Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 17E 18E 17E 18E HSI 1.3 6.1 24.2 12.1 9.0 13.1 12.0 HSCEI 0.7 4.5 15.3 3.4 8.8 8.6 7.9 MXCN 0.8 8.4 35.0 17.9 14.3 14.5 12.7 SHSZ300 0.4 1.9 12.9 17.2 12.8 14.4 12.8 SHCOMP 0.6 2.5 5.5 25.6 12.4 14.4 12.8 SZCOMP 0.6-1.0-4.6 55.0 24.0 23.7 19.1 INDU 0.3 2.5 10.8 11.9 9.7 18.0 16.4 SPX -0.1 1.9 10.3 19.8 11.4 18.9 17.0 CCMP -0.4 3.4 17.9 45.6 17.6 24.0 20.4 UKX 0.1 0.8 3.2 159.6 8.4 15.3 14.1 NKY 0.2-0.3 4.5 34.8 7.9 17.1 15.9 Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 700 TENCENT 313.4 2.82 102.0 3.29 1398 ICBC 5.5 0.92 13.9 0.30 941 CHINA MOBILE 83.8 0.36 16.6 0.09 939 CCB 6.5 0.46 112.5-0.14 857 PETROCHINA 5.0 0.00 28.9-0.83 5 HSBC 78.5 2.62 17.0 1.01 3988 BANK OF CHINA 3.9 1.58 28.5 1.39 2318 PING AN 58.0 1.31 4.3 2.14 2628 CHINA LIFE 24.8 0.20 98.9 1.54 386 SINOPEC 5.9 0.00 18.7 7.80 Source: Bloomberg A-Share Market Investment Strategy: Two key themes related to central SOE reform in 2H17 We highlight M&A and mixed ownership reform as two key themes related to central SOE reform that are worth watching in the second half. As a main way to reduce production capacity, central SOE restructuring will proceed closely with supply-side reform. In particular, the coal-fired power industry is likely to be the first to see industry concentration increase due to the pressure of upcoming decapacity checks this year. Separately, when a corporate system reform at central SOEs is completed by the end of this year, these enterprises board system will have been more developed with a more efficient governance structure, which should facilitate asset securitization and mixed ownership reform. Power Equip/New Energy: NEVs MLT prospects intact despite ST changes, wait for policy uncertainties to subside An MIIT spokesman indicated last week that a new scoring system based on auto makers average fuel consumption and NEV output will be introduced in the near future. While this might affect the market s short-term expectations about NEV sales volume, mid/long-term support for NEV development remains intact. We believe the proportion of distributed solar power will continue to pick up going forward on lower cost and policy support. Solar power is likely to be connected to power grids at cheap prices by the end of the 13th FYP period. Hong Kong Market CRRC TE (3898 HK, Accumulate): Stable growth ahead; prefer stake-holding companies instead; initiate with Accumulate and TP of HK$42.0 The company s share price has declined 6% YTD, mainly due to delays in MU orders. We estimate 2017/18 EPS of Rmb2.51/2.82, representing an EPS CAGR of 8.8% during 2016-2018. The stock is currently trading at 12.8x 2017E P/E. We initiate coverage of the company with an Accumulate rating and target price of HK$42.0, based on 14.5x 2017E P/E, equal to its average P/E valuation over the past three years. We believe a large amount of EMU orders will come in 2H17, resulting in 14% revenue growth next year. We anticipate a better recovery in MU orders next year. CRCC High-Tech Equipment (1786 HK, Accumulate): 1H17 net profit down 87.5% on order delays; downgrade to Accumulate We downgrade our rating from Buy to Accumulate and lower our TP from HK$4.40 to HK$3.22. 1H17 revenue declined 45% YoY and net profit was down 87.5% YoY. The disappointing results were due to China Railway Corporation postponing purchases of railway maintenance machines and a rise in both research & development and finance expenses. Overhaul services was the only segment to see a rise in sales. However, we believe the impact of the decrease in railway maintenance machine procurement by the CRC will be temporary, and expect revenue to pick up next year. We cut our 2017/18 revenue forecasts by 42%/32%, and cut our net profit estimates by 62%/31%. 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
Investment Strategy: Two key themes related to central SOE reform in 2H17 Central SOE reform to speed up in 2H17 Central SOE reform plays an exemplary role for SOE reform in a more general sense. We expect central SOE reform to accelerate in 2H17 given the emergence of a timetable for policy implementation, the introduction of auxiliary policy measures, and continued improvements in enterprises operating results. We highlight M&A and mixed ownership reform as two key themes related to central SOE reform that are worth watching in the second half. As a main way to reduce production capacity, central SOE restructuring will proceed closely with supply-side reform. In particular, the coal-fired power industry is likely to be the first to see industry concentration increase due to the pressure of upcoming decapacity checks this year. Separately, when a corporate system reform at central SOEs is completed by the end of this year, these enterprises board system will have been more developed with a more efficient governance structure, which should facilitate asset securitization and mixed ownership reform. Beneficiaries in 2H17 As for stock