Strategist's Blog. China / Hong Kong Market Focus. Three themes for rest of the year. DBS Group Research. Equity 16 September 2015 HSI : 21,455

Transcription

1 China / Hong Kong Market Focus Refer to important disclosures at the end of this report DBS Group Research. Equity 16 September 2015 Three themes for rest of the year China FAI plays and property are sweet spots in our investment theme matrix China banks and autos are attractive laggards Adding Bocom, CRCC, GAC, and ZTE to top ten picks Tick shaped market. Fed rate futures indicate only a 28% probability for a Fed rate hike later this week (pg 2). Although a rate hike delay is likely, we believe the Hong Kong market will not re-rate strongly due to other overhangs. But we do not expect large market downside based on index P/BV and several market-fear measurements (pg 3-5). We also believe Hang Seng Index PE comparisons to past troughs are not reliable due to component changes since 1998 and 2009 (pg 7-8). We believe the market to be tick-shaped, with a substantial rebound coming in the medium term if: 1) A-shares fall back to pre-rally PE valuations, 2) China rolls out more pro-growth policies, and 3) there is more clarity on Fed rate outlook. Our 3 month and 12 month HSI targets are 22,332 and 25,440 respectively (pg 9). Three themes for rest of year. We have mapped out relevant macro trends that will impact the market in the coming months (pg 13). In this environment, we prefer 1) companies that can benefit from expected macro policies and growth initiatives (pg 14), 2) companies that can benefit from expected monetary policies and currency trends (pg 15), and 3) value and laggard picks (pg17). We believe China fixed asset investment and properties are sweet spots in the market as they fit into multiple themes (pg 20). ZTE and TK Group also score well. In addition, we like China banks and China autos as laggard picks with turnaround potential. Upgraded CH property, CH construction, and CH materials; downgraded HK banks, healthcare, and coal. We have upgraded China property and China railway and construction from Neutral to Overweight. Both sectors have lagged, but will benefit from lower Rmb interest rates and fiscal support. We have also upgraded materials to Neutral. However, we have downgraded Hong Kong banks to Neutral on slower USD rate hike and macro uncertainties. We have also downgraded healthcare on valuation grounds and coal on poor fundamentals (pg 21). Adding four stocks to top ten. We are adding BoCom (3328.HK), China Railway Construction (1186.HK), Guangzhou Automobile (2238.HK), and ZTE (763.HK) into our top ten picks as they fit into our three investment themes. We have taken out Far East Horizon (3360.HK), Yestar (2393.HK), Dah Sing Financial (440.HK), and CR Land (1109.HK) (pg 22). HSI : 21,455 Analyst Alexander LEE CFA, alexander_lee@hk.dbsvickers.com Ian Chui ian_chui@hk.dbsvickers.com China/Hong Kong Research Team (852) hkresearch@hk.dbsvickers.com DBSV top picks performance (market cap weighted) (28 Feb 2014 = 100) DBSV top picks - market cap weighted HSI Jan/14 Apr/14 Jul/14 Oct/14 Jan/15 Apr/15 Jul/15 Source: DBS Vickers DBSV top ten Closing FY16F T gt Ticker price PBV PER y ield ROE Price (HK$) (X) (X) (%) (%) (HK$) BOCOM 3328.HK COLI 688.HK CH Railway Constr 1186.HK GZ Automobile 2238.HK Nexteer Auto 1316.HK Sinopharm Group 1099.HK Tencent 700.HK Value Partners 806.HK Wasion Group 3393.HK ZTE 763.HK Source: DBS Vickers Based on 15 September 2015 closing prices sa- AH

2 Delay in rate hike is more likely. Fed Fund Futures are pricing in a 28% probability for a rate hike decision this week. This has declined from 60% at the start of the year. Market expectations for a first hike in or before December is still fairly high at 60% probability. But this too, has been dropping from 80% at the start of the year. Weighing in arguments for and against a rate hike now, we believe the against arguments dominate this round: Arguments for a hike now: - Monthly non-farm payrolls since 2014 have improved by 84% from levels (240,600 compared to 131,000). - Unemployment rate has declined to 5.1% from the peak of 10%. This is below the original unemployment target of 6.5%. Arguments for waiting: - Core PCE inflation is below the 2% Fed target at 1.2%. - Unemployment rate, if adjusted for current low labor participation rate of 62.6% (vs. 66% before crisis), would be quite high at 10%. - Macro uncertainty of emerging markets. According to the IMF, emerging and developing economies account for almost half of 2014 US exports. ADP employment change US unemployment rate (reported and adjusted) (k) (200) (400) (600) (%) Assuming 66% labor participation Reported (800) (1,000) Probability of rate hike according to Fed Fund Futures 100% Probability of rate hike in or before Dec 2015 Probability of rate hike in or before Sept % 60% 40% 20% 0% Jan Feb Mar Apr May Jun Jul Aug Sep Page 2

