Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Aug 19, 2014

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1 Equity Research Dim Sum Express Alex Fan, CFA Head of Research SFC CE No. ADJ Dennis Yao Research Analyst SFC CE No. ALK Joseph Ho, CFA Research Analyst SFC CE No. AFP Gao Yedong Editor SFC CE No. BAI GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong A-Share Market Investment Strategy: 1H14 earnings growth improving from 1Q14 but deceleration expected in 3Q14 Non-financial companies that have issued 1H14 earnings or a profit alert are posting 1H14 earnings growth of 17.7% YoY, compared with 12.9% YoY in 1Q14. However, A-share ex. financial earnings growth of 22.5% YoY in 3Q13 will provide a high YoY base for 3Q14. In addition, industry data has not picked up significantly despite ongoing policy easing as property sales and investment continue to weaken. We expect company earnings growth to deteriorate again in 3Q14 if this situation continues. Shipping: BDI surges on higher iron ore shipping prices The BDI strengthened by 30.6% last week as the BCI surged 84.5% on reports of Australia and Brazil intending to strengthen iron ore exports. Higher capesize shipping capacity utilization on stronger iron ore import growth and lower capacity growth should mean substantial upside for capesize shipping rates this year. However, current improvements in supply-demand dynamics are not sustainable given a potential slowdown in iron ore import growth from 2015 and high shipping capacity growth on strong new ship orders. Property: Sell-through rate picking up Primary area sold in first and second-tier cities tracked picked up slightly last week. Overall property destocking gathered pace as sales improved WoW while new project launches remained stable during the low season. Our index tracking inventories in 15 large cities has stabilized at a high level. 30 of the 47 cities originally with HPRs in place have now relaxed these restrictions. We expect transactions to recover significantly from end-aug on HPR relaxation, strengthening mortgage support and continued MoM home price declines. Hong Kong Market Sunny Optical (2382 HK, NR): 1H14 results in line; upbeat guidance on 2H14 margins 1H14 net income rose 31% YoY, broadly in line, while gross profit margin fell to 14.6% (1H13: 15.8%), which management attributes to price concessions for XIaomi and a rise in revenue contribution from low-margin camera modules. Management is upbeat on the outlook for gross profit margin in 2H14 driven by new product launches, a ramp=up in high margin products, and cost-down measures. The company also announced the Rmb351m acquisition of Sunny Group, whose key assets are property and stakes in companies with micro-credit licenses. China Vanke (2202 HK, NR): 1H14 net profit in line with consensus 1H14 net profit rose 6% YoY, in-line with consensus, while revenue declined 1% YoY. Gross margin declined 290bps YoY to 26.5%. Booked ASP rose 5% YoY to Rmb10,338 per sqm. The company acquired 19 new projects in 1H14 and has GFA of 40m sqm at the planning stage, enough for development over the next 2-3 years. Management is bullish on the significant residential property demand from the ongoing urbanization process. We expect its earnings to grow 10% YoY in 2014 and 10-20% YoY in 2015, and expect it to be a key beneficiary of industry consolidation.

2 Investment Strategy: 1H14 earnings growth improving from 1Q14 but deceleration expected in 3Q14 1H14 earnings improving form 1Q14 Non-financial companies that had issued 1H14 earnings or a profit alert by Aug 16 represent 37% of overall A-share ex. financial earnings. These companies are posting 1H14 earnings growth of 17.7% YoY, compared with 1Q14 growth of 12.9% YoY. Based on the fact that 1H14 industrial profit also picked up from 1Q14, we now believe that overall 1H14 A-share earnings might come in slightly better than 1Q14, exceeding our previous expectation. That said, 1Q14 earnings growth of 12.9% YoY at the companies mentioned above was much higher than overall non-financial earnings growth of just 2.9% in 1Q14, meaning many companies with poor 1Q14 earnings have not issued 1H14 earnings or a profit alert and that actual 1H14 earnings might come in lower. A-share earnings 1H14 vs. 1Q14 % of co. with 1H14 earnings* 1Q14 1H14 A-share ex. financials 37% 12.9% 17.7% CSI % 15.4% 20.9% CSI % 15.1% 17.6% Main board 15% 18.8% 22.4% SME board 100% -0.4% 10.6% ChiNext board 100% 17.8% 16.2% ChiNext top 50% mkt cap 100% 32.0% 23.2% ChiNext bottom 50% mkt cap 100% 1.8% 9.2% Sources: Wind, GF Securities * Percentage indicates the proportion of sector earnings represented by companies that have issued 1H14 earnings or a profit alert. Earnings growth to weaken again in 3Q14 The earnings improvement in 1H14 was likely due to the low comparable base in 1Q14 and stronger policy easing in 2Q14. However, A-share ex. financial earnings growth of 22.5% YoY in 3Q13 will provide a high YoY base for 3Q14. In addition, industry data has not picked up significantly despite ongoing policy easing as property sales and investment continue to weaken. We expect company earnings growth to deteriorate again in 3Q14 if this situation continues. Sectors seeing the most significant earnings improvement in 1H14 are listed below. Sectors seeing most significant earnings improvements in 1H14 % of co. with 1H14 earnings* Q14 1H14 1H14 vs H14 vs. 1Q14 Livestock farming 39% % % 130.8% 321.5% 667.9% Rare metals 63% -46.3% 11.3% 324.5% 370.8% 313.2% Comprehensive agriculture 100% -2.3% -67.1% 8.0% 10.2% 75.1% Metallic products 85% 14.8% -13.2% 52.6% 37.8% 65.8% Diversified financials 30% 50.9% 101.0% 150.1% 99.3% 49.1% Chemical raw materials 100% -28.0% 213.1% 256.3% 284.3% 43.2% Planting 83% -65.2% 162.1% 199.1% 264.3% 37.0% Gold 46% -55.5% -30.7% 2.3% 57.8% 33.0% Securities 85% 30.1% 8.1% 32.4% 2.3% 24.2% Optics/optoelectronics 64% 26.2% 39.0% 58.7% 32.5% 19.8% Auto parts 88% 13.0% 28.6% 47.9% 34.9% 19.3% Environmental 78% 1.5% 16.9% 34.4% 32.9% 17.5% General machinery 69% 5.9% 26.2% 39.8% 33.9% 13.6% Electronics 100% 20.5% 17.5% 29.6% 9.1% 12.2% Sources: Wind, GF Securities * Percentage indicates the proportion of sector earnings represented by companies that have issued 1H14 earnings or a profit alert. Page 2

