Yum Cha 飲茶 TALKING POINT - A-SHARES: PICK-UP IN TRADING VELOCITY AND MFSL BALANCE INDICES Closing DoD% Hang Seng Index 22,323.9 0.5 HSCEI 9,398.1 0.6 Shanghai COMP 3,207.0 (0.1) Shenzhen COMP 2,124.4 0.5 Gold 1,228.8 0.6 BDIY 1,084.0 1.8 Crude Oil, WTI(US$/BBL) 45.8 5.7 9 8 7 6 5 4 3 2 1 0 Annualized trading velocity of A-share market (x) 1,200 1,150 1,100 1,050 1,000 950 900 850 800 MFSL balance (RMB bn) Crude Oil, BRENT(US$/BBL) 47.0 5.7 HIBOR, 3-M 0.7 (0.5) Sources: Bloomberg, CGIS Research SHIBOR, 3-M 2.9 0.4 RMB/USD 6.9 (0.01) DATA RELEASES DUE THIS WEEK Nov 18 Source: Bloomberg China October Property Prices Conference Board China October Company Ticker China securities companies Price (Local currency) Market cap (US$m) PER (x) PBR (x) ROE (%) ROA (%) 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E CITIC 6030 HK Equity 17.80 30,070 9.0 17.3 15.0 1.28 1.29 1.27 16.6 7.6 8.7 3.7 1.9 2.2 Haitong 6837 HK Equity 14.30 26,121 8.6 16.5 14.4 1.26 1.28 1.25 18.0 7.9 9.0 3.4 1.5 1.7 China Galaxy 6881 HK Equity 7.77 9,501 6.2 15.4 14.8 1.08 1.10 1.09 22.9 7.2 7.6 4.1 1.5 1.7 Guangfa 1776 HK Equity 17.78 20,069 8.5 14.3 12.3 1.44 1.50 1.45 22.5 10.5 12.2 4.0 2.0 2.4 HTSC 6886 HK Equity 16.90 20,278 8.3 14.8 12.1 1.25 1.27 1.19 17.5 8.7 10.2 3.0 1.6 1.9 CICC 3908 HK Equity 11.30 3,342 8.2 15.1 13.2 1.33 1.32 1.21 16.0 8.6 9.4 2.7 1.4 1.6 Everbright 6178 HK Equity 12.18 11,173 4.6 13.5 11.5 n.a. 1.03 0.96 23.1 7.8 8.7 4.9 1.8 2.3 China Merchants 6099 HK Equity 12.20 17,499 5.3 13.8 11.2 n.a. 1.30 1.19 24.3 10.5 11.0 4.5 2.1 2.5 Simple average 7.3 15.1 13.0 1.27 1.26 1.20 20.1 8.6 9.6 3.8 1.7 2.0 Sources: Bloomberg, CGIS Research Following the gradual recovery of CSI300 Index (up 4.6% in a month), the trading velocity of the A-share market picked up in the last few weeks, after a boring Q3 (left chart). Average daily turnover in the past five trading days rose to RMB697bn (year to date: RMB522bn). Margin financing and securities lending (MFSL) balance also recovered from RMB896bn to RMB941bn in a month. Given that a rebound in trading velocity can usually last for > 2 months, we believe stocks of China securities companies will continue to perform well in the next few weeks. As we have shown several times, the stock prices of securities companies have a very high positive correlation with trading velocity. Although most of the stocks of securities companies are likely to follow the same direction, our top pick is still GF Securities (1776.HK) because of its superior business performance this year (the only company under our coverage which is likely to achieve >10% ROE this year). RESEARCH NOTES Analyst: Wong Chi-man, CFA IRC GROUP [1029.HK; HK$0.265; NOT RATED] - IRC suffered heavy losses in the past few years as a result of a sharp correction in iron ore prices. However, we see a strong turnaround story in 2017 and 2018 when the K&S project commences commercial operations. Based on our scenario analysis, we estimate the Company is trading at 1.4x - 4.07x 2018E PER if the 65% Fe iron ore price is in the range of US$60-90/tonne (latest price: about US$90/tonne). As the share price of IRC surged 42% in the past two days, we may see profit-taking in the near term, but that would offer a good entry point, as the stock is still deeply undervalued based on the current share price. 1
Summary. IRC suffered heavy losses in the past few years as a result of a sharp correction in iron ore prices. However, we see a strong turnaround story in 2017 and 2018 when the K&S project commences commercial operations. Based on our scenario analysis, we estimate the Company is trading at 1.4x - 4.07x 2018E PER if the 65% Fe iron ore price is in the range of US$60-90/tonne (latest price: about US$90/ tonne). As the share price of IRC surged 42% in the past two days, we may see profit-taking in the near term, but that would offer a good entry point, as the stock is still deeply undervalued based on the current share price. Background. IRC Group produces iron ore concentrate products in far eastern Russia, near northeastern China. The K&S project has started a trial operation and is expected to commence commercial operations in early 2017. Meanwhile, the Kuranakh operations have been suspended since 1H16 because of high cash costs. Petropavlovsk PLC, a gold miner in Russia, owns a 35.8% stake in the Company. General Nice, a Hong Kong-based mining exploration and trading company, has a 20.5% stake. 2016 to be an irrelevant year. The Company recorded a net loss of US$9.9m in 1H16 because of weak iron ore prices (realized iron ore price: US$39/tonne) and the high cash cost of the Kuranakh project (>US$50/tonne). Its 2H16 results will remain unexciting as the Kuranakh operations have been suspended and the K&S project is still under trial operations with limited production volume. K&S to be a game changer for 2017 and 2018. Currently, management expects K&S to commence commercial operations in early 2017. On an annualized basis, the production volume of K&S is about 3.2m tonnes at full capacity. As the cash cost per tonne is only US$34 (assuming a 5- year average USD:RUB exchange rate of 67, currently at 66), the project is very lucrative at the latest price of about US$90/tonne (65% Fe). Even at US$60/tonne, cash profit per tonne is still high, at US$26, with annual EBITDA of the project at about US$82m. The estimated mining life of K&S is about 29 years. Trading at 1.4x - 4.07x 2018E