20121203-CLSA-ChinaOpps (Hard Work Begins Fixing China's Growth Engine)

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

ChinaOpps

2 [email protected] 3 December 2012

Contents

Executive summary ............................................................................ 3

Growth to slow further in 2013 .......................................................... 4

Property will remain a drag .............................................................. 14

New leadership policy ...................................................................... 20

Survey - What do Chinese people think? .......................................... 29

Investment ideas for 2013 ............................................................... 40

Index target ..................................................................................... 49

Sector profiles

Autos ........................................ 57

Banks ....................................... 63

Conglomerates ........................... 69

Consumer China ......................... 75

Consumer HK ............................ 84

Healthcare ................................. 91

Industrials ................................. 96

Insurance ................................. 104

Internet ................................... 108

Macau gaming .......................... 115

Machinery ................................ 122

Oil & Gas .................................. 131

Power ...................................... 139

Property ................................... 148

Resources ................................ 152

Steel ........................................ 159

Technology ............................... 166

Telecoms .................................. 174

Appendices

1: China chart book ............................................................................ 185

2: CLSA China/HK coverage ................................................................. 194

All prices quoted herein are as at close of business 29 November 2012, unless otherwise stated

Opportunities abound

Watch Francis on CLSA TV


https://www.clsa.com/member/reports/522648961.pdf



https://www.clsa.com/member/video/527657366

Executive summary ChinaOpps

3 December 2012 [email protected] 3

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

24,500, which suggests 12% upside.

China GDP target versus actual

Source: CEIC, CLSA Asia-Pacific Markets

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(%) Actual GDP growth Target GDP growth

A near miss this year

Sharpest decline in

two decades ex-global financial crisis

Better 1H than 2H

Policy changes will be incremental

The consumer is optimistic about 2013

Top 10 ideas and top 10 SELLs


Section 1: Growth to slow further in 2013 ChinaOpps


Growth to slow further in 2013 For China investors, 2012 was a difficult year as the economy slowed more

than consensus and the government expected. Beijing surprised by loosening

its property policy, restarting its interest-rate reform and accelerating

infrastructure investments, which brought about the current economic

recovery. There has been policy paralysis in other areas this year, perhaps

owing to leadership transition or recognition of the mistakes made in the

excessive stimulus in 2009.

Nonetheless, two major themes have emerged this year that will gain even

more importance in 2013: the need for reforms and using infrastructure to

support growth. We addressed these issues in our Closet reformers (May

2012) and Infrastructure bubble (August) reports. We believe 2013 will be a

year of planning rather than action, as Xi Jinping and Li Keqiang prepare a

bold new direction for the country for the next 10 years. There is downside

risk to GDP-growth estimates, but a slower pace will help rebalance the

economy. For investors, 2013 could also be volatile with a stronger 1H and

riskier 2H as growth is likely to disappoint. For long-term China investors, we

are optimistic and provide a framework for how the country plans to sustain

growth and migrate up the value chain.

Difficult 2012 This year has been eventful with the market delivering a reasonable

performance: MSCI China is up 12.3% YTD. Our outlook for 2012 has broadly

played out. We had thought that it would have been a difficult 1H, and the

government would be forced to accelerate easing by cutting interest rates to

provide a better 2H. We underestimated Beijing’s tolerance for slower growth.

This could have been either due to government’s overoptimism on the

economy or policy paralysis ahead of the leadership change. However, we

believe it is likely the latter.

In our 13 December 2011 Getting easier 2012 outlook report, we wrote:

‘Tightening ended when inflation peaked in July [2011] with the last rate

hike. China may have already overtightened. The easing cycle started with

December’s RRR cut and could accelerate by mid-year as the government

becomes more worried about growth and turns to boosting the economy.

China easing is a positive and should boost the market in early 2012 with

new loan quota and further RRR cuts. But the first half will likely be

difficult as the economy slows and effects from overtightening become

more evident. The market should be stronger in 2H12 as China moves

more aggressively to generate growth... We are constructive on the

market for 2012 with the start of an easing cycle and cheap valuations.

The biggest concerns are macro-risks and deteriorating European growth.’

What we learn from 2012 is that the government has few policy options to

push growth and this could lead to an equally volatile 2013. The economy is

slowing mainly due to the heavy investments made in 2009-10, which

accelerated growth, creating balance-sheet issues and narrowing policy

options. The high expansion of the past few years will need to be paid back

with slower growth. Consumption has been relatively stable, but government

policy to promote consumption through subsidies only provides a one-off

temporary boost. Other reforms such as social security will take a long time

to have an impact. Promoting exports is not a strong option given the state of

the global economy.

Economy slowed more

than expected with

Beijing underestimating extent of the slowdown

Beijing has few policy

options to push growth

and this could lead to an equally volatile 2013










China’s largest policy lever to promote growth remains investment, which needs

to slow structurally to rebalance the economy. There are three key components

of FAI. Property and manufacturing investment, which has plummeted, was

offset by more infrastructure investment. The broad trend should be similar in

2013 with FAI continuing to slow. The National Development and Reform

Commission’s (NDRC) FAI research institute expects a slowdown to 18% YoY.

1) Property investment - Property investment will continue to slow as the

government has no intention to loosen property restrictions. Inventory is

generally high except for tier-one cities, where there could be significantly

undersupply by next year. Property policy is not just used to prevent a

bubble but is also necessary to limit the continued widening of the wealth

gap. Property investment has dropped from 30% YoY to only 21% YoY in

2012. The International Monetary Fund (IMF) estimates that a 1% decline

in property investment shaves about 0.1% off China’s real GDP. Thus,

slowing property investment this year has slowed real GDP by almost 1%.

Figure 1

Monthly property FAI


2) Manufacturing investment - Manufacturing investment grew 32% in

2011, similar to the long-term growth rate since 2004. The high

investment has led to overcapacity in many sectors and investment

growth rate has slowed this year to 23%. There is little room for further

increases and the growth rate should continue to trend lower next year

unless there is significant improvement in global trade.

Figure 2

Monthly manufacturing FAI


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(YoY %) (%)Share of total FAI (RHS) 3MMA growth

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Investment still the

largest policy lever

to promote growth

. . . and will continue to slow

Property investment

dropped from 30% YoY to 21% YoY in 2012 . . .

Manufacturing

investment slowed to 23% this year . . .

. . . little room for

boosting growth




3) Infrastructure investment - Infrastructure is the government’s largest

policy lever and is a key driver of economic growth this year and should

remain the same in 2013. The worry is whether the government can

sustained the financing of infrastructure after having cracked down on

local-government financing vehicles (LGFV). Infrastructure investment

growth has accelerated from 4% YoY to 16% YoY in 2012 and could peak

by mid-2013.

Figure 3

Monthly infrastructure FAI


Growth will be challenging in 2013 Consensus 2013 GDP growth of about 8.2% appears high. There is little

reason for the economy to accelerate from the 7.7% rate this year. We

discuss the economic outlook with senior economists at the NDRC, World

Bank and Asian Development Bank (ADB) in Beijing, which generally believe

the forecast is at the high end of the range with a good chance for

disappointment. The economic drivers for 2013 are similar to this year and

should continue to trend lower. Infrastructure investment will remain a major

growth catalyst, but we are concerned that could slow in the latter half of

next year. Investment will decelerate in 2013 and if other economic factors do

not improve, then the economy could be even softer than in 2012.

One of the first dilemmas China’s new leaders are facing surrounds their GDP

growth target for 2013. Ideally, they want to show stronger economic growth in

the first year, which will give them political capital, but they also need to show

that they are rebalancing the economy. We believe they are likely to set a 2013

GDP target of 7.0% or 7.5%, which provides an important signal of future

policy. A 7.0% target is easier to meet but does risk showing a lack of

confidence and brings into question whether the average 7% GDP-growth

target for the 12th Five-Year Plan can be met. A 7.5% target will be risky as the

economy is likely to continue to slow and the government will have to ease and

use more fiscal measures to support growth. This is our central scenario.

The risk to GDP growth should come in 2H13. There is unlikely to be many

new policy initiatives by the new government and infrastructure investment

growth should peak by mid-year. Long-term average growth in infrastructure

investment is about 22% but it was almost flat last year as Beijing tightened

financing to LGFVs. Growth has normalised to 17% in 2012 and should peak

by mid-2013 when a large number of projects will get financed.

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Consensus 2013

GDP growth is about 8.2% appears high

New leadership

likely to set 2013 GDP target at 7.5%

Risk to GDP growth likely

in 2H13 due to a lack of

new initiatives and infra investment could peak

. . . and has been a key

growth, and should remain so in 2013

Infrastructure

rebounded to 16% growth in 2012 . . .




Infrastructure bubble Infrastructure will be a major

driver of China’s growth in 2013,

but there are concerns about

overcapacity and building roads to

nowhere. We wrote about the

extent of the country’s

overinvestment in our 29 August

2012 Infrastructure bubble report.

China has overcapacity in many

infrastructure sectors, but this may

not lead to a major financial crisis as the central

government maintains a strong balance sheet. As long

as spending remains controlled, the country will be able

to grow and utilise the excess capacity. We are still

likely to see rising NPLs, and the projects with the

weakest prospects are airports, bridges, expressways

and highspeed rail. Most of the new infrastructure

projects are in less-developed central and western

provinces. The worry is that these are also the less-

populated regions in China, so these developments are

likely to take longer time to generate returns.

China’s power and water sectors make up about half

of infrastructure spending but there is still large

demand as the country continues to face shortages.

With highly indebted energy producers, we are

unlikely to see much new capacity addition. The

nation’s water crisis is getting deeper with an

estimated 300 million people lacking access to safe

drinking water and about 12 million tonnes of grain

lost annually due to poor-quality water.

Roads and railways are among the highest-profile

investments. China has the second-largest road

network in the world, but utilisation is only about 40%.

Expressways are most problematic due to high debt,

but are only 3% of roads. By 2017, China will have

more vehicles than the USA with the third-longest

railway. The worry is in its highspeed rail, which makes

up only 10% of tracks but is already the largest

globally. The nation built up too much too quickly and it

could take a decade for demand to catch up.

Many airports in China are losing money and ports are

facing large excess capacity. Airports are built large for

future demand, making many of them unprofitable. This

is acceptable to the government as it is cheaper to build

big and wait for passenger traffic to grow. China ports

expanded right into the global credit crisis with

overcapacity as high as 40%. With supply discipline,

balance will be restored by 2015.

Shanghai: Maglev train (2004) Qingdao: Jiaozhou Bay Bridge (2010)

US$1.2bn spent on a 30km journey

US$1.6bn for longest bridge to nowhere

Source: Alex Needham Source: Qingdao Highway Management Authority

Sichuan: Yaxi Expressway (2012) Beijing: Airport Terminal 3D (2008)

Ganhaizi Grand Bridge with highest pier at 107 metres

Closed after 2008 Olympics

Source: Sichuan Transportation Department Source: http://starscreek.pixnet.net






Figure 4

China GDP target versus actual


Infrastructure investment should slow in 2H13, especially given a higher

base. Funding for infrastructure will also be more difficult next year as trust

companies’ wealth-management products, which fund infrastructure projects,

will face more scrutiny by the China Banking Regulatory Commission (CBRC)

given rising default risk. Trust assets have grown to Rmb6.3tn with

infrastructure accounting for 23% and property accounting for 11% of total

assets. Another 7% of trust assets are in bonds and a large portion of that is

likely to also be infrastructure/property related.

Figure 5 Figure 6

Trust-asset growth Composition of trust asset (Sep 2012)

Source: China Trustee Association, CEIC, CLSA Asia-Pacific Markets

The major policy option for the government to boost growth is to accelerate

infrastructure projects or to loosen its property measures, which it is unwilling

to do at this point. The government did relax its policy for the sector in 2012

as it had little choice when the economy slowed more than expected. In

2H13, we could see easing in the property market with more relaxed buying

policies in lower-tier cities, where there is still oversupply. Property policies

will remain tight in tier-one cities, where there is a lack of supply and high

demand; there is already upward pressure on prices in these areas and the

government is unlikely to loosen its control.

8.4 8.3

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We could see easing in

property market with

more relaxed policies in lower-tier cities

A near miss this year

Trust companies’ wealth-

management products will face more scrutiny




Upside risk to the economy mainly comes from exports, which depend on the

global economy and inventory restocking. Destocking has been a drag to GDP

in 2012 by about 0.4%, but this should turn next year. The latest official PMI

shows that inventory destocking is nearly complete with a rebound in new

orders, export orders and quantity of purchases. Raw-materials inventory has

been low for some time. PMI raw-material inventory has been in contraction

or below 50 for 17 months. If the economy continues to recover, we are likely

to see inventory restocking, especially for raw materials. This is positive to

the market as the material sector is a leading indicator of economic growth.

Export growth could surprise if the global economy, especially the USA, is

stronger than expected. The World Bank, which has recently trimmed its

forecast, estimates global GDP growth of 3.3% for 2012 and 3.6% for 2013.

Figure 7

NBS PMI raw-materials and finished-good inventory are low


The ideal situation for the new leadership is actual 2013 GDP growth of 8%

versus a target of 7.5%. Growth could surprise from:

Inventory restocking in raw materials and finished goods.

Property loosening in top-tier cities in 2H13 as inventories run low and

there is a need to soak up excess supply in lower-tier areas where

inventories are high.

Better-than-expected exports due to a stronger global economy,

especially in the USA.

Monetary policy to remain tight Historically, Chinese equities move in line, up or down, with monetary growth,

especially M2. The track record has been good as the recent rally, which

started in September, was accompanied by an acceleration in M2 to 14.8%

YoY. The intention of the People’s Bank of China (PBOC) is to keep monetary

policy relatively tight and we expect them to set a M2 target of 14% for 2013,

similar to this year. This would imply M2 growth/nominal GDP growth of 1.2x,

which is below the long-term average of 1.3x.

There is little room to cut the interest rate and we expect this to happen only

when there is little option and growth has slowed more than anticipated. This

is more likely in 2H13 and we expect one interest-rate reduction accompanied

by two cuts in the required-reserve ratio (RRR). The PBOC has been

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Finished goods Materials

Raw materials destocking is done

Upside risk mainly

comes from exports and inventory restocking

Ideal situation is a

GDP target of 7.5% with actual coming in at 8%

M2 target of 14%




increasing its use of reverse repos (temporary RRR cut) to increase liquidity

and has resisted cutting RRR. The tighter liquidity ensures that more efficient

SOEs get credit and forces inefficient SOEs to improve.

The PBOC remains concerned about inflation, especially with global easing

and potential market reforms. Market-oriented reforms to reduce government

control on prices will likely add to inflation pressures. There are also worries

about rising global liquidity, which would drive up commodity prices.

Geopolitical risk with Syria and Iran could push up the oil price. There is not

much room for the PBOC to cut interest rate. Assuming CPI of 3% next year,

real interest rate would be neutral and any rate cut would result in negative

real rates and putting pressure on consumers.

Figure 8

China’s M2 growth/nominal GDP growth


We expect the renminbi to be relatively stable throughout 2013, but it could

be weaker in 2H as growth slows, unless the government moves to stimulate

the economy. QE3 and continued global credit easing will put continued

pressure on the renminbi to appreciate, but this will be offset by slowing

China growth. China’s trade surplus has narrowed from 2% of GDP last year

to only about 0.5% of GDP and this is likely to continue next year. Despite the

weaker-than-expected growth this year, the yuan has still appreciated by 1%.

Figure 9 Figure 10

Trade balance as a share of GDP Current-account surplus as a share of GDP


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Expect the yuan to be

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Problems with China’s financial system China’s financial system has higher debt than officially recognised and has

excessive liquidity, which is the key reason why the PBOC remains so

concerned about inflation despite CPI being below 3%. We had estimated

China’s government debt/GDP to be about 65% as of 2011, compared to the

official statistic of 39%. The difference is from contingent liability from policy

banks, ministry loans and unfunded medical and pension liabilities. The State

Council’s Development Research Centre (DRC) recently published an estimate

for government debt, showing it to be at 60% of GDP, which is closer to our

calculation. Debt/GDP is not at an alarming level and is much lower than most

countries, but China’s government debt/revenue is high at 175%, similar to

countries with higher debt levels such as the UK and France.

Figure 11

Estimation of China’s government-backed debt with contingent liabilities

As at Dec 2010 (Rmbbn) As %

of GDP

As % of

fiscal

income

As % of

board

income

Central-government liabilities

- Central-government bonds 6,755 16.8 81.3 49.7

- Asset-management companies and NPLs 1,400 3.5 16.9 10.3

- Ministry of Railways 1,892 4.7 22.8 13.9

Local-government liabilities

- Province, city and county government debt 10,715 26.7 129.0 78.8

- Township debt 810 2.0 9.8 6.0

- Unfunded medical and pension funds 1,000 2.5 12.0 7.4

- Local highway debt 1,183 3.0 14.2 8.7

Total government-backed debt 23,757 59.2 285.9 174.7

Source: A study on China’s fiscal and financial risks by State Council’s DRC, September 2012

Figure 12

China’s government debt/revenue

Source: DRC, CLSA Asia-Pacific Markets

China’s economy is excessively liquid, made worst by the 2009 stimulus. The

excessive money growth means banks expanded their balance sheets too

fast, creating risk of NPLs, especially from local governments (18% of total

bank loans) and property (20%). This is likely why the government has been

so reluctant to provide a stimulus and so much more tolerant of slower

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(%)

DRC estimates

government debt to be 60% of GDP as at 2010

China’s government

debt/revenue is high at

175%, similar to nations with higher debt levels

PBOC remains concerned

about inflation despite CPI being below 3%

Economy is excessively

liquid, made worst by the 2009 stimulus




growth this year. The PBOC remains on heighten alert on inflation and has

started to use reverse repos as a tool to manage liquidity. Instead of cutting

RRR even during periods of capital outflows, it has used temporary RRR cuts

in the form of reverse repos. Pricing reform adds to the central bank’s worry.

China’s M2 has seen an 18% Cagr over the past decade with the M2/GDP

ratio now at 182%, compared with India’s 78%, the USA’s 86%, Korea’s 78%

and the UK’s 167%. What is evident in all of this is that China needs an

independent central bank that is not subject to control by the State Council.

This is all part of China’s financial reform but is unlikely to happen in the

foreseeable future. Adjusted M2 ex-RRR but adding back trust asset is

similarly high.

Figure 13 Figure 14

M2 as a share of nominal GDP Adjusted M2 (ex-RRR + trust assets) as a share of GDP

Source: CEIC, China Trustee Association, CLSA Asia-Pacific Markets

Need to show progress in rebalancing economy The one benefit of slowing growth is that the new leaders could show that

they have made progress in rebalancing the economy. Nicholas Borst from

Peterson Institute for International Economics has created insightful

indicators tracking the government’s performance in rebalancing the

economy. Progress has been good and should improve further in 2013.

Figure 15 Figure 16

Disposable income growing faster than GDP Positive real interest rate on deposits


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economy has been good

and should improve further in 2013




Figure 17 Figure 18

Resi property investment grows slower than GDP Loans to small firms up faster than total to enterprises

Figure 19

Faster growth in tertiary than secondary sector


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Section 2: Property will remain a drag ChinaOpps


Property will remain a drag The loosening of China’s property policy this year has helped lower inventory

levels, which have been under pressure as construction starts remained high

over the past three years. However, developers are still recovering. We

estimate the average inventory level will rise from 11.5 months in 2012 to

12.5 months in 2013. China’s property sector has become a two-tier market

with tight supply in tier-one cities and oversupply in many third- and fourth-

tier vicinities. Overall, property investment is likely to slow next year and this

could drag down annual GDP growth by up to 0.4%. The government has

stated that there will be no easing of property measures next year. However,

we would not be surprised if there was some moderation in 2H13 to support

GDP, similar to 2012. This is especially sensible for lower-tier markets where

this is large oversupply.

We expect overall property FAI growth to slow from 21% YoY in 2012 to 17%

YoY in 2013. With tight sector policy and new buyer demand being absorbed,

sales are likely to remain relatively flat. Amid rising inventory levels and

slowing social housing, we expect gross floor area (GFA) new construction

starts to decline 5% in 2013. Our base-case scenario is 5% growth in GFA

sold next year, with monthly average sales of 84m m².

Figure 20 Figure 21

Residential GFA starts less sold Residential sales less investment

Figure 22

Property investment

2008 2009 2010 2011 12CL 13CL

Investments (Rmbbn)

Property FAI 3,522 4,306 5,756 7,568 9,000 10,600

Growth (%) 23.0 19.9 33.5 29.7 21.0 17.0

Real-estate investment 3,058 3,623 4,827 6,174 7,200 8,200

Growth (%) 20.9 16.1 33.2 27.9 15.0 15.0

Share of total (%) 86.8 84.1 83.9 81.6 - -

Residential investment 2,208 2,562 3,404 4,431 5,000 -

Growth (%) 22.6 14.2 32.9 30.2 12.0 -

Share of total (%) 62.7 59.5 59.1 58.5 - -

GFA (m m²)

New construction starts 976 1,154 1,638 1,901 1,750 1,650

Growth (%) 3.2 18.3 41.9 16.1 (8.5) (5.0)

Total property sales 621 948 1,043 1,099 - -

Growth (%) (18.5) 52.6 10.1 5.4 - -

Avg monthly resi sales 47 72 78 81 80 84

Growth (%) (19.1) 54.2 8.0 4.3 0.0 5.0


0

200

400

600

800

1,000

1,200

2004 2005 2006 2007 2008 2009 2010 2011 2012

(m m²)

Many projects

in progress

(400)

(200)

0

200

400

600

800

1,000

1,200

1,400

2004 2005 2006 2007 2008 2009 2010 2011 2012

(Rmbbn)

Declining

cashflow

We could see easing in property market in 2H13

Property investment to slow to 17% YoY in 2013




FAI has slowed in 2012, as expected

Our 2012 outlook for the property sector has broadly played out. Property FAI

growth has slowed from 32.3% YoY in October 2011 to 21.1% in October this

year and has been a large drag on the economy. Inventory did reach very

high levels in 1Q12, pushing the government to ease policy. However new

construction starts was stronger and inventory fell faster than expected as

government cut mortgage rate.

Figure 23 Figure 24

Residential inventory in 10 cities Monthly new floor space starts

Note: 10-city inventory was calculated as 3MMA available for sale divided by 3MMA actual sales. Source: Wind, CEIC, CLSA Asia-Pacific Markets

Prices have started to rise

The government’s property policy has changed tone and the objective has

moved from pushing prices down to reasonable levels to limiting price

increases. However, primary residential prices have been going up since

3Q12. This is unavoidable: as transactions pick up, prices rise. The higher the

transaction level, the more severe the pressure on prices. In October, half of

the 70 cities surveyed by the National Bureau of Statistics (NBS) have seen

prices going up, at an average of 0.22% MoM.

Figure 25

Primary residential property-price trend

Source: NBS, CEIC, CLSA Asia-Pacific Markets

0

5

10

15

20

Apr 09 Oct 09 Apr 10 Oct 10 Apr 11 Oct 11 Apr 12 Oct 12

(months)

Avg 2009

5 months

Avg 2010

7 months

Avg 2011

10 months

Avg 2012

12 months

(50)

0

50

100

150

0

20

40

60

80

100

120

140

160

180

200

2009 2010 2011 2012

(m m²) (%)Monthly GFA new start

YoY growth (RHS)

6056

5056

5044

39

24 24

16

52 4

83

6

25

50

3631

35

7

6

8

511

14

17

30 29

20

1616 22

2116 24

21

24

11

14

15

18

38

129 9

12 14 16 17

34

4952

4845 46

43 43

21

9

2024

17

0

10

20

30

40

50

60

70

Jan 1

1

Feb 1

1

Mar

11

Apr

11

May 1

1

Jun 1

1

Jul 11

Aug 1

1

Sep 1

1

Oct

11

Nov 1

1

Dec 1

1

Jan 1

2

Feb 1

2

Mar

12

Apr

12

May 1

2

Jun 1

2

Jul 12

Aug 1

2

Sep 1

2

Oct

12

(No. of cities) Up Flat Down

Property FAI at 21.1%

in 10M12 versus our expectation of 23%

Prices have been quietly

going up since 3Q12

Half of 70 cities NBS

surveys have seen prices up in October 2012




Figure 26

Tier-1 cities: Prices and transaction volume

Source: Centaline Property Agency, CLSA Asia-Pacific Markets

Transactions will be flattish

China’s property market has been the main driver of economic growth. The

government needs a certain level of real-estate transactions to maintain a

stable economy. This is the reason why Beijing has eased purchase

restrictions this year to encourage first-time buyers. Since 1998, volume of

residential property sold has grown by more than 10-fold to 970m m² in

2011, or a near 20% Cagr. Sales growth this year should have been flat

despite the recent pickup in demand and we forecast a similar trend for 2013.

Our base-case scenario is that GFA sold will be up 5% next year, with a

monthly average of 84m m².

Figure 27

Nationwide residential monthly GFA sales


Tier-1 cities: low inventory except in Shanghai

Inventory in most tier-1 cities have declined to seven to eight months, as

transaction volume improved. With limited new supply, home prices could go

up in these areas in 2013. Having been in place in all tier-1 cities since early

2011, home-buying restrictions (HBRs) have contained demand especially

from non-locals, who need to provide one year of local tax paper before they

are allowed to buy (five years in Beijing). This group is gradually qualifying

for purchases, reducing inventory levels. An exception is Shanghai, where

inventory is at a historical high above 10m m².

0

1

2

3

4

5

6

7

5,000

10,000

15,000

20,000

25,000

30,000


Total primary area sold in tier-1 cities (RHS)

Tier-1 average secondary prices

(Rmb/m²) (m m²)

(50)

(25)

0

25

50

75

100

125

150

0

25

50

75

100

125

150

175

200

Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13

Resi GFA sold Avg Resi GFA sold Growth (RHS)

Avg 2011

81m m²

Avg 2010

78m m²

Avg 2009

72m m²

Avg 2008

47m m²

Avg 2007

58m m²

YTD 2012

70m m²

Est 201280m m²

Est 2013

84m m²

(m m²) (YoY %)

Remain cautious on GFA sold in 2013

Our base case is flat year-on-year property sales

Both prices and

transaction volume have recovered in tier-1 cities

Tier-1 cities: low

inventory could push up home prices




Figure 28

Figure 29

Figure 30

Tier-1 inventory (units-adjusted)¹

Beijing GFA inventory¹

Beijing inventory (units-adjusted)¹

Figure 31

Figure 32

Figure 33

Shanghai GFA inventory²

Shenzhen GFA inventory

Guangzhou GFA inventory

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

0

2

4

6

8

10

12

14

16

150,000

170,000

190,000

210,000

230,000

250,000

Jan 11 Aug 11 Mar 12 Oct 12

Units (LHS)

Months(months)(units)

0

5

10

15

20

25

30

5

10

15

20


(m m²) Supply (LHS)

Months

(months)

0

2

4

6

8

10

12

14

16

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000


Units (LHS)

Months

(months)(units)

0

5

10

15

20

25

30

4

6

8

10

12

14



Months

(months)

0

5

10

15

20

1.5

2.0

2.5

3.0



Months

(months)

0

5

10

15

20

25

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5



Months

(months)

0

5

10

15

20

25

30

35

40

50

60

70

80

90

100


Supply (LHS)

Months(months)(m m²)

0

10

20

30

40

50

60

10

12

14

16

18

20

22

Nov 11 Jan 12 Mar 12 May 12 Jul 12 Sep 12

Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

40

10

15

20

25

30


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

40

1.5

2.0

2.5

3.0

3.5

4.0


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

3

4

5

6

7

8

9

10

11


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

40

5

7

9

11

13

15


Supply (LHS)

Months

(months)(m m²)

Tier-2: inventory piling up from overinvestment




Figure 40

Figure 41

Figure 42

Xiamen GFA inventory

Suzhou GFA inventory

Nanjing GFA inventory

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

0

5

10

15

20

25

30

35

40

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

2

3

4

5

6

7


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

2

3

4

5

6

7

8


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

2

4

6

8

10

12

14

16


Supply (LHS)

Months(months)(m m²)

0

5

10

15

20

25

30

35

40

0.5

1.0

1.5

2.0

2.5

3.0

3.5


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

0.0

0.5

1.0

1.5

2.0

2.5

3.0


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

40

45

50

0.0

0.5

1.0

1.5

2.0

2.5


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

0.0

0.5

1.0

1.5

2.0

2.5


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

2

4

6

8

10

12

14

16

18


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

40

45

50

0.0

0.5

1.0

1.5

2.0

2.5

3.0


Supply (LHS)

Months

(months)(m m²)

0

5

10

15

20

25

30

35

60,000

70,000

80,000

90,000

100,000

110,000


Units (LHS)

Months

(months)(units)

0

5

10

15

20

25

30

20,000

30,000

40,000

50,000

60,000

70,000


Units (LHS)

Months

(months)(units)

Tier 3: inventory in

volume terms still high




Nationwide - Rising inventory

Extrapolating this trend nationwide, we estimate that inventory will increase

into 2013 to reach an average of 12.5 months. Seasonally weak property

demand in winter and Chinese New Year will cause inventory months to surge

in 1Q13, before stabilising in 2Q13. There has been a clear trend of rising

starts in the past few years, and declining cashflow for developers. With

cashflow still recovering, many projects will take longer to complete. This

could mean less inventory pressure, but also shrinking investment.