3 Several gauges suggest market is near bottom. Although the HSI 12 month forward PE is higher than past trough levels, we believe HSI membership and weighting changes since 2009 make an apple-to-apple comparison difficult. Instead, we have explored other market indicators to gauge potential downside. HSI trailing P/B We find several indicators which suggest limited downside from current levels. Price to book. The HSI trailing P/BV is now at 1.14, which is just slightly above 2009 s trough of 1.1x. Meanwhile, the HSCEI P/BV of 0.94 is already below the 2009 trough of (x) 3.5 HSI 1yr trailing P/B +2 stdev 10 yr mean -2 stdev HSCEI trailing P/B (x) HSCEI 1yr trailing P/B +2 stdev 10 yr mean -2 stdev Measurements of market fear. The China telecom sector s PE relative to the market is near 2 standard deviations above mean. This implies de-risking action by investors have already been carried out for some time. This relative measure was high in 3Q13, 3Q14, and 1Q15, which were favorable entry points. Similarly, the Hang Seng Utilities Index has already outperformed the HSI strongly in recent months. Meanwhile, the HSI volatility index has also spiked to 41% in early September, a level not seen since In addition, HSBC s forward dividend yield spiked to above 6% (pg 5). This is assuming HSBC can payout US$0.5 per share in DPS in 2015 and Such high yields only occur during crisis times and market performance in the subsequent year after such high yields have usually been positive. Page 3

4 China telecom operators PE vs. HSI PE HS Utilities Index performance relative to HSI x China telecom / HSI 2yr mean -2 stdev +2 stdev Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 HSI volatility index (1/1/'03 = 1.0) HSU vs. HSI HSI (RHS) ,000 30,000 25,000 20,000 15,000 10,000 (%) Page 4

5 HSBC forward dividend yield (top), Hang Seng Index (middle), and HSBC share price (bottom) (%) Buy signals Sell signals ,000 30,000 25,000 20,000 15,000 10,000 5, (HK$) Page 5

6 HSI PE comparison to past troughs is unreliable. In contrast to above gauges, HSI PE levels suggest there is still large downside if we were to reach 2009 crisis levels. The HSI 12 month forward PE is 10x, still significantly higher than 2009 s trough of 7.7x. However, we believe HSI member and weighting changes since 2009 have raised the PE levels of the HSI. More high PE members in current HSI compared to 2009 and We tried to reconstruct the HSI PE charts using only current members or past members, but this is technically challenging. Also, some current members were not listed in the past. Instead, we have calculated the weighted index PE using current members, 2009 members, and 1998 members using current valuations. The weighted average PE using current HSI members is 14.6x, which is higher than the x average when using past HSI members and weightings in 2009 and This confirms HSI PE comparison to the past is not an apples-for-apples comparison. We believe the HSCEI PE bands serve as a better trading range indicator for the market. HSI 12 month forward P/E (x) 30 HSI 1yr forward P/E 5yr mean -2 stdev +2stdev HSCEI 12 month forward P/E (x) 30 HSCEI 1yr forward P/E 5yr mean -2 stdev +2 stdev Page 6

7 Current weighted PE using current HSI weightings Current Current Index Bloomberg Weighted Current members weight (%) Est. PE PE (x) Weighted average PE HSBC Holdings PLC Tencent Holdings Ltd China Mobile Ltd AIA Group Ltd China Construction Bank ICBC CK Hutchison Holdings Ltd Bank of China Ltd HKEx China Life Insurance Co Ltd Ping An Insurance CNOOC Ltd Sun Hung Kai Properties Ltd Cheung Kong Property PetroChina Co Ltd Sinopec CLP Holdings Ltd Hang Seng Bank Ltd Hong Kong & China Gas Power Assets Holdings Ltd Link REIT China Overseas Land BOC Hong Kong CITIC Ltd Sands China Ltd China Unicom Hengan International Wharf Holdings Ltd/The Henderson Land Dev Galaxy Entertainment MTR Corp Ltd Swire Pacific Ltd 'A' Belle International Want Want China Lenovo Group Ltd Bank of Communications China Resources Land Ltd China Shenhua Energy Co Ltd New World Development Hang Lung Properties Ltd Bank of East Asia Ltd/The China Mengniu Dairy Co Ltd China Resources Power Sino Land Co Ltd China Merchants Holdings China Resources Ent Li & Fung Ltd Tingyi Kunlun Energy Co Ltd Cathay Pacific Airways Ltd Current weighted PE using 2009 HSI weightings 2009 Current Index Bloomberg Weighted 2009 members weight (%) Est. PE PE (x) Weighted average PE China Mobile Ltd HSBC Holdings PLC China Construction Bank Corp ICBC China Life Insurance Co Ltd PetroChina Co Ltd CNOOC Ltd Cheung Kong Holdings Ltd Sun Hung Kai Properties Ltd CLP Holdings Ltd Sinopec HKEx Bank of Communications Hang Seng Bank Ltd Bank of China Ltd China Unicom Hong Kong Ltd Power Assets Holdings Ltd China Shenhua Energy Co Ltd Ping An Insurance Tencent Holdings Ltd Swire Pacific Ltd 'A' Hong Kong & China Gas China Overseas Land Hang Lung Properties Ltd BOC Hong Kong Li & Fung Ltd Henderson Land Dev Wharf Holdings Ltd/The Bank of East Asia Ltd/The MTR Corp Ltd Sino Land Co Ltd New World Dev China Merchants Holdings China Resources Ent CITIC Ltd Cathay Pacific Airways Ltd Yue Yuen Industrial COSCO Pacific Ltd FIH Mobile Ltd Hutchison Whampoa Ltd 2.5 n.a. Esprit Holdings Ltd 1.4 n.a. Aluminum Corp of China Ltd 0.5 n.a. Page 7

