Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 17E 18E 17E 18E HSI -0.1 5.8 9.0 42.8 10.5 12.7 11.5 HSCEI 0.8 10.9 15.6 31.8 10.8 8.6 7.7 MXCN -0.5 4.3 10.2 53.5 15.7 14.2 12.3 SHSZ300 0.6 3.2 6.0 35.8 15.5 14.2 12.3 SHCOMP 0.4 2.1 4.7 40.6 14.5 13.5 11.8 SZCOMP 0.0-6.2-4.1 81.0 22.2 19.4 15.8 INDU -2.5 0.9 3.2 36.0 9.1 17.3 15.9 SPX -2.1 0.7 3.3 42.8 10.3 17.8 16.1 CCMP -2.0 1.5 4.9 80.4 16.2 22.1 19.0 UKX -0.6-3.6-3.2 153.5 6.1 14.3 13.5 NKY -1.8-3.6 0.4 44.2 12.2 18.6 16.6 Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 700 TENCENT 452.4-1.65 55.8-3.64 1398 ICBC 7.4 0.00 10.0-0.35 939 CCB 9.0 0.22 22.4-1.41 857 PETROCHINA 6.3 3.77 78.6 0.32 2318 PING AN 90.7-0.44 22.5-2.47 5 HSBC 83.7-0.42 53.3-1.55 941 CHINA MOBILE 80.9-1.34 51.3-2.03 3988 BANK OF CHINA 4.7-0.43 14.4-2.77 386 SINOPEC 7.0 3.87 86.5-0.18 2628 CHINA LIFE 26.6 0.76 7.9 0.19 Source: Bloomberg Hong Kong Market Investment Strategy: Feb preview and portfolio update Take a break from the bull run The market is vulnerable to consolidation in the near term, given the almost 5,000 points rise in the HSI in less than two months. Considering the higher chance of interest rate hikes in the US as the Fed sees higher inflation ahead, the likely slowdown in southbound trading with CNY approaching, and a period of uncertainty ahead of earnings reporting season, we believe investors should be less aggressive and wait for opportunities if a market correction occurs. However, we remain positive on the market outlook, which we expect to be driven by both earnings growth and valuation upgrades. Rail Equipment: Recent correction overdone; buying opportunity from Spring Festival travel The NDRC expects total passengers traveling during the 40-day Spring Festival travel season (from Feb 1-March 12 this year) to rise 8.8% YoY. The rail equipment sector has outperformed in 8 of the last 9 years during the corresponding periods, with an average relative return (compared with the HSI) of 2.5%. We believe the main reason for the recent correction is investor concern about CRC s conservative rail FAI target for 2018. However, we expect FAI to rise, backed by increasing new rail lines and the gradual increase in rail passenger and rail freight volume. Our top picks are still CRRC and CRRC TE. Modern Dental (3600 HK, Buy): Growth outlook remains intact; upgrade to Buy on excessive price correction We raise our FY18/19 earnings forecasts by 4/4% due to better integration of MicroDental, acquired in late 2016. The company is expected to see an EBITDA margin improvement as MicroDental s profit rises to about HK$40m in FY18, up from a previous loss of HK$20-30m. We believe the current valuation does not factor in the US margin recovery and growth potential in China. We also notice share liquidity improved significantly in Jan. Our new TP of HK$3.20 is based on 20% FY18 EPS growth and 0.8 PEG. We upgrade from Accumulate to Buy as we believe its growth outlook remains intact despite continued share price weakness. Alex Fan, CFA, Research Analyst, 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: Feb preview and portfolio update Take a break from the bull run Continued market rise in the new year The Hong Kong market has seen a continued rise since the beginning of the year with the HSI up 9.9% and the HSCEI up 15.8% MoM in Jan. Among major sectors, airlines, banks, property and coal rose more than 20% while auto and consumers lagged behind. There has been a clear change in investment style, as investors are chasing low valuation stocks with improving fundamentals while switching out of high growth but high valuation stocks. Average daily turnover jumped 54% MoM to HK$160.2bn after a slow Dec as investors repositioned their portfolios. Southbound net buying has more than doubled; banks in the spotlight Average daily southbound turnover reached HK$20.5bn in Jan, up 57% MoM, accounting for 12.8% of total Hong Kong market turnover, up from 12.6% in Dec. Average daily net buying surged 117% MoM to HK$3,478m in Jan, indicating that southbound funds remain upbeat on the Hong Kong market. The top ten actively traded stocks via the Shanghai stock connect in Jan included five banks, up from three in Dec, while the top ten stocks via the Shenzhen stock connect included two banks, while there was none in Dec. Further re-rating likely During