A positive surprise in inventory is possible, especially if the government

decided to loosen its property tightening measures selectively, particularly in

lower-tier markets. However, we believe this is unlikely until 2H13.

Figure 52

Nationwide residential property inventory estimate

Source: Wind, CEIC, CLSA Asia-Pacific Markets

Investment will continue to slow into 2013 Property investment will continue to slow, and we expect FAI to grow at 17%

in 2013 (self-built and developer projects). For developer investments alone,

our 15% growth forecast assumes 12% growth in construction GFA in and a

3% inflation in construction-material costs.

Figure 53

Property-investment growth


0

5

10

15

20

Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13

(months)Avg 2013

12.5 monthsAvg 2012

11.9 months

Avg 2011

9.2 monthsAvg 2010

8.0 months

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013

Residential only Real-estate investment Property FAI(YoY %)

Year-on-year increase in inventory levels

We estimate inventory

to increase in 2013

to reach an average of 12.5 months

Property FAI to grow at about 17% in 2013

Positive surprise

especially if government chooses to loosen in 2H13

Property-investment growth to slow


Section 3: New leadership policy ChinaOpps


New leadership policy We are hopeful, but do not believe that China’s new leaders will move quickly

to implement reformist policies. The power transition was a hard-fought

process and time is needed to build consensus. According to Cheng Li of

Brookings Institute, the current factional structure poses obstacles to

achieving cooperation on policy as the Politburo Standing Committee is

dominated by princelings, while the Politburo and Central Committee is more

evenly balanced. New leadership policies are likely to be incremental and

focused on areas where it is easier to make progress, such as financial

reform. Xi and Li will prepare a grand plan for the economy, but that is

unlikely to start until 2014 National People’s Congress. This should lead to a

new blueprint to guide China’s long-term reforms.

There have been critical assessments of Hu and Wen's legacy despite official

press highlighting their golden decade of achievements. Hu and Wen's

success has been mainly in sustaining China's high economic growth, which

brought tens of millions out of poverty with per-capita GDP rising from

US$200 to over US$4,000 during the past decade. At the same time, China

has also become the world's largest exporter and amassed large foreign

reserves. Critics would argue that the high growth was due to structural

reforms made by earlier leaders, such as cleaning up the banks, closing

unprofitable SOEs and joining the World Trade Organisation (WTO). There has

been a distinct lack of these types of reforms in the past 10 years.

Expectations of the new leadership are high. The upside to reforms is that

there is a general agreement on the country’s economic problems. Opponents

of reform have suffered major setbacks as there is consensus that the heavy

2009 stimulus was a mistake. It is clear now that while the central

government can move quickly in a crisis, it often could not control local-

government spending and credit growth.

‘If we speak candidly, this decade has seeded or created massive problems

and the problems are more numerous than the achievements,’ wrote Deng

Yumen, deputy editor of The Study Times newspaper in Caijin blog. The Study

Times is affiliated with the Party School of the Central Committee of the

Chinese Communist Party, which is headed by Xi Jinping. The article identified

‘ten grave problems facing China’:

1. No breakthroughs in economic restructuring and constructing a

consumer-driven economy.

2. Failure to nurture and grow the middle class.

3. The rural-urban gap has increased.

4. Population policy lags reality.

5. Bureaucratisation and profit-incentivisation of educational and scientific

research institutions continues to stifle creativity.

6. Environmental pollution continues to deteriorate.

7. The government has failed to establish a stable energy-supply system.

8. Moral lapses and the collapse of ideology: the government has failed to

build an effective and convincing value system that can be accepted by

the majority of its people.

The leadership transition

was a hard-fought

process and it takes time to build consensus

Distinct lack of reforms in the past 10 years

‘Ten grave problems facing China’




9. “Firefighting” and “stability-maintenance” style diplomacy lacks vision,

strategic thinking and specific measures.

10. Insufficient efforts in pushing political reform and promoting democracy.

The common thread of China’s problems has been that the pursuit of high

economic growth has created an imbalanced economy vulnerable to external

shocks and widening inequality. Social policies have lagged escalating social

tensions and conflicts. The continued focus on investment has been to sustain

growth, which is a near-term solution, and there has been inadequate effort

to rebalance the economy.

The government has neglected critical issues such as an ageing population

although China’s absolute work force would peak by 2014. Its population

policy has lagged reality as the hated one-child policy has resulted in a

gender imbalance, a heavier retirement burden and other social problems.

The middle class is also under pressure and its growth in size has lagged that

of the general economy. Rising property prices have lowered the group’s

standard of living, while weak stock markets have limited their channels to

generate investment returns.

The wealth gap has expanded to a worrisome level driven by the differences

between rural and urban areas. The outdated hukou (household registration)

system has not been able to keep up with the rapid migration of workers and

has increased worker tensions and social conflicts.

The environment has been the largest victim of unchecked growth and

environmental policies need to catch up with economic development. China’s

per-capita energy reserve is also quite low and it still relies heavily on

imports. Development of new energy sources has been rudimentary.

China’s 10 grave problems also represent the immediate priorities of the Party

and where their policies will be focused, hence potential policy-driven

investment themes:

Consumption and services could accelerate; investment-dependent

industries will continue to slow due to overcapacity.

Urbanisation will speed up and enlarge the middle class.

Upcoming income-redistribution plan is likely to offer subsidies to support

low-income groups, increase taxation on SOEs and open up lucrative SOE

markets to private companies.

Hukou and land reforms will encourage urbanisation.

Ending the one-child policy will be politically popular, but will only have a

marginal impact on the ageing population near-term.

The government will need to spend more on environmental services and

producing clean water.

Encourage efficient use and security of energy: China will continue to

acquire energy resources abroad and develop natural gas and shale gas.

Fundamental to energy policies is a price reform to promote energy

efficiency and encourage development of alternative resources.

To manage public opinion, the government will need to become savvier

on the internet and better leverage microblogs such as Sina Weibo, which

already has 51,000 accounts.

China’s immediate priorities

There has been

inadequate effort to rebalance the economy

Government has neglected critical issues




Forced to change This year marks the first time in eight years that the Chinese government

targets GDP growth of less than 8%. An 8% rate has always been the line in

the sand and China has not grown slower than that for two decades except

during the Asian financial crisis in 1997-98. The 8% target has been

important as it was thought that China needed to create about 10 million new

jobs per year to accommodate new workers entering the workforce. That is

likely to have changed as the country ages. China’s estimated average

labour/GDP intensity over 2000-07 is about 0.11, which means 1% GDP

growth during the period generated employment growth of 0.11%. Given a

labour force of 785m, 7.5% GDP growth would create about 7m new jobs.

The government forecasts the workforce to peak in 2014 and then start to

decline. Government policies starting this year will increasingly be influenced

by China’s ageing population and the need to maintain stable growth. This is

a dramatic shift as every major economic policy has been to keep people

employed and secure the central government’s power. Large SOEs that are

barely profitable or losing money could not lay off workers due to worries

about unemployment. Large industries with significant overcapacity, such as

metals and steel, could not close down plants to become more efficient

because that would displace workers. The political and economic reasoning

that has driven much of China’s macro and industrial policies will change as

workers become scarcer.

Chalco, China’s largest aluminium producer, provides a good example. The

company will lose Rmb4.5bn this year due to weak aluminium price. It is

overgeared and structurally uncompetitive. However, it is finding it difficult to

restructure as the firm would need to make part of its 200,000 workforce

redundant. Labour cost is only 3% of operating cost, so it would not be

difficult to trim the workforce and close down plants to make Chalco more

efficient. Ultimately, demographic change will push China to shut down excess

capacity and inefficient industries. However, this will not happen quickly and

Chalco has not expressed a plan to do so. The direction is clear and the new

government could accelerate the change.

Figure 54

China's industrial problems

Issue Targets

Excess capacity Iron and steel, textiles, alumina, coal chemicals, flat glass, caustic soda,

cement, solar polysilicon, shipbuilding, wind power

Fragmented Autos, auto parts, coal, cement, shipbuilding, nonferrous metals, steel,

aluminium, rare-earth mining, medical industries

Source: CLSA Asia-Pacific Markets

Two big solutions There are two broad areas that the government is looking at in order to

restructure the economy and move to higher-value manufacturing:

urbanisation and SOE reform. Accelerating urbanisation is the one policy that

capitalises on China’s large investment in infrastructure and can address

socioeconomic problems such as labour shortages, boost consumption and

narrow the wealth gap. SOE reform is critical to improving productivity,

promoting the private industry and moving China up the value chain.

Urbanisation and SOE

reform are two key

solutions to restructure the economy

Dramatic shift in policy

from sustainable

employment to maintain growth

An 8% GDP target has

been important to

create about 10 million new jobs per year

Demographic change will

push China to shut down

excess capacity and inefficient industries




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

0

1

2

3

4

5

6

0 1 2 3 4 5

1960 per-capita GDP relative to USA (log of %)

2010 per-capita GDP relative to USA (log of %)

China

Middle-income

trap

Became poor

Low-income trap

USA

Switzerland

Luxembourg

Hong Kong

Singapore

South

Korea

Venezuela

Botswana Brazil

Philippines

South Africa

Staying rich

Escaped income trap

40

45

50

55

60

65

70

75

80

1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

(%)

Less worker to

support dependents 4238

(10)

0

10

20

30

40

50

60

1982 1987 1992 1997 2002 2007 2012 2017

(% of GDP)

DRC estimate of GCF

Gross savings

Gross capital formation

External balance on goods and services






Urbanisation is the buzzword

Urbanisation has become a buzzword among policymakers as it has the

potential to aid China’s economic restructuring and create more sustainable

growth. It is not a new concept and is already well advanced with a 51% rate.

However, the rate is misleading as some 200m migrant workers in the cities

are second-class citizens that are exploited and do not have residency.

Urbanisation has gathered attention mainly due to rising wage pressure and

labour shortage. This has put more pressure on the government to address

outdated policies such as the hukou system and the one-child rule.

Urbanisation in many ways is a neat solution to the challenges facing the

country and unifies many of the disparate policies such as social housing,

property controls and infrastructure development. To rebalance the

economy, boost consumption and address labour shortage, China will need

to move more of its people to the cities. It is estimated that every 200m

farmers that move to urban areas boost GDP growth by 0.8ppts, due to

newly created consumption.

Whether government policies have been coordinated or not, much of the rules

and measures since the credit crisis have built the foundation for faster

urbanisation. Since 2008, the government has embarked on:

A Rmb4tn stimulus in 2009 - A majority was spent on infrastructure.

Social housing - Target of 36m units for 2011-15.

Property policy - Prevent property bubble and to make housing affordable

for migrants from rural areas.

Land reform - Give farmers land-use rights so they can capitalise on land

assets and increase their mobility.

Figure 55

Urbanisation - A tidy solution to sustain growth


Faster urbanisation has become more critical with an ageing work force and a

widening wealth gap. According to a landmark study on urbanisation by

consultancy firm McKinsey, nearly one billion people in China will live in urban

centres by 2025 and the urban economy will contribute more than 90% of the

country’s GDP.

Consumption

Social housing

Urbanisation

Property policy Infrastructure Land reform Hukou reform

Service sectorDecrease wage

pressuresNarrow

wealth gap

Urbanisation has

become a buzzword due

to rising wage pressure and labour shortage

Urbanisation is a

neat solution to many

challenges and unifies

policies such as social

housing, property and infrastructure

Urban economy to

contribute more than 90% of GDP by 2025




Figure 56

Urbanisation versus GDP per capita

Source: CEIC, McKinsey analysis, CLSA Asia-Pacific Markets

We have seen many studies on China’s urbanisation, from consulting firms

such as McKinsey to the Chinese Academy of Social Sciences (Cass), the

national scientific thinktank of the State Council. They all believe that China

will become a huge urban economy as that is the only way the country can

support such a large population. Their findings are similar and the latest Cass

study (September 2012) reiterates that China needs to develop large city

groups like the Pearl River Delta, the Yangtze River Delta, Bohai Rim,

Chengdu and Chongqing; and reduce the number of farmers through hukou

reform. There is a theoretical agreement and it is up to the new leadership to

make the changes.

Migrate up the value chain via SOE reform

It is highly unlikely that China can move up to higher-value manufacturing

by relying on the SOEs, which continue to dominate the country’s

industries. The comparison with Korea’s chaebols (family-run

conglomerates) do not add up as chaebols are privately driven, highly

competitive and less burdened by social policies. The largest difference is

that the Korean corporations take big risks such as making large

investments in an emerging IT and electronics industry, which fortunately

had paid off. In China, large SOEs have political and social burdens and

inherently are not risk-takers. Chairmen of chaebols strive to be global

industry leaders, while chairmen of SOEs strive to join the politburo or

Standing Committee. Only privately driven companies can push China up

the value chain. This is why SOE reform is so important and so far has

garnered much attention and research, but little real policy.

Chinese SOEs are dominant because of the central government’s

preferential policies. Their tentacles reach many sectors as China has too

many industries that are considered too important to be market-driven.

There are at least 25 industries that the government needs to have absolute

control of or have significant influence in. While the number of SOEs has

been reduced, they have become larger and stronger, controlling 42% of the

country’s industrial assets.

0

10

20

30

40

50

60

70

0

2

4

6

8

10

12

1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 2012 2018 2024

(log) (%)GDP per capita Urbanisation (RHS)

Forecast

Nearly one billion

people will live in urban centres by 2025

There is theoretical

agreement to boost urbanisation

Highly unlikely that China

can move up to higher-

value manufacturing by relying on SOEs




Figure 57

China’s classification of SOEs

Categories Industries Ownership

Strategic industries Defence, power generation & distribution,

telecom, oil and petrochem, coal, aviation, shipping

Maintaining 100% stake or absolute control

Basic & pillar

industries

Machinery, autos, IT, construction, steel,

base metals, chemicals, land surveying, R&D

Absolute or controlling

stake

Key industries Trading, investment, medicine,

construction, materials, agriculture, geological exploration

Maintaining influence by

controlling stakes in key industries

Source: BICCS

SOEs clearly generate lower returns even with preferential policies and

subsidies. A reform of the sector holds many promises such as increasing

productivity, moving China up the value chain and promoting sustainable

economic growth. It may be among the hardest reforms to do as it would

mean a move away from central planning, which was a hallmark of previous

administration. Entrenched interests will be hard to overcome, especially as

SOEs have gained so much economic influence.

The NDRC and Sasac as the central planner and guardian of SOEs will find it

hard to take power away from large SOEs, which are large employers with

strong political ties. The rise of the SOEs coincided with the Hu-Wen

administration, which came to power as the economy was recovering from the

Asian financial crisis. Hu and Wen were engineers whose experience was in

less-developed central and western provinces, where growth has been mainly

state-driven. After Hu-Wen took power, they established the Sasac as a

manager as well as a guardian of the SOEs, to restructure them, increase

their efficiency and enhance their value.

Figure 58

SOEs have declined in relative importance

Source: World Bank/DRC China 2030 report, CEIC, CLSA Asia-Pacific Markets

SOE reform is important for private companies as it will open many industries

for them to invest and compete on a level playing field. This is complemented

by policies such as interest-rate reform or promotion of capital markets,

which gives the private sector more and freer access to capital. China will

only move up the value chain through the private sector, as large SOEs are

unlikely to be innovative enough to do the job.

0

10

20

30

40

50

60

70

80

1998 2000 2002 2004 2006 2008 2010

(%) SOEs: share of industrial assets

SOEs: share of industrial output

SOEs: share of No. of enterprises

4.5% by number

26% by output

42% by assets

Power has become more

concentrated with large

SOEs especially those in

strategic industries

SOEs are classified as

strategic or basic and

pillar industry or sectors

where government wants to retain influence

Difficult to take power away from large SOEs




Figure 59

The path up the value chain


Figure 60

ROE of private firms exceeded that of SOEs

Source: World Bank/DRC’s China 2030 report, CEIC, CLSA Asia-Pacific Markets

Figure 61 Figure 62

ROA of SOEs and private enterprises ROA of SOEs in selected industries

Note: Industrial enterprises include refining, manufacturing, etc. Source: CEIC, CLSA Asia-Pacific Markets

SOE reform

Promote private sector

Interest-rate reform

Promote stock and bond markets

Migrate up value chain and increase

productivity

Escape middle-income trap

EfficientSOEs

0

5

10

15

20

25

30

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(%) Private Overall industrial SOEs

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011

(%) Private

Industrial enterprises

SOEs

0

20

40

60

80

100

1999 2001 2003 2005 2007 2009 2011

(%) Tobacco

Oil & gas

Electric, heat production & supply

SOEs have become more

efficient and productive with restructuring

China will only move up

the value chain through the private sector




What is needed for SOE reform?

The government does not have a clear policy in deciding the industries that

should be protected and nurtured, and to what degree. It is involved in many

sectors and many of the SOEs compete directly against private companies. A

clearer explanation is needed as to why selected industries are strategic and

where the government needs absolute control and why certain industries are

only pillar or key, where Beijing only needs to maintain a strong influence.

This will limit SOEs’ expansion and allow the private sector to expand and do

more long-term investments. The objective is to level the playing field for

private companies.

Redefine state ownership - The government lists four areas to be

controlled by SOEs: state safety, natural monopolies, public goods and

key companies in pillar industries. The broad definition includes a wide

list of companies. The government needs to restrict state ownership to

functions such as provision of public goods and only to industries that are

truly strategic and reduce the influence of the government in competitive

markets. The anti-monopoly law should be strengthened to bring down

regulatory barriers.

Review list of protected industries and downsize state sector -

The list of strategic, basic or pillar, and key industries have created

administrative monopolies, which should be minimised as much as

possible, especially for those companies that are already operating in

competitive industries such as construction and steel. State ownership

should be downsized to allow fair competition.

A clearer definition is

needed of why selected

industries are strategic

and where government needs absolute control

State ownership should

be downsized to allow

fair competition for private companies

The government needs to

restrict the definition of state ownership


Section 4: Survey - What do Chinese people think? ChinaOpps


Survey - What do Chinese people think? Last year, we polled ordinary Chinese across China from different walks of life

using an online survey of more than 500 respondents. We repeated our study

this year, using the same professional online-survey service that is popular

among universities, researchers and corporations. Consumers are generally

holding up well, benefiting from wage increases and more moderate inflation.

Although their incomes have risen less than they had expected, they foresee

a better 2013. This appears to be consistent with improving macroeconomic

data. Consumption is strong and travel remains a top priority. Property-price

expectations have softened. However, sentiment towards stock markets has

deteriorated, with more people believing A shares are ‘just for speculation’

and looking to reduce stock holdings next year. Top picks from our

respondents are PetroChina, Sinopec and ICBC.

Figure 63

Profile of survey participants

Age group <20 (5%); 20-29 (20%); 30-39 (30%); 40-49 (20%), >50 (25%)

Employment Student (10%); employed (88%); unemployed (2%)

Education High school or below (10%); community college (20%);

university or above (70%)

Region Eastern (50%), central (30%), western (20%)


The survey was divided into seven parts on people’s outlook for the economy,

Chinese leadership, investment, property, inflation, spending and social

issues. Key conclusions:

Economy - Although most people described 2012 as ‘average’ or ‘bad’ for

China, a higher proportion thought they were better off than the year

before. Most respondents are optimistic on 2013.

Government - Healthcare and corruption are now equally important

priorities for Beijing. Wealth gap and property prices are ranked as

China’s worst problems.

Investment - Gold is still considered as the best investment option,

although almost everyone has invested in wealth-management products.

Sentiment for A shares has deteriorated with more people believing that

it is ‘just for speculation’ and expect to reduce stock holding next year.

Top stock picks are PetroChina, Sinopec and ICBC.

Property - Even with the weak real-estate market this year, almost

everyone continue to believe property is overpriced. Views on tightening

policies are mixed, with most expecting some form of relaxation.

Inflation - Overall inflation expectations have softened. Actual wage

increase in 2012 has been worse than expected, but most remain

positive on wages in 2013.

Spending - Slower-than-expected wage growth has had little impact on

consumption, and the majority has increased their spending in 2012.

Travel remains a top consumption category. Smartphones continue to top

the purchase list.

Social issues - Overall impression on the social-housing programme has

improved, while most are still worried about fair allocation. Food safety is

still a major problem.

Optimism despite

property tightening,

rising inflation and a slowing economy

Gold is the most preferred investment

Inflation expectations have softened

A broad range of middle-

income participants from across the country

Average 2012, hoping for a better 2013

Healthcare has become more important

Lower price expectation for property for 2013

Travel and appliances/

electronics remain popular spending items

Impression on social housing has improved




1. Economy - Outlook remains optimistic Our respondents feel that they are generally better off this year than last

despite the belief that the local economy has deteriorated in 2012. This is

likely due to rising wages, relatively stable employment and declining

inflation. However, the perception of the economy is weaker than last year.

Figure 64

Was 2011/12 a good year for China/you?


Our respondents have an overwhelmingly positive outlook for 2013, with 78%

saying they are optimistic, up from 70% last year. An equal number believe

the economy will be stronger next year, with 12% saying that it will be much

better. It appears that the public believes the economy has bottomed, and

are looking for a better year in 2013.

Figure 65 Figure 66

Do you think the economy will be stronger next year? How do you think the economy will do next year?


We once again asked about the possibility of China having a hard landing. The

number of respondents that think China will have a hard landing has declined.

While 43% believe China is likely to have a hard landing, down from 55% last

year. However, note that some respondents may not have a good

understanding of what the term “hard landing” means.

35.6 31.5

45.2 48.2

44.745.5 21.2

25.1

19.7 22.933.6

26.5

0

10

20

30

40

50

60

70

80

90

100

Was 2011 a good

year for China?

Was 2012 a good

year for China?

Are you better off in

2011 than in 2010?

Are you better off in

2012 than in 2011?

(%) Good/better Average/same Bad/worse

12.3

66.3

13.5

7.0

0.7

0

10

20

30

40

50

60

70

Much better A little better About the

same

A little worse Much worse

(%) 2012 2013

8.9

33.9 34.7

16.1

6.3

0

5

10

15

20

25

30

35

40

Very

optimistic

Optimistic Somewhat

optimistic

Cautious Worried

(%) 2012 2013

More people felt they

were better off in 2012,

despite fewer describing 2012 as a good year

About 32% said 2012 was

a good year for China, down from 36% in 2011

Improved sentiment on 2013 with 78% optimistic

On hard landing




Figure 67

What chance do you see of China having a hard landing?


It is possible that our respondents’ positive prospects for next year are partly

due to the weak 2012. While fewer people described business conditions at

their workplace as ‘good’, more than half believe it will improve next year,

versus 47% last year. Job prospects have deteriorated this year with about

half saying that it has gotten worst. However, they generally expect an

improvement in the employment outlook in 2013.

Figure 68

Employment and business outlook


4.2

55.0

23.7

16.1

1.1 3.6

43.1

28.0

23.3

1.9

0

10

20

30

40

50

60

Very likely Likely Don’t know Unlikely Highly unlikely

(%) 2012 2013

Bad 8.0%

Decline

11.6%Decline

8.2%

Worse

44.3%

Worse

49.1%

Decline

17.4%

Decline

17.8%

Average

70.3%

Average

73.7%

Stay the

same

42.0%Stay the

same

40.2%

Balanced

45.8%

Balanced

43.9%

Stay the

same

50.5%

Stay the

same

45.3%

Good

24.6%

Good

18.1%

Improve

46.5% Improve

51.5%

Plentiful

9.9%

Plentiful

6.8%

Improve

32.2% Improve

36.8%

1 2 3 4 5 6 7 8 9 10 11

Bad 5.1%

What are current

business conditions

like at your workplace?

Do you think business

conditions will improve

in the next year?

What are current

job prospects like?

Do you think job prospects

will improve in the

next year?

Some 47% think “hard

landing” is likely or

very likely, down from 59% last year

More positive outlook on

business and employment prospects for 2013




2. Government - Healthcare is a bigger problem The government continues to receive above-average approval in managing

the global financial crisis and on executing reforms. It has managed public

perception well. Surprisingly, healthcare has risen to become Beijing’s top

priority, slightly higher than cracking down on corruption. It could be due to

the Bo Xilai scandal that broke this year, giving our respondents an

impression that the government is getting tough on corruption.

Property prices have dropped in priority given China’s tight property policy.

The largest decline in the government priority ranking is controlling property

prices, although it is still ranked one of the country’s worst problems

alongside the wealth gap.

Figure 69 Figure 70

Government leadership scores (1=worst, 5=best) What should be the government’s most pressing issues?¹

Figure 71 Figure 72

What are the country’s best hopes?² What are the country’s worst problems?¹

¹ Rank 1-7. ² Rank 1-5. Source: CLSA Asia-Pacific Markets

Our respondents still believe that the country’s strength lies in its large cash

reserves and assets and strong economy. However, scores have declined

marginally this year. Leadership is considered average but has improved.

Education system is considered below average, which is not surprising given

the number of unemployed college graduates.

2.98

2.28

3.19

3.06

3.31

1 2 3 4 5

How successful

have government

reforms been?

How have

government

policies managed

corruption?

Do you think that

China has managed

the global credit

crisis well?

2012

2011

BestWorst

This question

was censored

4.86

4.81

4.24

4.04

3.97

3.75

2.28

1 2 3 4 5 6

Healthcare

Corruption

Education

Property prices

Pensions

Jobs

Crime (score)

2013

2012

3.66

3.57

3.05

2.75

1.96

1 2 3 4 5

Large cash

reserve

and assets

Strong

economy

Strong

leadership

Strong

infrastructure

Strong

education

system(score)

2013

2012

5.09

5.08

4.77

4.47

4.24

3.24

1 2 3 4 5 6 7

Corruption

Wealth gap

Property

prices

Inflation

Employment

Pollution

Crime (score)

2013

2012

Average on reforms; poor on managing corruption

Large cash reserves

and assets and strong economy




3. Investment - Like gold and wealth-management products Gold remains the most preferred investment followed by bank deposits and A

shares, but popularity of these channels have all declined. Interest has grown

in foreign currency and alternative products, which is not surprising as the

renminbi is no longer a one-way appreciation bet.

Despite their low valuations, sentiment on A shares has deteriorated. The

proportions of respondents believing that the market is ‘good for long-term

investment’ and ‘just for speculation or gambling’ are roughly equal.

Wealth-management products have increased in popularity with almost every

one surveyed having invested in some. Slightly fewer people claimed to have

invested in private lending. Our sample size is limited, but there could be a

geographical shift in those participated. Last year, many people who

participated in private lending came from Zhejiang, neighbouring Jiangxi and

Jiangsu provinces. This year, we have relatively more respondents from the

central region, such as Shanxi and Hunan provinces.

Jewellery remains the top alternative investment channel, followed by art and

diamonds. Jade has declined in popularity, while wine and luxury watches

have gained prominence.

Figure 73 Figure 74

What would be the best investment option next year? Have you invested money in any of the following?

Figure 75 Figure 76

Are stocks a good investment or just for speculation? What other investment would you consider?


1.9

6.0

5.5

15.6

18.0

20.0

33.1

0 10 20 30 40

Foreign

stock market

Others

Forex

Property

Domestic

stock market

Bank savings

Gold

(% of respondents)

2013

2012

17.9

88.2

15.7

92.1

0 20 40 60 80 100

Private lending

Wealth-

management

products

(% of respondents)

2013

2012

18.4 17.8

43.840.8

37.8 41.4

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%)

Not sure Good long-term investment Only for speculation

18.5

19.5

23.5

30.0

31.7

60.1

0 10 20 30 40 50 60 70

Luxury

watches

Wine

Jade

Diamonds

Art

Jewellery

(% of respondents)

2013

2012

Popularity of gold,

bank savings and A shares has declined

Fewer people claimed

to have invested in private lending




Stocks - Sentiment has deteriorated

Most Chinese people do not own many stocks. As percentage of household

assets, our sample group this year owned more stocks than last year, with

about 40% of our respondents said they have less than 5% of their assets in

the domestic stock market.

Given the poor performance of A shares this year, it is not surprising that

respondents’ outlook for the stock market has worsened. Most still prefer to

maintain their stock holdings, but an increasing number indicated they would

reduce holdings next year.

Of our respondents, 39.4% would buy stocks next year, but this has declined

from last year’s survey. For those looking to buy, the top sectors continue to

be banks, technology, resources and consumer. However, overall interest in

banks, technology and insurances has declined. The top stock picks are

bluechips: PetroChina, Sinopec and ICBC.

Figure 77 Figure 78

What percentage of your household assets are in stocks? If you already own stocks, next year, would you . . .

