Yum Cha 飲茶. November 15, 2017 RESEARCH NOTES SNIPPETS. INDICES Closing DoD%

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1 Yum Cha 飲茶 INDICES Closing DoD% Hang Seng Index 29,152.1 (0.1) HSCEI 11,601.7 (0.7) Shanghai COMP 3,429.5 (0.5) Shenzhen COMP 2,025.8 (0.9) Gold 1, BDIY 1,445.0 (1.3) Crude Oil, WTI(US$/BBL) 55.7 (1.9) Crude Oil, BRENT(US$/BBL) 62.2 (1.5) HIBOR, 3-M 1.0 (1.7) SHIBOR, 3-M RMB/USD 6.6 (0.1) DATA RELEASES DUE THIS WEEK Nov 17 China October Property Prices Source: Bloomberg RESEARCH NOTES November 15, 2017 HKEX [0388.HK; HK$235.6; UPGRADE TO BUY] - In the past, investors usually treated HKEx as a traditional high-beta cyclical play. We believe this perception is outdated. The successful IPOs of Meitu (1357.HK) last year and ZhongAn Insurance (6060.HK), China Literature (0772.HK), Razer (1337.HK) and Yixin (2858.HK) this year at a high valuation signaled a major change in market structure, and we expect to see a structural increase in the trading volume of HKEx in the coming years. Therefore, we have raised our 2017E/2018E average daily turnover (ADT) assumptions from HK$78bn/85bn to HK$86bn/110bn. We revised our 2017E/2018E EPS up by 7.4%/11.7% accordingly. We lifted our target price from HK$246 to HK$287.6 with a 40.9x 2018E PER (assumptions in the Gordon Growth model remain the same). Upgrade from HOLD to BUY. HKEx is currently trading at 33.5x 2018E PER, which is just a mid-cycle valuation; we believe many investors still have not realized the potential in the structural growth in ADT. SNIPPETS SMIC [0981.HK, HK$13.56, NOT-RATED] reported its Q results last night. SMIC s Q turnover was US$769.7m, up by 2.5% QoQ (close to high end of the previously guided range), from US$751.2m in Q2 2017, and a decline of 0.7% YoY, from US$774.8m in Q The Company s Q gross margin was 23.0%, (lower than the previous guidance of 23 to 25%), down 2.8ppt QoQ, partly due to a lower utilization rate. SMIC s utilization rate dropped from 85.7% in Q2 017 to 83.9% in Q Its net profit of US$25.9m in Q3 17 was higher than our expectation of US$23.2m. In our view, the higher-than-expected Q results were due to lower operating expenses. SMIC management guided that a) turnover in Q would be from 1% to 3% QoQ; b) the gross margin would range from 18% to 20%; and c) operating expenses would be US$204m to US$210m (not including employee bonuses, government funding and disposal gains). The 4Q guidance is below our and market expectations, especially the gross margin, which in our view, was due to the lower utilization rate. The ramping-up of sales of 28nm is the positive point in the Q results, as 28nm sales as a percentage of total sales increased from 6.6% in Q to 8.8% in Q As discussed in our previous update, given their uniqueness, the HK-listed foundries have been re-rated recently; they are now trading at the higher end of their historical PBV range in recent years, so we suggest investors wait for a better re-entry opportunity. Shares of SMIC are expected to react negatively to weaker-than-expected Q guidance. SMIC s share price correction may be a drag on sentiment on other IC-related names. However, we continue to suggest clients broaden their radar screen from foundries to IC design names (CE Huada [0085.HK], Solomon Systech [2878.HK] and Shanghai Fudan [1385.HK]), materials (AVIC Int l [0161.HK] s Shannan Circuits), and equipment (ASMPT [0522.HK]). SMIC will hold a Q3 results conference call at 8:30am today, and more information will be provided later. COLOUR LIFE [1778.HK, HK$4.88, BUY] - The Company announced that it proposed to acquire 100% interest in Wangxiangmei Property Management from its parent Fantasia [1777.HK, NOT RATED] for a consideration of RMB2,012.5m. Based on our understanding, Wangxiangmei Property Management was derived from Wanda Property Management, so Colour Life will effectively take over the projects through this asset injection. The net profit after tax for Wangxiangmei for 2016 was RMB21.7m and it increased substantially to RMB128.8m thanks to increased income and stringent cost control. It is equivalent to 128% of Colour Life's 1H17 net profit. Colour Life is trading at 17.1x 2017E PER and the price of the acquisition implies 10.1x 2017E PER based on annualized profit. Since this is a connected transaction, it will be subject to the approval of independent shareholders, and we expect the deal could be closed as early as early Given the size of Wangxiangmei, the earnings boost to Colour Life will be substantial, at the expense of elevated debt level as the transaction will be financed by debt. We will review the earnings and provide a full update later. 1

