Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Oct 27, 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$) (%) (US$) (%) 941 CHINA MOBILE PETROCHINA ICBC HSBC CHINA CONST BANK TENCENT BANK OF CHINA SINOPEC CHINA LIFE INS CNOOC Econ data release China Data Date Period Prior Cons Ind Profit Mthly YoY 27-Oct SEP China Manf PMI 31-Oct OCT HSBC China Manf PMI 2-Nov OCT F China Non-Manf PMI 2-Nov OCT US Data Date Period Prior Cons Markit US Serv PMI 27-Oct OCT P US Pend Home Sales 27-Oct SEP US Durable Goods 28-Oct SEP S&P/Case-Shiller Cmp 28-Oct AUG US 3Q GDP 30-Oct 3Q A US Init Jobless Claims 30-Oct 25-Oct US Cnt Jobless Claims 30-Oct 18-Oct Source: Bloomberg GF events Date Event Location 28 Oct 500.com co. visit Shenzhen 28 Oct Highsun Group co. visit Guangzhou 28 Oct Grandbuy co. visit Guangzhou 29 Oct Better Life Com Chain co. visit Changsha 30 Oct Renrenle Commercial co. visit Shenzhen 30 Oct David Ji, Knight Frank lunch TBC 31 Oct Shanghai Jahwa co. visit Shanghai Source: GF Securities A-Share Market Great Wall Motor ( CH): 3Q14 earnings drop on GM decline and admin expense growth Gross margin came off in 3Q14 as its H2 model had yet to achieve economies of scale, while admin expenses picked up on higher R&D cost. The role of low prices as domestic auto brands competitive edge has weakened; domestic brands must now shift towards the higher-end market to succeed. We expect 4Q14 earnings growth to improve significantly from 3Q14 on H2 sales growth and a QoQ sedan sales recovery. We lower our EPS forecasts given the negative impact of the company s transition to a new business model. China Coal Energy ( CH): 3Q14 loss due to price weakness and output cut A loss was recorded in 3Q14 mainly as coal prices remained low and as the company reduced production. 9M14 commercial coal sales were stable YoY, picking up just 0.41% from 9M13; 3Q14 sales declined 4.55% QoQ. The company s average coal price has risen by Rmb15/tonne so far in Oct. We see further price upside on continued production controls, which should offset the earnings decline caused by production cuts. The company is trading at the lowest P/B ratio across the coal sector. However, valuation is not particularly attractive given declining earnings. TCL Corporation ( CH): 3Q14 earnings strength across various segments 3Q14 revenue rose 15.36% YoY with net profit growing 51.38% YoY. Earnings strength was seen across various business segments: quarterly smart TV shipments doubled YoY with profitability strengthening on an improved product mix; communications business maintained strong growth as GM improved further on an increase in smartphones as a proportion of overall mobile phone shipments. Domestic panel makers are set to maintain higher-than-industry-average capacity utilization and profitability given preferential government policy and strong downstream demand. Hong Kong Market China Smartphone Sector: Be selective - we prefer upstream smartphone component makers to downstream brand owners The Chinese handset sector (represented by our basket of ten stocks) has outperformed the MSCI China Index by 23% YTD. We see strong underlying smartphone volume growth, but are concerned about margin compression among downstream smartphone brand owners. We initiate coverage of the sector at Neutral. We initiate coverage of AAC Tech, Sunny Optical, Tongda and Scud with Buy ratings, expecting these component makers to benefit from strong shipment momentum at domestic handset makers. We are cautious on downstream handset brand owners given pricing pressure amid intense market competition and the 3G inventory overhang. Non-Bank Financials: Weekly update (Oct 18-24) We expect Chinese insurers to post enhanced profitability in 3Q14 given strong A-share market performance in 3Q14. However, in the short-term investors may prefer their A shares considering A/H discounts and the upcoming SH-HK Stock Connect. We recommend China Taiping given its attractive valuation and solid business growth. We also believe PICC Group is undervalued despite its slow growth in Life NBV. Among brokers, CITIC s 9M14 accumulated net profit rose 10% YoY; Haitong saw a rise of 19% YoY. We recommend CITIC given its leading position and innovative business development. 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 Great Wall Motor ( CH): 3Q14 earnings drop on GM decline and admin expense growth 3Q14 earnings down 21.7% YoY 9M14 revenue grew 4.4% YoY to Rmb42.59bn while net profit dropped 9.5% YoY to Rmb5.59bn with fully diluted EPS of Rmb Q14 revenue declined 2.1% YoY to Rmb14.06bn with net profit plunging 21.7% YoY to Rmb1.63bn. 3Q14 earnings hurt by low per-vehicle margin and high R&D cost The 3Q14 earnings decline was mainly due to a drop in gross margin and an increase in administrative expenses. Great Wall s gross margin fell 1.3pp YoY and 1.4pp QoQ to 27.7% in 3Q14 as its H2 model had yet to achieve economies of scale (leading to relatively low per-vehicle gross margin). In addition, the significant YoY drop in sedan sales also had a negative impact on its gross margin. The company