Equity Research Dim Sum Express Key index performance Chg (%) EPS (%) P/E Market 1D 1M YTD 17E 18E 17E 18E HSI -0.1 1.2 12.2 10.2 9.4 12.3 11.2 HSCEI -0.8-2.7 7.4 1.1 9.1 8.1 7.5 MXCN -0.8 1.0 15.7 14.0 13.8 12.8 11.3 SHSZ300-0.3-2.8 2.8 18.5 12.7 13.1 11.6 SHCOMP -0.3-4.4 0.8 34.1 13.2 13.6 12.0 SZCOMP -0.3-6.3-3.7 75.7 52.2 23.8 15.7 INDU 0.0 1.5 6.0 11.0 10.1 17.3 15.8 SPX 0.1 1.6 6.7 19.1 12.1 18.4 16.5 CCMP 0.0 3.6 12.9 56.2 17.3 23.1 19.7 UKX 0.2-1.1 1.5 164.3 8.2 14.8 13.7 NKY 0.7 3.1 1.7 25.3 9.2 17.0 15.5 Hong Kong ADRs HK ticker Company Local (HK$) Daily (%) ADR (US$) Daily (%) 700 TENCENT 243.8-1.85 31.3-1.88 1398 ICBC 5.0-0.79 12.8-1.46 941 CHINA MOBILE 83.7 1.03 53.5 0.32 939 CCB 6.3-0.48 16.0-0.87 857 PETROCHINA 5.4-1.47 67.8-2.28 5 HSBC 66.4 2.95 42.8 2.84 3988 BANK OF CHINA 3.7-0.80 11.8-2.47 2628 CHINA LIFE 23.5-0.63 15.0-1.06 2318 PING AN 43.6-0.34 11.2-0.80 386 SINOPEC 6.2-0.80 78.8-1.98 Source: Bloomberg GF events Date Event Location 4-5 May A-share defence sector NDR Hong Kong 5 May Nexteer site visit Suzhou 23 May GF Fintech forum Shenzhen Source: GF Securities (Hong Kong) A-Share Market Investment Strategy: 2016/1Q17 A-share earnings review; watch non-cyclical sectors with sustainable growth improvement and sectors positioned to bottom out A-share ex-financial earnings growth strengthened from 23.4% in 2016 to 48.1% in 1Q17, with contribution mainly from the property industry chain and cyclical sectors. However, both property sales and the prices of cyclical goods have started to decline recently. We believe A-share exfinancial earnings growth likely peaked in 1Q17, with upcoming quarterly earnings growth to slow in the remainder of the year; we expect full-year earnings growth of 19%. Prefer retail, toll roads, insurance, environmental, OLED, the Apple supply chain, airlines, power and new energy vehicles. Property: 2016/1Q17 review; sufficient bookable/saleable resources, tightening financing environment Industry concentration rose more rapidly in 1Q17 amid sector policy tightening with CR10 reaching 32%. Total land purchase cost as a proportion of annual sales value rose to 80%, which was higher than the 2009 level. As of end-2016, companies tracked had advance receipts of Rmb1.5trn on their books (+35%) and inventories worth Rmb3.5trn in total (+15%), which should provide some guarantee for upcoming earnings performance. Companies tracked issued debt worth a total of Rmb200bn during 2016, up 16% YoY; this dropped significantly by 74% YoY in 1Q17 to just Rmb17.4bn. Hong Kong Market Guangzhou Automobile Group (2238 HK, Buy): GAC Honda and SUV sales hit new high in April Overall sales rose 33% YoY in April but were down just 2.8% MoM on a high comparable sales volume base in March. GAC Honda sales hit a new high during the month, indicating that growth is set to continue in 2Q17. The JV accounted for 33% of overall sales in Jan-Apr 2017, and we expect it to provide strong support for overall sales growth going forward. The company s SUVs continue to see strong sales growth, and its SUV-heavy portfolio should ensure this trend continues. We reiterate our Buy rating given the sales growth outlook for this year and its rising profitability. Modern Dental (3600 HK, Under review): FY16 revenue in-line while net profit misses; focus will be on organic growth in FY17 Modern Dental reported FY16 revenue/net profit up 16.0%/23.8% YoY respectively. Core net profit rose 7.5% YoY. The company suggested that their delayed earnings release was due to the time needed to evaluate internal controls at MicroDental Group, which it acquired in late Oct 2016. The stock resumed trading on May 2. Revenue was in line with our forecast and consensus, driven by its North American, European and Australian markets, while net profit missed due to an increase in administrative and selling expenses. The company expects organic revenue growth to drive earnings this year, compared with about 1/3 of revenue growth from M&A in FY16. 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: 2016/1Q17 A-share earnings review; watch noncyclical sectors with sustainable growth improvement and sectors positioned to bottom out A-share earnings growth likely peaked in 1Q17 A-share ex-financial earnings growth came in at 23.4% YoY in 2016 and strengthened to 48.1% YoY in 1Q17, with contribution mainly from the property industry chain and cyclical sectors which are highly sensitive to product price changes. However, both property sales and the prices of cyclical goods have started to decline recently. We believe A-share ex-financial earnings growth likely peaked in 1Q17, with upcoming quarterly earnings growth to slow in the remainder of the year; we expect full-year earnings growth