Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Apr 21, 2017

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1 Equity Research Dim Sum Express 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 SINOPEC PING AN CHINA LIFE Source: Bloomberg GF events Date Event Location 25 Apr Harmony Auto 4S store visits Guangzhou 4-5 May A-share defence sector NDR Hong Kong Source: GF Securities (Hong Kong) A-Share Market Chemical: Zirconia ceramic showing great potential for use in consumer electronics Zirconia demonstrates considerable potential for being used in consumer electronic goods such as wearables and smartphones. The penetration of zirconia ceramic as a smartphone casing material is relatively low at present, but it will have substantial market potential as its production yield increases and product cost declines. In addition, the penetration rate of zirconia ceramic as a dental prosthetic material is likely to pick up further, with its market size to grow from Rmb1.5bn in 2015 to more than Rmb2bn in Non-Ferrous: Base metal prices highly volatile amid risk aversion; copper and zinc inventories down significantly Strikes at key copper mines in Peru and Chile have caused a drop in the supply of the metal. Meanwhile, we are about to enter the peak season for global copper demand in April-May. Copper prices are currently stable at a low level, but we believe further downside will be limited as the Chinese economy improves. We expect to see a zinc concentrate supply overhang of 170,000 tonnes and a refined zinc shortage of 30,000 tonnes in full-year While most base metals have suffered price drops, tin prices have continued to pick up on the back of a tight supply. Hong Kong Market Luk Fook (590 HK, Accumulate): Key takeaways from 4QFY17 post-result NDR; HK & Macau SSSG expected to remain positive in 1HFY18 Key topics covered at the meeting we held yesterday include LF s positive SSSG in HK & Macau in 4QFY17 and its sustainability, the softening of China s gem-set SSSG in March, store plans and rental trends. Management attributes the outperformance of gem-set SSSG in HK & Macau to the company s efforts in improving product design and value for money. We raise our FY17-19 net profit estimates by 4-6% mainly to factor in better GM and HK & Macau SSSG assumptions. Our target price is lifted from HK$27.70 to HK$29.50, still based on 15x FY18E P/E. Maintain Accumulate. TUL (3933 HK, Accumulate): Positive read-across from Tonghua Dongbao Stable insulin sales growth reported by Tonghua Dongbao bodes well for TUL. TUL has seen significant progress in the insulin/diabetes space, an area which has significant long-term growth potential. However, a re-rating would depend on the delivery of solid earnings growth and its successful transformation into an insulin-based biosimilar company. We expect earnings CAGR of 20.2% over E, and our earnings estimates are 11-15% above consensus. The stock is trading at 16x 2018E P/E for 20% EPS growth. Reiterate Accumulate and TP of HK$5.70. 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 Chemical: Zirconia ceramic showing great potential for use in consumer electronics A promising material for consumer electronics Thanks to its various physical, chemical and nanotech features, zirconia is widely used in structural devices, sensors, dental prosthetics, electronic products and artificial joints. In addition, the material is demonstrating considerable potential for being used in the body of consumer electronic goods such as wearables and smartphones. Chinese smartphone makers such as Gionee, Huawei and Xiaomi have taken the lead by launching smartphones using zirconia ceramic casing. The penetration of zirconia ceramic as a smartphone casing material is relatively low at present, but the ceramic will have substantial market potential as its production yield increases and product cost declines. Rising penetration in dental prosthetic field Zirconia ceramic is also widely used in the dental prosthetic field due to its biological features, aesthetics and stability. The dental prosthetic market has continued to grow amid global population ageing and an increasing interest in teeth whitening. According to the Dental Industry Association, spending on dental prosthetics in China totaled Rmb5.7bn in 2015, and is expected to rise to Rmb7.3bn in The penetration rate of zirconia ceramic as a dental prosthetic material is likely to pick up further as the market expands. Under an optimistic estimate, the size of the market for