Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Feb 17, 2017

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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 ICBC CHINA MOBILE PETROCHINA CCB HSBC BANK OF CHINA CHINA LIFE SINOPEC PING AN Source: Bloomberg GF events Date Event Location 28 Feb 2017 China healthcare sector outlook with industry expert Shenzhen 23 Mar Q Tech post-result NDR Hong Kong Source: GF Securities (Hong Kong) A-Share Market Rare Earths: A price rebound has likely been set in motion Following destocking towards the end of last year which led to relatively low rare earth inventories, downstream manufacturing companies are gradually replenishing raw materials now as they resume normal operations after the CNY holiday. Meanwhile, overall spot rare earth inventories have decreased following the latest government-led stockpiling. Rare earth prices have picked up slightly after the CNY also as MIIT crackdowns on illegal mining activities proceed across the country, and this trend is likely to continue on further crackdowns. In addition, strengthening environmental inspections will also help to force highly-polluting, illegal production capacity out of the market, leading to a contraction in rare earth supply. Building Materials: Spring cement price strength not necessarily entailing share price growth The ideal situation where share price growth can be seen is created by investor expectations that can materialize afterwards, namely those that are in line with current supply-demand conditions. We think that cement demand will remain stable in 1H17, and that many companies have strong earnings growth momentum. In addition, in terms of realizable investment ideas, we highlight regions that are about to see cement demand turn around and companies that can benefit from an increase in pricing power brought by enhanced industry concentration. Agriculture: Streamlining agricultural product pricing a key step in sector supply-side reform; 2017 key product price outlook Streamlining the agricultural product pricing mechanism is a key step in agriculture supply-side reform with the goal to allocate agricultural resources more efficiently and maximize farmers interests. Going forward, the current temporary stockpiling policy (i.e. short-term stockpiling aimed at supporting market prices) might be replaced by a direct subsidy based on agricultural products target prices. We expect corn prices to bottom in 2017 though the upside for a rebound might be limited. The average rubber price in China is likely to continue to rise as demand growth outpaces supply-growth. Hong Kong Market Lenovo (992 HK, Hold): Still tackling its two loss-making businesses Dec-quarter group sales fell 6% YoY and earnings fell 67% YoY, 25% below Bloomberg consensus. Management attributes the poor performance to the rise in component prices and increased marketing and promotion expenses in its mobile business. Its PC business was the only profitable segment PC shipments ended the six consecutive quarters of contraction since 2Q15. Mobile division sales fell 23% YoY during the quarter with smartphone shipments down 26% YoY, and data center group sales fell 20% YoY. The stock is up 4% YTD (HSI +10%). Maintain Hold. CSPC Pharma (1093 HK, Buy): Sixth ANDA drug approval received; maintain Buy CSPC Pharma received ANDA approval for Clopidogrel Bisulfate, an anti-thrombotic drug, earlier this month. This is the company s sixth approval of a generic drug in the US since 2013, and 2-3 more approvals are expected this year. Revenue from generics rose 3.7% YoY in 9M16, accounting for 34% of overall revenue. ANDA approvals will raise these drugs profiles and allow the company to sell at better margins. Consensus for 2017 earnings has been on the rise since March last year as its on-track pipeline and revised NDRL should boost growth. Maintain Buy and TP of HK$ 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 Rare Earths: A price rebound has likely been set in motion Price hikes due to post-cny restocking The Baogang Rare Earth International Trade Company ( 包钢稀土国贸公司 ) has raised the prices of its praseodymium-neodymium products for Feb by around 6%. Following destocking towards the end of last year which led to relatively low rare earth inventories, downstream manufacturing companies are gradually replenishing raw materials now as they resume normal operations after the CNY holiday. Meanwhile, overall spot rare earth inventories have decreased following the latest government-led stockpiling. As such, rare earth prices have gone up on the back of an improved supply-demand structure. Given tech industry development amid economic restructuring as set out in the 13th FYP, rare earth prices which have remained low for quite some time are now set to bottom out thanks to continued demand growth. State stockpiling to spur price rebound In the latest round of state stockpiling (finished on Jan 19), the government invites offers