Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Aug 25, 2017

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1 Equity Research Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 17E 18E 17E 18E 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 CCB PETROCHINA HSBC BANK OF CHINA PING AN CHINA LIFE SINOPEC Source: Bloomberg GF events Date Event Location 13 Sep Brilliance China NDR Hong Kong Source: GF Securities (Hong Kong) A-Share Market Investment Strategy: Quality of living, tech and services three ideas for identifying consumer stocks with sustainable share price growth potential Consumer stocks accounted for around 19% of total A-share market cap as of end-july this year, and 17% of total A-share earnings in 2016: both percentages are relatively low compared with the contribution of consumer spending to the economy. White goods (since 2006), baijiu ( ) and traditional Chinese medicine ( ) are examples of A-share consumer stocks that have demonstrated sustained share price strength. Looking ahead, we highlight consumer stocks that have to do with improving the quality of life and tech- and service-related consumer names as having such potential. F&B: High-end baijiu names our top picks for sustained share price growth In the current share price run-up since 2016, baijiu names have been valued given the favorable competitive landscape in the sector which is now at a mature stage of development with slower growth. This better competitive landscape means fewer new entrants and substitute products, which translates onto companies financial statements as high GPM, NPM and ROE. In particular, highend and mid/high-end baijiu companies operate in the most desirable competitive environment with strong pricing power, and they are the most likely to demonstrate sustainable share price strength. Hong Kong Market China Life (2628 HK, Buy): Solid life NBV growth, improved product mix; maintain Buy 1H17 net profit was in line at Rmb12.2bn, while comprehensive income totaled Rmb11.9bn, compared with a negative Rmb7.5bn in 1H16. NBV rose a solid 31.7% YoY on an improved new business margin (22.3% vs 17.2% in 1H16), meaning an improved product mix. The number of agents was up 6% HoH, which should support future growth of high-margin products. Premium growth was driven by regular premiums and renewal premiums. Currently trading at ~1.9x 2017E P/B, we maintain our Buy rating and target price of HK$ China Taiping (966 HK, Buy): Rapid life NBV growth, but net profit declines YoY; maintain Buy The company s underwriting business performed well in 1H17, life NBV grew 63% YoY on an improved NBV margin, and its mainland P&C combined ratio came in slightly better than expected. The company is trading at just ~1.6x P/B, undemanding, in our view. Also, its number of life agents rose by 49% HoH in 1H17, which should support future life NBV growth. Thus, although the 23.5% YoY decline in net profit in 1H17 may have a short-term negative impact on the share price, we maintain our long-term Buy rating and target price of HK$ Vanke (2202 HK, Underperform): 1H17 earnings up 37% YoY, expensive valuation 1H17 contract sales increased by 46% YoY, GFA sold rose 33% YoY, and earnings rose 37% YoY, despite a decline in revenue. The company only completed 26% of its 2017 full year GFA target, but the majority will be booked in 2H17. With sold but unbooked sales revenue of Rmb383bn, we see clear earnings growth visibility for the company in We expect EPS to grow at a CAGR of 25% during The stock is trading much higher than comparable peers. We maintain our Underperform rating. GAC Group (2238 HK, Buy): Strong 1H17 results, expenses under control; maintain Buy GAC Group posted encouraging 1H17 results, with revenue up 62.2% YoY on the back of 57% YoY sales growth for GAMC, its own-brand segment, particularly the Trumpchi SUV range which saw sales rise 54.8% YoY. Net profit rose by a strong 57.4% YoY. Administrative expenses/revenue ratio was down from 4.9% in 1H16 to 4.1% in 1H17, an encouraging level indicating the company maintained expense control in 1H17, benefitting overall profitability. With increased economies of scale, we expect profitability to improve further in 2H17. We maintain our Buy rating. 