Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Feb 9, 2014

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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 HSBC BANK OF CHINA TENCENT CHINA LIFE INS SINOPEC PING AN INS Econ data release China Data Date Period Prior Cons CPI 9-Feb JAN PPI 9-Feb JAN US Data Date Period Prior Cons Initial Jobless Claims 12-Feb 7-Feb Cont Jobless Claims 12-Feb 31-Jan Source: Bloomberg A-Share Market Coal: Monetary easing to benefit the sector We do not expect the coal sector to outperform around CNY, with some coal product dropping in price slightly. We expect weak prices to continue to Mar and April, mainly due to high inventory and weak low-season demand. The bright side is that the coal supply will remain low on seasonal mining suspensions, which will support the coal price. Despite the recent continued fall in the coal price, price will be supported given a lack of economic data announcements in Jan and Feb, the strong rebound in oil price expectations, improving liquidity and SOE reform. Building Materials: Short-term fluctuations in the oil price should not affect investment logic The national average cement price dropped by Rmb2/tonne WoW during the last week of Jan. Coal prices at Qinhuangdao declined by Rmb5/tonne WoW. In the short term, we believe timing is crucial for cyclical stocks. Cement and glass names are now in the typical low season, while macro demand remains weak. Based on fundamentals and valuations, we do not expect significant earnings increases for cement companies. Short-term fluctuations in the oil price are inevitable and unpredictable. If the oil price remains low, companies GPM will rebound sharply. Anoky ( CH): Expansion to new digital print business with high-end development strategy Digital printing technology will become the development trend of the Chinese dyeing and printing industry, given its technological advantages of simple operation, high efficiency, no pollution, low investment and high returns. The domestic digital printing materials market is currently monopolized largely by foreign companies. We see a bright outlook for Anoky in the digital printing materials business given industry development and import substitution. Along with an increase in production capacity, the company will steadily benefit from industry integration, resulting in improved profitability. Hong Kong Market Dairy sector: Fonterra price rebound may be priced in; domestic raw milk price continues to decline Raw milk producers and related dairy stocks have rebounded significantly over the past few days on expectation of a rebound in the New Zealand milk powder price. The drought in New Zealand may push the Fonterra price up further in coming auctions, but at a slower pace than before given weaker from China. However, the uptrend in the milk price in New Zealand is good news for dairy farmers in China, who have suffered a lot from the impact of imports. Current share prices may have priced this in but could still be affected by changes in the domestic raw milk price. Kangda (6136 HK, Buy): Jan operating data announced; maintain Buy Kangda was the first environmental company to announce operating data, something we believe should help to improve transparency at the company. Contracts executed were up 43.%YoY during the month while projects in operation rose 44.9% YoY. Kangda s shares were down 10% at one point last week amid the sell-off across the sector. We see the government s water pollution prevention plan and the company s 2014 results as short term catalysts. We expect net profit to rise 28% YoY in 2014, in line with consensus. Maintain Buy. 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 Coal: Monetary easing to benefit the sector Further RRR cut The PBoC cut the RMB deposit required reserve ratio for financial institutions by 0.5% effective Feb 5, 2015, and cut the RMB deposit required reserve ratio for city commercial banks and non-county level rural commercial banks that have met the standards of targeted required reserve reduction by an additional 0.5%. It also cut required reserve ratio for Agricultural Development Bank of China by an additional 4%. The central bank cut RMB benchmark loan and deposit interest rates for financial institutions as of November 22, The one-year RMB benchmark loan interest rate and deposit interest rate were lowered by 0.4% to 5.6% and by 0.25%to 2.75% respectively. Coal sector stocks have since stabilized The coal sector has seen steady performance following the previous eight RRR cuts. The absolute return and relative return of coal stock pricing index are -0.04% and -0.26% respectively (relative to Shanghai Securities Composite Index). But the absolute returns in 60 days and 120 days after the reduction of reserve requirement are 1.95% and 28.02% separately, and the relative returns are 2.22% and 14.97% respectively, esp. the performance after the reduction in 2008 which was better than that after the reduction in Coal prices typically stabilize after a cut on rebounds in property and infrastructure Qingang 5500 steam coal, Datong Nanjiao RN coal and Liulin No.4 coking coal fell by 34%, 22% and 48% after the interest rate cut in 2008; and dropped by 23%, 12% and 9% following the cut in But after these cuts, the coal price rebounded gradually and the accumulated growth of Qingang 5500 steam coal, Datong Nanjiao RN coal and Liulin No.4 coking coal were 39%, 3% and 20% one year after the cut in In 2012, due to the confirmed downward trend of coal pricing, the price continued to decline after