8 Current weighted PE using 1998 HSI weightings Current weighted PE using 1998 HSI weightings (con t) 1998 Current Index Bloomberg Weighted 1998 members weight Est. PE PE (x) Weighted average PE HSBC Hldgs plc China Telecom Hang Seng Bank CLP Hldgs SHK Prop Cheung Kong HK Electric Swire Pacific 'A' CITIC Pacific HK & China Gas Henderson Land New World Dev CKI Hldgs Wharf (Hldgs) Cathay Pac Air Bank of E Asia Current Index Bloomberg Weighted 1998 members weight Est. PE PE (x) Amoy Prop China Resources Shanghai Ind Hldgs Wheelock Hy san Dev Hang Lung Dev Shangri-La Asia TVB First Pacific Sino Land HK & S Hotels Guangdong Inv Hopewell Hldgs Great Eagle Hldgs HK Telecom Hutchison 9.7 n.a. Henderson Inv 1.0 n.a. Some key overhangs need to be lifted for sustainable rebound. Although we do not expect downside for the market, meaningful re-rating can only come when more overhangs are lifted. Firstly, the A-share market overhang needs to be addressed. We believe A-shares will continue to correct back to pre-rally PE valuations. This implies 12% downside for the SHCOMP. CSRC said it has cleaned up 60% of the grey market margin financing in the system, while the official margin financing amount has also declined from the peak. This paves the way for the final phase of the A-share market correction without repurcussions to the financial sector. This concern was why there was frantic response in July to halt the A-share decline. Secondly, there needs to be higher confidence in corporate earnings. Current market earnings forecasts point to an earnings recovery scenario for 2016, thanks to low base effect earnings growth projections for the HSI and HSCEI are 7.7% and 7.4% respectively. But weak macro conditions and potential CNY depreciation can trim earnings outlooks. More pro-growth policies from China and more clarity on CNY trends will help stabilize earnings expectations. SHCOMP still needs to fall 12% to 2,650, to return to pre-rally PE level of 10x 6,000 SHCOMP 5 yr mean of 1 yr forward P/E +1 std -1 std +2 std -2 std 5,000 4,000 3,000 2, x 14.7x 12.3x 10.0x 7.6x 1, Sources: DBS Vickers Page 8

9 HSI earnings forecasts (index points) HSCEI earnings forecasts (index points) ,700 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 Jan/13 Jul/13 Jan/14 Jul/14 Jan/15 Jul/15 CNY / USD ,800 1,700 1,600 1,500 1,400 1,300 1,200 Jan/13 Jul/13 Jan/14 Jul/14 Jan/15 Jul/15 CSI300 earnings forecasts (index points) Jan/13 Jul/13 Jan/14 Jul/14 Jan/15 Jul/ Jan/14 Apr/14 Jul/14 Oct/14 Jan/15 Apr/15 Jul/15 More bullish index targets in the medium term. We expect the market will remain in low valuations in the near term due to macro uncertainties and overhang from A-shares. This is reflected in our 3 month index targets, which only offer small upside. But we anticipate the medium term return for the market can be substantial. This is assuming China will roll out more pro-growth policies, CNY depreciation will stabilize, and A-shares will become less of a drag on the Hong Kong market. Upside will be driven by slight PE re-rating and earnings recovery from a low base in China banks, China telecom, commodities, and gaming. Hang Seng Index 3 month and 12 month targets HSI 3M target 12M target 29,000 27,000 25,000 23,000 21,000 19,000 25,440 Tgt PE =11x 22,332 Tgt PE =10.5x 17,000 15, Page 9

10 HSI PE bands 30,000 28,000 26,000 24,000 22,000 20,000 18,000 16,000 14,000 12,000 10,000 HSI 5 yr mean of 1 yr forward P/E +1 std -1 std +2 std -2 std 12.7x HSCEI 3 month and 12 month targets 11.6x 10.5x 9.3x 8.2x HSCEI 3M target 12M target 16,000 15,000 14,000 11,773 13,000 Tgt PE =7.8x 12,000 11,000 9,926 10,000 Tgt PE =7.1x 9,000 8, HSCEI PE bands 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - HSCEI 5 yr mean of 1 yr forward P/E +1 std -1 std +2 std -2 std x 9.9x 8.5x 7.1x 5.8x Page 10

11 Consensus earnings outlook for HSI components EPS (HK$) EPS growth HSI China banks BoCom HK % 2.2% BOC HK % 4.4% ICBC HK % 3.8% CCB HK % 3.8% HK banks BEA HK % 5.0% BOCHK HK % 10.2% Hang Seng Bank HK % -15.0% HSBC HK % 1.7% HKEX HK % 11.1% Insurance China Life HK % 9.9% Ping An HK % 5.3% AIA HK % 11.3% Telcos China Mobile HK % 5.5% China Unicom HK % 9.3% Oil PetroChina HK % 37.5% Sinopec HK % 22.9% CNOOC HK % 27.9% Coal China Shenhua HK % 3.2% China Coal HK % 15.3% Gas Kunlun Energy HK % 22.3% Towngas HK % 7.3% Power CLP HK % 4.6% China Res Power HK % 2.2% Power Assets HK % 2.4% HK property MTR HK % -13.8% Cheung Kong HK % 12.0% SHK Land HK % 18.6% Henderson Land HK % 8.6% New World Development HK % 12.4% Hang Lung Property HK % -2.2% Sino Land HK % 8.6% Llink REIT HK823 China property COLI HK % 12.0% China Resources Land HK % 13.4% Conglomerates China Resources HK291 (0.07) % 33.6% Citic Pacific HK % -1.9% China Merchants HK % 9.3% Swire HK % 2.8% Wharf HK % 7.5% Gaming Galaxy HK % 14.3% Sands China HK % 1.1% Tech Lenovo HK % -69.7% Tencent HK % 29.8% Transport Cathay Pacific HK % 10.3% Cosco Pacific HK % 7.9% Commerce Li & Fung HK % 11.5% Consumer Hengan HK % 12.4% Belle Int'l HK % 3.1% Want Want HK % 13.0% Tingyi HK % 18.8% Page 11

