Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Nov 16, 2016

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1 Equity Research Dim Sum Express 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 CHINA MOBILE ICBC PETROCHINA CCB HSBC BANK OF CHINA PING AN CHINA LIFE SINOPEC Source: Bloomberg A-Share Market Non-Bank Financials: Potential year-end rally on rebounding earnings, SZHK Connect and pension trial Market sentiment is stabilizing towards the end of the year despite complicated external conditions: the A-share market has continued to rise steadily recently despite further weakening of the Rmb exchange rate and the surprising result of the US presidential election. The net profit decline at listed securities firms narrowed substantially in 9M16 mainly thanks to the significant rebound in stock trading volume. In addition, annualized investment yields at insurance firms have picked up, while agency-channel life insurance has maintained relatively high new business growth. We see the upcoming launch of the Shenzhen-HK Stock Connect and expected trials for a tax-deferred pension as two potential catalysts worth watching. Power Equipment/New Energy: Positive on wind power industry and vehicle electrification Based on targets set out in the newly released 13th FYP for power industry development, the wind power industry in China will grow at a CAGR of 10-20% during the FYP period. We believe industry leaders are set to benefit from continued market share expansion. The sales volume of new energy PVs rose 52% YoY to 30,989 units in Oct, marking the fourth consecutive month when sales volume stayed at around 30,000 units. We remain positive on growth opportunities for new energy PVs amid the global trend of vehicle electrification. The sector is likely to experience a share price rally once short-term policy uncertainties are removed. Hong Kong Market Investment Strategy: Stocks to ride a new wave of southbound trading It has been reported that the Shenzhen Hong Kong Stock Connect will be officially launched soon. Although southbound trading has recently subsided slightly, the official launch of the Shenzhen Hong Kong Stock Connect will undoubtedly extend the growing southbound trading trend in the months and years ahead, given the growing need among mainland investors to diversify their assets to different classes and regions, and the general perception of a weakening renminbi. We believe yield plays are still a critical target for southbound interest. We have put together a top-ten watchlist for southbound trading please see full text. BOC Aviation (2588 HK, Accumulate): Strong growth expected; maintain Accumulate with TP of HK$47.00 The company has a young and well managed aircraft portfolio, and a diverse leasing customer base with solid records of advance lease arrangements and aircraft utilization rates. As is shown by its 3Q16 operating results, BOC Aviation has solid fundamentals and promising growth prospects. We expect the company to maintain sound lease quality and steady fleet growth. Given strong delivery and asset expansion expectations, we forecast revenue of US$1,184m/1,356m/1,619m and net profit of US$401m/444m/542m in 2016/17/18. We maintained our Accumulate rating and target price of HK$47.00, representing 1.1x 2017E P/B and 9.5x 2017E P/E. 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 Non-Bank Financials: Potential year-end rally on rebounding earnings, SZHK Connect and pension trial Market sentiment is stabilizing towards the end of the year despite complicated external conditions: the A-share market has continued to rise steadily recently despite further weakening of the Rmb exchange rate and the surprising result of the US presidential election. The SHCOMP has risen by 20.25% from the low reached earlier this year following the crash caused by the circuit breaker mechanism. Furthermore, the negative effects of low interest rates and the general shortage of high-yielding assets to invest in (which have plagued the sector throughout this year) is being factored in by the market, with insurance companies achieving higher annualized investment yields in 9M16 compared with 1H16. Earnings inflection point emerging The non-bank financial sector has posted share price growth of 10.4% and 7% over the past 60 and 20 days; a similar situation was observed towards end-2014, which helped drive the sector rally in While listed securities firms net profit dropped 49.3% YoY to Rmb67bn in 9M16, the decline narrowed substantially mainly thanks to the significant rebound in stock trading volume. In addition, annualized investment yields at insurance firms have picked up, while agency-channel life insurance has maintained relatively high new business growth. Two catalysts towards year-end We see the upcoming launch of the Shenzhen-HK Stock Connect and expected trials for a tax-deferred pension as two potential catalysts worth watching as we come closer to the end of the year. The SZHK Stock Connect will help make the A-share