the reduction of reserve requirement while Qingang 5500 steam coal stabilized after that. The coal pricing is still weak caused by the piling inventory and the weak demand; we estimate that the coal sector will be stabilized from the demand from the rebound from real estate and infrastructure construction. Coal prices to remain weak in the short term while a rise in the oil price and SOE reform should benefit the sector We do not expect the coal sector to outperform around CNY, with some coal product dropping in price slightly. We expect weak prices to continue to Mar and April, mainly due to high inventory and weak low-season demand. The bright side is that the coal supply will remain low on seasonal mining suspensions, which will support the coal price. Despite the recent continued fall in the coal price, price will be supported given a lack of economic data announcements in Jan and Feb, the strong rebound in oil price expectations, improving liquidity and SOE reform. Building Materials: Short-term fluctuations in the oil price should not affect investment logic Mininal price changes The national average cement price dropped by Rmb2/tonne WoW during the last week of Jan. Coal prices at Qinhuangdao declined by Rmb5/tonne WoW during the week. The national average glass price dropped by Rmb0.45 per heavy box. National average inventory was 32,810,000 heavy boxes, up 50,000 boxes and meaning a WoW growth of 6.11%. Not pessimistic; prefer companies with high elasticity In the short term, we believe timing is crucial for cyclical stocks (cement). Based on price level, cement and glass came to the traditional off season in Jan, while macro demand remained weak. As for performance, most companies recorded negative YoY growth in 1Q15, due to the high base in 1Q14. The sector valuation has recovered, after the share price increase from Nov to Dec. Based on fundamentals and valuations, we do not expect significant earnings increases for cement companies. We prefer BBMG ( CH) and Jidong Cement ( CH) who are seeing policy support (Beijing, Tianjin and Hebei integration). Compared with cyclical stocks, growth stocks with strong performance are more attractive. Our preferred names include Oriental Yuhong ( CH) and Luoyang Glass ( CH). Short-term fluctuations in oil price do not change our logic For one thing, the short-term fluctuations in oil prices are inevitable and unpredictable. If the oil price stays in a low level, companies GPM will rebound sharply. A good example can be found from 2008 to An oil price plunge came in 2H08 and then prices continued to rebound in Company GPM also rose substantially in For another, we prefer Oriental Yuhong since the waterproofing industry has formed a good structure to support its growth and retail business. Besides, M&A in 2015 will bring Page 2

3 new development while a property sales rebound will encourage its performance and a rise in valuation. Anoky ( CH): Expansion to new digital print business with high-end development strategy Expansion to new digital print business with high-end development strategy Based on highend development strategy and strong prospect of digital printing materials industry, the company planned to establish a subsidiary, "Shanghai anoky digital technology co., Ltd" with a controlling stake of 75%. This subsidiary will be mainly engaged in producing digital printing materials (800 tons/per year) and special distributed digital printing material (1200 tons/per year). Digital printing the trend for the dyeing and printing industry Digital printing technology will become the development trend of Chinese dyeing and printing industry, based on its technological advantages of simple operation, high efficiency, no pollution, low investment and high return. It will bring significant opportunities for textile dyeing industry, under present pressure of energy conservation and emissions reduction. Industry data indicates that the production of digital ink jet printing in China will exceed 500m meters, representing around 4% of total prints production. Domestic digital printing materials market is monopolized largely by foreign enterprises at present. From the perspective of the industry development and substitution for import, Anoky should see a bright outlook in digital printing materials business. Significant increase in production capability expected in FY15 The integrated production chain of raw materials (intermediate) and dye, which has start layout two years ago, is expected to bear fruit in FY15. The production of disperse dye could reach 36,000 tons with 25,000 tons set to be put into production in 1H15. Reactive dye capacity will gradually increase from the current 6,500 tons to 24,500 tons as end of In addition, another 30,000 tons of fine chemical intermediates is expected to gradually put into production in 2H15. Along with the increase of production capacity, the company will progressively form the advantage in industry integration, which is expected to result in profitability improvement. Dairy sector: Fonterra price rebound may be priced in; domestic raw milk price continues to decline What s new? Raw milk producers and related dairy stocks have rebounded significantly over the past few days on the back of expectation of a rebound in the milk powder price in New Zealand (NZ). In fact, from their trough, shares in China Modern Daily (1117 HK) are up 49%, YST (1431 HK) up 24%, Huishan (6863 HK) up 18%, Mengniu (2319 HK) up 35%, Yashili (1230 HK) up 42%, and Biostime (1112 HK) up 60%. So is the worst is over for the sector? NZ drought