Conviction Buy List (A-shr)

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1 Company Research China THIS IS THE TRANSLATION OF A REPORT ORIGINALLY PUBLISHED IN CHINESE BY GUOSEN SECURITIES CO., LTD ON June 4, 2012 June 13, 2012 Conviction Buy List (A-shr) Guosen s A-share research team covers nearly 30 sectors, providing a comprehensive coverage of the Chinese equity market. Each week, we will share with you our top BUY ideas, which will be accompanied by a summary of each individual story supporting our fundamental investment cases. Conviction Buy list China A-Shares Sector Non-bank financials Ticker Company Disclosure date of report EPS (RMB) PE (x) 10A 11A 12E 10A 11A 12E BVPS (RMB) PB (x) Price 12/6/ CITIC Securities 2010/11/ Insurance Ping An Insurance 2012/3/ Transport Transport Electricity supply& Public utilities Shanghai International Airport Shenzhen Expressway Beijing Originwater Technology 2012/2/ PEG (x) /4/ /3/ Power equipment NARI Technology 2012/2/ Food & Beverage Healthcare Wuliangye Yibin 2012/4/ Tianjin Tasly Pharmaceutical Electronics Shenzhen Changfang Light Source: Guosen Securities Economic Research Institute Non-bank financials 2012/3/ Sales Contact Dan Weil Global Head of Institutional Sales and Trading Managing Director dan.weil@guosen.com.hk Chris Berney Managing Director chris.berney@guosen.com.hk Roger Chiman Managing Director roger.chiman@guosen.com.hk Andrew Collier Director andrew.collier@guosen.com.hk Joe Chan Director joe.chan@guosen.com.hk Cancy Kong Vice President cancy.kong@guosen.com.hk Gary Wong Associate gary.wong@guosen.com.hk 1. We continue to suggest paying close attention to brokerage names. 1) We see the national brokerage innovation conference recently held as a prelude of industry diversification. China is determined to push forward financial reform with a focus on internationalization and marketization, and domestic brokerage firms have already gained some related experience. We believe it will be an inevitable trend for brokerage firms to seek diversified and differentiated revenue sources. 2) Average daily trading volume in the A-share market reached RMB122.7 billion over June 4-June 8, while the year-to-date average daily turnover was RMB153.3 billion. Assuming the average daily trading volume throughout the year is RMB180 billion, the median of the fluctuation range of the SSE Composite Index is 2,600, and the prevailing commission rate, employees remuneration and other expenses within the sector decline by 5%, 15% and 10% y-o-y respectively, we expect the industry s average PE and PB to be 32.77x and 2.36x respectively, implying 7.47% ROE for ) We suggest buying CITIC Securities and Haitong Securities, given their stable financial condition, sufficient balance sheet strength and strong innovative capability. We also add Southwest Securities to our watch list as For ratings definitions and other important disclosures, refer to the Information Disclosures at the end of this report. 1.

2 we believe the company, under the leadership of the new management team, could become a dark horse seizing new opportunities brought by the ongoing financial market reform. 2. We also prefer the insurance industry. 1) The upside of the interest-rate cut is that the advance of shares and bonds boost the adjusted net assets per share. The downside is that the decline in the marginal coupon rate of bonds will reduce the value of in-force business. In the short term, the upside outweighs the downside. 2) The deferred-tax policy on pension funds is expected to be implemented within this year. 3) Assuming new business value of insurance companies record zero growth, and the discount rate is 10%, these companies are expected to see their new business multiples rise to at least 10x. As for China Pacific and New China Life, whose new business value are expected to grow in 2012, their new business multiple should be no less than 15x. Therefore, we maintain our Buy rating on Ping An Insurance and China Pacific Insurance, and Cautious Buy rating on China Pacific Insurance and New China Life. CITIC Securities ( CH) 1. Being the initiator and major participator of China s capital market reform, CITIC is well positioned to develop new businesses. 2. The company s well-established distribution channel offers a clear edge in the brokerage business. Besides, the company has the largest share in the equity fund market. 3. CITIC s internal control system can effectively reduce risks. 4. As at the end of 1Q 2012, the book value of funds available for investment amounted to RMB77.4 billion. 5. Its 2012 P/B is expected to be 1.68x, lower than the industry average of 2.36x. 6. Risks: the pace of innovation may be slower than expected given the sluggish market conditions. Ping An Insurance ( SH) 1. This stock is oversold as its price implied new business multiples of 2.5x/-0.4x and 1.2x/1.0 P/EV for 2012/2013 and an assumption of total liquidation in The factors that weighed on the stock price (i.e. refinancing pressure and the reduction of non-tradable shares by stockholders with a shareholding smaller than 5%) have been removed. The issuance of RMB26 billion of convertible bonds has been approved and this will boost its capital. The issuance of subordinated debt for life insurance has been completed. The holders of non-tradable shares, whose holding is smaller 5%, have assigned 60% of their Guosen Securities (HK) Brokerage Co., Ltd. 2