s administrative expenses picked up YoY in 3Q14 as the development of new models pushed R&D cost higher. Earnings growth to strengthen in 4Q14 The role of low prices as domestic auto brands competitive edge has weakened as the prices of JV brands decline. Domestic brands now must adjust their product portfolio in line with market trends and shift towards the higher-end market in order to succeed. SUVs accounted for 75.1% of Great Wall s 3Q14 sales, up 14.7pp YoY and 5.4pp QoQ. Company operations and profitability are likely to strengthen further going forward as its product mix continues to move towards higher-end vehicles. We expect 4Q14 earnings growth to improve significantly from 3Q14 on H2 sales growth and a QoQ recovery in sedan sales. Earnings forecasts lowered We lower our 2014/15/16 EPS forecasts to Rmb2.55/3.33/4.56 as earnings are negatively impacted by the company s transition to a new business model. That said, we remain confident about its management and its strategy for moving into the higher-end market. China Coal Energy ( CH): 3Q14 loss due to price weakness and output cut 3Q14 loss due to coal price weakness and output cut 9M14 net profit dropped 79.3% YoY to Rmb660m with EPS of Rmb0.05, broken down into quarterly EPS of Rmb0.04, 0.01 and We believe a loss was recorded in 3Q14 mainly as coal prices remained low and as the company reduced production. 9M14 sales stable, ASP down 13.2% YoY The company produced 89.17m tonnes of commercial coal during 9M14 (+0.56% YoY) with 3Q14 output falling 5.9% QoQ to 28.69m tonnes. 9M14 commercial coal sales were stable YoY, picking up just 0.41% from 9M13 to m tonnes; 3Q14 sales declined 4.55% QoQ to 39.9m tonnes. The ASP of self-produced coal dropped 13.2% YoY to Rmb368/tonne in 9M14 with 3Q13 ASP down 7.2% QoQ to Rmb338/tonne. Production cost down on fee waive The cost of self-produced coal dropped significantly by Rmb25/tonne or 12% YoY to Rmb192/tonne in 9M14. In particular, an Rmb8/tonne decline in material cost and an Rmb7/tonne drop in other costs driven by the cancelation of two administrative fees collected from coal companies in Shanxi were the main drivers of the decline in overall production cost. The cost of self-produced coal dropped 13% QoQ to Rmb172/tonne in 3Q14. 2H14 output to drop 14% HoH on planned production cut The company previously announced a plan to reduce 2014 raw coal production by 5% from the actual output volume in Based on its commercial coal output data, we calculate that the company produced 80.10m tonnes of raw coal during 1H14. This means planned raw coal production of 68.66m tonnes in 2H14 (-14% HoH). Coal price upside to offset earnings declines The company s average coal price has risen by Rmb15/tonne so far in Oct. We see further price upside on continued production controls, which should offset the earnings decline caused by production cuts. The company is trading at the lowest P/B ratio across the coal sector. However, valuation is not particularly attractive given declining earnings. We forecast 2014/15/16 EPS of Rmb0.05/0.05/0.06. Page 2

3 TCL Corporation ( CH): 3Q14 earnings strength across various segments 3Q14 earnings strong 3Q14 revenue rose 15.36% YoY to Rmb25.4bn with operating profit up 71.53% YoY to Rmb536m; net profit grew 51.38% YoY to Rmb745m. Gross margin declined slightly QoQ to 18.39% but remained at a high for the past three years. Strength across various business segments The company s TV panel and communications segments contributed 90% of net profit during 3Q14, while its media business (once a negative earnings contributor) has remained profitable. In particular, quarterly smart TV shipments doubled YoY with profitability strengthening on an improved product mix. Its communications business maintained strong growth as gross margin improved further on an increase in smartphones as a proportion of overall mobile phone shipments. In addition, subsidiary CSOT continued to operate at full capacity utilization with its products sold out; high capacity utilization and product prices have continued to drive strong revenue and earnings growth. Panel industry strength to continue Business conditions in the TV panel industry is likely to remain strong as end-users increasingly prefer larger-sized screens and as diversified downstream demand has smoothened the fluctuations in demand. In particular, domestic panel makers are set to maintain higher-than-industry-average capacity utilization and profitability given preferential government policy and strong downstream demand. New plant to copy previous success CSOT s phase two production plant will very likely repeat the success seen by its phase one plant, meaning TCL s communications business will still have room for further development in its products and markets. We remain optimistic on the company and forecast 2014/15/16 EPS of Rmb0.30/0.36/0.44. Risk factors Key risks include a significant decline in downstream TV demand leading to plunges in panel prices, deterioration in the competitive environment of the TV industry causing losses in its media segment, and