may push the Fonterra price up further in coming auctions The NZ Fontana Milk Powder price averaged US$3,042/tonne across all contracts, up 9.4% over the last auction and up 21% from US$2,513/tonne on Dec 2, According to recent media reports, a drought has begun in NZ. Scientists at the National Institute of Weather and Atmospheric Research (NISW) have warned that nearly all of the island is experiencing much drier to severely drier than normal soils for this time of the year, meaning the country may again be plunged into drought. Since milk production will drop in drought conditions, NZ s dairy industry will probably be hit. Moreover, we are at the start of the typical low season in the southern hemisphere, with falling milk supply in the first half of the year. Domestic raw milk price yet to follow Due to the drought-caused supply contraction in NZ, the price of whole milk powder (WMP) reached more than US$5,000/tonne in 2013, surging 57% and almost doubling from its trough. We estimate the current drought will push the Fonterra price up at a slower pace, given weaker demand from China. However, the uptrend in the milk price in NZ is good news for dairy farmers in China, who have suffered a lot from the impact of imports. Meanwhile in China, the latest raw milk price is Rmb3.48/kg (4th week of Jan), down 1.1% WoW and 18.1% YoY. In fact the raw milk price has fallen almost 20% from its peak in 2014 and is now close to the level in early 2013 before the price surge. Given this and the latest Fontana price, we believe there is a good chance that the domestic raw milk price will stabilize before recovering. Current share prices may have priced this in but keep an eye on the domestic raw milk price Shares in China Modern Dairy have fallen over 40% (lowest: HK$1.88) since our rating downgrade to Underperform and a TP of HK$2.75 back in early Oct 2014, before the latest share price rebound. Page 3

4 The current share price of HK$2.80 is still in line with our expectation. Our TP of HK$2.75 is based on a DCF valuation and translates to a 2015E P/E of 11x, with an ASP assumption of Rmb5.06/kg, Rmb4.90/kg and Rmb5.00/kg for 2014, 2015 and 2016, respectively (Rmb4.67/kg in 2013). Given our forecast for 2% YoY EPS growth for 2015 and 28% YoY for 2016, and given that the domestic raw milk price remains on the downtrend, we believe the current P/E multiple remains reasonable. However, we will keep an eye on the raw milk price, as CMD s earnings sensitivity to its ASP is high (1% increase in the raw milk price translates into 5.4% increase in 2015 earnings, we estimate). Maintain TP of HK$2.75. YST: Likewise, shares in YST have fallen 37% (lowest: HK$0.68) since our rating downgrade to Hold and TP HK$1.03 (7.5x P/E) back in late Oct The current share price of HK$0.84 is still below our TP, and we expect some share price upside. We estimate that a 1% increase in the raw milk price translates into a 3.5% increase in 2015 earnings. Mengniu: The latest rebound in the NZ milk powder price has not yet affected Mengniu s costs as it still has a few months worth of milk powder in stock, while the domestic raw milk price remains on the downtrend. A further increase in the milk price may be negative for Mengniu as the benefits from the low raw milk price no longer exist. Yashili: The latest rebound in its share price has already pushed its share price back to when Mengniu announced the disposal of shares to Danone. We believe the business outlook remains unclear and still depends on its cooperation with Danone while the competition in the IMF market in China remains tough. Biostime: Shares have surged recently on the back of its plan to open up its Mama 100 member platform to third parties as well as the positive impact from a depreciating euro. We estimate a 4% depreciation in the euro translates into a 1% improvement in its COGS. However, after the share price rally, its valuation is no longer compelling while the positive impact from the monetization of its Mama 100 member platform is yet to be seen. The company is also affected by tough competition in the IMF market. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) Kangda (6136 HK, Buy): Jan operating data announced; maintain Buy What s new? Kangda has announced operating data for Jan. Contracts executed were up 43.%YoY to 2.47mt during the month, projects in operation rose 44.9% YoY to 2.09mt. Operating segment to outpace construction this year Kangda is the first environmental company to announce operating data, a move we like as we believe it should help to improve transparency at the company. Revenue growth in its operating segment is expected to outpace that in its construction segment this year. Forecasting in-line net profit Kangda s share price was down 10% at one point last week amid the sell-off across the sector. We see the government s water pollution prevention plan and the company s 2014 results as short-term catalysts. We forecast net profit of Rmb296m in 2014 (+28% YoY), in line with consensus of Rmb292.5m. Trading at 13.3x 2015E P/E, Kangda is still at a discount to its peers average of 17x. Maintain Buy Although the disclosure of this monthly operating data should help to spur a re-rating in the share price, we believe this will take some time given the weak sentiment on the sector. For now, we only suggest long-term investors accumulate Kangda. We maintain our Buy rating. (Wallace Cheng, Research Analyst, SFC CE No. AKX251, wallacecheng@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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