3 non-tradable shares to strategic investors. And the assignment of the remaining 40% would be a matter of time. 3. In the first quarter, its net assets grew 7.4% q-o-q, higher than competitors. We forecast its new policies of personal insurance to decline by 30%. Its personal insurance business needs adjustment and a breakthrough in marketing. 4. Risk factors. The stock market and bond market might continue to tumble. Property 1. Property stocks have declined by 3.81% on average, but outperformed the broad market by 0.82% month-to-date. Their relative returns moderated this month, compared with 3.42% in the previous month, which is line with our expectation. 2. The levelling off of property sales strengthened investors confidence to hold property stocks. Yet indicators like property investment and newly started GFA continue to decline at a faster pace and are conducive to policy loosening. 3. The pressure to ease property tightening measures is increasing as the pace of economic slowdown accelerates. This, together with liquidity improvement, is expected to be the future drivers. Catalysts for further gains in the property sector should stem from improved liquidity and policy lossening such as the recent interest-rate cuts, RRR reductions or removal of purchase limits. They may also come from the government s greater tolerance for surging home prices and sales volumes. The PBoC announced an interest-rate cut on June 7, which we believe points to an interest rate reduction cycle. Zhongnan Construction Group ( CH) 1. Leveraging off its business model of combining construction with property development, the company was able to acquire a large amount of land at very low cost and provide one-stop services. 2. We estimate the company s sales revenue to grow by 20% to over RMB10 billion in 2012, as sales in the first five months already reached RMB5.5 billion (including contract sales of RMB4.5 billion), which is indicative of its strong growth momentum. 3. The anticipated share incentive plan will further boost the company s results. 4. We forecast Zhongnan s EPS to reach RMB1.05, RMB1.37 and RMB1.68 for respectively, with net asset value per share of RMB14.1, implying a relatively low valuation and substantial upside potential. Guosen Securities (HK) Brokerage Co., Ltd. 3

4 Transportation The airline industry: 1. Rating: We upgraded our rating on the airline sector as well as the ratings on Air China ( CH), China Southern Airlines ( CH) and China Eastern Airlines ( CH) to Buy on May Valuation: we believe airline names are trading at a 20% to 30% discount to their intrinsic value, and their valuations have been on an uptrend. 3. Results: there is a small chance the airlines will see their results further worsen going forward, as the y-o-y decline in profits might have bottomed out, in our view. 4. Supply & demand: demand growth for air travel is unlikely to continue to slow down going forward, and supply growth is expected to fall starting from 3Q. The railway industry: we expect the general cargo rate to rise by about 10%, as the railway reform is quite likely to be launched in 2012, which should give a boost to railway names. We maintain our Buy rating on Daqin Railway and Tielong Container Logistics, and a Cautious Buy on Guangshen Railway. Shanghai International Airport ( CH) The financial results are likely expand at a CAGR of more than 20% for the following three years. The risks associated with its airport expansion are low. The ROI is stable in the long term. A widow for asset injections is opened now and charges for domestic and international flights are expected to converge, thereby boosting its income. Shenzhen Expressway ( CH) Qingyuan-Lianzhou Expressway would be the largest contributor of future growth, as the supplementary Beijing-Zhuhai Expressway is scheduled to be opened to traffic at the end of We think it is highly likely that the Qingyuan-Lianzhou Expressway will turn profitable in 2012 and will experience high growth from 2013 onwards. Its contribution to the company s profitability might be underestimated currently. We forecast Shenzhen Expressway s revenue from expressway operations to grow 41% and 84% in 2012 and 2013 respectively and forecast EPS to reach RMB0.37 and RMB0.52, which correspond to a P/E of 11.4x and 8.1x respectively. Power & public utilities Environmental protection & water conservancy: In the next quarter, this sector is expected to outperform the broad market on policy expectations. We are positive on sub-sectors like waste incineration, which is supported by the central government, and then sewage treatment. Watch Jiangsu WELLE Environmental ( CH) for short-term investment opportunities, and Sound Environmental Resources ( CH), Guosen Securities (HK) Brokerage Co., Ltd. 4