of 19%. Increased difficulty for ROE to improve further A-share gross margin came down from the peak of 19.5% in 2016 to 19.3% in 1Q17 due to the pressure of high costs brought by continued resources price growth. That said, ROE picked up for the third consecutive quarter on the back of improved asset turnover and sales margin. With an asset contraction yet to take place and revenue likely to peak soon, the improvement in asset turnover is unlikely to persist, adding to the difficulty with which ROE will continue to rise. Deteriorated operating cash flow It is worth noting that A-share ex-financial companies recorded an overall cash outflow in 1Q17, with operating cash flow as a proportion of revenue deteriorating significantly by 4.5% due to higher raw materials costs and the large amount of cash tied up in restocking. Decelerated ChiNext earnings growth Excluding Wens Foodstuff (300498 CH), ChiNext companies profit growth slowed from 33.5% in 2016 to 25.4% in 1Q17 mainly due to much higher costs and the reduced pace of external M&A. Excluding the impact of external M&A, ChiNext earnings growth would have actually dropped to just 10%. We expect the trading board s full-year earnings growth to come in at 18.5% in 2017 (Wens Foodstuff excluded). Watch non-cyclical sectors with sustainable growth improvement Sectors demonstrating the greatest earnings growth improvements in 1Q17 were mostly mid/upstream cyclical sectors. However, considering that cyclical earnings growth likely peaked in 1Q17, we highlight non-cyclical sectors which are experiencing sustainable earnings growth acceleration such as retail, toll roads, insurance, environmental, OLED and the Apple (AAPL US, NR) supply chain. and sectors positioned to bottom out While 1Q17 likely represented this year s peak in A- share earnings growth, we believe the following three sectors might be among the few to still achieve earnings improvements after 1Q17: 1) airlines, as oil price and forex negativities fade and higher PLF are likely to drive fare prices; 2) power, as peaking coal prices are alleviating the sector s cost burden while supply-side reform is set to improve the sector supply-demand balance; and 2) new energy vehicles, which likely have seen the worst in terms of sales volume and sector policies with short-term business conditions bottoming out. Property: 2016/1Q17 review; sufficient bookable/saleable resources, tightening financing environment Property sales: industry concentration rising China s property market remained strong during 2016. Listed developers we track posted growth of 37% and 44% in GFA sold and sales value respectively during the year, though net operating cash flow grew at a slightly slower pace than sales value growth as the number of projects jointly developed between companies increased and as the collection of sales receivables was affected by restrictions on bank mortgage issuance. It is worth noting that the top three property companies by sales each reported annual sales above Rmb300bn last year, and that industry concentration rose more rapidly in 1Q17 amid sector policy tightening with CR10 reaching 32%. Developer investment: land purchase cost above 2009 level Strong restocking demand was seen among property companies in 2016 as a result of robust property sales during the year and relatively low land purchases during 2014-2015. The 66 property companies tracked reported a combined operating cash outflow of Rmb1.23trn last year, up 25% YoY. The ratio of land parcels acquired to GFA sold among these developers reached 174% in 2016, with land purchases focused on first-tier and key second-tier cities (accounting for 70%+). Accordingly, the average land purchase price as a proportion of property ASP rose to 45%, while total land purchase cost as a proportion of annual sales value also rose to 80%, which was higher than the 2009 level. Page 2
Earnings: sufficient bookable/saleable resources The 66 developers tracked posted combined revenue of Rmb1.43trn (+29% YoY) and operating profit of Rmb193bn (+31%) in 2016, with larger developers showing more stable revenue growth and smaller companies demonstrating greater volatility. As of end-2016, these companies had advance receipts of Rmb1.5trn on their books (+35%) and inventories worth Rmb3.5trn in total (+15%), which should provide some guarantee for upcoming earnings performance. Joint development is increasingly popular (particularly preferred by large developers) as the industry becomes more mature. Profitability: gross margin likely stabilizing on cost control The 66 companies overall gross margin edged down 1pp to 27% in 2016, while their net margin edged up 0.5pp to 10.2% thanks to expense control and investment