zirconia dental prosthetic materials will grow from Rmb1.5bn in 2015 to more than Rmb2bn in Sinocera Functional Material a key beneficiary Manufacturers of high-end nano-grade composite zirconia powder are mainly found in Japan, Europe and the US. That said, Sinocera Functional Material ( CH) has made its way into the market by mastering the key production technology and is promoting the import substation of relevant products. It is the only company in China that can produce nano-grade materials using the hydrothermal synthesis method on an industrialized scale. The company will directly benefit from growing zirconia demand. Non-Ferrous: Base metal prices highly volatile amid risk aversion; copper and zinc inventories down significantly Copper Strikes at key copper mines in Peru and Chile have caused a drop in the supply of the metal. Meanwhile, we are about to enter the peak season for global copper demand in April-May. Copper prices are currently stable at a low level, but we believe further downside will be limited as the Chinese economy improves. We expect copper prices to fluctuate and show some strength in the near future. Key companies to watch include Yunnan Copper ( CH), Jiangxi Copper ( CH) and Tongling Nonferrous Metals ( CH). Lead/zinc There was a 2,000 tonne zinc supply shortage in the global market during Jan-Feb, compared with a supply overhang of 44,000 tonnes during 2M16. The domestic market saw a 266,000 tonne shortage of zinc concentrate and an 89,000 tonne supply overhang of refined zinc during the same period. We expect to see a zinc concentrate supply overhang of 170,000 tonnes and a refined zinc shortage of 30,000 tonnes in full-year As environmental inspection teams deployed by the central government arrived in Anhui and other lead producing provinces in mid- April, some large lead recycling companies might see their capacity utilization rate stay flat or come down. We are long-term positive on the lead and zinc market, highlighting Shengda Mining ( CH), Zhongjin Lingnan Nonfemet ( CH), Jianxin Mining ( CH) and Tibet Summit Resources ( CH). Tin Rising geopolitical tensions have boosted the demand for safe-haven assets. Meanwhile, market liquidity is being pressured by upcoming convertible bond issuances, tax collection and MLF maturity all of which have led the market to have a more cautious liquidity outlook. While most base metals have suffered price drops, tin prices have continued to pick up on the back of a tight supply. Overall tin trading is not active, with downstream players in a wait-and-see mode and smelting plants supporting product prices. Yunnan Tin ( CH) is a key company in the field. Nickel The global nickel market was highly volatile last week amid increased risk aversion in the market. Meanwhile, nickel ore shipments from the Philippines have increased significantly as the rainy season in a main production area has ended. In addition, Indonesia is also shipping out some low-grade nickel ore. Both have helped alleviate the continued decline in China s nickel ore inventory. Downstream demand for the metal is weak at present, and we expect to see continued price fluctuations in the short term. Page 2

3 Luk Fook (590 HK, Accumulate): Key takeaways from 4QFY17 post-result NDR; HK & Macau SSSG expected to remain positive in 1HFY18 Key topics covered at the meeting we held yesterday include LF s positive SSSG in HK & Macau in 4QFY17 and its sustainability, the softening of China s gem-set SSSG in March, store plans and rental trends. We raise our FY17-19 net profit estimates by 4-6% mainly to factor in better GM and HK & Macau SSSG assumptions. Our target price is lifted from HK$27.70 to HK$29.50, still based on 15x FY18E P/E. Maintain Accumulate. Why HK & Macau gem-set was strong? The +12% SSSG for gem-set products was partly boosted by an increase in big-ticket transactions. The figure was stronger than CSS (116 HK, Buy; c. high single-digit decline) and CTF (1929 HK, Hold; -17%). Management attributes the outperformance to the company s efforts in improving product design and value for money, designing more daily-wear products while expanding categories such as pearls and gemstones. Excluding a HK$20m jade product sale and transactions above HK$1m, gem-set product still saw high single-digit SSSG, which was volume driven. These big-ticket transactions not only came from mainland visitors, but also from local consumers. The proportion of sales settled through UnionPay or Rmb cash remained stable at 55%. Largest