5 Beijing Originwater Technology ( CH) and Anhui Shengyun Machinery ( CH). 1. The environmental protection sub-sector outperformed the broad market by 3.6%, while the water conservancy sub-sector underperformed by 0.4% last week. Relative P/E ratios of the two sectors are 149% (as against the average ratio of 134% for the years since 2008) and 73% (as against the average ratio of 69% for years since 2004), moving closer to average levels. 2. Not many companies in this sector will announce results between May and mid-august, but the number of tender invitations for environmental and water conservancy projects are increasing. This, in combination with related favourable policies, may act as catalysts, and drive related stocks higher. We see investment opportunities in the sector as the recently released 12 th Five-Year plan for environment protection and services industries may spur the sector s performance in Originwater Technology ( CH): 1. Projects located outside Yunnan have begun to generate profit. Leveraging its capital strength, the company is expected to replicate its success in Guangdong and Hebei provinces. 2. The company plans to continue to expand in Xinjiang/Inner Mongolia, where we think it would focus primarily on the recycling of industrial water, and secondarily on civilian environmental projects. The company s 2012 EPS is expected to reach RMB1.5 based on conservative assumptions, implying it s a very good pick in terms of valuation. 3. Considering the median valuation level in this sector, we apply an ex-rights target price of around RMB30. Risks include suspension of project construction and cash-flow strain. Power equipment 1) The Guosen Power Equipment Sector Index fell by 5.39% last week and underperformed the Shanghai Shenzhen CSI 300 Index by 4.13%. The previous strong performers like power electronics sub-sector and power generation sub-sector led the decline, while the secondary equipment sector was relatively stable. 2) What happened last week: on June 5, President Hu Jintao and Russian President Vladimir Putin oversaw the signing of a memorandum that aims to boost the export of Russian electricity to China, upgrade the power grid in Russia and jointly tap into the electricity market in a third country. On June 5 th and 6 th, NARI Technology Development sponsored a conference on ISO/IEC JWG international standards on electric cars, which focused on the global standards for the telecommunications protocols for interaction between electric cars and power grids. Guosen Securities (HK) Brokerage Co., Ltd. 5

6 3) Outlook for this week: the increasing concentration of tender winners for secondary equipment of sub-stations will benefit leading manufacturers. The State Grid s investment and M&A efforts abroad will produce additional demand for domestic manufacturers. Stocks of manufacturers of equipment used in distribution grids, especially secondary equipment, would be worth investing in. NARI Technology ( CH): We expect high growth in the company s annual results given its solid fundamentals. As NARI Technology is well poised to development its wind-hydro power system integration and automated dispatch system businesses, we believe the State Grid s overseas power grid construction projects will create new demand for the company s products. In addition, its electric vehicles business is likely to beat expectations. Food & beverage 1. Fundamental analysis: the business climate of the Chinese liquor industry has weakened slightly from its peak, with the prices offered by Maotai s tier-1 distributors falling to RMB1,400-1,500 per bottle. The retail prices of Maotai products could decline further after more Maotai franchise stores commence business. As a result, there is a small chance Maotai will raise prices in the short term. Based on the 1Q results released by white-spirit producers, although these companies continued to see their revenue grow rapidly in 1Q, their cash flow and advance payment received slid, which is in line with our forecast the business climate has peaked in the sector. 2. Valuation: the P/E of leading Chinese liquor makers range between 13x and 16x. The P/E ratios of food makers are around 20x and the PEGs are far from Strategic analysis: the share of food & beverage stocks in fund portfolios reached 12% on average as at the end of 1Q 2012, with a slight advance seen in April. The government s support to ease liquidity in the stock market may have a limited impact on the sector s current performance as it s not a cyclical sector, although we see possible price rebounds in leading white-spirit products in late May to June. 4. Outlook for the short term: CPI has moderated and China s export figures in May were better than expected. There are heightened market expectations of economic improvement. We expect the prices of Chinese liquor would continue to level off. We are positive on leading Chinese liquor makers and believe there are chances that small and medium-cap liquor makers, which have retreated significantly, will rebound. Wuliangye Yibin ( CH): As the government will stimulate economic growth, we expect prices of tier-1 white-spirit products to remain at a relatively high level in June. Therefore, we see short-term trading opportunities in Wuliangye Yibin. Guosen Securities (HK) Brokerage Co., Ltd. 6

