Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Mar 4, 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 HSBC TENCENT CHINA LIFE SINOPEC PING AN Econ data release China Data Date Period Prior Cons Trade Balance 8-Mar FEB Export Trade YoY 8-Mar FEB Import Trade YoY 8-Mar FEB CPI 9-Mar FEB PPI 9-Mar FEB US Data Date Period Prior Cons Markit US Serv PMI 4-Mar FEB F ISM Non-Mfg NMI 4-Mar FEB Initial Jobless Claims 5-Mar 28-Feb Cont Jobless Claims 5-Mar 21-Feb Trade Balance 6-Mar JAN Unemployment Rate 6-Mar FEB Source: Bloomberg GF events Date Event Location 3-5 Mar GF 2015 Industrial Internet Forum BJ, SH, SZ Source: GF Securities (HK) A-Share Market Environmental: Appointment of new minister to drive growth The Ministry of Environmental Protection appointed a new head with considerable experience in the sector. We have almost reached the limits of potential pollution, the sector is shifting towards a mode of operation with supervision, and there should be a significant increase in independent management, something which should drive the sector s development in terms of its operation. Leading companies with sufficient capital and strong brands will maintain growth. Large orders should continue to bring small companies out of their growth bottleneck. Natural Gas: Structural reforms accelerated The NDRC announced that natural gas prices in China will officially merge from April The maximum price of incremental natural gas will drop by Rmb0.44 per cubic meter, while the maximum price of existing gas will increase by Rmb0.04 per cubic meter. The prices of natural gas for residential use will not be changed at present. However, a tiered pricing system will be established within Gas pricing for direct supply will begin with prices negotiated based on supply and demand, something we believe is a way of further exploring marketization and reforms. Pharmaceuticals: Watch OTC drug companies By the end of Feb, 24 pharmaceutical companies had released their 2014 results, and 83 had issued earnings alerts. The companies that have disclosed results recorded average growth of 14.94% YoY in FY14, lower than the 15.84% in FY13 and 15.04% during 9M14. Net profit increased by an average of 20.44% YoY, higher than the 9.02% in FY13 and 18.37% in 9M14. Sales in the pharmaceutical market are expected to have increased 13.4% YoY during FY14. However, growth in prescription drugs has started to slow, led by a decrease in drug binding prices and health insurance fee control. Hong Kong Market Retail: Jan HK retail sales below expectation HK retail sales dropped 14.6% YoY in Jan (vs -4% in Dec), below market expectation of a 6.1% YoY decline. We expect the consolidated Jan & Feb 2015 retail sales growth to improve significantly compared to Jan 2015 thanks to the extended festive shopping season. Looking forward, softening mainland visitor arrivals and their decreasing purchasing power are major challenges for HK retail sector. Sector visibility is also clouded by a potential spate of protests against parallel traders. The key point to watch this month is the discussion of the Individual Visitor Scheme during the NPC meeting. TCL Comm (2618 HK, Buy): Rating upgrade on upbeat 2015 guidance 2014 net profit grew 249% YoY, in line with consensus. Gross profit margin improved sequentially during 4Q14, finishing at 19.2% on gains due to economies of scale during the peak season full-year sales grew by a strong 59% YoY on robust volume growth (+33% YoY) and a rise in ASP (+19% YoY). Management gave guidance for 30% YoY sales growth in 2015, which is above current Bloomberg consensus of about 20%. We raise our sales and net profit forecasts for We upgrade the stock from Hold to Buy, and set a new 12-month TP of HK$9.37 (20% upside), up from HK$7.81. 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 Environmental: Appointment of new minister to drive growth New environmental minister appointed The Ministry of Environmental Protection appointed Chen Jining as its new head. Mr Chen is the former president of Tsinghua University and has considerable experience in the environmental protection sector. He particularly has a strong reputation in sewage treatment. New situation for the sector We have almost reached the limits of potential pollution, the sector is shifting towards a mode of operation with supervision, and there should be a significant increase in independent management, something which should drive the sector s development in terms of its operation. Growth expected Leading companies with sufficient capital and strong brands will maintain growth. Large orders should continue to bring small companies out of their growth bottleneck, leading to rapid growth. In addition, local SOEs in the sector will grow and break through their regional limits with the release of PPP projects and SOE reform. Environmental protection policies and events The Ministry of Housing and Urban-Rural Development recently released a regulation aimed at the enforcement