Dim Sum Express. A-Share Market. Hong Kong Market. Equity Research. Sep 29, 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 CCB CHINA MOBILE PETROCHINA HSBC BANK OF CHINA PING AN CHINA LIFE SINOPEC Source: Bloomberg A-Share Market Chemical: Tire industry to bottom out on improving supply-demand balance As the world s largest tire producer and exporter by volume, China has a 15% global market share by sales value due to its focus on low-end products. In light of this, the government has issued several policies to promote tire industry consolidation with a goal to transition towards higher industry concentration, higher entry barriers and more advanced technology. As the industry is highly polluting and energy consuming, strict environmental regulation will lead to continued supply contractions, boosting industry concentration in favor of leading players. Machinery: 4Q17 outlook promising given balance sheet repair in traditional industries and growth verification in emerging industries Most companies in traditional machinery industries are repairing their balance sheets, reflected as impairment losses and the clearing-out of inventories and sales channels, which have had a significant impact on gross margin. Machinery companies with a 30%+ revenue CAGR over the past four years mainly come from the automation & smart equipment industry and industries resembling consumer/service industries. So far this year, these companies have maintained high revenue growth, and rising raw material prices have also had a relatively small impact on their profit margins. Hong Kong Market Auto: MIIT issues NEV scoring regulation; companies already proactive in NEV development to benefit The Ministry of Industry and Information Technology announced yesterday that it will require auto companies to ensure that 10% of vehicles produced/imported are NEVs in 2019, with the proportion rising to 12% in Under the system, effective from April next year, companies will receive positive scores for production over the new higher required level and negative scores for not meeting the requirement. The production threshold has also been lowered compared with the draft regulation, bringing a greater number of companies under the regulation. Extra preparation time allowed before implementation should make 2018 a key year for NEV development and marketing. Luk Fook (590 HK, Accumulate): Key takeaways from NDR; we estimate 2QFY18 SSS to be better than 1QFY18 Thanks to a low base and a recovery of consumer sentiment, we estimate 2QFY18 overall SSSG could be better than in 1QFY18. Management saw very good SSSG in July in HK, similar to HK jewelry retail sales growth in July (+13% YoY) and a less strong SSSG in Aug. By category, due to the lower base of overall gold SSSG, we estimate gold SSSG could be better than gem-set in 2QFY18. Management believes SSSG could remain in positive territory despite the high base as they expect the recovery in consumer sentiment to continue in 2HFY18. CRRC (1766 HK, Accumulate): Takeaways from Beijing site visit; speeding up of internal restructuring to benefit CRRC TE more We visited CRRC in Beijing on Sept 27. Management sees minimal impact from the Alstom and Siemens merger. The company plans to speed up its internal restructuring, firstly for freight wagons and later locomotives. An order of 104 EMU units should be announced in early Oct. We expect CRC to place another batch of EMU orders by the end of this year. The company also expects CRC to order another ~50 locomotives. However, it is unlikely to meet its overseas order target this year. We expect the company to see better performance from 3Q17. Lonking (3339 HK, NR): More positive on Lonking following our site visit Lonking has almost all of its manufacturing facilities in SH s industrial district, where it has a 1m sqm base and around 2,000 workers. Management does not expect property market restrictions to have much of an impact, it plans to put its new forklift production facility into operation by the end of the year, and it is targeting 20% YoY overseas revenue growth in the next few years, spurred on by One Belt One Road projects. We are more positive on Lonking following our visit. Demand for construction machinery is solid and potential price hikes should be a share price catalyst in the short term. 