7 Pharmaceuticals Industry overview 1. Data: profits in the pharmaceutical sector has hit a five-year low, but is expected to recover gradually. Sales revenue in the sector for Jan-April grew by 20.6%, 2.6% lower than Jan-March. Gross profit margin and net profit margin fell by 0.6% and 0.39% respectively, although the rate of decline moderated from the first quarter. 2. Policy: the worst period has past and no significant negative policies are expected. The policy framework for healthcare reform for the 12 th Five-Year Plan period and 2012 has been ironed out, but the separation of prescription charges and medicine revenue at hospitals is unlikely in the short term and there is no substantial change in dynamics of the pharmaceutical industry. The impact from government policies (such as the change in the tendering out of medicine supply, mandatory price reductions for some types of medicine and cutting healthcare bills) have moderated and are reflected in the financial reports of listed companies. We expect no further bad news for this sector in the 3-6 months. 3. The pharmaceutical companies with superior offerings would be in a better position to ride out the unfavourable policies. They will be the companies that offer unique products or have access to rare resources or possess well-known brands, as their cost pressure is less severe and they have stronger pricing power. The companies, whose products are high-end treatments and prevention products, are also expected to gain because the demand for such products is inelastic and their products are alternatives to imported ones. Healthcare service providers will also make headway. We expect their interim reports, due to be released in July and August, to show a greater divergence in results. 4. Valuation: the previous retreat across the sector was substantial and the divergence of financial results of listed companies is now fairly pronounced. The valuation is attractive for medium-term investment. The pharmaceutical sector outperformed the broad market by 5.42% in May, during which the 2 nd and 3 rd liner stocks rebounded significantly but leading stocks remained sluggish. The absolute valuation of the sector is at historic lows, while relative valuation is slightly above the intermediate level. As the average P/E ratio of leading companies is 20x and the PEG is 1x, the second half would be a window to add positions for medium-term investment as the business climate in the industry may improve and no further unfavourable government policy are expected to be issue. Tianjin Tasly Pharmaceutical ( CH) The company s core business is expected to enjoy robust growth in 2012, after it reported better-than-expected 1Q results. We apply a Buy rating on it, and believe it s suitable for investors that adhere to both aggressive and defensive investment strategies. Guosen Securities (HK) Brokerage Co., Ltd. 7

8 Electronics Industry review: Outlook: The Guosen electronics components index declined by 3.99% last week. The sector valuation (TTM) was 33x 2012P/E and the companies tracked by Guosen traded at 22x 2012 P/E. The book-to-bill ratio of North America-based manufacturers of semiconductor equipment reached 1.1 in April, staying above 1.0 for three consecutive months since February. Due to the weakening demand in Europe, SICAS estimates that the global sales of semiconductors in 2012 will grow by only 0.4% y-o-y. SICAS forecasts sales will rise by 3.2% in the US, 1.7% in Japan and 0.1% in Asia Pacific, and decline by 3.5% in Europe. TSMC s revenue for May rose by a record 20% y-o-y. Meanwhile, the monthly revenue of UMC in May also reached a 1-year high, rising by 2.1% y-o-y and 0.9% m-o-m. All of these point to a recovery in the business climate. Shenzhen Changfang Light ( CH) Shenzhen Changfang Light is 100% focused on the LED lightening business, and its products are 30% cheaper than its peers, indicating it enjoys obvious competitive advantages. Given the effort it made to expand capacity, Changfang s SMD chip package production could reach 1 million per month by the end of this year, in our view. The estimated 2012/13 P/E ratios are 20x and 12x. Investors are advised to monitor this stock, as its valuation is fairly attractive. Guosen Securities (HK) Brokerage Co., Ltd. 8

9 Information Disclosures Stock ratings, sector ratings and related definitions Stock Ratings: Buy: Indicates that the analyst expects the stock to outperform the Benchmark by 20% or more over the next six months. Cautious Buy: Indicates that the analyst expects the stock to outperform the Benchmark by 10% or more but less than 20% over the next six months. Neutral: Indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 10% over the next six months. Reduce: Indicates that the analyst expects the stock to underperform the Benchmark by 10% or more over the next six months. Sector Ratings: Buy: Indicates that the analyst expects the sector to outperform the Benchmark by 10% or more over the next six months. Cautious Buy: Indicates that the analyst expects the sector to outperform the Benchmark by 5% or more but less than 10% over the next six months. Neutral: Indicates that the analyst expects the sector to either outperform or underperform the Benchmark by less than 5% over the next six months. Reduce: Indicates that the analyst expects the sector to underperform the Benchmark by 5% or more over the next six months Disclaimers This report is based on public data. Guosen does not warrant the accuracy and completeness of the information contained herein. This report is published solely for reference purposes and shall in no way be construed as a solicitation or an offer to buy or sell securities or related financial instruments stated herein. Guosen and its employees do not accept responsibility for any direct or indirect losses arising from the use of this report. Guosen or its affiliates may hold or trade securities issued by the companies mentioned in this report, and provide or seek to provide investment banking services for these companies. All rights of this report are reserved by Guosen. Without the prior written consent of Guosen, no one may copy, reproduce or publish part or whole of this report. Guosen Securities (HK) Brokerage Co., Ltd. 9