Equity Research Dim Sum Express Alex Fan, CFA Head of Research SFC CE No. ADJ672 alexfan@gfgroup.com.hk +852 3719 1047 Ryan Zhu Research Analyst SFC CE No. BDK820 zhuran@gfgroup.com.hk +86 0755 88263160 Joseph Ho, CFA Research Analyst SFC CE No. AFP308 josephho@gfgroup.com.hk +852 3719 1030 Gao Yedong Editor SFC CE No. BAI002 yedonggao@gfgroup.com.hk +852 3719 1026 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong A-Share Market Property: Developers with large land bank in Sichuan to see ST strength on subsidy The subsidy for banks issuing first-home mortgages in Sichuan is in line with our expectation, and should help lower mortgage rates. In addition, it might also trigger expectations for similar moves in other provinces. The property and land markets in Chengdu are weak as residential area sold in Jun dropped 65% MoM and 48% YoY while 7M14 residential land sales fell 16% YoY. We see short-term investment opportunities from property companies that have a large land bank in Sichuan, and expect the property sector to offer excess returns on MoM home price declines, policy fine-tuning and improving mortgage lending conditions. Rare Earths: Crackdowns on illegal mining key factor for market conditions Based on media reports of ongoing rare earth state reserve building, the premiums of the reserve purchase prices over the current market prices fell short of expectation. Furthermore, lawful rare earth companies will be hurt significantly if the government fails to rein in illegal mining activities and push through industry consolidation. Overall rare earth inventory will decline significantly and the per-tonne gross margin for medium & heavy rare earths will increase following reserve building. We expect the government to launch a new round of crackdowns on illegal mining in the near term, and we see the possibility of another state reserve building later this year. Marine Engineering: Multiple factors driving sector growth Despite volatility in global marine engineering equipment orders, domestic equipment manufacturers have seen growth strengthen with market shares rising. Master contractors such as CIMC Raffles are turning profitable, and financial institutions such as ICBC Financial Leasing have strengthened support for the sector through substantial investments. In addition, government-driven oil drilling activities remain strong, while domestic equipment manufacturers have gained increasing recognition from customers. We remain positive on the sector given government initiatives to strengthen offshore economic development and the fact that the focus of the global marine engineering industry is shifting towards China. Hong Kong Market Online Gaming: Sustainable high growth in mobile games Online gaming names have seen substantial share price corrections in recent months on concerns about poor 1H14 results, disappointing news on core games and corporate management concerns. However, we remain positive on the sector, seeing buying opportunities as the industry s long-term growth outlook remains intact, driven by overseas expansion and an increase in the number of online gamers with the shift from PC to mobile platforms. We see mobile games as the future growth driver given the boom in smartphones and 3G/4G penetration. We initiate our coverage of Boyaa (Buy, $11.20), IGG (Buy, $6.58), NetDragon (Hold, $15.00) and Forgame (Hold, $17.10).
Property: Developers with large land bank in Sichuan to see ST strength on subsidy Sichuan mortgage subsidy a positive signal The Sichuan government has announced that it will subsidize banks that issue mortgages to first-home buyers with interest rates not exceeding the benchmark rate during Jul-Dec 2014 at 3% of the loan amount. This policy is in line with our previous expectation. Our recent channel checks indicate that first-home mortgage rates in Chengdu mostly stand at 1.1x of the benchmark and we expect this subsidy to help lower mortgage rates. In addition, it might also trigger expectations for similar moves in other provinces. Property/land sales weak in Chengdu Residential area sold in Sichuan during 1H14 declined 1.75% YoY, slightly better than the national average figure. However, the property market in Chengdu appears pessimistic, as residential area sold in Jun represented drops of 65% MoM and 48% YoY with the months of inventory rising to ten months. The city s land market was also weak, with 7M14 residential land sales dropping 16% YoY. Positive on developers with large land reserves in Sichuan We see short-term investment opportunities from property companies that have a large land bank in Sichuan such as BRC and Jinke Property (000656 CH). 63% of BRC s 9.26m sqm land reserve is located in Sichuan (5.79m sqm), while Jinke s land reserve of 2.11m sqm in Sichuan accounts for 8% of its overall land reserve. In addition, Poly Real Estate (600048 CH) also has a land bank of nearly 7m sqm located in the province. Expectations for sector recovery to be seen sooner Mortgage loans and property sales typically grow at similar paces based on historical patterns. As such we believe expectations for a recovery in property transactions will be seen sooner than previously expected. Furthermore, the recovery in sector fundamentals should accelerate if similar subsidies are introduced in other provinces. We expect the property sector to offer excess returns on MoM home price declines, policy fine-tuning and improving mortgage lending conditions. Our top picks are China Vanke (000002 CH), Poly Real Estate (600048 CH), Citychamp Dartong (600067 CH), Yango Group (000671 CH), Zhongnan Construction (000961 CH) and Thaihot Group (000732 CH). Rare Earths: Crackdowns on illegal mining key factor for market conditions Reserve purchase prices lower than expected There have been media reports that rare earth state reserve building is underway, detailing the prices and amount of rare earths to be purchased as reserves and a timetable for the purchases. Overall, the