2 Hong Kong Exchange [0388.HK] Most Direct Beneficiary of Market Transformation; Upgrade to BUY In the past, investors usually treated HKEx as a traditional high-beta cyclical play. We believe this perception is outdated. The successful IPOs of Meitu (1357.HK) last year and ZhongAn Insurance (6060.HK), China Literature (0772.HK), Razer (1337.HK) and Yixin (2858.HK) this year at a high valuation signaled a major change in market structure, and we expect to see a structural increase in the trading volume of HKEx in the coming years. Therefore, we have raised our 2017E/2018E average daily turnover (ADT) assumptions from HK$78bn/85bn to HK$86bn/110bn. We revised our 2017E/2018E EPS up by 7.4%/11.7% accordingly. We lifted our target price from HK$246 to HK$287.6 with a 40.9x 2018E PER (assumptions in the Gordon Growth model remain the same). Upgrade from HOLD to BUY. HKEx is currently trading at 33.5x 2018E PER, which is just a midcycle valuation; we believe many investors still have not realized the potential in the structural growth in ADT. (The coverage has been transferred from Livy Lyu to Wong Chi-man.) Investment Highlights Past: Old economy IPOs did not help much to improve ADT. The full-year ADT of HKEx never exceeded HK$70bn between 2011 and 2016 (2015 was an exception because of the very short bull market.). We believe one of the key reasons is that the IPOs in the past few years did not really match the interest of investors. Most of the them were old economy companies, especially banks and securities companies (Figure 1). If we look at the list of the Top 10 IPOs between 2013 and 2016, only seven of them (17.5% of the total) were in the Top 150 most-traded stocks, based on the average daily turnover in the past three months. In particular, it is embarrassing to note that none of the Top 10 IPOs in 2016 is currently in the Top 150 most -traded stocks list. Present: More new economy IPOs expected to drive trading volume. In the past, many China-based new economy IPOs preferred to be listed in the US because of the much higher valuation. This was a painful loss to HKEx, as the ADT of the Top 10 ADRs (most of them new economy plays) has reached HK$47bn (Figure 2; equivalent to 55.9% of HKEx s 2017 ADT YTD). However, the successful listing of Meitu last year at a high valuation opened the door to more new economy IPOs this year. Among the Top 10 IPOs for 2017 YTD, there are at least four new economy IPOs, including ZhongAn Insurance, China Literature, Razer and Yixin. In particular, China Literature s trading volume remained at HK$1.8bn yesterday, making it the sixth most actively traded stock. Meanwhile, Meitu s latest 3-month ADT is about HK$370m, making it the 43rd most traded stock in Hong Kong. The shift in investment style also benefits other TMT names. Tencent (0700.HK), Sunny Optical (2382.HK), AAC (2018.HK) and SMIC (0981.HK) are all in the Top 20 most actively traded stocks list, based on the latest 3-month ADT. This is one of the key forces driving HKEx s ADT from HK$66bn in 2016 to HK$84bn in 2017 YTD. Future: More and more new economy IPOs will follow. We believe other new economy companies will feel more comfortable choosing HKEx as their destination for IPOs after the successful cases we just mentioned. We would not be surprised to see companies like Lufax, Tencent Music, etc. coming to Hong Kong in Therefore, we believe our 2018E Hong Kong market ADT assumption of HK$110bn is not aggressive, as ADT already reached HK$92.7bn in Q3 2017, up from HK$76bn in 1H17. This target will not be difficult to achieve if we see more new economy IPOs next year. We believe investors have not realized the potential, as HKEx is still trading at a mid-cycle valuation of 33.5x 2018E PER (Figure 5). Year ended 31 December E 2018E Revenue(HK$ m) 12,233 10,398 11,640 13,233 Net income(hk$ m) 7,956 5,769 7,432 8,730 Net Margin 65% 55% 64% 66% Basic EPS (HKD) YOY Change 51% -29% 27% 16% PE (x) PB (x) ROAE 31.1% 18.6% 21.7% 22.7% ROAA Sources: Company, CGIS Research 3.2% 2.4% 3.0% 3.4% Hong Kong Financials Sector BUY (Upgrade from HOLD) Close: HK$235.6 (Nov 14, 2017) Target Price: HK$287.6 (+22%) Price Performance (HK$) Market Cap Shares Outstanding Auditor US$37,434m 1,231.6m PricewaterhouseCoopers Free Float 94.51% 52W range 3M average daily T/O Major Shareholding Sources: Company, Bloomberg HK$ US$174.4m HKSAR Govt. (5.42%) Wong Chi Man Head of Research (852) November 15, Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Turnover (RHS) Price (LHS) cmwong@chinastock.com.hk (HK$ million) Source: Bloomberg 2

