China pps Market outlook - 2013 Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com Francis Cheung, CFA Head of China-HK Strategy [email protected](852) 26008548 Man Ho Lam (852) 26008732 3 December 2012 China Strategy Overweight Consumer discretionary, healthcare, internet, oil & gas, property, telecoms Top ideas Bank of China (3988 HK) Belle Intl (1880 HK) China Mobile (941 HK) Cogo (81 HK) CR Power (836 HK) Haitong (6837 HK) Melco Crown (MPEL US) Sino Biopharm (1177 HK) Sinopec (386 HK) Tencent (700 HK) Top SELLs Angang (347 HK) BYD (1211 HK) Chalco (2600 HK) Dongfang (1072 HK) Esprit (330 HK) GCL-Poly (3800 HK) Li & Fung (494 HK) Shanghai Petrochem (338 HK) Sinoma (1893 HK) Yanzhou Coal (1171 HK) Dongfang (1072 HK) www.clsa.com Hard work begins Fixing China’s growth engine Prepared for: ThomsonReuters
200
Embed
20121203-CLSA-ChinaOpps (Hard Work Begins Fixing China's Growth Engine)
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
China pps Market outlook - 2013
Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor proprietary database at clsa.com
Hard work begins China has had a difficult year as economic growth saw the sharpest decline in
two decades with the exception of the credit crisis. There has been policy paralysis, perhaps due to the leadership change or recognition of the mistakes
made in the excessive stimulus in 2009. The country’s leaders have been
reluctant to boost growth due to overinvestment, which is estimated at 10% of GDP. These legacy issues will carry through into 2013.
We expect economic growth to improve in 1H13, but 2H13 is likely to disappoint.
The economy will continue to slow but the pace will be more gradual compared
to the sharp drop in 2012. Consensus GDP remains too high at 8.2% YoY.
Slowing property investment has pulled the economy back by 1% this year and
will be a 0.4% drag next year. Infrastructure will be a main growth driver, but
may not be enough with limited financing. We could see selective easing in
property and rate cuts similar to 2012. We expect one interest-rate reduction and
two cuts in the required-reserve ratio, mostly in 2H13.
We do not expect major changes in policy from the new leadership. That may
come at the 2014 National People Congress. Policies will be incremental and
focused on continuing reforms that have started, such as interest-rate reform,
pricing reform and amending outdated population policies. Low-hanging fruits
are to change the outdated hukou (household registration) system and the
one-child rule. The long-term path is clear. Urbanisation could provide more
sustainable growth and reforming state-owned enterprises (SOEs) is the key
to migrating up the value chain.
The consumer is the bright spot and our survey shows that mainlanders are
optimistic about 2013 and plan to continue spending, especially on travel.
Healthcare has risen to the top of their concerns alongside corruption. We are
Overweight consumer discretionary, healthcare, internet, property and telcos as
well as those that benefit from policy such as oil & gas. We are Underweight
investment-driven industries, eg, machinery, resources, steel and banks which
will have to fund more local-government financial vehicles next year.
Our China portfolio is up 14.6% this year, outperforming the market by 3.1%.
We provide our 2013 top-10 stock ideas and SELLs plus top-10 investment
trends. Our top recommendations include Tencent, Sino Biopharm, and
Sinopec; our top SELLs include Chalco, Angang and BYD. Our 2013 MSCI
China and MSCI HK target suggest 13% and 11% upside. Our HSI target is
¹ On 25 March 2012, Beijing’s Municipal Commission of Housing removed 33,000 invalid apartments from its inventory list, reducing stock available for sale from 124,000 to 91,000 apartments. ² Shanghai statistics exclude social housing. Inventory months are calculated as 3MMA available for sale divided by 3MMA sales. Source: CREIS, CLSA Asia-Pacific Markets
Tier-2 cities: inventory at record high
Inventory in eight tier-2 cities we sampled has reached a record high. Tianjin
and Wuhan are among the worst (both exceeding 20 months). Hangzhou,
Changsha, Qingdao and Xiamen are similarly worrying with relatively high
levels. Inventory peaked in 1Q12 in these cities and gradually improved as
sales picked up throughout the summer, but the recent increase in supply has
pushed it back to 9-13 months. In Changsha and Qingdao, inventory is at
record highs. Only Suzhou and Nanjing have seen marginal improvements.
Figure 34
Figure 35
Figure 36
Tier-2 GFA inventory
Tianjin GFA inventory¹
Wuhan GFA inventory
Figure 37
Figure 38
Figure 39
Hangzhou GFA inventory²
Changsha GFA inventory
Qingdao GFA inventory
¹ Tianjin started to report available-for-sale figures in November 2011. Inventory months are calculated as 3MMA available for sale divided by 3MMA sales. ² Hangzhou statistics exclude social housing. Inventory months are calculated as 3MMA available for sale divided by 3MMA sales. Source: CREIS, CLSA Asia-Pacific Markets
Note: Inventory months are calculated as 3MMA available for sale divided by 3MMA sales. Source: CREIS, CLSA Asia-Pacific Markets
Tier-3 cities: A mixed picture
Eight tier-3 cities we analysed show improvements in inventory levels, but it
is a mixed picture overall. Inventory relative to latest monthly sales have
improved and inventory months have fallen to 10 months. However, the
absolute square-metre space available for sale has not changed throughout
the year. Destocking in Fuzhou (Xiamen) and Huizhou (Guangdong) has been
successful. Inventory levels have rebounded in Dongguan (Guangdong), Jinan
(Shandong) and Nantong (Jiangsu).
Figure 43
Figure 44
Figure 45
Tier-3 GFA inventory¹
Fuzhou GFA inventory
Nanchang GFA inventory
Figure 46
Figure 47
Figure 48
Nantong GFA inventory
Yangzhou GFA inventory
Huizhou GFA inventory
Figure 49
Figure 50
Figure 51
Dandong GFA inventory
Dongguan unit inventory¹
Jinan unit inventory¹
¹ Dongguan and Jinan only report inventory in terms of number of units and were excluded from our calculation for tier-3 aggregate. Inventory months are calculated as 3MMA available for sale divided by 3MMA sales. Source: CREIS, CLSA Asia-Pacific Markets
Closet reformers Our 10 May 2012 Closet reformers report outlined the key reforms that China needs to take to maintain high growth. The highest priority for the country’s new leaders is economic restructuring by boosting consumption and reducing investment. The path is quite clear and Vice Premier Li Keqiang endorsed the World Bank’s China 2030 report on reforms, which
reportedly was led by the Development Research Centre (DRC), China’s top thinktank. The difficult part is whether the incoming leaders can generate enough consensus to tackle entrenched interests such as the large SOEs or local governments’ monopoly on land. We highlight three of the most needed reforms: financial, SOE and land. If China fails to change, it will be stuck in the middle-income trap like many conuntries.
Financial reform: China’s financial system remains repressed, unbalanced, costly to maintain and potentially unstable. The banking system will not become commercialised with protected margins. The incentives that created the protected margin will continue to encourage creation of NPLs. Some SOEs are financially weak and unlikely to survive without cheap credit or government support. Interest-rate reform would push SOEs to accelerate restructuring. There are many opponents of interest-rate reform. The group that will benefit from such reform the most, the average citizens, are not part of the decision process, while the large SOEs and banks, which favour the status quo, have powerful political influence.
SOE reform: China’s SOEs have been growing in dominance. The media has dubbed the trend as guojin mintui (the advance of the state and the retreat of private enterprises). The number of SOEs has gotten smaller, but the remaining ones are larger and stronger. SOEs make up about 5% of total industrial enterprises but control about 42% of industrial assets. The State-owned Assets Supervision and Administration Commission (Sasac) protects state-owned assets and has a long list of strategic or pillar industries. The
biggest priority in SOE reform has been the railway sector, which is still a monopoly and has gone through a corruption scandal this year. The other priority is to reduce government subsidies and increase pricing efficiency to better address the country’s energy needs in the oil & gas and electricity industries.
Land reform: Land reform is critical in narrowing the wealth gap and promoting social stability. Disputes over land rights and proper compensation for land transfer have been key sources of social protests. Rising land prices also push up home prices, further widening the wealth gap. China’s Gini-coefficient, a measure of income equality, is at 0.46, above the 0.40 warning level. Land reform is critical to ensure food supply, given scarce arable land, and equitable land revenue for local governments. It could also be the key to China’s shortage of labour as 35% of workforce is still in agriculture.
Only 13 countries avoided the middle-income trap
Source: World Bank, CLSA Asia-Pacific Markets
Labour force as % of population Less saving, slower investment
Source: UN Population Division, CLSA Asia-Pacific Markets Source: CEIC, DRC, CLSA Asia-Pacific Markets
Sector outlook and stock ideas China’s economy continues to slow, but we expect the pace to be more gradual
next year, with greater growth risk in 2H13 than 1H13. As our consumer survey
shows, the bright spot of the economy is the consumer and the slowing part is
investment. We are Overweight consumer-driven sectors such as consumer
discretionary, healthcare, internet, property and telcos. We also like those that
benefit from policy changes, such as oil & gas. We are generally Underweight
investment-driven sectors like machinery, resources, steel and banks that are
likely to lend more to LGFVs..
We also list the corporate-governance (CG) scores of our stock ideas. Our top
ideas generally have above-average scores and top SELL ideas usually have
below-average rankings. Our Tremors and cracks CG Watch 2012 report
provide CG and environment, social and governance (ESG) ratings on 865
stocks across the region. Five out of 10 of our top long ideas received above-
average CG scores, while eight out of our top 10 SELLs have below-average
scores. Of the 200 China/HK companies our analysts scored, the average for
China was 48.6, while for Hong Kong the average was 55.9.
Top 2013 ideas
We select 10 stocks that are mainly consumer- or service-oriented companies.
Our top SELL ideas are mainly from sectors with overcapacity, eg, materials
and autos, where we continue to expect subpar growth. Our top stock ideas
and SELLs are ranked based on their ROIC, Ebit/EV and Ebit growth.
Figure 103
Our 2013 China/HK top ideas
Company Code Sector Rec Comments
Cogo 81 HK Property BUY Associate of Coli with low gearing, targeting smaller and more profitable cities that has been overlooked by larger developers.
Tencent 700 HK Internet BUY Resilient earnings with strong game lineup. Upcoming Call of Duty could be a big hit. Ecommerce could surprise.
Sino Biopharm 1177 HK Healthcare BUY¹ Leader in drugs for hepatitis and cardio-cerebral medicine. Strong track record, growing at 33% in the past three years.
China Mobile 941 HK Telecoms O-PF China Mobile will start rolling out 4Q network in 2013 ahead of its competitors and will expand its lead.
Belle Intl 1880 HK Consumer BUY Quality brand owner with strong distribution. Revenue momentum should improve as retailers will do less discounting in 2013.
CR Power 836 HK Power BUY Coal price will likely stay low in a slowing economy. This will provide lower input cost and expand earnings.
Sinopec 386 HK Petro/chems BUY Expect oil price to soften and the government to approve petrol-price mechanism, which should turn its downstream business profitable.
Melco Crown MPEL US Hotels & leisure BUY Highest growth among Macau plays with strong exposure to premium mass market and new casino in the Philippines.
Bank of China 3988 HK Financial services BUY Low valuation, high dividend of 6.0% and more resilient margins than peers as a larger portion of deposits are at market rate.
Haitong 6837 HK Financial services BUY A-share market is near a bottom and will continue to get government support. Growth will expand with new financial products.
Autos - Discounts moving cars The Chinese auto sector is experiencing another slow year after only 2.45% YoY growth in 2011. YTD shipment data in October indicated 3.6% YoY growth compared to the same period last year, however this was helped by discounting at dealers and heavy promotions by automakers. Passenger car sales are up about 6% YoY. We also believe sales are much lower than the car shipment numbers as dealers are all reporting higher levels of stock and even the carmakers are building inventory.
Positive catalysts The government announced a Rmb6bn subsidy plan in May 2012, but so far there is no evidence of policy to support this. There is a chance the government will issue policies to help promote small-engine auto sales as they have done in the past.
Negative catalysts From our conversations with government officials, the new administration is not likely to stimulate the economy anytime soon. More cities could start to control license registration. Middle-class consumers may become more price sensitive due to a slowing economy.
Factors that could change our view Our view in 2013 is that the auto market will continue to grow slowly unless: A loosening property market boosts private vehicle consumption as there is a high correlation (over 60%) between car shipments and home sales. The government announces or implements a new auto-stimulus plan.
Auto sector valuation We rate Dongfeng Motor an Underperform as the previous government incentives did not come through, so we expect ASP to fall in 12CL and 13CL with slower growth. Trading at 12.1x 12CL and 9.8x 13CL PE, we have a SELL on Guangzhou Automobile Group (GAC) as we expect ASP deterioration due to tough mid- to high-end segment competition. BYD is trading at 15.06x 13F PE and 1.05x PB consensus. We have a SELL on the stock.
Passenger vehicle ASPs have declined in 2012 and we expect this to continue
Passenger-vehicle ASP declines all across the board According to the China Association of Automobile Manufacturers (CAAM), YoY passenger car shipments maintained double-digit growth on average from February 2012 to August 2012. However, we noticed that retail demand growth was zero or even negative growth when we did our channel checks.
We believe automakers were pushing more cars to the dealerships during 1Q-2Q12 as dealers heard there could be a stimulus package from the central government. The news report government officials saying inventory is about 2.5 months on average across passenger dealers whereas in the past three to four weeks inventory was normal. The auto dealers, on the other hand, had to offer bigger discounts to maintain cashflow.
Long-term passenger-car ASP also saw a decline as the Chinese auto market matures with each segment becoming more competitive and automakers will have to cut ASP in order to compete.
Long-term passenger vehicle ASP decline since 2007
Source: NDRC
The automakers, on the other hand, offered larger wholesale promotions in order to help dealerships manage their increasing inventory. This was shown during 1H12 interim reports as almost all automakers reported an increase in selling costs as a share of revenue. This is especially apparent for the mid- to high-end segment.
Selling cost as % of revenue rose in 1H12 due to increasing promotions
(Rmbm) 1H12 selling cost As % of revenue Increase (%)
ASP impacts earnings more than sales volume ASP cuts impact earnings more than a cut in sales volume. If we take a look at Dongfeng Motor’s sensitivity assumptions for 12CL and 13CL, ASP of +1% impacts earnings by 9.64% in 12CL and 9.18% in 13CL. However, a 1% rise in sales volume impacts earnings by 4.24% in 12CL and 2.32% in 13CL. This is why automakers can only reduce ASP to a certain degree and then they need to start to cut production.
+1% ASP impacts earnings more than +1% sales volume
Sensitivity (%) 12CL 13CL
Sales volume +1% 4.24 2.32
ASP +1% 9.64 9.18
Source: CLSA Asia-Pacific Markets
Consumer behaviour changes The reason for the ASP decline across the board is that consumer behaviour changes along with the economy as cars are still a discretionary purchase. Buyers usually spend six to 12 months to research buying a car and can easily put off a purchase as alternate forms of transport are cheap and plentiful. We want to highlight that in China, we still have an artificial economy cool down unlike anywhere else in the world. In a cooling economy, the mid- to high-end consumers (buying autos around Rmb150-250k) who used to be much less price-sensitive now become more so as they do not expect any salary or bonus increases for 2013. Price becomes the most important driver to move cars.
Japanese automakers mostly impacted The mid- to high-end segment slowdown started at end of 2011 as demand continued to slow with no signs of a recovering economy. The Japanese brands were already losing share before the disputed island problem as their cars are not as competitive compared with five years ago. The most popular brands still rely on old technology like the 2.0L and 2.4L engines on the Honda Accord, while competitors from VW now have 1.6T engines along with dual-clutch transmission. There are two clutches in the powertrain. When one of the clutches is in the gear, the next clutch will be preparing for the next gear, which then shifts smoother and faster than a normal driver can with a manual transmission. The result is to preserve more power from the engine and not lose it during the transition of power from the engine to the wheels. This way, the engine can be smaller yet push out power similar to a bigger non dual-clutch engine. This means the car is more fuel-efficient
This is the first time we saw Japanese automakers became ASP leaders dropping prices faster than their competitors in China (in the past they were the last to cut prices). The disputed island issue simply sped up the process of ASP deterioration which in turn will lead to ASP dropping across the board. The rest of the market is reacting to the Japanese ASP cuts with the Germans, Americans and Koreans likely having to cut prices further in order to compete.
Disputed island issue is short-lived Why we think the issue will be short-lived is because this is common from time to time in China. Japan certainly has the historical relationship to WWII but even the USA has had a similar problem when they bombed the Chinese embassy in Belgrade. But the effects at the time did not last despite the protests. Chinese consumers may show a lot of passion but they don’t have conviction. Practical values still influence the consumer the most.
Auto buyers tend to be biased towards German cars as VW is the oldest and best known brand in China while the Japanese are relative latecomers. The brands are still in the early stages of development but consumers still buy Japanese cars. Remember that the majority of buyers are first-time buyers, around 70% - their process of buying a car is far different than in the West. Since they are first-time buyers, they can delay their purchase.
We find it takes about six to 12 months normally before a consumer finally makes the purchase. The most important part of the process is checking with friends, family and the internet. So, the process tends to be very planned and decisive. We believe some consumers will change their buying decision where they are worried about their car being damaged, but in general people are more worried about their personal safety during protests by mobs. At least their cars are insured and carmakers have promised to provide service.
We recently met with a Hyundai dealer and he told us that while there were many visitors to the dealer from those previously planning to buy a Japanese car, not many did purchase in the end but instead delayed their purchase.
Policy will determine growth in 2013, but so far we expect none Auto-sector growth in China depends very much on government policies as the passenger-vehicle segment depends on consumer-spending sentiment and increasing wealth. The commercial-vehicle segment, on the other hand, depends on fixed-asset investment. All these factors are influenced by what the government decides to do with the economy.
The government made an announcement in May 2012 that it will spend Rmb6bn to help grow fuel-efficient automobiles with engines of 1.6L and smaller. However, we have yet to see any solid policies after the announcement which is why we went back to our previous assumptions that 2013 auto shipment growth will remain slow.
From our recent conversations with government officials, we learned that there is likely little chance for the government to release any stimulus plan in early 2013.
Because the economy is not likely going to improve, we believe auto sales at the retail level will be muted in 2013. We expect shipments to increase 3% YoY in 2013 with passenger-car sales growing at 3% YoY while commercial-vehicle sales see no growth. This assumption is also based on a continuing drop in ASP in 13CL as consumers only buy because the price is attractive. But at some point we should see some of the more rational carmakers cut back on production, although most are looking to China for growth.
SUVs may continue to outperform in 13CL We believe the SUV segment will likely continue to outperform the passenger-car segment in 2013. However, we think the SUV’s ASP will finally start dropping as more players enter the market.
We expect SUV sales to grow 23% in 12CL and 17% in 13CL
Source: CAAM, CLSA Asia-Pacific Markets
Auto sector valuations The sector is trading at 10.83x 2012 and 9.3x 2013 consensus PE, and 2.14x 2012 and 1.78x 2013 consensus PB excluding BYD, and 7.14x and 6.18x EV/Ebitda in 2012 and 2013 excluding GAC and Brilliance.
Consensus EV/Ebitda in 2012 and 2013
EV/Ebitda 2012 2013
DFM 2.89 2.59
Great Wall 8.63 7.55
BYD 10.16 8.61
Brilliance 50.89 42.31
GAC 50.49 29.67
Geely 6.90 5.98
Average 21.66 16.12
Average without GAC and Brilliance 7.14 6.18 Source: Bloomberg
Dongfeng - U-PF Dongfeng is trading at 9.4x12CL and 10.1x 13CL PE. The company is trading at 5.93x 2013 consensus PE and 1.11x PB. We rate Dongfeng We are SELLers as we expect more ASP deterioration in 2013 as Japanese automobiles lack features and technology compared to their high-end competitors.
GAC - SELL GAC is trading at 15.7x 12CL and 12.7x 13CL PE. The company is trading at 5.99x 2013 consensus PE and 0.87x PB. We have a SELL on GAC as we expect ASP deterioration due to tough mid- to high-end segment competition.
BYD - SELL BYD is trading 21.5x 2013 consensus PE and 1.5x PB. We have a SELL call.
Banks - Growth to lag amid recovery We prefer brokers to banks in 2013. While loan growth should be stable at 12-14% YoY with the pickup in infrastructure loans in 2013, the combination of NIM contraction and subdued fee-income growth might point to flat revenue for banks. There will be a tactical opportunity to chase high-beta small banks if the signs of export recovery persist. Bocom is our preferred name on this theme. We continue to prefer large banks for their defensiveness. BUY BOC for value and ABC for growth.
In-line performance in 2013 China banks have outperformed the MSCI China since mid-September. In 2013, we expect bank share prices to perform in line with the market. The banks’ revenue and profit growth should lag in an economic recovery. We see more opportunity in brokers than banks. On the economic-recovery theme, we advise investors to go for higher beta broker stocks. We remain BUYers of Haitong Securities.
Flattish revenue growth We expect loan growth at 12-14% YoY in 2013 with the pickup in LGFV loans in 2013. Assuming neutral CAR and 12-14% sustainable asset growth, a 10% fall in NIM (about 25bps) should bring zero growth to net interest income. On fee income, big banks should see a modest recovery in 2013 from the low 2012 base.
Stable asset quality Asset quality should remain stable in 2013, driven by the economic recovery. Our economics team forecast a 5% rise in China’s exports with sequential MoM growth (seasonally adjusted) every month in 2013. There will be a tactical opportunity to chase high-beta small banks if the export recovery persists. Bocom is a solid candidate with capital strength.
Prefer large banks to small ones On fundamentals small banks are likely to be subject to more margin pressure in 2013. Also, weak capital positions are negative for volume growth. We continue to prefer big banks to small ones for better capital protection. On stock picks: BUY BOC for value and ABC for growth. SELL CMB and Minsheng on volume and margin contraction, as well as fundraising overhangs.
CN banking stocks performance versus MSCI China
Source: CLSA Asia-Pacific Markets
90
95
100
105
110
115
120
19 Oct 12 22 Oct 12 25 Oct 12 28 Oct 12 31 Oct 12 3 Nov 12 6 Nov 12 9 Nov 12
CN banks MSCI China
Kevin Chan Head of HK/China Fin Res [email protected] (852) 260086277
Chen Huang (852) 26008591
Helen Keung (852) 26008131
Top ideas Haitong 6837 HK Rec BUY Market cap US$13.19bn Target HK$12.50 Up/downside +23% BOC 3988 HK Rec BUY Market cap US$121.51bn Target HK$3.92 Up/downside +21% ABC 1288 HK Rec O-PF Market cap US$135.27bn Target HK$3.51 Up/downside +4% Stocks to avoid CMB 3968 HK Rec SELL Market cap US$35.76bn Target HK$13.05 Up/downside -11% Minsheng 1988 HK Rec SELL Market cap US$27.67bn Target HK$6.07 Up/downside -19%
Growth to lag amid recovery In our 3Q preview: not so pretty China banks note published on 18 October 2012 we advised investors to trim some positions ahead of the 3Q12 results. China banking stocks have performed in line with the MSCI China over the past month. In 2013, we believe China banks’ share prices will perform in line with market as revenue and profit growth should lag amid an economic recovery. We see a better opportunity in (high-beta) brokers than banks, given the structural expansion story and supportive policy initiatives into 2013. On the economic recovery theme, we advise investors to go for higher beta broker stocks within the China financial space.
China banks stocks performance versus MSCI China
(%) CN banks MSCI China CN banks outperformance
Since mid-Jul 19.9 13.7 6.2
Since mid-Aug 9.6 9.0 0.6
Since mid-Sep 13.9 7.5 6.4
Since mid-Oct 4.0 4.0 0.0
Note: Data as of 29 November 2012. Source: CLSA Asia-Pacific Markets
Flattish revenue growth We expect loan growth of 12-14% YoY in 2013, with the pickup in infrastructure loans in 2013. Sector ROE is likely to be about 20% in 2012. So, with a dividend payout ratio of about 30%, internal capital generation via retained earnings should be about 14%. Assuming neutral CAR, the implied asset growth should be about 12-14%. With the implementation of Basel 3 from January 2013, regulators might monitor capital ratios particularly more closely next year. Therefore, should NIM fall by 10% (about 25bps) in 2013, net interest income (NII) and revenue growth is likely to slow to about mid-single-digit pace. About 85% of H-share banks’ revenue is NII. On fee income, we expect the big banks to have a modest recovery in 2013 from a low base in 2012. In sum, the overall revenue growth is too slow.
CN banks: NIM squeeze in 13CL
Source: CLSA Asia-Pacific Markets
(25)
(16)(15)
(14)
(11) (11) (11)
(8)
(30)
(25)
(20)
(15)
(10)
(5)
0
Minsheng Bocom ICBC ABC CMB BOCGroup
CNCB CCB(bps)
If NIM is to fall by 10%, NII will be flat
In 2013, China banks’ should perform in line with market
Stable asset quality Asset quality should remain stable in 2013, with the recovery in exports and Beijing’s re-endorsement on infrastructure loans, though the market might cast doubts over the return of LGFV loans.
Our economics team forecast 5% growth in China exports with sequential MoM growth (seasonally adjusted) every month in 2013. There will be tactical opportunity in 2013 to chase high-beta small banks, given that: the export recovery should persist; and asset-quality concerns on SME loans may peak. That said, the NPL risks on small banks should be less severe. We believe that Bocom is a solid candidate to play this theme among small banks. Bocom does not have fundraising needs. Following the US$8.9bn A+H share private placing in June 2012, Bocom is the best capitalised banks in the sector, whereas CMB and Minsheng will almost certainly tap into equity markets for funds.
Prefer large banks to small ones Valuations stay low for China banks at 1.0x/5.9x 12-month forward PB/PE. This leads to the question of whether there will be a reduction in payout ratios. Such risk should be higher for small banks as they have higher fundraising concerns. On fundamentals, small banks are subject to more margin and volume pressure in 2013. We continue to prefer big banks over small banks for defensiveness. On stock picks, BUY BOC for value and ABC for growth. SELL CMB and Minsheng on volume and margin contraction, as well as fundraising overhang.
CN banks: Dividend payout 13CL
Source: CLSA Asia-Pacific Markets
CN banking sector: 12-month forward PB
Note: Data as of 29 November 2012. Source: CLSA Asia-Pacific Markets
BOC (BUY): Buying value. BOC is the top-value BUY with the sector’s highest dividend at 6.0% 13CL dividend yield. As mentioned in our recent printed report, Apples to Apples: ‘BOC vs ICBC’, BOC is trading at 0.75x 13CL PB, excluding BOC (HK), which we see as too low. BOC’s overall NIM has been the lowest of the Big 4. However, the gap is narrowing as a consequence of management’s pledge to reduce high-cost domestic deposits. Furthermore, as a larger portion of BOC’s deposits have market-based rates, it should do relatively better than its Big-4 peers, as interest rates deregulate. Since
2Q12, BOC’s management has begun to address the issue of high domestic renminbi funding costs more proactively and has pledged to exit expensive deposits. BOC turned in better NIM performance in 3Q12, suggesting initial success in this area. Furthermore, BOC is cautious on NPLs and has adequate capital required in terms of CAR. The stock is trading at 0.8x/5.3x 13CL PB/PE, and a solid 6.0% dividend yield. Maintain BUY.
CN Big-4 banks: NIM
Source: Companies, CLSA Asia-Pacific Markets
ABC (O-PF): Better growth among Big 4. ABC has the best growth profile among the Big 4, at 7%/14% net-profit growth in 13/14CL. Moreover, it is still the most prudent Big-4 bank in terms of LLR/loan provisioning. We rate ABC an Outperform.
CMB (SELL): Unjustified premium. The bank’s capital position has been week with the Tier-1 CAR of 8.47%, the second-lowest among H-share banks. The Rmb30bn A+H rights issue is long-overdue and will remain an overhang. Further disruption to that should constrain CMB’s dividend payout and loan growth in 2013. As the most expensive bank under our coverage, the premium is unjustified and we rate the stock a conviction SELL.
Minsheng (SELL): Red light on capital adequacy. Minsheng’s pursuit of deposits from micro and small enterprises (MSE) has been impressive. As we expect China exports to improve in 2013, the asset quality of private sector lending might not be as severe. However, the sector’s lowest Tier-1 CAR highlights the capital needs urgency and high capital consumption of private-sector lending. We remain SELLers of the stock.
Haitong (BUY): Capture the secular growth in China brokers. Boasting China’s fourth-largest brokerage network and second-largest net capital as of end-2011, Haitong’s key equity story lies in its brokerage business and balance-sheet strength. China’s ongoing capital-market reform should provide the best secular growth opportunity for mainland brokers. Growth areas should be bond-market developments, new equity-derivative products and services. With ROA of 3-4% and ROE of 7-8%, Haitong’s leverage is low at about 2x and we expect the company to lift it gradually and improve its ROE profile in the next three to five years. Trading at 1.2x 13CL PB and 17x PE, Haitong is a BUY. Our SOTP target price is HK$12.5, and we advise investors to add holding for its undergeared balance sheet supported by continuous policy initiatives.