selection, we suggest watching central SOEs that are likely to implement M&A or mixed ownership reform in 2H17. The coal-fired power industry is likely to become more concentrated amid central SOE and supply-side reforms, benefiting large power companies. In view of mixed ownership reform which remains focused on the seven areas currently dominated by central SOEs, we highlight Daqin Railway (601006 CH), Tielong Container (600125 CH), Air China (601111 CH), Guangshen Railway (601333 CH) and Taishan Petrolum (000554 CH). Power Equip/New Energy: NEVs MLT prospects intact despite ST changes, wait for policy uncertainties to subside NEV An MIIT spokesman indicated last week that a new scoring system based on auto makers average fuel consumption and NEV output will be introduced in the near future. While this might affect the market s short-term expectations about NEV sales volume, mid/long-term support for NEV development remains intact. Advanced production capacity will gradually come on line amid policy support and technological upgrade, which should further promote NEV development. Meanwhile, companies along the midstream industry chain will continue to diverge with the industry increasingly concentrated towards leading players. Given Tesla s (TSLA US, NR) delivery of 30 Model 3 vehicles last week, we highlight that: 1) companies operating on Tesla s supply chain will benefit from the latter s volume growth, and 2) overseas suppliers might not be able to fulfil Tesla s growing demand, bringing opportunities to Chinese manufacturers. We suggest focusing on NEV batteries and components, and prefer Tianqi Lithium Industries (002466 CH), Huayou Cobalt (603799 CH), Nuode Investment (600110 CH), Guoxuan High-Tech (002074 CH), Hongfa Technology (600885 CH), Senior Technology Material (300568 CH), Chuangxin New Material (002812 CH), Sanhua Intelligent Controls (002050 CH), Lead Intelligent Equipment (300450 CH), Shanshan (600884 CH), Tinci Materials Technology (002709 CH) and Kedali Industry (002850 CH). Solar power The NEA has recently issued some guidelines on the implementation of the renewable energy development 13th FYP, approving the addition of 86.5GW of installed capacity during the period. We expect annual average capacity installation to reach 30GW over the next three years. In particular, distributed solar power capacity newly added during 1H17 surged 2.9x YoY to 7.7GW. We believe the proportion of distributed solar power will continue to pick up going forward on lower cost and policy support. Solar power is likely to be connected to power grids at cheap prices by the end of the 13th FYP period. We suggest watching LONGi Green Energy Technology (601012 CH), Sungrow Power Supply (300274 CH) and Jingsheng Mechanical & Electric (300316 CH). Industrial control Most industrial control companies have issued their 1H17 results, with key listcos maintaining mid-to-high earnings growth. We remain optimistic about industrial control in 3Q17 given the recovery in the manufacturing sector and equipment replacement demand. We like Inovance Technology (300124 CH), Hongfa Technology (600885 CH) and Xinje Electric (603416 CH). Power sector reform and electricity trading The NDRC and NEA have recently selected seven regions as pilots for spot electricity market development. The Jingjinji region and areas surrounding Yunnan are likely to be included in a second batch of pilots. These pilots are intended as Page 2
explorations into a balanced mechanism for market-oriented electricity trading, so as to bring opportunities to the electricity information system, distributed power sources and auxiliary service markets. We highlight NARI Technology Development (600406 CH), Sungrow Power Supply (300274 CH), LONGi Green Energy Technology (601012 CH) and Xinlian Electronics (002546 CH). CRRC TE (3898 HK, Accumulate): Stable growth ahead; prefer stakeholding companies instead; initiate with Accumulate and TP of HK$42.0 Subsidiary of CRRC Corp As a subsidiary of CRRC Corp (1766 HK, Accumulate), the company generates revenue from seven business segments: 1) train-borne systems (including traction converters, auxiliary power supply equipment and control systems) for locomotives, 2) train-borne systems for EMUs, 3) train-borne systems for urban rail vehicles, 4) railway maintenance vehicles related products, 5) signal & communication products, 6) key electric part and component products, and 7) marine engineering products and other products. Divergence among sub-sectors in 2017 Given that the demand of train-borne systems depends upon the demand of related rolling stock, the company s revenue is affected by the CRC s procurement schedule. We expect railway equipment FAI to rise from Rmb92bn in 2016 to Rmb110bn in 2017 with the ratio of railway equipment FAI to total railway sector FAI to go up to 13.8%, meaning the demand of train-borne systems remains supported. However, we see divergence among sub-sectors in 2017 depending on the CRC