last month, consensus earnings forecasts for HSI and HSCEI stocks have increased 3% and 4% respectively, indicating that the strong market was mainly driven by valuation gains. Despite the strong rally YTD, we believe a further re-rating is possible for financials, especially banks, as their valuations are still far below the level seen in 2015. With the exception of China Merchants Bank (3968 HK, NR) and Ping An (2318 HK, NR), banks are generally trading 10-40% below than their P/B multiples in 2015, insurers at a 15-40% discount, and securities at 50-60% cheaper than their valuations in 2015. Potential newly eligible stocks for the Stock Connect Hang Seng Indexes Company Limited will announce its semi-annual review of index stocks on Feb 6. Based on the criteria for stocks eligible for the Stock Connect, we believe new inclusions will come from new constituent stocks in the Hang Seng Composite Small Cap Index (HSSI), new inclusions in the Hang Seng Composite Mid Cap and Large Cap Indices, and some of the large cap IPOs in 4Q17. In our report dated Jan 31, we listed 21 potential new inclusions, among which Wisdom Education (6068 HK, Buy), Goodbaby Intl (1086 HK, Buy) and China Yongda (3669 HK, Buy) are covered by our analysts. Given the previous track record in Feb 2017 and Aug 2017, there is a high chance of strong share price performance for newly included stocks after the announcement date. Wait for opportunities from a correction However, in the near term, given the almost 5,000 points rise in the HSI in less than two months, the market is vulnerable to consolidation. Considering the higher chance of interest rate hikes in the US as the Fed sees higher inflation ahead, the likely slowdown in southbound trading with CNY approaching, and a period of uncertainty ahead of earnings reporting season, we believe investors should be less aggressive and wait for opportunities if a market correction occurs. Market outlook and portfolio recommendation We remain positive on the market outlook, which we expect to be driven by both earnings growth and valuation upgrades. We continue to recommend exposure to high growth sectors (tech, internet, auto), sectors with re-rating potential (insurance, banks, financial intermediates), and policy driven sectors (healthcare, environmental, education). However, after the strong run, we have made some adjustments to our portfolio. In particular, we replace BJE Water (371 HK, NR) with CNOOC (883 HK, NR) as there are signs that water PPP projects are facing uncertainties while the high oil price is likely to stay and as CNOOC s capex and output plan indicates its optimism. We also remove Brilliance China (1114 HK, Buy) and replace with China Yongda as Yongda s valuation is much more attractive and its earnings are not being dragged down as Brilliance China s are by the uncertain outlook for its minibus segment. Hence, our portfolio recommendations for Feb are Tencent (700 HK, NR), AAC Tech (2018 HK, NR), Ping An (2318 HK, NR), ABC (1288 HK, NR), HKEx (388 HK, NR), Geely Auto (175 HK, Buy), China Yongda, CSPC Pharma (1093 HK, Accumulate), CNOOC and Wisdom Education. Portfolio return Our portfolio recorded a 9.4% return in Jan, compared with 9.9% for the HSI and 15.8% for the HSCEI, hampered by AAC Tech, Brilliance China, Geely and BJE Water. Risks Faster-than-expected interest rate hikes; slower-than-expected earnings growth. (Alex Fan, CFA, Research Analyst, SFC CE No. ADJ672, alexfan@gfgroup.com.hk +852 3719 1047) Page 2
Rail Equipment: Recent correction overdone; buying opportunity from Spring Festival travel NDRC expects 8.8% YoY growth in rail passenger volume during this year s Spring Festival travel season The Spring Festival travel season began around Feb 1 this year and will continue until around March 12. According to the National Development and Reform Commission (NDRC), total passengers traveling during the 40-day period will be around 390m people, up 8.8% YoY growth. Rail equipment sector has outperformed during the Spring Festival travel period for the last 9 years Analyzing the performance of the rail equipment sector, including CRRC (1766 HK, Buy), CRRC TE (3898 HK, Buy) and GuangShen Rail (525 HK, NR) during the Spring Festival travel periods during 2009-17, we see that the sector outperformed the market in 8 out of these 9 