar financing nature as with bank loans. However, direct lease and operating lease businesses represent the future development trend as: 1) the leasing company could provide diversified leasing services in direct lease and operating lease, which have higher entry barriers, with direct leasing requiring the leaser to have professional knowledge of the lease subject and operating lease further requiring asset management and residual disposal capabilities. 2) Direct lease and operating lease could better support the real economy with more focus on leased assets. As the 19 th CPC National Congress report stated, the government will deepen financial system reform to enhance the financial institutions capabilities to serve the real economy. Key themes for the next 3-6 months Market interest rates to continue to rise Given a rise in interest rates globally, neutral monetary policy and continuous financial deleveraging, we expect market interest rates to continue to rise in the next 3-6 months. Rise in global interest rates As the global economy continues to recover, central banks have started to gradually adjust their monetary policy to quit the unprecedented easing, driving a rebound in interest rates. Canada has twice raised its benchmark interest rates this year and the UK also announced an interest rate hike of 25bps in Nov in response to its rising inflation rate (above 3% since Sept). Mark Carney, the chairman of the Bank of England, said there may be 2 more interest rate rises in the next 3 years. The ECB announced it will cut its bond purchases in half from Jan In the US, steady economic growth has urged the Fed to push forward rate hikes and normalize its balance sheet a Dec Fed rate hike currently has a probability of over 90%, according to market expectation. Rebounding global market interest rates have a positive impact on interest rates in China. After the Fed rate hike in Dec 2016 and March 2017, the PBoC increased its open market operation rates (repurchase rates) and SLF rates in Jan and March Although this pattern did not occur after the Fed hiked rates in June 2017, the market is still concerned that the PBoC may follow the Dec Fed rate hike. 7

8 Sector Outlook Figure 13: Some government bond rates have risen since Sept Figure 14: Government bond rate spread between China and the US UK Treasury 10Y(%) Germany Treasury 10Y(%) US Treasury 10Y(%) Japan Treasury 10Y(%) spread China Treasury 10Y US Treasury 10Y Neutral monetary policy As property sales volume has declined and industrial value-added has decreased along with ongoing supply-side constraints, Chinese economic growth slowed in the second half of 2017, but was still better than expected. The steady economic recovery provided the basis for neutral monetary policy. In terms of inflation, PPI remained high while CPI was continuously below the target rate of 2%. The market expects an upward spiral in raw material costs to slowly transfer to the downstream industry chain, thus in turn pushing up non-food products CPI and making a continued rise in CPI possible in In such case, the neutral somewhat tight monetary policy stance should continue. In addition, the PBoC rephrased its description of the economic situation from generally steady ( 总体平稳 ) to steady and sound ( 稳中向好 ) during the 3Q17 monetary policy regular meeting. Based on this judgment, the PBoC is likely to target broadly stable liquidity through its cut the peaks and fill in the valley operation. Figure 15: CPI and PPI CPI YoY PPI YoY 8