PER. In figure 1 and 2, we show the scenario analysis for 2018 based on full capacity of 3.2m tonnes/year for K&S. If the iron ore price stays at US$90/tonne, we estimate the Company will record net profit of US$147m, implying 1.4x PER. If we use a much lower price of US$60 (the Company s base case), IRC would still report net profit of US$51m, representing 4.07x PER. In 2017, if we assume production volume of about 2.5m tonnes, IRC is trading at 2.1x and 9x 2017E PER, based on an iron ore price of US$90 and US$60 per tonne, respectively (figure 3 and 4). If we use an even more conservative assumption of 2m tonnes in 2017, the Company is trading at 3.3x and 66x 2017E PER, based on an iron ore price of US$90 and US$60 per tonne, respectively (figure 5 and 6). Good location a key competitive advantage. As the Company s mining assets are located near northeastern China, with good railway infrastructure, its iron ore concentrate products can be shipped to its Chinese customers within a short period of time. This helps its steel plant customers better manage their production schedules and inventory. According to management, it may take >15 days to ship products from Australia to Heilongjiang, while IRC an deliver the products within a week. Cash flow pressure in Q4 2016 but still manageable. The Company will need to repay bank loans of about US$26m, while its cash balance at end Sep 2016 was only US$14.6m. But there is a US$37m fully funded performance bond in ICBC, held on behalf of IRC as a down payment on construction work at K&S. As a result of past project delays by the contractor, IRC is allowed to use the performance bond to repay its bank loans. The Company is also negotiating with ICBC for debt restructuring (e.g. later repayment after much stronger cash inflow in 2017). Medium-term development: K&S phase 2. In the near term, the Company does not expect to have much need for capex as the K&S project has been completed. In the medium-term, it may consider the development of K&S phase 2, which would double production capacity. Potential to write back. The Company recorded a total impairment loss of US$770m (equity at end-1h16: US$114m) between 2013 and 2015. Management does not rule out the potential of a write-back as a result of the strong rebound in iron ore prices. Trading volume improved significantly. In the past, trading volume of IRC shares was very thin because of falling iron ore prices. However, average trading volume in the past five trading days jumped to US$6m per day. Risk factors. (i) Later than expected commencement of K&S commercial operations; (ii) execution risks of K&S (e.g. higher-thanexpected cash costs); (iii) a sharp correction of iron ore prices; (iv) sharp appreciation of the rouble against the USD, as the Company s revenue is denominated mainly in USD while most of the cost items are dominated in roubles; and (v) failure to manage the repayment of bank loans in Q4 2016. Share price performance (HK$) 1.00 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Sources: Capital IQ, CGIS Research IRC Limited (SEHK:1029) - Share Pricing
Figure 1: Scenario analysis for 2018 based on 65% Fe at US$90/tonne Figure 2: Scenario analysis for 2018 based on 65% Fe at US$60/tonne 2018 Note 2018 Note Iron ore concentrate (65% Fe) (tonnes) 3,200,000 Iron ore concentrate (65% Fe) (tonnes) 3,200,000 90 Latest market price 60 The company's base case Irone ore concentrate 288,000 Irone ore concentrate 192,000 Cash cost (US$34/tonne) (108,800) Cash profit 179,200 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 162,366 Profit before tax 147,366 Net profit 147,366 EPS (HK$) 0.187 PER (x) 1.42 Cash cost (US$34/tonne) (108,800) Cash profit 83,200 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 66,366 Profit before tax 51,366 Net profit 51,366 EPS (HK$) 0.065 PER (x) 4.07 Figure 3: Scenario analysis for 2017 based on 2.5m tonnes Iron ore concentrate (65% Fe) (tonnes) 2,500,000 90 Latest market price Figure 4: Scenario analysis for 2017 based on 2.5m tonnes Iron ore concentrate (65% Fe) (tonnes) 2,500,000 60 The company's base case Irone ore concentrate 225,000 Irone ore concentrate 150,000 Estimated cash cost (US$38/tonne) Higher unit cost as it is not running at full (95,000) capacity Cash profit 130,000 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 113,166 Profit before tax 98,166 Net profit 98,166 EPS (HK$) 0.124 PER (x) 2.13 Estimated cash cost (US$38/tonne) Higher unit cost as it is not running at (95,000) full capacity Cash profit 55,000 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 38,166 Profit before tax 23,166 Net profit 23,166 EPS (HK$) 0.029 PER (x) 9.03
Figure 5: Scenario analysis for 2017 based on 2m tonnes Iron ore concentrate (65% Fe) (tonnes) 2,000,000 90 Latest market price Figure 6: Scenario analysis for 2017 based on 2m tonnes Iron ore concentrate (65% Fe) (tonnes) 2,000,000 60 The company's base case Irone ore concentrate 180,000 Irone ore concentrate 120,000 Estimated cash cost (US$42.5/tonne) Higher unit cost as it is not running at full (85,000) capacity Cash profit 95,000 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 78,166 Profit before tax 63,166 Net profit 63,166 EPS (HK$) 0.080 PER (x) 3.31 Estimated cash cost (US$42.5/tonne) Higher unit cost as it is not running at (85,000) full capacity Cash profit 35,000 Depreciation (7,448) have been written off in the past few years when iron ore price was low. EBIT 18,166 Profit before tax 3,166 Net profit 3,166 EPS (HK$) 0.004 PER (x) 66.05 Figure 7: USD:RUB 90 80 70 60 50 40 30 20 10 Depreciation of rouble Figure 8: 65% Fe iron ore price USD/ton USD/ton 160 160 140 140 120 120 100 100 80 80 60 60 0 1/11/2013 1/11/2014 1/11/2015 1/11/2016 USDRUB Sources: Bloomberg, CGIS Research 40 40 31-12-12 31-12-13 31-12-14 31-12-15 Iron Ore Price Index: 65%Fe: CFR Northern China Sources: WIND, CGIS Research Data Source: Wind Info