premiums of the reserve purchase prices over the current market prices are smaller than we previously expected. Assuming that dysprosium and terbium oxides are purchased at 30% above the current market prices, the total value of this round of reserve building would amount to Rmb8.4bn, which would be Rmb1.3bn higher than the market price level. Regulations key factor driving market conditions Lawful rare earth companies will be hurt significantly if the government fails to rein in illegal mining activities and push through industry consolidation. Following the short-lived success of regulatory crackdowns in 2013, illegal mining activities have risen again this year. We estimate that 50,000 tonnes of rare earths are produced illegally every year, compared with legal output of just 17,900 tonnes. As such changes in the market supply-demand dynamics and rare earth prices will remain dependent on the strength of industry regulation. Medium/heavy rare earths key beneficiaries Overall rare earth inventory will decline significantly on the back of reserve building. The reserve purchase prices of light rare earths are close to market price levels (just Rmb1,000/tonne above market prices), while an 11% premium is seen for medium & heavy rare earths. We believe the per-tonne gross margin for medium & heavy rare earths will increase from Rmb29,200/tonne to Rmb58,300/tonne following state reserve building. Company earnings to be enhanced Based on stable ore prices and current smelting quotas, Baotou Steel Rare-Earth (600111 CH), Minmetals Rare Earth (000831 CH), Rising Nonferrous Metals Share (600259 CH), Xiamen Tungsten (600549 CH), Ganzhou Rare Earth and Shenghe Resources (600392 CH) should see their net profit increase by Rmb50m, 83.52m, 64.02m, 72.75m, 29.1m and 5.5m, translating into EPS enhancements of Rmb0.02, 0.09, 0.26, 0.11, 0.01 and 0.01. Page 2
Another round of reserve building possible later this year We expect the government to launch a new round of crackdowns on illegal mining in the near term given pressure from the WTO ruling against China regarding its rare earth export restrictions earlier this year, though the strength of these crackdowns is yet to be confirmed. In addition, we see the possibility of another state reserve building later this year. Given that this round of reserve building will bring greater benefits for heavy rare earths, we prefer Minmetals Rare Earth (000831 CH), followed by Rising Nonferrous Metals (600259 CH), Xiamen Tungsten (600549 CH), Shenghe Resources (600392 CH) and Baotou Steel Rare-Earth (600111 CH). Details of rare earth reserve building compared with expected figures Actual Rare earth oxide Reserve amount (tonne) Reserve purchase price (Rmb'000/tonne) Market price (Rmb'000/tonne) Premium Value of reserve Market value Value difference Praseodymium oxide 500 570 525 8.57% 285 262.5 22.5 Neodymium oxide 500 308 292.5 5.30% 154 146.25 7.75 Praseodymium neodymium oxide 4,000 311.8 307.5 1.40% 1,247.2 1,230 17.2 Dysprosium oxide 1,200 1,865.5 1,435 30.00% 2,238.6 1,722 516.6 Terbium oxide 500 3,575 2,750 30.00% 1,787.5 1,375 412.5 Europium oxide 500 3,550 2,900 22.41% 1,775 1,450 325 Yttrium oxide 2,500 46 43.5 5.75% 115 108.75 6.25 Erbium oxide 300 315 275 14.55% 94.5 82.5 12 Lutecium oxide 90 7,700 7,500 2.67% 693 675 18 Total 10,090 8,389.8 7,052 1,337.8 Expected Reserve amount (tonnes of rare earth oxides) Sources: China Securities Journal, Ruidow, Baiinfo, GF Securities Reserve purchase price (Rmb'000/tonne) Market price (Rmb'000/tonne) Premium Value of reserve Market value Value difference Rare earth element Praseodymium Neodymium 5,000 400 307.5 30.08% 2,000 1,537.5 462.5 Europium 500 5,000 2900 72.41% 2,500 1,450 1,050 Terbium 300 4,000 2750 45.45% 1,200 825 375 Dysprosium 2,000 2,300 1435 60.28% 4,600 2,870 1,730 Lutecium 120 10,000 7500 33.33% 1,200 900 300 Erbium 300 380 275 38.18% 114 82.5 31.5 Total 8,220 11,614 7,665 3,949 Marine Engineering: Multiple factors driving sector growth Land rig leader moving into marine engineering Honghua Group (196 HK) has received the orders for its TIGER III and IV offshore drilling modules (worth US$56m) from Shanghai Shipyard. This came after Honghua s fulfilment of orders placed in Mar 2012 for its TIGER I and II drilling modules last year (collectively worth more than Rmb300m). As a leading land rig manufacturer, Honghua has expanded into the offshore drilling equipment space by overcoming a number of technical difficulties, with its TIGER drilling modules gaining recognition from the American Bureau of Shipping. In addition, the company has also conducted substantial preparatory work for the development of self-elevating drilling rigs which has attracted considerable client interest. Multiple drivers at play Despite volatility in global marine engineering equipment orders, domestic equipment manufacturers have seen business growth strengthen with their market shares rising further. It is worth noting that master contractors such as CIMC Raffles are turning profitable, and that financial institutions such as ICBC Financial Leasing have strengthened their support for the marine engineering sector through substantial investments. In addition, government-driven oil drilling activities remain strong, while domestic equipment manufacturers have gained increasing recognition from master contractors and end customers. Positive on sector We remain positive on the marine engineering sector given government initiatives to strengthen offshore economic development and the fact that the focus of the global marine engineering industry is shifting towards China. We like master contractors such as China International Marine Container (000039 CH), Rainbow Heavy Industries (002483 CH), China State Shipbuilding (600150 CH), Offshore Oil Engineering (600583 CH) and Zhenhua Port Machinery (900947 CH) given rapid business growth and significant earnings upside. We are also positive on key equipment manufacturers such as Honghua Group (196 HK) and TSC Group (206 HK). Page 3