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: Tire industry to bottom out on improving supply-demand balance Tire demand to grow steadily amid rising vehicle ownership According to an auto industry association, passenger vehicle output volume amounted to 24m units in 2016, representing YoY growth of 16% which strengthened significantly from previously. PV output growth is likely to remain strong in 2017 on the back of policy stimulus. In addition, commercial vehicle output should also rebound as heavy duty truck production picks up on regulation against overload. PV ownership in China reached 194m units in 2016 and has maintained annual growth above 10% in recent years. CV ownership has also risen steadily. Domestic tire demand is likely to maintain stable growth as the proportion of replacement demand continues to increase amid growing vehicle ownership. Domestic tire industry plagued by low-end products China produced a total of 947m tires during 2016, and ranked No. 1 in the world by both output and export volumes. However, low-end products account for a large proportion as these tire products are highly homogenous: China s global market share is less than 15% in terms of sales value. In light of this, the government has issued several policies to promote tire industry consolidation with a goal to transition towards higher industry concentration, higher entry barriers and more advanced technology. Environmental regulation to drive industry concentration Tire production plants in China are mainly located in Shandong and Zhejiang, with many of them in the Jingjinji region which is subject to enhanced air pollution control measures. As the industry is highly polluting and energy consuming, strict environmental regulation will lead to continued supply contractions, boosting industry concentration in favor of leading players. Export outlook positive Obstacles for Chinese tire exports have decreased as companies effectively avoid trade friction through market diversification and overseas production site development. The US is a key importer of Chinese-made all steel tires. The outlook for Chinese all steel tire exports is positive given that rulings on recent anti-dumping and antitrust disputes against Chinese truck and bus tire exports to the US were in favor of Chinese companies, and that infrastructure development in the US will increase steadily implying rising CV ownership. Relevant stocks to watch include Linglong Tyre ( CH), Triangle Tyre ( CH), Sailun Jinyu ( CH) and General Science Tech ( CH). Machinery: 4Q17 outlook promising given balance sheet repair in traditional industries and growth verification in emerging industries Share price performance unimpressive despite fundamentals improvement Despite a strong recovery in demand and significant improvement in earnings, share price growth in the machinery sector has been less than exciting so far in We believe this could be explained by the unfinished process of balance sheet repair in traditional industries which has weighed on profit margin growth, and by the fact that the high valuations of emerging industries are in the process of being validated by improved fundamentals. Demand outlook Amid low property investment and recovering manufacturing investment, machinery product sales are currently driven by increased construction activities with replacement demand also making important contribution. Investors are concerned about how rising raw material prices might impact machinery profit margins. Based on recent media reports and our channel checks, some of the machinery subsectors have begun to pass on the increased cost pressure by raising product prices. Traditional industries profitability being repaired Companies in traditional machinery industries tend to have healthier financials and businesses. Their profitability has rebounded to a relatively high level amid the current level of demand. Examples include CIMC s ( CH) road transportation vehicle business and Lonking s (3339 HK) loader business. Meanwhile, most companies are repairing their balance sheets, reflected as impairment losses and the clearing-out of inventories and sales channels, which have had a significant impact on their gross margins. Emerging industries growth potential being verified Based on our observation, machinery companies that have achieved a revenue CAGR of more than 30% over the past four years (excluding those driven by M&A) mainly come from the automation & smart equipment industry and industries operating under business models that resemble consumer and service industries. So far this year, these companies have maintained high revenue growth, and rising raw material prices have also had a relatively small impact on their profit margins. Page 2