for the supply of a total of 2,000 tonnes of rare earths at prices which were 2-8% higher than the previous stockpiling. This included 1,300 tonnes of praseodymium-neodymium whose tender prices were close to market levels. The stockpiling will give a boost to short-term rare earth demand as well as market sentiment. Crackdowns on illegal mining to drive continued price growth Industry earnings have continued to weaken along with declines in rare earth prices caused by illegal mining activities. China s rare earth export volume grew 35.6% YoY in 2016, while the average export price dropped 34% YoY; the industry suffered a net loss of Rmb160m in 9M16 following an annual loss of Rmb600m in However, rare earth prices have picked up slightly after the CNY holiday as MIIT crackdowns on illegal mining activities proceed across the country, and this trend is likely to continue on further crackdowns. In addition, as illegal mining typically produces severe pollution, strengthening environmental inspections will also help to force highly-polluting, illegal production capacity out of the market, leading to a contraction in rare earth supply. Our watch list We suggest watching Shenghe Resources ( CH), Xiamen Tungsten ( CH), China Minmetals Rare Earth ( CH), China Northern Rare Earth ( CH) and Grinm Advanced Materials ( CH). Building Materials: Spring cement price strength not necessarily entailing share price growth Spring cement price strength In order to understand how the share prices of cement stocks are driven by cement prices during the first half of the year, we have looked at average cement prices nationwide, in the YRD region, the PRD region and the Beijing-Tianjin-Hebei region since We found that cement prices picked up on a nationwide basis (except for 2015), in the YRD region (except for 2012 and 2015) and the Beijing-Tianjin-Hebei region (except for 2015) in most of the nine years, while such a phenomenon of spring cement price strength has not been so evident in the PRD region. Cement prices vs share prices Cement prices in the YRD region (or eastern China) typically start to pick up in early March or April. Price growth tends to be particularly strong during 1H if the sector just bottomed out at the beginning of the year, while 1H price growth is typically smaller if a specific year had a relatively high starting point. As for cement stock price performance, in Anhui Conch s ( CH) case, any share price increases during 1H tend to be seen during Jan-April, which points to the absence of any direct correlation between cement price and cement stock price growth. In fact, the ideal situation where share price growth can be seen is created by investor expectations that can materialize afterwards, namely those that are in line with current supply-demand conditions. Regional demand turnaround and companies benefiting from higher industry concentration Market attention to the cement sector has increased significantly recently. We think that cement demand will remain stable in 1H17, and that many companies have strong earnings growth momentum. In addition, in terms of realizable investment ideas, we highlight regions that are about to see cement demand turn around and companies that can benefit from an increase in pricing power brought by enhanced industry concentration. We like Tangshan Jidong Cement ( CH), BBMG ( CH), Yatai Group ( CH), Qingsong BM and Chemicals ( CH), Xinjiang Tianshan Cement ( CH), Gansu Qilianshan Cement ( CH) and Anhui Conch ( CH). Page 2

3 Agriculture: Streamlining agricultural product pricing a key step in sector supply-side reform; 2017 key product price outlook Streamlining of pricing mechanism amid supply-side reform In our opinion, streamlining the agricultural product pricing mechanism is a key step in agriculture supply-side reform with the goal to allocate agricultural resources more efficiently and maximize farmers interests. Going forward, the current temporary stockpiling policy (i.e. short-term stockpiling aimed at supporting market prices) might be replaced by a direct subsidy based on agricultural products target prices. Corn prices to bottom In 2017, the area of cornfields is likely to be reduced further, while downstream deep processing and feedstuff demand should pick up gradually, leading to a better supply-demand dynamic. Considering the currently high corn inventories and the potential pressure of stock unloading in 2H17, we expect corn prices to bottom in 2017 though the upside for a rebound might be limited. Dabeinong Technology ( CH), Tangrenshen Group ( CH) and COFCO Biochemical Anhui ( CH) are likely to benefit. Rubber prices to go up as demand growth outpaces supply growth China relies on imports for 75% of the rubber it uses. However, key rubber production areas in southeast Asia have demonstrated a significant deceleration in output growth. Meanwhile, the output of passenger vehicles, commercial vehicles and heavy duty trucks in China has grown at a