12 Consensus earnings outlook for HSCEI components EPS (HK$) EPS growth Banks BOC HK % 4.5% BoCom HK % 2.2% CCB HK % 3.9% CMB HK % 10.3% ICBC HK % 4.3% ABC HK % 4.9% Citic Bank HK % 5.5% Minsheng HK % 5.9% Insurance China Life HK % 9.8% PICC Group HK % 3.3% CPIC HK % 9.9% PICC P&C HK % 2.5% Ping An HK % 6.4% Brokers and AM Citic Securities HK % 8.3% Haitong HK % 1.7% China CINDA HK % 17.8% Telcos China Telecom HK % 9.7% Oil and services PetroChina HK % 46.6% Sinopec HK % 29.1% China Oilfield HK % 29.7% China property Dalian Wanda HK % 24.1% China V anke HK % 15.9% Power Huaneng Power HK % 8.9% China Longyuan HK % 16.3% CGN Power HK % 19.6% Construction and China Railway HK % 12.0% machinery China Comm Cons HK % 12.5% Cement Anhui Conch HK % 10.7% CNBM HK % 15.5% Coal China Coal HK (0.19) (0.09) % -54.3% China Shenhua HK % 3.9% Autos BYD HK % 15.8% GAC Group HK % 21.8% Dongfeng Motors HK % 9.2% Greatwall Motor HK % 14.7% Others Tsingdao HK % 9.5% Sinopharm HK % 19.3% Air China HK % 1.3% J iangxi Copper HK % 20.4% Page 12

13 Expected macro environment and their impacts Index Already occurred Ongoing events Expected events Impacts IMF SDR basket review delayed until 3Q16 China's macro outlook remains weak MSCI di d not include A shar es Fear of impact to financial system due to excess leverage Rmb depreciation trend Fiscal action to help transformation China's interest rate cut cycle is lengthening Desperate scram ble to prevent domino effect on margin Exports to find some relief China's five year plan for Domestic fiscal plan to pr op up jobs in near term Overhang for A share market from eventual exit plan Winded down most toxic leverage products Exporters and Chinese companies with overseas revenues to benefit Accelerate reforms and new economy FAI through Private Public Partnership A shares not as appealing until MSCI talks resume China can let market forces sort itself China's real interest rate dipping to zero Increase tech and automation in manufacturing One belt one road to expor t excess ca pa city Investment in infra and green sectors Domestic property appetite to increase IT and automation solution providers to benefit Railway, construction, telecom and power equipment to benefit Water, alternative energy, waste management to benefit China property developer s to benefit Sources: DBS Vickers Page 13

14 Three investment themes China s macro outlook remains lacklustre. We have mapped out the expected macro environment companies face on the next page. China s macro trends are still weak despite rate cuts since November The official data are well circulated so we will not repeat their publication here. If we look at other economic gauges, they point to an even more drastic slowdown than what the official figures suggest. In this environment, we recommend companies that can benefit from expected macro and monetary policies. We also favor laggards with turnaround potential. Electricity production Railway freight Electricity production yoy% (RHS) Railway freight ton km m yoy% (RHS) (kwh bn) Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 50% 40% 30% 20% 10% 0% -10% (Ton km m) 270, , , , , , , , , , ,000 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 30% 20% 10% 0% -10% -20% Sources: CEIC, Bloomberg Finance L.P., DBS Vickers Theme 1: Companies that benefit from macro policies and initiatives China to accelerate reforms and new initiatives. China will roll out its next five year plan for in coming months. We expect the plan will focus on accelerating reforms and new initiatives, to prop up new industries and wean China from its reliance on traditional FAI and cheap exports. Hence, we believe the upcoming five year plan will reiterate a lot of initiatives that were rolled out in the government work report earlier this year. These include encouraging companies to go global, partly through the one belt one road scheme. China will also upgrade its manufacturing sector, combat pollution, and continue SOE reforms to improve efficiency. We expect infrastructure companies and equipment providers to benefit from the go-global initiative, especially for companies with track record of winning overseas contracts. Meanwhile, IT and automation solution providers will see continued growth opportunities in China s economic shift. Similarly, environmental and alternative energy sectors should see faster growth than China s GDP given pollution initiatives. Lastly, SOEs earmarked for reform and restructuring can potentially benefit from efficiency or bargaining power gains. Page 14