Figure 79 Figure 80

Would you buy stocks next year? What sector would you buy? (can select more than one)


40.4

31.3

17.1

8.1

3.1

0 20 40 60

Less than 5%

Between 5% and 10%

Between 10% and 20%

Between 20% and 40%

More than 40%(% of respondents)

2012

2011

20.3 18.3

27.3 30.0

40.7 40.4

11.8 11.3

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%)

Buy more stocks Reduce stock holdings

Maintain position Would not invest

46.739.4

30.4

34.9

23.0 25.7

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%) Yes No Unsure

6.3

15.4

25.2

38.2

47.3

44.5

52.9

0 10 20 30 40 50 60

Others

Property

Insurance

Consumer

Resources

Technology

Banks

(% of respondents)

2013

2012

Respondents like

PetroChina, Sinopec and ICBC

Few Chinese people

own many stock s


https://www.clsa.com/member/company/index.asp?clsa_id=5650





4. Property - Expect to correct less next year Even with official data showing property prices flat or declining for most of

2012, almost all respondents continue to believe property is overpriced. The

sentiment has marginally improved, but virtually nobody believes that

property is cheap.

More respondents expect property prices to decrease next year, but by a

lesser amount. Over 70% expect prices to correct by less than 15%, a sharp

increase from last year. People generally expect prices to correct less than

15%. This is consistent with our China Reality Research (CRR) team’s on-the-

ground studies.

Given that over 80% of our sample panel owns one or more property, it is not

surprising to see most continue to wait for a better entry point to buy. But

prices would not have to fall much for them to come back into the market:

around 48% would buy if prices have fallen by less than 25%.

More respondents believe that the government will relax its property policy

moderately next year. It is consensus that policies will not be completely

removed. Opinion has become more split as a higher number also responded

that there would be no relaxation. Repeated tough talk on property from

high-ranking officials also appeared to be working.

China Reality Research’s findings In general, our survey is consistent with CRR’s on-the-

ground research. The outlook of CRR's consumer panel

for income and spending power improved sharply in

October. Meanwhile, the sentiment on property, A shares

and autos was broadly stable compared with the

previous month. On Property, overall prices at the 120

residential projects CRR tracks were again marginally

positive in October, but at coastal projects prices

corrected MoM for the first time in four months.

Consumer: The spending outlook has improved. The

share of CRR’s panel expecting their income to rise in

the next six months increased to 51% from 43% in

September as some business people on the panel said

their business had been improving recently. The share

expecting their spending power to grow over the next

six months also increased to 34% from 28% in

September, perhaps linked to expectations of pay

increases around Chinese New Year. Over 66% (versus

62% in September) expect overall prices to go up over

the next six months, in line with seasonal trends; their

expectations for food and non-food price hikes also

grew MoM.

Property: CRR finds that 4Q12 will be tough for local

property developers, given a tighter policy

environment, high inventories and worsening liquidity.

Absent some policy moderation their sales look set to

continue to slow over the next few months. At the same

time, large listed developers have more room for

manoeuvre and are gearing up to gain more market

share from smaller players.

Family income over next 6M will: Family spending power over next 6M will:

Source: CRR, CLSA Asia-Pacific Markets

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

0

10

20

30

40

50

60

70

80

90

100

Dec 1

1

Jan 1

2

Feb 1

2

Mar

12

Apr

12

May 1

2

Jun 1

2

Jul 12

Aug 1

2

Sep 1

2

Oct

12

Rise Same Fall(%)

44 4135 33 32 30 32 32 30 28

34

34 3740 43 43 47 45 44 48

4542

22 22 25 24 25 23 23 25 23 28 24

0

20

40

60

80

100

Dec 1

1

Jan 1

2

Feb 1

2

Mar

12

Apr

12

May 1

2

Jun 1

2

Jul 12

Aug 1

2

Sep 1

2

Oct

12

Increase Stay the same Decrease(%)

Over 70% of people

expect less than 15% correction

CLSA Asia-Pacific Markets

Tough talk is working


https://www.chinareality.net/member/



Figure 81 Figure 82

Do you think that property prices are . . . Do you own property?

Figure 83

Figure 84

If you are planning to buy, would you . . . Property-price expectations

Figure 85

Figure 86

Do you expect easing of property policies next year? If government eases on property policy, would prices . . .


This contrasts with CRR’s on-the-ground survey of property sales managers,

which has shown low expectations of policy easing in 2013. About 70% of

sale managers expect China to maintain its tightening measures, while 21%

expect some relaxation in 2013, and 9% expect policies to be tighter than in

2012. Most people remain positive on long-term property-price appreciation,

as 60% believe prices will shoot up once tightening polices are removed.

0.0

5.0

95.0

0.7

7.0

92.3

0

10

20

30

40

50

60

70

80

90

100

Cheap Fairly priced Overpriced

(%) 2012 2013

26.420.7

56.259.9

14.3 15.9

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%) 0 1 2 3 4

4.4 7.7

81.8 79.1

13.8 13.2

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%)

Buy now Wait for better entry point Cancel the purchase plan

49.7

71.9

11.6 16.3

30.2

21.1

36.1

48.0

20.1

7.0

52.3

35.8

0

20

40

60

80

100

(%)<15% 15-25% >25%

Do you think

that property

price will correct?

How much will prices

have to fall to make you

buy property now?

31.7

45.2

22.6

0.5

27.3

42.2

29.1

1.5

0 10 20 30 40 50

No

Moderate

relaxation

Only selected

regions

Complete

removal(% of respondents)

2013

2012

59.4

30.3

10.3

59.7

31.9

8.5

0 10 20 30 40 50 60 70

Shoot up

Stabilise

Decline

(% of respondents)

2013

2012

Sales managers has low expectation on easing




5. Inflation - Lower expectation An increased proportion of our respondents believes the government has

done a ‘good’ or ‘adequate’ job in fighting inflation, and only 10.6% said it

was ‘poor’ (2011: 16.8%). Even when the official CPI fell to 1.7% YoY in

October, over 55% of respondents still expect inflation to be up 5-10% next

year, with 20% anticipating that it will be up more than 10%. Overall,

inflation expectation has declined.

Figure 87 Figure 88

Is the government doing a good job managing inflation? How much will prices rise next year?


Wage growth weaker than expected

Although people’s income has improved, both household income and wage

increases in 2012 have been worse than expected. Only 4-5% have seen

their wage or household income increase by more than 20%. Most

respondents have had increases of 5-10%. This could explain the slowing

pace of retail sales this year. Most respondents are more positive on wage

increases in 2013 than last year and expect them to be larger those in the

current year.

Figure 89 Figure 90

How much has your household income improve by? How much has your personal income improve by?


5.3

26.9

57.2

10.6

0

10

20

30

40

50

60

70

Great Good Adequate Poor

(%) 2012 2013

20.124.7

16.222.6 24.1 27.1

56.455.8

51.948.3 48.1

48.3

19.216.8

24.524.0 22.5

21.1

4.4 2.7 7.4 5.1 5.3 3.6

0

10

20

30

40

50

60

70

80

90

100

0-5%

5-10%

10-20%

20%+

(%)

Overall Food Non-food

34.529.1

36.529.8

45.9

43.0

43.2

38.9

14.621.0

15.2

22.3

4.9 6.9 5.1 9.1

0

10

20

30

40

50

60

70

80

90

100

2011

actual

2012

expected

2012

actual

2013

expected

(%) <5% 5-10% 10-20% 20%+

2011 survey 2012 survey

39.432.2

43.5

31.5

42.3

41.2

35.5

41.6

14.3

19.016.8

20.0

4.0 7.6 4.3 6.9

0

10

20

30

40

50

60

70

80

90

100

2011

actual

2012

expected

2012

actual

2013

expected

(%) <5% 5-10% 10-20% 20%+

2011 survey 2012 survey

People do not believe inflation will fall

Wage growth weaker than expected




6. Spending - Looking to buy more Lower than expected wage growth appears to have little impact on

consumption on basic spending such as shoes and clothing purchase which

has remain unchanged. Less than 30% are waiting for sales or expect to cut

spending amount. Travel remains the top priority with 67% planning to travel

in 2013, up 13 percentage points from last year.

In terms of big ticket spending, home appliance and electronics continued to be

next on their list. More people are planning to buy new smartphones,

computers, air conditioners next year. Desire to buy a car was slightly reduced.

For those buying a car, almost three-quarters looking for an upgrade.

Figure 91 Figure 92

Compared to last year, spending on shoes/clothes has... What big items do you plan to purchase?

Figure 93 Figure 94

Do you plan to travel abroad or domestically next year? Do you plan to buy a home appliance/electronics?

Figure 95

Figure 96

Figure 97

Do you plan to buy a car next year?

If yes, what would it be?

If yes, what kind of brand?


18.3

37.7

14.7

13.4

5.5

10.5

0 10 20 30 40

No change

Increased

consumption

Upgraded to better

brands/products

Wait for sales

Switched to

cheaper brands

Reduced or cut

consumption (% of respondents)

2012

2011

67.3

61.5

43.8

36.3

25.7

21.8

13.7

0 20 40 60 80

Travel

Home appliance/

electronics

Car

Property

Life insurance

Children's extra-

curriculum classes

Others (% of respondents)

2013

2012

53.8 57.2

13.614.6

18.6

20.0

14.08.2

0

10

20

30

40

50

60

70

80

90

100

2012 2013

(%) Domestic International Both No plan to travel 69.5

54.5

39.7

34.8

30.3

22.3

0 20 40 60 80

Smartphone

Computer

Air-conditioner

Refrigerators

Washing

machine

Others (% of respondents)

2013

2012

51.0

49.0

52.5

47.5

44 46 48 50 52 54

Yes

No

(% of respondents)

2013

2012Upgrade

73%

Second Car

27%

Foreign

brand

59%

Domestic

brand

41%

Slowing economy

appears to have no impact on consumption




7. Social issues - Do not trust food safety or social housing The two hot social issues are food safety and social housing. Despite higher

completion targets in 2012, we are surprised by the increased level of

scepticism about social housing. Over 70% of respondents are worried about

fair allocation and only 30% believe the government will meet its social-

housing targets. However, overall impression of the programme has improved

with almost half of the respondents saying it is a good scheme.

People remain very worried about food safety, although sentiment has

marginally improved. Almost half of our respondents are very concerned

about safety and only 12% believe food safety will get better.

Figure 98 Figure 99

What do you think about the government’s social-housing programme (can pick more than one)?

What do you think about China’s food safety? (pick one)


More respondents believe Chinese product quality is improving. Chinese

companies are using better technology and improving product quality.

Another important theme is that SOEs are still considered too powerful and

dominant, squeezing out smaller companies. The sentiment is not surprising

as most respondents are likely working for small and medium enterprises.

Figure 100 Figure 101

Do you believe that Chinese companies are getting more innovative and producing better-quality products?

Do you think that China’s large SOEs are too dominant in the market?


47.6

29.6

18.5

70.6

0 20 40 60 80

Very good

programme

Will meet

target

Expect fair

allocation

Worried about

fair allocation

(%)

2013

2012

45.7

27.4

12.8

11.8

2.2

0 20 40 60

Very worried

Not hopeful

it will change

Isolated

problems

Confident it

will be improved

Overplayed

in the press (% of respondents)

2013

2012

22.3

63.5

10.8

3.4

0 20 40 60 80

Yes, quality

of products

are improving

Yes, technology

is improving

No, about

the same

No, quality

is declining (% of respondents)

2013

201213.7

70.6

15.8

0 20 40 60 80

No, they are

not too dominant

Yes, but they

squeeze out

smaller companies

Yes, but they

are well run

(% of respondents)

2013

2012

Food safety is a worry

Impression of social

housing has improved, but allocation still a worry

More respondents

believe Chinese product quality is improving


Section 5: Investment ideas for 2013 ChinaOpps


Investment ideas for 2013 In this section, we provide 10 key investment themes, sector

recommendations and our top-10 ideas and SELLs for 2013. Our investment

themes are heavily consumer-focused and relate to likely government policies

next year. Our top stock picks are ranked in order of return of capital,

cashflow yield and Ebit growth.

Ten investment themes

We expect 2013 to be a transition year and bold new policies are more likely to

come in 2014. Policy changes next year will be incremental and follow the path

that has already been laid, such as financial reform and urbanisation, which are

the low-hanging fruits for policymakers. Our survey indicates that consumers are

optimistic about 2013 and will continue to spend, boosting consumption.

1) Interest-rate reform - We are likely to see loosening or removal of the

lending-rate floor and another adjustment to the deposit-rate cap. This

could be accompanied by another interest-rate cut in 2H13 similar to

2012. Bank margins will remain under pressure.

2) Price reform for energy - Price reform is critical to China’s energy

security and increasing the efficiency of SOEs, which pay subsidised

tariffs. Reform starts with setting petrol/gas prices according to market

rates. Contract coal prices should also be more market-driven, allowing

increases in electricity costs to be passed on to end-users. These plans

have already been submitted to the State Council for approval. The most

immediate priority is likely to be petrol/gas price reform, which should be

positive for refiners such as PetroChina and Sinopec.

3) One-child policy - This is a low-hanging fruit for policymakers. The one-

child policy is outdated and comes at a large social cost. Phasing it out

would be a popular political move. There has already been gradual

loosening in rural areas and couples that were both the only child in their

own families can have more than one child. This could lead to higher

demand for baby products. Prince Frog is our preferred play.

4) Hukou reform - This is another low-hanging fruit, as the hukou system

has outlasted its usefulness and needs to be phased out. In February, the

State Council announced that migrant workers can apply for urban

household registration cards at county- and prefectural-level cities after

three years of employment and residency. We could see this process

accelerate or expand in 2013. Change in the hukou policy could provide a

large boost to consumption.

5) Urbanisation - China’s infrastructure spending, social housing, property

controls and hukou reform all point to faster urbanisation, which has

become a buzzword for policymakers as it can boost consumption. The

urban economy is expected to contribute more than 90% of GDP by

2025. Primary beneficiary are property developers.

6) Top domestic brands - Our consumer survey shows that consumers are

optimistic about 2013 and there is a strong preference for high-quality

local brands. Boston Consulting believes we have reached a tipping point

for Chinese brands and name the top 10 Chinese brands that are best

positioned to excel over the next eight years. We have positive ratings on

six of them. Top brands in descending order are Baidu (BUY); Changyu

Wine (N-R); China Mobile (Outperform); ICBC (Underperform); Lenovo

(Outperform); Mengniu (N-R); Tencent (BUY); Tsingtao (Underperform);

and Sinopec (BUY).

Policy change will

be incremental and

follow the path that has already been laid

Bank margins will remain under pressure

Petrol, gas and contract

coal prices should be more market-driven

Phasing out one-child

policy would be a popular political move

Hukou reform could

be accelerated or expanded in 2013

Urbanisation has

become a buzzword for policymakers

Strong preference

for high-quality domestic brands

Ten investment themes





7) Healthcare - According to our consumer survey, healthcare has become

a top concern for consumers mainly due to rising cost. This is despite

government expanding basic health-insurance coverage to 95% of the

population. Healthcare cost has risen by about 17% per year over the

past two decades. McKinsey expects China’s healthcare spending to triple

to US$1tn by 2020. Our top pick is Sino Biopharm and Mindray.

8) Travel - Leisure travel is again the top choice for spending on big-

ticket items in our survey. The government has been promoting

domestic tourism to boost consumption and waived road tolls during

the Golden Week holiday in October. Domestic travel expenditure has

grown 17% over 2009-11 and shows no sign of slowing. Budget-hotel

operators such as China Lodging are major beneficiaries, and also

online travel-service provider Ctrip, which has a newly built platform

targeting leisure travel.

9) Tough A-share market/good bond market - The government has

been trying to promote domestic stock markets without much

success. The number of IPO is expected to be down 40% YoY in 2012

and proceeds raised are likely to have dropped 55% YoY. We are not

optimistic that the government can boost the stock markets, but

there is less downside risk to market index and turnover next year.

The natural beneficiary is the bond market, which should do even

better in 2013 and Chinese securities companies, such as Haitong,

stand to benefit.

10) Largest earnings rebound/acceleration - This year is likely to

witness the largest deceleration in GDP in the past two decades, with the

exception of the global credit crisis. Thus, a number of companies have

suffered unusually large earnings declines. These names should rebound

strongly next year as growth stabilises. We highlight our top 10 ideas in

Figure 102.

Figure 102

Top companies with earnings rebound/acceleration (ranked by 13CL EPS growth)

Company Code Sector Rec Mkt cap (US$m)

PE (x) EPS g (%) PB (x) ROE (%) Yield (%)

13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL

CR Power 836 HK Power BUY 10,514 8.3 7.3 55.2 14.5 1.4 1.2 16.4 16.6 4.2 4.8

Sands China 1928 HK Hotels & leisure O-PF 34,246 18.5 15.6 58.1 19.1 6.3 5.7 34.0 38.5 4.3 5.1

CNBM 3323 HK Materials BUY 6,870 5.1 4.1 47.7 19.7 1.1 0.9 21.8 21.5 2.8 3.5

Haitong 6837 HK Financial services BUY 13,191 17.1 13.8 41.1 20.6 1.2 1.1 7.6 8.6 2.0 2.5

Sina SINA US Internet O-PF 3,128 51.0 23.9 nm 113.4 1.9 1.8 4.7 9.3 0.0 0.0

China Telecom 728 HK Telecoms BUY 45,848 13.5 11.1 35.0 18.0 1.0 0.9 7.4 8.2 2.4 2.9

Ctrip CTRP US Internet O-PF 2,596 19.8 14.3 32.7 34.0 1.7 1.4 9.3 10.6 0.0 0.0

Xinyi Glass 868 HK Materials O-PF 2,195 11.1 9.3 32.1 19.2 1.6 1.5 15.7 17.1 4.3 5.1

Sinopec 386 HK Petro/chems BUY 86,187 7.3 6.5 21.4 7.5 1.0 0.9 14.7 14.3 4.3 4.7

Golden Eagle 3308 HK Consumer BUY 4,589 19.2 14.9 19.8 25.7 4.4 3.5 25.2 26.1 1.6 2.0


Healthcare has

become a top concern for consumers

Domestic travel

expenditure has grown

17% over 2009-11 and shows no sign of slowing

Natural beneficiaries

are the bond market and securities companies

Firms that have suffered

unusually large earnings

declines in 2012 should rebound strongly in 2013




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.

Figure 104

Top ideas (ranked by ROIC)


PE (x) EPS g (%) PB (x) ROE (%) Yield (%) CG score 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL

Cogo 81 HK Property BUY 2,427 6.8 5.5 34.5 24.9 2.0 1.5 35.6 31.8 0.9 1.1 47.4

Tencent 700 HK Internet BUY 61,236 23.3 18.5 27.5 22.1 6.6 4.8 32.7 29.5 0.5 0.6 46.1

Sino Biopharm 1177 HK Healthcare BUY¹ 2,295 16.2 13.2 27.4 23.3 3.3 2.8 24.1 24.2 0.0 0.0 38.2

China Mobile 941 HK Telecoms O-PF 228,120 10.9 10.1 2.9 4.5 1.8 1.6 17.1 16.2 3.9 4.2 38.2

Belle Intl 1880 HK Consumer BUY 17,088 19.3 15.8 19.0 18.2 4.1 3.3 22.6 22.8 1.6 1.9 71.5

CR Power 836 HK Power BUY 10,514 8.3 7.3 55.2 14.5 1.4 1.2 16.4 16.6 4.2 4.8 55.4

Sinopec 386 HK Petro/chems BUY 86,187 7.3 6.5 21.4 7.5 1.0 0.9 14.7 14.3 4.3 4.7 65.1

Melco Crown MPEL US Hotels & leisure BUY 8,451 18.5 15.6 11.4 18.3 2.0 1.8 11.4 12.0 0.0 0.0 77.4

Bank of China 3988 HK Financial services BUY 121,510 5.3 4.8 2.3 7.1 0.8 0.7 15.9 15.5 6.0 6.6 52.2

Haitong 6837 HK Financial services BUY 13,191 17.1 13.8 41.1 20.6 1.2 1.1 7.6 8.6 2.0 2.5 41.0

¹ Sino Biopharm is covered by our joint venture Fortune CLSA. Source: CLSA Asia-Pacific Markets

Bright spot of the

economy is the consumer; gloomy part is investment







Figure 105

Top SELLs (ranked by ROIC)

Company Code Sector Rec Mkt cap

(US$m) PE (x) EPS g (%) PB (x) ROE (%) Yield (%) CG

score 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL

Chalco 2600 HK Materials SELL 9,095 (27.0) (33.4) nm nm 0.8 0.8 (2.9) (2.3) 0.0 0.0 29.7

Angang 347 HK Materials SELL 4,061 46.5 15.8 nm 186.1 0.6 0.6 1.2 3.4 0.0 3.2 34.3

BYD 1211 HK Autos SELL 6,131 552.3 282.3 51.3 89.8 1.7 1.6 0.8 0.9 0.0 0.0 31.9

Esprit 330 HK Consumer SELL 3,061 796.4 28.5 (97.7) 2,695 1.2 1.1 0.2 4.0 0.1 2.1 53.1

GCL-Poly 3800 HK Power SELL 2,676 nm 409.6 nm nm 0.9 0.9 0.6 0.9 0.0 0.0 34.2

Shanghai Petrochem 338 HK Petro/chems SELL 4,604 15.4 12.2 nm 22.9 0.8 0.7 5.1 6.1 2.6 3.3 36.4

Li & Fung 494 HK Consumer SELL 13,373 17.5 14.0 (6.4) 25.1 2.1 2.1 12.6 15.1 4.7 5.3 52.8

Sinoma 1893 HK Materials SELL 1,111 7.5 6.6 32.2 10.9 0.6 0.5 9.1 9.0 2.0 2.2 50.6

Yanzhou Coal 1171 HK Materials SELL 10,955 15.3 11.1 (45.5) 34.1 1.0 0.9 7.3 9.9 2.0 2.7 37.0

Dongfang 1072 HK Power SELL 3,876 9.7 10.9 (21.1) (13.6) 1.2 1.0 12.1 9.5 1.2 1.2 50.5


Sector outlook Our sector analysts have provided their outlook for next year, which provides

the framework for stock ideas. Refer to their individual sections.

Figure 106

Sector weighting & outlook

Sector Weighting Outlook

Consumer discretionary Overweight Consumers more optimistic; ASP to drive SSS growth; travel

Gaming Overweight Revenue growth to slow but earnings quality should improve as exposure to mass market rises

Healthcare Overweight Like device due to hospital growth and chemicals for age-related diseases

Internet Overweight Games will do well on smartphone; advertising will take time

Oil & Gas Overweight Key beneficiaries of price reform

Property Overweight Improving sales; lower policy risk and potential easing

Telecoms Overweight China Mobile could surprise

Cement Neutral Rising demand and utilisation; lower supply and price discipline

Consumer HK Neutral Global brands executing well

Industrials Neutral Recovery in 1H and weaker 2H

Power Neutral O-WT IPPs; U-WT HK utilities; SELL equipment makers

Tech Neutral Smartphone explosion; play component makers

Autos Underweight Weak demand with shipment of 3% YoY and pricing pressure

Banks Underweight Flat revenue growth with stable loan growth and declining NIM; higher LGFV infra risk

Consumer staples Underweight Expensive valuation; expect more promotions

Insurance Underweight Competition from wealth management; low-yielding products; weak auto-finance sales

Machinery Underweight Property investment to slow and infrastructure could disappoint

Resources Underweight Stay defensive; potential disappointment in commodity prices

Steel Underweight FAI is slowing; overcapacity remains an issue

Figure 107

Sector analysts’ top ideas

Sector Rec Top ideas Stocks to avoid

Autos Underweight - BYD

Banks & Financials Underweight ABC, BOC, Haitong, BOC (HK) CMB, Minsheng

Cement Neutral CNBM Sinoma

Conglomerates Neutral Hutchison, Cheung Kong, Jardine Matheson Swire Pacific, Beijing Enterprise

Consumer CN Neutral Belle, Golden Eagle, Want Want Sun Art

Consumer HK Neutral Prada, Samsonite Esprit, Li & Fung

Healthcare Overweight Mindray, Sino Biopharm -

Industrials Neutral Tiangong, Minth Yingde Gases

Insurance Underweight - China Pacific, New China Life

Internet Overweight Tencent, Baidu, NetEase Dangdang, Perfect World

Macau gaming Overweight Melco Crown, Wynn Macau, SJM -

Machinery Underweight Zoomlion H Weichai Power, Longking

Oil & Gas Overweight PetroChina, Sinopec, Antonoil SPC

Power & Renewables Neutral CR Power, CPI, CR Gas, Longyuan Dongfang, Shanghai Electric

Property Overweight Agile, Cogo, Wharf, KWG Soho China

Resources Underweight Shenhua, Zhaojin Chalco, Hidili Industry, Yanzhou Coal

Steel Underweight Magang Angang

Technology Neutral AAC ZTE

Telecoms Overweight China Mobile, China Telecom China Unicom

Utilities HK Underweight - CLP, CKI, Power Assets





Autos (Underweight) - 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.

Banks (Underweight) - 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.

Cement (Neutral) - As capacity growth slows, we expect utilisation to rise

to 75% in 2013 and 78% in 2014 - similar to the start of the 2009 cycle

peak. Producers are also likely to cooperate to support prices. We forecast

21-33% earnings Cagrs over 2013-14, with 26-28% gross margins for Conch

and CNBM 20% for CR Cement and 15% for Sinoma. CNBM is our top pick,

followed by Conch. CR Cement and Sinoma are SELLs given their expensive

valuations and sluggish profitability momentum.

Conglomerates (Neutral) - 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.

Consumer China (Neutral) - 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.

Consumer HK (Neutral) - 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.

Healthcare (Overweight) - 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 is our top pick for

devices and Sino Biopharm for chemicals (both stocks are covered by our

joint venture Fortune CLSA analysts).

Weak demand and pricing pressure

Flat revenue growth with

stable loans and declining

NIM; higher LGFV infrastructure risk

Rising demand and

utilisation; lower supply and price discipline

Cheung Kong is our top

pick, remain cautious on Chinese conglomerates

Consumers more

optimistic; ASP to drive SSS growth; travel

Global brands executing well

Like device due to

hospital growth

and chemicals for age-related diseases




Industrials (Neutral) - 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.

Insurance (Underweight) - 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 the

cautious view.

Internet (Overweight) - Accelerating smartphone growth should see

mobile grab the spotlight in 2013. But the transition could slow revenue

growth. The user-pays model may take off but advertisers are slower in

adopting mobile. Gaming plays outperformed in 2012 and could continue to

do well with expanding categories and mobile games should fuel the growth.

The ad market could slow due to a lack of major events and macro

uncertainty next year but online ads will fare better and performance

advertising will take a larger share. The sector has derated with attractive

valuations. Our 2013 picks are Tencent, Baidu and NetEase.

Macau gaming (Overweight) - With a lack of new casino openings, we

expect slower gaming revenue growth of 8-9% in 2013-14. Quality of

earnings should improve as casinos’ exposure to the mass segment continues

to rise. We favour the sector for its attractive dividend yields and the gradual

pricing in Cotai. Looking to 2016, we expect the sector to deliver 10-22%

average annualised return over the next four years. Valuation is still attractive

with a sector dividend yield of 5% (versus the market’s 3%). Top picks are

Melco Crown, Wynn Macau and SJM.

Machinery (Underweight) - 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.

Oil & Gas (Overweight) - 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.

Recovery in 1H and weaker 2H

Competition from

wealth management;

low-yielding products; weak auto-finance sales

Games will do well on

smartphone; advertising will take time

Quality of earnings should

improve as exposure to the mass segment rises

Property investment to

slow and infrastructure could disappoint

Key beneficiaries of price reform




Power (Neutral) - 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.

Property (Overweight) - 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.

Resources (Underweight) - 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.

Steel (Underweight) - 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.

Technology (Neutral) - 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.

Telecoms (Overweight) - 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.

O-WT IPPs; U-WT Hong

Kong utilities; SELL equipment makers

Improving sales;

lower policy risk and potential easing

Stay defensive; potential

disappointment in commodity price

FAI is slowing;

overcapacity remains an issue

Smartphone explosion; play component makers

China Mobile could surprise






CLSA China portfolio Our China portfolio is up 16% YTD, beating the market by 3.3%. Our biggest

holdings are in IT, consumer, property and banks. We are heavily Underweight

banks as it is a large part of the index. We are Underweight most cyclical

sectors. Our cyclical exposure is in property, which is a critical sector for the

economy and we are unlikely to see any more restrictive policies.