Online Gaming: Sustainable high growth in mobile games Buying opportunities ahead following share price corrections Online gaming names have seen substantial share price corrections in the last four months. The four HK-listed names under our coverage (Boyaa, IGG, NetDragon, Forgame) have posted an average drop of 41.4%, mainly due to concerns about poor upcoming 1H14 results (particularly for Forgame), disappointing news on core games and corporate management concerns. However, we remain positive on the sector, seeing buying opportunities following these corrections as the industry s long-term growth outlook remains intact, driven by overseas expansion and an increase in the number of online gamers as online games expand from PC to mobile platforms. Focus on mobile games We see mobile games as the future growth driver for the sector given the boom in smartphones and 3G/4G penetration, and the increase in time spent playing mobile games. We expect the number of smartphone gamers to rise 61% YoY in 2014 and grow at a CAGR of 19.2% during 2014-17. Long-term growth will also be driven by the convenience of gaming on mobile devices and the better experience afforded by the 3G/4G network. Opportunities in overseas markets Revenue from Chinese online games in overseas markets came in at US$18.2bn in 2013, up 219% YoY. We are confident that domestic online game developers will be able to take advantage of the broad and rapidly growing opportunities in overseas market in the coming two years. Our top picks We initiate our coverage of IGG (8002 HK, Buy) and Boyaa (434 HK, Buy) with a positive view on both. We believe IGG, supported by Tencent, will benefit from domestic market expansion as well as its rapidly growing mobile game business in overseas markets. We expect Boyaa to maintain its strong growth over the next 2-3 years, driven by an increase in the number of paying users for its mobile games and its strong overseas expansion momentum. How we differ? We forecast above-consensus earnings for Boyaa in 2014-16 as we believe the street currently under-estimates the company s growth potential in overseas markets and the upside from its existing mobile games in the domestic market. We are bearish on Forgame and expect consensus for its FY14-16 earnings to decline. This is an extract from a report due to be released today. Please contact us for the full report. (Analysts: Ryan Zhu, zhuran@gfgroup.com.hk; Joseph Ho, josephho@gfgroup.com.hk) Page 4
Hong Kong Equity 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. Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited ( GF Securities (Hong Kong) ) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies did not have any investment banking relationships with the companies mentioned in this research report in the past 12 months. (3) All of the views expressed in this research report accurately reflect the independent views of the analyst(s). Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the companies mentioned in this report, or has any financial interests in or holds any shares of the securities mentioned in this report. Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or a recommendation for investing in, any securities. This research report is intended solely for use by the clients of GF Securities (Hong Kong). The securities mentioned in this research report may not be allowed to be sold in certain jurisdictions. No action has been taken to permit the distribution of this research report to any persons in any jurisdictions that the circulation or distribution of such research report is unlawful. The information contained in this research report has been compiled or arrived at from publically available sources believed to be reliable in good faith, and no representation or warranty, either express or implied, is made by GF Securities (Hong Kong) as to their accuracy and completeness. GF Securities (Hong Kong) accepts no liability for any losses arising from the use of the materials presented in this research report, unless otherwise required by applicable laws or regulations. Please be aware of the fact that investments involve risks and that the prices of securities may fluctuate and therefore returns may vary. Past results do not guarantee future performance. Any recommendations contained in this research report do not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. This report is not to be taken in substitution for the exercise of judgment by the respective recipients of this report. Where necessary, the recipients should obtain professional advice before making investment decisions. GF Securities (Hong Kong) may have issued, and may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented in this research report. The points of view, opinions and analytical methods adopted in this research report are solely expressed by the analyst(s) but not GF Securities (Hong Kong) or its subsidiaries. The information, opinions and forecasts presented in this research report are the current opinions of the analyst(s) as of the date appearing on this material and are subject to changes at any time without notice. The salespersons, dealers or other professionals of GF Securities (Hong Kong) may deliver opposite points of view to their clients and the proprietary trading division with respect to market commentaries and dealing strategies either in writing or verbally. The proprietary trading division of GF Securities (Hong Kong) may have investment decisions which are contrary to the opinions expressed in this research report. GF Securities (Hong Kong) or its affiliates or respective directors, officers, analysts and employees may have rights and interests in the securities mentioned in this research report. The recipients should be aware of relevant disclosures of interests (if any) when reading this report. Copyright GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk Page 5