of sewage treatment and guaranteeing safe operation. The NDRC and Environmental Protection Department of Shaanxi Province release a program focusing on the transformation of coal-fired thermal power of 300,000kw and above, which is expected to be finished in three years. Natural Gas: Structural reforms accelerated Gas pricing merged The National Development and Reform Commission announced that natural gas prices in China will officially merge from April The maximum price of incremental natural gas will drop by Rmb0.44 per cubic meter, while the maximum price of existing gas will increase by Rmb0.04 per cubic meter. The prices of natural gas for residential use will not be changed at present. However, a tiered pricing system will be established within Gas pricing for direct supply will begin with prices negotiated based on supply and demand. Gas costs to decline; high sales volume growth We estimate a linkage pricing mechanism will start within 2015, aiming to fix the gas pricing adjustment. The changed gas prices still have room for a downward adjustment, when compared to fuel prices. The energy switch from coal to gas in cities driven by environmental protection will greatly contribute to a sales volume increase for natural gas. Given that the gas ASP is expected to go down, the market expects downstream customers to become more active. Structural reforms accelerated by opening direct supply and purchase rights We believe the opening of gas pricing for direct supply is a way of further exploring marketization and reforms. Shaanxi Provincial Natural Gas ( CH) and Shanxi Guoxin Energy ( CN) will benefit directly. Meanwhile, The National Development and Reform Commission approved the Oil and Natural Gas Trading Center in Shanghai, aiming to boost the marketization of LNG pricing. Import rights for natural gas are expected to be further opened. Gas distributors will become independent energy suppliers following the accelerated reforms. A new round of growth is expected. Our preferred names include Shaanxi Provincial Natural Gas ( CH), Shanxi Guoxin Energy ( CH), Shenzhen Gas ( CH), Shenergy ( CH) and Jinhong Energy( CH). Pharmaceuticals: Watch OTC drug companies Acceleration in earnings growth By the end of Feb, 24 pharmaceutical companies had released their 2014 results, and 83 had issued earnings alerts. The companies that have disclosed results recorded average growth of 14.94% YoY in FY14, lower than the 15.84% in FY13 and 15.04% during 9M14. Net profit increased by an average of 20.44% YoY, higher than the 9.02% in FY13 and 18.37% in 9M a key year for bidding Overall bidding prices in Hunan declined by 10% in Feb, while bargaining varieties price declined more clearly. The general office of the state council issued its guidelines for perfecting drug centralized procurement in public hospitals in Feb, which kept the existing bidding system and emphasized auxiliary medication, without clear statements on Page 2

3 secondary bargaining. Many of the rules should benefit preparations exports, children's medicines, infusion, anesthesia, and Chinese traditional medicine plays. The guidelines explicitly mentioned the requirement of accelerating bidding progress in each province. Prescription drugs focus on innovation Sales in the pharmaceutical market are expected to have increased 13.4% YoY to Rmb1245.7bn in FY14 and reach Rmb1407bn in FY15, rising 12.9% YoY. Growth in prescription drugs has started to slow, led by a decrease in drug binding prices and health insurance fee control. Under this new situation, investors should pay more attention to innovation capabilities and business models at prescription drugs companies. OTC drug firms and traditional Chinese medicines Except prescription drugs, other segments which are not affected by the policy are also worth watching. 1) The national basic medicine policy had a huge impact on the OTC industry during In recent years, some strong OTC drug firms have seen positive trends through product structure adjustments. We prefer Jiangzhong Pharmaceutical ( CH). 2) 2015 is the last year before the new GMP certification for traditional Chinese medicine decoction pieces. As a result, the majority of small plants operated as individual households or small workshops will be forced out of the industry. We prefer Xiangxue Pharmaceutical ( CH). Retail: Jan HK retail sales below expectation Jan retail sales below expectation HK retail sales dropped 14.6% YoY in Jan (vs -4% in Dec), below market expectation of a 6.1% YoY decline. Apart from the calendar shift for CNY (from Jan to Feb ), we think the declining purchasing power of mainland visitors, led by a decrease of overnight mainland visitors, was another reason for the weak retail sales. Food and supermarkets sales growth saw a noticeable slowdown from +7.4% to -8.7% and 0% to -13.1%, respectively, compared to Dec due to the CNY calendar shift. For other categories, consumer durable goods sales growth eased most compared to Dec (from 3.8% to -20.3%), followed by apparel (from -4% to -13.8%), department stores (from -5.6% to -11.3%), jewelry (from -16.3% to %) and cosmetics and medicines (from +4.2% to -0.1%). Slowdown in mainland Chinese tourist arrivals Mainland Chinese tourist arrivals rose 3.3% YoY in Jan 2015, lower than the 13.2% in Dec. Growth in same-day and overnight visitors dropped MoM from 17.6% to 8% and 6.6% to -4.5%, respectively. Such a mix of mainland visitors resulted in lower purchasing power. Though this set of figures was distorted by the different timing of the CNY holiday, the subsequent decline in mainland visitors seen during the CNY holiday showed a softening in mainland tourist arrivals. We believe this is due to the strong US$ and the protests against parallel traders. Sector underperformed in Jan Shares across the sector fell 6% MoM on average in Feb, weaker than the flat HSI. The unexpected 0.2% YoY decline in mainland visitor arrivals during the CNY holiday negatively affected sector sentiment. Watch retailers led the decline with Emperor Watch (887 HK, NR) and Oriental Watch (398 HK, NR) dropping 27% and 9%, respectively. Jewelry names also saw 5-12% decline as Chow Tai Fook (1929 HK, Hold) reported disappointing SSS during the CNY period. Street-shop rental to fall in 2015 According to Savills, overall prime street shop rental fell 3% QoQ in 4Q14 as retailers have been increasingly selective and cautious in committing to new space with tighter rental budgets. Savills cut its forecast for prime street shop rental from a 5% decline in 2015 to a 10-15% decline. On the other hand, rental growth in shopping centers is expected to increase 5-10% in Outlook We expect the consolidated Jan & Feb 2015 retail sales growth to improve significantly compared to Jan 2015 thanks to the extended festive shopping season. Looking forward, softening mainland visitor arrivals and their decreasing purchasing power are major challenges for HK retail sector. Sector visibility is also clouded by a potential spate of protests against parallel traders. The key point to watch this month is the discussion of the Individual Visitor Scheme during the NPC meeting. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) Page 3

4 TCL Comm (2618 HK, Buy): Rating upgrade on upbeat 2015 guidance Upgrade to Buy We upgrade TCL Comm from Hold to Buy following upbeat 2015 guidance from management results in line with expectation Net profit grew 249% YoY to HK$1.1bn, in line with Bloomberg consensus. Gross profit margin improved sequentially during 4Q14, finishing at 19.2% on gains due to economies of scale during the peak season. TCL was the number 4 ranked handset maker globally in 4Q14 with shipments of 24.9m units (+30% YoY), giving it a market share of 4.7%, behind Samsung (17.4%), Apple (14.3%) and Microsoft-Nokia (13.6%) full-year sales grew by a strong 59% YoY to HK$30.7bn on robust volume growth (+33% YoY) and a rise in ASP (+19% YoY). The company continues to sell most of its products abroad, with over 90% of sales from overseas markets during 2014 (largely via carrier channels). Sales in Americas, which accounted for over half of group revenue, were strong, growing 82% YoY during the year. Upbeat 2015 guidance Management gave guidance for 30% YoY sales growth in 2015, which is above current Bloomberg consensus of about 20%. This growth will come from both an increase in volume and further ASP improvements, while gross profit margin will remain at a "healthy" level, according to management. Upward earnings revisions: we now expect high-teen earnings growth in 2015 We have raised our 2015 sales forecast following the upbeat 2015 guidance. We now expect 27% YoY sales growth during the year, up from our previous forecast of 19%. We have also raised our 2015 net profit estimate by 19% to HK$1.27bn. We now forecast 18% YoY net profit growth in 2015, up from our previous forecast of flattish earnings. 1Q15 forecast industry low season We expect gross profit margin to gradually decline during 1Q15, the industry s low season, due to a QoQ decline in shipment volume. However, on a YoY basis, we expect a 15% increase in mobile phone shipments. Upgrade to Buy; TP raised The company s shares have traded sideways over the past four months since our initiation in late Oct. We upgrade the stock from Hold to Buy, and set a new 12-month target price of HK$9.37 (20% upside), up from HK$7.81, based on our revised 2015 EPS estimate and an unchanged 2015 target P/E of 9x, compared to 15x forward P/E for Apple (AAPL US, NR). The stock is trading at 7.5x forward PER and offer a decent dividend yield of 5.3%, based a 40% dividend payout ratio. Risks Downside risks include 1) Samsung steps up efforts to regain traction in the low-end smartphone market; 2) further sharp depreciation of the euro and Latin American currencies. (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@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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