Conglomerates - Outlook for giants Cheung Kong remains strategically well positioned and improving underlying operations should drive recurrent profit growth for associate Hutchison Whampoa. Exposure to Asean remains a catalyst for Jardine Matheson. We prefer Swire Properties over Swire Pacific where aviation is a drag. We remain cautious on China as weak governance is commanding a discount. Beijing Enterprises has a good management and strategy, but guidance remains ambitious and leaves the shares fully valued.
Hong Kong conglomerates have held up well Good corporate governance, strong management teams and risk-off sentiment has caused Hong Kong conglomerates to perform well in 2012. The regional conglomerate discount has contracted to 29% against a long-term average of 25%. Share-price performance next year will be more dependent on NAV growth that is expected to range between 7-12%.
Hutchison and Cheung Kong remain top picks We see 21% upside to Hutchison as consensus earnings remain low and the group continues to improve underlying operations which will drive recurrent profit growth. We see the telecom operations as cashflow and operating profit neutral and expect strong growth out of the Asian retail operations from new store openings. Despite policy tightening measures in Hong Kong, Cheung Kong’s robust balance sheet and sound strategy leave them best positioned to weather a softer market
Pair trades still working Exposure to Asean continues to be a tailwind for Jardine Matheson, which has 16% upside to our target. We continue to favour Matheson over Strategic where yield and liquidity are higher and where the controlling shareholders are invested. Given the rally in Swire Properties, we are less bullish on this stock. However, we remain even more cautious on the cyclical parent Swire Pacific as high oil prices will continue to weigh on Cathay Pacific’s profitability.
Beijing Enterprises fully valued China conglomerates as a whole have fallen out of favour as investors place a premium on corporate governance, transparency and quality management. Beijing Enterprises has good assets and a prudent strategy, but its ambitious guidance in the gas, water and beer business will not be met and the share price is fully valued.
Regional NAV premium/discount
Source: CLSA Asia-Pacific Markets
0
100
200
300
400
500
600
700
800
(60)
(40)
(20)
0
20
40
60
80
Mar 94 May 97 Jun 00 Jul 03 Aug 06 Sep 09 Oct 12
Regional NAV premium/discountMSCI Asia ex-Japan (RHS)
(%)
+1sd
-1sd
Mean discount = 25% Prevailing = 29%
(US$)
Top ideas Hutchison 13 HK Rec BUY Market cap US$43.44bn Target HK$93.00 Up/downside +17% Cheung Kong 1 HK Rec O-PF Market cap US$35.06bn Target HK$131.00 Up/downside +11% Jardine Matheson JM SP Rec O-PF Market cap US$8.13bn Target HK$31.4 Up/downside +11% Stocks to avoid Swire Pacific 19 HK Rec U-PF Market cap US$18.04bn Target HK$97.00 Up/downside +2% Beijing Ent 392 HK Rec U-PF Market cap US$7.41bn Target HK$53.00 Up/downside +4%
Danie Schutte, CFA Head of HK/China Research [email protected] (852) 26008573
Consumer China - Cherry picking in 2013 We prefer consumer discretionary plays to staple names in 2013, given attractive valuations, the market’s low earnings expectations and the improved macro outlook. Belle and Golden Eagle are our top picks in China consumer discretionary sector while Want Want is our preferred name in the staples space.
Preference for discretionary plays in 2012 Consumer staples’ forward PE premium to the discretionary sector remains high at 30%, despite a drop from its peak of 49% at the end of July. We expect improved average selling prices (ASP) to contribute to a same-store-sales (SSS) recovery for China’s consumer discretionary plays in 2013. In 1H13, we favour discretionary names with sound business models, quality management and good execution track records, which may feature low beta.
Why we like discretionary names With an improving macro outlook throughout 2013, investors may add beta stocks through discretionary plays in 2H13. Soaring SG&As in the staple space from promotions amid intense competition are likely to offset gross-margin expansion arising from input-cost corrections. Rich valuations and high earnings expectations heighten the importance of a selective approach to consumer staples in 2013.
Impact of e-commerce B2C online retail sales posted a 92% Cagr in 2006-11, from US$953m to US$25bn. Emerging e-commerce has a different degree of impact on retailers, with various business models, market positioning and product offerings. Belle and Golden Eagle are most resilient to e-commerce, while NWDS, Lilang, Sun Art and Gome are vulnerable to rising online shopping trends.
Prefer direct retailers With direct retailers set to benefit from macro improvement in 2013, we prefer them to wholesalers. We do not expect normalised channel inventories in sportswear industry until 2H13. Despite our cautious view on sportswear, we prefer Anta to other plays. In consumer staples we like multiproduct market leaders with established retail channels in categories with less competition from multinationals.
Staples trading at 30% premium¹ to discretionary
¹ Based on 12-month forward PE. Source: CLSA Asia-Pacific Markets
60
80
100
120
140
160
180
200
Sep 04 Feb 06 Jun 07 Oct 08 Feb 10 Jul 11 Nov 12
avg 109%
-1sd 85%
+1sd 133%
130%
(%)
Xiaopo Wei, CFA Head of China Consumer [email protected] (852) 26008639
Dawei Feng, CFA (852) 26008172
Zibo Chen, CFA (852) 26008705
William Tang (852) 26008215
Top ideas Belle 1800 HK Rec BUY Market cap US$17.1bn Target HK$19.89 Up/downside +24% Golden Eagle 3308 HK Rec BUY Market cap US$4.6bn Target HK$23.21 Up/downside +25% Want Want 151 HK Rec BUY Market cap US$19.3bn Target HK$13.52 Up/downside +20% Stock to avoid Sun Art 6808 HK Rec SELL Market cap US$13.9bn Target HK$10.07 Up/downside -14%
China’s consumer discretionary segment has underperformed staples in 2012 as investors remained defensive amid the backdrop of a macro slowdown and the top-down risk-off trade.
Preference for discretionary plays in 2013 Our preferred stock in China’s staples sector is food and beverages maker Want Want, which is among the top outperformers this year. Our top picks in China’s discretionary sector are Belle and Golden Eagle, which have also done well compared with peers.
Stock perf vs MSCI China - consumer discretionary, YTD Stock perf vs MSCI China - consumer staples, YTD
Source: Bloomberg, CLSA Asia-Pacific Markets
Why we like discretionary names China consumer staples’ valuation premium on a 12-month forward PE basis over the discretionary sector remains high at 30%, despite a drop from its peak of 49% at end-July 2012.
Staples trading at 30% premium¹ to discretionary
¹ Based on 12-month forward PE; Source: Datastream, CLSA Asia-Pacific Markets
(56)
(40)
(38)
(38)
(36)
(35)
(4)
5
11
13
14
15
20
(60) (50) (40) (30) (20) (10) 0 10 20
Gome
Anta
Lilang
Parkson
Dongxiang
Li Ning
Trinity
NWDS
MSCI China
Intime
Golden Eagle
Daphne
Belle
(%)(52)
(5)
(2)
0
6
7
11
21
22
32
48
115
(100) (50) 0 50 100 150
Yurun
Tingyi
Hengan
Tsingtao
CRE
Vinda
MSCI China
Mengniu
Sun Art
China Foods
Want Want
UPC
(%)
60
80
100
120
140
160
180
200
Sep 04 Feb 06 Jun 07 Oct 08 Feb 10 Jul 11 Nov 12
avg 109%
-1sd 85%
+1sd 133%
130%
(%)
Staples valuation premium over
discretionary segment remains high at 30%
Prefer consumer discretionary plays to staple names in 2013
We prefer consumer-discretionary plays to staple names in 2013, given attractive valuations, the market’s low earnings expectations and improved macro outlook. Despite eased input costs, we expect competition to intensify in 2013, resulting in more promotional activities. Soaring SG&As are likely to offset most benefits of gross-margin expansion, arising from input-cost corrections. Rich valuations and high earnings expectations have made us more selective in the consumer space in 2013.
We like discretionary names with sound business models in 1H13, quality management and good execution track records, which may feature low betas. With a gradually improving macro outlook throughout 2013, investors may consider adding more beta by investing in discretionary plays in 2H13.
We expect improved ASPs to contribute to a same-store-sales (SSS) recovery of China’s consumer discretionary plays in 2013, given the following factors:
After about one year of destocking, China brands’ channel-inventory pressure is much eased and less promotional activities are expected
To avoid repetition of channel-inventory issues, many retailers have enhanced inventory management and supply-chain management with reduced inventory markdowns in future
Throughout a tough 2012, dominators in different segments have consolidated the market, phasing-out small players; market leaders should regain more pricing power to lift ASPs
Together with a favourable calendar shift of Chinese New Year in 2013 and improved consumer sentiments (which our China Reality Research team recently observed in its consumer-monthly survey, we expect accelerated SSS growth for discretionary plays in 4Q12-1Q13 compared with 3Q12
Outlook for family income over next 6M will: Outlook for family spending power over next 6M will:
Source: CRR, CLSA Asia-Pacific Markets
We anticipate SSS acceleration underpinned by resumed ASP increase to lead to rerating of consumer-discretionary plays in 2013. Belle and Golden Eagle are our top picks in China consumer-discretionary sector.
55 54 52 48 46 43 45 44 44 4351
39 40 40 47 49 53 52 52 53 5346
7 6 8 5 6 4 4 4 3 4 4
0102030405060708090
100
Dec
11
Jan
12
Feb
12
Mar
12
Apr
12
May
12
Jun
12
Jul 1
2
Aug
12
Sep
12
Oct
12
Rise Same Fall(%)
44 41 35 33 32 30 32 32 30 2834
34 3740 43 43 47 45 44 48
4542
22 22 25 24 25 23 23 25 23 28 24
0102030405060708090
100
Dec
11
Jan
12
Feb
12
Mar
12
Apr
12
May
12
Jun
12
Jul 1
2
Aug
12
Sep
12
Oct
12
Increase Stay the same Decrease(%)
Recommend low- beta discretionary
names in 1H13
Improved ASPs to positively contribute
to SSS recovery discretionary plays
Top-line growth acceleration to lead to
rerating of discretionary
Selective in consumer due to rich valuation and high
Note: SSS growth for NWDS is converted in Rmb; CRE SSS growth only relates to its China supermarket division; Evergreen SSS growth only relates to self-operated stores in mainland China; Trinity SSS growth only relates to its stores in mainland China and Trinity figures were adjusted for exchange rate as reported SSS growth is in HK$ term; Source: Company data, CLSA Asia-Pacific Markets
Impact of e-commerce B2C online retail sales in China have posted a 92% 2006-11 Cagr from US$953m to US$25bn. However, emerging e-commerce has a different degree of impact on China retailers with various business models, market positioning and product offerings.
In evaluating the impact of e-commerce on bricks-and-mortar Chinese retailers, we have proprietarily developed a comprehensive framework (consisting of five perspectives of product, branding, targeted consumers, retail channels and IT/logistics infrastructure) after our interviews with chief information officers/merchandising managers of brick-and-mortar retailers and executives of e-commerce platforms.
In our view, Belle and Golden Eagle are most resilient to e-commerce impact while NWDS, Lilang, Sun Art and Gome are more vulnerable to rising online shopping trends.
Investment ideas amid e-commerce impact
Code Rec Products Branding Targeted consumers
Retail channels
IT/logistic infrastructure
MOST resilient & LEAST vulnerable to e-commerce impact
Belle 1880 HK BUY Footwear that needs try-out and frequent exchanges
Self-owned brands; a large brand portfolio covering a wide spectrum of consumers
Middle-upper to high end consumers
Nationwide retail networks
Most efficient supply chain; sophisticated IT system with almost 100% coverage; piloting its own e-commerce platform
Golden Eagle
3308 HK BUY High-end footwear & apparels that needs more personal feel
Piloting private label apparel products for years
High operating flexibility with most self-owned store properties
High exposure to low-tier cities
Most successful VIP programme in sector; SAP-based ERP system
LEAST resilient & MOST vulnerable to e-commerce impact
Sun Art 6808 HK SELL 40% sales from nonfood items, most of which are mass-market footwear/apparel & household products
No exposure to supermarket/CVS formats (with higher exposure to food); Mainly selling third-party brands
Price-sensitive consumers
Concentrated on Eastern China
Most openings in new markets with less-established logistic infrastructure
NWDS 825 HK U-PF Mid-end positioned Concessionaire model mostly selling third-party brands
Relatively price-sensitive consumers
Concentrated on three cities (Shanghai, Beijing & Wuhan)
Less sophisticated IT system
Lilang 1234 HK U-PF Mid-end positioned Only one single successful brand
Price-sensitive consumers
Wholesale model, whose pricing discipline is vulnerable to e-commerce
50% of EPR coverage ratio
Gome 493 HK SELL 3C products vulnerable to e-commerce impact, while bulky white goods are more resilient
Increasing sales exposure to OEM/ODM/exclusive sales items to mitigate impact from e-commerce
Relatively price-sensitive consumers
Relatively higher exposure to high-tier cities
Well-established nationwide logistic infrastructure to support its own e-commerce initiatives
Prefer direct retailers Direct retailers (including brands with a direct-retail distribution model and department stores) are set to benefit from macro improvement in 2013 ahead of wholesalers.
Secondly, compared with companies with a whole/franchising distribution model (such as sportswear players), we prefer brands with greater exposure to a direct retail distribution model, given:
Brands’ close monitoring of channel inventory for better supply-chain management
Brands’ prompt learning of consumer preference changes and market feedback on products to reduce product-fashion risk
Stricter implementation of pricing strategy and avoidance of distributors’ pricing discipline breach (especially in e-commerce channels) inherent to a wholesale/franchising business model
Investors’ better visibility on product sell-through (to consumers) and avoid missing channel-inventory issues
Lastly, those direct retailers operating a portfolio of brands (including Chinese department stores, which are managers of product mix at stores) are likely to resume the trade-up of sales mix to lift blended ASP. On this front, we like Belle and Golden Eagle.
Still cautious on China sportswear sector We do not expect normalised channel inventories in the sportswear segment until 2H13. Sportswear brands are cutting back sell-in (ie, brand wholesale to distributors) or buying back inventories to solve channel inventory issues this year. Investors may have two misconceptions about channel destocking.
Wrong perception 1: ‘The brand with the deepest wholesale decline in 2012 will sort out inventory issues earlier’.
According to our observations, those brands with fewer new products in store (due to sharp wholesale decline in 2012) have gradually lost appeal to consumers and run the risk of damaging brand equity in the long run.
Brands need to continue product R&D and maintain a reasonable level of new product sell-in (ie, sales of new products to distribution channels) to avoid brand erosion, especially in a period filled with industry challenges.
Wrong perception 2: ‘Inventory buybacks is the most effective way of channel destocking’
Returned/repurchased inventories that are not destroyed or exported outside China will continue to impact the market via “new channels” as factory outlets or through e-commerce (at deeper discounts, subsidised by brands) on a delayed basis.
We expect to see a surge of supply in the next one to two quarters, coming from the resale of returned inventories by new channels.
Despite our cautious view on the China sportswear segment, we prefer Anta, given its continuous brand-building efforts, more controlled retail networks and better-managed product sell-in.
Pre-order growth of China sportswear companies (based on retail ASP)
Channel control and expansion of product categories We favour consumer-staple names with well-established retail channels, which could improve distribution efficiency (especially in China’s vast rural areas and low-tier cities) to lower SG&A/sales ratios and mitigate some pressure on operating margins.
With eased input-cost pressure in 2013, we expect small players to come back to the market with heightened competition. The retail networks’ and supply-chain’s efficiency will come under great stress again in 2013. In recent years, quality staple companies have reinforced supply-chain management (including vertical integration) or reformed distribution systems.
Chinese consumers’ preferences and tastes shift quickly, especially in the beverage segment. Successful food & beverage plays need to have sophisticated branding strategies (with a good portfolio of sub-brands) and develop a wide selection of product categories, as well as product depth.
Palm oil
Soybean
Sugar
Source: Wind, CLSA Asia-Pacific Markets
PET resin
Softwood pulp
Malting barley
Source: Datastream, CLSA Asia-Pacific Markets
Source: Bloomberg, CLSA Asia-Pacific Markets
We prefer multiproduct plays with strong market leadership and well-established retail channels, operating in categories with less exposure to competition from deep-pocketed multinationals. We prefer Want Want in the consumer staple space.
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
Jan 07 Dec 08 Nov 10 Nov 12
(RM/t)
2
3
4
5
6
7
Jan 07 Dec 08 Nov 10 Nov 12
(Rmb/kg)
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Jan 07 Dec 08 Nov 10 Nov 12
(Rmb/t)
500
700
900
1,100
1,300
1,500
1,700
1,900
Feb 07 Jan 09 Dec 10 Nov 12
(US$/tonne)
500
600
700
800
900
1,000
1,100
Jan 09 Apr 10 Aug 11 Nov 12
(US$/tonne)
150
200
250
300
350
400
Oct 09 Oct 10 Oct 11 Nov 12
(A$/tonne)
Prefer consumer-staple names with established
retail channels
Retail network and supply chain to face tests in 2013
Consumer HK - Strong brands matter We like consumer names with strong brands, product innovation and robust corporate governance. Focus on retail also leads to wider margins and better brand control. We maintain our positive view on luxury goods demand by emerging markets’ consumers. Prada, Samsonite and L’Occitane remain our top long-term BUYs. We are SELLers of Esprit for its high execution risk and Li & Fung for low earnings visibility. We rate Chow Tai Fook an Underperform for its operating deleverage in the near term, but we see the outlook improving for the clear leader in the attractive Chinese jewellery industry.
Still bullish on long-term luxury goods demand We maintain our positive view on luxury goods demand by emerging markets’ consumers, which is a structural growth story. We like the global luxury goods sector because: revenue growth in 2013 should still be above the long-run average; high operating leverage; high free-cash generation due to falling capex to sales; and market-share gains for top brands.
Three long-term BUYs Prada should continue to take market share. Its high exposure to leather goods and retail channel leads to more resilient earnings. The company also has a diversified revenue mix with 65% of sales coming from emerging-market customers. Sales slowdown is already factored into our estimates, and we see further margin upside. We also like luggage maker Samsonite, which is growing in both mature and developed markets. We see huge potential in its American Tourister brand, Asia, as well as the business and casual segments. We also expect to see more M&As. L’Occitane is one of our preferred consumer-staple names in Asia. We expect the cosmetics company to deliver solid topline growth supported by mid-single-digit same-store-sales. L’Occitane continues to invest in A&P, store networks, its Melvita brand and infrastructure. This should offset near-term operating leverage. We rate the stock an Outperform given recent outperformance.
Three negative ideas Execution risk of Esprit’s transformation plan is very high. We believe that the earnings recovery would still lag the sales recovery by at least two to three years and the apparel company would see very weak cash flows during this period. We believe earnings visibility for supply-chain firm Li & Fung is low given macro uncertainty. We are 29% below management’s 2013 core OP target. Jeweller Chow Tai Fook is under short-term pressure with slower sales growth leading to heavy discounting and operating deleverage. However, we believe the industry leader’s fundamentals remain attractive and its outlook is slowly improving. We rate the stock an Underperform.
Valuations
Company Code Mkt cap (US$m)
Rec Price (lcy)
Target (lcy)
Up/down side (%)
PE (x)
12CL 13CL
Prada 1913 HK 21,248 BUY 63.5 80.2 26 27.5 22.0
Samsonite 1910 HK 2,902 BUY 16.6 20.1 21 17.9 14.9
L'Occitane 973 HK 4,603 O-PF 24.2 27.9 15 25.7 22.1
Chow Tai Fook 1929 HK 13,524 U-PF 10.9 10.8 (1) 19.0 16.0
Esprit 330 HK 3,061 SELL 12.2 9.1 (25) 35.2 55.0
Li & Fung 494 HK 13,373 SELL 12.6 10.6 (16) 16.3 17.4 Source: CLSA Asia-Pacific Markets
Aaron Fischer, CFA Head of Consumer & Gaming Res [email protected] (852) 26008256
Mariana Kou, CFA (852) 26008190
Top ideas Prada 1913 HK Rec BUY Market cap US$21.2bn Target HK$80.20 Up/downside +26% Samsonite 1910 HK Rec BUY Market cap US$2.9bn Target HK$20.10 Up/downside +21% Stocks to avoid Esprit 330 HK Rec SELL Market cap US$3.1bn Target HK$9.10 Up/downside -25% Li & Fung 494 HK Rec SELL Market cap US$13.4bn Target HK$10.60 Up/downside -16%
Strong brands matter Our three long-term BUY ideas Prada, L’Occitane and Samsonite have outperformed the market significantly so far this year. The Hang Seng Index has gained 19% in 2012 YTD. Meanwhile, Prada has jumped 81%, L’Occitane 55% and Samsonite 37%.
Our negative calls have also worked out well with Chow Tai Fook down 22% in 2012 and Li & Fung down 13%. Esprit’s stock price has been very volatile this year amid senior management changes, rights issue and continuous weak sales performance. The stock has been down 71% since we first downgraded it to a Conviction SELL in 2010. We maintain our negative view on the transformation story.
Stock performance YTD
Source: CLSA Asia-Pacific Markets
Economic moats We favour companies with strong economic moats that generate visible, consistent cashflow growth and score well on corporate governance. High-end consumer goods especially luxury goods benefit from strong branding, long heritage and a consistent track record of product innovation. Also, these leading companies get the best access to prime retail locations. This makes it difficult for new brands to be created from scratch especially in categories such as watches, leather goods (handbags and accessories).
In our Dipped in gold - 2012 report, we highlighted four reasons to overweight the global luxury goods sector.
Revenue growth is slowing but still above the long-run average
High operating leverage - positive in light of point one
High free-cash generation due to falling capex to sales
Market-share gains for top brands
Luxury goods sales are dominated by emerging-market customers, who account for about 65% of global sales. We prefer global luxury goods names, which see mainland Chinese generating around one-third of global sales.
(22)
(13)
19
32
37
55
81
(30) (20) (10) 0 10 20 30 40 50 60 70 80 90
Chow Tai Fook
Li & Fung
Hang Seng
Esprit
Samsonite
L'Occitane
Prada
(%)
Our three long-term BUYs significantly outperformed YTD
Developing vs developed markets breakdown of luxury goods market (2012)
Source: CLSA Asia-Pacific Markets
Our global consumer top picks Prada, Samsonite and L’Occitane have a more diversified earnings profile, generating more than two-thirds of sales from non-Chinese consumers. Meanwhile, many of the Hong Kong/China high-end names are 100% dependent on Chinese customers.
High-end stocks’ Chinese exposure
Source: Companies, CLSA Asia-Pacific Markets
Prada (BUY) We believe the company will continue to take market share. Its high exposure to leather goods and retail channel leads to more resilient earnings. The company also has a more diversified revenue mix with 65% of sales coming from emerging-market customers.
Prada’s highly advanced industrial model allows the company to quickly react to evolving customer tastes and enhances inventory control. Emerging-market consumers’ increasing sophistication also benefits Prada, which carries innovative non-logo products. A sales slowdown is already factored into our estimates and we see further margin upside. We are BUYers of Prada to a price target of HK$80.20 based on 25x FY14/01 earnings.
Samsonite (BUY) Samsonite is a leading player in the travel industry with 5% long-term growth. The company is growing in both mature and developed markets. Its lower-priced American Tourister brand helps the company to gain market share in fast-growing emerging markets.
Samsonite also has a solid track record of product innovation, such as the four-point wheel technology and the exclusive Curv material. We also see ample opportunities for Samsonite to grow in the business and casual segments as well as expand its brand portfolio.
With a strong balance sheet, the company may look into acquiring more brands to expand into new product categories. This should be positive given Samsonite’s strong distribution network. Integration of brands should lead to considerable synergies and cost savings. In July-August 2012, it acquired casual brand High Sierra and luxury luggage brand Hartmann. We are BUYers of Samsonite to a HK$20.10 target based on 18x 13CL earnings.
L’Occitane (O-PF) L’Occitane is one of our preferred consumer-staple names in Asia. We expect the French cosmetics firm to deliver solid topline growth supported by mid-single-digit same-store-sales. L’Occitane continues to invest in A&P, store networks, its Melvita brand and infrastructure. This should offset near-term operating leverage.
L’Occitane remains focused on expanding its retail network in emerging markets. The company added a net 48 L’Occitane and nine Melvita stores in 1H, of which about 40% were in BRIC countries. Management reiterates its target of doubling revenue over the next five years, and believes the company is on track to achieve this. We rate the stock an Outperform to a HK$27.90 target price based on 25x FY14CL earnings.
New stores opened in 1HFY13 Sales breakdown by market (2QFY13)
Source: Company, CLSA Asia-Pacific Markets
Esprit (SELL) Management should be stepping up spending on the HK$18.5bn transformation plan in FY13/06. We forecast FY13/06 earnings to be close to zero (we are 95% below consensus). Free cashflow will suffer a similar fate. Sales should start to recover, since the products will eventually improve and the base is getting easier: indeed, SSS in 1QFY13 were an improvement on 4QFY12. However, we strongly believe that execution risk remains high, as the mass-market apparel segment is ultra-competitive.
We believe the earnings recovery will lag the sales recovery by at least two to three years and expect the company to see weak cashflow during this period. Earnings visibility remains low at Esprit. We reiterate our SELL call to a price target of HK$9.10, based on the average of a PE-based valuation and a DCF model.
Li & Fung (SELL) It was slightly disappointing that Li & Fung only announced two acquisitions - US apparel-agent Foreign Resources Corp and Hong Kong sweater manufacturer Brilliant Global - at its analyst day on 15 November. The company recently issued US$500m of perpetual securities, which were earmarked for business development and acquisitions. Management also indicated that the company still has US$150-200m from the March placement.
We believe that Li & Fung is seeing less growth opportunity in its sourcing business given the company’s leading position and already strong relationships with large retailers. We like the long-term growth potential in distribution and Asia, but this will take time. Operating margin for 2H and 2013 should improve as rising input costs and restructuring costs from L&F USA roll off.
We believe earnings visibility is low given macro uncertainty. We are 29% below management’s 2013 core OP target of US$1.5bn. We are SELLers to a price target of HK$10.60, based on 15x 2013 earnings.
Core OP forecast
Source: Company, CLSA Asia-Pacific Markets
Chow Tai Fook (U-PF) We continue to be bullish on the long-term prospects of Greater China’s watch and jewellery market. Chow Tai Fook is the clear leader in the industry with a strong brand, excellent product-development ability and vertical integration with greater control over distribution.
Chow Tai Fook’s 1HFY12 results were weak but in line with our expectations after the company’s profit warning. SSS dropped from 4% growth in 1Q to a 7% loss in 2Q. Operating-profit margin fell by 510bps due to timing of gold-hedging activities and deleveraging. October sales were weak but the outlook is slowly improving with November SSS turning positive.
With conditions in China improving, we believe investors will be buying stocks where medium-term fundamentals are attractive. We rate the stock an Underperform with a price target of HK$10.80, based on 15x FY14CL PE.
Healthcare - Healthy spending Thanks to rising government spending on healthcare, improved medical coverage and ageing population, we expect China’s healthcare revenue to sustain 15-20% growth in the next few years after rising by 25% over 2006-11. We prefer device and chemical segments as both offer higher-than-industry growth. We advise investors to be cautious on active pharmaceutical ingredient (API) and bio. Mindray and Sinobiopharm are our top picks in device and chemical respectively. We also like Yuyue and Yunnan Baiyao among A shares.
Catching up from underinvestment China’s healthcare spending remains low at 5.1% of 2010’s GDP, compared to the world average of 10.4%, Japan’s 9.5% and the USA’s 17.9%. According to government plan, this should grow from Rmb357bn in 2011 to Rmb1tn in 2020, a 10-year Cagr of 12%. Thanks to the “big bang” reform initiated in 2009, China’s medical coverage has increased to 97.5% of rural population.
Higher growth in device and chemical categories Among all healthcare categories, we expect device and chemical to benefit from rising procurement from county hospitals on equipment and drugs. Device and chemical account for 7% and 32% of healthcare revenue and have increased by 37% and 24% over the past three years. In particular, a few blockbuster drugs will see patent protection expired during 2012-15, which should be growth potential for Chinese generics companies.
TCM is top pick, avoid vaccine and API sectors traditional Chinese medicine (TCM) a Rmb340bn sector, growing at about 20% per annum. This is the best sector to own thanks to Chinese’s exclusive patent and potential inclusion in insurance plan. API manufacturers will continue to suffer from sluggish US and European markets. We suggest avoiding the vaccine sector as its oversupply issue further deteriorates.
Top picks Mindray, as a leader in patient monitor and medical imaging system, will continue to monetise the growth potential in emerging markets. Sinobiopharm, as China’s largest hepatitis and cardio-cerebral medicine manufacturers, will benefit as China’s population ages. Yuyue A, as the largest China’s home-device company, will enjoy strong growth due to low penetration and strong demand. Yunnan Baiyao A, as the largest TCM company, will contribute defensive growth thanks to its exclusive recipe.