s procurement schedule. Thanks to the procurement of 586 locomotives earlier this year, the locomotive sub-sector is likely to rebound, while the EMU sub-sector is expected to come under pressure. Attractive outlook for railway maintenance vehicles segment CRRC TE provides six series of railway maintenance vehicles. Considering that the CRC will increase the automation rate of railway maintenance, the demand of railway maintenance vehicles is likely to increase gradually. The railway maintenance vehicles segment accounted for 12.2% of revenue in 2016; we expect this will increase to 19% in 2018, with segment revenue to grow at a CAGR of 25% during 2016-2019. Prefer parent company instead Both CRRC Corp and CRRC TE can benefit from the investment theme of a recovering railway equipment sector in China, as well as increased opportunities from overseas markets. However, we prefer CRRC Corp over CRRC TE at the moment, mainly due to: 1) CRRC Corp s better growth momentum, 2) existing intragroup competition issues, and 3) the downward trend in CRRC TE s GPM. Initiate at Accumulate with TP of HK$42.0 The company s share price has declined 6% YTD, mainly due to delays in MU orders. We estimate 2017/18 EPS of Rmb2.51/2.82, representing an EPS CAGR of 8.8% during 2016-2018. The stock is currently trading at 12.8x 2017E P/E. We initiate coverage of the company with an Accumulate rating and target price of HK$42.0, based on 14.5x 2017E P/E, equal to its average P/E valuation over the past three years. We believe a large amount of EMU orders will come in 2H17, resulting in 14% revenue growth next year. We anticipate a better recovery in MU orders next year. Key risks: 1) High dependence on the CRC s procurement plan, 2) smaller-than-expected railway FAI, 3) delays in rapid transit project construction, 4) delays in the collection of trade and bill receivables from clients, and 5) pressure on product ASP. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk +852 3719 1218) CRCC High-Tech Equipment (1786 HK, Accumulate): 1H17 net profit down 87.5% on order delays; downgrade to Accumulate Disappointing 1H17 results CRCCE s 1H17 revenue declined 45% YoY to Rmb930m, and net profit was down 87.5% YoY to Rmb26m. GPM was flat at 26.1%. The disappointing results were due to: 1) China Railway Corporation postponing purchases of the company s railway maintenance machines, resulting in a slump in machines sold in 1H17. 2) Research and development costs increasing by Rmb20m during the period. 3) Finance costs rising by Rmb35m due to an increase in interest on discounted long-term trade receivables. Overhaul services momentum continued Sales in the company s machine segment, which accounted for 43% of total revenue, declined by 63% YoY. Sales of parts and components, 20% of Page 3
total revenue, dropped by 47% YoY. Its overhaul services segment, which contributed 35% of total revenue, saw revenue jump 50%, making it the only segment to maintain momentum. Revenue expected to pick up next year We believe the impact of the decrease in railway maintenance machine procurement by the CRC will be temporary. We see a high correlation between the number of machines sold by the company and new operating length of railway lines in China. With a rebound in operating length expected this year, we expect an increase in CRC orders. Potential integration with CRCHI a positive catalyst According to CRCC (1186 HK, NR), CRCCE s controlling shareholder, CRCCE may be integrated with China Railway Construction Heavy Industry (CRCHI). CRCCE s management has said that the proposed integration is still at the planning stage and that there is uncertainty as to whether the integration will go ahead. CRCHI was established in 2007 and mainly manufactures heavy machinery such as sophisticated TBMs, earth pressure balance and slurry balance shield machines (used for tunnel construction) and railway equipment. In 2016 it had total assets of Rmb11.2bn, equal to 1.6x that of CRCCE s, while net profit came in at Rmb963m, 2x that of CRCCE s. A successful merger would lead to a more diversified product mix and customer base. Downgrade to Accumulate and lower TP to HK$3.22 The shares are down 12.5% YTD, underperforming the market. We cut our 2017/18 revenue forecasts by 42%/32%, and cut our net profit estimates by 62%/31%, mainly to factor in a lower number of railway maintenance machines sold. The company is currently trading at 17.4x 2017E P/E and 8.6x 2018E P/E, based on our EPS estimates for 2017/18 of Rmb0.14/0.28. We downgrade our rating from Buy to Accumulate and lower our target price from HK$4.40 to HK$3.22, based on 10x 2018E P/E. Key risks: 1) Dependence on China Railway Corporation procurement; 2) lower-than expected new operating railway line length; 3) reliance on its major suppliers. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk +852 3719 1218) 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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