3 Figure 1: Top 10 IPOs in HK ( YTD) 2013 In the Top 150 most actively traded stocks list? 6818 Everbright Bank 2, China Cinda 2, Sinopec Engineering 1, Huishan Dairy 1, Huishang Bank 1, China Galaxy Securities 1, Qinghuangdao Port Langham Hospitality Bank of Chongqing Conch Venture In the Top 150 most actively traded stocks list? 3699 Dalian Wanda 4, CGN Power 3, HK Electric Investments 3, WH Group 2, BAIC Motor 1, Shenjing Bank 1, China CNR 1, Harbin Bank 1, Luye Pharma Tianhe Chemical In the Top 150 most actively traded stocks list? 6886 HTSC 4, GF Securities 4, China Huarong 2, China Reinsurance 2, Legend Holdings 1, China Energy Engineering 1, China Railway Signal 1, Dali Food 1, Fuyao Glass 1, CICC Postal Savings Bank 7, CR Pharma 1, China Zheshang Bank 1, China Merchants Securities 1, Everbright Securities 1, BOC Aviation 1, DFZQ 1, CSC Financial 1, Bank of Tianjin CDB Financial Leasing 810 In the Top 150 most actively traded stocks list? 2017 YTD 2611 GTJA Securities 2, ZhongAn Online P&C Insurance 1, China Literature 1, GZ Rural Commercial Bank 1, Zhongyuan Bank 1, Yixin Group Wuxi Biologics Razer Crystal International Jilin Jiutai Rural Commercial 446 Sources: HKEx, Bloomberg, CGIS Research 3

4 Figure 2: Trading volume of Top 10 most traded Chinese ADR companies Ticker Company name Current market cap (US$m) 3-month average daily turnover (HK$m) BABA US Equity Alibaba Group Holding Ltd 466,039 25,875 JD US Equity JD.com Inc 56,063 5,013 BIDU US Equity Baidu Inc 80,993 4,998 NTES US Equity NetEase Inc 38,908 2,821 CTRP US Equity Ctrip.com International Ltd 23,440 2,125 MOMO US Equity Momo Inc 5,765 1,685 WB US Equity Weibo Corp 23,635 1,577 TAL US Equity TAL Education Group 14,298 1,110 EDU US Equity New Oriental Education & Technology Group Inc 13,274 1,104 YY US Equity YY Inc 5, Total 47,278 HKEx's 2017 ADT YTD 84,049 Sources: Bloomberg, CGIS Research Figure 3: ADT of HKEx HK$bn Hong Kong Stock Exchange Average Daily Turnover in the past 6 years Figure 4: ADT of HKEx (monthly) HK$bn Hong Kong Stock Exchange Average Daily Turnover in the past 12 months E 2018E Year 0 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Month Figure 5: Rolling forward PER range of HKEx /1/2011 3/1/2012 3/1/2013 3/1/2014 3/1/2015 3/1/2016 3/1/2017 Figure 6: Rolling forward EV/EBITDA range of HKEx /1/2011 3/1/2012 3/1/2013 3/1/2014 3/1/2015 3/1/2016 3/1/2017 Rolling forward PER Average PER+1 standard deviation Rolling forward average PER Average PER-1 standard deviation Rolling forward EV/EBITDA Average EV/EBITDA +1 standard deviation Rolling forward average EV/EBITDA Average EV/EBITDA -1 standard deviation Sources: Bloomberg, CGIS Research estimates Sources: Bloomberg, CGIS Research estimates 4

5 Figure 7: Trading volume of Top 20 most traded Hong Kong stocks Ticker Company name Market cap (HK$m) 3-month average daily turnover (HK$m) 700 HK Equity Tencent Holdings Ltd 3,685,583 6, HK Equity Ping An Insurance Group Co of China Ltd 1,458,958 2, HK Equity China Construction Bank Corp 1,699,982 1, HK Equity Industrial & Commercial Bank of China Ltd 2,406,655 1,965 5 HK Equity HSBC Holdings PLC 1,501,806 1, HK Equity Bank of China Ltd 1,280,237 1, HK Equity Hong Kong Exchanges & Clearing Ltd 292,099 1, HK Equity China Life Insurance Co Ltd 1,023,776 1, HK Equity China Mobile Ltd 1,608,349 1, HK Equity Geely Automobile Holdings Ltd 252,883 1, HK Equity China Evergrande Group 388,047 1, HK Equity AIA Group Ltd 795,693 1, HK Equity Sunac China Holdings Ltd 143, HK Equity Sunny Optical Technology Group Co Ltd 160, HK Equity CNOOC Ltd 486, HK Equity BYD Co Ltd 210, HK Equity AAC Technologies Holdings Inc 213, HK Equity China Merchants Bank Co Ltd 820, HK Equity Semiconductor Manufacturing International Corp 63, HK Equity Country Garden Holdings Co Ltd 274, Sources: Bloomberg, CGIS Research 5