CLSA China portfolio sector weighting CLSA China portfolio performance

Source: CLSA Asia-Pacific Markets Source: Bloomberg, CLSA Asia-Pacific Markets

Figure 110

CLSA China portfolio by sector


PE (x) EPS g (%) PB (x) ROE (%) Yield (%) Wgt

13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL (%)

Agricultural Bank 1288 HK Financial services O-PF 135,271 5.6 4.8 6.6 13.6 1.0 0.8 19.2 19.1 5.4 6.3 4.0

Bank of China 3988 HK Financial services BUY 121,510 5.3 4.8 2.3 7.1 0.8 0.7 15.9 15.5 6.0 6.6 3.0

Bank of China (HK) 2388 HK Financial services BUY 32,881 11.7 10.3 7.2 13.9 1.7 1.6 14.7 15.7 5.4 6.3 2.0

Bocom 3328 HK Financial services O-PF 52,080 5.6 4.9 (3.4) 11.4 0.7 0.6 14.0 13.8 2.1 2.5 2.0

Haitong 6837 HK Financial services BUY 13,191 17.1 13.8 41.1 20.6 1.2 1.1 7.6 8.6 2.0 2.5 3.0

Agile Property 3383 HK Property BUY 4,358 5.1 3.9 27.1 27.0 1.0 0.9 24.1 27.2 4.9 6.4 3.0

Coli 688 HK Property O-PF 23,571 9.9 8.2 24.5 20.5 2.0 1.7 21.5 22.3 2.0 2.4 2.0

Cogo 81 HK Property BUY 2,427 6.8 5.5 34.5 24.9 2.0 1.5 35.6 31.8 0.9 1.1 3.0

KWG Property 1813 HK Property BUY 1,844 4.9 4.1 23.2 16.4 0.7 0.6 15.2 15.8 6.4 7.6 2.0

Longfor 960HK Property O-PF 9,848 8.5 7.2 14.7 13.8 1.8 1.5 24.8 23.0 2.4 2.8 3.0

Wharf 4 HK Property BUY 22,516 15.3 12.7 15.8 20.2 0.7 0.6 5.2 5.6 2.6 3.1 3.0

Belle Intl 1880 HK Consumer BUY 17,088 19.3 15.8 19.0 18.2 4.1 3.3 22.6 22.8 1.6 1.9 3.0

Daphne 210 HK Consumer O-PF 1,988 15.2 12.9 20.3 18.1 3.3 2.5 22.3 21.8 2.2 2.7 2.0

Hengan 1044 HK Consumer BUY 11,046 21.2 17.8 18.7 19.0 5.5 4.9 27.3 28.6 2.8 3.4 2.0

Great Wall Motor 2333 HK Autos BUY 9,263 11.2 10.1 26.0 7.5 2.6 2.1 23.9 21.3 0.1 0.1 4.0

Prada 1913 HK Consumer BUY 21,248 25.4 20.5 37.2 23.9 6.6 5.3 29.1 28.9 1.0 1.2 3.0

Samsonite 1910 HK Consumer BUY 2,902 15.0 13.7 20.1 9.7 2.6 2.4 18.7 18.1 2.6 2.8 2.0

Melco Crown MPEL US Hotels & leisure BUY 8,451 18.3 15.4 11.4 18.3 2.0 1.7 11.4 12.0 0.0 0.0 2.0

Sands China 1928 HK Hotels & leisure O-PF 34,246 19.1 16.0 53.3 19.5 6.3 5.8 33.1 37.7 4.2 5.0 3.0

SJM 880 HK Hotels & leisure BUY 12,913 14.6 13.0 3.3 12.0 5.2 4.8 37.0 37.9 5.5 6.2 2.0

Sino Biopharm 1177 HK Healthcare BUY1 2,295 16.2 13.2 27.4 23.3 3.3 2.8 24.1 24.2 0.0 0.0 3.0

Baidu BIDU US Internet BUY 33,637 15.9 11.7 33.2 31.7 5.5 3.7 40.7 36.6 0.0 0.0 6.0

Ctrip CTRP US Internet O-PF 2,596 19.6 14.2 32.7 34.0 1.7 1.4 9.3 10.6 0.0 0.0 2.0

Tencent 700 HK Internet BUY 61,236 23.3 18.5 27.5 22.1 6.6 4.8 32.7 29.5 0.5 0.6 8.0

NetEase NTES US Internet BUY 5,639 8.2 7.0 20.9 13.5 2.3 1.9 28.6 28.6 0.0 0.0 3.0

AAC 2018 HK Technology O-PF 4,833 13.9 12.1 19.9 11.5 3.8 3.1 30.0 27.7 2.9 3.3 4.0

Lenovo 992 HK Technology O-PF 9,524 17.1 14.5 20.3 17.7 3.5 3.0 21.6 21.8 1.7 2.0 3.0

PetroChina 857 HK Petro/chems BUY 249,518 8.9 7.8 14.1 11.1 1.3 1.1 14.7 14.8 5.0 5.8 3.0

Sinopec 386 HK Petro/chems BUY 86,187 7.3 6.5 21.4 7.5 1.0 0.9 14.7 14.3 4.3 4.7 3.0

CR Power 836 HK Power BUY 10,514 8.3 7.3 55.2 14.5 1.4 1.2 16.4 16.6 4.2 4.8 3.0

CNBM 3323 HK Materials BUY 6,870 5.1 4.1 47.7 19.7 1.1 0.9 21.8 21.5 2.8 3.5 3.0

China Mobile 941 HK Telecoms O-PF 228,120 10.9 10.1 2.9 4.5 1.8 1.6 17.1 16.2 3.9 4.2 3.0

China Telecom 728 HK Telecoms BUY 45,848 13.5 11.1 35.0 18.0 1.0 0.9 7.4 8.2 2.4 2.9 3.0

Weighted average 13.3 11.0 24.2 17.6 2.9 2.3 22.7 22.2 2.4 2.9 100

¹ Sino Biopharm is covered by joint venture Fortune CLSA. Source: Bloomberg, CLSA Asia-Pacific Markets

Internet

19%

Property

16%

Financials

14%Consumer CN

11%

Gaming

7%

Technology

7%

Oil & gas

6%

Telecoms

6%

Consumer HK

5%

Materials

3%

Healthcare

3%Power

3%

80

100

120

140

160

180

200

220

240

260

280

Feb 09 Apr 10 Jul 11 Sep 12

Portfolio MSCI China

China portfolio is up

16% YTD, beating the market by 3%




CLSA China value portfolio Our China value portfolio is up 10% YTD, underperforming MSCI China by

2.3%. It has not been an easy year for value as lower liquidity and risk

aversion have impacted many mid-cap companies. We expect performance to

improve as growth will be more stable in 2013. The portfolio is quantitatively

driven by selecting the top stocks with positive ratings ranked by ROIC, Ebit

yield and Ebit growth.


CLSA China value portfolio sector weighting Our China value portfolio performance


Figure 113

CLSA China value portfolio (equal weighting)




Great Wall Motor 2333 HK Autos BUY 9,263 11.2 10.1 26.0 7.5 2.6 2.1 23.9 21.3 0.1 0.1

Everbright Intl 257 HK Capital goods O-PF 2,058 11.7 10.3 5.2 13.1 1.6 1.4 14.4 14.2 0.4 0.4

Prince Frog 1259 HK Consumer BUY 399 7.7 5.8 10.8 28.1 1.6 1.3 22.3 23.8 2.6 3.8

Emperor Watch 887 HK Consumer BUY 711 9.7 7.1 23.4 36.9 1.3 1.1 14.3 17.5 3.2 4.3

Daphne 210 HK Consumer O-PF 1,988 15.2 12.9 20.3 18.1 3.3 2.5 22.3 21.8 2.2 2.7

Oriental Watch 398 HK Consumer BUY 189 9.2 9.1 12.0 0.9 0.8 0.7 9.1 8.5 2.9 2.9


Belle Intl 1880 HK Consumer BUY 17,088 19.3 15.8 19.0 18.2 4.1 3.3 22.6 22.8 1.6 1.9

Bank of China 3988 HK Financial services BUY 121,510 5.3 4.8 2.3 7.1 0.8 0.7 15.9 15.5 6.0 6.6

CNCB 998 HK Financial services BUY 26,452 4.4 3.8 5.0 11.4 0.7 0.6 15.5 15.4 5.7 6.5

SJM 880 HK Hotels & Leisure BUY 12,913 14.6 13.0 3.3 12.0 5.2 4.8 37.0 37.9 5.5 6.2

MGM China 2282 HK Hotels & Leisure BUY 6,728 13.6 12.6 (12.3) 8.3 7.8 6.7 62.1 57.0 5.9 6.4

Galaxy 27 HK Hotels & Leisure O-PF 15,574 16.6 14.7 2.8 12.9 4.3 3.3 29.6 25.4 0.0 0.0


Baidu BIDU US Internet BUY 33,637 15.9 11.7 33.2 31.7 5.5 3.7 40.7 36.6 0.0 0.0

Giant Interactive GA US Internet BUY 1,270 5.7 5.0 12.5 11.8 2.0 1.7 42.2 38.8 0.0 0.0

NetEase NTES US Internet BUY 5,639 8.2 7.0 20.9 13.5 2.3 1.9 28.6 28.6 0.0 0.0


Shenhua 1088 HK Materials BUY 71,709 10.4 10.1 0.1 (0.1) 1.7 1.5 17.9 16.0 3.8 4.0

PetroChina 857 HK Petro/Chems BUY 249,518 8.9 7.8 14.1 11.1 1.3 1.1 14.7 14.8 5.0 5.8

Sinopec 386 HK Petro/Chems BUY 86,187 7.3 6.5 21.4 7.5 1.0 0.9 14.7 14.3 4.3 4.7

CR Gas 1193 HK Power BUY 4,528 16.6 13.7 22.8 21.4 3.2 2.8 19.6 20.4 1.5 2.1

KWG Property 1813 HK Property BUY 1,844 4.9 4.1 23.2 16.4 0.7 0.6 15.2 15.8 6.4 7.6

Vanke 200002 CH Property BUY 15,013 7.7 5.9 3.2 25.8 1.5 1.3 17.7 23.5 1.9 2.5

Agile Property 3383 HK Property BUY 4,358 5.1 3.9 27.1 27.0 1.0 0.9 24.1 27.2 4.9 6.4

Cogo 81 HK Property BUY 2,427 6.8 5.5 34.5 24.9 2.0 1.5 35.6 31.8 0.9 1.1

Longfor 960 HK Property O-PF 9,848 8.5 7.2 14.7 13.8 1.8 1.5 24.8 23.0 2.4 2.8

Digital China 861 HK Technology BUY 1,843 10.1 8.4 6.7 20.4 1.7 1.5 17.9 18.1 3.4 4.1

AAC 2018 HK Technology O-PF 4,833 13.9 12.1 19.9 11.5 3.8 3.1 30.0 27.7 2.9 3.3

China Mobile 941 HK Telecoms O-PF 228,120 10.9 10.1 2.9 4.5 1.8 1.6 17.1 16.2 3.9 4.2

Average 10.8 9.1 15.8 16.4 2.4 2.0 23.5 23.0 2.7 3.2

Source: Bloomberg, CLSA Asia-Pacific Markets

Consumer

23%

Property

17%

Internet

13%

Hotels & leisure

10%

Financials

7%

Materials

7%

Petro/chems

7%

Technology

7%

Capital goods

3%

Power

3%Telecoms

3%

60

80

100

120

140

160

Jan 10 Dec 10 Dec 11 Nov 12

Value portfolio MSCI China

Our China value portfolio is up 10% YTD


Section 6: Index target ChinaOpps


Index target This year has been difficult as the decline in economic growth is one of the

largest in the past two decades, given that the economy has become so

capital-intensive. Growth will continue to slow but at a more gradual pace.

The market should do better in 1H13 as infrastructure investments result in

positive momentum in the economy. By mid-year, the risk to growth will

become evident as infrastructure investments peak and total FAI starts to

weaken. There is a good chance that the government will selectively ease its

property measures and cut the interest rate in 2H13. Where we could be

wrong is that the global economy turns out to be stronger than expected,

especially in 2H13. This would give the government much needed support.

Market valuations are below long-run averages and are still considered cheap.

MSCI China is trading at 9.4x 13CL PE against 10% EPS growth with a 3.1%

dividend yield. ROE is healthy at 16%, well above cost of equity. We have

12% upside for MSCI China given that the economy is still slowing and

consensus growth estimates remain too high. Valuations for MSCI HK is not

low and the index is trading near its long-term average, but the market is

more exposed to global liquidity. We have less upside for MSCI HK at 10%.

Top-down earnings model shows downside risk to earnings Our top-down earnings model for MSCI China shows some upside risk to our

4Q12 estimates and moderate downside risk to our 2013 numbers. We have

slashed our bottom-up forecast for 2012 and expect it to drop 1.8% YoY before

rebounding to 10.5% in 2013. For our 4Q12 projections, upside risk mainly

comes from oil and consumer sectors. The oil price has moderated, providing a

boost to downstream earnings. The consumer sector will likely benefit from

lower-cost input in staple sector as well as less discounting in retail. Top down

for 2013, we forecast about 9.6% EPS growth versus the 10.5% consensus.

The biggest differences are banks and materials, where we are more positive

than the street, and consumers, where we are more negative.


MSCI China EPS estimates MSCI HK EPS estimates


HSCEI EPS estimates HSI EPS estimates

Source: Datastream, CLSA Asia-Pacific Markets

80

90

100

110

120

130

140

Apr 10 Feb 11 Jan 12 Nov 12

MXCN EPS 13CL

MXCN EPS 12CL

19%

Indexed (Apr-10 = 100)

80

85

90

95

100

105

110

115

120

125


MXHK EPS 13CL

MXHK EPS 12CL


13%

80

90

100

110

120

130


HSCEI EPS 13CL

HSCEI EPS 12CL


20%

70

80

90

100

110

120

130


HSI EPS 13CL

HSI EPS 12CL


17%

Valuations still cheap

We estimate about 9.5%

EPS growth versus 10.5% consensus for 2013

Better 1H and weaker 2H

Earnings estimates for

2013 have been marked down by 13-20%




Figure 118

Top-down earnings model

(YoY %) Top-down forecast Bottom-up forecast

12CL 13CL 12CL 13CL

Banks 10.3 4.4 10.3 5.6

Property (11.7) 13.4 (11.4) 13.2

Telecoms & internet 2.5 10.5 2.5 10.5

Oil 4.3 11.3 0.1 11.0

Coal (21.6) (1.1) (3.3) (3.0)

Materials (64.1) 133.4 (61.1) 127.5

Consumer 5.8 12.7 (3.3) 17.9

Others (7.0) 2.5 (7.0) 2.5

Total (0.9) 9.8 (1.8) 10.4


Figure 119

Top-down earnings model drivers

Unit 2008 2009 2010 2011 12CL 13CL

Banks

New Rmb loans Rmbbn 4,170 9,629 7,951 6,875 8,500 9,000

Total Rmb loans Rmbbn 30,339 39,968 47,920 54,794 63,294 72,294

Growth YoY % 15.9 31.7 19.9 14.3 15.5 14.2

LDR ratio % 0.65 0.67 0.67 0.68 0.70 0.71

Industry NIM % na na 2.50 2.70 2.66 2.47

Property

Residential GFA sold m m² 559 862 931 970 960.0 1,008.0

Growth YoY % (19.1) 54.2 8.0 4.3 (1.1) 5.0

Residential ASP Rmb/m² 3,655 4,474 4,724 5,011 5,311.7 5,630.4

Growth YoY % (0.3) 22.4 5.6 6.1 6.0 6.0

Oil & gas

Brent crude (CO1 Cmdty) US$/bbl 98.5 62.7 80.3 110.9 112.1 100.0

Growth YoY % 35.6 (36.4) 28.2 38.1 1.1 (10.8)

Rmb/US$ Rmb/US$1 6.9 6.8 6.8 6.5 6.3 6.2

Diesel price Rmb/tonne 6,564 6,339 7,338 8,359 8,574 8,800

Petrol price Rmb/tonne 7,102 7,088 8,096 9,161 9,395 9,600

Coal

Coal spot price Rmb/tonne 896.3 629.4 777.1 947.7 660.0 720.0

Coal contract price Rmb/tonne 485.0 540.0 570.0 599.0 629.0 660.0

Growth YoY % 38.9 (15.3) 15.2 14.8 (16.7) 7.1

Coal production m tonnes 2,716 3,050 3,300 3,587 3,775 3,915

Growth YoY % 7.6 12.3 8.2 8.7 5.2 3.7

Materials

FAI YoY % 26.1 30.5 24.5 23.8 20.5 18.0

Cement price Rmb/tonne 358 360 373 408 353 370

Steel price Rmb/tonne 5,010 3,728 4,256 4,672 4,024 4,000

Copper price US$/tonne 6,686 5,199 7,558 8,826 7,962 8,500

Aluminium price US$/tonne 2,409 1,704 2,199 2,421 2,063 2,200

Consumer

Nominal retail sales Rmbbn 11,483 13,268 15,700 18,392 20,985 24,225

Growth YoY % 22.7 15.5 18.3 17.1 14.1 15.4

CPI YoY % 5.9 (0.7) 3.3 5.4 2.8 4.0

Real retail sales YoY % 15.9 16.4 14.5 11.6 11.6 11.0

Car sales volume m units 9.34 13.64 18.06 18.51 19.13 20.09

Car ASP Rmb/car 6.2 46.1 32.4 2.5 3.4 5.0

Source: CEIC, Bloomberg, CLSA Asia-Pacific Markets

Multiple expansion has driven return in 2012 In 2012, all of the index return has been driven by PE expansion as market

earnings are down by about 1%. PE expanded from 8.5x to 9.4x with most of

the upside coming in 4Q, as economic growth hit a bottom. The last time PE

For 4Q12 earnings, upside

risk mainly comes from oil and consumer sectors




contributed the majority of the upside was in the boom years of 2007 and

2009. This year, the market has been overly worried about hard landing. We

expect 2013 to be more stable and earnings growth should again be the major

driver of returns. We have not factored in minimal multiple expansion in our

2013 index target as we believe consensus GDP growth remains too high. The

risk is another round of global easing or stronger-than-expected global growth.

Figure 120

Drivers of MSCI China

(%) 2003 2004 2005 2006 2007 2008 2009 2010 2011 12CL 13CL

EPS gwth revision (current) 7.9 20.1 12.4 3.4 16.6 (14.3) (4.9) 5.3 0.8 (9.7) na

EPS growth (1Y fwd) 8.7 7.2 7.4 10.2 22.1 7.0 21.8 15.0 10.7 10.1 10.3

Fwd PE change 34.0 (16.0) (4.1) 48.3 23.9 (49.2) 36.5 (15.8) (25.7) 11.2 3.2

Index perf (%) 57.3 8.1 15.7 68.9 76.4 (53.4) 58.1 2.0 (17.1) 10.6 12.6

EPS (1Y fwd) 1.8 2.3 2.7 3.1 4.4 4.1 4.7 5.7 6.4 6.3 7.0

PE (1Y fwd, 1 Jan) (x) 9.8 13.2 11.1 10.6 15.7 19.5 9.9 13.5 11.4 8.5 9.4

PE (1Y fwd, 31 Dec) (x) 13.2 11.1 10.6 15.7 19.5 9.9 13.5 11.4 8.5 9.4 9.6

Index 23.2 25.1 29.0 49.0 86.5 40.2 63.6 64.9 53.8 59.5 67.0

Source: DataStream, CLSA Asia-Pacific Markets

We base our index target on bottom-up valuations calculated by our analysts,

PE, PB and cyclically adjusted PE based on average and historical five-year EPS.

China: Index target for MSCI China is 67 and 11,600 for HSCEI, implying

13% and 11% upside.

Hong Kong: Index target for MSCI HK is 13,600 and 24,500 for HSI,

implying 11% and 12% upside.

Figure 121

China/HK index target valuations

Index Target Upside (%)

PE (x) PB (x) Yield (%) ROE (%)

13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL

MSCI China 67 13 10.6 9.6 1.5 1.4 2.8 3.0 14.6 14.6

HSCEI 11,600 11 8.4 7.7 1.3 1.2 3.4 3.6 15.3 15.1

MSCI HK 13,600 11 17.1 15.3 1.4 1.3 2.8 3.0 8.0 8.5

HSI 24,500 12 11.5 11.8 1.4 1.3 3.2 3.4 12.2 11.3

Figure 122

MSCI China index target

Methodology Target multiple (x)

Index target

Weighting (%)

Comment

Bottom-up na 63.6 30 Aggregate upside of CL-covered index members

PE (2014) 10.0 69.9 30 LT avg PE of 12.4x; FY12 actual is 9.4x

CAPE (2006-12) 13.0 56.3 10 2006-12 avg CAPE 19.9x; FY12 actual 12.7x

PB (2013) 1.6 71.5 30 LT avg PB of 2.6x; FY12 actual is 1.6x

Index target 67

Implied upside (%) 13 Index @ 59.5 as of 29 Nov 2012 market close

Figure 123

HSCEI index target


Index target

Weighting (%)

Comment

Bottom-up na 11,213 30 Aggregate upside of CL-covered index members

PE (2014) 8.0 12,208 30 LT avg PE of 14.5x; FY12 actual is 7.2x

CAPE (2006-12) 10.2 9,751 10 2006-12 avg CAPE 17.9x; FY12 actual 10.2

PB (2013) 1.3 12,161 30 LT avg PB of 2.5x; FY12 actual 1.4x

Index target 11,600

Implied upside (%) 11 Index @ 10,488 as of 29 Nov 2012 market close


Index target for

MSCI China is 67 and

MSCI HK is 13,400




Figure 124

MSCI Hong Kong index target


Index target

Weighting (%)

Comment


PE (2014) 16.0 14,193 30 LT avg PE of 15.4x, FY12 actual 15x

CAPE (2006-12) 19.5 13,260 5 2006-12 avg CAPE 18.7x

PB (2013) 1.4 14,265 35 LT avg PB of 1.7x, FY12 actual 1.4x

Index target 13,600

Implied upside 11 Index @ 12,274 as of 29 Nov 2012 market close

Figure 125

HSI index target


Index target

Weighting (%)

Comment


PE (2014) 11.0 22,847 35 LT avg PE of 14.0x,FY12 10.5x

CAPE (2006-12) 13.3 20,562 10 2006-12 avg CAPE 17.8x; FY12 actual 13.3x

PB (2013) 1.6 28,223 35 LT average PB of 1.8x; FY12 1.6x

Index target 24,500

Implied upside (%) 12 Index @ 21,923 as of 29 Nov 2012 market close


MSCI China and HK have had a good rally, up 12% and 23% YTD. MSCI China

is trading at 9.4x forward PE, one standard deviation below its long-term

average. For MSCI Hong Kong, our index target implies no upside for this

year. It is trading at the long-term average forward PE of 15.4x.


MSCI China trailing PB MSCI HK trailing PB

Figure 128

Figure 129

HSCEI trailing PB HSI trailing PB


-2sd 1.0x

-1sd 1.7x

Avg 2.4x

+1sd 3.2x

+2sd 3.9x

0

1

2

3

4

5

6

200420052006200720082009201020112012

(x)

1.20x@Oct-08

1.43x@Oct-11

-2sd 1.0x

-1sd 1.3x

Avg 1.7x

+1sd 2.0x

+2sd 2.4x

0.5

1.0

1.5

2.0

2.5

3.0

200420052006200720082009201020112012

(x)

0.83x@Oct-08

1.13x@Oct-11

-2sd 0.8x

-1sd 1.6x

Avg 2.4x

+1sd 3.1x

+2sd 3.9x

0

1

2

3

4

5

6

2004 2005 2006 2007 2008 2009 2010 2011 2012

(x)

1.13x

@Oct-081.13x

@Oct-11

-2sd 1.1x

-1sd 1.6x

Avg 2.1x

+1sd 2.7x

+2sd 3.2x

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

200420052006200720082009201020112012

(x)

1.15x@Oct-08

1.28x@Oct-11

MSCI China is trading at

1.7x trailing PB, one

standard deviation below its long-term average





MSCI China 12M fwd PE MSCI HK 12M fwd PE

Figure 132

Figure 133

HSCEI 12M fwd PE HSI 12M fwd PE


Money growth leads A-share market China’s A-share market has a strong track record of moving in the direction

of monetary growth, up or down, over the past eight years: M1 growth has

slowed from 7.85% in December 2011 to 6.10% YTD, while Shanghai A

shares have plummeted by 7.8% YTD. M1 and M2 have a strong positive

correlation with the stock markets, hence it is possible to predict market

direction based on money-supply trends. We believe the PBOC is still

worried about inflation and will maintain a relatively tight monetary policy,

with a M2 target of 14%.

Figure 134

Market direction can be predicted

(%) M1 growth M2 growth Chg in M1 Chg in M2 MSCI CN A shares

Dec 04 13.58 14.63 DOWN DOWN DOWN DOWN

Dec 05 11.78 17.57 DOWN UP UP DOWN

Dec 06 17.48 16.94 UP DOWN UP UP

Dec 07 21.01 16.72 UP DOWN UP UP

Dec 08 9.06 17.82 DOWN UP DOWN DOWN

Dec 09 32.35 27.68 UP UP UP UP

Dec 10 21.19 19.72 DOWN DOWN UP DOWN

Dec 11 7.85 13.61 DOWN DOWN DOWN DOWN

Oct/Nov 12 6.10 14.10 DOWN UP UP DOWN

Source: CEIC, Datastream, CLSA Asia-Pacific Markets

-2sd 6.9x

-1sd 9.8x

Avg 12.6x

+1sd 15.5x

+2sd 18.3x

5

10

15

20

25

2001 2003 2005 2007 2009 2011

(x)

6.9x@Oct-11

5.7x@Oct-08

-2sd 10.0x

-1sd 12.8x

Avg 15.5x

+1sd 18.2x

+2sd 20.9x

5

10

15

20

25

1997 1999 2001 2003 2005 2007 2009 2011

(x)

10.9x@Oct-11

8.0x@Oct-08

7.0x

@Jul-98

11.8x

@Apr-03

-2sd 5.5x

-1sd 8.5x

Avg 11.7x

+1sd 14.8x

+2sd 17.9x

2468

101214161820222426

2003 2005 2007 2009 2011

(x)

5.5x@Oct-11

5.0x

@Oct-08

-2sd 8.2x

-1sd 11.1x

Avg 14.1x

+1sd 17.1x

+2sd 20.1x

5

10

15

20

25

1997 1999 2001 2003 2005 2007 2009 2011

(x)

6.5x@Oct-08

7.2x

@Oct-11

7.3x@Aug-98

Change in M1 growth

moves in line with A-share market

M1 and M2 have strong

positive correlation

with the stock market

MSCI China is trading at

9.4x forward PE, one

standard deviation below its long-term average




Figure 135

China M1 growth versus MSCI China

Source: CEIC, Datastream, CLSA Asia-Pacific Markets

Do A shares matter? H shares’ performance have diverged from A shares this year, where MSCI

China is up 12.3% YTD versus Shanghai Composite’s 10% decline. The

divergence is consistent with the historical trend. We provided an initial

analysis in our 2 February 2012 Does A-share matter? ChinaOpps note. The

A-share market suffers from structural problems such as fund outflows to

wealth-management products and a momentum-driven retail-investor base.

H-share investors using the A-share market as an indicator in 2012 would

have seen their portfolios underperform.

‘Why A-share investors remain cautious?’ and ‘what impact would that have on

H-share performance?’ are some common questions. Yet, they may not matter

much as A shares have low correlation with offshore-listed Chinese companies

(it has an R² of only 0.22 with MSCI China). MSCI China also has long periods

of outperformance relative to A shares: 87%, 15%, 8% during periods of 2003-

06, the 2007-08 bubble and the global financial crisis in 2009-11.

Figure 136

Relative performance of MSCI China versus Shanghai Composite


0

20

40

60

80

100

120

0

5

10

15

20

25

30

35

40

45

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(%) Money Supply M1: YoY%

M1 minimum = 3.1%

MSCI China (RHS)

(Index)

(20)

0

20

40

60

80

100

120

140

160

180

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

(%)

Money growth leads the market

H-share performance diverged from A shares

A shares may not

matter much as they

have low correlation with MSCI China

Long periods of

outperformance of MSCI

China relative to A shares





Figure 137

MSCI China versus Shanghai Composite


Surprisingly, correlation between the two markets has not changed much over

time. Tracking eight-week rolling performance, correlation has been relatively

stable since 2005.