9 Sector Outlook Ongoing financial regulation and deleveraging In 1H17, deleveraging in the financial system led to a rapid rise in interbank interest rates. According to the report from the 19 th CPC National Congress as well as speaking with key regulatory officials, the strict regulatory environment will continue to be the main tone in the near future. As the 19 th CPC National Congress report stated, the government will deepen the financial system, aiming to better support the real economy, explore the double pillar regulatory framework of monetary policy and macro-prudential policy, deepen market-oriented reform in interest rates and exchange rates, and improve the financial regulatory system in order to keep the bottom line of no systemic financial risks. Guo Shuqing, the chairman of CBRC, also said that more strict financial supervision is the overall trend, signaling that risk control is a top priority. In other words, the main purpose of regulation is to guard against risks and stabilize the market, which inevitably impacts liquidity negatively. As shown in Figure 16, the PBoC has established an interest rate corridor through open market operations (OMP rate) as well as innovative liquidity management tools such as SLF, thus successfully keeping the DR007 target rate (interest rate for the 7-day pledged reverse repo in depository financial institutions) fluctuating within the interest rate corridor, demonstrating a stable and neutral monetary policy stance. However, under the combined effect of tightening regulation and financial deleveraging, the R007 (7-day interbank pledged repo rate) has been more volatile, which could better reflect overall market liquidity as it includes depository financial institutions and non-banking financial institutions. Figure 16: Interest rate corridor DR007 OMP rate(reverse Repo: 14 days) SLF rate:overnight R007 OMP rate(reverse Repo: 7 days) SLF rate:7 days NIS could remain stable Leasing companies generally gain a larger NIS amid rising interest rates and mild inflation, as the growing economy enables companies to bear higher financing costs. However, economic growth may continue to slow given the negative impact which has resulted from supply-side policies aimed at reducing inefficient investment and promoting growth rebalancing, including property policy tightening, manufacturing capacity cuts, financial deleveraging, the proposed deleveraging of local governments and state-owned enterprises by the National Financial Work Conference, and the recent environmental inspection. With implementing these policies, we could see negative consequences on economic growth, which may prevent a significant increase in leasing asset yields, together with rising mild inflation expectations, and we believe leasing companies may achieve relatively stable NIS in 1H18. 9

10 Possible industry regulation tightening Licenses for companies in the financial leasing business can be categorized into the CBRCadministered Financial Leasing license (capitalized to distinguish from financial leasing in the general sense, same hereinafter), and the MOFCOM-administered Foreign-Funded Leasing and Domestic-Funded Leasing licenses. Companies with the Financial Leasing license tend to have greater capital strength given the nature of non-banking financial institutions while the leasing companies regulated by MOFCOM are general industrial and commercial enterprises. There have been market rumors since July that the CBRC may replace the MOC in supervising all leasing companies in the future. MOC-regulated leasing companies carry out similar business as financial leasing companies but have an easier license application and fewer regulatory requirements. As Li Keqiang, the premier of the State Council, pointed out at the National Financial Work Conference, all financial business should be supervised in order to enhance financial regulation. Given highly homogeneous business models regardless of the type of business license, we see a trend towards the integration of regulation against the backdrop of tightening regulation. However, we are unlikely to see a regulation shift immediately due to the difficulties of implementation. The number of domestic and foreign-funded leasing companies regulated by the MOC was over 8,000 as of end-1h17, with a leasing contract balance of Rmb34,85bn. The CBRC would be severely understaffed in supervising over 8,000 leasing companies given only 66 Financial leasing companies need to be covered now. There are some guesses that the government may take measures to strengthen regulatory requirements, clean-up zombie companies and promote industry mergers then do the transfer of regulation authority. It is also possible that the CBRC issues leasing industry practices, standards and regulation requirements but entrusts the local financial services office to carry out daily management. No matter what form of regulation is adopted, supervision is sure to be strengthened for the over- 8,000 leasing companies regulated by the MOC. Possible impacts include: 1) leasing business operations will be subject to more strict regulation to prevent leasing businesses involving local government financing platforms and channel businesses which act as shadow banking; 2) overall risk control will be strengthened through specific requirements on capital, liquidity and internal controls; 3) qualified leasing companies may obtain financing support from the regulation change. For example, they may be allowed to enter the interbank financing market for short term liquidity or issue financial bonds with the approval of the CBRC. 4) Industry concentration could increase substantially with regulation tightening while some leading leasing companies may become more competitive. 10

11 Figure 17: Comparison of three types of leasing company Leasing contract balance(bn rmb) 2,115 1,730 1, No of companies 66 7,928 0% 20% 40% 60% 80% 100% CBRC regulated leasing companies Domestic funded leasing companies Foreign funded leasing companies Valuation analysis Market performance review for the leasing sector Listed leasing company performance was relatively weak in 1H17, with the shares of Far East Horizon, CDB Leasing, CALC, BOC Aviation and Universal Medical rising by 16.6%, -6.0%, 3.2%, 14.2% and 30.5% respectively, compared to 33.6% for the HSI. Listed leasing companies mostly underperformed in 2Q17, mainly due to deteriorating NIS expectations amid rising interest rates. Share price performance of listed leasing companies later diverged significantly following interim results announcements. CALC continued to decline due to its disappointing 1H17 results while Universal Medical and Far East Horizon rebounded on steady growth. Figure 18: 10M17 performance for Far East Horizon (3360 HK) Figure 19: 10M17 performance for CDB Leasing (1606 HK) Far East Horizon HSI(Comparable) CDB Leasing HSI(Comparable) 11