quickening pace since mid-2016, while rubber inventory in the Qingdao bonded area has dropped 58% YoY to just 90,000 tonnes. The average rubber price in China is likely to continue to rise as demand growth outpaces supply-growth, which we believe will benefit Hainan Rubber Industry ( CH). Potential adjustments to white sugar import tariffs It is estimated that China will see a white sugar supply shortage of 4.5-5m tonnes in the 2016/17 sugar season, which will need to be balanced out through state stockpiling. Meanwhile, MOFCOM has launched investigations into potential protectionism issues with imported sugar. The fact that China s import tariff for sugar is lower than other WTO members means tariff rate hikes are possible, which would increase the upside to domestic sugar prices. Potential beneficiaries include Nanning Sugar Industry ( CH) and COFCO Tunhe Sugar ( CH). Soy bean prices to be range-bound 85% of China s soy bean supply comes from imports. It is estimated that global soy bean output will increase by more than 7% in the 2016/17 production season due to harvests in the US and Brazil. We expect soy bean prices to remain range-bound with extreme weather conditions such as the outbreak of La Nina key to watch. Lenovo (992 HK, Hold): Still tackling its two loss-making businesses What s new? Lenovo reported lower-than-expected Dec-quarter earnings. Worse-than-expected Dec-quarter earnings Dec-quarter group sales fell 6% YoY to US$12.2bn, and earnings fell 67% YoY to US$98m, 25% below Bloomberg consensus of US$130m (GF: US$140m). Management attributes the poor performance to the rise in component prices and increased marketing and promotion expenses in its mobile business. Its PC business was the only profitable segment, while its mobile and server business still made a loss during the quarter. Blended gross profit margin for the group fell to 13.1%, down 1.2ppt from 14.3% in the previous quarter. PCs & Smart Devices (PCSD) - hitting bottom and resuming growth PCSD sales grew 2% YoY to US$8.6bn and accounted for 71% of group sales during the quarter. Lenovo s PC shipments ended the six consecutive quarters of contraction since 2Q15, with 15.7m units shipped (+2% YoY). This compares to the 2% YoY decline for the market during the quarter, according to IDC. Mobile Business Group (MBG) - still making a loss Mobile division sales fell 23% YoY to US$2.2bn with smartphone shipments of 15m units (down 26% YoY) in the quarter. The mobile business incurred a pretax loss of US$155m, the same as in the previous quarter. Smartphone ASP was around US$146. Lenovo s 2016 smartphone shipments came in at about 51m units, which is behind Huawei (139m units), Oppo (99m units) and Vivo (77m units). Management aims to bring the division to breakeven by the second half of the next fiscal year (i.e. around Oct-Dec 2017). Data Center Group (DCG) - will take longer to fix DCG sales fell 20% YoY to US$1.1bn (9% of group sales), with a pretax loss of US$124m in the Dec quarter. Its DCG business is in Page 3

4 transformation mode with new management recently on board. We expect the business to take a longer time than its mobile division to reach breakeven. Maintain Hold The stock is up 4% YTD, vs +10% for the Hang Seng Index. We maintain our Hold rating. (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) CSPC Pharma (1093 HK, Buy): Sixth ANDA drug approval received; maintain Buy What s new? US FDA data show that CSPC Pharma received ANDA approval for Clopidogrel Bisulfate, an anti-thrombotic drug, earlier this month. This is the company s sixth approval of a generic drug in the US since 2013, and 2-3 more approvals are expected this year. Improving margins in its generic business CSPC Pharma s revenue from generics rose 3.7% YoY to HK$3.1bn in 9M16, excluding the effect of foreign currency movements, and accounted for 34% of overall revenue. It has over 150 major drugs in various therapeutic areas. Although each generic s sales contribution is relatively small, ANDA approvals will raise these drugs profiles and allow the company to sell at better margins. Potential out-licensing of NBP in US P3 trials For new drug development, NBP soft capsules began P2 clinical trials in the US in Aug 2016, while mitoxantrone hydrochloride liposome is also in P2 stage via the 505(b)(2) pathway, as it is a new formulation for treatment of various cancers. Consensus for 2017 earnings on the rise since March 2016 as on-track pipeline and revised NDRL should boost growth The stock s current valuation of 20x FY17E P/E does not appear excessive compared to historical data or relative to the 17x forward P/E for the H-share healthcare segment. We maintain our Buy rating and target price of HK$10.10, based on a 22x P/E target multiple on an EPS CAGR of 22.6% during FY17-18E. (Natalie Chiu, Research Analyst, SFC CE No. AVH029, nataliechiu@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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