Figure 138

MSCI China-Shanghai composite correlation

Source: DataStream, CLSA Asia-Pacific Markets

0

50

100

150

200

250

300

350

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

SH Comp MSCI China

Rebased

Nov 2012 = 100

(Nov 2012 = 100)

(1.0)

(0.8)

(0.6)

(0.4)

(0.2)

0.0

0.2

0.4

0.6

0.8

1.0

Jan 03 Feb 04 Mar 05 Apr 06 May 07 Jun 08 Jul 09 Aug 10 Sep 11 Oct 12

Negative correlation

(R correlation coefficient)Positive correlation

Avg R

= 0.47

H-share investors using

A-share market as an

indicator would have underperformed

Correlation between the

two markets has not changed much over time


ChinaOpps


Sector profiles

Autos ................................................................................................ 57

Banks ............................................................................................... 63

Conglomerates ................................................................................. 69

Consumer China ............................................................................... 75

Consumer HK.................................................................................... 84

Healthcare ........................................................................................ 91

Industrials........................................................................................ 96

Insurance ....................................................................................... 104

Internet .......................................................................................... 108

Macau gaming ................................................................................ 115

Machinery ....................................................................................... 122

Oil & Gas ........................................................................................ 131

Power ............................................................................................. 139

Property ......................................................................................... 148

Resources ....................................................................................... 152

Steel ............................................................................................... 159

Technology ..................................................................................... 166

Telecoms ........................................................................................ 174

All prices quoted herein are as at close of business 29 November 2012 unless otherwise stated


Autos ChinaOpps


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

Source: NDRC

102,000

102,500

103,000

103,500

104,000

104,500

Jan 12 Feb 12 Mar 12 Apr 12 Jun 12 Jul 12 Aug 12

(Rmb)

Passenger-vehicle ASP suffers a long-term

decline as more cheaper models are released

Scott Laprise [email protected] (86) 1059652126

George Yang (86) 2120205807

Stock to avoid BYD 1211 HK Rec SELL Market cap US$6.131bn Target HK$0.41 Up/downside -98%


Autos ChinaOpps


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 (%)

DFM 3,063 4.5 0.4

Brilliance 201 7.1 1.7

GAC 308 5.6 1.4

BYD 792 3.7 (0.2)

Geely 659 5.9 0.3

Great Wall 634 3.5 (0.2)

Source: Companies

102,000

104,000

106,000

108,000

110,000

112,000

114,000

116,000

118,000

120,000

Jan 07 Dec 07 Nov 08 Nov 09 Oct 10 Sep 11 Sep 12

(Rmb)

Across-the-board decline

PV ASP declines in the long run as each segment

becomes more competitive

Automakers aided the dealers with promotions

Most companies’ selling costs as a share of

revenue was up in 1H12 due to more promotions


Autos ChinaOpps


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


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.

ASP a greater impact than sales volume

Cars are still a discretionary purchase

Japanese automobiles were already losing share

Historically, these sorts of flare-ups have

tended to be short-lived

ASP impacts earnings more than sales volume


Autos ChinaOpps


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.

VW is the oldest and best known brand in China

Yet to see any solid policies on promised boost

Some of the more rational automakers may

cut back on production


Autos ChinaOpps


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.

17

56

25

47

100

23 2317 17

23

14 1713 10 9

30

22

7

53

33

5 7 3

15 148 11 8 5 5

0

20

40

60

80

100

120

2006

2007

2008

2009

2010

2011

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL

SUV growth PV growth(% YoY)

ASP deterioration to continue at GAC

SUVs to continue to outperform PVs

The sector is trading at 10.83x 2012 and 9.3x

2013 consensus PE


Autos ChinaOpps


Consensus valuation

Code Last (lcy) PE (x) PB (x) ROE (%)

12CL 13CL 12CL 13CL 12CL 13CL

Geely 175 HK 3.54 13.18 11.11 1.95 1.66 17.1 16.8

Great Wall 2333 HK 25.35 13.98 12.72 3.04 2.63 22.5 21.2

DFM 489 HK 10.92 6.58 5.82 1.32 1.09 21.5 20.1

BYD 1211 HK 19.22 27.73 21.10 1.59 1.47 6.1 7.1

Brilliance 1114 HK 9.26 15.77 12.95 3.87 3.03 27.5 26.0

GAC 2238 HK 6.21 6.63 5.60 0.89 0.81 14.4 15.2

Average 13.98 11.55 2.11 1.78 18.2 17.8

Average w/o BYD 11.23 9.64 2.22 1.85 20.6 19.9

Average w/o BYD and Brilliance 10.09 8.81 1.80 1.55 18.8 18.3

Auto valuations

Code Last price PE (x) PB (x) ROE (%)


Geely 175 HK 3.54 16.09 13.56 2.38 2.03 17.1 16.8

Great Wall 2333 HK 25.35 17.85 16.25 3.89 3.36 22.5 21.2

DFM 489 HK 10.92 8.27 7.32 1.66 1.37 21.5 20.1

BYD 1211 HK 19.22 34.88 26.55 2.00 1.85 6.1 7.1

Brilliance 1114 HK 9.26 19.74 16.22 4.85 3.80 27.5 26.0

GAC 2238 HK 6.21 8.75 7.39 1.18 1.07 14.4 15.2

SAIC 600104 CH 13.47 6.34 5.55 1.24 1.03 21.0 20.1

FAW 000800 CH 5.84 9.90 8.92 1.07 1.01 5.9 6.8

Foton 600166 CH 5.46 8.67 6.84 1.09 0.96 14.4 13.6

VW VOW GR 155.05 7.73 6.76 1.08 0.95 15.5 15.0

Daimler DAI GR 37.67 7.11 6.42 0.94 0.85 13.7 14.3

BMW BMW GR 67.75 8.45 8.06 1.44 1.29 18.3 16.6

Toyota 7203 JP 3,515 40.38 13.49 1.08 1.03 2.7 8.1

Honda 7267 JP 2,726 9.46 1.02 0.0 11.2

Nissan 7201 JP 792.00 10.04 7.83 1.07 0.96 11.0 12.8

Suzuki 7269 JP 1,951 19.49 14.31 1.13 1.04 5.8 7.4

Isuzu 7202 JP 485.00 11.00 10.67 2.12 1.78 20.4 19.7

Hyundai 005380 KS 230,500 7.14 6.56 1.42 1.19 21.4 18.9

Kia 000270 KS 62,000 5.60 5.15 1.42 1.14 28.5 23.9

GM GM US 26.09 7.01 5.68 1.17 0.92 21.8 22.0

Ford F US 11.53 7.69 6.55 2.30 1.71 38.8 35.6

Tata TTMT IB 278.25 7.96 6.95 3.10 2.23 46.7 37.1

Source: IBES


Banks ChinaOpps


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


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%


Banks ChinaOpps


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


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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




Banks ChinaOpps


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.

China exports YoY growth


CN banks: Tier-one CAR 3Q12

Source: Companies, CLSA Asia-Pacific Markets

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Minsheng CMB ABC CNCB BOC ICBC CCB BOCOM

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NPL risks to small banks should be less severe

We expect YoY growth to bottom in 2Q13

Bocom has highest tier-1 within China sector


Banks ChinaOpps


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


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

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Prefer big banks to small banks

Question on reduction in payout ratio




Banks ChinaOpps


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


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.

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ICBC CCB ABC BOC (RHS)(%) (%)

NIM expansion for BOC

Minsheng: Red light on capital adequacy

CMB: Rights issue is long overdue

ABC: Better growth among Big 4

Haitong: Capture the secular growth

in China brokers


Banks ChinaOpps


H-share banks: Sector valuation

Company Code Price PE (x) PB (x) Div yield (%)

(HK$) 12CL 13CL 14CL 12CL 13CL 14CL 12CL 13CL 14CL

ICBC 1398 HK 5.19 6.8 6.7 6.2 1.33 1.16 1.03 4.4 4.5 4.8

CCB 939 HK 5.91 6.3 5.8 5.2 1.28 1.11 0.97 4.8 5.1 5.7

ABC 1288 HK 3.37 6.1 5.7 5.0 1.18 1.03 0.90 4.9 5.2 5.9

BOC 3988 HK 3.24 5.6 5.5 5.1 0.91 0.82 0.74 5.7 5.8 6.3

Bocom 3328 HK 5.57 5.6 5.8 5.2 0.86 0.76 0.68 2.0 2.1 2.3

CMB 3968 HK 14.64 7.6 7.3 6.2 1.37 1.20 1.05 3.3 3.4 4.0

CNCB 998 HK 3.95 4.8 4.5 4.1 0.76 0.68 0.60 5.3 5.5 6.2

Minsheng 1988 HK 7.49 5.1 6.2 6.7 1.05 0.98 0.87 3.8 3.0 3.0

Simple avg 6.0 5.9 5.5 1.09 0.97 0.85 4.3 4.3 4.8

Mkt cap weighted avg 6.2 6.0 5.5 1.18 1.03 0.91 4.6 4.8 Note: Data as of 29 November 2012. Source: CLSA Asia-Pacific Markets

Companies mentioned Agricultural Bank (1288 - HK$3.29 - OUTPERFORM) Bank of China (3988 - HK$3.11 - BUY) Bocom (3328 - HK$5.33 - OUTPERFORM) CCB (939 - HK$5.68 - OUTPERFORM) CMB (3968 - HK$13.84 - SELL) CNCB (998 - HK$3.84 - BUY) Haitong (6837 - HK$10.08 - BUY) ICBC (1398 - HK$5.01 - UNDERPERFORM) Minsheng (1988 - HK$7.09 - SELL)


Conglomerates ChinaOpps


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


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Regional NAV premium/discountMSCI Asia ex-Japan (RHS)

(%)

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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

Jonathan Galligan (86) 21 38784818

Jessica Anwar (852) 26008357











Twelve-month performance


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(20) (10) 0 10 20 30 40 50 60 70 80

IJMNanya PlasticsSamsung C&T

First PacificSwire PropertiesTaiwan Fertilizer

Sime DarbyFar Eastern New Century

Astra IntlKospi

LG CorpTaiwan Weighted

HSCEISingapore Press Holdings

China ResourcesTaiwan Cement

Strait timesSwire Pacific

Jardine StrategicAsia Cement

Jardine MathesonJakarta CompositeKeppel Corporation

HutchisonHang Seng Index

GamudaBeijing Enterprises

LS CorpShanghai IndustrialShun Tak Holdings

MTRCSemb Corp Ind

Larsen & ToubroMetro Pacific Inv

Phil CompST Engineering

Cheung KongMax india

DMCIHopewell Holdings

WharfAlliance Global

Ayala CorpFirst Philippine

SM Investments

(%)

HK conglomerates outperforming




Hong Kong/China valuations

Company Code Rec Price (lcy)

Mkt cap (US$m)

Target (lcy)

Upside (%)

13CL

Yield (%) PE (x) ROE (%) PB (x) Hutchison 0013 HK BUY 79.3 43,435.3 93.0 17.4 3.2 11.6 8.5 0.9

Shun Tak 0242 HK BUY 3.7 1,268.1 4.0 7.8 3.9 7.8 7.9 0.5

Wharf 0004 HK BUY 58.7 22,516.2 64.0 9.0 2.6 15.3 5.2 0.7

Cheung Kong 0001 HK O-PF 118.4 35,059.4 131.0 10.6 3.0 10.2 7.7 0.8

China Resources 0291 HK O-PF 25.5 3,540.0 0.0 (100.0) 0.0 28.4 6.8 1.8

First Pacific 0142 HK O-PF 8.3 4,136.5 9.0 8.8 3.3 8.6 12.6 1.1

Hopewell 0054 HK O-PF 30.4 3,350.4 32.5 7.1 3.4 22.7 4.1 0.8

Jardine Matheson JARD SI O-PF 28.2 8,132.5 31.4 11.4 1.6 12.2 11.4 1.1

Jardine Strategic JSH SI O-PF 58.0 38,884.6 67.0 15.5 2.4 11.5 9.7 0.9

Swire Properties 1972 HK O-PF 26.0 18,948.2 26.0 0.2 2.1 24.3 3.5 0.8

Beijing Enterprises 0392 HK U-PF 50.8 7,405.9 53.0 4.4 2.0 15.3 9.3 1.3

MTRC 0066 HK U-PF 30.9 22,603.0 29.0 (6.0) 2.7 20.6 6.4 1.3

Swire Pacific 0019 HK U-PF 95.3 18,041.7 97.0 1.8 3.6 13.7 4.9 0.6

Hutchison NAV premium/discount

Cheung Kong NAV premium/discount


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NAV (LHS) Premium to NAV (%)(HK$)

Average historical discount: 16%

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Trading at a 38% discount, well below the

long-term average of 16%

Despite good performance in 2012 Cheung Kong is still

trading at a 30% discount




Swire Pacific NAV premium/discount

Swire Properties NAV premium/discount

Hopewell Holdings NAV premium/discount


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NAV (LHS) Premium to NAV

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Swire Properties is trading at 26% discount

after outperforming Swire Pacific by 25%

Hopewell Holdings has outperformed despite the

highway drag and still trades at a 40% discount





First Pacific NAV premium/discount

MTRC NAV premium/discount

Beijing Enterprises NAV premium/discount


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At 38%, the NAV discount of First Pacific

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The discount on MTRC has contracted to just 9%

Beijing Enterprises is currently trading at just

a 3% discount to NAV






Jardine Matheson NAV premium/discount

Jardine Strategic NAV premium/discount


Companies mentioned Beijing Ent (392 - HK$49.70 - UNDERPERFORM) Cheung Kong (1 - HK$113.70 - OUTPERFORM) First Pacific (142 - HK$8.40 - OUTPERFORM) Hopewell Hldgs (54 - HK$28.85 - OUTPERFORM) Hutchison Whampoa (13 - HK$77.35 - BUY) Jardine Matheson (JM - US$58.82 - OUTPERFORM) Jardine Strategic (JS - US$34.57 - OUTPERFORM) MTRC (66 - HK$29.95 - UNDERPERFORM) Swire Pacific (19 - HK$93.40 - UNDERPERFORM) Swire Properties (1972 - HK$24.70 - OUTPERFORM)

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NAV (LHS) Disc to NAV(US$) (%)

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Jardine holding companies are trading at

attractive discounts - Matheson at 26% and . . .

. . . Strategic at 33%



Consumer China ChinaOpps


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

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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


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

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Gome

Anta

Lilang

Parkson

Dongxiang

Li Ning

Trinity

NWDS

MSCI China

Intime

Golden Eagle

Daphne

Belle

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MSCI China

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Sun Art

China Foods

Want Want

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Staples valuation premium over

discretionary segment remains high at 30%

Prefer consumer discretionary plays to staple names in 2013

Discretionary sector has underperformed

staples in 2012




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:


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.

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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

earnings expectations




SSS growth of China retailers

Company 2009 1Q10 2Q10 3Q10 4Q10 2010 1Q11 2Q11 3Q11 4Q11 2011 1Q12 2Q12 3Q12

Belle- footwear

8.0 18.0 18.0 18.0 16.0 17.0 22.0 20.0 18.5 8.2 Over 15

2.8 10.5 2.8

Belle-sportswear

(6.0) 4.0 4.0 3.0 7.0 5.0 7.0 5.5 2.5 3.5 Mid- single

digit

(2.4) 5 3.6

Daphne 2.8 2.5 in 1H10 2.5 in 2H10 2.5 1 32 23 26 20.5 22 14 5

Golden Eagle 17.5 26.0 24.0 25.0 25.0 25.0 29 28 27-28 18 25 9 8.2 Low- single digit

Parkson 7.5 10.8 11.9 10.9 12.0 11.4 13.9 12.5 12 8 11.4 2 4 (1)

Intime 16.7 18.4 16.0 17.7 20.7 18.2 27.0 29.8 27.2 High-single

digit

23.1 9 9 4

NWDS Low single- digits

Low to mid single-

digit

High single-

digit

About 10 in 2H10

About 9 High teens

High teens

Mid teens

Low to mid

teens

Mid to high

teens

High- single

digit

High- single

digit

Mid- single

digit

Evergreen – V.E. DELURE

30.4 na na na na 33.6 35 in 1H11 About 30

Mid- teen

18.5 6.6 in 1H12 na

Trinity 3.1 15.1 in 1H10 25 in 2H10 20.1 17.4 in 1H11 12.8 in 2H11 15.1 2.5 in 1H12 na

Li Ning (2.3) 5.0 4.0 4.0 3.6 3.9 Low single-digit in 4M11

Low single-

digit

Low single-

digit

Slightly negative

Flat Slightly negative

Expected slightly

negative

na

Anta High single-

digit

10+ High single-

digit

High single-

digit

High single-

digit

High single-

digit

High single-

digit

High single-

digit

Mid single-

digit

Flat Mid single-

digit

Low- single digit

decline

Mid to high-single digit

decline

Mid-single digit

decline

Dongxiang Flat 4.0 0.4 4.7 Mid single-

digit

Low- single

digit

Low single-

digit decline

Mid-teen decline

na na na na na na

Sun Art 5.6 11.6 in 1H10 11.2 in 2H10 11.4 14 Low teens

9.5 2-3 8.8 “In line with CPI”

About 3 Above CPI

CRE 0.8 8.1 8.7 Low-teens

High single-

digit

8.5 12.7 12.1 10 High single-

digit

10.9 6.4 About 5 Low-single digit

Gome 2.8 23.9 26.8 14.1 22.6 21.8 7.6 7.2 4.1 (5.9) 3.1 34.4 decline

18.7 decline

16.3 decline

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.

Our “five-perspective” framework to evaluate

the impact of e-commerce




China B2C online retail sales

Source: Euromonitor, CLSA Asia-Pacific Markets

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


0

50

100

150

200

250

300

350

0

5,000

10,000

15,000

20,000

25,000

30,000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

(US$m) B2C online retail sales YoY growth (RHS) (%)

Belle and Golden Eagle are most resilient to e-commerce impact

Online retail sales in China posted a

92% 2006-11 Cagr




Scoring with five-perspective framework Company Products Branding Targeted consumers Channels IT/logistic infrastructure Total Parkson 36 25 37 43 30 171 Golden Eagle 40 32 45 42 35 194 Intime 40 30 41 39 30 180 NWDS 33 22 27 35 24 141 Belle 38 36 37 40 37 188 Daphne 32 29 31 39 27 158 Sun Art 28 21 21 37 29 136 Trinity 40 36 44 37 29 186 Lilang 34 28 33 30 23 148 Evergreen 38 30 39 34 25 166 Li Ning 33 28 25 21 20 127 Anta 33 27 25 34 24 143 Dongxiang 36 28 27 31 21 143 Gome 23 24 26 40 30 143 Note: Low scores=LEAST resilience/MOST vulnerability to e-commerce; High scores=MOST resilience/LEAST vulnerability to e-commerce; Source: CLSA Asia-Pacific Markets

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.

No normalised channel inventories until 2H13

Direct retailers to benefit from macro

improvement in 2013

Various benefits of running self-

operated stores

Multibrand retailers likely to resume

trade-up of sales mix




YoY change of sportswear brands’ revenue


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)

(%) Li Ning Anta¹ Dongxiang 1Q09 36.00 40+ 30+ 2Q09 31.60 30+ 31 3Q09 12.70 Low-teen 8 4Q09 14.50 25+ 21 1Q10 11.60 18 16 2Q10 15.40 16 22 3Q10 20.30 18 22 4Q10 20.30 25+ 22.90 1Q11 12.00 23+ 11.80 2Q11 0 21 2.80 3Q11 8% decline 20 40% YoY decline in

2H11 (after voluntary cancellation of orders)

4Q11 5 25

1Q12 Mid-single digit Low-single digit growth in 1H12E after voluntary

adjustment

na 2Q12 Flat na

3Q12 Mid-single digit decline High-single digit decline Mid-teen decline 4Q12 High-teen decline Low-teen decline 1Q13 na 15-25% decline na 2Q13 na 10-20% decline na ¹ Anta’s retail ASP-based figures are estimated by CLSA. Source: Companies, CLSA Asia-Pacific Markets

(40)

(30)

(20)

(10)

0

10

20

30

2011 12CL 13CL

Anta Li Ning Dongxiang(%)

Preferring Anta in China sportswear sector

A surge of supply from “new channels”

We are still cautious on the sector




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



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


(Rmb/kg)

2,000

3,000

4,000

5,000

6,000

7,000

8,000


(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

Importance of categories and product depth

Prefer Want Want in consumer staple space




Combined China market share of MNCs in top five in each category in 2011

Source: Euromonitor, CLSA Asia-Pacific Markets

Distribution network and product categories of F&B plays

No of sales staff

No of distributors

No of Controlled POS

Product categories

Hengan 14,000+ 1,700+ 660k+ Tissue, sanitary napkins, diapers

Vinda About 1,400 na About 300k Tissue

Want Want 12,000+ 8,000+ 700k+ Rice crackers, dairy products & beverages (incl flavoured milk, yoghurt drinks, RTD coffee, and milk powder), snack foods (including candies, popsicles and jellies, ball cakes

Tingyi 15,000+ 25,000+ 1 million+ Instant noodle, beverage (incl bottled water, RTD tea, diluted juice)


Companies mentioned Anta Sports (2020 - HK$6.12 - OUTPERFORM) Belle Intl (1880 - HK$14.40 - BUY) Dongxiang (3818 - HK$1.00 - UNDERPERFORM) Golden Eagle (3308 - HK$17.62 - BUY) Li Ning (2331 - HK$4.20 - SELL) Vinda (3331 - HK$11.76 - BUY) Want Want (151 - HK$10.80 - BUY) Sun Art (6808 HK - HK$11.96 - SELL) Gome (493 HK - HK$0.78 - SELL) NWDS (825 HK - HK$4.69 - U-PF) Lilang (1234 HK - HK$4.21 - U-PF)

0

1

2

3

4

5

6

0102030405060708090

100

Inst

ant

nood

les

Milk

pro

duct

s

Oils

and

fat

s

RTD

tea

Spi

rits

Gra

pe w

ine

Cig

aret

tes

Tiss

ue

Frui

t Ju

ice

Ice

crea

m

Fem

inin

e hy

gien

e

Hom

ecar

e

Bot

tled

wat

er

Con

fect

ione

ry

Bee

r

Soa

ps

Ski

ncar

e

Bab

y di

aper

s

Sha

mpo

o

Ora

l car

e

Cof

fee

Car

bona

tes

MNCs' market share in top five (LHS)No. of MNCs among top five

(%) (No. of MNCs)

Sw

eet

and

savo

ury

snac

ks

We like Chinese players operating in categories

less exposed to multinationals










Consumer HK ChinaOpps


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


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

Luxury goods companies have strong

economic moats

Negative calls also worked out well






Developing vs developed markets breakdown of luxury goods market (2012)


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


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.

26

65

74

35

0102030405060708090

100

Sales by region Sales by customer

(%) Developing markets Developed markets

0 20 40 60 80 100

SitoySamsoniteL'Occitane

PradaPorts Design

Chow Tai FookBelle

Golden EagleLifestyleHengdeliLuk Fook

SasaChow Sang Sang

TrinityI.T

Emperor WatchEvergreen

Oriental Watch

(%)

Other customers Greater Chinese

Global consumers names have more diversified

earnings profile

More leather goods and retail lead to

earnings resiliency

Developing markets’ consumers account for

65% of global sales

Prefer global names




Retail sales growth, ROCE and inventory level

Source: Company, CLSA Asia-Pacific Markets

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.

Multibrand strategy


200

240

280

320

360

400

20

25

30

35

40

45

50

FY11/01 1HFY12 FY12/01 1HFY13

(€m)Inventory (RHS) Retail sales growth ROCE(%)

Luxury

Mass

Luggage Business Casual

Possibly more M&As

Highly advanced industrial model enhances

inventory control

Capturing a broad customer base




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)


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.

Local currency sales growths by channel (June YE)


011

22

33

455

799

0 2 4 6 8 10

IndiaMexicoTaiwanCanada

SpainUK

ItalyBrazil

GermanyJapanKoreaChina

Russia

(Stores)

Japan22%

HK11%

China7%

Taiwan3%France

8%

UK5%

US11%

Brazil4%

Russia5%

Other countries

24%

(7.8)

(2.2)(3.5)

(10.9)(11.7)

(8.8)

(24.6)

(13.1)

(19.5) (17.1)

(25)

(20)

(15)

(10)

(5)

0

1QFY12 2QFY12 3QFY12 4QFY12 1QFY13

RetailWholesale

(%)

Focus on emerging markets

Massive cash outflows

Diversified revenue base

Sluggish sales performance




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


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.

565

201 355

556 625 700

304

16

271

287

409

700

13

4

15

20

25

100

0

200

400

600

800

1,000

1,200

1,400

1,600

2011 1H12 2H12CL 12CL 13CL Mgmt target2013

(US$m)

882

221

641

862

1,059

1,500

More opportunities in distribution and Asia

Weak earnings visibility

Some 29% below management target

October sales were weak but the outlook

is slowly improving




Same-store-sales growth


Companies mentioned Chow Tai Fook (1929 - HK$9.90 - SELL) Esprit (330 - HK$12.96 - SELL) Li & Fung (494 - HK$12.66 - SELL) L'Occitane (973 - HK$23.65 - BUY) Prada (1913 - HK$61.20 - BUY) Samsonite (1910 - HK$15.02 - BUY)

15.6

33.8

61.9

18.7

40.3

(1.7)

9.5

4.0 7.6

(10)

0

10

20

30

40

50

60

70

FY10A FY11A 1HFY12A 2HFY12A FY12A 1HFY13A 2HFY13CL FY13CL FY14CL

(%)

Expect 2H SSS at 9%, off an easier base


Healthcare ChinaOpps


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.

Overweight device, chemical and TCM

Note: Bubble size represent market size. Source: NBS, FortuneCLSA

API

Chemical

TCM

Bio

Device

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15 20 25 30 35 40 452008-11 Revnue Cagr (%)

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Zen Zhou Analyst, Fortune CLSA [email protected] (86) 21 38784818

Thanks to: Heather Hsu, CFA Head of A-share Research, Fortune CLSA (86) 21 38784818

Top ideas Mindray MR US Rec BUY Market cap US$3.79bn Target US$48.00 Up/downside +45% Sino Biopharm 1177 HK Rec BUY Market cap US$2.30bn Target HK$4.30 Up/downside +22% Yuyue 002223 CH Rec BUY Market cap US$1.12bn Target Rmb17.00 Up/downside +31% Yunnanbaiyao 000538 CH Rec O-PF Market cap US$6.92bn Target Rmb68.00 Up/downside +8%

Please see important notice on page 198.




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.

Low spending 23% more aged by 2017

Source: Espicom, FortuneCLSA Source: NBS, FortuneCLSA

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”.

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10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-8485-8990-9495-99100+ Men Women

Government increase the healthcare spending

Three main drivers

Milder policy on both price-cut and bidding




Total healthcare spending To grow by 20% in 2013

Source: NBS, FortuneCLSA

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.

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Solid healthcare demand

We expect margin to improve to 30% in 2013




Gross margin of healthcare sector

Source: NBS, FortuneCLSA

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.

Subsector 2013 outlook

Subsector Revenue growth (%) 2013 growth forecast (%)

Drivers Risk

2008-11 Cagr 9M12 Chemicals 25 23.7 22.0 Patents expire Price-cut API 20 7.8 5.0 Overseas demand rebound Overcapacity TCMs 30 21.5 21.0 Expand into healthcare products;

Government support Safety issue

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

Source: MoH, FortuneCLSA

31.1

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Margin bottomed

We prefer device, chemical and TCM sector




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.

FCLSA healthcare coverage

Company Code Rec Price (local currency)

Upside (%)

Mkt cap (US$m)

PE (x)

ROE (%)

EPS (Rmb)

Target Last 12FCL 13FCL 12FCL 13FCL 12FCL 13FCL

Kelun Pharma 002422 CH BUY 60.0 50.18 19.6 3,850 23.3 18.1 12.3 14.1 2.15 2.78

Mindray MR N BUY 48.0 33.2 44.7 3,792 19.1 16.0 16.3 17.0 1.74 2.07

Shanghai Pharma-A 601607 CH BUY 15.0 10.1 48.8 4,522 12.4 11.1 9.5 9.8 0.81 0.91

Shanghai Pharma-H 2607 HK BUY 15.5 14.5 6.9 4,522 9.8 8.0 9.5 9.8 0.81 0.91

Sino Biopharm 1177 HK BUY 4.3 3.6 21.7 2,295 20.7 16.2 23.8 24.1 0.17 0.22

Yuyue Medical 002223 CH BUY 17.0 13.0 31.1 1,119 22.5 18.6 22.3 25.1 0.58 0.70

Yunnan Baiyao 000538 CH O-PF 68.0 62.81 8.3 6,922 29.0 24.2 24.4 24.1 2.16 2.60

Hualan Bio 002007 CH U-PF 24.0 19.3 24.5 1,878 33.6 28.9 12.7 12.9 0.57 0.67

Tongrentang 600085 CH U-PF 19.6 16.8 16.7 3,431 38.9 30.5 17.1 18.7 0.43 0.55

Lepu Medical 300003 CH SELL 9.0 7.8 15.8 1,019 12.2 10.7 21.1 21.4 0.64 0.72

Walvax 300142 CH SELL 33.0 35.2 (6.2) 1,027 25.2 22.8 9.0 9.3 1.39 1.54

Weigao 1066 HK SELL 10.3 8.0 28.8 4,673 26.1 20.5 12.8 14.2 0.24 0.29

Zhifei Bio 300122 CH SELL 20.0 32.3 (38.1) 2,042 61.8 46.9 9.0 11.0 0.52 0.69

Source: FortuneCLSA

Chinese generics companies face an

opportunity in 2012-15

Sino Biopharm and Mindray are our top picks


Industrials ChinaOpps


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


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Paul Quah Head of Small/Mid Caps Res [email protected] (852) 26008298

Zac Gill (852) 26008725

Earnings upgrades needed to support

valuations

Top ideas Tiangong 826 HK Rec BUY Market cap US$0.47bn Target HK$2.90 Up/downside +55% Minth 425 HK Rec BUY Market cap US$1.11bn Target HK$11.0 Up/downside +33% Stock to avoid Yingde Gases 2168 HK Rec SELL Market cap US$1.77bn Target HK$6.0 Up/downside -22%




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)


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)

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Industrials we track have strongly

outperformed the market

Industrials have performed well as many

cyclicals have rerated

Industrials trading at 10x forward PE

Industry recovered in 3Q12




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)


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:

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Earnings upgrades needed to support

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FY13 should have more growth due mostly to low base effect




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.