12 Figure 20: 10M17 performance for CALC (1848 HK) Figure 21: 10M17 performance for BOCA (2588 HK) CALC HSI(Comparable) BOCA HSI(Comparable) Figure 22: 10M17 performance for Universal Medicine (2666 HK) Figure 23: Yields (including dividends) Rating 1H17 % chg YTD % chg Far East Horizon 3360 HK Buy BOC Aviation 2588 HK Buy CDB Leasing 1606 HK Hold CALC 1848 HK Hold Universal Medical 2666 HK Buy HSI HSI HI Universa Medical HSI(Comparable) Valuation HK-listed leasing companies are now trading at relatively cheap valuations, except Universal Medical, either on a P/B or P/E basis, reflecting market concerns about deterioration in NIS at leasing companies. The industry is trading at 9.5x 2016 P/E (using closing prices on Nov 10, 2016), compared with a 2-year average of 11.5x; industry P/B is at 1.3x, compared with a 2- year average of 1.4x. The industry P/E and P/B were calculated as the average of the five listed leasing companies: Far East Horizon, CDB Leasing, Universal Medical, CALC and BOC Aviation, which recorded 2-year average P/E ratios of 8.5x, 15.9x, 12.3x, 11.6x and 9.2x respectively, with 2-year average P/B ratios of 1.1x,1.1x, 1.5x, 2.2x and 1.1x. 12

13 Figure 24: P/E valuations for HK-listed leasing companies Figure 25: P/B valuations for HK-listed leasing companies Far East Horizon CDB Leasing Universal Medical CALC BOC Aviation Far East Horizon CDB Leasing Universal Medical CALC BOC Aviation Investment strategy A stronger-than-expected economic recovery helped leasing companies to improve asset quality and drove leased asset yields in 1H17. However, the rapid rise in market interest rates has led to an increase in funding costs and thus put pressure on NIS for FY2017. Looking into 2018, NIS movements remain a major concern, and will depend on a combination of economic growth and inflation, as well as monetary policy stance. As discussed above, market interest rates are likely to rise continuously both in US dollar financing and Rmb financing. Specifically, for the major two financing methods: 1) interest rates for commercial loans should be reset at the beginning of 2018; 2) issuance rates for bonds are expected to increase moderately. In addition, leasing companies regulated by the CBRC could turn to the inter-bank market for short term liquidity. Inter-bank market interest rates suffered most under tightening regulation and financial deleveraging, which is expected to continue in 1H18. Leasing companies generally gain a larger NIS amid rising interest rates and mild inflation, as economic growth enables companies to bear higher financing costs. However, economic growth may continue to slow in 1H18 given the negative impact from supply-side policies. With the implementation of these policies, there may be negative consequences on economic growth going forward, preventing a significant increase in leasing asset yields. Together with a mild rise in inflation expectations, we expect leasing companies to achieve relatively stable NIS in 1H18, compared with 2H17. Under the pressure of narrowing NIS as market interest rates continue to increase while the China economy slows moderately, we remain positive on leasing companies with diversified business operations such as Universal Medical and Far East Horizon. In addition, aircraft leasing is still an attractive sub-sector given its long lease durations, the large proportion of prepaid interest, predictable cash flows, relatively stable lease rates, and given the security deposit aircraft leasing companies hold even if airlines default. As most fleets consist of 13

