Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Aug 20, 2015

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1 Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 14E 15E 14E 15E HSI HSCEI MXCN SHSZ SHCOMP SZCOMP INDU SPX CCMP UKX NKY Hong Kong ADRs HK Local Daily ADR Daily ticker Company (HK$) (%) (US$) (%) 857 PETROCHINA CHINA MOBILE ICBC CCB BANK OF CHINA TENCENT HSBC CHINA LIFE SINOPEC PING AN Econ data release China Data Date Period Prior Cons Caixin China Mfg PMI 20-Aug AUG P US Data Date Period Prior Cons Initial Jobless Claims 20-Aug 15-Aug Cont Jobless Claims 20-Aug 8-Aug Existing Homes Sales 20-Aug JUL Markit US Mfg PMI 21-Aug AUG P SPCS Composite Aug JUN Markit US Serv PMI 25-Aug AUG P Dur Goods New Ord 26-Aug JUL Source: Bloomberg GF events Date Event Location Aug Tibet-based listco visits Tibet 20 Aug Ourgame post-result NDR Shenzhen 20 Aug China Jushi post-result call - 20 Aug GF Financial Eng Annual Forum Dunhuang 21 Aug Tongda post-result meeting Hong Kong 24 Aug ChinaSoft post-result NDR Hong Kong 24 Aug YST post-result conf call Aug GF 2015 Autumn Investor Forum Hangzhou 28 Aug Kingdee post-result meeting Hong Kong 2 Sep Great Wall Motor site visit Baoding Source: GF Securities (HK) A-Share Market Pharmaceutical: Innovative and generic drug makers to benefit from drug approval reform The State Council has recently issued opinions on reforming the drug and medical equipment review and approval system, which we believe will likely speed up the new drug approval process. Innovative drugs will benefit from a special and express approval procedure. Higher standards will be used when reviewing generic drugs, which would increase R&D costs for drug companies and help to push smaller drug makers out of the market by raising entry barriers. New drug sales permits can now also be granted to companies focusing on drug R&D and sales. AVIC Capital ( CH): 1H15 comprehensive income surges 152% We remain positive on the company s growth outlook, and expect its financial holding platform and project incubator to see both organic and external growth. Some of the company s investment highlights include: 1) frequent stake increases by major shareholders and senior management demonstrate confidence in the company s growth prospects; 2) the company has solid fundamentals given stable growth in its financial holding business and sustainable high returns from its incubator; 3) the company benefits from space and arms industry asset securitization as well as SOE reform. Originwater Technology ( CH): Water purifier business main growth driver in 1H15 Water purifier revenue surged 273% with a gross margin of 55.7%, making it the main revenue growth driver. The company saw significant increases in its advance payments, inventory and operating cash outflow during 1H15, suggesting that it is actively pushing forward projects on hand. We expect to see a peak of PPP project launches in the near future, and remain positive on the company given expected strong earnings growth in the coming few years driven by the competitive edge introduced by CDB Innovation Capital and Originwater s large order backlog. Hong Kong Market Geely Auto (175 HK, Accumulate): Revenue up sharply but margins need to be improved 1H15 results beat expectation, with revenue up 35.9% YoY and net profit up 26.0% YoY, representing 56% of Bloomberg consensus for full-year earnings. However, profit margins did not perform in line with revenue. COGS rose by a considerable 40.5% YoY, resulting in a GP margin of 17.6%. Sales performance has been satisfactory despite a weaker auto market overall. With five new models to be unveiled in the next 12 months and impressive customer feedback on the B-class GC9, we believe Geely can maintain decent growth going forward. Maintain Accumulate. Tongda (698 HK, Buy): Rising metal casings contribution to drive growth 1H15 net income grew by 76% YoY, broadly in line with market expectation. Group sales grew by 37% YoY, and sales of smartphones casings grew by 83% YoY during the period and accounted for close to two-thirds of group sales, up from 46% of sales in 1H14. Management is upbeat on the business outlook for 2H15 and 2016, underpinned by the rise in industry adoption of metal casings. Despite the surge in share price, Tongda s valuation remains undemanding at 7.5x 2016E P/E. We raise our target price from HK$1.27 to HK$1.62, representing 26% upside. Kingdee (268 HK, Buy): 1H15 results miss on lower-than-expected sales 1H15 results missed, with revenue up just 1% YoY and net profit up 12% YoY, 10% below Bloomberg consensus and 5% lower than our forecast. While traditional ERP sales declined 4%, its emerging cloud service business maintained strong revenue growth of 82% to Rmb82m, representing 11% of total sales, compared to 6% one year ago. The not-so-good 12% YoY growth in net profit actually came from its non-core financial activities. The shares may come under selling pressure today. Continued on next page 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 Hong Kong Market (continued) Chinasoft (354 HK, Buy): Huawei business the key growth driver; maintain Buy