15 Some anticipated policies of upcoming five-year plan Policies Financial reforms Go global strategy "Made in China 2025" SOE reform Combat pollution Promote desired consumption Sources: DBS Vickers Rely less on SOE banks to channel country's savings Encourage Chinese companies to go global, particularly for recommended sectors. Silk road plan complements this strategy. Upgrade manufacturing to German model, with more automation and design. China will also promote breakthroughs in ten sectors Introducing mixed ownership to SOEs, through divestments and employee share incentives. Energy and water conservation, increase renewable energy sources, emission controls. Encourage development of in healthcare, information goods, and leisure services and goods Beneficiaries Insurance, brokerages, asset managers Railways, electric power, communications, engineering machinery, automobile, aircraft, electronics Automation, information technology, railway equipment, energy-saving cars, high-end medical equipment SOEs with restructuring possibilities. Ie COFCO group, Everbright Ltd, Sinopharm, CNBM. Water companies, alternative energy, waste to energy operators Healthcare, airlines, theme parks, internet Theme 2: Companies that benefit from monetary and currency trends China s real interest rate decline to benefit property and FAI. We expect Chinese policy makers will continue to cut interest rates. We expect another 50bps in benchmark rate cuts to come before mid This will help lower funding cost for investments. Combined with lower funding hurdles for infrastructure projects enacted by the NDRC recently, we expect FAI will gradually pick up. Further interest rate cuts will also push China s real deposit rates towards zero. This should further help property pre-sales recovery, especially when A- shares is less appealing as an asset class. Thus we expect China property and fixed asset investment plays to benefit from China s interest rate cycle. Falling real interest rates in China China property monthly pre-sales (%) (2) (4) (6) Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 1 yr real lending rate 1 yr real deposit rate rate hikes rate cuts Rmb m 1,000, , , , , , , , , ,000 0 Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 May-09 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 USD strength to help exporters. Our DBS currency team forecasts continued USD strength in the coming 12 months, and foresee substantial EUR weakness and moderate weakness in CNY and Asian currencies. We believe Chinese exporters can benefit from a weaker CNY, but we favor companies that export more to the US rather than to Europe. On the flip side, Chinese companies with HKD or USD borrowing stand to lose from USD strength. Page 15

16 DBS house currency forecasts EUR usd/ usd/ usd/ usd/ usd/ usd/ usd/ usd/ usd/ usd/ /usd JPY CNY HKD TWD KRW SGD MYR THB IDR PHP 9-Sep , Q , , Q , , Q , , Q , , Q , , Sources: DBS Vickers Winners and losers from Rmb depreciation Sector Companies Impact Positiv e Exporters Techtronic (669.HK) TK Group (2283.HK) Shenzhou Int'l (2313.HK) Pacific Textiles (1382.HK) V tech (303.HK) Samson (531.HK) Majority of costs are in Rmb while sales are largely in foreign currencies. Technology Lenovo (992.HK) ASM (522.HK) AAC Acoustics (2018.HK) Sales are primarily denominated in USD, while costs are largely in Rmb. Autos and Minth (425.HK) 30% of sales are from overseas while costs are largely Rmb others Guangdong Investment (270.HK) Water sales to HK are fixed in HK$ but costs are in Rmb ZTE (763.HK) Margins or competitiveness for overseas business to improve Negative Airlines Air China (753.HK), China Eastern Airlines (670.HK), China Southern Airlines (1055.HK) Sources: DBS Vickers Revenues are in Rmb, but majority of debt and some costs are US$ based Paper L&M Paper (2314.HK) Rmb revenues but forex cost base; HK$/US$ liabilities Nine Dragons (2689.HK) Rmb revenues but forex cost base; HK$/US$ liabilities China COGO (81.HK), COLI (688.HK), Has HKD/USD liabilities property Agile (3383.HK) HK banks BEA (23.HK) Rmb depreciation will have negative translation effect. More impact for BEA given larger portion of Rmb assets. HK retail Slightly lower purchasing power of mainland tourists in HK$ terms Gaming Slightly lower spending power of mainland tourists Others Texhong (2678.HK) 90% revenues are in Rmb but 65% of COGS is in USD Brilliance China (1114.HK) Slight negative as some engines are imported from Germany V alue Partners (806.HK) Translation of A-shares to fund NAVs for performance fees China Unicom (762.HK) Offshore debt translation Baosteel (600019) USD debt translation to hit Rmb EPS Far East Horizon (3360.HK) Offshore funding Maanshan Iron & Steel (323.HK) USD/EUR debt is 30% of total debt Sinopharm (1099.HK) Some procurement of overseas drugs for sale in China Page 16