exposure to Macau market The company saw teens SSSG in the Macau market in 4QFY17 (vs +1% in HK & Macau), with 20%+ growth for gem-set products and single-digit growth for gold products. The SSSG for shops in Macau, especially those in casinos, outperformed shops in HK. Based on our estimates, LF had the largest exposure to the Macau market among peers (12% of total revenue in 1HFY17, vs CTF s ~5%), and should benefit most from the return of high spending tourists. Sustainability of HK & Macau SSSG Management thinks a positive SSSG could be sustainable in 1HFY18 on a low base. For 2HFY18, they believe it is too early to tell. It depends on the momentum of the recovery because the comparable base will be higher in 4QFY18. 2HFY17 GM higher YoY Driven by a better gem-set sales mix and higher gold price YoY, GM is expected to improve YoY in 2HFY17. Our GM estimate of 25.6% for FY17 is higher than the street estimate of 24.7%. Softening of China gem-set SSSG in March The SSSG for gem-set products came down in March following double-digit growth in Jan and Feb. Management thinks the softening in March was mainly due to a shift of sales to gold products (double-digit growth) and fewer promotion activities at department stores. Rental trend Management expects a blended double-digit decline in rental expenses in the HK market in FY17, and thinks this pace of decline could continue in FY18 and FY19. For FY17, total rental expense should remain roughly flat or shows a slight increase or decline according to company guidance. Rental saving in HK will be largely offset by higher rental in Macau and increased turnover rent in China. Store plan Looking into FY18, management expects shop number in HK & Macau to be quite stable. In overseas markets, LF may add more shops in the US and Malaysia. In China, the company plans to open around 50 stores, which will mainly be licensed shops. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) TUL (3933 HK, Accumulate): Positive read-across from Tonghua Dongbao What s new? Tonghua Dongbao s ( CH) FY16 annual report shows human insulin sales growth of 16.4% YoY to Rmb1.6bn. Excluding insulin API, sales of insulin in finished drugs rose 18% YoY, extending a solid growth momentum in recent quarters. The company s stable insulin sales growth is positive to The United Lab (3933 HK, Accumulate) given the latter s upcoming launch of new insulin products and focus on provincial-level hospitals, although API price volatility will continue to weigh on its share price in the near term. Positive 2017 outlook TUL has gained production approval for insulin Glargine in two delivery types, prefilled syringes and refilled cartridges, whereas its domestic competitor, Gan Lee, only has the refilled option. Therefore, TUL has an advantage of providing more product options. Although Sanofi also offers both prefilled and refilled options, TUL expects to benefit from a cheaper price. Page 3

4 Building foundation with provincial-level hospitals TUL generates 50% of its second-generation insulin sales from the hospital channel, which includes class 2 and 3 hospitals. It is possible to cross-sell glargine insulin with second-generation insulin. The company has already prepared 100 core salespersons for promoting glargine insulin and hopes to achieve faster sales conversion once the product is launched. Ramp-up of insulin portfolio In addition to glargine insulin, the company has completed the clinical trial for insulin Aspart which has a large untapped market. It is likely to receive approval for production by 2018, while currently its insulin Lispro and GLP-1 mimic Liraglutide are also in the preclinical study phase. More catalysts yet to come TUL has seen significant progress in the insulin/diabetes space, an area which has significant long-term growth potential. However, the potential of a re-rating for the stock would depend on the delivery of solid earnings growth and its successful transformation from a bulk medicine and intermediate manufacturer to an insulin-based biosimilar company. We expect the company to post an earnings CAGR of 20.2% over E, and our earnings estimates are 11-15% above consensus. The stock is currently trading at 16x 2018E P/E for 20% EPS growth. We reiterate our Accumulate rating and target price of HK$5.70. (Natalie Chiu, Research Analyst, SFC CE No. AVH029, nataliechiu@gfgroup.com.hk ) Page 4

5 Rating Definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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