3 Our watchlist We remain positive on the sector given improving demand and company financials, and prefer industry leaders. We like Sany ( CH), CIMC ( CH), Hengli Hydraulic ( CH), Longma Environmental ( CH), Zhejiang Dingli Machinery ( CH), KDT Machinery ( CH), Jingce Electronic Technology ( CH), Jack Sewing Machine ( CH) and Yizumi Precision Machinery ( CH) in the near term, while in the mid/long term, we favor top companies in the lithium battery equipment space, such as Lead Intelligent Equipment ( CH), Yinghe Technology ( CH) and Kanhoo Industry ( CH). Auto: MIIT issues NEV scoring regulation; companies already proactive in NEV development to benefit MIIT releases NEV scoring regulation The Ministry of Industry and Information Technology announced yesterday that it will require auto companies to ensure that 10% of vehicles produced/imported are NEVs in 2019, with the proportion rising to 12% in 2020; both requirements are in line with the draft version released in June. Under the system, companies will receive positive scores for production over the required level and negative scores for not meeting the NEV production requirement. The regulation will be effective from April 1, 2018, and companies will be able to transfer 80% of their positive score gained during 2018 forward to 2019; 90% can be transferred forward thereafter. This should boost NEV production from 2018, as auto companies will need to push forward their efforts in 2018 to make them better prepared to meet the requirement in Actual implementation later than previously drafted Actual implementation will not begin until 2019, later than the original plan to start in 2018, giving companies more time to prepare. However, we do not expect the delayed implementation to hamper NEV development, as the announcement of this regulation prior to the upcoming National Congress on Oct 18 is an indication that companies should take NEV development seriously in 2018 and that we may see further related supportive policies, such as the construction of electrical charging stations. More companies will be regulated Companies that produce or import more than 30,000 passenger vehicles annually will be required to comply with the regulation. This is lower than the 50,000 stated in the previous draft version. It brings more companies under the regulation and demonstrates the government s determination to develop the NEV segment. Companies proactive in NEV development to benefit The extra preparation time allowed should make 2018 a key year for NEV development and marketing. We believe companies that have actively developed NEVs and have seen good market response for their models will benefit, such as Geely Auto (175 HK, Buy), for which NEVs account for around 4% of sales, including the wellreceived Emgrand NEV, and BYD (1211 HK, NR), the biggest NEV player in China, that has recently launched its highly anticipated Song Max model. (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 ) Luk Fook (590 HK, Accumulate): Key takeaways from NDR; we estimate 2QFY18 SSS to be better than 1QFY18 2QFY18 likely to be better than 1QFY18 Thanks to a low base and a recovery of consumer sentiment, we estimate 2QFY18 overall SSSG could be better than in 1QFY18. Management saw very good SSSG in July in HK, similar to HK jewelry retail sales growth in July (+13% YoY) and a less strong SSSG in Aug. By category, due to the lower base of overall gold SSSG (-47% vs gemset s -14% in 2QFY17), we estimate gold SSSG could be better than gem-set in 2QFY18. 2HFY18 outlook Management believes SSSG could remain in positive territory despite the high base as they expect the recovery in consumer sentiment to continue in 2HFY18. Store expansion plan The company targets to open 50 stores in China in FY18, with selfowned/licensed store mix at 50/50. Due to the recovery of SSSG, new openings of licensed stores may exceed their target. In HK, the company expects both store number and store area to be stable in FY18. Page 3

4 Focus on value-for-money, daily-wear products Due to the adoption of new gold product manufacturing technology (3D 硬金技術 ), the same amount of gold can produce products of a larger size with a thinner layer of gold. With fixed-asp below HK$1,000, sales volume saw strong growth. The fixed-price gold products currently account for mid-teens of gem-set revenue in HK, compared to a single-digit of sales one year ago. In China, these gold products, which are weight-priced as consumers are sensitive to selling prices, are also well received. Going forward, management will keep launching new value-for-money products to ride on growth of the affordable, daily-wear accessories segment. China jewelry market to grow in the medium to long-term Management sees the growing middle class and consumers increasing acceptance of diamond jewelry and daily-wear accessories as key growth drivers for China s jewelry market, despite a declining female population in the age group. According to research done by the company, wedding related purchases account for around 30-40% of jewelry sales in China. Also, China s gem-set sales mix could increase from the currently 30% to 50% in the medium to long-term as purchasing power grows. (Albert Yip, CFA, Research Analyst, SFC CE No. ADT599, albertyip@gfgroup.com.hk ) CRRC (1766 HK, Accumulate): Takeaways from Beijing site visit; speeding up of internal restructuring to benefit CRRC TE more What s new? We visited CRRC in Beijing on Sept 27. Key takeaways below. Minimal impact from the Alstom and Siemens merger It has been reported that Alstom and