14 aircraft produced by the two main manufacturers, aircraft assets can be conveniently reallocated to other locations. The global nature of the aircraft leasing business, with the majority of transactions denominated in US dollars, means that leasing companies in other countries are also comparable. In fact, the P/E valuations of HK-listed aircraft leasing companies have been cheaper than their A-share and even US-listed counterparts. We recommend BOC Aviation for long-term investors given its promising fleet expansion and steady earnings growth outlook. Figure 26: Peer comparison Equipment Leasing Market Total P/E P/B ROE (%) Equity Revenue Net profit (HK$ bn) Cap assets E E E 3360 HK Far East Horizon HK CDB Leasing HK Universal Medical URI N United Rentals CAR O AVIS BUDGET GROUP R N Ryder System AAN N AARON' S INC MGRC O MCGRATH RENTCORP N/A HEES O H&E EQUIPMEN T SERVICE Average Aircraft Leasing Market Total P/E P/B ROE (%) Equity Revenue Net profit (HK$ bn) Cap assets E E E 1848 HK CALC HK BOC Aviation CH Bohai Financial N/A AL N Air Lease AYR N AIRCASTLE LTD AER N Aercap Average Sources: Bloomberg, GF Securities (Hong Kong) estimates Note: Updated as of Nov 10,

15 Universal Medical (2666 HK) Buy (maintained) Target price: HK$8.60 Fast growing medical services provider Figure 27: Stock performance Figure 28: Key data Nov 10 close (HK$) 8.02 Shares in issue (m) 1716 Major shareholders China Gen Tech (37.73%) Market cap (HK$ 100m) 138 3M avg. vol. (m) W high/low (HK$) 8.24/6.05 Universa Medical HSI(Comparable) Sources: Bloomberg Figure 29: Stock valuation Revenue Net profit EPS EPS P/E BPS P/B ROE (Rmb m) (Rmb m) (Rmb) YoY (Rmb) % % % % 2017E % % 2018E % % 2019E % % Sources: Bloomberg, GF Securities (Hong Kong) Fast growing medical services provider With China General Technology as its major shareholder and CITIC Capital as its strategic partner, Universal Medical has extensive global resources and medical service experience. Its three major business segments are financial leasing, medical equipment & financing advisory services, and clinical department upgrade services. The company has maintained rapid growth in assets, revenue and net profit since 2012, with a CAGR of ~46% for both its assets and revenue during Total assets increased from Rmb28.9bn as of end-2016 to Rmb33.4bn as of end-3q17, up 16%. 9M17 operating income amounted to Rmb2.4bn, an increase of 25% YoY; profit before tax was reported at Rmb1.2bn, up 30% YoY. Efficient platform for integrating healthcare resources Relying on the support from its major shareholder China General Technology, Universal medical has: 1) established strategic partnerships with 68 leading international healthcare institutions and more than 200 experts across various fields; 2) developed strong global medical equipment importing capabilities, acting as the exclusive agent for 19 medical device categories in China, covering a total of over 200 medical products, and; 3) built a large client base of more than 1,400 hospitals. Its stroke unit upgrade service model has become an example for promoting business development through resource integration. Steady growth in its financial leasing business Financial leasing is the company s core business with a gross profit contribution of over 60%; most assets are allocated in the healthcare and education industries. Thanks to its strong pricing power and improving financing structure, the company has maintained a higher-than-peers leasing asset yield. The quality of its leasing assets is solid with a non-performing asset ratio below 1% and a zero historical write-off ratio. Hospital operation business to take off In Aug 2016, the company signed a contract with the First Affiliated Hospital of Xi an Jiaotong University to co-establish an International Land Port Hospital under the PPP model. Total investment is expected to be no more than Rmb2bn, and the company will be able to generate new revenue sources from its construction & operation rights and supply chain business. We estimate that the revenue and net profit of the project will increase rapidly and that the project will become an important source of revenue and profit for the company 15