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 Investment Strategy: Quality of living, tech and services three ideas for identifying consumer stocks with sustainable share price growth potential Overseas experience Based on experience from the US, Japan and Korea, stocks that can demonstrate sustained share price strength typically come from: 1) sectors in which the country in question has a global competitive edge and thus benefits from global market share growth, 2) consumer staples industries with stable growth, and 3) service industries that are in line with changes in the local population structure and trend of consumer upgrade. In particular, consumer stocks in these countries have achieved share price strength that lasted for a relatively long period of time as they are: 1) relatively resistant to cyclical changes with stable earnings growth; 2) set to benefit from consumer upgrade and innovation driven by the rise of the new generation of consumers and affluent individuals; and 3) industry-leading companies which are likely to become even stronger thanks to rising market shares. Consumer stocks yet to represent larger proportion of A-share market cap/profit Consumer spending has become one of the key drivers of China s economic growth in the last two years, and is likely to remain important due to a changing population structure and consumer demand upgrade. Consumer stocks accounted for around 19% of total A-share market cap as of end-july this year, and 17% of total A-share earnings in 2016: both percentages are relatively low compared with the contribution of consumer spending to the economy. Consumer staples vs. consumer discretionary Institutional investors tend to increase their positions in consumer staples stocks during weak markets, leading to excess returns from these stocks at such times and hence their defensiveness. Meanwhile, these stocks might not be suitable for aggressive moves during a bull market, something which consumer discretionary plays such as property and auto are better cut out for. Three ideas for finding consumer names with sustainable share price growth potential White goods (since 2006), baijiu ( ) and traditional Chinese medicine ( ) are examples of A-share consumer stocks that have demonstrated sustained share price strength. Looking ahead, we highlight the following ideas for identifying other consumer stocks with similar potential. Consumer stocks that have to do with improving the quality of life, such as fresh food, small appliances, customized furniture and specialized apparel, should see substantial room for growth. Tech related consumer goods: the increasing penetration of the mobile internet will stimulate a long-tail market, driving the e-commerce and online gaming industries. Some A-share growth stocks are likely to emerge amid rising asset turnover in service industries such as healthcare, education and entertainment. F&B: High-end baijiu names our top picks for sustained share price growth Baijiu sector preferred due to favorable competitive landscape During their share price rally in , baijiu stocks were valued based on their growth potential as the sector was going through a stage of rapid growth at the time. In the current run-up since 2016, baijiu names have been valued given the favorable competitive landscape in the sector which is now at a mature stage of development with slower growth. This better competitive landscape means fewer new entrants and substitute products, which translates onto companies financial statements as high GPM, NPM and ROE. In particular, high-end and mid/high-end baijiu companies operate in the most desirable competitive environment with strong pricing power, and they are the most likely to demonstrate sustainable share price strength. High-end baijiu: an oligopoly CR3 in the high-end baijiu market increased from 71% in 2008 to 95% in We expect sales volume to grow at a CAGR of more than 13% over the next 3-5 years with a relatively tight supply-demand equilibrium over the long term to drive continued price growth. Mid/high-end baijiu: monopolistic competition A correction in the baijiu sector during caused the market share of mid/high-end baijiu to shrink from 15% to 2.6% during the period, though growth upside resumed when the price of high-end baijiu started to go up again in We expect the market share of mid/high-end baijiu to rise to 8% in 2020, with a sales volume CAGR of 25% and revenue CAGR of 30% during Mid-end baijiu: perfect competition The market for mid-end baijiu (priced Rmb ) had a CR10 of less than 10% in 2016, and is likely to grow at a CAGR of 10% in the next few years with Page 2