Minth is cheap due to short-term issues in China

We expect earnings to normalize by 2H13

We prefer industrials with structural drivers

Hurricane should only provide a small net

benefit to sales




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-

street expectations

New order from Samsung in copiers




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


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QE3 was a catalyst for more risk in the market

Cyclicals trading close to their historical average

of 10x forward PE




CLSA small/mid cap industrials coverage (full-year analysis of profit and margins)

FY06A FY07A FY08A FY09A FY10A FY11A FY12CL FY13CL FY14CL Average Sales YoY growth (%) 26 33 23 5 49 17 10 16 14 Net profit growth YoY (%) 40 37 5 3 165 7 (5) 29 18 EVA Precision Sales 691 952 1,085 1,026 1,703 1,978 2,445 2,945 3,464 Net profit 109 147 77 32 300 196 85 169 222 Gross profit margin (%) 32.0 31.8 25.2 19.9 31.8 24.7 20.7 22.3 23.1 Net profit margin (%) 15.7 15.4 7.1 3.2 17.6 9.9 3.5 5.7 6.4 Sales growth YoY (%) 43 38 14 (5) 66 16 24 20 18 Net profit growth YoY (%) 31 35 (47) (58) 826 (35) (57) 99 31 Haitian Sales 3,176 3,825 3,694 3,861 7,057 7,028 6,459 7,062 8,218 Net profit 458 612 418 432 1,092 1,112 997 1,088 1,313 Gross profit margin (%) 30.0 30.9 28.6 27.0 31.1 30.7 30.9 30.9 30.7 Net profit margin (%) 14.4 16.0 11.3 11.2 15.5 15.8 15.4 15.4 16.0 Sales growth YoY (%) 23 20 (3) 5 83 0 (8) 9 16 Net profit growth YoY (%) 31 34 (32) 3 153 2 (10) 9 21 Minth Sales 956 1,408 1,966 2,545 3,576 3,889 4,195 4,732 5,411 Net profit 268 411 491 614 781 781 803 872 963 Gross profit margin (%) 42.4 42.2 38.9 41.0 38.8 37.6 36.7 36.9 36.7 Net profit margin (%) 28.0 29.2 25.0 24.1 21.8 20.1 19.1 18.4 17.8 Sales growth YoY (%) 41 47 40 29 41 9 8 13 14 Net profit growth YoY (%) 40 53 19 25 27 0 3 9 10 Techtronic Sales 2,805 3,184 3,421 3,083 3,383 3,667 3,843 4,075 4,427 Net profit 138 76 106 54 118 159 187 223 274 Gross profit margin (%) 31.6 31.5 30.8 31.3 32.2 32.5 32.9 33.0 33.0 Net profit margin (%) 4.9 2.4 3.1 1.7 3.5 4.3 4.9 5.5 6.2 Sales YoY growth (%) (2) 14 7 (10) 10 8 5 6 9 Net profit growth YoY (%) 5 (45) 40 (49) 121 34 18 20 23 Tiangong Sales 1,304 1,736 1,993 1,324 2,349 3,112 3,422 4,064 4,374 Net profit 99 183 117 125 229 403 472 603 661 Gross profit margin (%) 22.4 19.8 19.0 24.9 23.6 26.4 27.0 27.1 27.3 Net profit margin (%) 7.6 10.5 5.9 9.4 9.7 12.9 13.8 14.8 15.1 Sales growth YoY (%) 19 33 15 (34) 77 32 10 19 8 Net profit growth YoY (%) 87 85 (36) 7 83 76 17 28 10 Vtech Sales 1,464 1,552 1,448 1,532 1,713 1,785 1,870 1,961 2,086 (Mar YE) Net profit 178 205 171 213 202 192 205 219 239 Gross profit margin (%) 36.9 37.6 36.4 36.5 33.1 32.0 32.4 32.6 32.8 Net profit margin (%) 12.1 13.2 11.8 13.9 11.8 10.7 11.0 11.2 11.4 Sales YoY growth (%) 22 6 (7) 6 12 4 5 5 6 Net profit growth YoY (%) 36 16 (17) 25 (5) (5) 7 7 9 Xinyi Glass Sales 1,933 2,775 3,894 3,958 6,364 8,227 9,752 11,690 13,249 Net profit 399 590 644 846 1,544 1,204 1,162 1,563 1,863 Gross profit margin (%) 40.7 43.1 36.3 42.9 45.0 33.8 32.5 33.8 34.9 Net profit margin (%) 20.6 21.2 16.5 21.4 24.3 14.6 11.9 13.4 14.1 Sales YoY growth (%) 40 44 40 2 61 29 19 20 13 Net profit growth YoY (%) 54 48 9 31 83 (22) (4) 34 19 Yingde Gases Sales 485 784 1,412 2,066 3,005 4,240 5,014 6,723 8,435 Net profit 122 204 418 585 799 828 734 944 1,179 Gross profit margin (%) 53.7 47.0 46.7 43.0 44.0 40.7 36.9 35.8 35.1 Net profit margin (%) 25.1 26.0 29.6 28.3 26.6 19.5 14.6 14.0 14.0 Sales YoY growth (%) 62 80 46 45 41 18 34 25 Net profit growth YoY (%) 68 105 40 36 4 (11) 29 25 Source: Companies, CLSA Asia-Pacific Markets




CLSA VMOS screen (HK/China industrials highlighted)


CLSA industrials recommendations and recent share performance Company Code Mkt cap ADTV Rec Target Upside Performance (%)

(US$m) (US$m) (HK$) (%) 1M 3M 6M 12M Minth 425 HK 1,109 1.8 BUY 11.00 33 1 (8) (12) 9 Tiangong International 826 HK 466 1.6 BUY 2.90 55 (2) 32 19 32 EVA Precision 838 HK 220 1.4 O-PF 1.18 17 26 63 7 (48) Haitian International 1882 HK 1,899 1.1 O-PF 10.00 8 0 18 9 46 VTech 303 HK 2,885 3.3 O-PF 91.00 2 0 (4) 6 17 Xinyi Glass 868 HK 2,146 5.7 O-PF 5.00 14 3 17 (0) 6 Techtronic Industries 669 HK 3,671 11.6 U-PF 16.00 3 11 42 63 120 Yingde Gases 2168 HK 1,767 3.2 SELL 6.00 (22) 3 13 13 (8) Lee & Man Paper 2314 HK 2,602 3.5 N-R 9 31 31 52 Nine Dragons 2689 HK 3,405 11.5 N-R 17 50 21 14 CLSA industrials valuations Company Code 12M forward EPS Cagr (%) PE/G

(x) Gearing

PE (x) PB (x) Yield (%) ROE (%) FY0-FY2 (%) EVA Precision 838 HK 11.9 0.9 2.8 8 (12) 8 Haitian International 1882 HK 10.9 2.0 4.1 19 (1) (43) Lee & Man Paper 2314 HK 11.3 1.3 3.2 12 20 0.6 65 Minth 425 HK 7.9 1.0 3.8 13 10 0.8 (41) Nine Dragons 2689 HK 11.2 0.9 2.1 9 26 0.4 100 Techtronic Industries 669 HK 15.4 2.1 1.3 15 24 0.7 40 Tiangong International 826 HK 4.9 0.9 4.6 21 21 0.2 37 VTech 303 HK 13.5 5.1 7.3 38 7 2.1 (57) Xinyi Glass 868 HK 11.5 1.6 4.2 15 6 1.8 32 Yingde Gases 2168 HK 11.9 1.8 2.1 16 27 0.4 84 Average 11.0 1.8 3.5 17 13 0.9 22 Source: Bloomberg, CLSA Asia-Pacific Markets

Companies mentioned EVA Precision (838 - HK$0.85 - OUTPERFORM) Haitian (1882 - HK$8.74 - OUTPERFORM) Minth (425 - HK$7.72 - BUY) Techtronic (669 - HK$14.70 - OUTPERFORM) Tiangong (826 - HK$1.91 - BUY) VTech (303 - HK$89.15 - UNDERPERFORM) Xinyi Glass (868 - HK$4.54 - BUY) Yingde Gases (2168 - HK$7.25 - SELL)

Seegene HomePro

GKL

Robinson

Ace Hardware

Café de Coral

Hartalega

Mayora Indah

FCT

Emperor Watch

Raffles Medical

Major Cineplex

Bumi SD

STX OSV

Oriental Watch China Steel Chem

Holcim Indo

Metro PacificVTech

EzionEVA Precision

Tiangong

MagnificentHengdeli

Dorsett Hospitality

China Automation

Jubilant Food

Mitra Adiperkasa

Top Glove

Hotel Shilla

Yingde Gases

Robinsons Land

Prince Frog

Nagacorp

URCKPJ

PC Home

Gourmet Master

Formosa HotelsVista Land

Xinyi GlassVinda

Wowprime

ParadiseUEM Land

Havells India

Apollo Tyres

Haitian

Techtronic

PadiniGiant

Ginko

Samsonite

Stecon

Minth

Standard Foods

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Insurance ChinaOpps


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

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China Life Ping An China PacificNew China Life China Taiping PICCHSCEI

Underperform expected

Patricia Cheng [email protected] (852) 26008683

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%


Insurance ChinaOpps


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.

Tight regulatory scrutiny

Wealth management products in demand

High maturity payout

Uncertain macro situation

Restructuring not over

No recovery in 2013


Insurance ChinaOpps


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

No rebound back to double-digit growth

anytime soon

Auto deterioration

PICC downgrade from BUY to U-PF

New China Life: not able to fund itself


Insurance ChinaOpps


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)

China Taiping: massive fundraising needed

Ping An: only stock with clear long-term

strategy but selldown by HSBC possible

China Pacific: overhang remains

PICC: stick with PICC rather than PICC Group

China Life: no major negative surprise














Internet ChinaOpps


Internet - Mobile transition Accelerating smartphone growth should see mobile grab the spotlight in 2013.

But the transition could slow revenue growth. The user-pays model may take

off but advertisers are slower in adopting mobile. Gaming plays outperformed

in 2012 and could continue to do well with expanding categories and mobile

games should fuel the growth. The ad market could slow due to a lack of

major events and macro uncertainty next year but online ads will fare better

and performance advertising will take a larger share. The sector has derated

with attractive valuations. Our 2013 picks are Tencent, Baidu and NetEase.

Next year is about mobile

Mobile transition will accelerate and China is likely to add another 110m 3G

users (60-70m smartphone users) in 2013. Total smartphone users could

reach 200-250m by 2013, equivalent to 30-35% of PC Internet users. Mobile

transition could slow revenue growth in 2013 as monetisation models are new

and less optimised than PC. But, mobile potential is big, given the large user

base and new revenue streams. The user-pays model is likely to take off first.

Advertisers are slower to adopt mobile platforms but will always follow users.

Advertising could slow but performance ads gains share

China ad revenue could grow at a slower 11.5% in 2013 due to lack of major

events. Online ad should fare better and revenue may grow 35% YoY but

traditional display ads will be in a structural decline. Performance advertising

will gain larger share. Search advertising will continue to benefit from

booming e-commerce market in China and revenue can grow 35% YoY in

2013. Video-advertising growth could slow, given high penetration and slow

content acquisition but there is scope for price increases. Video sites may turn

profitable and social advertising is likely to gain momentum. Tencent and Sina

have launched performance advertising platforms to boost monetisation.

Gaming will continue to do well

China’s gaming revenue growth could rebound in 2013 as efforts to expand

game categories and create new play modes have borne fruit. There were

many hit game launches in 2012 such as Tencent’s LOL, NetEase’s ZhanHun,

Changyou’s ShenQ with more to come in 2013. Web and mobile games will

fuel the growth. We expect the gaming industry to grow 20% YoY in 2013,

while revenue for client-end games may rise 15% and webgames 35% YoY.

Tencent and Netaease should remain dominant in the gaming market but

small operators may find new growth with new webgames and mobile games.

Internet sector continues to outperform

¹ CLSA internet coverage. Source: CLSA Asia-Pacific Markets

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Top ideas

Tencent 700 HK

Rec BUY

Market cap US$61bn

Target HK$320

Up/downside +25%

Baidu BIDU US

Rec BUY

Market cap US$34bn

Target HK$215

Up/downside +117%

NetEase NTES US

Rec BUY

Market cap US$5.6bn

Target HK$69

Up/downside +57%

Stocks to avoid

Dangdang DANG US

Rec U-PF

Market cap US$362mn

Target HK$4.5

Up/downside -2%

Perfect World PWRD US

Rec U-PF

Market cap US$516mn

Target US$11

Up/downside +3%

Elinor Leung, CFA Head of Tel & Internet Res

[email protected] (852) 26008632


Internet ChinaOpps


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

¹ CLSA internet coverage. Source: CLSA Asia-Pacific Markets Source: CLSA Asia-Pacific Markets

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.

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GiantTencent

Mobile will grab the spotlight in 2013

Internet sector outperformed

by 17% YTD

Tencent was the best performer in 2012


Internet ChinaOpps


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.

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slowdown and some have regrown revenue

Ctrip was among the worst performer in 2012

Smartphone growth to accelerate

Mobile transition could slow revenue

growth in 2013


Internet ChinaOpps


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.

China advertising revenue could grow at a slower

11.5% YoY in 2013

Online revenue may grow 35% YoY in 2013

Search advertising will continue to benefit from

e-commerce boom

Video advertising growth could slow in 2013

Social advertising could gain momentum

Mobile adspend will likely remain small


Internet ChinaOpps


China online ad market 2008 2009 2010 2011 12CL 13CL 14CL China nominal GDP (Rmbbn) 31,405 34,090 40,151 47,156 51,778 57,266 63,966 YoY 18.1 8.6 17.8 17.4 9.8 10.6 11.7 Total adspend (Rmbbn) 240 263 302 347 392 438 495 YoY 22.3 9.8 14.7 14.9 13.0 11.6 13.0 Adspend % of GDP 0.76 0.77 0.75 0.74 0.76 0.76 0.77 Online ads (Rmbbn) Display 12.0 13.7 24.6 32.4 50.3 66.8 83.4 Paid search 5.0 7.0 11.0 18.8 28.2 38.0 48.9 Total 17.0 20.6 35.6 51.2 78.4 104.8 132.3 YoY (%) Display 55 14 80 32 55 33 25 Paid search 73 38 58 71 50 35 29 Total 60 21 73 44 53 34 26 % of online ads Display 70 66 69 63 64 64 63 Paid search 30 34 31 37 36 36 37 Total 100 100 100 100 100 100 100 % of total ads Display 5.0 5.2 8.2 9.3 12.8 15.3 16.9 Paid search 2.1 2.6 3.6 5.4 7.2 8.7 9.9 Total 7.1 7.8 11.8 14.7 20.0 23.9 26.7 Source: CEIC, iResearch, CLSA Asia-Pacific Markets

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

China gaming revenue growth could rebound

Web-games boom will continue

Mobile games could surprise

Tencent and NetEase to continue to dominate

the gaming market


Internet ChinaOpps


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.

China gaming revenue Client-end game revenue

Source: iResearch Source: IDC, CLSA Asia-Pacific Markets

Web game revenue Mobile game revenue

Source: IDC, CLSA Asia-Pacific Markets

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

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Baidu valuation is cheap at 16x 13CL PE


Internet ChinaOpps


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)

NetEase could rebound with new expansion

pack of WoW and new games such as Diablo3




















Macau gaming ChinaOpps


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

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VIP revenue Mass gaming revenue Industry Ebitda(%)

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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


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.

New gaming revenue forecasts

(MOPm) 2011 To Oct 12 12CL 13CL 14CL

High-end (VIP Baccarat) 195,851 174,781 207,935 217,784 228,674

YoY growth (%) 44 7 6 5 5

Mass market 60,620 65,247 80,202 96,204 110,634

YoY growth (%) 38 33 32 20 15

Slot machines 11,476 10,983 13,255 14,580 16,038

YoY growth (%) 33 16 16 10 10

Total gaming revenue 267,946 251,011 301,392 328,568 355,346

YoY growth (%) 42 13 13 9 8

Gaming revenue (US$bn) 33.5 31.4 37.7 41.1 44.4 Source: DICJ, CLSA Asia-Pacific Markets

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.

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SandsMacao

Wynn Macau,Starworld

Grand Lisboa,MGM Macau,

Altira, Venetian

City of Dreams, L'Arc, Oceanus

FourSeasons,Ponte 16

WynnEncore

GalaxyMacau

Sands Cotai Central

No new opening

Galaxy Macau Phase 2, Macau Studio City,

Wynn Cotai, Sands Site 3

Expect no new casino opening in 2013-14

VIP declined, while mass market improved

Assume moderate VIP gaming revenue growth




Macau gaming revenue/Ebitda growth Macau: Gaming revenue growth versus Ebitda margin


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)


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.

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Macau: best way to gain exposure to rising

Chinese middle class

Macau casinos also benefit from the gradual

pricing in of Cotai

Forecast Macau names to deliver 4-6%

yield in 2013





Cotai, Macau

Source: Google Maps, CLSA Asia-Pacific Markets

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%).

Macau gaming: 2016 target price

Sands China

Wynn Macau

MGM China

Melco Crown

SJM Galaxy

2014 adj. Ebitda (US$m) - Existing operations 2,833 1,178 726 1,016 1,174 1,485

2016 adj. Ebitda (US$m) - Existing operations 3,123 1,299 800 1,120 1,295 1,637

Cotai capex (US$m) 3,000 3,500 2,500 2,000 2,000 2,000

Cotai ROIC (%) 15 19 14 17 17 17

2016 Cotai Ebitda (US$m) 450 665 350 340 340 340

2016 Total Ebitda (US$m) 3,573 1,964 1,150 1,460 1,635 1,977

EV/Ebitda multiple 15 13 11 10 11 11

Enterprise value (US$m) 53,592 25,528 12,652 14,604 17,982 21,747

Net debt (US$m) 2,328 813 5 15 (2,695) (1,577)

Equity value (US$m) 51,265 24,715 12,646 14,589 20,677 23,325

No. of shares 8,050 5,188 3,800 552 5,523 4,180

Target price (local ccy) 49.4 36.9 25.8 26.4 29.0 43.2 Note: Assume 5% Ebitda growth on existing operations in 2015-16 for the six gaming companies; Source: CLSA Asia-Pacific Markets

Six potential Cotai projects in the pipeline

Use “yield to completion” as an alternative

valuation method

Apply 10-15x multiple to 2016 Ebitda to derive our 2016 price target




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: Yield to completion

Company Price (lcy)

Target (lcy)

Dividend yield (%)

Annualised capital return (%)

Annualised dividend return (%)

Annualised total return (%)

2016 13CL 14CL 15CL 16CL 13-16CL 13-16CL 13-16CL

Sands China 33.4 49.4 4.2 5.0 5.0 5.0 10.3 5.4 15.7

Wynn Macau 22.6 36.9 4.4 4.8 4.8 4.8 13.0 4.9 17.9

MGM China 14.2 25.8 5.9 6.4 6.4 6.4 16.1 6.2 22.3

Melco Crown 15.3 26.4 0 0 0 0 14.6 0 14.6

SJM 18.3 29.0 5.5 6.2 6.2 6.2 12.2 6.4 18.6

Galaxy 29.8 43.2 0 0 0 0 9.7 0 9.7


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)


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Revenue Dividend (RHS)(US$bn) (US$bn)

Macau casinos converted US$35bn of revenue

into US$4bn of FCF and US$3bn of dividends

The research thesis

Macau casinos distributed US$3bn dividend in 2011




China consumer/gaming: key financials (2011)

Sector Industry revenue (US$bn)

Listco revenue (US$bn)

Listco net profit (US$bn)

Listco FCF

(US$bn)

Listco dividend (US$bn)

As % of industry revenue

Listco revenue

Listco net profit

Listco FCF

Listco dividend

Macau gaming 35.0 35.0 3.7 4.2 3.0 100.0 10.5 11.9 8.4

Department stores 35.1 2.1 0.6 0.3 0.2 5.9 1.7 0.8 0.6

Jewellery 39.9 13.2 1.3 (1.0) 0.2 33.1 3.3 (2.5) 0.5

Daily use goods 42.7 3.5 0.5 0.1 0.3 8.2 1.1 0.3 0.6

Apparel (incl sportswear) 128.4 6.5 1.0 0.3 0.4 8.7 1.2 0.4 0.5

Food, beverage and tobacco 159.5 27.7 1.8 (0.8) 0.7 17.4 1.1 (0.5) 0.5

Autos 321.3 96.3 6.5 2.4 1.1 30.0 2.0 0.8 0.3

Supermarket 543.9 14.8 0.3 0.1 0.2 2.7 0.1 - -

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 (%)


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


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.

Trim multiples and earnings estimate

Trading at discount to the consumer sector

Melco Crown (top pick for growth); Wynn Macau

(top pick for yield)




Comp valuation of the six Macau operators

Company Code Ctry Price (lcy)

Target (lcy)

Upside (%)

Rec Mkt cap (US$m)

PE (x) EV/Ebitda (x) CF yield (%) Div yield (%)

2012 2013 2012 2013 2012 2013 2012 2013

Wynn Macau 1128 HK HK 22.6 26.3 16.6 BUY 14,560 18.2 18.3 15.1 12.9 5.2 2.7 4.4 4.4

Melco Crown MPEL US US 15.3 18.7 22.4 BUY 8,451 20.4 18.3 9.7 9.3 10.6 (0.4) - -

Sands China 1928 HK HK 33.4 34.6 3.6 O-PF 34,245 29.2 19.0 19.6 15.4 1.7 3.0 3.4 4.2

SJM 880 HK HK 18.3 22.8 24.5 BUY 12,913 15.2 14.7 12.1 11.3 8.2 7.1 5.3 5.4

MGM China 2282 HK HK 14.2 18.4 29.4 BUY 6,728 11.9 13.6 10.1 10.3 9.2 5.9 5.2 5.9

Galaxy 27 HK HK 29.8 32.1 7.9 O-PF 15,573 17.1 16.6 12.9 11.9 3.7 4.7 - -


Companies mentioned Galaxy (27 - HK$27.90 - BUY) Melco Crown (MPEL - US$14.50 - BUY) MGM China (2282 - HK$13.68 - BUY) Sands China (1928 - HK$29.90 - O-PF) SJM (880 - HK$17.94 - BUY) Wynn Macau (1128 - HK$22.55 - O-PF)


Machinery ChinaOpps


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.

FAI infrastructure YoY growth

Source: FortuneCLSA, NBS

0

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Jan 09 Aug 09 Apr 10 Nov 10 Jul 11 Feb 12 Sep 12

(%)

Yan Yang Analyst, Fortune CLSA [email protected] (86) 21 38784818

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%

Please see important notice on page 198.


Machinery ChinaOpps


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.

Growth projection for different machinery 2011-14

Machine type (%) 11A 12FCL 13FCL 14FCL Concrete machinery 48 18 5-10 5-10

Excavator 8 (36) (10)-(15) 10-15

Wheel loader 10 (28) 0-5 5-10

Mobile crane 0 (35) 15-20 15-20

Heavy duty truck (13) (29) 0-5 0-5

Bulldozer (6) (27) 15-25 15-20

Growth forecast by quarters 2013

Sales volume growth (%) 3Q12 4Q12FCL 1Q13FCL 2Q13FCL 3Q13FCL 4Q13FCL

Concrete machinery (9) (10)-(20) (10)-0 0-10 5-15 10-20

Excavator (31) (20)-(30) (15)-(25) (10)-(20) (5)-5 5-15

Wheel loader (33) (20)-(30) (10)-(20) (5)-5 0-10 10-20

Mobile (truck) crane (22) (20)-(25) (5)-(15) 15-25 25-35 25-35

Heavy duty truck (29) (20)-(25) (10)-(20) (10)-0 5-15 15-25

Bulldozer (6) (5)-5 (10)-0 5-15 15-25 15-25 Source: FortuneCLSA, CCMA

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.

Robust 2Q and 3Q 2013

Machinery market to recover in 2Q13

A rail accident and corruption investigation

slowed sector growth

Base-case assumptions

Excavators to be the weakest

Soft 1Q13


Machinery ChinaOpps


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.

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2012

FCL

2013

FCL

2014

FCL

(%)Excavator sales volume YoY (RHS)(units)

(60)(40)(20)020406080100120140160

010,00020,00030,00040,00050,00060,00070,00080,00090,000

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(%)Excavator sales volume YoY (RHS)(units)

Market pricing in a possible decline in

concrete machinery sales

XCMG to continue losing market share

ASP and gross margin to improve in 2013


Machinery ChinaOpps


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.

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More social housing

As smaller mines shut down, demand took a hit

Replacement demand to decline following

lower operating hours


Machinery ChinaOpps


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


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)

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2008

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(%)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 ChinaOpps


Top players in HDT segment 1H12

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


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.

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Demand for larger mining models to decline

Tough competition and ASP erosion for DFM

Mining to contribute 20% and 40% of volume and

sales revenue to the excavator segment


Machinery ChinaOpps


Top players in excavator segment 1H12

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.

Elevated brand equity

Many Chinese machinery manufacturers ventured

overseas via M&A in 2012

A return in demand for foreign equipment

China machinery makers are looking to

own foreign brands


Machinery ChinaOpps


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.

M&As to also drag down blended margins

Machinery equities underperformed in 2012

We prefer defensive names

A drag on net margins


Machinery ChinaOpps


Figure 1

Valuations

Company Code FCLSA Rec

Mkt cap (US$m)

PE (x) PB (x) 13FCL

ROE (%) 13FCL

Cagr 12-14FCL

12FCL 13FCL

Construction machinery

Weifu High-Tech 000581 CH BUY 2,766 18.9 12.4 2.6 22.7 52

Zoomlion A 000157 CH BUY 9,756 6.9 6.1 1.2 21.4 11

Zoomlion H 1157 HK BUY 9,756 6.7 5.6 1.1 21.4 11

Beiqi Foton 600166 CH O-PF 2,463 5.6 5.5 1.1 21.7 (10)

Sany Heavy Industry 600031 CH O-PF 9,949 9.1 7.8 2.0 28.8 25

Shantui 000680 CH O-PF 715 (756.2) 19.4 1.1 5.2 -

Hualing Xingma 600375 CH SELL 451 11.1 11.1 1.0 8.9 (2)

Lonking 3339 HK SELL 972 8.9 6.9 0.8 11.7 20

Weichai Power A 002338 CH SELL 6,960 14.2 13.8 1.5 10.2 (2)

Weichai Power H 2338 HK SELL 6,960 14.6 13.5 1.4 10.1 (2)

XCMG 000425 CH N-R 3,315 7.5 6.4 1.0 15.8 18

Liugong 000528 CH N-R 1,467 22.5 15.2 0.9 6.2 30

Average

11.5 10.3 1.3 15.3 13

Regional

Caterpillar CAT US N-R 56,233 9.4 9.9 2.5 28.9 4

Doosan Infracore 042670 KS N-R 2,506 9.2 9.3 1.1 12.6 12

Hitachi 6305 JP N-R 3,727 16.1 13.9 1.5 10.9 13

Kawasaki Heavy 7012 JP N-R 3,876 11.1 9.6 0.9 8.8 9

Komatsu 6301 JP N-R 21,903 11.6 11.0 1.5 13.5 6

Average

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 ChinaOpps


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.

Refining back in black in 13CL 14CL


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(US$/bbl) Sinopec PetroChina

Simon Powell [email protected] Head of Oil & Gas Research (852) 26008626

Nelson Wang (852) 26008589

Refining profit back to positive in 2013

Top ideas PetroChina 857 HK Rec BUY Market cap US$249.5bn Target HK$13.41 Up/downside +31% Sinopec 386 HK Rec BUY Market cap US$86.2bn Target HK$9.72 Up/downside +20% Antonoil 3337 HK Rec BUY Market cap US$0.72bn Target HK$2.21 Up/downside -30% Stock to avoid SPC 338 HK Rec SELL Market cap US$4.6bn Target HK$1.97 Up/downside -11%


Oil & Gas ChinaOpps


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


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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

over 2013-15

We expect crude price to soften in the

next two years


Oil & Gas ChinaOpps


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


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.