17 Theme 3: Value and laggard picks Chinese banks and autos as laggard picks. Airlines, oil, global banks, gaming, Chinese brokers, banks, and autos are key laggards since the A-share collapse on July 8, Among these, we believe China banks and China autos are attractive bottom fishing targets. Both sectors ROE vs. P/BV relationships are on the cheap side. China banks PB hit 2 standard deviations below mean, which is only justified if there is systemic risk in the system. We also expect Chinese banks earnings growth recovery next year can be a catalyst. Earnings confidence for the sector will be higher with more pro-growth initiatives from China. Meanwhile, we have seen improving m-o-m auto sales in August, and this should continue in 4Q thanks to new models and seasonality. Our PEG screen also contained many auto companies which have low PEGs. Sector performance since July 8th 30% 20% 10% 0% -10% -20% -30% Transport (airlines) Oil Banks - Global Gaming Brokers-China Banks - China Autos and parts HSCEI Consumer (retailers) Coal Steel & aluminium Consumer (household) HSI Properties -HK Consumer (luxuries) Gas Properties - China Food and beverages Banks -HK Software & IT services Conglomerates -HK Hardware & equip Insurance Power - China REIT Cement Telecom -HK Telecom - China Pharmaceuticals Water, environmental Industrial Transport (toll roads) Transport (ports) Consumer (apparel) Consumer (personal) Power, infra & utilities Alternative energy Rail & construction Transport (shipping) Consumer (sportswear) Sources: DBS Vickers China banks P/BV China autos PE relative to market PE x x '13 max = max = '13 trough = trough = Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Auto / HSI 2yr mean -2 stdev +2 stdev Page 17

18 P/B vs. ROE China F&B 2.5 Pharmaceutical & healthcare China non-bank financials (2015 P/B) Hong Kong property China telecom carriers China coal Hong Kong telecom Environmental Apparel and footwear Railway and construction Retailers China materials Oil China property Hong Kong banks China telecom equipment China IPPs Textiles China auto and parts China banks (2016F ROE) Sources: PBOC, DBS Vickers Stocks with earnings growth improvement in 2016 and reasonable valuations (2016F PE < 10x or PEG < 1x) EPS growth PE EPS CAGR Ticker Company F change F PEG 173 K. Wah Intl -6% 93% 100% % Evergrande Real Estate -50% 37% 87% % (0.25) 311 Luen Thai -7% 65% 72% % Franshion Properties -47% 24% 71% % (0.18) 1114 Brilliance China -22% 28% 51% % (50.0) 570 China Traditional Chinese Medicine 16% 73% 57% % Trigiant Group -37% 13% 50% % (0.25) 3377 Sino-Ocean Land -21% 26% 47% % (13.8) 1117 China Modern Dairy -26% 20% 45% % (1.27) 1378 China Hongqiao Group -14% 30% 44% % China Resources Land -28% 16% 43% % (0.85) 6136 Kangda International -4% 38% 41% % China Resources Cement -24% 4% 29% % (0.50) 2007 Country Garden -20% 8% 27% % (0.59) 1366 J iangnan Group -1% 23% 24% % Dongfeng Motor Group 1% 10% 9% % China V anke 8% 17% 8% % China CITIC Bank 1% 8% 7% % 0.92 Sources: DBS Vickers Page 18

19 Lowest PEG ratios in DBSV universe EPS growth PE EPS CAGR Ticker Company F F PEG 881 ZhongSheng 70% 35% % China Everbright Ltd 71% 61% % Texhong Textile Group 70% 64% % China ZhengTong 34% 21% % Great Wall Motor 36% 22% % Greenland (Hong Kong) 328% 207% % Xinchen China Power Hldgs 14% 32% % Luen Thai -7% 65% % Guangzhou Automobile 33% 16% % Comba 105% 15% % K. Wah Intl -6% 93% % Geely Automobile 77% 12% % China Fiber Optic Network 5% 19% % China Financial Services 12% 13% % Chongqing Rural Bank 12% 7% % T K Group 30% 18% % 0.50 Sources: DBS Vickers Barbell strategy buy policy beneficiaries and laggards. No sector fit into all of the three themes, mainly because it is hard for a stock to lag the market when its fundamentals should benefit from ongoing interest rate cuts and expected fiscal policies. Hence we believe the sweet spot to be the overlapping area between beneficiaries of macro and monetary policies. These would include China property and fixed asset investment plays. At the same time, we also recommend laggards with turnaround potential, being Chinese banks and Chinese autos. Page 19

20 Matrix for stock selection Can benefit from expected fiscal initiatives Can benefit from monetary policies or currency trends China railway and construction China property (net +ve) Environmental companies CH property China railway and construction Other infra and FAI plays China railway and Environmental companies IT and automation solutions construction HK banks (net +ve for non-cnh) Environmental SOE reform: COFCO, Sinopharm, ZTE 763 Exporters: Techtronic 669, Vtech 303, CNBM, Unicom, COSCO Pac Textile 1382, Shenzhou 2313, Sinopec Samson 531 Sinopec 386 TK Group 2283 Offshore revenues: Lenovo 992, Minth 425 GD Inv 270 China banks China autos and parts Airlines, global banks, oil Chinese brokers, gaming Screen - growth improvement with cheap valuations: CTCM 570, Kangda 6136, Luen Thai 311 China Modern Dairy 1117, Jiangnan 1366 Laggards and value picks Sources: DBS Vickers Page 20