3 Shipping: BDI surges on higher iron ore shipping prices BDI surges on stronger iron ore exports from Brazil The BDI strengthened by 30.6% last week as the BCI surged 84.5%, the BPI rose 30.6% and the BSI increased 9.1%. The rise in the BDI was mainly driven by rising iron ore shipping prices (capesize ships). There have been media reports that Australia and Brazil will strengthen support for iron ore exports, with exports from Brazil likely to increase. In addition, Vale S.A. has indicated that it will expand its fleet by hiring ships instead of building new ships in order to help increase exports to China. These reports have led to a surge in the charter rates for capesize ships. 7M14 dry bulk shipping market much stronger than M14 Chinese iron ore imports picked up 17.9% YoY, compared with growth of 8.1% in However, capesize shipping capacity grew by just 4.7% YoY during 7M14, compared with 2013 growth of 9.3%. As a result, the 7M14 average BCI increased by 27.5% YoY with capesize ship charter rates rising 67.5% YoY. Ship utilization to rise on stronger imports growth and slower capacity growth Based on the annualized figure of 7M14 imports, we calculate that 2014 iron ore imports should grow 12.9% YoY, strengthening from 10% in In contrast, capesize shipping capacity growth will likely slow from 7.68% YoY in 2013 to 4.5% YoY this year. As such shipping capacity utilization should pick up YoY, meaning substantial upside for capesize shipping rates. Based on estimates from Clarksons, the average charter rates for capsize and panamax ships are likely to reach US$21,000 and US$9,000 per day in 4Q14, corresponding to BCI reading of 3,000 and BPI of 1,000, which represent 100% and 50% from this month s average levels. Dry bulk shipping demand to remain strong The Chinese manufacturing PMI has been improving over the past few months with the gap between the new orders and inventory subindices rebounding to a three-year high. We believe improvements in the economy will continue to drive demand in the dry bulk shipping market. In addition, crude steel output continues to grow as steel mill earnings improve on declining iron ore import prices. As such we expect strong iron ore import growth to be maintained. Supply-demand improvements unlikely to be sustained However, we point out that sector conditions have not fundamentally reversed given a potential slowdown in iron ore import growth from 2015 onwards and high shipping capacity growth on strong new ship orders, which means current improvements in supply-demand dynamics are not sustainable. We like COSCO Shipping ( CH), China Merchants Energy Shipping ( CH), China COSCO ( CH) and CSCL ( CH) in the short term given recent BDI rebounds and cyclical sector strength on macroeconomic improvements. Property: Sell-through rate picking up Transactions up slightly WoW Primary area sold in first and second-tier cities tracked picked up 3% and 4% WoW respectively last week. Shenzhen outperformed the other first-tier cities, rising 30%, while Kunming (+65%) grew more than other second-tier cities tracked. Changes in the Bohai Rim region were mixed, with Tianjin up 39% WoW; most YRD cities posted an increase except for Ningbo and Suzhou; cities in the PRD also saw positive growth except for Guangzhou (-5%); transactions came off in central China with Nanchang and Guiyang dropping 23% and 18% WoW. Sell-through rate picking up Overall property destocking gathered pace as sales improved slightly WoW while new project launches remained stable during the low season. Our index tracking inventories in 15 large cities has stabilized at a high level, with Beijing remaining flat WoW and Shanghai up slightly. Strengthening mortgage support to boost demand An increasing number of cities/provinces have rolled out measure to support property market development, with 30 of the 47 cities originally with HPRs in place now having relaxed these restrictions. We believe it will be a trend for secondtier cities to relax HPRs going forward. In addition, there have been rumors about CCB ( CH) loosening mortgage lending restrictions in Shanghai strengthening support for mortgage issuance should give a strong boost to demand. We expect property transactions to recover significantly starting from end-aug on HPR relaxation, strengthening support for mortgage issuance and continued MoM home price declines. Our preferred names are China Vanke ( CH), Poly Real Estate ( CH), Yango Group ( CH), Citychamp Dartong ( CH), Zhongnan Construction ( CH) and Thaihot Group ( CH). Page 3