3 sales channels a more important growth driver than branding. Going forward, serial products from well-known brands (with their strong branding) are likely to compete head-to-head with provincial leaders (which have strong sales channels), squeezing other locally produced products out of the market and enhancing industry concentration. We suggest watching provincial leaders such as Gujing Distillery ( CH), Kouzi Distillery ( CH), Laobaigan Liquor ( CH), King's Luck Brewery ( CH) and Yilite Industry ( CH). Our stock picks Considering the potential of sustained share price growth, we like high-end baijiu names Kweichow Moutai ( CH), Wuliangye Yibin ( CH) and Luzhou Laojiao ( CH) the best, followed by mid/high-end players such as Swellfun ( CH), Xinghuacun Fen Wine ( CH), Tuopai Shede Wine ( CH), Jiugui Liquor ( CH) and Yanghe Brewery ( CH). China Life (2628 HK, Buy): Solid life NBV growth, improved product mix; maintain Buy 1H17 results in line 1H17 net profit came in at Rmb12.2bn, with EPS of Rmb0.43 and BVPS of Rmb10.92, in line with expectation. Comprehensive income totaled Rmb11.9bn, compared with a negative Rmb7.5bn in 1H16. ROE (not annualized) was 4.0%. Solid NBV growth on an improved margin New business value (NBV) was Rmb36.9bn, up 31.7% YoY. Overall new business margin for FYP improved to 22.3% in 1H17, compared with 17.2% in 1H16, meaning an improved product mix. The total number of agents was 1.58m in 1H17, a 6% increase HoH, which should support future growth of high-margin products. The company posted a strong solvency ratio of 276%. Overall, we like the company s NBV growth and improved product structure. Investment performance Investment structure was virtually unchanged compared with end Annualized total investment yield was 4.6% in 1H17, compared with 4.4% in 1H16. Maintain Buy The company posted solid NBV growth and an improved NBV margin in 1H17. Its premium growth was driven by regular premiums and renewal premiums. Currently trading at ~1.9x 2017E P/B, we maintain our Buy rating and target price of HK$31.50, representing ~2.4x 2017E P/B. (Felix Luo, Research Analyst, SFC CE No. AQF573, felixluo@gfgroup.com.hk ) China Taiping (966 HK, Buy): Rapid life NBV growth, but net profit declines YoY; maintain Buy 1H17 results Total comprehensive income came in at HK$5.1bn, compared with a negative HK$1.87bn in 1H16, but this was partly due to forex gains. Net profit declined 23.5% YoY to HK$2.37bn, while EPS came in at HK$0.624 and BVPS was HK$ Embedded value of its life insurance segment rose by 13.6% HoH. Life NBV up 63% YoY on an improved NBV margin New business value (NBV) came in at HK$8.1bn, up 63.4% YoY. Aggregate new business margin from FYP was ~18.4%, compared with ~12.0% in 1H16. The number of agents continued to rise, up from 262k in 2016 to 391k in 1H17. The company posted a strong life solvency ratio of 244%. Overall, the company saw rapid growth in life NBV and an improved business margin, in line with our expectation. Mainland P&C combined ratio slightly better than expected Net profit in its mainland P&C business dropped due to poor investment performance. However, its combined ratio was 98.8% in 1H17, a slight improvement compared with 99.6% in 1H16. The segment had an adequate solvency ratio of 216% in 1H17. Investment performance needs to be improved Total investment yield came in at an annualized 4.0% in 1H17, weaker than the 4.7% in 1H16. Although the company s total comprehensive income was HK$5.1bn (negative in 1H16), HK$1.46bn of this was from forex gains. The company needs to improve its investment performance going forward. Page 3