16 from In addition, the project with Handan First Hospital and ongoing reform of SOE-affiliated hospitals will further promote the development of the company s hospital operation business in the near future. Maintain Buy rating with TP of HK$8.60 Due to intensifying competition and rising market interest rates, the company s NIS has come under pressure in 2H17. Its hospital operation business will begin to generate revenue in 2H17 and is expected to be a significant business segment from We expect revenue growth of 31%, 42% and 32% and net profit growth of 26%, 18% and 16% in 2017/18/19. As the contribution of its hospital operation business increases, we expect the company s P/E valuation will pick up to reflect the business nature change as well as an ROE recovery over the next three years. We maintain our Buy rating and target price of HK$8.60, based on 10x 2018E P/E and 1.7x 2018E P/B. Risk factors include disappointing growth in the company s financial leasing business, slowerthan-expected progress in its hospital operation projects, and changes in healthcare policies. Figure 30: Financial statements Year ended 31 Dec (Rmb m) E 2018E 2019E Year ended 31 Dec (Rmb m) E 2018E 2019E Cash and cash equivalent 1,866 1, , Revenue 2,193 2,701 3,539 5,027 6,641 Restricted deposits , Cost of sales ,400-2,491-3,655 Inventories Gross profit 1,309 1,735 2,139 2,535 2,987 Loans and accounts receivable 21,317 26,761 32,243 38,327 45,225 Other income and gains Prepayments, deposits and other receivables Selling and distribution costs PPE Adiministrative expenses Derivative financial assets Other expenses Goodwill Interest expenses Intangible assets ,011 1,410 Profit Before tax 900 1,206 1,520 1,798 2,081 Available-for-sale investments Income tax epxense Deferred tax assets Profit for the year ,100 1,301 1,506 Other assets Attributable to owners ,100 1,301 1,506 Total assets 23,658 28,965 34,902 41,534 49,010 Attributable to non-controlling interests Trade payables Other payables and accruals 2,093 2,576 2,824 3,444 4,142 Interest-bearing bank and other borrowings 15,458 19,485 24,359 29,711 35,730 Year ended 31 Dec (Rmb m) E 2018E 2019E Tax payable Cash flow from operating activities Derivative finanical liabilities Net income ,100 1,301 1,506 Defferred tax liabilities Add: Deprecation of PPE Other liabilities Net working capital changes -6,088-4,304-5,423-5,324-6,450 Total liabilities 17,777 22,390 27,550 33,602 40,409 Others 94 1, Equity 5,881 6,574 7,353 7,932 8,600 Cash generated from operations -5,321-2,382-4,069-3,705-4,561 Equity attributable to owners 5,881 6,574 7,344 7,810 8,398 Cash flow from investing Share capital 4,328 4,328 4,328 4,328 4,328 Net purchase of PPE Reserves 1,553 2,247 3,017 3,482 4,071 Minus: Net investment Minor interests Others Sources: GF Securities (Hong Kong) Net cash flows used in investing Cash flow from financing Year ended 31 Dec E 2018E 2019E Net changes of debt 4,483 2,267 4,386 4,816 5,417 Drivers Share issuance 2, NIS(Recaculated) 1.4% 2.6% 3.1% 3.0% 2.9% Minus: share repurchase NIM(Recaculated) 3.3% 4.2% 4.5% 4.3% 4.2% dividend paid Credit cost 0.18% 0.24% 0.17% 0.14% 0.13% Others Asset quality Net cash flows from financing 6,668 2,175 4,125 4,486 5,027 Non Performing assets ratio 0.8% 0.8% 0.9% 0.9% 0.9% Net cash flows: Provision coverage ratio 171.5% 183.9% 180.0% 180.0% 180.0% FX adjustment Profitability 0.0% 0.0% 0.0% 0.0% 0.0% Other adjusts ROE 15.9% 14.0% 15.8% 17.2% 18.6% Net (decrease)/increase in cash and cash equivalents 1, ROA 3.3% 3.3% 3.4% 3.4% 3.3% Cash and cash equivalents at beginning of year 454 1,866 1, ,000 Leverage(A/E) Cash and cash equivalents at end of year 1,866 1, , Valuation Blance sheet Financial Ratios P/E P/B Dividend yield(%) Income statement Cash flow statement 16

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