4 Sunny Optical (2382 HK, NR): 1H14 results in line; upbeat guidance on 2H14 margins Upbeat guidance on 2H14 gross profit margin 1H14 net income rose 31% YoY to HK$257m, broadly in line with consensus of 34% YoY growth to HK$264m. 1H14 gross profit margin fell to 14.6% (1H13: 15.8%), which management attributes to price concessions for its new customer Xiaomi, and the rise in revenue contribution from low-margin camera modules. Management is upbeat on the outlook for gross profit margin in 2H14, driven by a) new product launches (e.g. camera modules with optical image stabilization, which it started to ship in July); b) the ramp-up in high margin products (camera and vehicle lenses in 2H14), and; c) the implementation of cost-down measures. China-centric customer mix The company s top five customers (Huawei, Xiaomi, Oppo, Lenovo, Coolpad) accounted for 55% of sales in 1H4, up from about 50% in 1H13. According to management, Huawei is its largest customer, and the other four each account for a similar proportion of sales. Handset-related products accounted for 81% of sales in 1H14. Apple is currently not a customer. Management stated that they have inferior economies of scale compared with Taiwanese suppliers Largan (3008 TT) and Genius (3406 TT), and that they are not keen on cutting prices to lure orders from Apple. Buying property and stakes in companies with micro-credit licenses As well as its results, Sunny Optical announced the Rmb351m acquisition of Sunny Group, whose key assets are property (manufacturing complex), and its 25% and 12.2% stakes in Sunny Huitong (financing services) and Zhengxing Yiqi (consulting and information services). The consideration was based on 1.0x PB ratio and 26x 2013 P/E (2013 net profit of Rmb13.5m) for the assets, and will be funded by internal resources from its sizeable end-june gross cash and cash equivalents of over Rmb1.2bn. Valuation The share price has risen 39% YTD and the stock is currently trading at 15.4x 2014E P/E and 2.7x 2014E P/B. (Analyst: Joseph Ho, josephho@gfgroup.com.hk) China Vanke (2202 HK, NR): 1H14 net profit in line with consensus 1H14 net profit rose 6% YoY to Rmb4.8bn, in-line with consensus Revenue during the period declined 1% YoY to Rmb38.5bn; gross margin declined by 290bps YoY to 26.5%; other revenue & net income came in at Rmb1.3bn; EPS rose 7% YoY to Rmb0.44. No dividend was announced. The company currently has sold-but-unbooked GFA of 17.5m sqm. Review of operations Booked revenue from property development and sales accounted for 97.5% of total revenue; booked ASP rose 5% YoY to Rmb10,338 per sqm. The Guangshen and Shanghai regions accounted for 32% and 23% of total revenue respectively, and accounted for 51% and 28% of total net profit. Land bank review The company acquired 19 new projects in 1H14 with attributable GFA of 2.64m sqm at an average land premium of Rmb3,665 per sqm. It has GFA of 40m sqm in projects at the planning stage, enough for development over the next 2-3 years. Business partnership scheme to promote the sense of ownership The company set up a coinvestment scheme for non-director/supervisor employees during 1H14; 2.06% of its total shares (A-share) was purchased through the scheme during the period. Management bullish on urbanization in China As the largest mass-residential developer in China, management is bullish on the significant residential property demand from the ongoing urbanization process. The company will maintain a target sales rate of 60% for projects in their first month on sale, with its cash levels the major focus. Key advantages: mass-residential focus, standardized operation, collaboration with various land-owners The company has a brand name that is recognized nationwide and a large and loyal client base. It typically develops 50-60% of its land bank through joint-ventures with local land owners, and focuses on small/mid-sized mass-residential products, with centralized management and a standardized operating system and products. It has industry leading designs and an Page 4

5 industrialized production process. Construction is outsourced to various contractors, and it uses centralized procurement to ensure consistent construction quality and cost control. Positive on future earnings growth Given its mass-residential focus, fast asset turnover, proven execution and industry-leading management team, we expect its earnings to grow 10% YoY in 2014 and 10-20% YoY in We believe it will be one of the main beneficiaries of industry consolidation. We will have a conference call with China Vanke at 10-11am on Wed Aug 20. (Analyst: Dennis Yao, dennisyao@gfgroup.com.hk) Page 5

6 Hong Kong Equity 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. Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited ( GF Securities (Hong Kong) ) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies did not have any investment banking relationships with the companies mentioned in this research report in the past 12 months. (3) All of the views expressed in this research report accurately reflect the independent views of the analyst(s). Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the companies mentioned in this report, or has any financial interests in or holds any shares of the securities mentioned in this report. Disclaimer This report is prepared by GF Securities (Hong Kong). 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