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(US$/bbl) Sinopec PetroChina

More timely fuel-price adjustments helping

refining profits to improve

Refining profit is improving on QoQ

basis, with profits in 13CL and 14CL

The government’s hawkish approach

to inflation has delayed increases

Demand growth returns in 2013

Key revisions in the fuel-price mechanism

A significant move towards deregulation:

could end large periods of national service and

resultant refining losses


Oil & Gas ChinaOpps


China’s diesel: Apparent demand China’s gasoline: Apparent demand

Source: CEIC

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


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Guidance well-head priceGuidance price of Rmb1.5/m³

from December 2010

Transport cost

Operating cost

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prices

NDRCwill monitor

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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

NDRC will monitor

Burner tip price (resi, C&I ) The price that

end-users pay

Local governments negotiate acceptable

return with piped gas operators

Investors have been waiting for the “trial”

to extend to additional cities and provinces

Gasoline demand is strong versus diesel

New mechanism links gas price to crude price


Oil & Gas ChinaOpps


Major events in China’s gas-pricing reform


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

Source: CEIC, CLSA Asia-Pacific Markets Source: Company, CLSA Asia-Pacific Markets

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

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It will take about two years to roll out the new gas-pricing

mechanism nationally

Losses was due to imported gas


Oil & Gas ChinaOpps


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


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Turkmen imported gas

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(HK$)

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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


Oil & Gas ChinaOpps


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


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.

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PetroChina Sinopec

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PetroChina Sinopec

Service firms benefit from rising per-well capex

Western China and unconventionals require greater service intensity

Offshore will see growth but COSL fairly valued

Sinopec spinoffs in 2013


Oil & Gas ChinaOpps


Consensus global oil & gas valuations Company Code PE

(x) PB (x)

ROE (%)

Div yield (%)

EV/TTM Ebitda (x)

12F 13F 14F 12F 13F 14F 12F 13F 14F 12F 13F 14F 12F 13F 14F Oil majors Exxon Mobil XOM US 10.8 10.8 10.5 2.4 2.1 2.0 24.0 21.1 18.9 2.5 2.7 2.9 4.6 5.0 4.7

Royal Dutch Shell - A RDSA LN 7.9 7.5 7.3 1.1 1.0 0.9 14.8 13.9 13.1 5.3 5.4 5.6 3.9 3.7 3.6

BP BP/ LN 7.1 7.0 6.4 1.1 1.0 0.9 14.3 14.0 14.6 5.0 5.4 5.6 4.1 4.0 3.7

Chevron CVX US 8.2 8.3 8.3 1.5 1.3 1.2 18.6 17.4 15.0 3.5 3.7 3.9 3.4 3.5 3.3

Total - ADR TOT US 6.8 6.8 7.0 1.1 1.0 0.9 16.9 17.5 14.6 6.3 6.4 6.6 - - -

ConocoPhillips COP US 9.6 9.1 8.9 1.2 1.1 1.0 11.9 13.5 11.6 4.9 5.0 5.1 3.7 3.8 3.5

Repsol YPF REP SM 9.9 9.4 8.7 0.7 0.7 0.7 8.1 8.3 8.7 5.3 5.5 5.7 5.4 5.2 4.9

Average 8.6 8.4 8.2 1.3 1.2 1.1 15.5 15.1 13.8 4.7 4.9 5.1 4.2 4.2 4.0 Chinese oil majors

PetroChina - H 857 HK 11.4 10.2 9.2 1.4 1.3 1.2 12.3 12.8 12.9 3.9 4.4 4.7 5.8 5.3 4.9

Sinopec - H 386 HK 9.1 7.4 7.0 1.0 1.0 0.9 12.6 13.8 13.3 3.7 4.3 4.6 5.0 4.4 4.1

CNOOC 883 HK 8.8 8.8 8.8 1.8 1.6 1.4 22.2 19.0 16.6 2.6 2.8 2.8 4.2 4.0 3.9

Average 9.8 8.8 8.3 1.4 1.3 1.2 15.7 15.2 14.2 3.4 3.8 4.0 5.0 4.6 4.3 Emerging market players

Reliance Industries RIL IN 12.2 11.5 11.0 1.4 1.3 1.2 11.9 11.3 11.0 1.2 1.2 1.4 7.9 7.6 6.9

Oil & Natural Gas ONGC IN 9.6 8.9 9.2 1.8 1.6 1.5 19.0 17.5 16.7 3.8 4.1 4.3 4.5 4.3 4.4

Oil India OINL IN 8.3 7.6 7.1 1.4 1.3 1.2 17.7 17.2 17.3 3.9 4.2 4.7 3.3 2.9 2.7

PTT PTT TB 8.4 7.6 7.1 1.4 1.2 1.1 17.8 17.4 16.7 4.2 4.5 4.8 5.8 5.3 4.9

PTT Explor & Prod PTTEP TB 9.7 8.9 8.8 2.1 1.8 1.6 24.2 22.0 19.1 3.9 4.3 4.4 4.8 4.1 3.9

Oil & Gas Development OGDC PA 7.6 6.8 6.0 - - - 33.4 29.2 31.6 4.4 5.9 8.5 4.2 3.8 -

Pakistan Petroleum PPL PA 6.5 6.3 5.8 2.2 1.8 1.7 32.3 26.8 25.9 6.3 6.9 7.4 3.3 3.4 -

Average 8.9 8.3 7.9 1.7 1.5 1.4 22.3 20.2 19.7 4.0 4.5 5.1 4.8 4.5 4.6 E&P players

Apache APA US 7.8 7.5 6.6 0.9 0.8 0.7 11.9 12.9 13.6 0.9 0.9 0.9 3.5 3.2 2.9

Devon Energy DVN US 16.2 11.9 8.8 1.0 0.9 0.8 6.0 8.6 10.9 1.4 1.4 1.3 4.9 4.1 3.6

EOG Resources EOG US 22.3 19.0 13.6 2.2 2.0 1.7 9.8 12.1 14.4 0.6 0.6 0.6 6.1 5.4 4.4

Chesapeake Energy CHK US 32.9 12.1 7.3 0.8 0.7 0.7 1.3 8.0 12.5 1.7 1.6 1.5 10.8 6.9 5.7

Suncor Energy SU CN 9.7 9.5 10.0 1.2 1.0 1.0 12.7 11.7 11.1 1.6 1.8 2.0 4.6 4.4 4.5

Encana ECA CN 20.3 26.3 14.3 2.1 2.1 1.8 6.5 6.5 13.4 3.9 3.9 3.9 10.9 6.0 4.8

Husky Energy HSE CN 13.0 13.5 13.3 1.4 1.3 1.2 10.5 9.6 9.6 4.5 4.5 4.5 5.2 5.2 4.8

Talisman Energy TLM CN 38.3 19.9 14.5 1.1 1.0 1.0 4.6 4.8 6.7 2.5 2.5 2.5 4.0 4.0 3.3

Woodside Petroleum WPL AU 12.6 13.0 12.0 1.8 1.7 1.6 15.0 13.6 13.2 4.0 4.1 4.4 7.8 7.4 6.9

Santos STO AU 17.6 18.1 16.1 1.1 1.1 1.0 6.1 5.9 6.5 2.8 2.8 2.8 6.5 6.0 5.4

Oil Search OSH AU 59.0 55.7 23.6 3.0 2.8 2.6 5.1 5.4 11.9 0.6 0.6 1.0 26.9 25.1 13.1

Cairn India CAIR IN - - - - - - - - - 3.6 3.2 3.0 - - -

Average 22.7 18.8 12.7 1.5 1.4 1.3 8.1 9.0 11.2 2.3 2.3 2.4 8.3 7.1 5.4 Source: Bloomberg

Companies mentioned Antonoil (3337 - HK$3.17 - BUY) CNOOC (883 - HK$16.38 - UNDERPERFORM) COSL (2883 - HK$14.78 - UNDERPERFORM) PetroChina (857 - HK$10.20 - BUY) Shanghai Petrochem (338 - HK$2.22 - SELL) Sinopec (386 - HK$9.72 - BUY)


Power ChinaOpps


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

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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%


Power ChinaOpps


Power consumption, GDP and industrial value added Elasticity of power demand to GDP growth

Weak demand and strong hydro: Thermal negative YTD thermal capacity utilisation is low

Source: National Energy Bureau, CEIC, CLSA Asia-Pacific Markets

Coal-price weakness continues in the winter season Coal inventory at 26 days is close to all-time highs

Source: CCTD, CLSA Asia-Pacific Markets Source: sxcoal.com, CLSA Asia-Pacific Markets

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.

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Mar

07

Jun

07Sep

07

Dec

07

Apr

08

Jul 0

8O

ct 0

8Ja

n-Fe

b 09

May

09

Aug

09

Nov

09

Mar

10

Jun

10Sep

10

Dec

10

Apr

11

Jul 1

1O

ct 1

1Ja

n-Fe

b 12

May

12

Aug

12

(%) Total Thermal

Long-term avg utilisation for thermal plants: 59%

400

500

600

700

800

900

1,000

1,100

Jan 07 Dec 07 Dec 08 Dec 09 Dec 10 Nov 11 Nov 12

Datong premium blend 5,800 kcal/kgShanxi premium blend 5,500 kcal/kgShanxi blend 5,000 kcal/kg

(Rmb/tonne)

0

5

10

15

20

25

30

35

40


National National (excl south)(days)


Power ChinaOpps


CLSA coal-price and cost forecasts

Base case Last 12CL 13CL 14CL

QHD¹ spot (Rmb/t) 640 708 720 740

QHD contract² (Rmb/t) 599 599 629 660

Shanxi coking coal (Rmb/t) 1,170 1,471 1,300 1,382

YoY change (%)

QHD spot (Rmb/t) - (13.3) 1.7 2.8

QHD contract (Rmb/t) - 5.1 5.0 5.0

¹ QHD: Qinghuangdao. ² Reflects price basis for central SOE coal producers, 5,500kcal. Source: CLSA Asia-Pacific Markets

Coal-price scenario

Alternative coal-price case 13CL 14CL

QHD spot (Rmb/t) 670 700

QHD contract (Rmb/t) 615 630

Note: No changes to metallurgical coal-price forecasts. Source: CLSA Asia-Pacific Markets

Our forecast of QHD 5,500kcal thermal-coal price Our estimates for 2013 earnings growth for China IPPs

Our 2013 earnings rel to consensus for China IPPs Proportion of IPPs losing money in China


580

600

620

640

660

680

700

720

740

760

780

800

2011 1H12 2H12CL 1H13CL 2H13CL

(Rmb/tonne)

0

20

40

60

80

100

120

140

CPI CR Power Datang Huadian Huaneng

(% YoY)

(10)

(5)

0

5

10

15

20

25

30

Datang CPI Huaneng CR Power Huadian

(%)

30

35

40

45

50

55

Dec 10 Mar 11 Jun 11 Sep 11 Jan 12 Apr 12 Jul 12

(%)

Most likely coal prices in 2013-14

Downside risk to our near-term coal forecasts,

as demand continues to lag expectations


Power ChinaOpps


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

Source: Chinamoney, Companies, CLSA Asia-Pacific Markets Source: Companies, CLSA Asia-Pacific Markets

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

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50

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70

1990

1991

1992

1993

1994

1995

1996

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1999

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2001

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2003

2004

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2007

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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

May not translate into new construction activity

Capacity addition of power equipment

stays weak


Power ChinaOpps


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

Gross margin (%) 2008 2009 2010 2011 12CL 13CL 14CL

Dongfang Electric 15.90 17.10 19.60 20.30 19.33 17.88 17.31

Shanghai Electric 17.00 15.40 16.30 17.90 18.83 17.63 17.03

Harbin Electric 13.40 12.80 14.40 20.00 21.58 19.53 18.43

Change gross margin (bps)

Dongfang Electric 1,590 120 250 70 (97) (146) (57)

Shanghai Electric 1,700 (160) 90 160 92 (120) (60)

Harbin Electric 1,340 (61) 160 560 157 (206) (110)


Earnings sensitivity to 1ppt change in gross margins

(%) 2013 2014

Dongfang Electric 16.5 19.3

Shanghai Electric 15.3 17.2

Harbin Electric 24.9 31.3


0.0

0.5

1.0

1.5

2.0

2.5

3.0

2007 2008 2009 2010 2011 12CL 13CL

Dongfang Electric Shanghai Electric Harbin Power(x)

We expect ratio of new orders to revenue to fall

to close to 1x in 2012-13

AP1000 reactors can still start construction

CPR1000 reactor may need redesign to meet new norms

We forecast 2-3ppt decline in gross margins

over next three years

A 1ppt change in gross margins can move earnings 17-31%


Power ChinaOpps


Gross margins


Hong Kong utilities - Returns under attack CLP’s proposal for 2012 tariffs and subsequent changes

(HK¢/kWh) 2011 2012

First proposal

% change

Second proposal

% change

Final proposal

% change

Average basic tariff 80.0 85.0 6.3 85.0 6.3 84.2 5.3

Fuel-clause surcharge 14.1 17.8 26.2 16.1 14.2 17.8 26.2

Rents and rates special rebates 0.0 0.0 0.0 (3.3)

Total 94.1 102.8 9.2 101.1 7.4 98.7 4.9

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(%)

80

90

100

110

120

130

140

150

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

(HK¢/kWh)

(5)

0

5

10

15

20

25

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Electricity tariff with rebates

Electricity tariff without rebates

(%)

Gross margins could fall more than our forecasts

Utilities in the USA are typically allowed

an ROE of 10-11%


Power ChinaOpps


Allowed ROE for utilities in the USA

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


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

Hong Kong’s utilities

Average allowed ROE in USA was about

10.5% in 2009-10


Power ChinaOpps


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


0

10,000

20,000

30,000

40,000

50,000

60,000

09A 10A 11A 12CL 13CL

(MW)

Second tier (30% discount)First-tier poly supply (minus semi demand)Base-case demandBull-case demand

1.27x

avg1.66x

2.34x

max3.02x

3

4

6

10

15

min0.89x

Nov 09 Nov 10 Nov 11 Nov 12 Nov 13

(log)

Outlook for Chinese renewables is very similar

to this time last year

Share-placement expectation a drag on

share price, but we remain BUYers for

sound fundamentals

Oversupply has driven a 48% decline in

polysilicon prices YTD


Power ChinaOpps


Valuations Stock Code Price Mkt cap

(US$m) 3M-

ADTO (US$m)

PE EV/Ebitda PB ROAE 12CL

Div yield 11A

Net gearing

11A

Target price

Rec TP upside

(%) 11A 12CL 13CL 11A 12CL 11A 12CL

China China Power 2380 HK 2.1 1,504 1.6 17.4 7.5 6.2 9.2 6.5 0.7 0.6 9.4 2.6 247.0 2.5 BUY 18.4 CR Power 836 HK 17.2 10,514 12.7 18.1 12.9 8.3 11.3 8.8 1.7 1.6 11.5 1.9 129.5 23.0 BUY 33.7 Datang Power 991 HK 2.7 7,619 3.8 14.8 10.5 7.4 10.5 9.1 0.8 0.7 9.8 3.2 316.7 2.8 U-PF 2.9 Huadian Power 1071 HK 2.4 3,925 2.5 180.5 14.0 6.1 10.7 7.2 0.8 0.8 6.2 - 430.0 2.3 O-PF (3.0) Huaneng Power 902 HK 6.4 14,021 14.3 63.2 11.9 7.8 11.1 7.8 1.5 1.3 11.6 0.9 266.2 6.7 O-PF 4.9 Longyuan Power 916 HK 5.1 4,672 4.6 12.0 12.2 10.5 9.7 8.5 1.2 1.1 11.5 1.6 147.4 6.6 BUY 28.5 Datang Renewable 1798 HK 0.9 762 1.0 7.0 9.5 9.6 10.2 11.1 0.6 0.5 5.5 - 264.3 0.6 SELL (27.6) HN Renewables 958 HK 1.2 1,234 1.3 7.1 6.7 7.0 7.5 8.3 0.6 0.7 9.9 - 152.1 0.9 U-PF (23.2) CR Gas 1193 HK 16.6 4,528 4.8 25.3 20.4 16.6 12.3 12.0 3.8 3.8 17.3 0.8 (1.8) 20.0 BUY 20.2 ENN Energy 2688 HK 33.8 4,774 6.3 23.5 20.0 16.1 12.4 10.2 3.9 3.4 20.7 1.3 82.8 35.0 O-PF 3.6 Hong Kong CLP 2 HK 67.6 20,819 20.8 17.5 17.7 14.2 9.3 8.9 2.0 1.9 11.1 3.7 75.8 60.0 SELL (11.2) Power Assets 6 HK 68.5 18,811 24.4 16.1 15.0 14.6 na na 2.5 2.3 16.2 3.4 33.0 54.0 SELL (21.2) Cheung Kong Infra 1038 HK 46.8 14,912 15.1 13.8 12.2 11.7 na na 2.1 1.9 16.4 3.3 31.7 41.0 SELL (12.3)

Stock Code Price Mkt cap

(US$m) 3M-

ADTO (US$m)

PE EV/Ebitda PB ROAE 12CL

Div yield 12CL

Net gearing

12CL

Target price

Rec TP upside

(%) 11A 12CL 13CL 11A 12CL 11A 12CL

Power equipment suppliers Dongfang 1072 HK 13.0 3,876 9.8 7.1 7.9 9.7 3.9 4.7 1.6 1.3 17.5 1.5 (27.0) 10.5 SELL (19.4) Harbin Electric 1133 HK 6.4 1,153 3.3 5.9 6.0 8.9 0.4 2.1 0.7 0.6 10.5 2.9 (52.9) 5.0 SELL (21.5) Shanghai Electric 2727 HK 3.1 7,424 10.2 9.9 9.0 10.3 4.3 4.1 1.1 1.0 12.1 3.3 (44.4) 2.7 SELL (11.5) ABB India ABB IB 704.5 2,699 0.8 80.9 55.2 42.3 51.3 36.1 5.9 5.5 10.3 0.3 (10.4) 600.0 SELL (14.8) BHEL BHEL IB 224.0 9,884 22.7 7.8 8.1 10.4 5.1 5.7 2.2 2.2 24.3 2.9 (25.6) 210.0 SELL (6.3) Larsen & Toubro LT IB 1,620 17,540 49.7 21.1 20.1 17.8 14.1 14.1 3.4 3.4 15.1 1.1 117.4 1,665 U-PF 2.8 Crompton Greaves CRG IB 116.3 1,321 7.0 19.9 25.8 14.3 8.8 12.4 2.1 2.1 7.7 1.4 15.0 100.0 SELL (14.0) Thermax TMX IB 570.6 1,200 0.5 16.8 20.4 18.3 9.9 11.5 4.2 4.2 18.0 1.2 (24.6) 525.0 SELL (8.0) MHI 7011 JP 372.0 14,967 64.0 51.1 20.6 17.0 7.2 5.7 1.0 1.0 4.6 1.6 68.5 410.0 BUY 10.2 Doosan Heavy 034020 KS 41,750 4,166 - - - - - - - - - - - - - (100.0) Renewables & energy efficiency Suntech Power STP US 0.9 148 1.4 (0.2) (0.4) (0.8) (4.3) (17.8) 0.2 0.3 (57.1) - 187.4 0.6 SELL (32.5) Trina Solar TSL US 2.8 199 5.9 (5.2) (0.9) (2.5) 2.3 (3.1) 0.2 0.2 (21.7) - 1.2 3.1 SELL 9.4 GCL-Poly 3800 HK 1.3 2,676 34.8 4.8 (31.5) NM 4.7 14.9 0.9 0.9 (2.1) - 82.9 1.1 SELL (14.1) Suzlon SUEL IB 17.1 486 4.2 18.7 7.1 5.2 6.2 4.6 0.5 0.5 6.5 - 129.8 19.0 SELL 11.4 Everbright Intl 257 HK 3.7 2,058 8.5 15.3 12.3 11.7 8.2 7.2 2.2 1.9 15.9 0.4 53.0 4.8 O-PF 31.5 Daikin 6367 JP 2,581 9,306 119.4 18.3 19.7 16.8 7.4 8.5 1.5 1.5 8.0 1.4 48.5 2,500 O-PF (3.1) THK 6481 JP 1,413 2,372 43.2 14.4 37.7 39.2 4.1 5.7 1.0 1.0 2.7 0.6 (30.0) 1,250 U-PF (11.5) Komatsu 6301 JP 1,826 22,119 300.1 10.4 11.1 14.4 5.8 5.4 1.7 1.7 14.9 2.6 53.4 1,850 U-PF 1.3 Fanuc 6954 JP 13,950 40,867 361.7 19.7 19.8 20.8 9.5 9.7 3.4 3.4 13.5 1.6 (61.6) 16,600 BUY 19.0 Keyence 6861 JP 22,600 16,266 66.2 21.5 20.9 20.6 7.1 7.5 1.9 1.9 9.3 0.3 (58.2) 23,600 U-PF 4.4 Yaskawa Electric 6506 JP 670.0 2,042 44.6 19.9 21.2 17.8 8.8 8.7 1.5 1.5 7.8 1.5 72.1 750.0 O-PF 11.9


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 ChinaOpps


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%








Property ChinaOpps


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


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

2Q11 avg:16,530

1Q11 avg:18,772

3Q11 avg:17,536

4Q11 avg:14,937

YTD12 avg: 23,075

1Q12 avg:13,939

2Q12 avg:24,738

3Q12 :27,660

4Q12:27,277

(No. of transactions)

The market is warming

Upbeat about 2013

Growing off a high base

Volume has hold up well


Property ChinaOpps


Sales recovery spreading to third-tier cities Nationwide 1st tier 2nd tier 3rd tier ('000m²) YoY chg (%) ('000m²) YoY chg (%) ('000m²) YoY chg (%) ('000m²) YoY chg (%) 1Q10 138,619 9,314 37,120 92,185 2Q10 216,347 9,947 59,283 147,118 3Q10 212,627 10,182 61,443 141,002 4Q10 362,922 14,679 94,595 253,649 1Q11 158,495 14.3 8,173 (12.2) 45,038 21.3 105,284 14.2 2Q11 239,551 10.7 9,153 (8.0) 61,559 3.8 168,839 14.8 3Q11 237,990 11.9 9,763 (4.1) 62,713 2.1 165,514 17.4 4Q11 334,267 (7.9) 13,099 (10.8) 90,587 (4.2) 230,581 (9.1) 1Q12 133,868 (15.5) 6,632 (18.9) 39,124 (13.1) 88,113 (16.3) 2Q12 219,601 (8.3) 11,371 24.2 64,429 4.7 143,802 (14.8) 3Q12 255,375 7.3 12,412 27.1 73,812 17.7 169,151 2.2 Source: CREIS, CLSA Asia-Pacific Markets

Combined inventory level of 11 cities

Note: Includes 11 cities that reports inventory monthly: Beijing, Shanghai, Shenzhen, Nanjing, Wuhan, Suzhou, Xiamen, Fuzhou, Qingdao, Nanchang, Huizhou). Source: CREIS, CLSA Asia-Pacific Markets

Beijing inventory Shanghai inventory

Shenzhen inventory Xiamen inventory

Source: CRR

300,000

350,000

400,000

450,000

500,000

550,000

600,000

650,000

700,000

750,000

Jan 10 Jun 10 Dec 10 May 11 Oct 11 Apr 12 Sep 12

(No. of units)

0

10

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30

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50

Feb

08

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08

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08

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09

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09

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09

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10

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(month)

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2

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07

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08

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Inventory stabilising

Inventory in individual cities; Beijing and

Shanghai . . .

. . . Shenzhen and Xiamen all showing

the same trend


Property ChinaOpps


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


Nationwide sale by GFA Nationwide resi GFA construction start


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)

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Outlook for 2013

Few investors in the market












Resources ChinaOpps


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


70

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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%


Resources ChinaOpps


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

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SouthGobiMMC

Yanzhou CoalG-Resources

HidiliChina Coal

ShenhuaRusal

ChalcoFushan

ZijinZhaojin

MSCI ChinaJiangxi Copper

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CLSA China mining coverage

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ChalcoRusal

China CoalFushan

Yanzhou CoalZijin

Jiangxi CopperShenhuaZhaojin

G-Resources

(%)

Miners underperformed from March through

September

An ongoing earnings- downgrade cycle

Expectations rebased substantially lower

Copper and gold perform better, coal derates


Resources ChinaOpps


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.

Earnings-based valuations remain

reasonable

We like Shenhua, Fushan and Zhaojin

Favour the defensively positioned companies

Wide margins and strong balance sheets

have become key investment attributes


Resources ChinaOpps


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.

Figure 1

Commodity price forecasts Commodity (Rmb/t) Spot 12CL 13CL 14CL 15CL SHFE aluminium 15,385 16,831 15,939 16,418 16,530 SHFE copper 56,330 66,017 58,332 63,458 60,920 Gold (US$/oz) 1,723 1,572 1,684 1,850 2,000 FOB QHD spot, 5,500Kcal 635 817 710 720 740 FOB QHD contract - 570 599 629 660 Shanxi raw coking coal 1,260 1,666 1,465 1,300 1,382 YoY change (%) SHFE aluminium - 4.7 (5.3) 3.0 0.7 SHFE copper - 11.5 (11.6) 8.8 (4.0) Gold - 28.2 7.2 9.9 8.1 FOB QHD spot, 5,500Kcal - 9.6 (13.2) 1.5 2.8 FOB QHD contract - 0.0 5.1 5.0 5.0 Shanxi raw coking coal - 12.6 (12.1) (11.2) 6.3 Source: Bloomberg, CLSA Asia-Pacific Markets

Figure 2

Ebitda margins, gearing and yields (%) Code Ebitda margin Net debt/equity Dividend yld

Coal 12CL 13CL 12CL 13CL China Coal 1898 HK 20.0 20.3 20.1 2.8 Hidili Industry 1393 HK 45.6 40.7 70.2 1.6 MMC 975 HK 24.6 32.6 76.6 0.0 Shenhua Energy 1088 HK 37.7 38.7 (5.0) 3.8 Shougang Fushan¹ 639 HK 53.0 43.2 (27.4) 3.1 SouthGobi 1878 HK (111.5) 15.0 14.9 0.0 Yanzhou Coal 1171 HK 15.8 15.7 46.9 2.0 Metals 2.6 5.7 165.9 0.0 Chalco 2600 HK 0.0 84.5 2.1 0.0 G-Resources 1051 HK 5.8 6.7 0.3 4.1 Jiangxi Copper 358 HK 8.5 10.7 116.6 0.0 RUSAL1 486 HK 48.2 48.8 26.8 1.7 Zhaojin Mining 1818 HK 19.7 21.5 15.8 2.8 Zijin Mining 2899 HK 20.0 20.3 20.1 2.8 ¹ Excludes listed securities. Source: IBES, CLSA Asia-Pacific Markets

Figure 3

Big-three coal producers Ebit

Note: Group Ebit/self-produced coal volumes. Source: Companies, CLSA Asia-Pacific Markets

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Expect some recovery in commodity prices

Fushan and Shenhua among the highest-

margin coal producers, with Yanzhou the lowest; Zhaojin among the most profitable metals names

Shenhua the margin leader, Yanzhou

Coal a laggard


Resources ChinaOpps


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


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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


Resources ChinaOpps


Yanzhou Coal unit mine-production cost

Note: Shandong HQ mines. Source: Company, CLSA Asia-Pacific Markets

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

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. . . 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 . . .


Resources ChinaOpps


CL/consensus EPS

(%) Code 12CL 13CL 14CL

Coal

China Coal 1898 HK 100.8 103.3 95.2

Hidili Industry 1393 HK 71.6 80.4 95.2

MMC 975 HK 90.2 77.4 105.2

Shenhua Energy 1088 HK 101.5 96.4 89.2

Shougang Fushan 639 HK 85.1 66.3 76.1

SouthGobi 1878 HK - 77.3 73.9

Yanzhou Coal 1171 HK 79.0 86.2 91.9

Metals

Chalco 2600 HK 116.0 92.8 77.0

G-Resources 1051 HK - 19.4 117.2

Jiangxi Copper 358 HK 96.8 104.6 107.4

RUSAL 486 HK 100.8 90.0 84.0

Zhaojin Mining 1818 HK 98.7 84.4 82.8

Zijin Mining 2899 HK 94.4 111.0 104.5

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)

We are mostly below consensus earnings

expectations

Upside and downside scenarios
















Steel ChinaOpps


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.

Steel price

Source: Antaike, CLSA Asia-Pacific Markets

3,500

4,000

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5,000

5,500

6,000

Jan 10 Jun 10 Dec 10 Jun 11 Nov 11 May 12 Oct 12

Overall Wire & rod Rebar HRC(Rmb/tonne)

Scott Laprise [email protected] (86) 1059652126

Will Chen, CFA (86) 2120205920

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%

Down 30% this year to September and has

rebounded by 20% since


Steel ChinaOpps


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.

High crude-steel output

Negative net margin

Sector gearing at new high

Source: NBS, CISA, CEIC, CLSA Asia-Pacific Markets

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.