Chinasoft reported solid 1H15 results on Tuesday, with net profit increasing by 38% YoY. The company hosted a conference call yesterday morning. The acquisition of Huawei s remaining interest in their joint venture is basically confirmed (but not yet executed), which will increase its net profit with a decrease in minority interest. We are positive on the company s business strategy and the overall outlook for the software sector in the medium term. Maintain Buy. Wasion GP (3393 HK, NR): 1H15 net profit up 25% YoY 1H15 revenue rose 17% YoY and net profit was up 25% YoY to Rmb253.8m, equal to 41% of fullyear Bloomberg consensus. Advanced Distribution Operations segment revenue was up 71% YoY, contributing 12% of total revenue; we expect rapid growth from this segment, the main growth driver, in the future. The State Grid Corporation of China plans to invest Rmb420bn in grid infrastructure in China this year (+24% YoY). Wasion will be the major beneficiary of this. Page 2

3 Pharmaceutical: Innovative and generic drug makers to benefit from drug approval reform Reform to speed up new drug approval The State Council has recently issued opinions on reforming the drug and medical equipment review and approval system, which we believe will likely speed up the new drug approval process. Slow new drug approval has been a major factor inhibiting sector growth. The CFDA receives more than 8,000 new drug applications every year but approves just 5,000 of them annually, with the application backlog now amounting to 19,000 items. Under the latest reform, the CFDA will strictly control the production of oversupplied generic drugs produced using outdated techniques. It will strive to clear the application backlog by end-2016 and begin to approve new drugs on schedule from 2018 onwards. Other highlights of the reform include: Faster approval for innovative drugs Innovative drugs will benefit from a special and express approval procedure, which would be favorable for innovative drug makers such as Hengrui Medicine ( CH). Higher standards for generic drugs Higher standards will be used when reviewing generic drugs, which would increase R&D costs for drug companies and help to push smaller drug makers out of the market by raising entry barriers. This should benefit generic drug markers with solid fundamentals such as Huadong Medicine ( CH), Salubris Pharmaceuticals ( CH) and Jingxin Pharmaceutical ( CH). Relaxed issuance of new drug sales permits In addition to companies actually manufacturing drugs, new drug sales permits can now also be granted to companies focusing on drug R&D and sales. This should benefit Haisco Pharmaceutical ( CH), Yifan Xinfu Pharmaceutical ( CH) and Gloria Pharmaceuticals ( CH). AVIC Capital ( CH): 1H15 comprehensive income surges 152% 1H15 comprehensive income surges 152% 1H15 comprehensive income and net profit surged 152% and 28% YoY thanks to continued growth in the company s financial holding platform and high investment returns from its project incubator. Net profit from its trust business rose 22% YoY as the amount of AUM picked up 29% YoY. Financial business net profit slid 5% YoY mainly due to a decline in its deposit balance. Leasing business net profit grew 66% YoY as business scale expanded. Net profit from its securities business surged 337% YoY driven by contributions from its brokerage, investment banking and asset management businesses. The company is seeing substantial floating gains from projects in its incubator, which is set to continue to benefit from its parent group s asset securitization. Investment highlights We remain positive on the company s growth outlook, and expect its financial holding platform and project incubator to see both organic and external growth. Some of the company s investment highlights include: 1) frequent stake increases by major shareholders and senior management demonstrate confidence in the company s growth prospects; 2) the company has solid fundamentals given stable growth in its financial holding business and sustainable high returns from its incubator; 3) the company benefits from space and arms industry asset securitization as well as SOE reform. Key risks include certain related-party businesses between the company s subsidiaries, and volatility in the military equipment industry. Originwater Technology ( CH): Water purifier business main growth driver in 1H15 Water purifier business main growth driver Net profit rose 12.8% YoY to Rmb153m on revenue of Rmb1.05bn (+5.99% YoY). It is worth noting that the company s business is highly seasonal with 4Q typically accounting for two-thirds of annual revenue and earnings. Water treatment revenue grew 8% YoY to Rmb670m, while water purifier revenue surged 273% to Rmb113m with a gross Page 3