With rising government spending on healthcare, improving medical coverage and ageing population, we estimate the whole industry revenue in 2012 and 2013 to grow 19% YoY and 20% YoY, respectively. The main drivers include increasing government spending, easier to improving medical coverage and ageing population.
Increasing government spending. In the healthcare 12th Five Year Plan, the government plan to reduce the percentage of out-of-pocket health expenditure to 30%, versus 35% in 2010. Meanwhile, the subsidy Per Capita for rural citizens is expected to raise to Rmb360 per capita in 2015 from 240 per capita in 2012, which implies a 14% Cagr.
Improving medical coverage. Thanks to the investment on county level hospitals and NRCMS (New Rural Cooperative Medical System), which has covered 97.5% of total rural citizens. More people have the money and the place to solve their health problems.
Ageing population. In 5 years there will be 23.4% more people over the age of 65 in China. Healthcare spending of the aged is usually 6-7x to the youth due to higher chronic diseases incidence.
Government leading the way In the 12th five-year plan of Healthcare, the government plan to reduce the percentage of out-of-pocket health expenditure to 30%, versus 35% in 2010. While the subsidy Per Capita for rural citizens is expected to raise to Rmb 360/Per Capita in 2015 from 240/Per Capita in 2012, which implies a 14% Cagr. We expect government spending on healthcare to stay at high growth rate and forecast total health expenditure to be up 13% YoY.
After several quality scandals such as “toxic capsule” due to aggressive policy on reducing drug price, the government is on the way to revise the former policies. In the latest round of price-cut, the average nominal cut range is 17%. However, for most of drugs on the list, the limited retail prices after cut were still higher than the bidding price, which means almost no impacts on their ex-factory price.
We also see mild bidding policy in the recent bidding process in Anhui province, which was the most aggressive province in formal bidding policy. They began to permit “higher price for higher quality and advanced formulation”, instead of “the lowest price to win”.
0
5
10
15
20
25
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
USA UK Germany France Japan China Brazil
(US$) (%)2010 Healthcare spending per capita
Cagr 2005-10 (RHS)
(6) (4) (2) 0 2 4 6
0-45-9
10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-8485-8990-9495-99100+ Men Women
Despite several headwinds such as price-cut and aggressive price bidding system, the demands for healthcare products continues to be strong due to the growth both from increase in number of patients and spending per capita. In 2011, the number of outpatient increased 7.4% YoY while inpatient up 7.9% YoY. Furthermore, both expense per capita of outpatient and inpatient grew 7.7% YoY.
The number of outpatient Spending per capita (outpatient)
The number of inpatient Expense per capita (inpatient)
Source: MoH, FortuneCLSA
Margin recovery due to easing impact from price cut We expect margin pressure to ease in 2013 for healthcare companies after the price cuts and rising material cost to pressure the sector margin in 2011. The sector margin has troughed at 28.9% in 2011 and we expect the sector margin to improve to 30% in 2013.
Overweight device, chemical and TCM We prefer device and chemical sector as both sectors offer higher-than-industry growth. We also overweight TCM sector due to Chinese’s exclusive patent and potential inclusion to insurance plan. We believe API and bio sectors will continue to suffer from weak export market and oversupply, in particular antibiotics players and vaccine companies.
Biopharma 29 15.2 20.0 New products Homogeneity Medical devices 37 22.1 25.0 Hospital infrastructure;
Equipment upgrade Centralized tender
Source: FortuneCLSA
Device - Due to government’s investment into county hospital and rising capex cycle, device companies have benefited from growing hospital purchase on device upgrade since 2009. We see both the number and the scale of county hospitals have been increased, which promotes the demand of medical device with better price performance.
Number of county hospitals Scale of county hospitals
Chemical - Chemical drugs play the major role in treating the ageing related disease such as cardio-cerebral, diabetes and cancer. Many blockbusters will lose patent protection during 2012-15, which should be the opportunity for Chinese generics companies.
TCM - TCM is a RMB340bn sector, growing at 20+% p.a.. This is the best sector to own thanks to Chinese’s exclusive patent and potential inclusion to insurance plan.
Top picks Sinobiopharm - Sino Biopharm is one of China’s largest Hepatitis and cardio-cerebral medicine manufacturers. The two business segments contributed 64% of the company’s revenue and have been growing at 33% Cagr in past three years. We like its high gross margin (79.5%), high R&D devotion and strong sales and distribution channels through subsidiaries.
Mindray - As a leader in patient monitor and medical imaging system, the company will continue to monetize the growth potential in emerging market thanks to low penetration in these markets. We expect company to record 20% earnings growth in 2013 driven by rising hospital capex cycle and new IVD(In-vitro diagnostic) business.
Yuyue - Yuyue has a dominant 50% market share on oxygen concentrator and has built the largest distribution network in China for retail market. The company has successfully added new products (e.g. wheelchairs) to monetize its leading position in the home medical devise channels while branching out to enter hospital and OTC businesses.
Yunnan Baiyao - Baiyao is the largest TCM companies with defensive growth thanks to their exclusive recipes. We forecast the company’ net profit to grow 20% YoY in 2013.
Industrials - Down to stock specifics Industrials are well positioned for a strong 2013 as long as macro-China indicators continue to point the right way. Company earnings are riding the tailwind of a low comparative base, lower input costs and recently improving utilisation, a factor absent for most of the past 18 months. Valuations are fair but not expensive. We believe emerging catalysts will be earnings led, in light of the strong sector rally hard in the past three months. Top picks on attractive valuations are Tiangong and Minth.
A strong finish to the year Industrials have seen a strong surge recently, outperforming the market by more than 10% in the past three months. The driving forces behind the outperformance include more positive macro data points in China (PMI) and a US recovery (housing and consumption). We believe a recovery in selling prices and better earnings off a low base suggesting that the worst is over.
Valuations fair but not expensive Valuations seem fair but generally not expensive. One-year forward PEs are at 10x (in line with five-year averages) and PBs are at 1.5x (1.9x five-year average). Earnings expectations are for net-profit growth of 9% YoY in 2H12, followed by a 29% surge in FY13 off a low base. The key catalyst is likely to be earnings led (February 2013) in substantiating the rally of the past three months. The stimulus fuelled 2009/10 recovery, where industrial PEs accelerated to 16x, provides a guide but is not what we expect.
Top picks are Tiangong and Minth Steel processor Tiangong is our top BUY pick due to its low 5x PE as a result of its small size and niche industry. The business has high entry barriers delivering steady growth. We rate auto-parts supplier Minth a BUY, premised on overselling in China on anti-Japan sentiment. Investors should focus on the structural and long-term growth aspects.
Elsewhere fine, but not cheap Exporters like VTech, Techtronic and EVA Precision have performed well in recent months should hold their own in a broader recovery. Industrial machine manufacturer Haitian should benefit in the latter stages of a capex recovery. Xinyi Glass is seeing its float-glass margins improve but it is close to fair value at 12x PE. We need to see a demand pickup before upgrading earnings. Yingde Gases is a good concept stock but is struggling amid steal overcapacity and a depressed merchant-gas market and looks better on a three-year view.
CLSA China small/mid-cap industrials forward PE versus forward EPS
The industrial sector has seen a strong recovery, particularly notable over the past three months, where the sector outperformed HSCEI and Hang Seng Index by more than 10%.
CLSA China small-mid-cap industrials versus MSCI China (one year)
CLSA China small-/mid-cap industrials versus MSCI China (short term)
Source: CLSA Asia-Pacific Markets
Sector valuation now at five-year average. The industrial sector’s PE recently touched 10x, recovering sharply in the past three months from 7.2x, nearly a full standard deviation below its five-year mean. On a price-to-book basis, we note that the sector can be deemed cheap and attractive. Sector PB is 1.5x, still some way off its five-year average of 1.9x.
Industrial PE’s have potential to rerate further ahead of earnings upgrades as seen during 2009-10, reaching more than 15x in the latter part of 2009. However, we caution that PE expansion in 2009/10 came on the back of high expectations of a major government stimulus programme (which was subsequently announced) after a prolonged period where analysts had cut numbers aggressively during the GFC. This time around, we are certainly not expecting major government involvement in reheating the economy and hence the upward trajectory in PE should not be as pronounced as 2009-10.
(10)
(5)
0
5
10
15
20
25
30
35
Nov 11 Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12
China small/mid cap industrialsHSCEI IndexHSI IndexHSI Smallcap index
(%)
3
1
11
10
6
2
4
13
10
9
3
1
10
17
18
2
7
22
17
20
0 5 10 15 20 25
1-week
1-month
3-month
6-month
YTD
China small/mid cap industrialsHSIHSI Smallcap indexHSCEI Index (%)
Current expectations are for small-/mid-cap industrials to report positive net profit growth of 9% in 2H12, on aggregate, partially reversing a 14% decline seen in 1H12. Both gross profit and net-profit margins are likely to be flat YoY. We expect 2013 to reflect a more positive period with sales growth of 16% but expectations are high for a large margin recovery (pricing recovery and lower raw-material costs) to result in net-profit growth of 29%.
Overall, sector valuations are fair but not expensive. Still, on this basis, we believe the sector should consolidate in the near term, with the market likely looking for more concrete earnings recovery before pricing in higher earnings expectations. The 2013 earnings season from February hence becomes the first key catalyst.
CLSA China small-/mid-cap industrials forward PE versus forward EPS
CLSA industrials index (historical PE) CLSA industrials index (historical PB)
Source: Datastream, CLSA Asia-Pacific Markets
Overall, the case for an investment in small-/mid-cap industrials now comes down to individual stock selection, with the call to buy the sector a few months back (largely on oversold reasons) now mostly played out. On this basis, we identify a number of stock specific investment themes for 2013:
Structural growth at the right price. We expect the market to continue to reward quality structural growth stories at the right price. Tiangong fits into this bracket well, also driven by a discovery factor that this is more than just a steel company. The company’s characteristics include a high value added process in making specialised steel (high-speed steel), where entry barriers are high due to the need for rare metals. Furthermore, as proven in its five-plus years of listing, gross margins have been stable due to its cost-plus model. Indeed margins have risen through the years on product-mix shift.
Tiangong is upscaling its production to wider-margin products with rapid growth in die steel and titanium capacity. Gross-profit margin has been expanding since 2007 on recent capacity add. Tiangong also boasts excellent revenue/employee and profit/employee ratios, improving by 100% and 350% in the past three years. We see more room for improvement here, with easy pickings as yet unplucked. Tiangong remains our highest conviction pick into 2013, the thesis being its high entry barriers, cost-plus model, margin growth and improving balance sheet at only 5x one-year forward PE.
Recovery in anti-Japan sentiment. High quality Minth Group is one of the top picks in our overall small-/mid-cap universe regionally. The stock has been held back, given the concerns over its high exposure to Japanese-branded car manufacturers in China, a reality that should affect earnings for at least the next two halves. However, we do not see such an impact as permanent and hence investors should be positioning for a recovery here, as well as sharing a strong structural growth outlook. History speaks volumes: eight years ago the company’s revenue was only 10% of the HK$3.9bn it generated last year. Most of the growth has been organically driven on a combination of industry growth (structural) and market-share gains (smart management). Just as impressive is its relatively stable and high gross-profit margin throughout, backed by its superb net-cash generative business model.
Given the above, we feel the stock is undervalued trading at 8x forward PE, a discount to Hong Kong/China industrials, which are trading at 10x forward PE. The stock also gives investors a margin of safety with a Rmb3bn net-cash position on the balance sheet, which lends the company firepower to pay bigger dividends and/or make an acquisition. While the Japan issue may continue to be a near-term overhang, this stock should be attractive to long-term investors.
Exporters look richly valued. The past two months have been a period of outperformance from quality branded exporters like Techtronic and VTech. With valuations near historical high PE ranges and what we believe are realistic growth expectations, we do not see much further upside for now.
A recent update with Techtronic management suggests that sales in 2H have progressed better than our expectation. We have lifted earnings by 10% and 9% in 2012 and 2013 as we now assume approximately 9% sales growth for the year, up 6%. This suggests a very strong low-double-digit YoY increase in 2H12. The hurricane should only provide a small net benefit to sales. The investment thesis for the company is unchanged; an exciting rollout of new product, leveraged to an improving housing environment, increasing skew to professional trade with higher price points and, in the meantime, lowering the cost of doing business by focusing on cost saves at the production level and deleveraging its balance sheet.
Following the earnings upgrade, we have lifted our target price from HK$13.50 to HK$16, which we derive from probability-weighted target PE. Essentially we value the power tools business at 14x (two-year forward) and floor care at 8x, and weigh it by a bull, bear and base case outcome (20%, 10% and 70%), which implies a one-year target forward PE of 15.5x. Despite the uplift in target price, we are taking our recommendation down to from Outperform to Underperform following the strong share-price rally, which outperformed the index by 26% and 11% in the past three months and last month respectively.
VTech’s 1H13 result was in line with our lower-than-street expectations. Growth was held back by the poor economic environment but margins were flat. Chairman is positive on 2H13 citing improved retail sales in the USA in the past month for its ELP (toys), some orders returning in TEL and new orders to reflect in Australia. We expect flattish margins in 1H14, reflecting benefits from efficiency gains and lower raw-material costs. We have upgraded our recommendation from Underperform to Outperform, given the pullback in the share price in the past three months, underperforming the market by 12%. At the current price, VTech offers a 7% dividend yield and is trading at a forward PE of 13.6x.
EVA Precision is seeing an improvement in the mix of orders with higher-margin business gradually returning, which had been impacted by the economic slowdown as its customers focused on lower-price and lower-margin product. While we note the recent results from Canon still suggest consumption headwinds for corporate spending, the company is launching 16 new printers and multi-function printers (which our analyst notes have been well received) which should feed into EVA’s revenue. It is also exciting to see EVA pick up a brand new order from Samsung in copiers for the first time. This follows a significant order win in 2010 from a Japanese OA customer.
A positive signal by the company in recent months is its ongoing share buyback activity. Since the end of June, the company has bought back more than 4% of its issued capital. This is in keeping with a precedent set in 2008/09 when EVA acquired 17% of their issued shares at the bottom of the cycle. Another notable event is the issue of 138m share options to directors and eligible employees in early November, a third of which granted to directors. This again was a precedent set in 2008/09. We have upgraded our target price to HK$1.18 (from HK$0.90), based on a higher multiple to reflect improving conditions for EVA. We are valuing EVA based on a target multiple of 10x on 14CL PE, which implies a 12-month forward PE of 13.4x. We maintain our Outperform recommendation.
Cyclicals have also had a strong run recently with stocks like Xinyi Glass, Lee & Man Paper, Nine Dragons and Kingboard Chemicals all rerating versus the market after lagging for much of the year. These stocks have found favour as earnings are likely near the bottom and we have seen a better appetite for risk since QE3 announcement out of the USA in mid-September. Many cyclicals will show strong earnings recovery in 2H12 and 1H13 due to a weak base effect and in some cases improving ASPs.
Cyclicals have outperformed since
mid-September
First-half result was in line with our lower-than-
For Xinyi Glass, which we rate a Outperform, we expect net profit to rise by 58% YoY in 2H12 and 1H13 should be similarly strong. Likewise, Kingboard Chemicals, Lee & Man Paper and Nine Dragons are all reporting that ASPs have likely bottomed and are now slowly on the mend. However, given the recent outperformance, we would caution chasing these stocks as the economic outlook for China remains uncertain in 2013 and a sustained recovery can only be supported by earnings upgrades. With a seasonal slow period kicking off in December and lasting through Chinese New Year, these stocks may retreat until better visibility on the rest of the year is available in 2Q13.
Cyclicals’ share-price performance versus HSI Index
Cyclicals historical 12M forward PE
Source: Datastream, CLSA Asia-Pacific Markets
80
90
100
110
120
130
140
150
Jan 12 Feb 12 Apr 12 Jun 12 Aug 12 Sep 12 Nov 12
HSI Cyclicals average
0
5
10
15
20
25
Jan 07 Dec 07 Dec 08 Dec 09 Dec 10 Nov 11 Nov 12
(x)
+1 Std, 15.6x
Avg, 10.8x
+1 Std, 6.5x
Expect a better 2H12 due to a low base effect
QE3 was a catalyst for more risk in the market
Cyclicals trading close to their historical average
Insurance - Another challenging year We expect 2013 to be another challenging year for the insurance industry, which is still grappling with slower growth and higher operating costs. Though the problems are well known, there won’t be a swift recovery. That’s where we differ most from the street; we expect the life segment to produce only single-digit growth next year. While we like the long-term P&C potential, the combined ratio is edging back up to 100%. Moreover, overhangs such as selldowns by major shareholders and fundraising will cloud sector performance. We stick to our cautious view.
Review of 2012 The sector rallied in the first half of the year, led by hopes for a bottoming out of industry reform and liquidity into Hong Kong. Yet, with no A-share recovery, impairment charges started to kick in, leading to substantial earnings decline and losses for some life insurers. The market was keen to buy the sector but there’s no compelling reason.
Still cautious 2013 We expect only single-digit premium growth in life insurance on no significant pickup in bancassurance and modest agency sales. P&C insurers have to deal with a rising combined ratio, potentially up to 100% on commission and price competition. The P&C situation will be worse than 2012, while it’s better for life, growth will be more subdued.
Major overhangs Balance sheets remain weak and the sector relies on subdebt to boost solvency with some companies above the limit already. Several companies face fundraising risk (China Taiping and PICC) and some are vulnerable to selldown by major shareholders (China Pacific, New China Life and Ping An). The trading headwinds will crimp share performance in the recovery process.
Resetting expectations The industry isn’t the same as the when the sector was first listed. It’s easy to argue a buy case on a low base but demand for life insurance is weaker than before with more alternatives and higher operating costs. Share performance is driven as much by expectations as fundamentals. Unfortunately, street expectations for a 2013 rebound seem high.
Chinese insurers stock performance vs HSCEI
Note: Stock performance rebased to 100 as of 30 Dec 2010. Source: CLSA Asia-Pacific Markets
35
55
75
95
115
135
155
Jan 11 Apr 11 Aug 11 Dec 11 Apr 12 Aug 12 Nov 12
China Life Ping An China PacificNew China Life China Taiping PICCHSCEI
Stocks to avoid China Pacific 2601 HK Rec U-PF Market cap US$25.7bn Target HK$25.4 Up/downside +2.4% New China Life 1336 HK Rec U-PF Market cap US$9.2bn Target HK$26.00 Up/downside +10%
It’s a little difficult to find something new to write in about for this outlook piece and it may look the same as the one for 2012. Yes, we are still cautious about the insurance sector, and the problems that plagued the industry haven’t been solved. But in what may seem like typical broker language, these issues are well known and hence, should be priced in. Here’s a reminder of why we have established ourselves as permabears, or at least, why we do not expect to see a recovery in 2013.
Life Tight regulatory scrutiny. The motto of former CIRC leadership was all
about “being big and strong”. Size came first. Insurance premiums almost tripled between 2005 and 2010. With the expansion came lots of problems, such as rogue sales practices, unproductive agents and poor product mix. CIRC started the crackdown on bank distribution two years ago (prompted by CBRC). Mis-selling has been the key focus, as some policyholders thought they just placed a deposit. Recently, the agency channel has also been added to their radar screen. With the regulator looking over their shoulders, agents are extra careful.
Wealth-management products in demand. We see no sign of a slowdown in wealth-management products. Some people have voiced their concern. But asset accumulation, in general, is what the market wants. So far, the government hasn’t indicated any intention to clamp down on it. Let’s face it, wealth management and trust products have an important function - helping direct liquidity to areas that need capital. Their surge in the past two years has raised consumers’ awareness of other professionally managed investment tools other than life insurance and mutual funds (the latter being hugely underdeveloped in China). Even though the returns of these wealth management and trust plans have fallen, not all consumers will move their money to life.
High maturity payout. The industry sold a lot of single premiums in 2008 (premium growth 48% that year) and most policies will be maturing next year. The high maturity benefits will put pressure on cashflow and some companies may be tempted to sell more single premiums to support the payout. Unless they are willing to bite the bullet and say no to single premiums, we will be dealing with this short cycle again. And this will hamper efforts to move to regular business.
Uncertain macro situation. While the 18th Party Congress has ended and new leaders named, the investment sentiment remains fragile and interest in financial products in general isn’t robust. This will continue to hurt life sales.
Though the industry slowdown has been going on for two years, the restructuring isn’t over. The pie is still inflated. Of life products, 90% plus are investment related. Every insurer has been shifting focus to protection business. Yet, the demand is limited (at least in the near term without any reform in the social security system). The size is small, despite better growth than investment, it’s not enough to drive the whole pie.
Rapid expansion in the past few years has led to an undesirable social image - that agents aren’t professional enough and products are unattractive. The industry is taking steps to instil more control and discipline to regain consumer confidence and draw people into the profession. But it won’t happen overnight.
This is where we differ from the market. The market believes next year’s comps will be easier after two years of restructuring. It’s true; there’ll be some growth, given the low base. Yet, this is more likely to be single-digit rather than a full recovery, going back to double-digit. Indeed, we don’t see a rebound back to double-digit growth anytime soon.
The potential market in China is not 1.3bn people. The high end is self-insured and the bottom end simply doesn’t have the disposable income. Most people that could afford life insurance have already bought it. We are cautious about incremental growth.
P&C Auto deterioration. The underwriting cycle is surprisingly short in China.
The industry seems to be happy with only two years of profit. Now, it’s edging back into underwriting loss. Weak auto sales this year have made everybody more anxious about premium growth and pay out more in commissions to win business.
Non-auto deterioration. Prices for commercial property aren’t regulated. So the weak growth has led to much price competition (unlike in auto where competition is more in commissions).
We like the long-term P&C potential as non-auto lines are so underdeveloped. Yet, in the near term, the reality is that the combined ratio is approaching 100%. We thought the industry would have learnt a lesson but we clearly overestimated their discipline. Current forecasts are vulnerable to downward revision and we recently downgraded PICC from BUY to U-PF.
Figure 1
Sector valuation
Code Rec PE (x) PB (x) P/EV (x) NBM (x)
12CL 13CL 12CL 13CL 12CL 13CL 12CL 13CL China Life 2628 HK U-PF 22.8 18.3 2.3 2.1 1.5 1.3 7.8 4.9
China Pacific 2601 HK U-PF 38.0 22.0 1.9 1.8 1.8 1.4 10.0 6.0
China Taiping 966 HK U-PF 19.1 13.2 1.5 1.3 1.0 0.7 (0.3) (3.3)
New China Life 1336 HK U-PF 18.3 16.3 1.7 1.5 1.0 0.9 0.4 (1.0)
Ping An 2318 HK U-PF 16.6 14.3 2.4 2.1 1.5 1.2 5.1 2.6
PICC 2328 HK U-PF 9.5 9.4 2.2 1.7 2.2 1.7 na na
AIA 1299 HK SELL 17.4 15.0 2.0 1.7 1.6 1.5 15.1 10.9 Note: Data as of 29 Nov 2012. Source: CLSA Asia-Pacific Markets
The slowdown in life insurance is unprecedented. In the past, it was easy to recruit agents and sell a policy. Most insurers haven’t experienced such a dramatic change and still haven’t figured out how to respond. They don’t have a clear strategy. One quarter could be after low-margin, high volume, the next high-margin low volume, then back to volume again. Several stocks face especially strong trading headwinds over the coming months.
New China Life - Strategic investors will be unlocked in December 2012 and the H-share free-float will more than double. Though the stock trades below the IPO price, the cost for Zurich Financial (the largest in H shares after the unlock) was only a few renminbi as the stake was bought many years ago and may well be sold down if the group has any capital needs. Those that got in right before the IPO (the likes of CICC and Nomura) may also consider selling even though it may mean a realised loss. NCI’s business has never
been too profitable and the company is not able to generate enough profit to sustain itself. It made a promise not to sell any new shares two years after the IPO and is relying on subdebt in the meantime. When the two-year period ends in December 2013, the company is likely to do an equity issue.
China Taiping - The company is restructuring in a bid to meet Beijing’s group-listing requirements. Instead of doing a separate group listing like PICC, Taiping will inject its assets into the Taiping holding company and the listed company will become a shell for the group. All these asset injections along with the need to shore up solvency ratio at Taiping Life mean massive fundraising. Taiping is trying to sell debt to ease some burden. But it won’t be enough to replace equity.
Ping An - All eyes are on the Rmb26bn convertible bond issue and the capital injection into Ping An Bank. The company is the only insurance stock with a clear long-term strategy - that of a financial conglomerate instead of being an insurance stock. But this ambition has also exposed the stock to more volatility, such as the NPL cycle in banking system. There may be trading headwind in the near-term as HSBC, the largest shareholder, is reportedly seeking to sell its stake.
China Pacific - The Carlyle overhang, despite being well known for years, remains an overhang. It’s an interesting stock. Everybody likes it because of its stronger solvency. Yet, it has never managed to outperform. The placement in September has given the impression that management is not optimistic about the coming year.
PICC - Apart from the increase in combined ratio, the market is also concerned about the listing of the parent company, that it could draw liquidity away from PICC. We are not worried about this as we prefer P&C over life and will stick with PICC rather than the PICC Group, which has a weak life business, unless the valuation of the latter is more attractive. But PICC itself also faces fundraising risk. While solvency ratio is above 150%, it is near another capital ceiling - the 4x premium to capital ratio.
China Life - The company is probably the only stock where we do not expect any negative news in the coming year, other than from industry restructuring, which affects everybody, and maturity pressure (could be some Rmb100bn from policies sold in 2008) - but no surprises. But let’s not underestimate the impact from industry restructuring. Things are unlikely to get any worse but we are realistic about the upside. We are cautious about the structural growth in life insurance in China. Valuations are a different matter. We aren’t big fans of the valuation story either. But we will spare you the pain and not repeat our preaching. Indeed, we add just one remark: if the market only looks at new business value and the growth multiple, it’s not difficult to argue for a buy case. Yet, if we look at the balance sheet (which is more important than premium growth), it’s not attractive. Share-price performance is driven by expectations as much as fundamentals, and for us, there’s still a bit too much hope here.
Companies mentioned New China Life (1336 HK - HK$24.10 - U-PF) China Taiping (966 HK - HK$12.88 - U-PF) Ping An (2318 HK - HK$58.65 - U-PF) CPIC (2601 HK - HK$25.40 - U-PF) PICC (2328 HK - HK$9.97 - U-PF) China Life (2628 HK - HK$22.85 - U-PF)
Mobile will grab the spotlight in 2013 with accelerating smartphone growth but the transition could slow revenue growth. The user-pays revenue model may take off but advertisers are usually slower to adopt mobile. Gaming plays outperformed in 2012 and could continue to do well in 2013 with expanding categories and mobile games will fuel the growth. E-commerce should maintain phenomenal growth but competition could intensify and operators struggle to balance growth and profitability. The ad market could slow due to a lack of major events and macro uncertainty in 2013. But online ads will fare better and performance advertising will take more share. The sector has derated with attractive valuations. Tencent, Baidu and NetEase are our picks.
Gaming plays outperformed in 2012 The internet sector has done well in 2012, outperforming the MSCI China by 17%. Gaming outperformed in 2012 as it is immune to the economic slowdown and mobile investment is limited. Advertising plays were pressured by the gloomy economic outlook in China and 4Q guidance remained weak.
YTD performance - Internet outperformed by 17% YTD performance - Gaming outperformed
Tencent has been the best performer in China’s internet sector in 2012 with share up 64%. It has regrown its revenue with a strong game pipeline and new advertising platforms. Its new flagship game (League of Legend or LOL) has done well with 70m registered users and 3m PCU globally. Its China gamers reached half that of Cross Fire in just one year. It launched two MMORPGs - Legend of YuLong and Legend of XuanYuan in September and November, respectively. The new games will continue to drive growth. Community business has been boosted by apps on its open platform. Advertising business benefits from new video and performance advertising. Margin has stabilised. The growth momentum should continue as big games such as NCSoft’s Blade and Soul (B&S) and Blizzard’s Call of Duty (COD) are likely to be launched in 2013. Tencent’s mobile social platform Weixin (WeChat) has grown quickly with over 200m users. The company still focuses on growing users and expanding services but its corporate accounts platform and open platform will pave the way for future monetisation.
Macro, mobile, competition and regulatory concerns pressured Baidu share in 2012. However, earnings growth remained strong at 52%, despite the weak economy. China search advertising market will continue to benefit from e-commerce boom and growing advertisers in China. Baidu will raise investment and acquisitions in 2013 to expand its mobile presence. However, the risk has already been reflected in its share price. The valuation is trading at a historical low of 16x 13CL PE against 28% three-year EPS Cagr and competition concerns are overdone.
Gaming stocks outperformed in 2012 as they are immune to the economic slowdown and have started paying dividends. Some have regrown revenue with new hit games such as NetEase’s ZhanHun (MMORPG), Changyou’s ShenQu (webgame) and Giant’s ZT Online3 and ZT2 - Qianjun. Netdragon’s share doubled in 2012 by expanding into mobile games. Gaming-revenue growth has rebounded since 4Q11 and should continue to improve with expansion of game categories and new game platforms in China.
