Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 16E 17E 16E 17E HSI -1.9 0.1 6.3-10.4 9.7 12.8 11.6 HSCEI -2.2-1.1-0.8-13.4 9.0 8.4 7.7 MXCN -1.7 1.1 6.2-15.0 15.1 13.4 11.7 SHSZ300 0.3-1.8-12.8 1.0 12.8 13.7 12.1 SHCOMP 0.2-2.0-15.1 12.6 13.0 14.1 12.5 SZCOMP 0.5-0.7-13.6 73.9 29.5 24.9 19.3 INDU 0.9-1.0 5.1-2.0 13.6 17.2 15.1 SPX 0.8-0.5 6.1 7.5 13.4 18.6 16.4 CCMP 0.8 1.2 6.1 38.8 17.6 22.7 19.3 UKX -0.3 0.1 10.5 114.9 16.6 17.5 15.0 NKY -1.5-2.8-13.6 12.8 6.4 16.3 15.3 Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 700 TENCENT 213.0-2.11 27.9 0.05 941 CHINA MOBILE 93.9-2.44 61.5-0.60 1398 ICBC 4.9-2.81 27.0-0.70 857 PETROCHINA 5.1-0.78 66.8 1.52 939 CCB 5.8-2.38 15.0 0.44 5 HSBC 57.2-1.72 37.6 1.21 3988 BANK OF CHINA 3.5-1.94 11.5 0.09 2318 PING AN 40.2-1.95 68.3 1.41 386 SINOPEC 5.7-0.53 73.9 1.99 2628 CHINA LIFE 20.0-3.38 - - Source: Bloomberg A-Share Market Pharmaceutical: Overview of potential beneficiaries given upcoming essential drug list adjustment The Ministry of Human Resources & Social Security has identified the adjustment to the list of essential drugs covered by the state medical insurance as a priority in 2016. It is worth noting that a number of drugs have achieved significant sales growth since they were added to the essential drug list back in 2009. We believe pharmaceutical companies with a large number of domestically produced innovative drugs, exclusive products and products that are on multiple provincial medical insurance drug lists are likely to benefit. Auto: Sept sector sales data review Overall auto sales volume picked up 24.4% YoY in Aug, with passenger vehicles rising 29.9% and commercial vehicles up 12.0%. Among passenger vehicles, SUVs and MPVs maintained relatively high sales growth of 44.3% and 62.3% respectively; sedans grew 20.3% while minibuses fell 15.0%. Among commercial vehicles, the sales volume of medium and heavy duty trucks increased 38.3% YoY, which was in line with our expectation, while light trucks went up 5.9%. Medium and large buses picked up 10.9%, with medium and large public transport buses growing particularly strongly by 53.0%. Hong Kong Market Investment Strategy: Oct preview uncertainties ahead despite improving China data There are increasing signs that the Chinese economy is stabilizing. Aug macro data were generally better than July, with improvements on multiple fronts. Most encouraging was the 19.5% YoY jump in industrial profit in Aug, the highest growth in three years. The improvement in PPI continued in Aug, indicating an improving supply/demand balance in the domestic market. De-stocking has also seen some positive progress, meanwhile Sept Caixin PMI edged up to 50.1. We believe these positive developments should help to alleviate market concerns on the Chinese economy for the time being. Macro: PMI data confirm China economic stabilization China s NBS manufacturing PMI stood at 50.4 in Sept, the highest level in almost two years. The Caixin manufacturing PMI also edged up to 50.1, the third straight month above 50. Industrial profit in China surged 19.5% in Aug, the biggest gain in three years, mostly driven by rebounding commodity and property prices. Overall, both data indicate that China s economy continues to improve and is on the right track of reform. The economic improvement also reduces the urgency for the PBoC in terms of policy easing, meaning it will not cut the IR or RRR before the year-end. Alex Fan, CFA, Head of Research, SFC CE No. ADJ672 alexfan@gfgroup.com.hk +852 3719 1047 Gao Yedong, Editor, SFC CE No. BAI002 yedonggao@gfgroup.com.hk +852 3719 1026
Pharmaceutical: Overview of potential beneficiaries given upcoming essential drug list adjustment The Ministry of Human Resources & Social Security has identified the adjustment to the list of essential drugs covered by the state medical insurance as a priority in 2016. It is worth noting that a number of drugs have achieved significant sales growth since they were added to the essential drug list back in 2009 (among a total of 297 new drugs which were added that year). Safe and cost effective drugs are preferred when decisions are made as to which drugs should be included in the state s essential drug list. We believe the following three types of drugs are most likely to be included: 1) drugs that are already on the list of drugs covered by the government-led medical insurance in more than 15 provinces, 2) those that have been included in evidence-based medicine and clinical treatment guide books, and 3) products that are highly cost effective. Based on these three categories, we believe pharmaceutical companies with a large number of domestically produced innovative drugs, exclusive products and products