4 Maintain Buy The company s underwriting business performed well in 1H17. Life NBV grew 63% YoY on an improved NBV margin and its mainland P&C combined ratio came in slightly better than expected. The company is trading at just ~1.6x P/B, undemanding, in our view. Also, the company s number of life agents rose by 49% HoH in 1H17, which should support future life NBV growth. Thus, although the decline in net profit in 1H17 may have a short-term negative impact on the share price, we maintain our long-term Buy rating and target price of HK$27.10, representing ~1.8x P/B. (Felix Luo, Research Analyst, SFC CE No. AQF573, felixluo@gfgroup.com.hk ) Vanke (2202 HK, Underperform): 1H17 earnings up 37% YoY, expensive valuation What's new? 1H17 contract sales increased by 46% YoY to Rmb277bn, and GFA sold rose 33% YoY to 18.7m sqm. Revenue dropped by 10% YoY to Rmb65.5bn (booked GFA dropped 11% YoY to 5.8m sqm), with an improved gross margin of 33% (26% in 1H16). New starts GFA was flat at 16.6m sqm; completed GFA was 6.4m sqm. Due to a better gross margin, earnings rose 37% YoY to Rmb7.3bn, despite declining revenue. EPS also increased by 37% YoY to Rmb0.66. No interim DPS was announced. Clear earnings visibility for 2017 According to management, the company only completed 26% of its 2017 full year GFA target, but the majority will be booked in 2H17. With sold but unbooked sales revenue of Rmb383bn, we see clear earnings growth visibility for the company in We expect EPS to grow at a CAGR of 25% during Expensive valuation; maintain Underperform The stock is trading at 1.8x 2016 NBV, much higher than comparable leading developers like COLI (688 HK, Buy) (1.3x NBV) and CR Land (1109 HK, Buy) (1.4x NBV). The company s current valuation is expensive, in our view, given declining GFA sold in first and second-tier cities since May We maintain our Underperform rating. (Dennis Yao, Research Analyst, SFC CE No. ALK994, dennisyao@gfgroup.com.hk ) GAC Group (2238 HK, Buy): Strong 1H17 results, expenses under control; maintain Buy Strong earnings maintained in 1H17 GAC Group posted encouraging 1H17 results, with revenue up 62.2% YoY to Rmb34.8bn, on the back of 57% YoY sales growth for GAMC, its own-brand segment, particularly the Trumpchi SUV range which saw sales rise 54.8% YoY. Gross profit rose 54.3% YoY to Rmb5.7bn, while GPM slid slightly to 16.5%, compared with 17.1% in 1H16. The contribution from JVs rose 45.4% YoY, mainly on steady growth for Japanese brands (GAC Honda, GAC Toyota and GAC Mitsubishi) and the rising contribution from GAC Fiat-Chrysler. Net profit rose by a strong 57.4% YoY to Rmb6.3bn, and EPS was up 56.5% YoY to Rmb0.97. The company announced an interim dividend of Rmb0.1/share, up 1.25x YoY, following its strong earnings growth. Expenses under control Selling expenses rose 59.3% YoY in 1H17, broadly in line with sales growth in its own-brand segment; selling expense/revenue ratio was down slightly from 5.9% to 5.8%, reflecting its conservative marketing campaigns in 1H17 following strong market responses. Administrative expenses were up 37.1% YoY but administrative expenses/revenue ratio was down from 4.9% in 1H16 to 4.1% in 1H17, an encouraging level indicating the company maintained expense control in 1H17, benefitting overall profitability. With selling and administrative expenses coming in at 10.8% of revenue in 1H17, vs 9.9% in 1H16, OPM increased to 7.9% in 1H17, up from 7.6% in 1H16. JV contribution grew steadily Revenue at major JVs was up 29% YoY to Rmb105.9bn, and gross profit up 26.7% to Rmb18.6bn, on the back of steady 25% sales growth. GPM came in at 17.5%, similar to the level in 1H16 (17.8%). Gross profitability at JVs is seeing a good trend, in our view, given the upward sales trend without aggressive pricing discounts. After-tax profit came in at Rmb7.7bn, up 42.9% YoY, and NPM was up 0.7pp to 7.2%, meaning improved profitability on operating efficiency with operating expense/revenue ratio down from 1pp to 10.3% in 1H17. Maintain Buy Sales for both own-brands and JVs were strong in 1H17, spurring strong profit growth. We expect this to continue in 2H17 amid the upcoming peak season in 4Q and the capacity Page 4

5 reversion for the Trumpchi GS8. The company s market share has risen to 7.2%, reflecting strong market response from customers. With increased economies of scale, we expect profitability to improve further in 2H17. We maintain our Buy rating. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk ) (Chongjing Deng, Research Analyst, SFC CE No. BEY953, dengchongjing@gfgroup.com.hk ) Page 5

6 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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