Ctrip was among the worst performer in 2012, given slowing corporate travel, increasing competition and investment in leisure and mobile products. However, revenue-growth momentum is likely to improve in 2013. Competition will remain tough but further price cuts are less likely. Coupon will be less effective in air ticketing business, which has lower commission rates and thinner margins. Better revenue could help support margins.
Next year is about mobile Mobile will grab the spotlight, given accelerating smartphone user growth in China. We expect that China will have 110m new 3G users (60-70m smartphone users) in 2013. Total smartphone users could reach 200-250m, which is equivalent to 30-35% of PC internet users. China’s 3G download speed is disappointing but users could access wireless internet through WiFi in public areas and through home WiFi. New generation low-cost smartphones (US$200) have minimum 4.7” displays and 1.5GHz processors. Mobile monetisation will become a crucial focus for all Internet operators.
Mobile transition could slow revenue growth in 2013 as monetisation models are new and less optimised compared with PC. However, mobile revenue potential should be bigger than PC as there will be three times more users and mobile opens up new revenue streams such as location based services. The user-pays revenue model such as mobile games and e-commerce are likely to take off first. Advertisers are slower in adopting mobile platform but will always follow the user time spent and e-commerce trend.
3G user growth Internet user growth
Source: CLSA Asia-Pacific Markets
47 128 234 345 453
6
13
21
28
33
0
5
10
15
20
25
30
35
0
50
100
150
200
250
300
350
400
450
500
2010 2011 12CL 13CL 14CL
(%)(m)
3G users3G % of total users (RHS)
210 298 384 457 513 569 625 681 736 792
16 22
29
34
38 42
46 50
54
57
0
10
20
30
40
50
60
70
0
100
200
300
400
500
600
700
800
900
2007 2008 2009 2010 2011 12CL 13CL 14CL 15CL 16CL
Internet usersPenetration (RHS)
(m) (%)
Baidu share was pressured by macro
and mobile concerns despite strong growth
Gaming stocks outperformed as they are immune to macro
Ad growth could slow, but performance ads gaining share China’s advertising revenue could grow at a slower 11.5%YoY in 2013 (vs 13.5% YoY in 2012) due to a lack of major events such as the Olympics or World Cup. China’s economic data improved with higher fixed-asset investment, stable retail-sales growth and PMI back to 50. Our CRR SME survey also showed a rebound in domestic orders in 3Q12. However, 2013 GDP growth may only be moderately better, given the uncertain global economy and a structural change in China’s economy.
Online advertising should fare better and revenue may grow 35% YoY in 2013. Traditional display advertising on portals is likely to be in a structure decline, while performance advertising like search and social are likely to gain more share. Advertisers are more cautious about adspending returns in a tough economy and prefer platforms that help them hit sales targets.
Search advertising will continue to benefit from the e-commerce boom and revenue could grow 35% YoY. iResearch suggest B2C transactions grew at a phenomenal 125% YoY in 3Q12 and leading e-commerce sites such as 360buy, Amazon and Sunning are still spending aggressively to compete for market share. Smaller sites (Vancl, M18 and Dangdang) have cut back their adspend to improve profitability but this may not be sustainable as they have been losing traffic and revenue market share. New adspend will also come from traditional companies migrating online and new sectors such as F&B, retail and cosmetics. Baidu added a record 60,000 SMEs on its platform in 2012, which should ramp up spending in 2013. Cost per click should continue to rise, given growing advertisers. PC traffic growth is likely to slow.
Video advertising has been well received by advertisers. Almost all online video operators grew revenue by more than 100% in 2012 but revenue growth may slow with traffic and ad inventory in 2013. Over 70% of internet users watch video online with the average time spent per active user at about an hour per day. Operators have slowed their content acquisition to improve profitability. They have reduced the lead time of content acquisition from over a year in 2011 to one month in 2012. This could imply more competition or less ad inventory in 2013. While top-line growth may slow, online video sites could turn profitable in 2013.
Social advertising could gain momentum. Tencent opened up its social platforms to advertisers and introduced performance based advertising platform in 2012. It expanded its advertiser base from e-commerce and gaming segment to education services in 3Q12 with more to come in 2013. Sina has also ramped up advertising on Weibo, which contributed around 10% of ad revenue in 2012 and could reach 15-20% in 2013. Currently, Sina mainly generates ad revenue on Weibo from display ads. It plans to launch a sponsored news-feed advertising platform in 4Q12, which should increase ad inventory and monetisation capability on Weibo. Social traffic is moving to mobile fast, which is challenging for monetisation. However, social advertising has a low base in China.
Mobile adspend is likely to remain small in 2013. Educating advertisers to adopt a new platform takes time. Advertisers have only spent about 20% of their budget online and their mobile allocation will be small. Mobile advertising is also more difficult to track than PC. However, mobile can offer greater marketing variety, such as brandzone, video, location-based services, local business search and m-coupons. It should have higher long-term revenue potential than PC.
Gaming will continue to do well China’s gaming-revenue growth could rebound in 2013 with new categories. Operators’ efforts to expand categories and create new game-play modes have borne fruit. More hit games were launched in 2012 such as Tencent’s LOL (real-time strategy game), NetEase’s ZhanHun (MMORPG), Changyou’s ShenQu (webgame) and Giant’s ZT online 3 and ZT2 - Qianjun (micro-client game). More will come in 2013 such as Tencent’s Call of Duty and NetEase’s Dragon Sword and Diable3. Web games and mobile games will fuel growth. We expect the gaming industry to grow 22% YoY in 2013. Client-end game revenue may grow 15% YoY and webgame revenue is likely rise 35% YoY.
The web-game boom will continue in 2013 as the market has attracted many new developers. Traditional game operators have also expanded their portfolios to webgames and expect to introduce three to four titles per quarter. The segment has grown fast, given the easy access and short-session game play and webgames will improve in complexity and graphic design with PC and browser upgrades. Some of the latest webgames, such as 7Road’s Wartune, can simulate 3D effects, enticing gamers away from traditional RPGs (role-playing games). But hard-core gamers are likely to stick with RPGs, which can provide more sophisticated and intriguing play. Webgames used to have short lifecycles of one to two years due to limited content. But 7Road, Changyou’s webgame subsidiary, has extended the popularity of its legacy title, DDTank, with frequent content updates. DDTank was launched in 2009 and is still ranked among the top-five most popular webgames in China.
Mobile games could surprise with revenue up 85% YoY in 2013. Mobile games generate revenue mostly from selling in-game advertising and virtual items, given piracy concerns. Mobile-game Arpu is lower at Rmb30-50/month, compared with over Rmb100 for PC games, as most mobile games are causal, such as car racing, shooting and life simulation. However, some new mobile games are expanding to RPG play as smartphones become more powerful and tablets take off. Arpu of RPG games is higher at Rmb70-80/month.
Tencent and NetEase are likely to continue to dominate the gaming market. However, some game operators such as Changyou and NetDragon have found new growth from webgames and mobile games. Giant offers the most
attractive regular yield of 8%. Its new self-developed 3D fantasy MMOG World of Xianxia (WX) offers innovative group-versus-group game play and will is likely to be launched in 2013. It may also launch its self-developed FPS or first person shooting game, Glorious Mission in 2013.
Top picks for 2013 Tencent should continue to do well, given its strong pipeline. Its new games LOL, Legend of YuLong and XuanYuan have gained good traction with monetisation to follow in 2013. Blade and Soul (B&S) and Call of Duty (COD) are under localisation and may be launched next year. Community-revenue growth could accelerate with increasing contribution from open platform. Ad revenue will be boosted by video and ad-platform performance. Tencent has also stepped up efforts to grow its e-commerce business, both marketplace and principle e-commerce platforms, and is already the third-largest operator in China. It could continue to deliver 35% revenue growth (30% ex e-commerce) in 2013 and margin should be stable, given increasing contribution from in-house developed games and content. We have yet to factor in revenue from B&S and COD. Its valuation is reasonable at 24x 13CL PE.
Baidu’s is cheap at 16x 13CL PE which is near its trough historical PE and it is now trading at similar PE multiple to Google although its earnings growth was more than double. Google can still raise revenue by 20% with US real GDP growing at 2% and Baidu’s revenue growth should be much higher with
China targeting a real GDP growth of 7% in 2013. Macro concerns remain the biggest overhang and the ad market could slow further. However, search advertising is still in an early stage in China and growth will be boosted by e-commerce. It has been taking share from offline and traditional display ads.
We expect Baidu to continue to raise revenue by 35% in 2013. Competition concerns have been overdone and the mobile transition is a more imminent issue. Baidu is likely to speed up acquisitions, which could help it either acquire large mobile traffic or expand services for its mobile users and internet companies on its cloud-computing platform. It has just acquired the remaining stake of QiYi that it did not already own. Video is the most downloaded and used app on smartphones and should be a good traffic contributor. Baidu’s operating margin is likely to fall 2% in 2013, given accelerated investment. However, Baidu has already doubled capex and increased its employees by 50% per year. Most of internet companies and software firms are relatively small compared with Baidu. Margin impact from acquisitions is likely to be limited.
NetEase share is trading below 10x 13CL PE, given the weak 2Q and 3Q results. Its WoW gamers fell over 50% during the quarters due to a lack of new content and the global launch of Daiblo3. However, Blizzard and NetEase launched a new major expansion pack Mists of Pandaria for WoW in November and PCU has rebounded to 1.3-1.4m (versus 700,000 in 3Q12). NetEase’s in-house developed games (85% of its total gaming revenue) continue to grow at double digits. Its new game, ZhanHun, has gained good user traction. It is likely to launch multiplayer game Dragon Sword, Diablo3 and a FPS game in 2013. Company may consider paying regular dividend.
Valuations Rec Price Mkt cap
(US$bn) PE (x) EPS
3Y (%) (14-16)
PE/G (x)
13CL
ROIC (%) 12CL
Net cash/ mkt cap (%)
12CL Ccy 29 Nov 12CL 13CL
Tencent BUY HK$ 255.40 61.2 30.6 24.0 24 1.3 34 7 Baidu BUY US$ 99.00 33.6 21.9 16.5 31 0.7 82 10 Sina O-PF US$ 46.77 3.1 na 51.0 83 0.6 (1) 23 Ctrip O-PF US$ 19.38 2.6 27.0 20.3 29 0.9 11 35 Sohu U-PF US$ 39.76 1.4 17.4 11.1 42 0.4 24 57 Dangdang U-PF US$ 4.57 0.4 na na Losses na (14) 39 NetEase BUY US$ 43.86 5.6 10.3 8.5 na na 109 37 Shanda Games O-PF US$ 3.02 0.9 4.6 4.2 na na 44 17 Perfect World U-PF US$ 10.86 0.5 5.4 5.1 na na 14 66 Giant BUY US$ 5.37 1.3 6.7 6.0 na na 71 33 Changyou BUY US$ 24.84 1.3 4.6 3.9 na na 73 9 Sector average 25.0 20.8 51 12 Sector (non-gaming) 26.5 22.1 28 0.9 48 10 Sector (gaming) 8.3 7.0 89 33 Source: CLSA Asia-Pacific Markets
Companies mentioned Tencent (700 HK - HK$253.20 - BUY) Baidu (BIDU US - US$99.00 - BUY) NetEase (NTES US - US$43.92 - BUY) Dangdang (DANG US - US$4.57 - U-PF) Perfect World (PWRD US - US$10.71 - U-PF) Sina (SINA US - US$46.40 - O-PF) Changyou (CYOU US - US$24.84 - BUY) NCsoft (036570 KS - 161,500 won - O-PF) Giant Interactive (GA US - US$5.37 - BUY)
Macau gaming - Slower, but better growth With a lack of new casino openings in Macau, we expect slower gaming revenue growth of 8-9% over 2013-14. Earnings quality should improve as casinos’ exposure to the mass-gaming segment continues to rise. We like the sector for its attractive dividend yields and the gradual pricing in of Cotai. Looking to 2016, we expect the sector to deliver 10-22% average annualised return in the next four years. Its valuation is still attractive with the average dividend yield at 5% (versus 3% market). We are Overweight the sector and our top BUYs are Melco Crown, Wynn Macau and SJM.
Slower, but better growth There won’t be a major casino opening in 2013-14, the first time this has happened in the past seven years. With limited gaming-table additions, we expect moderate revenue growth of 8-9% over 2013-14. We also expect earnings quality to improve as mass-market growth should remain robust at 15-20% and we forecast VIP growth to stay at a slow 5% off a high base.
Still ‘Raining Cash’ As detailed in our Still raining cash report, we believe the Macau gaming sector is the best way to gain exposure to the rising Chinese middle class due to the industry’s capability to convert consumer spending into free cashflow and dividends. With the strong cashflow generation, we expect Macau gaming companies to deliver attractive dividend yields of 4-6% in 2013.
Additional catalyst: Gradual pricing in of Cotai In addition to the attractive dividend yield, Macau gaming operators also benefit from the gradual pricing in of their Cotai projects. Wynn Cotai, Galaxy Macau Phase 2, and Macau Studio City have commenced construction, while the others are still pending permits to break ground. Combining the strong dividends yields and the potential capital gain from the upcoming Cotai projects, Macau gaming companies can offer average annualised total return (dividends + capital return) of 10-22% over 2013-16.
Top picks: Melco Crown, Wynn Macau and SJM We believe the valuations are still attractive with sector dividend yields at 5% (versus the market’s 3%). We remain positive on Macau for its attractive dividend yields and gradual pricing in of Cotai. Our top picks are Melco Crown for growth and Wynn Macau/SJM for yield.
Macau: Gaming revenue/Ebitda growth
Source: DICJ, CLSA Asia-Pacific Markets
(40)
(20)
0
20
40
60
80
100
120
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
VIP revenue Mass gaming revenue Industry Ebitda(%)
ForecastActual
Aaron Fischer, CFA Head of Consumer/Gaming Res [email protected] (852) 26008256
Richard Huang (852) 26008455
Top ideas Melco Crown MPEL US Rec BUY Market cap US$8.45bn Target HK$18.7 Up/downside +22% Wynn Macau 1128 HK Rec BUY Market cap US$14.56bn Target HK$26.3 Up/downside +17% SJM 880 HK Rec BUY Market cap US$12.91bn Target HK$22.8 Up/downside +25%
Macau - Slower, but better growth For the first time in the past seven years there will be no major casino opening in 2013-14. Table-supply growth is likely to be minimal as it is doubtful that the Macau government will allow casino operators to add more tables to existing properties, despite table caps expiring in March 2013.
Macau: Increase in gaming tables
Source: DICJ, CLSA Asia-Pacific Markets
Expect 8-9% gaming revenue growth in 2013-14 With limited gaming table additions, we forecast moderate revenue growth of 8-9% in 2013-14. Mass-market growth should remain at a robust 15-20% in 13-14CL, while we expect VIP growth to be slower at 5% off a high base.
Improving earnings quality VIP has declined over recent months and mass market has improved. We believe that this is due to casinos actively upgrading the grind mass players to premium mass players and trying to prevent mass players from upgrading to the VIP segment. With no major change in average spending, we see this as being massively positive for margins as mass margins are four times wider than those of VIP (40% versus 10%). This could translate into further earnings upgrades. Also, VIP has been boosted by unsustainable revenue-share agreements that are being wound down. Credit seems to have contracted moderately but not excessively.
Still raining cash As detailed in our Still raining cash report, we believe the Macau gaming sector is the best way to gain exposure to the rising Chinese middle class due to the industry’s capability to convert consumer spending into free cashflow and dividends. In 2011, Macau gaming companies were able to convert US$35bn of casino revenue into US$4.2bn of free cashflow (11.9% of revenue) and US$3.0bn of dividends (8.4%). The conversion ratio of Macau gaming firms is significantly higher than that of other consumer companies, which were able to convert less than 1% of industry revenue into free cashflow and dividends. With the strong cashflow generation capability, we forecast Macau gaming companies to deliver attractive dividend yields of 4-6% in 2013.
Macau: Dividend yield (13CL)
Source: CLSA Asia-Pacific Markets
Gradual pricing in of Cotai In addition to the attractive dividend yield, the Macau gaming operators also benefit from the gradual pricing in of Cotai projects. Wynn Cotai, Galaxy Macau Phase 2, and Macau Studio City have already commenced construction, while the others are pending permits. With most of the casino properties running at high capacity utilisation, we expect the upcoming Cotai projects to drive substantial earnings growth.
Alternative valuation: Yield to completion To combine the strong dividends yields and the potential capital gain from the upcoming Cotai projects, we look at “yield to completion”, which shows the average total return (dividends + capital return) that the Macau gaming companies can offer between 2013 and 2016, before the opening of the next Cotai property.
We calculate our 2016 target price by applying 10-15x EV/Ebitda to our 2016 Ebitda estimate. The 2016 Ebitda is composed of two components, Ebitda from existing operations and Ebitda from the new Cotai projects. We calculate the 2016 Ebitda on existing operations by applying 5% pa growth to our 2014 estimate. For the Cotai projects, we assume all of the six companies open in 2016 and generate US$340-665m Ebitda (calculated based on US$2.0-3.5bn construction capex and return on investment of 14-19%).
Our 2016 target prices imply an annualised capital return of 10-16% over the next four years. The 10-16% capital return, combined with the forecasted 5-6% dividend yield suggest that Macau gaming firms are set to offer investors an average four-year annualised return of 10-22% from now until 2016.
Macau gaming: Best way to play Chinese consumption We believe the Macau gaming sector is the best way to gain exposure to the rising Chinese middle class due to the industry’s capability in converting consumer spending into free cashflow and dividends. In 2011, Macau gaming companies were able to convert the US$35bn of casino revenue into US$4.2bn of free cashflow (11.9% of revenue) and US$3.0bn of dividends (8.4%). The conversion ratio of Macau gaming firms have been significantly higher than that of other consumer companies, which were able to convert less than 1% of industry revenue into free cashflow and dividends.
We carried out our analysis by collating industry revenue from Euromonitor estimates and various industry sources. Next, we aggregate the revenue, net profit, free cashflow and dividend of various listed consumer companies to calculate their key financial metrics. By comparing the listed company financials with industry revenue, we can determine how much of mainland Chinese consumer spending has been converted into the company’s free cashflow and dividends.
China consumer/gaming: Listco’s revenue and dividend (2011)
Note: Industry revenue of department stores is based on gross department store sales from Euromonitor multiplied by average concession rate of listed department store operators (26.4%); industry supermarket revenue is based on Euromonitor estimates; while industry revenue of daily use goods, apparel, food, beverages and tobacco and autos are based on China retail sales figure prepared by the National Bureau of Statistics of China; Industry revenue of jewellery is an aggregate of jewellery retail sales in Hong Kong and Mainland China. Source: CEIC, Euromonitor, company data, CLSA Asia-Pacific Markets
Gaming cheap versus consumer Compared with other Asian consumer segments, Macau remains inexpensive with expected free cashflow yield at 4-5% in 2012-13 (versus Asian consumer of 2-3%) and dividend yield at 4-5% (versus Asia consumer of 3%).
Valuations
PE (x) FCF yield (%) Dividend yield (%)
12CL 13CL 12CL 13CL 12CL 13CL
Macau Gaming 21.4 17.4 4.9 3.7 4.1 4.6
China consumer 25.8 19.9 0.5 2.9 1.8 2.1
Asia consumer 19.3 17.0 1.6 3.1 2.9 3.3
Source: CLSA Asia-Pacific Markets
Six BUYs; Top pick Melco Crown and Wynn Macau We value Macau gaming companies on 10-15x 13CL EV/Ebitda, which is in line with their historical trading average. Our target prices represent 4-29% upside and an implied target 13CL PE of 16-19x, which we believe is reasonable, given the strong dividend payout and the solid demand-supply dynamics that offer good long-run earnings visibility.
Our top sector pick is Melco Crown, which has the strongest growth pipeline among the six Macau gaming companies. In the shorter term, growth will be sourced from improvements at City of Dreams. On the longer term, the company will be opening Belle Grande Manila in 2014 and Macau Studio City in 2015, while having the optionality to develop City of Dreams Phase III. We also favour Wynn Macau for its quality execution and defensive earnings and highlight it as the top pick for investors seeking dividend yields.
Machinery - On the way up More infrastructure FAI is needed to make up for falling manufacturing FAI to support growth. Rail-related projects will benefit mobile cranes most and Zoomlion is the clear H-share beneficiary. Concrete machinery will stand a better chance over wheel loaders, heavy-duty trucks and excavators due to low mining exposure. Top-line and overseas sales will be positive due to M&A in 2012. Mid-term export potential should offset short-term drag on margins. Go defensive, BUY Zoomlion H for 22% ROE.
Infrastructure FAI to the rescue Manufacturing FAI is set to decelerate in 2013, given severe overcapacity kicking-in after a normal three-year investment cycle for most companies. Property FAI should maintain growth, thanks to robust social housing construction as well as Beijing’s effort to control price by increasing supply of residential property. To uphold reasonable GDP growth (7.5% in our view), Beijing will have to boost infrastructure FAI that may grow 15-20% in 2013.
Winners and losers in 2013 Mobile crane should benefit most from railway construction, at 15-20% YoY. Concrete machinery will continue to grow in 2013, as new demand from increased residential property construction will more than offset idle machines. Weak mining activity will drag heavy truck, wheel-loader and excavator demand. With a shorter replacement cycle, wheel-loaders and heavy trucks will fare better than excavators.
Wild card is overseas sales With a series of overseas acquisitions in 2012, most machinery companies will report surprisingly strong top-line growth in 2013. Overseas acquisitions will also help boost export sales for these companies, thanks to improved distribution channels and elevated brand equity in overseas markets. However, M&As will also drag in blended margins as acquired companies are mostly loss-making or barely profitable. Watch out for Weichai Power.
Market consolidation - Go defensive, BUY Zoomlion H Stocks rallied from mid-September lows but valuations are still reasonably attractive, with most trading 30-50% below historical, average book value. We prefer big-cap defensive names with SOE backgrounds, as they benefit most from government projects and available resources. Zoomlion H is our top pick. Investors should avoid companies with structural challenges and/or may lose out in consolidation. Negative on Weichai Power H and Lonking.
Thanks to: Alexious Lee Senior Analyst, Fortune CLSA (86) 21 38784818
Nick Feng Associate, Fortune CLSA (86) 21 38784818
Top ideas Zoomlion H 1157 HK Rec BUY Market cap US$9.76bn Target HK$12.92 Up/downside +33% Stocks to avoid Weichai Power 2338 HK Rec SELL Market cap US$6.96bn Target HK$13.42 Up/downside -52% Lonking 3339 HK Rec SELL Market cap US$0.97bn Target HK$1.53 Up/downside -13%
Infrastructure FAI to the rescue We expect the machinery market to recover in 2Q13 on a slightly cautious macro view for 2013 as the new Chinese leaders may be comfortable with the current economic growth, while focusing on reforms, politically, then economically. Overall fixed-asset investment (FAI) by Beijing may slow further to 18-19% in 2013, versus 20-21% in 2012; weighed down mainly by the slowdown in manufacturing FAI. Companies and local government may cut capital expenditure as the nation is in a state of oversupply.
FAI forecast 2009-13
Growth (%) 2009 2010 2011 12FCL 13FCL Total FAI 30 25 24 20-21 18-19
Infrastructure FAI 40 17 4 14-16 15-20
Mining FAI 18 18 21 18-20 18-20
Manufacturing FAI 27 27 32 22-24 9-10
Property FAI 20 33 30 24-26 24-26 Source: FortuneCLSA
Winners and losers in 2013 We expect the NDRC-announced infrastructure spending and newly approved projects to translate into more robust construction activities in 2Q and 3Q 2013, similar to guidance from Chinese machinery manufacturers and dealer contacts we talked to. Key segments to benefit include railway, subway, water and other urban projects. Based on different machineries’ end-demand mix, we are positive on mobile crane, concrete machinery, bulldozers, and less on heavy-duty trucks (HDT), wheel loader and least on excavators.
Mobile (truck & crawler) cranes take spotlight in 2013 Demand for mobile (truck) cranes was flat in 2011 and we forecast a 35% YoY decline in 2012, as rail construction was halted in March 2011 and again in August 2011 amid a corruption investigation and the Wenzhou train collision. Many of these mobile cranes were rendered redundant as projects either got shut down or moved at a snail’s pace.
Big on railway and subway: rail-related construction accounted for nearly 40% of mobile-crane demand in 2010 and before. Contractors used truck cranes mostly for laying the tracks and crawler cranes for bridge work. New starts in rail and subway will drive mobile-crane demand.
XCMG continues to bleed: Despite its 50% presence, we expect XCMG to continue losing market share to Zoomlion and Sany Heavy, especially in the larger tonnage segments. Based on historical trends, we expect XCMG to lose 1.5% and 2.5% market share in volume and sales revenue in 2013 and 2014.
Top players in mobile crane segment 1H2012
Company Market share % of business Gross margin (%) Xugong Machinery 53 41 24.5 Zoomlion Heavy 25 24 27.4 Sany Heavy 13 10 30.5 Others 9 - -
Annual truck crane sales and forecasts . . . . . . and sales on a quarterly basis
Source: FortuneCLSA, CCMA
Single-digit growth for concrete machinery in 2013 The market is pricing in a possible decline in concrete machinery sales due to its relatively stronger performance in 2011 and 2012. We believe the penetration story for concrete machinery is intact and demand will continue to grow with increased penetration of ready-mix cement in 2013 and 2014.
Private residential new start will pick up in 2013. We noted that several property-listed companies’ recent acquisitions of more land and improving sales.
Product upgrades in process. As buildings gets taller, concrete pumps with longer arms will be in greater demand. We expect product mix to be in favour of ASP and gross margins to improve in 2013, as demand will focus more on over 60m rather than 50-59m pumps.
Duopoly maintained in concrete-pump segment: Despite XCMG and Shantui’s intention to venture into the concrete pump market, Zoomlion and Sany Heavy will continue to be the major players in this fastest-growing niche market. The two dominant brands will represent more than 95% of the domestic market.
Social housing construction will only gain momentum into 2014: Beijing will continue to manage property prices via increasing the supply of low-cost social housing units into the property market. With stronger residential-property investment and slower social-housing construction, we expect concrete-machinery sales to grow 5-10% in 2013-14.
Top players in concrete machinery segment 1H2012
Machinery Cos. Market share (%) % of business Gross margin (%) Zoomlion Heavy 46 58 36.2 Sany Heavy 46 54 42.2 Xugong Machinery 6 13 26.7 Source: FortuneCLSA, CCMA, and company data
Annual concrete machinery revenue and forecasts . . . . . . and revenue on a quarterly basis
Note: Use Sany’s & Zoomlion’s concrete revenue to represent the industry. Source: FortuneCLSA, company data
More wheel loaders to be replaced in 2013/14 Based on CCMA and company-reported data, the mining sector should contribute 30% and nearly 40% of volume and sales revenue to the wheel-loader segment. When smaller mines were shut down in 1H12, demand for larger tonnage (five and six tonne) wheel loaders started failing off the cliff.
More local content, poorer quality, higher replacement demand in 2H13 and 1H14: Wheel loaders have nearly 95-98% local content and low lifespan due to their poorer quality than wholly-imported models. Our estimates on life expectancy include five and eight years for mining models and construction.
With operating hours declining by almost 50% YoY in 2012, we expect replacement demand for mining models (2009) and construction models (2005) to decline by 20% in 2012. Total replacement demand in 2013 may increase by 68% YoY from 58,000 to 98,000 units.
XCMG and SDLG to lead and Lonking to lose out: From the October CCMA data, we note that market leader Liugong will find it more difficult to maintain its market share as demand in the mining segment softens. Based on the current momentum, Volvo-owned Shandong Lingong (SDLG) should continue to gain market share and we expect a 1% increase in 2013 from better product quality and productivity.
XCMG may take market share (1-2%) due to its stronger presence in road and municipality segments. Smaller players such as Lonking and XGMA will continue to face market-share losses of 1-2% in 2012.
Top players in wheel loader segment 1H2012 Machinery Cos Market share (%) % of business Gross margin (%) Liugong 17 50-55 15-20 SDLG (70% by Volvo) 18 70-80 15-20 XGMA 13 50-60 15-20 Lonking 16 65-70 20-25 XCMG 10 15-20 15-20 Others 26 - 15-20 Source: FortuneCLSA, CCMA, and company data
Annual Wheel loader sales and forecasts . . . . . . and sales on a quarterly basis
Source: FortuneCLSA, CCMA
Heavy duty trucks have passed the volume growth stage Based on CAAM and company reported data, the mining sector should contribute 35% and 30% of volume and sales revenue to the heavy-duty truck segment. Despite a pickup in medium-duty trucks (MDT) and heavy construction trucks, demand from logistic applications remained weak on lower trade activities and manufacturing FAI.