4 margin of 55.7%, making it the main revenue growth driver. Municipal project engineering revenue dropped 21.5% YoY to Rmb268m. The company saw significant increases in its advance payments, inventory and operating cash outflow during 1H15, suggesting that it is actively pushing forward projects on hand. Growth sustainable given large project backlog CDB Innovation Capital s stake acquisition will enhance the company s business strength in various ways. In addition, the BT, BOT and PPP projects disclosed in the announcement of this latest placement involve total investment of Rmb9.78bn, three times the company s 2014 full-year revenue. We are therefore confident about the company s growth sustainability. Remain positive on company We expect to see a peak of PPP project launches in the near future, and remain positive on the company given expected strong earnings growth in the coming few years driven by the competitive edge introduced by CDB Innovation Capital and Originwater s large order backlog. Key risks include slower-than-expected execution of orders in the backlog, and declining gross margin amid fierce competition. Geely Auto (175 HK, Accumulate): Revenue up sharply but margins need to be improved What s new? Results beat expectation 1H15 revenue grew by 35.9% YoY to Rmb13.8bn, gross profit rose 17.9% YoY to Rmb2.4bn and net profit rose by 26.0% YoY to Rmb1.4bn. The result beat market expectation with 1H15 earnings representing 56% of Bloomberg consensus for full-year earnings of Rmb2,490m. While revenue grew consistently on strong sales volume (which rose by 34% YoY), cost of sales as well as distribution and selling expenses rebounded by 40.5% YoY, meaning GP and NI grew just moderately. EPS increased by 26.2% to Rmb Still benefitting from government subsidies The main contributor to other income was government subsidies. Subsidies grew by 11.3% YoY to Rmb532.6m during the period, and were mainly cash subsidies related to operation and R&D. Financial costs rose noticeably Due to interest expense on senior notes, the company s financial costs rose by 91.6% YoY to Rmb49.5m. As its bank and other interest income grew by 23.4% to Rmb28.5m, net financial costs rose to Rmb21.0m, up 6.6x. Cash from operations up considerably The company s 1H15 cash from operations grew 1.16x to Rmb4.4bn, which was a strong positive for the company s operations and a positive indication for its business outlook this year. Plans for new models The Emgrand EV and Emgrand SUV will be launched in 2H15; another SUV and two new sedan models will be launched in SC7, GC7, LG-1 and Panda series will also be upgraded. Interim dividend The company announced that no interim dividends will be paid to shareholders. Revenue growth in line on strong sales growth 1H15 sales volume rebounded strongly to reach 252,220 units, up 34.7% YoY. Its A-grade sedans (most significantly the Xindihao and New Vision models) maintained strong performance with 71% YoY growth to 179,236 units; its SUV segment (mainly supported by the GX7) grew by 15% YoY to 38,298 units. The company s strategy on the higher-end positioning of its sedan production proved strong so far. 5,783 GC9 units were sold in 1H15 since its launch in Mar this year, representing average monthly sales volume of 1,446 units; in Jul, the model reached 3,201 units. The company has also been conservative on price cuts which were previously aggressive for the current domestic auto market its ASP for 1H15 rose by 10.1% to Rmb53,583. With growth in sales volume and ASP, the company s total revenue grew noticeably. While the company maintains its official full year sales target of 450,000 units, the management is confident it can achieve higher volume given the YTD sales. Margins need to be improved Although revenue rose sharply on strong sales growth, profit margins did not perform in line with revenue. Due to R&D costs and production costs related to new launches this year, COGS rose by a considerable 40.5% YoY, resulting in a GP margin of 17.6%. GP margin declined 13.3% YoY coming in lower than its 3-year average of 19%. Distribution and selling expenses also increased noticeably by 40.5% YoY, accounting for 5.7% of revenue. However the proportion was in line with the company s 3-year average of 5.6%; the increase was mainly due to the lower comparable base in 1H14 when the company adjusted its sales network. EBT margin came in at 12.6%, down by 10.8% YoY, while this was slightly beyond the 3-year average of 12.3%. NI margin dropped by 7.2% to 10.1% but was maintained around the 3-year Page 4

5 average of 9.9%. Considering the cost of new launches in 1H15, we believe margins could gradually improve when production scale grows with the ramp up in sales in 2H15. Foreign exchange risk will be closely monitored by management Given previous foreign exchange losses mainly due to the depreciation of the Russian Ruble in 2014, the company has implemented strict control on exports and foreign exchange management this year. Exports were down 47.9% YoY to 17,883 units during 1H15, and were 7.1% of total sales volume (9.2% in 2014). In addition, most of the company s export sales are denominated in US$ this year. We believe that both are beneficial to the company s foreign exchange risk management. Further, to mitigate foreign exchange risk, the company plans to build additional overseas plants to increase its costs in local currencies when engaging local businesses, especially for the company s local subsidiaries, associates or joint