21 Recommended sector weightings Overweight on China banks, property, railway and construction, environmental, and IT. We have upgraded China property and China railway and construction from Neutral to Overweight. Both sectors have lagged, but will benefit from lower Rmb interest rates and fiscal support. We were lukewarm towards China banks during the results season and took out our China banking picks from our top ten. But we are now more positive as valuations have hit 2 standard deviations below mean. We like banks with low dilution risk and strong ability to pay dividends even in the face of rising NPLs. We also like environmental and IT and e-commerce companies, as they will likely be featured in the coming five year plan. Underweight on China coal, F&B, HK property, HK REITs, and HK retailers. Hong Kong is entering a structural downturn. We do not see a turnaround for HK retail, and HK property outlook is clouded by USD rate changes and poor capital market performance in recent weeks. For these reasons, we have downgraded Hong Kong banks to Neutral. We still expect HK banks to benefit from USD rate hikes, but macro uncertainties and CNH funding pressures can offset the benefit. We also downgraded China coal to underweight due to poor profitability and earnings revisions. Latest recommended sector weightings Sector Weighting Change Rationale China banks Overweight Trough valuations; earnings recovery from low base to be catalyst China property Overweight Upgraded Expecting sales recovery due to rate cut, HPR and mortgage policies Railway and construction Overweight Upgraded Lower borrowing rates, domestic fiscal spending, and overseas contracts Environmental Overweight Pollution control to be featured in 5 yr plan; prefer smaller caps Internet and e-commerce Overweight E-commerce continues to gain market share; IT to be featured in 5-year plan Apparel and footwear Neutral Prefer sportswear companies; avoid companies with large HK exposure China airlines Neutral Earnings upgrades thanks to falling oil price, but hurt by CNY depreciation China appliances Neutral Outlook to improve on back of expected rebound in property sales China auto and parts Neutral Slow car sales balances cheaper commodity input costs China coal Neutral Documentary "Under the Dome" is scary; structurally unattractive China IPPs Neutral Helped by lower coal prices; prefer operators with more alternative exposure China materials Neutral Upgraded Fundamentals can improve slightly if domestic FAI picks up moderately China non-bank financials Neutral We look to revisit this sector when SZ-HK stock connect kicks off China retailers Neutral Prefer players with strong O2O initiatives or defense against e-commerce China telecom carriers Neutral VAT reform will no longer negatively drag earnings in 2016 China telecom equipment Neutral 4G network capex to slow slightly in 2015; prefer overseas exposure Gaming Neutral Worst seems to be over for y-o-y gaming revenue declines Hong Kong banks Neutral Downgraded A rare sector that can benefit from USD interest rate normalisation Hong Kong telecom Neutral Industry consolidation should help pricing in the future Oil Neutral Oil price remains weak on both demand and supply concerns Pharmaceutical + healthcare Neutral Downgraded Positive long term drivers, but pricey valuations limit upside in current mkt Textiles Neutral Profitability is normalizing in 2015 thanks to cotton prices China coal Underweight Downgraded Documentary "Under the Dome" is scary; structurally unattractive China F&B Underweight High valuations cap upside, particularly with earnings downgrades Hong Kong property Underweight US interest rate cycle and HK political pressure are key risks HK REITs Underweight Rising risk appetite and US$ interest rate normalization are key risks HK retailers Underweight Unfavorable structural change in mainland tourist spending behavior Sources: DBS Vickers Page 21

22 Top ten picks Adding BoCom, CRCC, GAC, and ZTE. We are adding these stocks as they fit into our three investment themes. We took out China banking picks in early 3Q due to macro uncertainty and an extension in China s interest rate cut cycle. We believe the sector is now oversold and see value re-emerging. Thus we are adding BoCom (3328.HK) back into our top ten picks. Aside from China banks, we also like China autos as another laggard play. We like Guangzhou Automobile (2238.HK) as its sales YTD have fared well, while seasonality and new models should lift 4Q sales. We are also adding in ZTE. The company stands to benefit from Rmb depreciation. Overseas contracts should also grow as China accelerates its go-global and one belt one road initiatives as part of its five year plan. Similarly, we believe CRCC (1186.HK) will benefit from overseas contract wins and a pick up in domestic FAI. Taking out Yestar, Dah Sing, Far East Horizon, and CR Land. Yestar has gained 33% since we highlighted it as an oversold play and included it in our top ten. We believe its risk-reward is less appealing than before and we opt for larger caps in our top ten list. Meanwhile, we are taking out Far East Horizon as an extension of China s interest rate cut cycle will hurt its interest margins. The de-rating of pure play healthcare service companies also dampens FEH s sentiment. For Dah Sing Financial, we still like the stock, but we believe large caps may be in focus in the first leg of a market recovery. Lastly, we are also replacing CR Land, largely to make room for more diversified picks. We leave COLI to represent China properties, which we like as a sweet spot for the market. GAC sales BoCom P/BV bands unit 200, , , , , ,000 80,000 60,000 40,000 20,000 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec HK$ x 0.89x 0.80x 0.71x 0.62x DBSV top picks performance (simple average) DBSV top picks performance (market cap weighted) (28 Feb 2014 = 100) DBSV top picks HSI Jan/14 Apr/14 Jul/14 Oct/14 Jan/15 Apr/15 Jul/15 (28 Feb 2014 = 100) DBSV top picks - market cap weighted HSI Jan/14 Apr/14 Jul/14 Oct/14 Jan/15 Apr/15 Jul/15 Page 22