grains. Larger developers saw their net margins remaining steady at around 11%, while smaller players suffered larger declines to 8-9%. Overall sector ROE came in at 12.73%. Financials: tightening financing environment The 66 companies issued debt worth a total of Rmb200bn during 2016, up 16% YoY; this dropped significantly by 74% YoY in 1Q17 to just Rmb17.4bn. The borrowing of bank loans remained stable, with larger developers more advantageous in this channel. At end-2016, cash held by the 66 companies represented a shortterm debt coverage of 150%, and they had a net gearing ratio of 96%. The cost of new financing declined to ~4% in 2016. Guangzhou Automobile Group (2238 HK, Buy): GAC Honda and SUV sales hit new high in April April sales growth steady Overall sales hit 169,755 units in April, up 33% YoY but down just 2.8% MoM on high sales volume in March. 41,705 own-brand units were sold, up 56.2% YoY, while the company sold 105,414 Japanese-brand units, up 20.7% YoY. GAC-FCA sold 20,953 units, up 82.7% YoY. GAC Honda hits a new sales high GAC Honda sold 60,172 units in April, up 22.8% YoY and 3.6% MoM, after its sales high in 1Q17. The brand s monthly sales hit a new high, indicating that growth is set to continue in 2Q17. The JV accounted for 33% of the Group s overall sales in Jan-Apr 2017, and we expect it to provide strong support for overall sales growth going forward given an increased market share for Japanese brands. SUV sales continue to rise sharply The Group sold 99,313 SUVs in April, hitting a new sales high after March (breakdown by model not yet available). We believe the Group s current product portfolio, of which 58% were SUVs during Jan-Apr 2017, is very competitive given the popularity of SUVs among Chinese buyers, and we expect this sales trend to drive Group sales growth to new highs. Maintain Buy and TP of HK$15.00 We reiterate our Buy rating on the stock given the sales growth outlook for this year and its rising profitability, as seen in its 1Q17 results. The stock is currently trading at 7.5 2017E P/E, below its historical average at 10x, and undervalued in our view. We maintain our Buy rating and target price of HK$15.00, based on 10x FY17E P/E, in line with its 3- year average. (Alex Fan, CFA, Head of Research, SFC CE No. ADJ672, alexfan@gfgroup.com.hk +852 3719 1047) (Chongjing Deng, Research Analyst, SFC CE No. BEY953, dengchongjing@gfgroup.com.hk +86 20 8757 0515) Modern Dental (3600 HK, Under review): FY16 revenue in-line while net profit misses; focus will be on organic growth in FY17 What s new? Modern Dental reported FY16 revenue/net profit of HK$1.64bn/HK$101m, up 16.0%/23.8% YoY respectively. Excluding acquisition costs and other one-off expenses, core net profit rose 7.5% YoY to HK$215m. The company declared a final dividend per share of HK$0.9cent, bringing its full-year dividend payout ratio to 29%. Resumption of trading The company suggested that their delayed earnings release was due to the time needed to evaluate internal controls at MicroDental Group, which it acquired in late Oct 2016. Key areas of concern related to the verification of sales receipts with customers (dental clinics Page 3
or third-party distributors) and the auditor requiring a longer checking process. The review is now complete and the stock resumed trading on May 2. Revenue in line with our forecast and consensus, driven by North America, European and Australian markets The acquisition of MicroDental led to a 52% increase in North American revenue, contributing HK$97m, or 6%, of total revenue in FY16. MicroDental is the second largest dental laboratory in the US and the acquisition allows Modern Dental to manufacture dental prosthetic products locally with a quicker turnaround time than offshore products. Net profit missed due to increase in administrative and selling expenses The company included HK$37.5m of transaction costs, HK$9.83m of goodwill impairment and HK$34.35m of amortization resulting from previous acquisitions. Adjusted EBITDA came in at HK$321m, up 5.2% YoY. They expect lower acquisition costs this year due to its focus on integration. Smaller acquisitions this year The company spent about HK$600m on M&A in FY16 after raising about HK$650m from its IPO in Dec 2015. With bank loans of HK$430m, they still have about HK$110m from the IPO proceeds to utilize in end-dec. They expect organic revenue growth to drive earnings this year, compared with about 1/3 of revenue growth from M&A in FY16. The company is trading at 11.4x FY17 P/E. Our rating and target price are under review. (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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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