that are on multiple provincial medical insurance drug lists are likely to benefit. We particularly like Hengrui Medicine (600276 CH), Xianju Pharmaceutical (002332 CH), Tasly Pharmaceutical (600535 CH), Kanion Pharmaceutical (600557 CH), Jumpcan Pharmaceutical (600566 CH), Salubris Pharmaceuticals (002294 CH) and Livzon Pharmaceutical (000513 CH). Auto: Sept sector sales data review Overall auto sales volume picked up 24.4% YoY in Aug, with passenger vehicles rising 29.9% and commercial vehicles up 12.0%. Among passenger vehicles, SUVs and MPVs maintained relatively high sales growth of 44.3% and 62.3% respectively; sedans grew 20.3% while minibuses fell 15.0%. Among commercial vehicles, the sales volume of medium and heavy duty trucks increased 38.3% YoY, which was in line with our expectation, while light trucks went up 5.9%. Medium and large buses picked up 10.9%, with medium and large public transport buses growing particularly strongly by 53.0%. Our index tracking auto making raw material prices rose 11.7% YoY and 2.4% MoM in Aug, while the ratio of natural gas prices to diesel prices for the 21 provinces we track edged up from July to 63.3% in Aug. Apart from this price ratio, local subsidies is also a key factor driving natural gas vehicle demand. Investment Strategy: Oct preview uncertainties ahead despite improving China data China factors improving There are increasing signs that the Chinese economy is stabilizing. Aug macro data were generally better than July, with improvements on multiple fronts. Most encouraging was the 19.5% YoY jump in industrial profit in Aug, the highest growth in three years. YTD industrial profit is up 8.4% YoY, driven by stronger sales growth, higher ex-factory price, lower costs, and a low base last year. Aug PPI was -0.8%, continuing the uptrend and improving from -1.7% in July, indicating an improving supply/demand balance in the domestic market. De-stocking has seen some positive progress, particularly 8M16 coal output which was down 10.2% YoY, inventory down 12.2%, and property inventory down 30m sqm. Meanwhile Sept Caixin PMI edged up to 50.1 while the Official PMI was unchanged at 50.4. We believe these positive developments should help to alleviate market concerns on the Chinese economy for the time being. Southbound fund flow has accelerated Southbound trading has increased substantially in recent months given continued expectation of renminbi depreciation and the relaxation on foreign equity investment by mainland insurance companies. In particular, southbound buying and selling represented 8.6% of Hong Kong market turnover in Sept, up from 2.1% one year ago, while average daily southbound net buying increased to HK$2949m in Sept, up from HK$234m one year ago. While buying interest from mainland investors cannot guarantee an up market, we believe this force provides important market support. but uncertainties lie ahead However, global market risk remains high ahead of the US presidential election (Nov 8). Although the US media have given the first debate victory to Democratic Party candidate Hillary Clinton, the opinion poll difference between her and her Republican counterpart Donald Trump is too close to draw any conclusion at this stage, as the Brexit referendum case demonstrated. An unexpected victory for Mr Trump could be the biggest black swan this year, following Brexit, especially when most markets have seen strong performance YTD. Besides, although the market has already factored in about a 50% chance of a Dec rate hike, the sharp market decline following the interest rate hike in Dec 2015 should serve as a warning of Page 2
likely market performance should the Fed actually decide to raise rates twice during this interest rate cycle. The latest OPEC production control agreement, if implemented effectively, could push oil prices higher leading to a greater chance of an interest rate hike. Valuation and profit-taking pressure Supported by the low interest rate, the S&P 500 is up 6.1% YTD and hanging around a record high, with its valuation at a stretched P/E level despite five consecutive quarterly YoY earnings declines. The HSI has risen 12% over the past three months and is up 6.3% YTD, outperforming the US, European and Japanese markets, but underperforming the FTSE and many Asian and emerging markets. In terms of valuations, the HSI s trailing P/E has increased to 12.8x, and the ex-chinese financial P/E stands at 17.0x, both at 5-6 year highs. In addition, the A-H share price premium has narrowed substantially from about 40% at the beginning of the year to around 20%, the lowest level in almost two years. With an uncertain political and interest rate outlook in the US, we see limited