23 DBSV top ten BUYs EPS Closing DBSV Tgt PER CAGR ROE PBV Div yield Ticker price rating Price FY FY16F FY FY16F FY F Y16F FY FY16F Top picks (HK$) (HK$) (X) (X) (%) (%) (%) (X) (X) (%) (%) BOCOM 3328.HK 5.56 BUY COLI 688.HK BUY CH Railway Constr HK BUY GZ Automobile 2238.HK 5.61 BUY Nexteer Auto 1316.HK 7.88 BUY Sinopharm Group 1099.HK BUY Tencent 700.HK BUY V alue Partners 806.HK 7.14 BUY Wasion Group 3393.HK 8.22 BUY ZTE 763.HK BUY Simple average * consensus estimates Sources: DBS Vickers Our updated top ten list: Bank of Communications (3328.HK) 2Q NPL and NPL formation trends were better than other SOE banks. The bank has higher exposure to Yangtze River Delta, which has hurt the bank in the past. But NPL pressure is now higher in Western, Central, and Northeast China. BoCom was approved by the State Council to conduct mixed-ownership reform. Better ownership structure and internal reforms (e.g. employee stock ownership plan, performance-driven compensation system) will help to align interest and improve efficiency and profitability. Allowed to acquire Huaying Securities, and can have headstart in leveraging its bank network on new non-bank financial businesses. China Overseas Land (688.HK) Recently revised up sales targets after gaining market share from smaller peers Impact of Rmb depreciation is not as bad as feared since 2/3 of foreign liabilities are hedged by foreign cash and investments Can benefit from falling real interest rates and a lukewarm equity market China Rail Construction (1186.HK) Chinese policy makers are helping infrastructure funding by lowering borrowing costs and project capital requirements, and this will help domestic demand. Company can win overseas contracts as part of China s one belt one road strategy. Decline in borrowing costs to help high gearing companies like CRCC. GAC Group (2238.HK) Has lagged the market on slowing sales concerns; current valuation is attractive against new growth profile (PEG of 0.35). New models and seasonality should help 4Q sales. Parent company Guangzhou Automobile Industry Group has been buying H-shares. Nexteer (1316.HK) Nexteer is the world's leading electronic power steering producer Push for fuel-efficiency is triggering shift from hydraulic power steering to electronic systems Traditionally strong in the US, Nexteer is expanding to China to augment growth Page 23

24 Sinopharm (1099.HK) Healthcare is highlighted as a focus area in China's government work report; parent company is also pilot for SOE reform Aging population and rising wealth underpin the industry's demand growth Large drug distributors like Sinopharm has been gaining market share with its reliability in supply and ability to extend credit Tencent (700.HK) New advertising offerings help drive revenue growth; Tencent only has 5% market share in online ads We foresee Tencent can better monetize its >800m users through new ad offerings and new apps We project Tencent can grow its revenues by 50% CAGR during FY14-16 Value Partners (806.HK) We do not foresee large downside risk to AUM given market valuations and past redemption patterns, while P/AUM is already at trough levels The fund house is still in a performance fee cycle, because watermark levels are attainable Company will also benefit from trend of mainland wealth diversifying to offshore assets and asset managers Wasion (3393.HK) Energy metering and energy efficiency management company. Customers include the State Grid, the Southern Grid, various industries and local governments in China, Egypt, Indonesia, Thailand, Vietnam, Brazil. The company has been winning overseas contracts to augment growth. Latest contract wins include a US$9.4m AMI contract in Tanzania. It has also won Rmb68m and Rmb10m AMI contracts in Mexico and Brazil through partnership with Siemens. Total overseas contract value amounts to >Rmb300m YTD. China s power grid needs upgrading to minimize energy loss as part of China s conservation plans. The company benefits from increasing ADO sales orders. ZTE (763.HK) Beneficiary of Rmb depreciation thanks to overseas revenues and Rmb cost base. 4G network buildout in China supports strong growth in the near-term. Beneficiary of one belt one road and go global initiatives. Page 24

25 DBSV universe comparison table Mkt Cap (US$m) Share Price (HK$) Target Price (HK$) Stock code Stock name upside (%) Remd PE (x) PE (x) 16F PB (x) Yld (%) ROE (%) A uto manufacturers & dealers 1114 Brilliance China 6, B China ZhengTong B Dah Chong Hong B Dongfeng Motor Group 10, B Geely Automobile 3, H Great Wall Motor 8, H Great Wall 9, H Guangzhou Automobile 4, B Minth Group 2, B Nexteer Automotiv e Group 2, B Xinchen China Power Hldgs B ZhongSheng B Banking and Finance Agricultural Bank of China-A 145, H Bank of China-A 180, H Bank of Comm-A 74, B China CITIC Bank-A 45, S China Construction Bank-A 216, H China Merchants Bank-A 71, B China Minsheng Bank-A 51, FV ICBC-A 254, B Banking and Finance (China) 1288 Agricultural Bank of China 127, H Bank of China 135, B Bank of Communications 53, B China CITIC Bank 28, B China Construction Bank 175, B China Financial Services B China Merchants Bank 60, B China Minsheng Bank 34, H Chongqing Rural Bank 5, B ICBC 217, B Banking and Finance (HK) 2388 Bank of China HK 33, B Bank of East Asia 8, H China Everbright Ltd 3, B Dah Sing Banking Group 2, B Far East Horizon 3, B Hang Seng Bank (1) 35, B HSBC Holdings 151, B Cement 914 Anhui Conch Cement 16, B Anhui Conch 12, B China Nat'l Bldg Mat 3, FV China Resources Cement 3, H Shanshui Cement 2, FV Chemicals 2283 T K Group B Source: DBS Vickers (1) TP and/or Rec under denominated in RMB Page 25