ventures. In our view, this will consolidate its foreign exchange management in the future. Impact of Rmb depreciation The recent depreciation of the Rmb will benefit the company s exports, but due to the current small proportion of exports for the company, we see little profit growth from this. Investors should also note that the company issued senior notes with a principal of US$300m in Oct 2014, for which interest expenses in 1H15 was equivalent to Rmb1.98m. As the Rmb has recently depreciated by around 3% and there is uncertainty surrounding further depreciation this year and the high possibility that the US will raise interest rates in 2H15 resulting in an appreciation of the US$, the company may incur more interest expenses from its senior notes in 2H15 when converted to Rmb. Maintain Accumulate Sales performance has been satisfactory during the year despite a weaker auto market overall. With five new models to be unveiled in the next 12 months and impressive customer feedback on the B-class GC9, we believe Geely can maintain decent growth going forward. We maintain our Accumulate rating. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Chongjing Deng, Research Analyst, SFC CE No. BEY953, dengchongjing@gfgroup.com.hk ) Tongda (698 HK, Buy): Rising metal casings contribution to drive growth What s new? 1H15 net income grew by 76% YoY, broadly in line with market expectation. Robust growth driven by surge in sales of smartphone casings Group sales grew by 37% YoY to HK$2.9bn. Sales of smartphones casings grew by 83% YoY during the period and accounted for close to two-thirds of group sales, up from 46% of sales in 1H14. Key customers for its smartphone casings include Huawei (25% of group sales), Xiaomi (20% of group sales) and OPPO (less than 10%). 1H15 gross profit margin improved to 23.5%, up from 23.0% in 1H14, driven by a rise in the proportion of sales of metal casings during the period. Separately, effective opex control also contributed to the strong bottom line growth (1H15 opex-to-sales dropped to 8.7%, down from 10.5% in 1H14). Efficient use of CNC machines to lower capex and enhance return Tongda currently has about 1,500 sets of CNC machines for the manufacture of metal casings. The number of sets will increase to 2,000 by the end of Tongda adopts a more effective use of the CNC machines by combining the CNC metal casing process with metal stamping, die-casting and nano molding technologies to reduce CNC machine run-time per casing. This approach has helped to reduce the company s significant capex investment in CNC machines and improve profit margin by lowering depreciation expenses. There is little pressure on further capex spending, with 2015 full year capex expected to come in at HK$650m (1H15 capex: HK$489m). In addition, the company also outsources some of its CNC manufacturing to third parties. Positive outlook for 2H15 Management is upbeat on the business outlook for 2H15 and 2016, underpinned by the rise in industry adoption of metal casings. Some of the key models that Tongda is involved with include Huawei s Mate 7, Xiaomi s Mi 4, the Redmi Note 2, and OPPO s R7. Metal smartphone casings should account for 20-25% of total output in 2H15, up from 10% in 1H15, according to management. For 2016, metal casings are expected to account for 30-50% of total shipments. Interim dividend Management declared an interim dividend of HK$1.6 cents (+60% YoY), based on a dividend payout of 30%. Management has guided for a full-year dividend payout of 30-35%. Page 5

6 Undemanding valuation The stock has outperformed the market this year, rising 40% YTD. Despite the surge in share price, its valuation remains undemanding at 7.5x 2016E P/E. We raise our target price to HK$1.62 (from HK$1.27), representing 26% upside, after rolling over to our 2016 EPS estimate of HK$0.17 (from 2015 EPS basis) on an unchanged target P/E of 10x. Risks Key risks include a rapid slowdown in China s smartphone market, a poor yield rate for metal casings, and delays in the installation of CNC machines. (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) Kingdee (268 HK, Buy): 1H15 results miss on lower-than-expected sales 1H15 results miss Kingdee recorded net profit of Rmb92m in 1H15, up 12% YoY, 10% below Bloomberg consensus and 5% lower than our forecast. 1H15 diluted EPS grew 10% YoY to Rmb3.28 cents. Revenue of Rmb758m was up just 1% YoY, lower than our estimate. While traditional ERP sales declined 4% to Rmb676m (89% of total sales), its emerging cloud service business maintained strong revenue growth of 82% to Rmb82m, representing 11% of total sales, compared to 6% one year ago. Operating margin contraction 1H15 operating profit came in at a 5% YoY decrease to Rmb130m. Operating margin dropped 1.1pp YoY to 17.2% in 1H15, along with an 1.8pp decline in gross margin. Net margin rose 1.2pp YoY to 12.1% in 1H15, mainly due to a decrease in net financial costs. Operating cash flow was stable at Rmb158m in 1H15, versus Rmb151m one year ago. Be cautious 1H15 results missed on lower-than-expected revenue and a slight operating margin contraction. The not-so-good 12% YoY growth in net profit actually came from its non-core financial activities. Our full-year earnings forecast is now under review. The stock is trading at 27x FY15E P/E, based on Bloomberg consensus. The shares may come under selling pressure today. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) Chinasoft (354 HK, Buy): Huawei business the key growth driver; maintain Buy What s new? Chinasoft reported solid 1H15 results on Tuesday, with net profit increasing by 38% YoY to Rmb140m, beating market expectation. Revenue grew by 23% YoY to Rmb2389m. EBITDA rose by 18% YoY to Rmb272m. The company hosted a conference call yesterday morning. Huawei business to be the key growth driver Huawei is Chinasoft s single largest client, accounting for 68% of outsourcing service (OSG) sales, and 33% of total revenue in 1H15. OSG posted solid revenue growth of 21% YoY in 1H15, mainly due to the strong 32% YoY growth in its Huawei business, while sales from its other outsourcing service clients increased by a moderate 3% YoY. The company will maintain its strategic focus on Huawei. As a giant in the telecommunication industry, Huawei is showing strong momentum in enterprise services, benefiting from its strong R&D capabilities and import substitution in the domestic IT sector. As one of Huawei s key partners, Chinasoft will expand their cooperation from the outsourcing service to professional service and cloud service businesses globally. Management expects the company to see solid YoY growth of 20-30% in its business with Huawei over the next 2-3 years. Margin uptrend Gross margin dropped 1.6pp YoY to 28.4% in 1H15, mainly due to increased sales in its zero-profit hardware business, which accounted for 8% of total revenue in 1H15, compared with 1% one year ago. Stripping out hardware sales, gross margin from service revenue rose 0.3pp from 30.4% in 1H14 to 30.7% in 1H15. Net margin rose 0.6pp to 5.8% in 1H15, partly due to the adjustment in minority interest related to the Chinasoft-Huawei joint venture. We believe total profit margin (including minority interests) would be a better indicator, which rose 0.1pp from 5.9% in 1H14 to 6% in 1H15. Management has guided that profit margin should maintain a moderate uptrend in the next few years, with improving management efficiency and more businesses moved to the JointForce platform. JointForce on track The company is speeding up its promotion of the JointForce platform both online and offline. Regional promotion will be introduced in eight selected cities in 2H15. The company has started with Wenzhou, Zhejiang, targeting to attract 4,000 small-medium companies. By the end of Jul, the number of registered engineers had reached 41,000 (12,000 of which are Page 6

7 internal), compared with 8,000 at the end of The number of outsourcing enterprises also topped 1,600. The company gave a strong target of 100,000 registered engineers and 10,000 enterprises by the end of this year. Maintain Buy The acquisition of Huawei s remaining interest in the joint venture is basically confirmed (but not yet executed), which will increase its net profit with a decrease in minority interest. Its growth visibility is now clearer given strengthening and extending cooperation with Huawei. JointForce promotion is on track. We are positive on the company s business strategy and the overall outlook for the software sector in the medium term. We maintain our Buy rating. The stock is trading at 15.3x 2015E P/E, based on our estimates. (Ryan Zhu, Research Analyst, SFC CE No. BDK820, zhuran@gfgroup.com.hk ) Wasion GP (3393 HK, NR): 1H15 net profit up 25% YoY What s new? Wasion GP is a solution provider of metering, distribution and energy efficiency management services in China. 1H15 net profit rose 25% YoY to Rmb253.8m, equal to 41% of fullyear Bloomberg consensus. Revenue grew by 17% YoY to Rmb1,603.1m; gross profit increased 8.9% YoY to Rmb497.1m, and GPM declined from 33% to 31%. ADO segment the main growth driver Thanks to increasing demand for energy efficiency services and smart grid development in China, the company s ADO (advanced distribution operations) segment revenue was up 71% YoY to Rmb195.9m, contributing 12% of total revenue. The Chinese government targets to achieve an 80% penetration rate for ADO in 2020, up from 10% now. We believe Wasion s ADO segment will maintain rapid growth in the near future. Steady growth in AMI business and SM segment Revenue from the company s AMI (advanced metering infrastructure) and SM (smart meter) segment was up 15% to Rmb830.7m and 9% to Rmb576.5m respectively. The segments contributed 52% and 36% of total revenue respectively. Valuation The stock is down 30% from its 52-week high, but still up 20% YTD. The State Grid Corporation of China plans to invest Rmb420bn in grid infrastructure in China this year, representing a YoY increase of 24%. Wasion will be the major beneficiary of this. The stock is currently trading at 11x 2015E P/E based on Bloomberg consensus. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk ) Page 7

8 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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