room for further valuation expansion unless the A- share market trends up, while downside risk is actually increasing. We are not tempted by the improving market sentiment and rising fund inflow, but are rather concerned about the risk of market downside. We continue to favor high growth stocks, policy plays and sectors with more stable income. Portfolio up 19.5% YTD vs HSCEI s -0.8% Our top-10 watchlist recorded a 15.7% return in 3Q16, outperforming the HSCEI s 10.0% and the HSI s 12.0%. We rebalance our portfolio for Oct with six new stocks with greater upside potential. Our new watch list consists of Tencent (700 HK, NR), Chinasoft (354 HK, NR), Truly (732 HK, Accumulate), Geely (175 HK, Accumulate), Li Ning (2331 HK, Buy), China TCM (570 HK, NR), China Life (2628 HK, Accumulate), CRSC (3969 HK, NR), CTEG (1363 HK, NR) and Yuexiu Property (123 HK, Buy). (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk +852 3719 1047) Macro: PMI data confirm China economic stabilization More economic data points to a Dec hike The US released several important data last week, which showed that its economy is in good shape. Although personal spending dropped slightly during Aug, consumer confidence rose to a nine-year-high in Sept, revealing that the outlook for consumption in 4Q16 remains strong. In addition, core PCE inflation rose from 1.6% in July to 1.7% in Aug, closer to the Fed s 2% target. Both these data points show that the US economy remains on the right track. Moreover, Fed Chair Janet Yellen testified in Congress last week and reiterated that the US economy will be ready for a rate hike by the end of the year. Ms Yellen also warned about the risk of the economy overheating in her speech. She said that if the unemployment rate drops much further, it may push inflation above 2%. This would cause the Fed to hike its rate rapidly and result in another recession. The speech was hawkish, showing that the Fed plans to hike at one of the next two meetings. Therefore, if the labor report (which is due to be released this Friday) outperforms again, it would put more pressure on the Fed to act as soon as possible. China PMI shows further signs of economic stabilization China s NBS manufacturing PMI stood at 50.4 in Sept, the highest level in almost two years. The Caixin manufacturing PMI also edged up to 50.1, the third straight month above 50. The NBS data showed that large enterprises fared better, while small and medium companies continued to deteriorate. This indicates that economic improvements have been mainly driven by fiscal stimulus, since large SOEs can more easily benefit from policy. In addition, industrial profit in China surged 19.5% in Aug, the biggest gain in three years, mostly driven by rebounding commodity and property prices. Overall, both data indicate that China s economy continues to improve and is on the right track of reform. We expect the Chinese economy to remain stable in 4Q16, and GDP growth to stay at around 6.7%. The economic improvement also reduces the urgency for the PBoC in terms of policy easing, meaning it will not cut the IR or RRR before the year-end. Limited upside for oil prices despite OPEC production cut agreement Last week, OPEC held an informal meeting in Algeria to discuss limiting oil production. Members agreed to a surprise modest cut to oil output, the first such deal since 2008. According to the agreement, OPEC will reduce production to 32.5-33m barrels per day, from roughly 33.4m in Aug. However, more details are yet to be finalized at the next formal OPEC meeting in Nov. Following the deal, WTI crude prices surged 6% last Wednesday and reached a three-week-high. However, we remain cautious on oil prices for several reasons. First, there are many uncertainties surrounding the deal. OPEC does not have a clear plan for the production cuts for each country, as well as when and for how long the agreement will take effect. Second, we are not optimistic that other non-opec countries (e.g. Russia and the US) will join the deal. Third, US shale gas companies may increase production to Page 3
gain market share if oil prices continue to rise. Fourth, oil supply is still set to exceed demand until late 2017, even if the production deal is implemented well, since OPEC oil production is at a record high level. We therefore only see limited upside for oil prices, and expect WTI crude prices to remain at US$40-50 per barrel before the end of the year. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk +852 3719 1047) (Frankie Wan, Research Analyst, SFC CE No. AVK969, frankiewan@gfgroup.com.hk +852 3719 1052) Page 4
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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