Product upgrades due to China-IV emission standards and LNG engines: In our Crossroads ahead report, we highlighted 5-8% ASP improvement for heavy-duty trucks on upgraded engines (common-rail diesel engines for China-IV and LNG engines). Gross-margin-percentage improvement will happen for fully-integrated truck makers. Smaller truck makers that need to order engines from third-party suppliers (Weichai Power) will continue to lose out due to cost-based disadvantages.
Fully integrated truck makers will continue to gain shares: FAW, DFM and Sinotruk will continue to gain market share ahead of smaller truck manufacturers. During product upgrades (engine technology), fully integrated truck manufacturers have cost-based advantages and higher gross margin and resources to compete. It is unlikely that smaller brands find success over peers with deep corporate pockets.
Shaanxi Auto takes a breather: Weichai Power owned Shaanxi Auto outperformed peers in 2012 and market share improved 2% in 10M12. We believe it is unlikely that the brand maintained its market-share gain (on shipment data), especially when dealer inventory is rising.
Foton Motor will start to sell Daimler-model trucks: Foton Motor will turn fully integrated by 4Q12. The new Daimler JV will open up competitive advantages in construction trucks and especially high-end segments, dominated by DFM. We expect tough competition and ASP erosion for DFM in the heavy truck business.
(14)
52
10
(28)
(0)
10
(40)(30)(20)(10)0102030405060
0
50,000
100,000
150,000
200,000
250,000
2008
2009
2010
2011
2012
FCL
2013
FCL
2014
FCL
(%)Wheel loader sales volume YoY (RHS)(units)
(60)
(40)
(20)
0
20
40
60
80
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
FCL
1Q13
FCL
2Q13
FCL
3Q13
FCL
4Q13
FCL
(%)Wheel loader sales volume YoY (RHS)(units)
Demand from logistic applications
remained weak
Fully integrated truck manufacturers have
cost-based advantages
Weichai Power owned Shaanxi
Auto outperformed peers in 2012
Lonking and XGMA will continue to face market share losses
Machinery Cos. Market share % of business Gross margin (%)
Dongfeng 22 30-40 10-15
Sinotruk 18 85-90 10-15
FAW 17 10-15 10-15
Shanxi Auto 14 80-85 10-15
Foton 12 45-50 5-10 Source: FortuneCLSA, CCMA, company data
Annual HDT sales and forecasts . . . . . . and sales on a quarterly basis
Source: FortuneCLSA, CCMA
Excavators to consolidate and recover in 2014 only Based on CCMA and company reported data, the mining sector should contribute 20% and nearly 40% of volume and sales revenue to the excavator segment. Despite improving machine operating hours, demand remained relatively weak, as funding was in the hands of local government.
Operating hours up for construction but down on mining: From our tracked GPS data, operating hours in mining regions (Shanxi, Inner Mongolia and Ningxia) declined 13% YoY, 26% YoY and 30% YoY for October versus -13% YoY, -37% YoY and -35% YoY in September, indicating weaker mining activities than expected. A large construction market, such as Jiangsu and Anhui jumped. Excavators in Jiangsu province clocked 56% more hours versus September and 23% more than a year ago. Excavators in Anhui market continue to trend up 22% MoM and -4% YoY versus -3% YoY and -27% YoY in August and September. We get more construction jobs but less mining activities.
20-40 tonne to see more demand: Demand for larger mining models (>40t) will decline. Mining models represent 30-35% on different years and weak demand will drag overall shipment volume and much more in terms of revenue. With more infrastructure investment, we expect to see a bigger mix of 20-40-tonne excavators, benefiting Chinese brands.
Japan and Korean brands will gain market share in 2014: In times of consolidation, we expect Japanese and Korean brands to come under pressure. Our sector assumptions include 10 Chinese brands exiting this product segment, leaving 40 brands by end of 2013. Japanese and Korean brands will start to gain momentum in 2014 as subway new starts will enter into the tunnel construction period.
Chinese brands Market share (%) % of business Gross margin (%)
Sany Heavy 14 21 30
Zoomlion 2 5 25-30
Lonking 2 11 20-25
Foreign brands Market share (%) % of China % of global
Japan brands 25 80-85 7-10
Western (CAT) 14 40-50 3
Korean (Doosan) 15 80-85 10-15 Source: FortuneCLSA, CCMA, company data
Wild card is oversea sales Investors are focusing on accelerated government spending to drive China’s demand for machinery, but many Chinese machinery manufacturers ventured overseas via M&A in 2012. Chinese machinery manufacturers acquired foreign companies, mostly in Europe. With the series of overseas acquisitions in 2012, most machinery companies will report surprisingly strong top-line growth in 2013, when Chinese machinery makers consolidate the books.
Overseas expansion
Machinery Cos Foreign Cos. JV/M&A % share
Sany Heavy Putzmeister M&A 90
Sany Heavy Intermix M&A 100
Sany Heavy Palfinger Truck crane JV 50
Weichai Power Kohl Group M&A 30
Weichai Power Linde Hydraulics M&A 70
XCMG Doosan Heavy JV 50
Liugong HSW (Civil machinery) M&A 100
Liugong Cummins JV 50
Foton Motor Daimler JV 50 Source: FortuneCLSA, CCMA
Overseas acquisitions will also help boost export sales for these companies, thanks to improved distribution channels and elevated brand equity in overseas markets. Other benefits will include:
Industrial footprint overseas. Chinese manufacturers try to shorten the learning curve via mergence and acquisitions and/or joint ventures. The industrial footprint in foreign markets will open up sourcing opportunities, valuable foreign-local management experience, cost-based advantages and gain relevant talents to help accelerate global expansion. This is the most common approach by foreign brands when they enter China market.
Foreign brand ownership. During the course of any cooperation, China machinery makers are looking to own foreign brands that help to smooth the introduction of existing products into developed markets. Zoomlion displayed the crawler crane in USA/EU tradeshows under CIFA brand.
Channel platform. Developing a well-structured distribution system in a foreign market is always challenging. With the acquired company, Chinese machinery manufacturers can quickly tap the matured distribution system.
Technology ownership. Chinese manufacturers are years behind their foreign peers most in the power and hydraulic technology. Zoomlion, Shantui, Weifu High Tech, and many others CV companies have found success before. Now Sany Heavy, Weichai Power, Liugong, Foton Motor, Sinotruk will attempt via joint-venture.
Beside the benefits, M&As will also drag down blended margins as acquired companies are mostly loss-making or barely profitable.
Gross margin erosion. Chinese manufacturers are making significantly wider gross margin than foreign companies. Sany Heavy make around 35% to 40% gross margin on concrete machinery but the acquired companies (Germany’s Putzmeister and Intermix) make 12-20% on gross margin only. When booking a much bigger portion of overseas sales, gross margin percentage will show significant decline.
HR expenses and commitment. Stepping into foreign markets means Chinese machinery makers are committed to more intact labour laws and stronger unions. Drawing examples from the previous Zoomlion-CIFA M&A, we expect Sany Heavy, Weichai Power and Liugong’s HR expenses per head to increase by 60-100% in 2013.
Net margin impact. Next year will be the first most Chinese manufacturers incorporate the newly acquired foreign companies into their balance sheets and financial statements. These newly acquired firms are usually loss making or have thin (1-2%) net margins, and as such will act as a drag on net margins for Chinese-listed machinery manufacturers.
Market consolidation - Go defensive, BUY Zoomlion H China’s machinery equities underperformed in 2012. Macro concerns weighed on investment and weaker demand, contributing to a cyclical-stock derating. The outlook remains clouded, with uncertainty in Europe, growth moderation in China and new leadership’s stand on investment.
Stocks rallied from mid-September lows but valuations are still reasonably attractive, with most trading substantially below historical, book valuation. We expect persistent volatility as sentiment oscillates around headwinds but the macro environment should improve by mid-2013.
We prefer defensive names with state-owned background, as they benefit the most from government projects and have better access to loans and other resources. Zoomlion H is our top pick.
We recommend adding exposure into weakness for names with technology advancements, product upgrades, and recently completed their investment cycle (capex to decline in 2013) such as Sinotruk (O-PF).
Investors should avoid companies that have structural challenges that may lose out in times of market consolidation, including Weichai Power H. We recently downgraded Lonking from BUY to SELL on concerns over the company’s sustainability due to macro uncertainties.
11.5 10.7 1.5 15.0 9 Note: Excluded Shantui in 2012 PE average. Source: FortuneCLSA, Regional NR share consensus from Bloomberg, other NR share consensus from Wind
Oil & Gas - Downstream dream As oil prices and inflation soften and demand recovers, 2013 will be the year to own integrated and downstream players. We predict price reform in ex-refinery gate liquids and further moves in natural gas, both of which will help improve earnings in those categories for PetroChina and Sinopec. In upstream we favour service providers that will benefit from a lift in wells drilled in China.
Crude prices drift lower We expect spot crude to soften in the next two years on weak global demand, oversupply and an end to the geopolitical tensions which had been driving up oil prices. We forecast Brent to average US$100/bbl for 2013 and 2014.
Refining margins keep improving Finally, after seven consecutive quarters of losses, the refining units of Sinopec and PetroChina will post small profits in 2013 and 2014. In addition to general improvements in refining profit, we expect the government to announce key changes to the fuel-pricing mechanism that will also help reduce the risk of large losses in refining reoccurring.
Slow recovery in petrochemicals While petrochemicals earnings appear to have bottomed, we believe that demand will remain very weak. Production capacity will come back online in 2013, delaying an earnings recovery.
International M&A continues and spinoffs begin This year has been a significant one for outbound M&A in China’s oil and gas space and 2013 will see similar levels of activity as the country continues to try to secure interests in upstream and midstream assets globally. We believe the Canadian regulator will approve CNOOC’s takeover of Nexen late in 2012, but do not see significant value creation for minority shareholders. Sinopec will spin off a number of business units in 2013 - mostly from its parentco.
Strong growth in oilfield services Oilfield services are a warrant on the development of China’s upstream oil and gas resources. We expect earnings upgrades and policy to benefit share prices in 2013. E&P capex of CNPC/PetroChina and Sinopec drives China’s onshore oilfield services, while capital spending by CNOOC and its production-sharing contract (PSC) partners is key for offshore. Our top pick across China’s oilfield services is Antonoil.
Getting better The earnings outlook of China’s two vertically integrated oil and gas companies - PetroChina and Sinopec - will continue to improve as the government introduces price reform in liquid fuels is and continues to roll it out in natural gas. As a result the elimination of losses in refining and a slowing of losses on imported natural gas dominate 2013 earnings growth.
In the upstream part of the industry we expect onshore producers to continue to deliver acceptable production growth - especially in conventional and unconventional gas - but we believe it will be harder for China to expand offshore output.
China’s national oil companies (NOCs): E&P production growth, 9M12
Note: Total is the aggregated production of all three companies. Source: Companies
Crude prices drift lower At the beginning of this year we were forecasting Brent at a US$108/bbl average for 2012, and we are not too far off given where it is now. We expect crude to soften in the next two years on weak global demand, oversupply and the end of geopolitical tensions which had been driving up oil prices.
Our Brent spot forecast vs Brent futures into 2015
Source: Bloomberg, CLSA Asia-Pacific Markets
2.0 2.31.1
1.9
8.3
14.7
(6.8)
7.3
3.94.9
(0.4)
3.4
(10)
(5)
0
5
10
15
20
PetroChina Sinopec CNOOC Total
(% YoY) Crude production growth Gas production growth
80
85
90
95
100
105
110
115
120
125
130
Jan 12 Sep 12 May 13 Jan 14 Sep 14 May 15 Dec 15
(US$/bbl) Brent spot Brent futures
CLSA Brent forecast 2012 avg @US$108/bbl
Brent 2012 YTD avg @US$112/bbl
CLSA Brent forecast 2013-14 avg @US$100/bbl
CLSA Brent forecast 2015 avg @US$103/bbl
The earnings of the two vertically integrated
oil and gas companies will improve in 2013
Sinopec is the only NOC that relies more on
natural gas for total production growth
Brent futures are in backwardation: we forecast contango
Despite the crude price headwinds in 2013, we expect the E&P business of China’s NOCs to continue delivering earnings growth by expanding total production and through gas-price hikes in 2013.
Refining margins keep improving With recent changes to ex-refinery gate prices, the government has finally applied changes in a more timely fashion. Our analysis suggests that the five most recent changes came exactly when they were due. This improved approach suggests that the large losses we saw as government dragged its feet on increases and decreases are to be narrowed in the fourth quarter and back to positive in 2013.
Refining profits for Sinopec and PetroChina, on a per-bbl basis
Source: Companies, CLSA Asia-Pacific Markets
We continue to argue that the current mechanism that looks at the change in a basket of three crudes over a 22-day moving average period is about to change to:
A shorter moving average (10 days instead of 22);
A slightly different basket of crudes;
And the companies would manage it, rather than the NDRC.
It is this last point that is the most impactful to the earnings of the downstream players. For the past six quarters the government’s hawkish approach to inflation has meant that it has delayed increases, and as a result the refining spread moved significantly negative.
In addition to the three changes we discuss above, we believe there is debate between government officials and advisors that the 4% increase/decrease threshold in the basket of crude that has historically triggered the change may be scrapped, resulting in a price change (mark to market) every 10 days. This is a significant easing and shows a major move towards deregulated market structures that could spell the end of large periods of national service and resultant losses in refining.
The slowdown in oil-product demand that we saw in 2012 - most specifically in diesel - comes to an end and China will return to above-5% growth in oil-product demand. Increases in gasoline volume did not appear to slow in 2012 and, despite sluggish car sales, we expect that miles driven per car per year will rise and help propel gasoline demand at a double-digit increase in 2013.
One of the key improvements in refining margins comes from the government making more timely adjustments to ex-refinery gate prices - basically sticking to the timing dictated by mechanism as opposed to delaying changes.
Natural-gas price reform continues In December 2011 the NDRC announced a change to the “city-gate” price for natural gas. The move linked gas prices to oil, resulting in 20-30% increase. Initially tested in two locations - Guangdong and Guangxi - investors have been waiting for the “trial” to spread to additional cities and provinces.
Linking gas price to crude oil prices
Source: CLSA Asia-Pacific Markets
2.22.42.62.83.03.23.43.63.84.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
(mbpd) 2008 2009 2010
2011 2012
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
(mbpd) 2008 2009 2010
2011 2012
Guidance well-head priceGuidance price of Rmb1.5/m³
from December 2010
Transport cost
Operating cost
City gate price
City gate price is now floating driven by oil
prices
NDRCwill monitor
Actual well-headprice
received
Transport cost still be regulated by NDRC
Fuel oil price x 0.860% of price
LPG x 0.66740% price
This mix of LPG and HFO matches the heat content of 1m3 of gas
We believe that additional cities will be included in 2013. There are strong rumours that Shanghai, Sichuan and Chongqing will be next to link gas prices to oil.
City-gate gas price by location and before reform PetroChina realised gas price
Investors have rightly become concerned about “national service” in natural gas. As the Turkmen gas take-or-pay arrangements have kicked in and volumes from Turkmenistan have risen, so have losses on imported gas.
This is hard to detect as the losses in imported gas are booked in the gas and pipelines business and until 2Q12, strong earnings in gas-transmission tariffs partly offset them. Our forecasts suggest that volumes of imported piped gas will increase and given high oil prices, the purchase price will jump at the same time.
Dec 2011
New pricing reform announced.First trial in Guangdong/Guangxi.Gas price linked to HFO/LPG.Aims to adjust gas price quarterly.
Jul 2012
NDRC announced Sichuan-to-Shanghai Gas-pricing mechanism.Shanghai city gate price lifted by 68%.One price for all downstream users.
Dec 2012 (CL estimate)
Trialled pricing mechanism rolledout to more areas such as Shanghaiand Sichuan; about 40% gas-price lift for above areas
Dec 2013 (CL estimate)
New pricing mechanism rolled out nationally.
It takes 2 years to roll out the new pricing mechanism nationally
0.00.51.01.52.02.53.03.5
Sha
anxi
Sha
nxi
Sha
ndon
g
Heb
ei
Bei
jing
Tian
jin
Hen
an
Anh
ui
Jian
gsu
Zhe
jiang
Sha
ngha
i
Gua
ngdo
ng (
befo
re)
Gua
ngxi
(be
fore
)
Gua
ngdo
ng (
curr
ent)
Gua
ngxi
(cu
rren
t)
Sic
huan
(ru
mou
red)
Sha
ngha
i (ru
mou
red)
Zhe
jiang
(ru
mou
red)
Jian
gsu
(rum
oure
d)
(Rmb/m³) Industry Consumer
0
1
2
3
4
5
6
7
8
9
06 07 08 09 10 11 12CL 13CL 14CL 15CL
(US$/mcf)
Shanghai, Sichuan and Chongqing are next
It will take about two years to roll out the new gas-pricing
How the new pricing mechanism will reduce losses in gas imports
Source: NDRC, CLSA Asia-Pacific Markets
International M&A continues and spinoffs start Since 2006 the three large SOE’s have been active in international M&A. The most prominent deal in 2012 was CNOOC’s US$15bn bid for Canadian oil and gas producer Nexen. It is still uncertain if the Canadian regulator will approve the deal. If it does then we envisage a maximum 3% uplift in CNOOC’s consolidated 2013 EPS, despite a 30% jump in 1P reserves and a 20% increase in production in terms of barrels per day.
The Canadian government has delayed its decision on the CNOOC takeover by an additional 30 days. While we believe the deal is highly likely to proceed, we do not see the earnings boost to CNOOC as particularly attractive.
CNOOC share price: Timeline for CNOOC/Nexen deal
Source: Company, CLSA Asia-Pacific Markets
2.4
2.2
2.9
0.5
0.5 0.5
0.7 as a loss
0.00.51.01.52.02.53.03.5
Wel
lhea
d pr
ice
Tran
smis
sion
tar
iff
City
gat
e pr
ice
City
gat
e pr
ice
inG
uang
dong
as
cacu
late
dby
oil
linke
d fo
rmul
a
Tran
smis
sion
tar
iff
Net
bac
k to
wel
lhea
d pr
ice
Estim
ated
Tur
kmen
impo
rted
gas
pric
e at
boa
rder
Tran
smis
sion
tar
iff
Cur
rent
city
gat
e pr
ice
in S
hang
hai
Proj
ecte
d ci
ty g
ate
pric
ein
Sha
ngha
i
(Rmb/m³) Current cost plusmechanism
Trial in Guangdong/Guangxi (oil linked)
Turkmen imported gas
70% lift
Breakeven2.2-2.4
2.7-2.9
1.7-1.9
1.2-1.4
14.0
14.2
14.4
14.6
14.8
15.0
15.2
15.4
15.6
15.8
16.0
16.2
16.4
3 Jul 12 26 Jul 12 18 Aug 12 10 Sep 12 3 Oct 12 26 Oct 12 18 Nov 12 11 Dec 12
(HK$)
23 JulCNOOC announcemes
Nexen deal
29 AugCNOOC applies for approval
to Canadian govt, which must make a final decision
within 45 days
20 SepNexen shareholders
vote in favour of a takeover by CNOOC
11 OctThe 44th day of the deadline:Canadian govt extends the review period by one month
27 JulSEC accuses CNOOC of
insider trading and starts investigating Rongsheng (1101 HK)
19 OctCanadian govt
rejects Petronas takeover of
Progress Energy
10 Nov Reset deadline for first delay
45 days 30 days
10 Dec Reset deadline for second delay
30 days
New mechanism will effectively lift domestic gas price
Earnings uplift to CNOOC is not attractive
China NOCs will continue international M&A activities in 2012
We see further foreign investment as likely in the upstream and midstream space. We expect more deals in Canadian oil-sands, in Africa and in shale.
Asset injection and spinoffs likely In early 2012 we guided that Sinopec Group was likely to spin off some of its divisions. It looks like the oil-services and the EPC businesses could have IPOs in 2013. We believe the oil-services company could be quite large - possibly even as big as COSL.
Sinopec possible spinoffs Business unit Details Current
location Expected
listing date
E&P oil services Sinopec's in-house oil-services company. Management advises that if listed, this unit could be bigger than COSL in terms of revenue and assets, but it has only focused on onshore services so far, with no offshore business. Almost all of Sinopec’s E&P capex (around Rmb50bn) goes to this business unit. In addition this BU also has external customers, mostly from overseas.
Inside parent 4Q13
Engineering and construction
Sinopec's EPC business focuses on the design, construction and engineering of assets and facilities, such as service stations and refinery plants. Management claims it is a leading player in the domestic market.
Inside parent 4Q13
Lubricants (brand name is Great Wall Lubricants)
The lubricants unit buys base oil and blends them with additives and distributes the product. The key competitiveness lies in blending techniques. We believe Sinopec has about 30-40% of the domestic lubricants market.
Inside listco 3Q14
Catalyst As Sinopec is China's largest petroleum and chemical refiner, we believe it will have a catalyst business unit manufacturing and deploying chemical, polyolefin and refining-process catalysts.
Inside parent No visibility
Sales & marketing We understand that this refers to Sinopec's significant retail service-station business unit. Inside the listco No visibility
Source: Company, CLSA Asia-Pacific Markets
China oilfield services Oilfield services are a warrant on the development of China’s upstream oil and gas resources. We expect earnings upgrades and policy to benefit share prices in 2013. Our top pick is Antonoil.
Onshore oilfield services Upstream capital spending from PetroChina (CNPC) and Sinopec drives China’s US$40bn onshore oilfield-services industry. Service firms will benefit from rising per-well capex as more is spent to overcome challenging geology in western China and to enhance production in the ageing fields of the country’s east. Unconventional gas will be the focus of policy and we expect the government to announce a range of new measures in 2013.
China onshore upstream capex Average capex per well
Source: Company, CLSA Asia-Pacific Markets Source: Company
Strong growth in oilfield services Capital expenditure from CNOOC and its production-sharing contract (PSC) partners is key to China’s offshore oilfield-services market. We expect this to increase in 2013 as CNOOC exploits new discoveries in Bohai Bay and invites foreign partners to jointly develop the South China Sea. COSL is CNOOC’s sister service company. However, at current prices, we rate it an Underperform due to declining margins, unclear capex plans and low earnings visibility.
0
50
100
150
200
250
300
03A 04A 05A 06A 07A 08A 09A 10A 11A 12F
PetroChina Sinopec
02468
1012141618
03A 04A 05A 06A 07A 08A 09A 10A 11A
PetroChina Sinopec
Service firms benefit from rising per-well capex
Western China and unconventionals require greater service intensity
Power - IPPs over equipment makers Continued coal-price weakness should help China’s IPPs to beat consensus earnings in 2013. In contrast, weak equipment demand and falling ASPs mean power-equipment makers will miss by 17-38%. China’s push to improve the environment should help gas utilities grow at a steady pace. Hong Kong’s utilities face a crucial 2013, with tariff hikes, mid-term review of the Scheme of Control and anti-tax-avoidance laws in the UK. BUY CRP, CPI, CR Gas and Longyuan. SELL Dongfang, SEG, Harbin, CLP, CKI and Power Assets.
China Power - Coal-price weakness continues in winter China’s spot coal prices have been remained weak in recent weeks, despite an early winter. While YoY power-demand growth picked up in October (+6.4%) it was still low historically and down 0.2% MoM. IPPs’ high inventory and expectations of restart of small mines following the CPC’s National Congress also played a role. Even with a coal price rebound from current lows, IPP earnings are likely to rise by 30-130% in 2013. The risk is to the downside for our coal-price estimate, and to the upside for our EPS forecasts for China’s IPPs, which are already higher than the street. Our top picks are CR Power and CPI. Among wind power developers Longyuan has demonstrated the capability to steer around grid difficulties and take advantage of low equipment cost. BUY.
Weak power capacity addition; steady growth in gas usage China’s additions to its thermal-power capacity are down 28% YoY YTD. With low thermal utilisation (50.7% in September 2012, 55.8% YTD) and the country’s IPPs having high (400-580%) net gearing, we do not expect this to reverse anytime soon. Weak equipment demand has pressured ASPs, which are down 10-20% in past two years. This will hurt the earnings of Shanghai Electric, Dongfang and Harbin. Our 2013-14 EPS estimates are 17-52% below consensus: SELL all three. There was increased focus on “ecological progress” in 18th CPC meeting. We believe government will continue to support increased usage of natural gas in China which should support steady revenue and earnings growth for city gas distributors like CR Gas and ENN.
Hong Kong’s utilities - Regulatory challenges CLP needs over 30% tariff hikes by 2015 to pass on the cost of more expensive gas. While the Scheme of Control (SoC) allows them, this will be a political minefield and will bring into focus the high rate of return that the SoC grants the territory’s utilities. CKI and Power Assets’ tax expenses could also rise, with the UK implementing an anti-tax-avoidance law called General Anti-Abuse Rule (GAAR), as well as Australian courts ruling on a tax dispute.
China’s power-demand growth
Source: National Energy Bureau, Statistics of China, CLSA Asia-Pacific Markets
(10)(5)05
1015202530
Jan-
Feb
00
Aug
00
Mar
01
Sep
01
Apr
02
Oct
02
May
03
Nov
03
Jun
04
Dec
04
Jul 0
5
Jan-
Feb
06
Aug
06
Mar
07
Sep
07
Apr
08
Oct
08
May
09
Nov
09
Jun
10
Dec
10
Jul 1
1
Jan-
Feb
12
Aug
12
(%)
Rajesh Panjwani Head of Power Research [email protected] (852) 26008271
Charles Yonts Head of Sustainable Research (852) 26008539
Matthew Li (852) 26008275
Top ideas CR Power 836 HK Rec BUY Market cap US$10.51bn Target HK$23.00 Up/downside +34% CPI 2380 HK Rec BUY Market cap US$1.50bn Target HK$2.45 Up/downside +18% CR Gas 1193 HK Rec BUY Market cap US$4.53bn Target HK$20.00 Up/downside +20% Longyuan 916 HK Rec BUY Market cap US$4.67bn Target HK$6.57 Up/downside +29% Stocks to avoid Dongfang 1072 HK Rec SELL Market cap US$3.88bn Target HK$10.50 Up/downside -19% SH Electric 2727 HK Rec SELL Market cap US$7.42bn Target HK$2.70 Up/downside -11% CKI 1038 HK Rec SELL Market cap US$14.91bn Target HK$41.00 Up/downside -12%
Downside risk to coal price = Upside to IPP earnings We have already factored in an increase in coal prices in China in 2013. Despite that, the country’s IPPs are likely to grow earnings by over 30%, and our estimates for IPP profits are above consensus. IPPs are not likely to cut tariffs due to low coal prices, as 43% of them lost money in August 2012.
China power equipment: Capacity additions stay weak The net gearing of IPP groups is also very high, so the companies plan to add less generating capability. YTD thermal additions are down 22% on the same period in 2011 and we expect 40-50GW of new thermal capacity in China annually in future, which should be enough to meet China’s power-demand growth. Thermal utilisation is likely to remain below 60% even in 2015.
Net gearing levels of large IPP groups in 2011 New coal-fired capacity additions of listed IPPs
Thermal-power utilisation Overseas orders as % of total new orders
Source: National Energy Bureau, CLSA Asia-Pacific Markets Source: Companies, CLSA Asia-Pacific Markets
Nuclear power - A small spurt then a lull China has raised safety standards for nuclear power plants, given serious safety concerns even before the Fukushima accident.
Key conclusions of the State Council Research Office report on nuclear power
Gen-2 design underestimates risk of severe accidents
Only China is building Gen 2 on massive scale
Manpower shortage
Lack of laws and regulations on nuclear safety
Quality of equipment not satisfactory
Limit 2020 capacity to less than 70GW Source: Media articles, CLSA Asia-Pacific Markets
314
266
430
247
583
400
486
465
0 100 200 300 400 500 600 700
Datang
Huaneng
Huadian
CPI
Parent co
Listco
(%)0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
2009 2010 2011 2012 2013
Huaneng CPI DatangHuadian CRP
(MW)
40
45
50
55
60
65
70
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
12C
L13
CL
14C
L15
CL
Total Thermal(%)
22
48
40
4442
55
0
10
20
30
40
50
60
Dongfang Electric Shanghai Electric Harbin Power
2010 2011(%)
There were concerns on China’s nuclear buildout even before Fukushima
New stricter safety standards have been imposed for all the projects targeted after the 12th Five-Year Plan. The new rules imply a much lower risk of radiation leakage and core meltdown compared to the current standard. We understand that the CPR1000 reactor design does not meet the enhanced safety requirements and will need to be redesigned to comply with them, which could take two to three years. During this period only projects with Gen 3 designs (ie, AP1000 and EPR reactors) can be approved.
We expect some AP1000 (and maybe a couple of EPR) reactors to begin construction in the coming years. However, we do not think China will bet big on AP1000 reactors given that they are untested: there are none operating anywhere in the world, and the only ones under construction are in China. Thus, equipment makers will have to wait before the orders begin in a serious way. The risk to our nuclear-order estimates for Chinese equipment in 2012 and 2013 is to the downside.