market more internationalized and give a direct boost to market trading volume. Trading quotas currently applicable to the SHHK Stock Connect might be removed for the SZHK Connect, while a longer list of stocks to be included in cross-border trading will further promote market integration. Our watch list Based on historical valuations, the non-bank financial sector still offers a margin of safety and share price upside. The sector will become even more attractive if a short-term rally is established in the market. We like Huatai Securities ( CH), Guoyuan Securities ( CH), Soochow Securities ( CH), Dongxing Securities ( CH), Ping An Insurance ( CH) and New China Life Insurance ( CH). Power Equipment/New Energy: Positive on wind power industry and vehicle electrification 13th FYP setting targets for wind power development The NDRC and NEA issued the 13th FYP for power industry development last week, setting targets for wind power installed capacity across the country to exceed 210GW (with ~5GW of offshore wind power installed capacity) and solar power installed capacity to exceed 110GW (with 60GW+ of distributed solar capacity and 5GW of concentrated solar power generation capacity) by Based on these targets, the wind power industry in China will grow at a CAGR of 10-20% during the FYP period. We believe industry leaders are set to benefit from continued market share expansion, and we like Goldwind Science & Tech ( CH), Taisheng Wind Power ( CH), Titan Wind Energy ( CH) and Funeng ( CH). 10M16 NEV sales volume more than doubled According to the CPCA, the sales volume of new energy passenger vehicles rose 52% YoY to 30,989 units in Oct, marking the fourth consecutive month when sales volume stayed at around 30,000 units. 10M16 sales volume surged 110% to 240,000 units, reflecting the continuation of strong sales growth. We remain positive on growth opportunities for new energy passenger vehicles amid the global trend of vehicle electrification. The sector is likely to experience a share price rally once short-term policy uncertainties are removed. We prefer Aucksun ( CH), Guoxuan High-Tech ( CH), Far East Smarter Energy ( CH), Founder Motor ( CH), Cangzhou Mingzhu Plastic ( CH), Hongfa Technology ( CH) and CEEPOWER ( CH). Investment Strategy: Stocks to ride a new wave of southbound trading On your marks, get set It has been reported that the Shenzhen Hong Kong Stock Connect will be officially launched soon. Based on previous announcements, Hong Kong stocks for southbound trading will include stocks in the HS Composite Small Cap Index (HSSI) with market caps of over HK$5bn and dual-listed Shenzhen A-H shares, on top of the existing stocks in the HS Composite Page 2

3 Large Cap Index (HSLI), the HS Composite Mid Cap Index (HSMI), and Shanghai A-H shares under the Shanghai Hong Kong Stock Connect. Southbound trading to regain momentum Since the launch of the Shanghai Hong Kong Stock Connect, mainland investors participation in the Hong Kong market through this system of mutual access has grown substantially. Total southbound net buying amounted to HK$230bn between Sept 2015 and Oct 2016, while southbound trading as a percentage of Hong Kong average daily turnover surged from 2.1% in Sept 2015 to 10.8% in Sept Although southbound trading has recently subsided slightly due to the week-long National Day holiday and a weaker Hong Kong market due to global uncertainties, the official launch of the Shenzhen Hong Kong Stock Connect will undoubtedly extend the growing southbound trading trend in the months and years ahead, given the growing need among mainland investors (including institutions, corporate and individuals) to diversify their assets to different classes and regions, and the general perception of a weakening renminbi. Tracking southbound trading interest On top of the advantage of Hong Kong shares being denominated in HK dollars, mainland investors are typically interested in yield plays, relatively stable businesses and income, and tech or high growth stocks, we believe. These characteristics are also reflected in the top-ten actively traded stocks over the last ten months, where banks and Tencent have consistently been in the list, and insurance, auto and property stocks have entered the list from time to time. With A/H-share price differentials narrowing, especially for some Chinese banks, Shenzhen investors may be slightly more interested in tech and high growth stocks, in our view. Watchlist for the Stock Connect Despite the high chance of a US interest rate hike in Dec and the ongoing interest rate upcycle, interest rates are likely to remain relatively low in the short to medium term. As a result, we believe yield plays are still a critical target for southbound interest, as dividend payments can mitigate potential losses from renminbi depreciation. Based on a criteria of: 1) relatively stable business; 2) ~5% dividend yield (still compares favorably with the 10-year US treasury yield); 3) positive EPS growth in 2017E, and; 4) 30%+ earnings growth tech stocks (for those with low yields), we have put together a top-ten watchlist for southbound trading which we believe should see interest from mainland investors. The list: HSBC (5 HK, NR), Red Star Macalline (1528 HK, NR), BOC HK (2388 HK, NR), PCCW (8 HK, NR), Xtep (1368 HK, Hold), Sands China (1928 HK, NR), CCB (939 HK, NR), Xinjiang Goldwind (2208 HK, NR), VTech (303 HK, Hold) and Tencent (700 HK, NR). (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk ) BOC Aviation (2588 HK, Accumulate): Strong growth expected; maintain Accumulate with TP of HK$47.00 What s new? Global markets went through some turbulence following Trump s victory for the presidency. The 10-year US treasury bond yield jumped 20bps on the election day, before rushing further to 2.14% last Thursday, a record high since Jan. The US Dollar Index has remained strong after the election, and the Rmb weakened by 230bps against the US dollar on Nov 11, dropping below 6.8 for the first time in six years. US$-denominated assets benefiting from currency appreciation Judging by latest market reactions, the outcome of the election has not changed the strong momentum of the US dollar, which might further strengthen the widespread expectation that Rmb devaluation will continue. As business transactions in the aircraft leasing industry are denominated in US dollars, the strength in the currency makes BOC Aviation s assets more attractive compared with other Chinese financial institutions. In addition, the company s local operating expenses might decrease on the back of US dollar appreciation, while borrowings denominated in other currencies have been fully hedged according to its interim report. Well-prepared for US rate hike Given the rise in the treasury bond yield and a strengthening inflation outlook driven by Trump s economic development plans, the Fed might raise the benchmark interest rate faster than previously expected over the next two years. We expect BOC Aviation s funding cost to increase from 2% in 2015 to 2.3%/2.6%/2.7% in 2016/17/18. Meanwhile, the company has carefully matched its leases and debt to control interest rate risk. As at 30 June 2016, the company s floating-rate leases were 100% backed by floating-rate debt, while the proportion of fixed-rate debt had increased to 35.5% from 19.5% at end-2015 so as to cater increased customer demand for fixed-rate leases. 80% of the company s mismatched interest rate Page 3

4 exposure had been hedged. According to the company s estimates, a 10bps increase in interest rates would reduce annual profit by US$1m, which is minimal given the company s 1H16 net profit of US$239.5m. 3Q16 operating performance As of 30 Sept 2016, the company had a fleet of 231 owned aircrafts and 38 managed aircrafts, with an average aircraft age of 3.4 years and average remaining lease term of 6.9 years. The 215 aircraft on its order book suggests average deliveries of 41 aircrafts per year during All of the aircrafts delivered to the company during 2016 have been leased out, while 90% of the upcoming deliveries in 2017 have also been placed with lessees: the company has kept a 100% aircraft utilization rate. Well managed fleet and leasing business The company has a young and well managed aircraft portfolio, and should continue to grow relying on its considerable financial strength; these are the two key drivers of leasing income growth for the company. Annual aircraft deliveries from manufacturers are estimated to be 40 units based on the order book, but we believe actual deliveries over the coming three years might be greater than estimated, as 40 aircrafts were already delivered during 3Q16. On top of a quickly expanding fleet, the company also has a diverse leasing customer base comprising 67 airlines across 31 countries, and it has maintained solid records of advance lease arrangements and aircraft utilization rates. Investment highlights As is shown by its 3Q16 operating results, BOC Aviation has solid fundamentals and promising growth prospects. We expect the company to maintain sound lease quality and steady fleet growth. Given strong delivery and asset expansion expectations, we forecast revenue of US$1,184m/1,356m/1,619m and net profit of US$401m/444m/542m in 2016/17/18. We maintained our Accumulate rating and target price of HK$47.00, representing 1.1x 2017E P/B and 9.5x 2017E P/E. Key risks include the company s fleet expansion falling short of expectation, a drop in the aircraft lease rate factor due to intensified competition, a rise in the company s financing cost due to the cessation of low-cost financing support from Bank of China (3988 HK, NR), and aviation-related black swans such as terrorist attacks and political tension. The company will see its restricted shares come out of lockup on Dec 1, which might cause short-term share price fluctuations. (Wang Wen, Research Analyst, SFC CE No. BGL298, wangwen@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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