6 Key financials P&Lsummary (HK$m) E 2018E Trading fees and trading tariff 5,469 4,428 4,794 5,526 Stock exchange listing fees 1,114 1,092 1,297 1,373 Cearing and settlement fees 3,118 2,358 2,802 3,409 Depository related fees Market data fees Other revenue ,014 Revenue 12,233 10,398 11,640 13,233 YoY 34% -15% 12% 14% Net investment income 1, ,497 1,636 Other income Revenue and other income 13,375 11,116 13,160 14,891 Staff costs (2,020) (2,035) (2,175) (2,260) IT expenses (517) (500) (445) (490) Premises expenses (294) (333) (350) (365) Marketing expenses (41) (54) (58) (62) Legal and professional fees (99) (106) (100) (120) Other operating expenses (396) (427) (440) (470) EBITDA 10,085 7,661 9,592 11,125 Depreciation& amortisation (684) (771) (757) (767) Operating profit 9,401 6,890 8,834 10,358 Finance costs (114) (82) (116) (90) Share of loss of JV (9) (9) (9) (9) Profit before tax 9,278 6,799 8,709 10,259 Tax (1,347) (1,058) (1,306) (1,559) Minorities (25) (28) (29) (30) Net Profit 7,956 5,769 7,432 8,730 YoY 54.0% -27.5% 28.8% 17.5% Balance Sheet summary (HK$m) E 2018E Cash 110, , , ,192 Financial assets 92,144 99,159 88, ,620 Accounts receivable 15,535 12,928 15,049 21,085 Current assets 218, , , ,897 Financial assets Goodwill 17,872 17,812 17,850 17,820 Fixed assets 1,560 1,499 1,450 1,430 Non-current assets 19,622 19,508 19,502 19,457 Financial liabilities 64,486 61,627 46,009 55,009 Margin deposits 115, , , ,000 Accounts payable 15,270 12,246 12,655 18,459 Clearing House Fund of Participants 7,474 8,656 10,062 10,510 Current liabilities 203, , , ,732 Borrowings 3,409 3,422 3,524 3,625 Deferred tax liabilities ,092 Non-current liabilities 4,255 4,246 4,561 4,850 Shareholders' Equity 29,816 32,266 36,241 40,596 Minorities

7 Key financials Cash Flow summary (HK$m) E 2018E Profit before tax 9,278 6,799 8,709 10,259 Depreciation& amortisation Net working capital adjustment (293) (321) (181) (1,282) Net cash from operations 8,321 6,164 8,437 8,641 Capex (710) (620) (746) (717) Others 290 (2,715) (2,198) (3,980) Net cash from investing (420) (3,335) (2,944) (4,697) Dividends paid (3,017) (3,329) (3,141) (3,928) Net cash from financing (3,224) (3,586) (3,459) (4,250) Free cash flow 7,611 5,544 7,691 7,924 Net cash/(debt) 9,335 5,864 7,796 7,389 Net Gearing n.a. n.a. n.a. n.a. Gross gearing 11% 11% 10% 9% Ratios E 2018E EBITDA margin 82% 74% 82% 84% Net margin 65% 55% 64% 66% ROAE 31% 19% 22% 23% ROAA 3.2% 2.4% 3.0% 3.4% PE (x) PB (x) EV/EBITDA Basic EPS (HKD) Diluted EPS (HKD) DPS (HKD) Dividend yield 2.5% 1.8% 2.3% 2.7% BVPS (HKD) 90% 90% 90% 90% Segment Income Contribution Cash 28% 26% 29% 30% Equity and financial derivatives 18% 20% 18% 17% Commodities 14% 15% 13% 12% Clearing 36% 35% 35% 36% Platform and infrastructure 4% 5% 5% 4% Key assumptions E 2018E ADT of equity products (HK$bn) ADT of DWs, CBBCs &warrants (HK$bn) Total Cash Segment ADT (HK$bn) ADT of northbound( bn) ADT of southbound(hk$bn) Southbound Contribution 3.2% 6.1% 11.0% 13.6% Number of newly listed (main board) Number of newly listed (GEM) ADT of DWs, CBBCs &warrants (HK$bn) ADnumber of derivative contracts 393, , , ,000 ADnumber of stock options contracts 374, , , ,000 ADvolume of metals contracts (LME) 670, , , ,000 7

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