New orders/revenue for Chinese power-equipment makers
Our assumptions for gross margins over next three years
CLP’s electricity tariff for Kowloon and New Territories Annual tariff hike CLP needs over next few years
Source: CLP, CLSA Asia-Pacific Markets
Returns in Hong Kong versus the UK and the USA Here we compare the returns allowed in Hong Kong with those in the USA and the UK. In the USA, the state regulatory commissions, like the regulator in the UK, sets the revenue requirement of utilities based on operating expenses and returns that are sufficient to attract capital into the sector. According to a study by Fitch, the average allowed cost of equity in 41 rate cases (different state regulatory commissions in the USA) in 2009 and 2010 was about 10.5%. In general, US utilities have commission-approved capital structures typically with 40-60% debt.
10
12
14
16
18
20
22
24
2007 2008 2009 2010 2011 12CL 13CL 14CL
Dongfang Electric Shanghai Electric Harbin Electric(%)
State Regulator Allowed ROE (%) Texas Public Utilities Commission of Texas 9.96 - 10.33 Oklahoma Oklahoma Corporation Commission 10.15 West Virginia Public Service Commission of West Virginia 10.33 Virginia Virginia State Corporation Commission 10.30 - 10.90 Indiana Indiana Utility Regulatory Commission 10.50 Kentucky Kentucky Public Service Commission 9.75 - 10.75 Louisiana Louisiana Public Service Commission 10.57 Arkansas Arkansas Public Service Commission 10.25 Michigan Michigan Public Service Commission 10.20 Source: American Electric Power, CLSA Asia-Pacific Markets
In the UK, electricity, gas and water distribution utilities are allowed to earn a 4.3-5.1% real rate of return on their regulated asset bases. The UK regulator, Ofgem, specifies a debt-to-capital ratio of around 65%, which is used to calculate the assets’ WACC. The real rate of return on equity that UK utilities can earn before performance incentives or disincentives is around 6.7%.
UK - Allowed real rate of return for electricity, gas and water utilities
(%) Power distribution (Apr 2010 - Mar 2015)
Gas distribution (Apr 2008 - Mar 2013)
Gas distribution (Apr 2013 - Mar 2021)
Water distribution (Apr 2010- Mar 2015)
Cost of debt 3.6 3.6 3.0¹ 3.6 Cost of equity 6.7 7.3 6.7 7.1 Debt/regulated asset base 65.0 62.5 65.0 57.5 WACC 4.7 4.9 4.3 5.1 ¹ Ofgem has proposed indexing the cost of debt to iBoxx 10-year simple trailing average index (currently 3.03%). Source: Ofgem, Ofwat, CLSA Asia-Pacific Markets
Allowed return on assets and implied return on equity for Hong Kong utilities
(%) Allowed return on assets ROE in 2010 ROE in 2011 CLP 9.99 20.3 19.9 PAH 9.99 30.5 32.0 Note: The returns earned by Power Assets may not be representative as some of the debt used for the Hong Kong business is intra-company loans at very low interest costs, so CLP’s ROE is more representative. Source: CLP, Power Assets, CLSA Asia-Pacific Markets
Long-term return on equity for Hong Kong’s utilities
Source: Companies, CLSA Asia-Pacific Markets
8
9
10
11
12
13
14
15
16
17
2011 12CL 13CL 14CL 15CL 16CL 17CL 18CL 19CL 20CL
CLP PAH CKI(%)
Regulator sets real cost of equity for UK
utilities at close to 7%
Hong Kong utilities earn much higher ROEs
We expect negligible or negative organic earnings growth for
Renewables in 2013 The outlook for Chinese renewables going into 2013 is very similar to the prospects for 2012 this time last year. Every component going into solar-panel and wind-turbine production is locked into a situation of oversupply, that only huge capacity shutdowns can address. Low costs and stable government-support policies - bolstered under the 12th Five-Year Plan - ensure healthy returns for renewable operators over time. Near term, grid curtailment will continue to be a problem, with wind capacity stranded in the north/northwest and solar capacity stuck in the west, far from the demand loads in the coastal provinces.
In 2012, the leading renewable-energy operator, Longyuan, has demonstrated an ability to steer around grid difficulties while taking advantage of lower equipment prices, unlike its closest peers. Meanwhile, the oversupply-driven slump in prices has hit leading upstream-solar name, GCL. We expect both trends to remain in place in 2013.
Year-to-date (by 20 November 2012), Longyuan had outperformed GCL by 21%. However, Longyuan has still lagged the HSI by 21% YTD on the back of a May announcement that the company would dilute shareholders by up to 18%. The placement has not yet happened and will remain an overhang until it does, which is why Longyuan is not a top pick overall in the Chinese power sector. However, looking through the placement, we rate the stock a BUY. Returns are bottoming as grid infrastructure begins to catch up with demand from late-2013, and support from low turbine prices and strong policy will continue to be consistent. Factoring in an 18% dilution, Longyuan is trading on 0.9x 13CL PB against an ROE of 11%.
Oversupply has driven a 48% decline in polysilicon prices YTD, making it impossible for even the lowest-cost producers to make money. Most manufacturers across the chain are losing money even on a cash basis. And yet, though last November we had expect some first-tier producers to have shut down by mid-2012, this has not happened. Given the horrible balance sheets across the sector, economics will limit the continuing cash losses and we will finally start to see meaningful consolidation in 2013. At that point, prices will stabilise and even rise slightly, and companies will return to a more normalised (if low) margin structures. This could begin to happen as early as 2Q13, but we are not willing to bet on it until we see concrete signs of closures, particularly given the distorting impact of government subsidies and support - around the world but especially in China.
Solar: Same old oversupply story Longyuan: The bottom is not dropping out
Companies mentioned China Power (2380 HK - HK$2.07 - BUY) CR Power (836 HK - HK$17.20 - BUY) Huaneng Power (902 HK - HK$6.39 - O-PF) Huadian Power (1071 HK - HK$2.37 - O-PF) Datang Power (991 HK - HK$2.72 - U-PF) Dongfang (1072 HK - HK$13.02 - SELL) Shanghai Electric (2727 HK - HK$3.05 - SELL) Harbin Electric (1133 HK - HK$6.37 - SELL) ENN Energy (2688 HK - HK$33.80 - O-PF) CR Gas (1193 HK - HK$16.64 - BUY) CLP (2 HK - HK$67.55 - SELL) Power Assets (6 HK - HK$68.50 - SELL) Cheung Kong Infra (1038 HK - HK$46.75 - SELL)
Property - Steady improvement The China property sector enjoyed a year of healing in 2012. Inventory was digested; balance sheets were rebuilt; bigger units were redesigned into smaller and more affordable units; end-users took over investors as the backbone demand; and uncompetitive smaller developers were eliminated. This sets the platform for a stable market and for stronger developers to grow through market-share gains.
Go more Overweight The sector is entering a period of higher growth and lower risk, amid prospects of less policy intervention. We look to a broader recovery with volume growth now spreading to third-tier cities. This is likely to be underpinned by more stable economic growth and continued improvements in the credit environment. Inventory has continued to fall while construction starts have not risen.
Stronger growth at lower risk We expect a modest growth in GFA sold nationwide in 2012 to accelerate and continue into 2013. We forecast the tame price growth of 2012 to pick up due to better supply-demand balance in 2013. And we expect this price rise to be insufficient to trigger government action. Earnings growth will be stronger for companies that can gain market share as smaller players retreat, and firms that can expand future margins by entering the land market now. We look to lower company risk, as most developers have strengthened their balance sheets and improved cashflow.
Five-year gap will close The PE multiples for the China property sector have never really reexpanded. At an average 9.7x 13CL PE, this seems a staggering mismatch with the growth/risk outlook for the sector. The valuation/growth disconnect means upside for investors.
Winning names Companies that have replenished will have the strongest launch pipelines, and hence strongest contract sales, cashflow and earnings growth. These include Vanke and Cogo. Laggards will either benefit operationally from a market pick up or from a multiple normalisation. Suburb developer, Country Garden, slower growth Guangzhou R&F, hiccupped Agile small and less liquid KWG Property will benefit.
Primary market residential sales by GFA (nationwide)
Source: CREIS, CLSA Asia-Pacific Markets
(20)
(15)
(10)
(5)
0
5
10
15
20
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12
(% YoY)
Nicole Wong [email protected] Head of Property Research (852) 260086207
Susanna Leung (852) 26008597
Jackson Hui (852) 26008723
A year of healing
Top idea Agile 3383 HK Rec BUY Market cap US$4.36bn Target HK$13.5 Up/downside +34% Stock to avoid Soho China 410 HK Rec U-PF Market cap US$3.70bn Target HK$5.90 Up/downside +2%
Steady improvement Nationwide sales by gross floor area (GFA) this year have improved steadily from a 15.5% YoY decline in 1Q, to an 8.3% YoY decline in 2Q, to a 7.3% YoY increase in 3Q. Assuming an acceleration to 15% YoY growth in 4Q (off a low base), we expect 2012 sales to finish up 2.4% YoY.
Primary market residential sale by GFA (nationwide)
Weekly sales in 18 cities
Source: CREIS, CLSA Asia-Pacific Markets
The encouraging signals are that first, the recovery in volume has become broader-based, spreading from first-tier to second-tier to now also third-tier cities, likely underpinned by stabilising economic growth and continued improvement in the credit environment. Second, inventory has returned to a more comfortable level but construction starts have failed to rise, which means competition will stay tame to allow pricing power and market share to grow. Third, policy risk is unlikely to suddenly worsen as the current market is driven predominantly by end-users.
(20)
(15)
(10)
(5)
0
5
10
15
20
1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12
(% YoY)
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
Jan 11 Mar 11 Jun 11 Sep 11 Dec 11 Feb 12 May 12 Aug 12 Nov 12
For 2013, we expect growth in sales by GFA to rise further, driven by: stronger economic growth; a normalised credit environment, potentially with a seasonal pick up in 1Q; release of pent-up demand from upgraders who held back in 2012; and improved supply-demand balance. We expect modest growth in GFA sold nationwide in 2012 to accelerate and continue into 2013. We also look to relatively tame price growth in 2012 to pick up due to a better supply-demand balance in 2013. And we expect this price rise to be insufficient to trigger government action. Earnings growth will be stronger for companies that can gain market share as smaller players retreat, and companies that can expand future margins by entering the land market now. Since most developers had strengthened their balance sheets and improved cashflow the company level risk will be lower.
Buyer profile
Source: CRR, CLSA Asia-Pacific Markets
Nationwide sale by GFA Nationwide resi GFA construction start
Source: CREIS, CLSA Asia-Pacific Markets
Companies mentioned Vanke (200002 CH - HK$12.00 - BUY) Cogo (81 HK - HK$8.35 - BUY) Country Garden (2007 HK - HK$3.70 - O-PF) Guangzhou R&F (2777 HK - HK$13.22 - BUY) KWG Property (1813 HK - HK$5.59 - BUY)
Resources - Quality over leverage We expect some recovery in commodity prices in 1H13, but recognise that the cycle has matured. Wide margins and strong balance sheets are key investment attributes; and we see cost performance as increasingly important. We prefer exposure to the defensively positioned companies that have low-cost assets, strong balance sheets and a favourable capital-allocation policy. Top long ideas include Shenhua and Zhaojin. We continue to avoid leverage, including Chalco, Hidili and Yanzhou Coal.
Another tough year Mining equities underperformed through much of 2012 as lower commodity prices lead to negative earnings momentum and weak expected returns on new investment. Jiangxi Copper was the only stock in our coverage that has outperformed MSCI China YTD, while the coking-coal names are the biggest laggards. The cycle has matured, and mining companies’ focus has shifted from growth to cost control and optimising capital expenditure.
Play defence Consistent with our view on the price cycle, our investment strategy remains to favour the defensively positioned companies which have low-cost, profitable assets, strong balance sheets and favourable dividend policies. These companies have less downside earnings risk if commodity prices underperform our expectations, less downside to consensus estimates and less funding risk than higher-leveraged peers. Their valuations are also mostly more attractive. Our preferred names include integrated thermal coal leader Shenhua and leading gold producer Zhaojin Mining.
Margins matter more On average, our 2013 commodity-price forecasts imply a 10-15% increase from spot prices, based on expectation of some recovery in Chinese demand and on cost-curve analysis. This implies on a mark-to-market basis there is downside risk to our earnings estimates, with the impact greatest for producers with thinner margins and hence higher operating leverage; and on companies with stretched balance sheets. Investors should continue to avoid companies that have high-cost assets or high financial leverage, including Chalco, Hidili and Yanzhou Coal.
Costs in focus With commodity markets well supplied, there is less potential variance in prices compared to when markets were tight. Further, unit profitability is lower. Hence, we believe peer-relative cost performance will be an increasingly important factor for companies to deliver earnings surprise and share-price performance.
Bang then fizzle - Share-price performance
Source: CLSA Asia-Pacific Markets
70
80
90
100
110
120
130
Jan 12 Feb 12 Apr 12 Jun 12 Jul 12 Sep 12 Nov 12
Basekt rel to MSCI ChinaCLSA China mining coverage
Andrew Driscoll, CFA [email protected] Head of Resources Research (852) 26008528
Daniel Meng (852) 26008355
Top ideas Shenhua 1088 HK Rec BUY Market cap US$71.71bn Target HK$27.50 Up/downside +19% Zhaojin 1818 HK Rec O-PF Market cap US$4.98bn Target HK$14.80 Up/downside +14% Stocks to avoid Chalco 2600 HK Rec SELL Market cap US$9.10bn Target HK$2.00 Up/downside -39% Hidili Industry 1393 HK Rec U-PF Market cap US$0.53bn Target HK$2.00 Up/downside +2% Yanzhou Coal 1171 HK Rec SELL Market cap US$10.96bn Target HK$9.50 Up/downside -20%
Another tough year After rallying in January on the long-term refinancing operations (LTRO) liquidity event and better sentiment towards China, mining equities substantially underperformed the broader market through September as the country’s slowing demand growth and lower commodity prices contributed to negative earnings momentum and investor sentiment. The confirmation of “open-ended” QE3 in early-September coincided with a shift in investor sentiment towards China and supportive macro data lead to a rally in cyclical equities, and outperformance of the sector. Jiangxi Copper was the only stock in our basket that has outperformed MSCI China year-to-date, while the coking-coal names are the biggest laggards.
YTD share-price performance Resource sector rel to MSCI China
Note: Priced 29 November 2012. Source: Bloomberg, CLSA Asia-Pacific Markets
Much of the underperformance has reflected an ongoing earnings-downgrade cycle as commodity prices lagged expectations. This was particularly true of the thermal- and coking-coal markets, which were sold off during the second and third quarters respectively. On average, we believe earnings troughed during the second/third quarters, but it was loss-making for some companies.
Consensus 2013 EPS change YTD
Note: For SouthGobi, Yanzhou Coal, Chalco, G-Resource, and Rusal, we compare changes of Ebitda consensus. Source: Bloomberg, CLSA Asia-Pacific Markets
Play defence Consistent with our view on the price cycle, we prefer exposure to defensively positioned companies with low-cost, wide-margin assets, strong balance sheets and a favourable capital-management policy. They have less downside earnings risk if commodity prices underperform our expectations, less downside to consensus earnings estimates, and less funding risk than higher-leveraged peers, while earnings-based valuations are mostly more attractive.
Our preferred names include coal-leader Shenhua, which trades on 10x 13CL PE with a 38% Ebitda margin, has a net-cash balance sheet and pays a 4% dividend yield; and Zhaojin for gold exposure, offering an above-2x earnings leverage to the gold price. From a relative perspective, we prefer Fushan among the coking-coal names and Jiangxi Copper among the base metals. The investment risk/reward profile has deteriorated following the recent rally. Investors should continue to avoid companies that have high-cost assets or high financial leverage, including Chalco, Hidili and Yanzhou Coal.
CLSA China mining universe Company Code Rec Mkt cap Last price Target price Up/down Coal (US$m) (HK$) (HK$) side (%) China Coal 1898 HK U-PF 14,311 32.31 7.73 8.00 Hidili Industry 1393 HK U-PF 528 2.80 1.96 2.00 MMC 975 HK U-PF 1,822 2.31 3.92 3.90 Shenhua Energy 1088 HK BUY 71,709 61.62 31.40 37.50 Shougang Fushan 639 HK U-PF 2,039 8.62 2.89 3.00 SouthGobi 1878 HK U-PF 376 0.46 15.66 17.00 Yanzhou Coal 1171 HK SELL 10,955 49.19 11.82 9.50 Metals Chalco 2600 HK SELL 9,095 8.02 3.25 2.00 G-Resources 1051 HK U-PF 891 2.75 0.36 0.36 Jiangxi Copper 358 HK U-PF 10,392 32.12 19.42 20.00 RUSAL 486 HK U-PF 8,823 1.59 4.65 4.50 Zhaojin Mining 1818 HK O-PF 4,980 13.50 13.04 14.80 Zijin Mining 2899 HK SELL 11,842 19.67 3.08 2.70 Note: Priced 29 November 2012. Source: CLSA Asia-Pacific Markets
China mining universe earnings-based valuations Code PE (x) EV/Ebitda (x) Coal 12CL 13CL 14CL 12CL 13CL 14CL China Coal 1898 HK 9.8 8.9 8.4 6.3 5.9 5.1 Hidili Industry 1393 HK 12.0 12.4 6.4 7.9 9.2 6.8 MMC 975 HK 24.4 10.3 6.7 13.7 6.9 4.2 Shenhua Energy 1088 HK 10.7 10.4 10.1 6.3 5.6 5.2 Shougang Fushan 639 HK 10.5 14.4 13.5 3.2 4.0 3.7 SouthGobi 1878 HK - - 39.2 - 10.5 4.8 Yanzhou Coal 1171 HK 8.6 15.3 11.1 7.5 7.2 5.8 Metals Chalco 2600 HK - - - 32.4 14.6 13.1 G-Resources 1051 HK - 49.6 4.0 - 25.2 1.8 Jiangxi Copper 358 HK 10.6 9.0 8.9 7.1 5.3 4.7 RUSAL 486 HK 32.1 9.6 6.9 10.5 7.5 5.3 Zhaojin Mining 1818 HK 17.5 15.8 15.7 10.3 8.9 8.0 Zijin Mining 2899 HK 11.2 7.8 7.9 6.5 4.9 4.6 Note: Priced 29 November 2012. Source: CLSA Asia-Pacific Markets
Margins matter more We expect some recovery in commodity prices from current levels in 1H13, based on an improvement in China’s demand environment and our cost-curve analysis. However, prices will continue to be set off supply curves for the majority of commodities. Copper and gold are best placed to outperform, while winter-weather patterns are a near-term variable for the coal markets.
Among coal stocks, Fushan and Shenhua have the widest margins and Yanzhou Coal the thinnest, while for metals plays Zhaojin is the most profitable and Chalco the worst. Companies with high operating or financial leverage to avoid include Chalco, Hidili and Yanzhou Coal.
Costs in focus With commodity markets well supplied, there is less potential variance in prices compared to when markets were tight. Further, lower prices generally mean lower unit profitability and hence the earnings leverage of operating margins compared to volumes increases. Hence, we believe peer-relative cost performance will be an increasingly important factor for companies to deliver profit surprise, which will contribute to differentiated share-price performance.
Recent meetings with producers and industry contacts in Beijing confirmed our view of the coal industry that cost inflation will moderate, but is very unlikely to be flat or negative. Structural factors of depth and grade depletion underpin rising costs, with limited scope for productivity gains among the big-three (largely fully mechanised). Labour costs are likely to continue to increase, along with materials costs (after rebasing in 2H12). The greatest potential for cost relief is government-related fees. There have been limited reductions so far, and risk of a higher resources fee.
China Coal unit mine-production cost
Note: Per-unit commercial coal production (2003-04 is raw coal). Source: Company, CLSA Asia-Pacific Markets
Shenhua unit mine-production cost
Source: Company, CLSA Asia-Pacific Markets
43
64
182173 180
204 205
230
254 250
(10)
(5)
0
5
10
15
20
0
50
100
150
200
250
300
2003 2004 2005 2006 2007 2008 2009 2010 2011 12CL
(%)(Rmb/tonne) Unit production cost YoY (RHS)
50 5357
6675
95101
111119
127
0
5
10
15
20
25
30
0
20
40
60
80
100
120
140
160
2003 2004 2005 2006 2007 2008 2009 2010 2011 12CL
(%)(Rmb/tonne) Unit production cost YoY (RHS)
An 8% 5Y Cagr to 2011; costs were flat YoY in 2009, and potentially
lower YoY in 12CL
An 11% 10Y Cagr to 12CL, with a steady increase
Cost performance increasingly important to deliver earnings surprise
Cost inflation to moderate, but unlikely to be flat or negative
Consensus cautious, but will lag The sector remains subject to a consensus earnings-downgrade cycle, which is likely to present some headwind when investor sentiment is cautious. However, we note that equity prices always lead consensus forecasts, which is evident in the rally from the September lows: numerous stocks traded up 20-30% despite 3Q12 earnings misses and further street-estimate and analyst-rating downgrades.
Earnings momentum and ratings
Company Code EPS chg¹ Rec chg¹ No.² Analyst rating BUY ratio
Coal (MoM) (2M) (net) BUY Hold SELL (%)
China Coal 1898 HK 1 19 15 7 46
Hidili Industry 1393 HK 1 3 4 13 15
MMC 975 HK 1 8 3 4 53
Shenhua Energy 1088 HK 1 31 8 2 76
Shougang Fushan 639 HK 4 13 8 2 57
SouthGobi 1878 HK 1 8 3 2 62
Yanzhou Coal 1171 HK 4 8 10 19 22
Metals
Chalco 2600 HK 2 0 4 20 0
RUSAL 486 HK - 1 8 12 6 31
Jiangxi Copper 358 HK - 0 13 7 5 52
Zhaojin Mining 1818 HK 3 15 5 3 65
Zijin Mining 2899 HK 1 19 3 1 83
G-Resources 1051 HK - 0 6 1 2 67
¹ EPS revision and recommendation revision: is positive, - is flat, is negative; ² No. is net number of recommendation revisions. Source: Bloomberg, CLSA Asia-Pacific Markets
94117
160 170196
274260 259
289
334
(10)
0
10
20
30
40
50
0
50
100
150
200
250
300
350
400
2003 2004 2005 2006 2007 2008 2009 2010 2011 12CL
(%)(Rmb/tonne) Unit production cost YoY (RHS)
. . . which is likely to present some
headwind when investor sentiment is cautious
A 13% 10Y Cagr to 12CL, with substantial volatility
in cost performance
Subject to a consensus earnings-downgrade cycle . . .
Note: For SouthGobi, Yanzhou Coal, Chalco, G-Resource, and Rusal, we compare Ebitda. Source: IBES, CLSA Asia-Pacific Markets
Wildcards Any upside potential to our cautious stance on the sector is likely through a stronger-than-forecast recovery in commodity prices. This could eventuate should China embark on a major stimulus package, if the Eurozone and US economies enjoy strong synchronised growth, or if there is a series of major commodity supply disruptions. Conversely, there is downside risk to our price target estimates if commodity prices don’t recover of fall further from current levels. This could occur should China’s economy experience no recovery, or there is a further flattening in commodity supply curves.
Companies mentioned Shenhua (1088 HK - HK$31.75 - BUY) Zhaojin (1818 HK - HK$13.14 - O-PF) Chalco (2600 HK - HK$3.30 - SELL) Hidili Industry (1393 HK - HK$1.98 - U-PF) Yanzhou Coal (1171 HK - HK$11.86 - SELL) Jiangxi Copper (358 HK - HK$19.90 - U-PF) Shougang Fushan (639 HK - HK$2.89 - U-PF)
Steel - Improving gradually Chinese steel mills have suffered big losses in 2012 amid sector oversupply, weak downstream demand and elevated raw-material costs. Our ground checks show slow project development in 4Q12, but we expect construction and infrastructure investments to speed up in late-1Q13 or early-2Q13. Output glut remains a key risk, but we are turning more positive going into next year, believing that sector profitability and demand will improve, albeit off a low base.
Bottomed in 3Q12 H-share steel names underperformed in the first three quarters of 2012 and have finally started to rebound this quarter on a pickup in infrastructure investment and recoveries of the macro economy and the property sector. However, our ground checks reveal still-slow development of infrastructure projects, due to local-government transition and weather disruption in northern China. Costs of raw materials, especially iron ore, were a key issue but prices have come off significantly recently.
Slowly improving The real-estate sector will continue to recover, but at a slow pace as buyers are highly sensitive to property prices and marginal easing of government policy. The largest change should come in infrastructure investment. We already see a pickup in railway projects (77% YoY growth) and infrastructure FAI (32% YoY). Our outlook for China’s crude steel output in 2013 is 750m tonnes, up 4% YoY from our 2012 estimate of 715m tonnes. Oversupply in China’s steel sector is an ongoing issue, and poses the greatest risk to pricing in 2013.
Still favour Magang over Angang Among H-share steel names, we still favour Magang over Angang given its superior capacity-growth prospects and exposure to long products. Magang is trading at 0.51x 13CL PB and Angang at 0.59x 13CL, versus a 12CL average of 0.69x for their A-share peers and the 0.71x Asian steelmaker mean. Both names have rallied more than 35% in the past three months on positive macro trends. We believe further upside is limited.
Top idea Magang 0347 HK Rec O-PF Market cap US$2.32bn Target HK$2.10 Up/downside +0% Stock to avoid Angang 0323 HK Rec SELL Market cap US$4.06bn Target HK$4.19 Up/downside -15%
Dark period - Worst profit since the GFC China’s steel sector reported the worst profit since the GFC this year. Stocks were down 20% in the first three quarters due to weak demand amid a slowing macro economy and soft export orders. We believe the industry hit a bottom in August and market sentiment has improved since on news about the NDRC’s accelerated infrastructure investment and property-sector recovery.
Mills have little incentive to cut their production and expect the government to issue some stimulus to boost the sector, resulting in a high crude-steel output level. Our forecast for 2012 is 715m tonnes. Sector net margin turned negative in 2Q12 and reached a bottom of -1.4% in August.
Steel traders have started to clear out their inventory since March, expecting weak downstream demand. According to Mysteel, their inventory is down 36% since February. Our warehouse and trader visits also show dealers’ financial condition has deteriorated in the past nine months and we have heard that several well-known traders have closed down, due to liquidity problems and losses.
Traders clear off their inventory and have low incentive to purchase goods
Source: CEIC, Mysteel, CLSA Asia-Pacific Markets
Sector rally started in 4Q12 with improving sentiment October’s positive PMI and power-generation numbers support our view that the sector has started to rally. Our channel checks also suggest improving market transactions, with traders reporting more new orders from property and infrastructure sectors since September. Prices of long steel have outperformed those of flat products, due to strong downstream demand.
We also find that manufacturers have finally started to restock this month on the back of a gradual recovery of the macro, which also helps flat steel - hot-rolled-coil (HRC) price starts to outperform long steel from November).
Steel mills positive on 4Q12 and 2013 demand outlook Mills hiked their prices in September and have turned more positive on the 2013 outlook. We believe profitability has largely improved and steelmakers should be back to the breakeven point in 4Q12. Our cash-cost model also suggests that both SOE and private mills have started making decent profit since October, with raw-material costs stabilised and steel price recovering.
Rebar-HRC price gap HRC prices
Source: Antaike, CLSA Asia-Pacific Markets
All mills make profit now In November, our calculation for steel mills’ cash profit retain at a decent level, though lower than a month ago, due to rising raw-material costs. SOE mills’ cash profit has expanded compared to October, thanks to a lagging effect of their raw-material contract purchases.
According to our numbers, Angang’s cash profit widens to Rmb142/tonne in November, compared to Rmb53/tonne in October and a Rmb85/tonnes loss in September. Magang’s cash profit was up from to Rmb184/tonnes in October to Rmb234/tonne in November.
Rebar cash profit stabilised at Rmb160/tonne HRC cash profit stabilised at Rmb220/tonne
Cash profit from spot long steel dropped from Rmb349/tonne to Rmb190/tonne in the past month and that from spot HRC is down from October’s Rmb276/tonne to Rmb238/tonne, which is mainly due to the recovery of raw-material prices (iron ore up by 9% and coke up by 11% in October).
Rebar cash profit stabilised at Rmb160/tonne HRC cash profit stabilised at Rmb220/tonne
Angang cash cost Magang cash cost Angang (flat) Nov 2012
Cost (US$/t)
Conversion US$ Rmb
Iron ore 128 1.6 204 1,280 Coking coal 192 0.7 134 842 Scrap 391 0.1 39 245 Alloy 1,755 0.01 18 110 Energy & other materials 40 251 Overhead (labour+R&D+others) 55 345 Overall conversion cost to HRC 15 94 Total domestic cash cost 505 3,166 Price vs
current cost Angang Nov price 528 3,309 Domestic cash profit 23 142
Magang (long and flat) Nov 2012
Cost (US$/t)
Conversion US$ Rmb
Iron ore 133 1.6 213 1,333 Coking coal 158 0.7 111 693 Scrap 383 0.1 38 240 Alloy 1,755 0.01 18 110 Energy & other materials 40 251 Overhead 55 345 Overall conversion cost to HRC 8 47 Total domestic cash cost 482 3,019 Price vs
current cost Ave 50% flat and 50% long price 519 3,253 Domestic cash profit 37 234
Better in 2013 The sector’s profitability should stabilise in 2013 and supply and demand should become more balanced, with improving demand, though the potential key risk is still overproduction. We forecast next year’s spot iron-ore price to reach US$110/tonne, which should be positive for Chinese steel mills.