a slower-than-expected pace in the company s shift to a new business model. China Smartphone Sector: Be selective - we prefer upstream smartphone component makers to downstream brand owners Chinese handset sector has outperformed the MSCI China Index YTD The Chinese handset sector (represented by a basket of ten handset-related stocks in this report; see table below) has outperformed the MSCI China Index by 23% so far this year. The sector valuation remains reasonable, currently at an average of 11.1x 2015 P/E, supported by sector average EPS growth of 17% in 2015, according to our estimates. While we see strong underlying smartphone volume growth, we are concerned about margin compression among downstream smartphone brand owners. We initiate coverage of the sector with a Neutral sector rating. Multi-year handset replacement cycle China is at a nascent stage in its 4G adoption, as it only began to launch 4G services at the beginning of We see a multi-year handset replacement cycle driven by the transition from the 3G to 4G era in China. An increase in handset exports will also drive volume growth at Chinese handset makers. Our investment strategy focuses on buying a selected group of upstream component makers that are set to benefit from this volume growth. On the other hand, we recommend avoiding downstream smartphone brand owners given margin contractions in this crowded and competitive market. Our top picks We initiate coverage of AAC Tech, Sunny Optical, Tongda and Scud with Buy ratings. These upstream component makers will benefit from strong shipment momentum at domestic handset makers. Underperform ratings We are cautious on downstream handset brand owners given pricing pressure amid intense market competition and the 3G inventory overhang. We initiate coverage of Coolpad with an Underperform rating. We initiate coverage of FIH Mobile at Underperform given their poor profitability metrics. Hold ratings We initiate coverage of Ju Teng at Hold given its ex-growth notebook casings business and the limited contribution from its smartphone casings business. We initiate coverage of TCL Comm with a Hold rating as its margins are likely to contract as overseas competition increases. We initiate coverage of Truly at Hold given their weak earnings outlook due to Page 3

4 unfavorable customer mix. We initiate BYD Electronic at Hold following the recent rally and suggest waiting for a better entry point. Summary of investment recommendations Sources: Bloomberg, GF Securities (Joseph Ho, CFA, Research Analyst, SFC CE No. AFP308, josephho@gfgroup.com.hk ) Non-Bank Financials: Weekly update (Oct 18-24) China brokers to release quarterly results (Oct 24) CITIC Securities (6030 HK) will release its quarterly results on Oct 30, 2014, while Haitong Securities (6837 HK) will release on Oct 28, Our view: CITIC s 9M14 accumulated net profit rose 10% YoY; Haitong saw a rise of 19% YoY. Accumulated comprehensive income during the period rose 53% YoY and 37% YoY respectively. We recommend CITIC (Buy, TP: HK$19.30) given its leading position and innovative business development. Short-term risks include the A/H share price discount amid the upcoming SH-HK Stock Connect. China insurers to release quarterly results (Oct 24) NCI (1336 HK) and CPIC (2601 HK) will release their quarterly results on Oct 24, 2014; Ping An Insurance (2318 HK) and China Life (2628 HK) will release on Oct 28, Our view: We expect Chinese insurers to post enhanced profitability in 3Q14 given strong A-share market performance in 3Q14. However, in the short-term investors may prefer their A shares considering A/H discounts and the upcoming SH-HK Stock Connect. We recommend China Taiping (966 HK, Buy, TP: HK$24.00) given its attractive valuation (trading at ~1.1x P/EV) and solid business growth. Its 1H14 NBV growth of 44% YoY and NBV margin of 36.4% were higher than market expectation. We also believe PICC Group (1339 HK, Accumulate, TP: HK$4.40) is undervalued despite its slow growth in Life NBV. We value it at HK$4.38 per share using a prudent SOTP approach, which does not include NBV goodwill or any possible EV increases after 1H14. Both China Taiping and PICC Group are not listed in the A-share market and will therefore be less affected by the upcoming SH-HK Stock Connect. HKEx to introduce its first Asia commodities contracts for trading on Dec 1 (Oct 22) HKEx will introduce its first Asia Commodities contracts (London Aluminum Mini Futures, London Zinc Mini Futures and London Copper Mini Futures) for trading on Monday, Dec , subject to market readiness. The three mini metals contracts will trade in Renminbi (Rmb). According to HKEx Chief Executive Charles Li, "the new contracts will provide currency convenience, they will expand our range of RMB products, and they will further strengthen Hong Kong's position as the leading offshore RMB center". (Felix Luo, Research Analyst, SFC CE No. AQF573, felixluo@gfgroup.com.hk ) Page 4

5 Hong Kong Equity 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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