Figure 9: Location of K&S Source: Company
Disclaimer This research report is not directed at, or intended for distribution to or used by, any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation or which would subject China Galaxy International Securities (Hong Kong) Co., Limited ( Galaxy International Securities ) and/or its group companies to any registration or licensing requirement within such jurisdiction. This report (including any information attached) is issued by Galaxy International Securities, one of the subsidiaries of the China Galaxy International Financial Holdings Limited, to the institutional clients from the information sources believed to be reliable, but no representation or warranty (expressly or implied) is made as to their accuracy, correctness and/or completeness. This report shall not be construed as an offer, invitation or solicitation to buy or sell any securities of the company(ies) referred to herein. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. The recipient of this report should understand and comprehend the investment objectives and its related risks, and where necessary consult their own independent financial advisers prior to any investment decision. Where any part of the information, opinions or estimates contained herein reflects the personal views and opinions of the analyst who prepared this report, such views and opinions may not correspond to the published views or investment decisions of China Galaxy International Financial Holdings Limited and any of its subsidiaries ( China Galaxy International ), directors, officers, agents and employees ( the Relevant Parties ). All opinions and estimates reflect the judgment of the analyst on the date of this report and are subject to change without notice. China Galaxy International and/or the Relevant Parties hereby disclaim any of their liabilities arising from the inaccuracy, incorrectness and incompleteness of this report and its attachment/s and/or any action or omission made in reliance thereof. Accordingly, this report must be read in conjunction with this disclaimer. Disclosure of Interests China Galaxy Securities (6881.hk) is the direct and/or indirect holding company of the group of companies under China Galaxy International. China Galaxy International may have financial interests in relation to the subjected company(ies) the securities in respect of which are reviewed in this report, and such interests aggregate to an amount may equal to or more than 1 % of the subjected company(ies) market capitalization. One or more directors, officers and/or employees of China Galaxy International may be a director or officer of the securities of the company(ies) mentioned in this report. China Galaxy International and the Relevant Parties may, to the extent permitted by law, from time to time participate or invest in financing transactions with the securities of the company(ies) mentioned in this report, perform services for or solicit business from such company(ies), and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. China Galaxy International may have served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the last 12 months, significant advice or investment services in relation to the investment concerned or a related investment or investment banking services to the company(ies) mentioned in this report. Furthermore, China Galaxy International may have received compensation for investment banking services from the company(ies) mentioned in this report within the preceding 12 months and may currently seeking investment banking mandate from the subject company(ies). Analyst Certification The analyst who is primarily responsible for the content of this report, in whole or in part, certifies that with respect to the securities or issuer covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject, securities or issuer; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by the analyst in this report. Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the securities covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the securities covered in this research report three business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong-listed companies covered in this report; and (4) have any financial interests in the Hong Kong-listed companies covered in this report. Explanation on Equity Ratings BUY SELL HOLD : : share price will increase by >20% within 12 months in absolute terms share price will decrease by >20% within 12 months in absolute terms : no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL Copyright Reserved No part of this material may be reproduced or redistributed without the prior written consent of China Galaxy International Securities (Hong Kong) Co., Limited. China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459 Room 3501-3507, 35/F, Cosco Tower, Grand Millennium Plaza, 183 Queen s Road Central, Sheung Wan, Hong Kong. General line: 3698-6888.