(400)
(200)
0
200
400
600
800
1,000
1,200
Jan 07 Dec 07 Dec 08 Dec 09 Nov 10 Nov 11 Nov 12(400)
Accelerating downstream demand Our monthly demand indicator chart also shows real-estate FAI was at 21% until September. We believe the property sector will continue to recover, supported by real demand, though the recovery pace will be slow as real-demand buyers are highly sensitive to pricing and marginal easing policy from the government. The largest change should come in infrastructure investment. We already see a pickup in railway projects (77% YoY growth) and infrastructure FAI (32% YoY).
Steel downstream-demand indicator Usage share
Downstream sectors (YoY %)
2009 2010 2011 2012 YTD
11M 11
12M 11
1-2M 12
3M12 4M12 5M12 6M12 7M12 8M12 9M12
Total FAI 31 25 24 21 21 18 22 20 19 20 21 20 19 22 40% FAI real estate 20 34 30 21 23 9 30 24 16 23 20 16 21 22
High steel output still a risk Our 2013 forecast for China’s crude steel output is 750m tonnes, or 4% YoY growth from our 2012 forecast of 715m tonnes. With the macro economy recovering, downstream demand will pick up. However, the oversupply situation is likely to continue in the short term, which will exert pressure on steel prices continuously.
Crude steel output
Source: NBS, CLSA Asia-Pacific Markets
Positive but cautious towards 2013 outlook Strengths Weaknesses
The sector has found a solid floor in 3Q12 with demand gradually improving.
The macro economy continues to recover with further policy loosening, but at a slow pace.
Crude steel output still at a high level with 12CL and 13CL forecasts of 715m tonnes and 750m tonnes.
Crude steel capacity is a possible risk with CISA forecasting total capacity to exceed 900m tonnes in 2012.
Chinese steel technology is still low and the sector still lacks high-value-added products.
We haven’t seen much of a pickup in construction on the ground yet, due to weather disruptions and government transition.
Opportunities Threats (Risks)
Infrastructure investment speeding up. Property developers’ new starts and construction
accelerate. The manufacturing sector starts to recover with
improving macro-economy sentiment. The government may issue subsidy to boost steel-
product exports.
Overall steel demand growth slowed with overcapacity and margins staying thin in 2013.
Raw-material costs get volatile again, causing cost pressure. Mills have no incentive to cut output even though they are loss-
making, due to pressure from local governments to pay taxes and keep employment.
Source: CLSA Asia-Pacific Markets
Prefer Magang to Angang Magang is trading at 0.51x 13CL PB and 0.49x 13F. We downgraded it on 18 October from BUY to Outperform due to book-value erosion last quarter. However, we still prefer the stock to Angang considering its better product structure and capacity-growth prospects.
Angang is trading at 0.59x PB 13CL and 0.49x 13F. We are SELLers and advise investors take profit now as it has rallied 30% in the past two months.
40
45
50
55
60
65
70
Jan 11 Jun 11 Nov 11 Apr 12 Sep 12 Feb 13 Jul 13 Dec 13
Shougang Intl is trading at 0.31x PB 13CL and 0.25x 13F. We still like it as an integrated mill with upstream resources.
Since mid-October, Angang is down 0.2% and Magang is up 1.5%. Our BUY call on Shougang Intl goes well and the stock is up 19.2% since early June; we maintain our BUY call.
Technology - Few themes Few themes will drive the technology sector in 2013. We recommend focusing on Lenovo’s market-share gains in emerging markets (EMs) despite our overall negative view on PCs, and on low-end smartphone growth through AAC Tech. We believe the best diversified exposure to the growth of “made-in-China” tech products and increasing Chinese consumer demand is through diversified distributions, such as WPG.
PC overall depressed but emerging markets growing We forecast PC units to developed markets to keep declining in 2013 (-9%) - the culprit in the enterprise space will be a lack of employment growth, and in the consumers segment, it will be due to competition from tablets. At the opposite end, we forecast PC units to grow by about 7% in emerging markets, mainly driven by consumer notebooks. Low household penetration rate, reduced price points and different purchasing priorities support our positive view with on EM consumer notebooks. Asustek and Lenovo are gaining market share in EMs, hence our positive view on the stocks.
Smartphone - Explosive growth in the low end The shipment of premium segment of smartphones is decelerating sharply to about 20% in 2013-14 but we forecast the entry-level segment (sub-US$100) to expand by 160% in 2013 and 50% in 2014. Growth in the low end is supported by rapidly declining prices and the emergence of a China-based supply chain reminiscent of the feature-phone boom over 2006-10. Major brands such as Huawei, Lenovo and ZTE have already established solid market positioning in this segment but most phone makers are unprofitable. We recommend gaining exposure to this segment through component vendors such as AAC Tech and A-share-listed Anjie and Goertek (Fortune CLSA).
Positive on WPG We remain long-term positive on ASM Pacific on the back of the surface-mount-technology (SMT) acquisition and despite short-term slowdown in wirebonding capex. We believe WPG is among the best proxy for exposure to China’s tech manufacturing and consumption of lower-end products and firm-specific risk. We remain negative on ZTE as revenue growth is derived from smartphone growth (breakeven), and structural headwinds of shrinking soft loans from Chinese banks and growing bargain power of Chinese telcos are likely to persist into 2013.
China retail sales YoY 3mva
Source: National Bureau of Statistics of China, CLSA Asia-Pacific Markets
(20)
(10)
0
10
20
30
40
50
60
Jan 06 Feb 07 Mar 08 May 09 Jun 10 Aug 11 Sep 12
Communication equipment Audiovisual equipment(%)Audiovisual
equipment turned weak since May 2012
Nicolas Baratte Head of Technology Research [email protected] (852) 26008325
Cherry Ma (852) 26008704
Top idea AAC 2018 HK Rec O-PF Market cap US$4.83bn Target HK$31.30 Up/downside +8% Stock to avoid ZTE 763 HK Rec SELL Market cap US$4.61bn Target HK$9.10 Up/downside -22%
PCs - Growth in emerging markets This year has seen weak overall PC growth in both developed and emerging markets as 2Q-3Q12 volumes came in lower than previous seasonality and we do not expect a dramatic rebound in 4Q12. We estimate a 3.6% YoY decline for 2012 - the first negative growth since 2001. Developed-market contraction is structural with negative growth of 8% YoY in 2011 and we project -9% in 2012, but spending cutback in emerging markets this year should be cyclical as the enterprise and consumers subsegments are very sensitive to macro trends. For 2013, we forecast 1.6% YoY growth in overall PC with the rebound coming from emerging markets but we continue to see declines in developed markets.
Emerging markets are macro-sensitive and have experienced a dip in 2012, similar to the 2009 period when economies were weak with spending cuts. PC demand there rebounded sharply in 2010 as soon as the macro environment recovered, and we expect a similar situation in 2013. We expect EM PC demand to grow 9% YoY next year.
Enterprise PCs: GDP and employment growth are key to EM enterprise computer spending. Forecasting negative enterprise PC growth would be equivalent to projecting no employment growth. We forecast this segment to grow 5% in 2013 and 2014.
Consumer PCs: Low household PC penetration in EMs (average of 26% in 2010) continues to support growth of the consumer segment, particularly in India, Indonesia and South Africa, where penetration is below 18%. We expect EM consumer PC demand to grow 11% and 8% in 2013 and 2014.
We forecast overall EM PC demand to rebound to 9% YoY in 2013 as we expect the macro environment to turn better. We advise not to reach structural conclusions as the 3Q12 decline should be short-lived.
Desktop growth Notebook growth
Source: Gartner, CLSA Asia-Pacific Markets
China and BRIC PC growth in China has slowed significantly in 2012 on the back of negative growth in the enterprise segment, due to the slowing economy. Comparing 1Q-3Q12 with 1Q-3Q11, overall PC only grew 1%, given a 6% YoY decline in enterprise PCs versus 11% growth in consumer PCs. We do not expect a dramatic rebound in 4Q12, hence our flat to low-single-digit growth projections for 2012. For 2013, we expect China’s economy to stabilise and enterprises to turn less conservative in their tech capex, and consumer spending to improve as household PC penetration was still low (35% in 2010).
PC household/consumer penetration in emerging markets, 2010 (%) Household Household Mobile phone/ PC penetration internet access 100 person Brazil 35 27 104 China 35 24 64 India 6 4 61 Indonesia 11 4 92 Russia 50 42 166 South Africa 18 10 100 Average 26 16 73 Source: World Bank, CLSA Asia-Pacific Markets
On top of emerging-market growth, Asustek and Lenovo are gaining market share, mainly at the expense of HP and Acer. This is the core reason for our positive view on the stocks. The firms are exposed to the only growing geography and are increasing share while all other vendors are flat or down.
China notebook and desktop YoY China notebook market share by brand
Source: Gartner, CLSA Asia-Pacific Markets
Lenovo: PC to PC+ Lenovo has weathered weakness in China surprisingly well. It has a few levers of margin improvement. First, Lenovo’s share of China smartphones was 14.2% in 3Q12, ranking a close No. 2 to Samsung’s 15% share. As it sells phones via higher-margin retail channels, we expect its smartphones to break even in 2Q13. Also, Lenovo is increasing the mix of high-end, higher-ASP models (ie, Rmb2000 range), which carry better margins. Second, the move to in-house production (we expect 30-40% of notebooks to be made in-house in 2013, up from 20% in 2012) will help the company capture more value. This, together with loss-making regions (eg, Europe, Middle East, and Africa) turning round, suggests notebook margins can expand. Lenovo’s balance sheet shows the move to in-house PC production is panning out a lot faster than expected.
Smartphones - Made-in-China rules Blended smartphone ASP continues to decline YoY as competition intensifies and brands lack differentiation since advanced specification, such as quad-core CPU, large screen and 8Mpx camera, exist in both low-end and high-end phones. Brands with high-end specifications such as HTC and Nokia cut their ASPs in the past year to compete with mid-end models, while low-end brands
(20)
0
20
40
60
80
100
1Q08 4Q08 3Q09 2Q10 1Q11 4Q11 3Q12
Notebook
Desktop(%)
0
10
20
30
40
50
1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12
Lenovo ASUS AcerDell HP
(%)
Asustek and Lenovo are gaining market share
Lenovo has weathered weakness in China
surprisingly well
Blended smartphone ASP continues to decline YoY
China PC has slowed this year due to weakness in enterprise market
such as Lenovo, Huawei and ZTE are shipping more cheaply priced phones with mid-end specifications. As prices come down, affordability increases, thus we expect 2013 global smartphone shipment to grow 44% and 66% YoY in China alone.
Low-end explosive growth dominated by Chinese firms We forecast high-end smartphones to slow to about 20% of total shipments in 2013-14, while entry-level models are seeing explosive growth from 100m in 2012 to 400m in 2014. All low-end smartphones are made in China by either Chinese brands (Huawei, ZTE, Lenovo) that have both low- and mid-end models (from US$50-200) or by whitebox (unbranded) makers that only focus on entry-level phones below US$100.
Chinese vendors’ market share We forecast the three major Chinese brands - Huawei, ZTE and Lenovo - to double their shipments to 2014 and progressively focus on higher-priced phones and on overseas markets, where margins should be wider than in China. The branded makers slowly abandoning the very low-end segment also reflects low profitability and difficulty to compete with a myriad of small-phone makers.
Shipment forecasts (low- and mid-end)
(m units) 2010 2011 12CL 13CL 14CL
ZTE 0.0 12.6 24.4 40.0 50.0
Huawei 2.4 16.8 28.3 50.0 62.5
Lenovo 0.4 3.5 22.6 36.0 46.8
Coolpad 1.3 5.1 12.2 20.0 26.0
TCL 0.1 1.4 6.7 10.0 13.0
Gionee 0.0 0.0 6.2 8.5 11.1
Xiaomi 0.0 0.4 5.8 9.0 12.2
Total branded 4.2 41.2 124.5 225.3 307.6
Whitebox 0.4 3.1 54.7 177.3 253.4
Total China smartphones 4.7 44.3 179.2 402.6 561.1 Source: Gartner, Strategy Analytics, CLSA Asia-Pacific Markets
We have seen a very rapid increase in the number of “unbranded” phone makers (or at least very confidential brands) in 2012, from less than five firms a year ago to more than 20. We expect this number to keep rising as the barriers to entry keep declining thanks to reference design provided by semiconductor vendors Mediatek and Spreadtrum.
We forecast the unbranded segment to increase 5x from 2012 to 2014 or from 50m to 250m. This is similar to the feature-phone era of 2005-10, when Mediatek has hundreds of clients in China, each making less than five million phones per year.
As such, we estimate that Chinese brands and unbranded whitebox phones to dominate 74% of the low-end segment and 47% of mid-end space, where few foreign brands will be able to compete profitably, with the exception of Samsung due to its lower cost structure, bigger scale and reach of the brand.
One of the major reasons for exponential growth of low-end smartphone demand is rapidly declining costs. We estimate that the price of entry-level models has dropped from US$73 at the end of 2011 to US$48 and believe that costs will keep plummeting, due to lower IC prices and cheaper reference design costs by Mediatek, Spreadtrum and RDA.
Smartphone 3.2” entry price Mainstream Chinese smartphones prices
Source: CLSA Asia-Pacific Markets
5
41
26 30
47
2510
8
4
6
6
13
8
5
8
74
47
17 15
0
10
20
30
40
50
60
70
80
90
100
Entry-tier Mid-tier High-tier Premium-tier
Apple Samsung HTC Sony Nokia RIM Others(%)
73
65
59
53 51
48
45
50
55
60
65
70
75
80
Dec 11 May 12 Sep 12 Mar 13
(US$)
94
84
76 69 69 66
129
115 110 110
105
60
70
80
90
100
110
120
130
140
Dec 11 May 12 Sep 12 Mar 13
(US$) 3.7" low-end 4.5" mid-end
Rapid increase in the number of “unbranded”
phone makers
Chinese brands and unbranded whitebox phones to dominate
the low-end segment
Rapidly declining costs a strong driver
Collapse of smartphone prices
Majority of entry and mid-tier “others” are non-branded Chinese
China handset whitebox shipments China handset shipment mix
Source: CLSA Asia-Pacific Markets
Two important side effects of the rapid growth in low-end smartphones and rapid cost decline:
Shipments of feature phones are collapsing and their remaining product niche is the ultra-low end with ASP below US$15.
The vast majority, if not all, Chinese smartphone makers are unprofitable.
Emerging-market penetration We estimate global smartphone penetration has reached 35% in 2012 and will reach 64% by 2016.
China. Smartphone penetration in China is estimated at 38% in 2012, a big increase from 14% in 2011. As smartphone ASP further declines, we expect feature-phone users to migrate to low-end smartphones. We project smartphone volume to deliver a Cagr of 26% over 2012-16, which feature phones should decline at a 15% Cagr. China is leading in terms of penetration compared to other emerging markets (38% in 2012 YTD) and we forecast a continuously rapid increase, with the market reaching saturation by 2015-16 at the 70% level.
Penetration of smartphones has been slower in other emerging markets, especially Asia Pacific ex-China, where the penetration rate will only reach 40% by 2016, and Latin America, where we forecast a higher penetration rate but still 20ppts below that of China.
Similarly to China, increasing penetration rates in these regions are predicated upon declining prices. We believe Chinese smartphone makers will capture an overwhelming proportion of the market and that Chinese firms will start exporting (to other emerging markets) in very large volumes in 2013.
ZTE - Lost ground in Asia Pacific ZTE’s smartphone shipments increased by 3% QoQ (58% YoY) in 3Q12 to 6.0m units. Its global market share stabilised at around 3-4% in 3Q11-3Q12. In 3Q12, ZTE lost ground in Asia Pacific with its market share falling below 5% (versus Lenovo at 8%). This was the first time ZTE saw a market-share drop in the region, due to intensified competition from Huawei, Lenovo and Chinese whitebox vendors.
In mid-November, ZTE debuted its quad-core smartphone, ZTE U950, featuring a 4.3-inch display and 5Mpx camera with a price tag of Rmb999 (about US$160) without subsidies. A year ago, the same price can only buy a single-core smartphone with 3.5” display and 3Mpx camera. It’s unlikely for ZTE to make a profit on this aggressive pricing. Gross and operating margins of its smartphone business will remain depressed.
Lenovo - Soaring in Asia Lenovo’s smartphone shipments jumped 28% QoQ (1,126% YoY) in 3Q12 to 6.4m units, the first time it beat Nokia and ZTE after overtaking Motorola in 2Q12. The company’s global market share of 3.4% was up from 3.1% in 2Q12 and 0.4% in 3Q11 thanks to booming shipments in China. Asia accounted for 100% of Lenovo’s total shipments.
Lenovo’s A800 and A789 are two of the 13 new mass-market smartphones launched by Unicom in September 2012. The A800 is equipped with Mediatek’s 1GHz dual-core processor, a 5Mpx camera and a 4.5-inch display with a price tag of about Rmb1,000. The A789 features MEDIATEK’S 1GHz dual-core processor, a 5Mpx camera and a 4-inch display and is priced at less than Rmb1,000. With an aggressive marketing and pricing strategy, better brand awareness and strong relationships with operators, Lenovo is likely to continue gaining share in China. The company is likely to exceed LG, HTC and RIM in the following one to two quarters.
AAC - Beat competitors AAC has fared better than upcoming rival GoerTek. We believe this is because of its faster learning curve for Apple’s new components. ACC sees further margin drivers. First, the mix shift to speaker boxes (AAC’s highest-margin component) is accelerating. Less than 10% of Chinese vendors use speaker boxes. Management expects to ship 4m units to the Chinese in the coming quarter, which would grow its overall speaker-box volumes by about 7-10%. Second, the final phase towards automation will be completed by end-2012. Third, microelectrical-mechanical-system microphones are growing in scale. AAC’s in-house die manufacturing can help lower costs here in 2013.
ASM Pacific - SMT acquisition While the SMT industry is going through a cyclical downturn, ASM has used the past two years to gain share. Evidence can be seen in comparing the performance of its SMT division versus leader Fuji Machine.
In 3Q12, ASM’s SMT sales rose 17% QoQ, a strong showing. This comes after a solid 2011, when the figure rose 18% YoY, versus Fuji’s 10% decline YoY. Over 1Q-3Q12, the number fell 30% YoY, on par with Fuji, which saw a 26% YoY drop. Even in a cyclically slow environment, ASM has held its SMT margins flat at 10%.
These share gains give us comfort that ASM’s customers are happy with its move to in-house component production. Hundreds of components are in the process of field trials, with mass production starting in 4Q12. With this, we expect ASM’s SMT margins to expand.
ZTE - No lights in the tunnel yet ZTE manufactures and provides telecom equipment, handsets and telecom software, services and other products. Its smartphone global market share was 3% in 3Q12. Its smartphone market share in China was 6% in 3Q12, followed by Lenovo, Samsung and Huawei.
ZTE’s 2H12 and 2013 revenue drivers will come from smartphones (24% of total sales) and service & other products (17%), eg, Wi-Fi routers. However, both command lower-than-corporate-average gross margin. This implies margin pressure will continue in 2H12 and 2013. ZTE’s smartphones are unlikely to make profit in the coming quarters, due to aggressive pricing strategies of its local peers, eg, Lenovo and whitebox makers.
We believe the structural headwinds of shrinking soft loans from Chinese banks and growing bargain powers of Chinese operator-customers will persist into 2013. We reiterate our SELL rating. Our target price of HK$9.1 is based on 12x 13CL PE.
Telecoms - 4G in 2013 China Mobile was the best performer in 2012 with 20% total return YTD. It should continue to do well with growing TD-SCDMA smartphone users and 4G migration. The government and small operators expect 4G licensing in 2013 and China Mobile is likely to be the first to launch 4G commercial service, hence it is our long-term pick. We also like China Telecom: competition could ease in 2013 as Unicom has to focus on profitability and Telecom can use the opportunity to accelerate high-end user acquisition and revenue growth with iPhone 5. This may slow its 2013 earnings expansion, but a 20% Cagr in the longer term is possible.
3G growth to accelerate China Mobile was the best-performing Chinese telco in 2012 with a total return of 20%. The strong performance could continue with growing TD-SCDMA (TD) smartphone users and 4G. China’s 3G growth could surprise with better low-cost smartphones and China Mobile is finally getting competitive TD smartphones and pushing growth. The country could continue to add 10m new 3G users (or 6-7m smartphone users) per month. Competition could ease as Unicom has been pressured to improve profitability.
4G service in 2013 China Mobile has started rolling out 4G network. It is likely to be the first to launch 4G commercial service in late 2013. It network will cover 100 key cities. The Ministry of Industry and Information Technology (MIIT) expects 4G licensing in 2013 and has done with spectrum allocation (120MHz for FDD and 190MHz TDD-LTE). It is incentivising small telcos to do TD. Small telcos also prefer early 4G licensing as China Mobile will have a big head start. TD-LTE prospect has improved with China potentially having two TD-LTE operators and Softbank launching TD-LTE network in Japan and the USA. 4G capex should be incremental. China Mobile’s 4G capex could be around Rmb20bn in 2013 as most 4G base stations could be upgraded from 3G.
Top picks We are Overweight telcos with China Mobile and Telecom as preferred plays. China Mobile is an attractive defensive play with a 4% yield and 4G option. Earning should stabilise in 2013 and can regrow with 4G. Telecom could accelerate revenue growth by adding high-end users. It will launch iPhone5 along with Unicom in December. Its iPhone5 net adds could reach 3-4m, compared to 2m for iPhone 4S. Greater iPhone user growth could lead to higher subsidies and lower earnings, which may grow 20% in 2013 versus our forecast of 30%. Yet, future earnings could sustain a 20% Cagr. Valuation is reasonable at 13.9x 13CL PE.
YTD performance
Source: CLSA Asia-Pacific Markets
3
7
13
16
(9)
(2)
18
(5)(5)(2)
13
(26)(30)
(20)
(10)
0
10
20
1M 3M 6M YTD
(%)
China Mobile China Telecom China Unicom
Elinor Leung, CFA Head of Asia Telecom & Internet Research [email protected] (852) 26008632
China Mobile could continue to do well
Top ideas China Mobile 941 HK Rec O-PF Market cap US$228.12bn Target HK$100 Up/downside +13% China Telecom 728 HK Rec BUY Market cap US$45.85bn Target HK$5.5 Up/downside +31% Stock to avoid Unicom 762 HK Rec U-PF Market cap US$37.59bn Target HK$13 Up/downside +8%
China Mobile - Total return of 20% YTD China’s telecom sector has done well in 1H12, although it has been a laggard in the recent market rally, underperforming MSCI China by 4% YTD. However, China Mobile has been the best performer among Chinese telcos and outperformed MSCI China by 8% YTD (including yield). It has benefited from accelerating 3G user growth with competitive TD-SCDMA smartphones and government accelerating 4G licensing process.
Unicom has been the worst performer in 2012 as its earnings disappointed. Consensus forecast for 2012 has been revised down by 25% since the beginning of the year. 3G user growth has fallen behind the rumoured 50m new-user target.
China Telecom has been pressured by iPhone subsidies concern. However, its earnings have met market expectation. The company has bought back its CDMA network from the parentco at favourable terms. Total acquisition price was at book value and was only Rmb115bn, of which Rmb30bn was non-interesting bearing liabilities. Telecom only has to pay 30% of the remaining Rmb85bn upfront. The rest can be paid over five years at an interest rate of 4%. The deal is earnings-accretive (5% for 2013 and 15-20% for 2014).
YTD performance of China telcos versus MSCI China YTD performance of Chinese telcos
Source: Bloomberg, CLSA Asia-Pacific Markets
3G growth to accelerate China’s 3G user growth could surprise in 2013 with better low-cost smartphones and China Mobile is finally getting competitive TD-SCDMA smartphone and pushing growth. China’s 3G net adds reached 10m in September, of which 60-70% were smartphone users. The growth momentum should continue in 4Q12 due to seasonality and new smartphone launch. China Unicom launched 13 new models with 4-4.5” screen in September. China Telecom has showcased a new generation of low-cost smartphones with 4.7” screen and 1.5GHz processor.
TD-SCDMA smartphones have also caught up with their peers and are comparable to WCDMA in term of selection, pricing and launch time. China Mobile with a big handset-subsidy budget (Rmb26bn) has accelerated its smartphone user growth. It has led 3G user growth in China since August 2012 and 3G net adds reached 3.45m with a 35% share in September.
We expect China to continue to add about 10m new 3G users (or over 6m smartphone users) per month in 2013. The three Chinese telcos should maintain about one-third of market share each. Despite its strong balance sheet, China Mobile is likely to cap its 3G market share at 33% before 4G
licensing. Otherwise, this could increase its dominance concern and delay 4G. The fast-growing data traffic could also overload its TD-SCDMA network which has limited 3Mbps download speed.
Growth in 2G users will slow. China Telecom’s 2G user base has even started shrinking. However, this is unlikely to be an issue as 3G users generally generate 20-30% higher Arpu with data usage.
China 2G and 3G users China mobile user growth (2G + 3G)
3G users 3G net adds
Source: Companies, CLSA Asia-Pacific Markets
Competition could ease Competition could ease as Unicom has to focus on profitability. The Sasac has been concerned about the low ROE of China SOEs and has pressured them to improve profitability. Unicom has to cut back subsidies and avoid aggressive price cut to achieve profit target set by the Sasac. The target will be even higher in 2013.
Unicom has removed subsidies for low-end 3G plans (monthly plan less than Rmb66) in 2012. It also offered 10-15% lower handset subsidies than its peers. Its new products are either priced attractively or with restrictions and have had limited impact. For example, its Rmb20 prepaid plan has lowered the entry level for its 3G services, but the data pricing of the Rmb20 prepaid plan is more expensive than its standard 3G plans. Its new 3G data plans do offer attractive data pricing (Rmb0.06-0.10/MB versus standard Rmb0.15-0.30), but the plans are only available to 2G users and its old 3G users.
China Unicom’s 3G user growth has fallen behind its peers, likely due to its reduction of subsidies. Unicom has removed subsidies for low-end 3G plans (<Rmb66). Its subsidies is generally 10-15% lower than China Telecom and China Mobile. The competitive CDMA2000 and TD-SCDMA smartphones make it increasingly difficult for Unicom to compete for mid- to high-end users with lower subsidy. Unicom may be pressured to raise subsidies again to remain competitive. It has raised the subsidies for its new WCDMA smartphones with 4-4.5” display to about 40% of Arpu (versus standard of about 30%), but this is still lower than its peers’ 40-50%.
4G in 2013 China Mobile has already started rolling out its 4G network in China. It targets to deploy 200,000 4G base stations by end-2013. This has showed its commitment to TD-LTE equipment and handset vendors and pressured government and small operators to accelerate 4G licensing. The strategy has worked well. China Telecom and Unicom also want an early 4G licensing now. Otherwise, China Mobile will have a strong head start in 4G. We expect 4G licensing in mid or late 2013. China Mobile is likely to launch commercial 4G service in late 2013. TD-LTE prospect has improved with China potentially having two TD-LTE operators and Softbank launching TD-LTE in Japan and the USA (through its acquisition of Sprint, which owns Clearwire). 4G capex should be incremental as most China Mobile’s TD-SCDMA 3G base stations can be upgraded to 4G.
MIIT now expects 4G licensing in 2013 Minister of the MIIT now expects 4G licensing to be in 2013 instead of two to three years away. The government has also allocated additional 190MHz spectrum at 2.5-2.65GHz for TDD. Total spectrum for TDD increases to 330MHz (at 1.9GHz, 2.3GHz and 2.6GHz frequency bands). The 20MHz spectrum at the 1.9GHz frequency band, which is used by PHS, will also be reallocated to TDD when the network is terminated. However, China has only allocated 2x60MHz spectrum at 1.9GHz and 2.1GHz for FDD-LTE. China has incentivised China Telecom and Unicom to do TD-LTE by offering them large spectrum, but require them to have min TD-LTE base stations deployment commitment. The spectrum allocation is still under negotiation. China Telecom may eventually get both FDD and TDD-LTE spectrum. The government is ready to issue 4G licences once they finalise the spectrum allocation. No 4G auction or payment is required.