years, with an average relative return (compared with the Hang Seng index) of 2.5% during the period. Recent correction overdone We believe the main reason for the recent correction is investor concern about China Railway Corporation s conservative rail FAI target for 2018. However, we expect FAI in rail equipment in China to rise, backed by increasing new rail lines going into operation in 2018, and the gradual increase in rail passenger and rail freight volume in China. Our top picks are still CRRC and CRRC TE. (Dominic Chan, Research Analyst, SFC CE No. APP609, dominicchan@gfgroup.com.hk +852 3719 1218) Modern Dental (3600 HK, Buy): Growth outlook remains intact; upgrade to Buy on excessive price correction Undervalued dental device player We believe the company s unique value proposition as a leading dental prosthetics provider means it deserves a valuation closer to its dental peers average of 31x FY18E P/E vs its current 13x, especially considering the higher earnings expectations for Topchoice Medical (600763 CH) and recent share outperformance of other device players. Growth to reemerge on increased demand for non-gp services Specialist hospital operators such as Aier Eye Hospital (300015 CH), Meinian Onehealth (002044 CH) and Topchoice Medical entered an earnings upcycle in FY17 due to 1) increased patient traffic and average charges; 2) operating efficiency driven by better brand recognition, and; 3) capex cycles coming to an end. We believe the recovery should pass to midstream players, such as Modern Dental. Revenue from Greater China saw continued improvement in 3Q17 The company recorded 12% YoY growth in the greater China market in 3Q17, vs 2% YoY in 1H17, due to stronger volume growth driven by new private clinics in first-tier cities. About 50% of dental clinics/hospitals in China are privately-owned, in a market of about Rmb90bn (including services for preventive, curative and aesthetic purposes). We believe private dental hospitals in China are set to enter an expansion phase with supportive government policies, spurring demand for higher quality and custom-made dental prosthetics products. Modern Dental has a 1.5% revenue share in the dental prosthetics market in China, and there are significant consolidation opportunities. In 1H17, Modern Dental partnered with global dental implant player Straumann (STMN SWX) to establish a joint production platform to tap into the premium prosthetic products market in China. Consumption upgrade beneficiary The average treatment rate for tooth replacements in people aged between 65-74 years is less than 10%, according to NHFPC. Given increasing awareness of oral health, improved technology and an aging population, the dental prosthetics industry is expected to grow at 19.2% during FY14-18, vs 16.9% in FY08-14. Currently, the national health insurance only provides reimbursement for limited treatment items, such as tooth fillings and extractions, while dentures and orthodontics are not covered. Despite this limited insurance coverage, we believe rising disposable incomes will serve as a near to medium term driver that will increase implant penetration. Upgrade to Buy and raise TP from HK$3.10 to HK$3.20 We keep our FY17 estimate unchanged but raise our FY18/19 earnings forecasts by 4/4% due to the better integration of MicroDental, acquired in late 2016. The company is expected to see an EBITDA margin improvement as MicroDental s profit rises to about HK$40m in FY18, up from a previous loss of HK$20-30m. The US market accounted for about 33% of revenue in 1H17. We believe the current valuation of 13x FY18E P/E on 20% growth does not factor in the US margin recovery and growth potential in China. We also notice share liquidity improved significantly in Jan (average 7.4m shares vs 0.76m shares Page 3
in Dec 2017). Our new target price of HK$3.20 is based on 20% FY18 EPS growth and 0.8 PEG. We upgrade our rating from Accumulate to Buy as we believe its growth outlook remains intact despite continued share price weakness. Risks 1) Slower-than-expected integration of acquired targets; 2) Relatively low trading volume (small cap stock). (Natalie Chiu, Research Analyst, SFC CE No. AVH029, nataliechiu@gfgroup.com.hk +852 3760 2030) 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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