Siemens are discussing a merger of their rail businesses to form a new group called Siemens Alstom. CRRC sees minimal impact for two reasons: 1) the competitive environment will not change much; 2) CRRC s key competitive advantage is its lower manufacturing costs, which will not be affected. Internal restructure to speed up CRRC has already set up a team to discuss how to solve intragroup competition. According to management, the first segment to be restructured will be freight wagons, and they expect a proposal to be announced by the end of this year. After that, it plans to restructure its locomotive segment. We expect CRRC to speed up their internal restructuring process, particularly after Alstom and Siemens announcement. 104 EMU units order to be announced soon According to management, the procurement of 104 EMU units is currently being internally processed at CRC, and will be announced by early Oct. Meanwhile, they reiterated that CRC targets to buy 400 EMU units this year, but has only procured 210 YTD. We therefore expect CRC to place another batch of EMU orders by the end of this year. Order of 50 locomotive units announced Sept 25 to be delivered in 4Q17 CRC announced on Sept 25 that it would procure 50 locomotive units, and CRRC reiterated that this batch would be delivered by the end of this year. Meanwhile, the company expects CRC to order ~50 more locomotives. Unlikely to hit overseas orders target this year CRRC has won USD3.8bn in new orders from overseas markets in 1H17, and had originally targeted to have USD9bn in new orders during the year. However, there is a high chance the company will not win the order for New York s rapid transit vehicles. It is therefore unlikely the company will hit its overseas orders target this year. CRRC will see better performance from 3Q17 Considering the delivery schedule for EMUs and locomotives, we believe CRRC will see better performance from 3Q17. We also believe CRRC will speed up its internal restructuring process; CRRC TE (3898 HK, Accumulate) will benefit from getting into CNR s supply chain in the near future. Meanwhile, recent locomotive orders will mean higher earnings sensitivity for CRRC TE, given its higher contribution from locomotives compared with CRRC. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk ) Lonking (3339 HK, NR): More positive on Lonking following our site visit What s new? We visited Lonking s manufacturing facilities in Shanghai on Sept 26. Key takeaways below. Page 4

5 Lonking s main manufacturing facility Lonking has almost all of its manufacturing facilities in Shanghai s industrial district, where it has a 1m sqm base (45% of its loader capacity is in Longyan, Fujian province). It has around 2,000 workers in the city, producing loaders, excavators, forklifts, road rollers and key components. Price hikes likely Some loader manufacturers, including Liugong Machinery ( CH) and Shantui Construction Machinery ( CH), plan to increase their prices from Oct 1. Although Lonking has not officially made a similar announcement, we expect it to follow suit, given strong demand. The company is also not ruling out a price hike for its excavators, given solid demand in 8M17. Minimal impact from property market restrictions Management does not expect the restrictions on the property market to have much of an impact on the company, as: 1) most of its products are supplied to infrastructure-related companies 49% of loaders and 69% of excavators are supplied to infrastructure companies, based on its sales data, while only 10% of loaders and 11% of excavators are supplied to property-related companies. 2) Fixed asset investment in China s property market has maintained steady growth recently. New forklift production facility to begin operation soon Forklift production is currently operating at full capacity. The company is building a new forklift facility with capacity of 15,000 units per year in Yixing, and targets to begin operation by the end of the year. Targeting 20% YoY revenue growth in its overseas business in the next few years The company s proportion of sales from overseas markets is small, accounting for just 7.4% of total revenue in 1H17. But with demand related to the One Belt One Road initiative, management aims to achieve 20% YoY revenue growth in its overseas business in the next few years. 2H GPM typically lower than in 1H GPM is typically lower in the second half of the year, due to higher costs incurred. More positive on Lonking following our visit We are more positive on Lonking following our visit. Demand for construction machinery is solid and potential price hikes should be a share price catalyst in the short term. The stock is currently trading as 15.7x 2017E P/E. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@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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