Small operators also want a 4G license China Unicom and China Telecom have been lobbying hard to delay 4G licensing given their 3G technology advantage. However, small operators are now facing a dilemma and also want a 4G licence early. If government issues 4G licences by end-2013, China Mobile will have a one-year head start of rolling out 4G. Its 4G network will cover 100 key cities in China and it can launch commercial service soon after receiving a 4G licence. This will put China Telecom and Unicom in a big disadvantage as all high-end smartphones now are 4G phones. They can only narrow the 4G deployment gap with China Mobile by getting a 4G licence early.
TD-LTE prospect has improved Softbank is a big supporter of TD-LTE as it starts off as an internet company and it has limited FDD spectrum. It expects 70% of future mobile traffic to be running on TDD-LTE network. Its recent acquisition of Sprint, which owns 49% of Clearwire, should also help boost the global scale of TD-LTE. Clearwire
China Unicom’s 3G user growth has fallen
behind its peers
China Mobile has started rolling out its 4G network in China
has 160MHz spectrum at 2.5GHz, largest among all US telcos. It is in financial trouble with US$4bn debt and was loss-making over the past five years. With the backing of Softbank, Sprint could buy out Clearwire and its spectrum and roll out an extensive TD-LTE network in the USA. TD-LTE could be more competitive with FDD-LTE if three of the world’s largest telecom markets roll out the technology at the same time. Emerging markets like India and Africa incline to adopt TD-LTE as paired spectrum is limited and 4G will need to support wireless broadband services for large data-consumption devices such as PCs and tablets. Qualcomm has already produced global chipset, which supports both FDD/TDD-LTE. Handset vendors will be willing to produce compatible FDD/TD-LTE phones if TD-LTE has attractive scale.
4G capex could be Rmb20bn for 2013 China Mobile does not provide 4G capex guidance for 2013 yet, but its 4G capex could be less than Rmb40bn. The company spent about Rmb4bn on 4G to build 20,000 base stations in 2012. Capex could be around Rmb40bn if it is planning to build out 200,000 new 4G balance in 2013 based on back-of-the-envelope calculation. However, the upgrade cost of a 3G base station to 4G is only 15% of building a brand new base station. 4G capex should be lower than the Rmb40bn, depending on the split of upgraded and new base stations. Over half of the planned 4G base stations in 2013 could be upgraded from 3G.
China Mobile is better off to upgrade existing 3G base stations to 4G as the upgrade cost is low and the 4G base stations will be run on 1.9GHz. It needs to continue to expand its 3G network to optimise and improve coverage, serve the mass market and ease political pressure. However, there is limited downside for the 3G network expansion if it can be upgraded to 4G. The parentco has been spending Rmb20bn to deploy 3G base stations per year and could increase the capex to Rmb40bn in 2013 (3G and 4G). It will be responsible for 4G capex at least before 4G licensing. China Mobile doesn’t have a schedule for buying back the 3G/4G network from the parent. However, any acquisition should be favourable to the listco, given its historical track record among Chinese telcos. The listco is likely to maintain a steady Rmb130bn capex for 2G, Wi-Fi and core network expansion with more allocation to the latter.
China Mobile can regrow its dominance with 4G China Mobile can regrow its dominance with 4G given its large market share (70%), big balance sheet (US$50bn net cash), strong brandname and competitive technology. The company’s net-adds market share could rebound to 60-70% (versus below 50% now). It could maintain a dominant 60-70% mobile market share in the long term. However, the competitive landscape will not be as biased as pre-2008. 4G is all about data and is a different ball game for telcos. China Telecom may have a competitive edge with its extensive fixed broadband network to provide fast data services and competitive bundled packages.
Better earnings iPhone launch and accelerating 3G smartphone user growth depressed Chinese telcos’ earnings in 2012 but improvement ensues in 2013, on higher revenue from smartphone users. Unicom should generate the highest growth, but from a low base. Net margin is only at 3%. Risk is on the downside as revenue could disappoint with more new users from low-end markets.
China Mobile 4G capex could be less than Rmb40bn in 2013
China Telecom should generate attractive 20-30% earnings growth in 2013. Its profit will be relatively resilient, benefiting from accelerating 3G and mobile-data growth and earnings accretion from CDMA acquisition. The company enjoys higher operating efficiency as its CDMA network operates at 800MHz with better coverage and lower upgrade cost.
China Mobile’s earnings may stabilise in 2013, but growth is likely to remain modest before 4G launch as TD-SCDMA network has limited 3Mbps download speed, which limits data services. 4G can accelerate revenue growth by providing bigger data capacity, lowering pricing and releasing data demand. China’s data demand is strong given its large internet market and vast amount of free content. However, data is expensive in the country given limited capacity and network. 4G capex should be incremental (Rmb20bn) as over half of the planned 200,000 base stations in 2013 could be upgraded from 3G. China Mobile’s parentco will invest in 4G capex before licensing. The listco’s capex should be stable in 2013 and its earnings growth could return to 5-10% post 2014.
Ebitda growth Net earnings growth
Source: Companies, CLSA Asia-Pacific Markets
Data supports revenue growth China’s mobile revenue can continue to grow at a stable 11% YoY rate in 2013 on healthy user additions and strong mobile data usage. Mobile data (ex SMS) is likely to grow at a robust 26% YoY next year and reach 31% of total service revenue. Mobile voice will continue to expand at mid-single-digit rates driven by increasing adoption in rural places. China Mobile continues to add 2m new 2G users per month, mostly from rural areas.
Service revenue growth
Mobile service revenue growth
Fixed-line service revenue growth
Source: Companies, CLSA Asia-Pacific Markets
5 5
(1)
2
5
2
7
16 16
14
7 7
2 3
10
(2)
0
2
4
6
8
10
12
14
16
18
2010 2011 12CL 13CL 14CL
(%) CM CU CT
4 5 0 2 5
(60)
15
65 64
46
15 7
(10)
21 22
1 6
1 7 10
(80)
(60)
(40)
(20)
0
20
40
60
80
2010 2011 12CL 13CL 14CL
(%) CM CU CT Total
7
10 9 98
0
2
4
6
8
10
12
14
16
2010 2011 12CL 13CL 14CL
(%) CM CU CT Total
11 14 11 11 10
0
20
40
60
80
2010 2011 12CL 13CL 14CL
(%) CM CU CT Total
(3)
(1)
22
2
(5)(4)(3)(2)(1)012345
2010 2011 12CL 13CL 14CL
(%) CM CU CT Total
China Telecom may grow profit by 20-30% in 2013
China Mobile’s earnings may stabilise
China’s mobile revenue can continue to grow 10-11% YoY in 2013
China Telecom may maintain robust 30% mobile service revenue growth or 12% total service revenue growth in 2013 (versus 11% in 2012). Next year presents a great opportunity for the company as Unicom focuses on profitability and China Mobile has yet to launch 4G service. China Telecom may take the chance to grow its high-end user base. It will be launching iPhone 5 along with Unicom in December 2012 and may boost its iPhone 5 net adds to 3-4m, compared to 2m for iPhone4S.
Data revenue growth Data as a share of Arpu
Source: Companies, CLSA Asia-Pacific Markets
Arpu declines at a slower pace China Mobile’s Arpu will continue its downward trend in 2013 as 2G user growth remains strong and given the transition from voice/SMS usage to mobile data usage. However, the decline should narrow given growing smartphone users. Mobile apps such as Tencent’s WeChat will have a negative impact on telcos’ Arpu initially, as they offer free messaging and VOIP service over the internet. However, it is positive for the long term as it accelerates smartphone migration and data usage. Mobile users are unlikely to limit their usage of WeChat once they migrate to smartphones as China has the largest amount of free mobile internet content in the world (digital books, digital music and videos, games).
Mobile commerce will be big in China. Mobile users have already started booking air tickets and hotels using their smartphones. Mobile accounts for 10% of transactions of Ctrip and Qunar, the two largest travel platforms in China, in 2013 and mobile contribution could jump to 20%. China doesn’t have unlimited data plans, so growing data usage will help lift Arpu.
China Telecom’s mobile Arpu could expand in 2013 given increasing high-end smartphone customers such as iPhone and Samsung Galaxy users.
Unicom’s overall mobile Arpu is likely to be stable in 2013, given an increasing mix of 3G users. However, its 3G Arpu decline could be fast as capitalised subsidies will be deducted from Arpu and a majority of its new 3G users now come from the low-end market.
Subsidies continues to rise China Mobile’s subsidies are likely to increase by another 19% YoY to Rmb31bn in 2013, given accelerating 3G user growth. However, the company is unlikely to launch iPhone 5 and there should not be another jump in subsidies. While iPhone 5 may support TD-SCDMA, China Mobile may not be able to reach a commercial deal with Apple. China Mobile may only be willing to sell 3m iPhone per year to match its competitors as it only controls one-third of China’s 3G market and iPhone subsidies are high: iPhone subsidies alone could amount to Rmb12bn (half of its 2012 subsidies) for 3m iPhone sales. iPhone is losing market share in China as users want a big screen (sales of 4S was disappointing). Global demand for iPhone 5 could be driven by 4G upgrade. However, iPhone 5 will only be sold as a 3G phone in China. Hence, demand could be comparable to iPhone 4S. There is limited downside for China Mobile to wait for iPhone 6 and launch the first 4G iPhone in China.
China Telecom’s subsidies may increase from Rmb26bn in 2012 to Rmb35bn in 2013 (up 30% YoY). iPhone subsidies alone could surge by Rmb8bn if the company doubles its iPhone net adds to 4m. This could lower its 2013 earnings by 8% to Rmb18bn (20% YoY growth), but could sustain a 19% profit Cagr for 2014-16.
Handset subsidies Subsidies as a share of mobile revenue
Unicom subsidies are likely to bounce to Rmb1.5-2bn per quarter in 4Q12 and 1Q13 (versus Rmb1.1bn in 3Q12), given the launch of iPhone. However, the company is likely to continue to control its subsidy expense in 2013 to improve profitability. Its low subsidy expense is also due to the fact that the company only provide about half of the subsidies upfront and capitalise the remaining half by subtracting it from Arpu. Unicom could be trading future growth for near-term profitability.
Margin could contract, but at a slower rate Ebitda margin could fall as operators are rapidly growing smartphone users. China Mobile’s Ebitda margin could plummet by another 1.8% YoY in 2013 as it only started accelerating 3G user growth in 2H12 and offers the highest subsidies among its peers. However, the decline should be narrowed as revenue growth improves with data.
China Telecom’s Ebitda margin may also fall 3% YoY with higher iPhone subsidies. Yet, it should rebound and earnings should grow 20% in 2013.
Unicom’s margin may rebound from a low base as the firm tightens control of subsidies and investment. However, it could risk losing future competitiveness and both expenses could pick up again with 4G.
Ebitda margin Ebit margin
Source: Companies, CLSA Asia-Pacific Markets
4G capex will be incremental Total capex for Chinese telcos could be flat at Rmb329bn for 2013. China Mobile’s parentco could spend additional Rmb16bn on 4G deployment in 2013, but the listco is likely to maintain a steady Rmb130bn. Unicom, however, could reduce its capex by Rmb16bn as it has accelerated its 3G rollout this year and is targeting to turn FCF-positive in 2013. China Telecom should maintain a Rmb73bn capex (Rmb54bn for listco and Rmb19bn for parentco) for 2013.
Capex of Chinese telcos should stay high with 4G deployment. China Mobile is likely to invest an additional Rmb20-40bn on 4G in 2013 or 2014. China Telecom and Unicom will have to roll out new 4G base stations whether they have to deploy FDD or TD-LTE network. They may have to spend a similar Rmb20-40bn per year on 4G as China Mobile. However, this could be partly offset by lower 3G capex. The rollout could be gradual. China Telecom should be in a better position than Unicom, given its stronger balance sheet, more extensive 3G coverage and cheaper 3G capex.
Top picks - China Mobile and China Telecom China Mobile remains our long-term pick. Its 2H12 result could be weak given rising subsidies and leasing costs due to accelerating smartphone user growth. However, it should stabilise in 2013 and rebound with 4G launch. It is likely to be the first to launch 4G commercial service in China in 2013. Valuation is attractive at 11x 13CL PE with a sustainable 4% yield. Cash accounts for 20% of its total market cap. Data is a free option.
We also like China Telecom, which is attractively valued at 13.9x 13CL PE with a 19% three-year EPS Cagr (2014-16), or 9x 16CL PE. China Telecom benefits from strong smartphone-user and mobile-data growth like Unicom and enjoys higher operating efficiency but is trading at much lower multiples. It will face tougher competition as China Mobile migrates to 4G. However, it is better positioned than Unicom given its stronger execution, bigger balance sheet and dominant fixed-line broadband network.
This publication/communication is subject to and incorporates the
terms and conditions of use set out on the www.cf-clsa.com website.
The analyst/s who compiled this publication/communication hereby
state/s and confirm/s that the contents hereof truly reflect his/her/their
views and opinions on the subject matter and that the analyst/s
has/have not been placed under any undue influence, intervention or
pressure by any person/s in compiling such publication/ communication.
FortuneCLSA has produced this publication/communication for
private circulation to selected professional and institutional clients
only. This publication/communication is confidential and proprietary
to FortuneCLSA and shall not be reproduced, copied, redistributed
or circulated (whether in whole or in part) without the express
written permission of FortuneCLSA. The information, opinions and
estimates herein are not directed at, or intended for distribution to
or use by, any person or entity in any jurisdiction where doing so
would be contrary to law or regulation or which would subject
FortuneCLSA to any additional registration or licensing requirement
within such jurisdiction. The information and statistical data herein
have been obtained from sources we believe to be reliable and
legitimate. However, the accuracy, completeness or correctness of
such information has not been independently verified and we make
no representation or warranty as thereto. Any opinions or
estimates herein reflect the judgment of FortuneCLSA at the date
of this publication/communication and are subject to change at
any time without notice. Where any part of the information, opinions or
estimates contained herein reflects the views and opinions of a sales
person or a non-analyst, such views and opinions may not correspond to
the published view of FortuneCLSA. This is not a solicitation or any offer
to buy or sell. This publication/communication is for information
purposes only and is not intended to provide professional,
investment or any other type of advice or recommendation and
does not take into account the particular investment objectives,
financial situation or needs of individual recipients. Before acting on
any information in this publication/communication, you should
consider whether it is suitable for your particular circumstances and,
if appropriate, seek professional advice, including tax advice.
FortuneCLSA does not accept any responsibility and cannot be held
liable for any person’s use of or reliance on the information and
opinions contained herein. To the extent permitted by applicable
securities laws and regulations, FortuneCLSA accepts no liability
whatsoever for any direct or consequential loss arising from the use
of this publication/communication or its contents.
Subject to any applicable laws and regulations at any given time
FortuneCLSA, its affiliates or companies or individuals connected with
FortuneCLSA may have positions in, may from time to time purchase
or sell or have a material interest in any of the securities mentioned or
related securities or may currently or in future have or have had a
business or financial relationship with, or may provide or have provided
investment banking, capital markets and/or other services to, the
entities referred to herein, their advisors and/or any other connected
parties. As a result, investors should be aware that FortuneCLSA
and/or such individuals may have one or more conflicts of interests
that could affect the objectivity of this report.
Regulation of People’s Republic of China prohibits FortuneCLSA
employees to hold shares or trade in shares or to receive shares from
other person in the form of gift. Regulation of People’s Republic of
China does not allow FortuneCLSA analysts to take up part-time job or
outside activity. FortuneCLSA does not allow gift or advantage to be
provided to analysts. FortuneCLSA is not allowed to engage in
proprietary trading (other than those positions arising from
underwriting) and does not make any market. Any departure from the
above which may give rise to conflict of interest will be disclosed in the
concerned research report. Disclosure of conflict of interest include the
position of FortuneCLSA and / or its employees and Fortune Securities
Company Limited, the Chinese shareholder of FortuneCLSA, only and
does not reflect those of CLSA Asia-Pacific Markets (“CLSA”) and / or
its affiliates (including but not limited to Credit Agricole Corporate &
Investment Bank).
This publication/communication is distributed in People’s Republic of
China by FortuneCLSA; and subject to applicable laws and regulations,
for and on behalf of FortuneCLSA in Australia by CLSA Limited; in Hong
Kong by CLSA Research Ltd.; in India by CLSA India Ltd.; in Indonesia
by PT CLSA Indonesia; in Japan by Credit Agricole Securities Asia B.V.,
Tokyo Branch, a member of the JSDA licensed to use the “CLSA” logo
in Japan; in Korea by CLSA Securities Korea Ltd.; in Malaysia by CLSA
Securities Malaysia Sdn Bhd; in the Philippines by CLSA Philippines Inc.
(a member of Philippine Stock Exchange and Securities Investors
Protection Fund); in Thailand by CLSA Securities (Thailand) Limited;
and in Taiwan by CLSA Limited, Taipei Branch.
United Kingdom: Notwithstanding anything to the contrary herein, the
following applies where the publication/communication is distributed in
and/or into the United Kingdom. This publication/communication is only
for distribution and/or is only directed at persons (“permitted
recipients”) who are (i) persons falling within Article 19 of the
Financial Services and Markets Act 2000 (Financial Promotion) Order
2001 (the “FPO”) having professional experience in matters relating
to investments or high net worth companies, unincorporated
associations etc. falling within Article 49 of the FPO, and (ii) where
an unregulated collective investment scheme (an “unregulated CIS”)
is the subject of the publication/communication, also persons of a
kind to whom the unregulated CIS may lawfully be promoted by a
person authorised under the Financial Services and Markets Act 2000
(“FSMA”) by virtue of Section 238(5) of the FSMA. The investments
or services to which this publication/communication relates are
available only to permitted recipients and persons of any other
description should not rely upon it. This publication/ communication
may have been produced in circumstances such that it is not
appropriate to categorise it as impartial in accordance with the FSA
Rules.
Singapore: This publication/communication is distributed for and on
behalf of FortuneCLSA in Singapore through CLSA Singapore Pte Ltd
solely to persons who qualify as Institutional, Accredited and Expert
Investors only, as defined in s.4A(1) of the Securities and Futures Act.
Pursuant to Paragraphs 33, 34, 35 and 36 of the Financial Advisers
(Amendment) Regulations 2005 with regards to an Accredited Investor,
Expert Investor or Overseas Investor, sections 25, 27 and 36 of the
Financial Adviser Act shall not apply to CLSA Singapore Pte Ltd. Please
contact CLSA Singapore Pte Ltd in connection with queries on the
report. MICA (P) 168/12/2009 File Ref. No. 931318
United States of America: This research report is distributed into the
United States by FCLSA solely to persons who qualify as “Major U.S.
Institutional Investors” as defined in Rule 15a-6 under the Securities
and Exchange Act of 1934 and who deal with Credit Agricole Corporate
& Investment Bank. However, the delivery of this research report to
any person in the United States shall not be deemed a
recommendation to effect any transactions in the securities discussed
herein or an endorsement of any opinion expressed herein. Any
recipient of this research in the United States wishing to effect a
transaction in any security mentioned herein should do so by
contacting Credit Agricole Securities (USA) Inc. (a broker-dealer
registered with the Securities and Exchange Commission and an
affiliate of FCLSA).
Key to FortuneCLSA investment rankings: BUY: Total return expected to exceed market return AND provide 20% or greater absolute return;
O-PF: Total return expected to be greater than market return but less than 20% absolute return; U-PF: Total return expected to be less than
market return but expected to provide a positive absolute return; SELL: Total return expected to be less than market return AND to provide a negative absolute return. For relative performance, we benchmark the 12-month total return (including dividends) for the stock against the 12-
month forecast return (including dividends) for the local market where the stock is traded.
This publication/communication is subject to and incorporates the terms and conditions of use set out on the www.clsa.com website. Neither the publication/ communication nor any portion hereof may be reprinted, sold or redistributed without the written consent of CLSA and/or CAS, a broker-dealer registered with the Securities and Exchange Commission of US and an affiliate of CLSA. CLSA and/or CAS has/have produced this publication/communication for private circulation to professional, institutional and/or wholesale clients only. The information, opinions and estimates herein are not directed at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so would be contrary to law or regulation or which would subject CLSA and/or CAS to any additional registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable. Such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness or correctness. Any opinions or estimates herein reflect the judgment of CLSA and/or CAS at the date of this publication/communication and are subject to change at any time without notice. Where any part of the information, opinions or estimates contained herein reflects the views and opinions of a sales person or a non-analyst, such views and opinions may not correspond to the published view of CLSA and/or CAS. This is not a solicitation or any offer to buy or sell. This publication/communication is for information purposes only and does not constitute any recommendation, representation, warranty or guarantee of performance. Any price target given in the report may be projected from 1 or more valuation models and hence any price target may be subject to the inherent risk of the selected model as well as other external risk factors. This is not intended to provide professional, investment or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before acting on any information in this publication/ communication, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice, including tax advice. CLSA and/or CAS do/does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein. To the extent permitted by applicable securities laws and regulations, CLSA and/or CAS accept(s) no liability whatsoever for any direct or consequential loss arising from the use of this publication/communication or its contents. Where the publication does not contain rating, the material should not be construed as research but is offered as factual commentary. It is not intended to, nor should it be used to form an investment opinion about the not rated companies. Subject to any applicable laws and regulations at any given time CLSA, CAS, their respective affiliates or companies or individuals connected with CLSA/CAS may have used the information contained herein before publication and may have positions in, may from time to time purchase or sell or have a material interest in any of the securities mentioned or related securities or may currently or in future have or have had a business or financial relationship with, or may provide or have provided investment banking, capital markets and/or other services to, the entities referred to herein, their advisors and/or any other connected parties. As a result, investors should be aware that CLSA, CAS and/or their respective affiliates or companies or such individuals may have one or more conflicts of interest. Regulations or market practice of some jurisdictions/markets prescribe certain disclosures to be made for certain actual, potential or perceived conflicts of interests relating to research report. Details of the disclosable interest can be found in certain reports as required by the relevant rules and regulation and the full details are available at http://www.clsa.com/member/research_disclosures/. Disclosures therein include the position of the CLSA Group only and do not reflect those of Credit Agricole Corporate & Investment Bank and/or its affiliates. If
investors have any difficulty accessing this website, please contact [email protected] on (852) 2600 8111. If you require disclosure information on previous dates, please contact [email protected]. This publication/communication is distributed for and on behalf of CLSA Limited (for research compiled by non-US analyst(s)) and /or CAS (for research compiled by US analyst(s)) in Australia by CLSA Australia Pty Ltd; in Hong Kong by CLSA Research Ltd.; in India by CLSA India Ltd. (Address: 8/F, Dalamal House, Nariman Point, Mumbai 400021. Tel No: +91-22-66505050. SEBI Registration No: BSE Capital Market Segment: INB010826432; BSE F&O Segment: INF010826432; NSE Capital Market Segment: INB230826436; NSE F&O Segment: INF230826436); in Indonesia by PT CLSA Indonesia; in Japan by Credit Agricole Securities Asia B.V., Tokyo Branch, a member of the JSDA licensed to use the "CLSA" logo in Japan; in Korea by CLSA Securities Korea Ltd.; in Malaysia by CLSA Securities Malaysia Sdn Bhd; in the Philippines by CLSA Philippines Inc. (a member of Philippine Stock Exchange and Securities Investors Protection Fund); in Thailand by CLSA Securities (Thailand) Limited; and in Taiwan by CLSA Limited, Taipei Branch. United States of America: Where any section of the research is compiled by US analyst(s), it is distributed by CAS. Where any section is compiled by non-US analyst(s), it is distributed into the United States by CLSA solely to persons who qualify as "Major U.S. Institutional Investors" as defined in Rule 15a-6 under the Securities and Exchange Act of 1934 and who deal with Credit Agricole Corporate & Investment Bank. However, the delivery of this research report to any person in the United States shall not be deemed a recommendation to effect any transactions in the securities discussed herein or an endorsement of any opinion expressed herein. Any recipient of this research in the United States wishing to effect a transaction in any security mentioned herein should do so by contacting CAS. United Kingdom: Notwithstanding anything to the contrary herein, the following applies where the publication/communication is distributed in and/or into the United Kingdom. This publication/communication is only for distribution and/or is only directed at persons ("permitted recipients") who are (i) persons falling within Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (the "FPO") having professional experience in matters relating to investments or high net worth companies, unincorporated associations etc. falling within Article 49 of the FPO, and (ii) where an unregulated collective investment scheme (an "unregulated CIS") is the subject of the publication/communication, also persons of a kind to whom the unregulated CIS may lawfully be promoted by a person authorised under the Financial Services and Markets Act 2000 ("FSMA") by virtue of Section 238(5) of the FSMA. The investments or services to which this publication/communication relates are available only to permitted recipients and persons of any other description should not rely upon it. This publication/ communication may have been produced in circumstances such that it is not appropriate to categorise it as impartial in accordance with the FSA Rules. Singapore: This publication/communication is distributed for and on behalf of CLSA Limited (for research compiled by non-US analyst(s)) and /or CAS (for research compiled by US analyst(s)) in Singapore through CLSA Singapore Pte Ltd solely to persons who qualify as Institutional, Accredited and Expert Investors only, as defined in s.4A(1) of the Securities and Futures Act. Pursuant to Paragraphs 33, 34, 35 and 36 of the Financial Advisers (Amendment) Regulations 2005 with regards to an Accredited Investor, Expert Investor or Overseas Investor, sections 25, 27 and 36 of the Financial Adviser Act shall not apply to CLSA Singapore Pte Ltd. Please contact CLSA Singapore Pte Ltd in connection with queries on the report. MICA (P) 162/12/2011 The analysts/contributors to this publication/communication may be employed by a Credit Agricole or a CLSA company which is different from the entity that distributes the publication/communication in the respective jurisdictions.
MSCI-sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an "as is" basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by CLSA Asia-Pacific Markets.
EVA® is a registered trademark of Stern, Stewart & Co. "CL" in charts and tables stands for CAS estimates unless otherwise noted in the source.
Prepared for: ThomsonReuters
Research & sales offices www.clsa.com
Australia CLSA Australia Pty Ltd CLSA House Level 15 20 Hunter Street Sydney NSW 2000 Tel: (61) 2 8571 4200 Fax: (61) 2 9221 1188
India CLSA India Ltd 8/F, Dalamal House Nariman Point Mumbai 400021 Tel: (91) 22 6650 5050 Fax: (91) 22 2284 0271
Philippines CLSA Philippines, Inc 19/F, Tower Two The Enterprise Center 6766 Ayala corner Paseo de Roxas Makati City Tel: (63) 2 860 4000 Fax: (63) 2 860 4051
USA - Boston Credit Agricole Securities (USA) Inc 99 Summer Street Suite 220 Boston, MA 02110 Tel: (1) 617 295 0100 Fax: (1) 617 295 0140
China - Beijing CLSA Limited - Beijing Rep Office Unit 10-12, Level 25 China World Trade Centre Tower 2 1 Jian Guo Men Wai Ave Beijing 100004 Tel: (86) 10 5965 2188 Fax: (86) 10 6505 2209
Indonesia PT CLSA Indonesia WISMA GKBI Suite 901 Jl Jendral Sudirman No.28 Jakarta 10210 Tel: (62) 21 2554 8888 Fax: (62) 21 574 6920
USA - New York Credit Agricole Securities (USA) Inc 15/F, Credit Agricole Building 1301 Avenue of The Americas New York 10019 Tel: (1) 212 408 5888 Fax: (1) 212 261 2502
China - Shenzhen CLSA Limited - Shenzhen Rep Office Room 3111, Shun Hing Square Di Wang Commercial Centre 5002 Shennan Road East Shenzhen 518008 Tel: (86) 755 8246 1755 Fax: (86) 755 8246 1754
Korea CLSA Securities Korea Ltd 30/F, One IFC 10 Gukjegeumyung-ro Yeongdeungpo-gu, Seoul, 150-712 Tel: (82) 2 397 8400 Fax: (82) 2 771 8583
Thailand CLSA Securities (Thailand) Ltd 16/F, M Thai Tower All Seasons Place 87 Wireless Road, Lumpini Pathumwan, Bangkok 10330 Tel: (66) 2 257 4600 Fax: (66) 2 253 0532
USA - San Francisco Credit Agricole Securities (USA) Inc Suite 850 50 California Street San Francisco, CA 94111 Tel: (1) 415 544 6100 Fax: (1) 415 434 6140
Hong Kong CLSA Limited 18/F, One Pacific Place 88 Queensway Hong Kong Tel: (852) 2600 8888 Fax: (852) 2868 0189
Malaysia CLSA Securities Malaysia Sdn Bhd Suite 20-01, Level 20 Menara Dion 27 Jalan Sultan Ismail 50250 Kuala Lumpur Tel: (60) 3 2056 7888 Fax: (60) 3 2056 7988
United Kingdom CLSA (UK) 12/F, Moor House 120 London Wall London EC2Y 5ET Tel: (44) 207 614 7000 Fax: (44) 207 614 7070
CLSA Sales Trading Team Australia (61) 2 8571 4201 China (Shanghai) (86) 21 2020 5810 Hong Kong (852) 2600 7003 India (91) 22 6622 5000 Indonesia (62) 21 573 9460 Japan (81) 3 4580 5169 Korea (82) 2 397 8512