1.21.31.41.51.61.71.81.92.02.1

Feb 09 Apr 10 Jun 11 Sep 12

Daily output by NBSDaily output by CISA

(m tonnes)

(4)(3)(2)(1)012345678

Jan 10 Nov 10 Oct 11 Aug 12

(%)

1.41.51.61.71.81.92.02.12.22.3

Jan 10 Nov 10 Oct 11 Aug 12

(%)

8,000

10,000

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Mar 10 Aug 10 Jan 11 Jun 11 Nov 11 Apr 12 Sep 12

Key mills' inventory (CEIC)Traders' inventory (Mysteel)

('000 tonnes)

The sector bottomed in 2012

Traders’ inventory is down 36% since February


Steel ChinaOpps


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

Source: Mysteel, CLSA Asia-Pacific Markets

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SOE mills’ cash profit continue to improve in 4Q12

Manufacturers finally starting to restock

Steel mills have turned more positive

on 2013 outlook


Steel ChinaOpps


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

Source: companies, CLSA Asia-Pacific Markets,

Long-steel cash cost HRC cash cost Spot price, Sep 2012 Cost (US$/t) Conversion US$ Rmb Iron ore 127 1.6 203 1,275 Coke 207 0.6 124 777 Scrap 399 0.1 40 250 Alloy 1,755 0.01 18 110 Energy & other materials 50 313 Overhead (labour+R&D+others) 45 282 Overall conversion cost to HRC 0 0 Total domestic cash cost 480 3,007 Price vs

current cost Spot long steel price 510 3,197 cash profit/loss 30 190

Spot price, Sep 2012 Cost (US$/t) Conversion US$ Rmb Iron ore 127 1.6 203 1,275 Coke 207 0.6 124 777 Scrap 399 0.1 40 250 Alloy 1,755 0.01 18 110 Energy & other materials 50 313 Overhead (labour+R&D+others) 45 282 Overall conversion cost to HRC 10 63 Total domestic cash cost 490 3,070 Price vs

current cost Spot HRC price 528 3,309 cash profit/loss 38 238

Source: Mysteel, CLSA Asia-Pacific Markets

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.

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Cash profit from long steel and HRC is down


Steel ChinaOpps


CLSA commodity-price forecasts 4Q12CL 1Q13CL 2Q13CL 3Q13CL 4Q13CL 1Q14CL 2Q14CL 3Q14CL 4Q14CL

Coking coal benchmark 170 185 195 190 190 200 200 200 200

Shanxi Liulin Clean coking coal (Inclu. VAT) 1,250 1,300 1,300 1,300 1,300 1,403 1,389 1,375 1,361

Iron ore fines spot (62%fe CFR China) 120 125 110 105 100 95 85 80 80

Iron ore fines Benchmark (62% CFR China) 120 125 130 105 100 95 85 80 80

Iron ore lumps benchmark (62% CFR China) 132 138 143 116 110 105 94 88 88


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

Area sold 53 10 5 (4) (2) (7) (14) (13) (13) (9) (3) 13 13 (4) - Residential sold 54 8 4 (4) (3) (8) (16) (15) (13) (9) (5) 14 13 (2)

- Office sold 36 24 7 3 (18) (6) (9) 36 (24) 11 19 42 (3) (28) - Commercial sold 36 33 14 0 13 4 11 1 (5) (13) 13 (5) 15 (16)

Area started 18 42 16 (9) 9 (19) 5 (4) (15) (5) (16) (27) 14 (24) - Residential started 16 40 13 (13) 3 (25) 0 (10) (14) (9) (19) (30) 5 (28)

- Office started 23 31 46 6 66 11 7 38 (21) 24 (32) 8 53 (15) - Commercial started 33 41 18 6 25 (10) 32 20 (19) 5 (4) (26) 47 (5) Area completed 24 5 17 16 47 9 45 32 3 11 0 9 29 (6) - Residential completed 25 3 17 17 46 9 48 31 1 13 2 7 30 (6) - Office completed (3) 9 25 (7) 105 0 (24) 34 (1) (7) (45) 53 8 (41)

- Commercial completed 19 22 14 17 42 1 48 45 2 14 (2) 11 16 (8) 10% FAI infrastructure 48 20 2 5 (2) (14) (10) (4) (9) (2) 10 14 5 32

- Railway 68 13 (23) (12) 41 (31) (44) (37) (47) (35) (18) (6) 40 77 - Highway 40 21 10 4 5 (9) (9) 2 (2) (5) 9 13 (3) 19

- Water transport 38 24 (1) 10 (11) (22) 96 (29) 10 41 9 27 (32) (2) - Airport transport 3 46 0 15 (74) (14) 15 (43) (31) (7) 110 22 3 42

6% Auto 48 32 3 7 (1) (7) (2) 5 11 19 14 12 8 6 - Sedans 47 29 6 8 (1) (6) (3) 3 15 23 8 12 11 10

5% Shipping 40 48 25 (13) (19) 51 5 (19) (2) 6 31 (37) (29) (34) 4% White goods

- Refrigerator 19 27 20 (5) 28 33 10 1 2 0 2 (6) (1) 8

- Air conditioner (4) 42 25 0 (1) 5 (5) (4) 8 3 (6) (18) 2 14 - Washing machines 13 27 12 1 (9) (2) (6) (1) (6) 3 4 7 (6) 25

1% Container (72) 220 28 2 (36) (17) (46) (5) 2 2 43 56 51 (16) 34% Machinery (17%) Others (17%)

- Harvest machinery 55 10 50 12 4 10 15 (2) 18 17 30 6 21 27 - Metal-cutting machinery (14) 33 15 (17) (2) (11) (12) (4) (16) (24) (18) (34) (32) (13)

- Mining machinery 5 19 23 27 6 34 (33) 45 30 27 19 29 26 18 - Construction machinery 1 57 14 (28) (10) (16) (28) (16) (33) (41) (33) (13) (36) (33) - Power-gen machinery (12) 8 14 (11) 15 3 (21) (15) (12) 18 (2) (25) (12) (14)


Accelerating railway investment


Steel ChinaOpps


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.


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.

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(m tonnes)

13CL Crude Steel output at 750mt

We forecast 750m tonnes for 2013

Magang - O-PF

Angang - SELL

With the macro economy recovering, downstream

demand will pick up


Steel ChinaOpps


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.

H-share performances

Source: Wind, CLSA Asia-Pacific Markets

Companies mentioned Magang (347 – HK$2.10 – OUTPERFORM) Angang (323 – HK$4.19 – SELL) Shougang (697 – HK$0.57 – BUY)

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Shougang - BUY

Up 30% since September


Technology ChinaOpps


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

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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).

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A tough year

Decline in 3Q12 likely short-lived

EM PC demand rebounded sharply in 2010 as macro

trends recovered

PC growth in China has slowed

significantly this year

Emerging markets leading PC growth




China’s enterprise and consumer PC growth since 2009 YoY (%) 2008 2009 2010 2011 1-9M 2012 Enterprise PCs 22 31 22 9 (6) Consumer PCs 16 34 18 12 11 Total PCs 19 32 20 11 1 Source: Gartner, CLSA Asia-Pacific Markets

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

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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

PC penetration in EMs still low

Lenovo securing over 30% market share at

the expense of HP




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.

Smartphone shipment by price tiers

Source: Strategy Analytics, CLSA Asia-Pacific Markets

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

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Explosive growth in smartphone demand

Chinese brands Huawei, ZTE, Lenovo to double

shipments to 2014

Entry-level smartphones from non-existence

in 2011 to 30% share in 2014CL

By 2014, whitebox to represent 45% of Chinese

smartphone shipments




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.

Smartphones by price tier, 2Q12


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


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Rapid increase in the number of “unbranded”

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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

smartphones




China handset whitebox shipments China handset shipment mix


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.

Smartphone penetration by region


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China and Eastern Europe are fastest growing among EM regions




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%.

AAC has fared better than upcoming rival GoerTek

Asia accounted for 100% of Lenovo’s shipments

Losing ground to Huawei and Lenovo




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.

Companies mentioned AAC (2018 - HK$29.00 - OUTPERFORM) ASM Pacific (522 - HK$88.10 - BUY) Lenovo (992 - HK$6.97 - OUTPERFORM) WPG (3702 - NT$35.9 - BUY) ZTE (763 - HK$11.20 - SELL)

Hundreds of components undergoing field trials

Smartphones are ZTE’s 2H12 and

2013 revenue driver


Telecoms ChinaOpps


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


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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%


Telecoms ChinaOpps


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


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

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(26)(30)(25)(20)(15)(10)(5)05

101520

1M 3M 6M YTD

(%)

China Mobile China Telecom China Unicom

China Mobile outperformed MSCI

China by 7% YTD

China Telecom has been pressured by iPhone

subsidies concern

Unicom was the worst performer

China 3G user growth could surprise

New-generation low-cost smartphones has

4.7” screen and 1.5GHz processor

TD-SCDMA models have caught up with peers

China will continue to add about 10m new

3G users per month


Telecoms ChinaOpps


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


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.

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2010 2011 12CL 13CL 14CL

(m) CM CU CT

Competition could ease as Unicom has to focus

on profitability

Unicom has reduced subsidies and new pricing

plans are not effective


Telecoms ChinaOpps


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

Minister of MIIT now expects 4G

licensing in 2013

Small operators also want a 4G licence

Softbank is a big supporter of TD-LTE


Telecoms ChinaOpps


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 Mobile can regrow its dominance with 4G

Chinese telcos’ earnings should improve in 2013


Telecoms ChinaOpps


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


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


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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


Telecoms ChinaOpps


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


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).

Blended Arpu (2G + 3G) Blended Arpu (2G+ 3G) growth


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China Mobile’s Arpu will continue to decline,

but at a slower pace


Telecoms ChinaOpps


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


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China Mobile’s subsidies may increase by 19% YoY

to Rmb31bn in 2013

China Telecom’s iPhone subsidies

could rise in 2013

China Telecom’s mobile Arpu could expand

Unicom’s 3G Arpu decline could be fast


Telecoms ChinaOpps


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


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.

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Margin contraction due to upfront handset

subsidy expenses

Unicom’s margin improvement

could be gradual

Total capex for Chinese telcos could be flat at

Rmb329bn for 2013

Capex of Chinese telcos should stay high

with 4G deployment

iPhone subsidies will pressure margin

Unicom likely to remain cautious with subsidy


Telecoms ChinaOpps


Capex (Rmbbn) 2010 2011 12E 13E 12E

YoY (%) 13E

YoY (%)

China Mobile

Total capex (listco & parentco) 147 153 156 172 2.2 10.3

Transmission/others (listco) 70 55 78 78 40.8 0.0

Mobile (listco) 55 73 54 54 (26.2) 0.0

3G TD-SCDMA (parentco) 23 24 20 20 (16.7) 0.0

4G TD-LTE (parentco) 4 20

China Unicom

Total capex (listco) 70 77 100 84 30.4 (16.3)

Fixed-line/Transmission/others (listco) 47 51 61 53 21.0 (14.0)

2G GSM (listco) 8 5 3 3 (30.4) (20.0)

3G WCDMA (listco) 16 21 36 28 66.0 (20.0)

China Telecom

Total capex (listco & parentco) 67 72 73 73 2.0 0.0

Fixed-line (listco) 40 50 54 54 9.0 0.0

2G CDMA (parentco) 7 2 0 0

3G CDMA EV-DO (parentco) 20 20 19 19 (4.0) 0.0

Total (Rmbbn) 285 301 329 329 9.4 (0.1)

Total (US$bn) 42 44 48 48

Source: Companies

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.

Chinese telecom valuations PE

(x) EV/

Ebitda (x) PB (x)

Yield (%)

FCFe yield (%)

ROIC (%)

ROE (%)

13CL 14CL 15CL 16CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 13CL

CM 11.2 10.7 10.3 9.8 4.1 3.7 1.8 1.7 3.8 4.0 7.7 8.2 30.6 17.0

CU 20.4 13.9 11.4 9.8 4.2 3.6 1.1 1.0 1.4 2.0 0.2 4.9 3.5 5.3

CT 15.7 12.8 10.7 9.3 3.7 3.3 1.0 1.0 2.1 2.5 6.4 5.3 5.0 5.7

Service rev growth (%)

Ebitda growth (%)

Ebitda margin (%)

Ebit growth (%)

Ebit margin (%)

Net profit growth (%)

Net margin (%)

13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL 13CL 14CL

CM 7 7 2 5 43 42 (0) 2 24 23 2 5 22 21

CU 13 10 16 14 30 31 50 37 6 8 64 46 4 5

CT 12 9 3 10 31 31 32 19 9 10 21 22 6 6


China Mobile may increase its 4G

capex, but Unicom may scale back

China Mobile remains our long-term pick

We also like China Telecom


Telecoms ChinaOpps


Asian telecom valuations Rec Price Target PE (x) EPS 3Y (%) EV/Ebitda (x) FCF/EV (%) Yield (%)

Curr 29 Nov 12 price 12CL 13CL (2013-15) 12CL 13CL 12CL 13CL 12CL 13CL

Integrated

China Telecom BUY HK$ 4.19 5.50 18.1 13.9 24.8 6.2 4.2 2.8 3.8 2.1 1.8

Telkom BUY Rp 9,250 9,150 12.5 12.2 (2.1) 3.9 3.7 9.6 9.9 4.8 5.0

KT O-PF won 37,350 37,000 8.6 10.5 2.4 3.2 3.1 5.7 8.1 5.4 5.4

PLDT O-PF P 2,586 2,950 14.0 14.2 5.9 7.7 7.2 4.5 5.3 6.7 6.2

Telstra O-PF A$ 4.31 4.61 15.2 14.4 6.0 7.3 7.1 6.0 4.2 6.5 6.1

China Unicom U-PF HK$ 12.02 13.00 33.4 20.4 41.3 4.6 4.0 (7.2) (0.8) 1.0 1.3

Chunghwa Telecom U-PF NT$ 93.80 91.66 17.5 17.7 (1.1) 7.5 7.7 6.5 3.7 5.1 5.8

Tata U-PF Rs 235.85 250.00 39.2 34.5 6.8 7.3 6.8 1.5 2.6 1.1 1.0

Telekom Malaysia U-PF RM 5.51 5.92 17.2 22.6 (19.6) 6.6 6.1 3.6 4.6 3.8 3.7

MTNL SELL Rs 25.55 21.00 (0.4) (0.4) na (5.5) (6.8) (21.1) (17.3) 0.0 0.0

Singtel SELL S$ 3.27 2.97 14.0 13.2 5.3 11.4 11.4 3.9 4.0 4.9 5.4

HTHK N-R HK$ 3.38 na 13.7 12.2 8.5 6.7 6.2 7.7 8.9 5.5 6.2

PCCW N-R HK$ 3.22 na 12.8 12.2 6.6 5.5 5.3 10.8 11.5 5.3 5.4

Weighted average 18.2 15.2 11.1 6.9 6.4 3.3 4.0 4.2 4.2

Wireless

AIS BUY Bt 209.00 265.00 17.5 15.5 14.6 9.2 8.4 7.6 2.1 5.7 6.5

Far EasTone BUY NT$ 72.00 79.67 20.7 16.8 19.1 7.9 7.1 6.9 7.6 4.8 6.1

Taiwan Mobile BUY NT$ 104.50 118.29 18.5 15.1 18.4 12.4 11.0 3.9 5.1 4.9 6.5

Axiata O-PF RM 5.91 6.73 18.0 17.0 4.7 6.7 6.4 4.3 5.3 4.1 5.4

China Mobile O-PF HK$ 88.35 100.00 11.6 11.2 4.2 4.5 4.2 7.2 8.4 3.7 3.8

Digi O-PF RM 4.84 5.15 28.2 22.6 20.1 11.2 10.9 5.8 6.0 6.3 6.9

Excelcomindo O-PF Rp 5,900 5,253 14.7 13.3 12.3 5.3 4.6 3.3 6.1 0.0 0.0

LG U+ O-PF won 7,440 7,500 (62.4) 9.7 (310.0) 7.0 4.7 5.9 3.1 2.0 2.7

MobileOne O-PF S$ 2.71 2.82 16.5 14.9 8.7 8.6 7.8 5.8 6.7 4.9 5.4

SK Telecom O-PF won 148,000 150,000 11.8 7.4 15.1 5.0 4.0 1.5 8.7 6.4 6.4

Bharti Airtel U-PF Rs 330.35 300.00 33.3 21.4 44.8 6.6 5.5 3.2 6.0 0.4 0.4

Globe Telecom U-PF P 1,125 1,200 13.4 13.6 1.1 5.7 5.7 0.5 2.4 5.4 6.7

Maxis U-PF RM 6.45 6.68 23.4 24.1 (2.3) 11.5 11.6 5.5 5.5 6.2 6.2

Starhub U-PF S$ 3.67 3.71 18.5 18.0 (1.2) 9.0 8.5 6.4 7.0 5.4 5.4

Idea Cellular SELL Rs 99.45 78.00 35.9 31.5 11.4 7.0 6.1 3.1 5.1 0.0 0.0

Indosat SELL Rp 6,300 4,900 21.4 18.4 14.8 4.5 4.0 10.2 12.5 2.6 3.0

Reliance Comm SELL Rs 69.50 54.00 15.8 14.6 7.1 7.4 6.8 (4.4) 8.9 0.0 0.0

Smartone N-R HK$ 14.40 na 13.9 13.2 15.1 4.1 3.8 12.9 17.5 7.2 7.6

TAC N-R bt 86.00 na 17.6 16.8 (0.7) 7.8 7.2 9.0 10.0 5.3 5.6

Weighted average 14.9 13.9 8.2 6.0 5.5 6.2 7.3 3.9 4.2

Asia x J avg 16.3 14.4 9.3 6.4 5.9 5.0 5.9 4.0 4.2


Companies mentioned China Mobile (941 HK - HK$88.60 - O-PF) Unicom (762 HK - HK$12.08 - U-PF) China Telecom (728 HK - HK$4.22 - BUY)








Appendices ChinaOpps


Appendix 1: China chart book Stock markets Earnings have driven China’s stock markets historically, except during periods

of crisis such as the global credit crisis. In 2007, 2009, 2011 and 2012, the

majority of market return was driven by PE multiple expansion.

MSCI China earnings yield versus US treasury bond yield

MSCI China PE MSCI China PB

MSCI China consensus EPS growth Nominal GDP growth versus 12M fwd EPS growth

Source: CEIC, Bloomberg, Datastream, CLSA Asia-Pacific Markets

+2sd 8.7%

+1sd 5.8%

Avg 3%

-1sd 0.1%

-2sd -2.7%

(6)

(4)

(2)

0

2

4

6

8

10

12

14

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

+3sd 11%

GFC

Sars

Dotcom

Asian financial crisisBig spike

-2sd 6.9x

-1sd 9.8x

Avg 12.6x

+1sd 15.5x

+2sd 18.3x

5

7

9

11

13

15

17

19

21

23

25

2001 2002 2004 2006 2007 2009 2011 2012

(x)

6.9x

@Oct 20115.7x

@Oct 2008

-2sd 1.0x

-1sd 1.7x

Avg 2.4x

+1sd 3.2x

+2sd 3.9x

0

1

2

3

4

5

6

7

2004 2005 2006 2007 2009 2010 2011 2012

(x)

1.20x

@Oct 2008

1.43x

@Oct 2011

0

2

4

6

8

10

12

14

16

18

Feb 11 May 11 Aug 11 Nov 11 Feb 12 May 12 Aug 12 Nov 12

(YoY %) 2012 2013

2013

@9.5%

2012

@1.2%

0

5

10

15

20

25

2005 2006 2007 2008 2009 2010 2011 2012 2013

(YoY %)

Nominal GDP growth

MSCI China 12M fwd EPS growth

Historically, earnings drive stock markets




Economy China’s economy remains heavily investment-driven, with gross capital

formation at 51% of GDP. Progress has been made in rebalancing the

economy as consumption has become the largest contributor to GDP growth

since 4Q11.

Breakdown of China’s GDP growth

Consensus GDP growth NBS PMI employment subindex

Fiscal revenue growth Fiscal expense growth

Source: CEIC, Bloomberg, CLSA Asia-Pacific Markets

(4.2)

(2.9)(3.6) (3.5)

(0.4)0.7 1.0

0.4 (0.1) 0.1 0.1 (0.4)

(0.7) (0.9)(0.4)

6.0 6.2 7.3

8.1

4.9

5.5 5.4 5.5

3.8 4.5 4.4 4.5

2.4 4.0 3.9

4.3 3.8

4.0

4.6

7.6 5.0 4.3 4.5

6.1 5.0 5.0 5.2

6.4 4.7

4.2

6.1 7.1

7.7

9.1 12.1

11.2 10.7 10.4

9.8 9.6 9.5 9.3

8.1 7.8 7.7

(5)

0

5

10

15

Mar 09 Jun 09 Sep 09 Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12

(YTD %) Net exports of goods & services Gross capital formation Final consumption GDP growth

7.6

7.8

8.0

8.2

8.4

8.6

8.8

Jan 12 Apr 12 Jul 12 Oct 12

(YoY %) 2013 2012

2013

2012

@7.7%

42

44

46

48

50

52

54

56

2007 2008 2009 2010 2011 2012

(40)

(30)

(20)

(10)

0

10

20

30

40

50

60

Jan 10 Jul 10 Jan 11 Aug 11 Feb 12 Aug 12

(%) Overall Central Local

(40)

(20)

0

20

40

60

80

100

Jan 10 Jul 10 Jan 11 Aug 11 Feb 12 Aug 12

(%) Overall Central Local

Rebalancing the economy




Foreign exchange and trade China’s trade and current-account surpluses have been declining and are

small compared to GDP. As a result, Beijing believes its currency is near fair

value and will continue widening the currency band.

Capital-flow estimate Renminbi NDF 12-month implied change

Import value (monthly) Export value (monthly)

Trade surplus Exports to major trade partners (monthly)

Source: CEIC, Wind, Bloomberg, CLSA Asia-Pacific Markets

(600)

(400)

(200)

0

200

400

600

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(Rmbbn)Inflow

Outflow

Estimated hot money

= Change in FX position

- trade surplus

- FDI + ODI

(10)

(5)

0

5

10

15

2007 2008 2009 2010 2011 2012 2013

Appreciation

Depreciation

(%)

0

20

40

60

80

100

120

140

160

180

(50)

(25)

0

25

50

75

100

2007 2008 2009 2010 2011 2012

Import (RHS)

Import YoY

(%) (US$bn)

0

50

100

150

200

250

300

350

400

(40)

(30)

(20)

(10)

0

10

20

30

40

50

2005 2006 2007 2008 2009 2010 2011 2012

Export (RHS)

Export YoY

(%) (US$bn)

(40)

(30)

(20)

(10)

0

10

20

30

40

2005 2006 2007 2008 2009 2010 2011 2012

Surplus

Deficit

(US$bn)

(40)

(20)

0

20

40

60

80

Jul 08 Jul 09 Jul 10 Jul 11 Jul 12

(YoY %) Asean USA EU

Oct exports:

Asean 45%

USA 9%

EU -8.1%

Government believes the renminbi is near fair value




Fixed-asset investment FAI is the best proxy for investment’s contribution to GDP. It differs from

gross capital formation as it includes land sales. The largest components of

FAI are property, manufacturing and infrastructure. Government policy to

lower property prices has led to lower property investments. Overcapacity in

manufacturing has put pressure on manufacturing investment.

Overall urban FAI slowing and stabilising Infrastructure FAI rising

Manufacturing FAI stabilising Real-estate investment declining

Real versus nominal FAI (quarterly) Medium- to long-term loans versus infra FAI

Source: CEIC, Wind, CLSA Asia-Pacific Markets

15

20

25

30

35

40

2007 2008 2009 2010 2011 2012 2013

(YoY %)

0

10

20

30

40

50

60

2007 2008 2009 2010 2011 2012 2013

(YoY %)

10

15

20

25

30

35

40

45

50

2007 2008 2009 2010 2011 2012 2013

(YoY %)

0

10

20

30

40

50

2007 2008 2009 2010 2011 2012

Residential only

Real-estate investment

(monthly YoY %)

10

15

20

25

30

35

40

2005 2006 2007 2008 2009 2010 2011 2012

Nominal FAI Real FAI(YTD YoY %)

0

10

20

30

40

50

60

0

100

200

300

400

500

600

700

800

900

Jan 09 Jan 10 Jan 11 Jan 12 Jan 13

Mid & long-term new loans

Infra FAI (RHS)

(Rmbbn) (YoY %)

FAI is slowing and

has been a drag on the economy




Property China has tried to limit property-price increases to prevent a bubble. Its

home-buying restrictions, introduced in 2010, have been effective in

controlling prices but have also dampened transactions and investment. We

expect inventory to rise in 2013.

NBS residential GFA new starts NBS residential GFA sold

NBS 70-city property price index Weekly property GFA sold in eight major cities1 (CREIS)

Land transaction volume 10-city residential property inventory

¹ Includes Beijing, Shanghai, Tianjin, Shenzhen, Guangzhou, Hangzhou, Nanjing, Chengdu. Source: CEIC, Wind, CREIS, CLSA Asia-Pacific Markets

(50)

0

50

100

150

0

20

40

60

80

100

120

140

160

180

200

2009 2010 2011 2012

Monthly GFA new starts

YoY % (RHS)

(m m²) (%)

(50)

(25)

0

25

50

75

100

125

150

0

25

50

75

100

125

150

175

200


Resi GFA sold Avg resi GFA sold Growth (RHS)

Avg 201181m m²

Avg 201078m m²Avg 2009

72m m²

Avg 200847m m²Avg 2007

58m m²

YTD 201270m m²

Est 201280m m²

Est 201380m m²

(YoY %)(m m²)

24

24

16

5

2

0

4

8

3

6

25

50

36

31

35

30

29

20

16

16

22

21

16

24

21

24

11

14

15

18

16

17

34

49

52

48

45

46

43

43

21

9

20

24

17

0 10 20 30 40 50 60 70

Aug 11Sep 11Oct 11Nov 11Dec 11Jan 12Feb 12Mar 12Apr 12May 12Jun 12Jul 12

Aug 12Sep 12Oct 12

(No. of cities)

Up Flat Down

0.0

0.5

1.0

1.5

2.0

2.5

Aug 11 Oct 11 Dec 11 Feb 12 Apr 12 Jun 12 Aug 12 Oct 12

(m m²)

(100)

(50)

0

50

100

150

0

10

20

30

40

50

60

Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12

Monthly sold

YoY % (RHS)

(m m²) (YoY %)

0

5

10

15

20

Apr 09 Dec 09 Sep 10 May 11 Feb 12 Oct 12

(months)

Homebuying restrictions have been effective




Consumption & inflation Boosting consumption is at the heart of the new leaders. This will be a long

process as the government needs to build a social security net. Consumption

subsidies introduced since 2009 have had only a temporary effect on

consumption. The PBOC’s inflation worries remain high given excessive

liquidity, with M2/GDP over 180%.

China retail sales1 China auto sales1 (CAAM)

NBS CPI NBS PPI versus nominal GDP growth

Macau monthly gaming revenue HK retail sales

¹ YTD YoY figures for January and February to remove effect of Chinese New Year. Source: CEIC, Wind, CLSA Asia-Pacific Markets

500

1,000

1,500

2,000

8

10

12

14

16

18

20

22

24

2007 2008 2009 2010 2011 2012

(YoY %) (Rmbbn)Monthly (RHS)

Nominal

Real

500

1,000

1,500

2,000

(50)

(25)

0

25

50

75

100

125

150

2007 2008 2009 2010 2011 2012

(YoY %) (units)Monthly (RHS)

Monthly growth

(5)

0

5

10

15

20

25

2005 2006 2007 2008 2009 2010 2011 2012

(YoY %) CPI CPI food CPI non-food

0

5

10

15

20

25

30

(10)

(5)

0

5

10

15

2005 2006 2007 2008 2009 2010 2011 2012

(YoY %) (%)PPI (LHS) Nominal GDP

0

10

20

30

40

50

60

70

80

90

100

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000


(MOPm) (YoY %)Macau gaming revenue

YoY growth (RHS)

0

5

10

15

20

25

30

35

40

45

50

(20)

(10)

0

10

20

30

40

2006 2007 2008 2009 2010 2011 2012

(YoY %) (HK$m)Value (RHS)

Value growth

Volume growth

Boosting consumption is a long-term process




Materials & energy China’s commodity boom is nearing an end as the country slows investment.

Thermal coal is still critical in providing power, but there is now overcapacity

of power generation at the IPPs and China is expanding alternative energy

sources such as natural gas.

Thermal coal – Australia & China Coking coal – China Shanxi & Australia

Source: CCTD, Global coal, Tex report, Platts, CLSA Asia-Pacific Markets

Iron ore Aluminium

Copper Gold

Note: CIF China spot iron-ore price is from TSI after March 2010, before then it was from MB. Source: Bloomberg, CLSA Asia-Pacific Markets

0

25

50

75

100

125

150

175

200


FOB NEWC spot

FOB NEWC contract

FOB China QHD spot

(US$/tonne)

100

150

200

250

300

350

400

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13

(US$/t)(Rmb/t)Liulin clean coking-coal price (with VAT)

Australian premium hard coking-coal FOB (RHS)

50

70

90

110

130

150

170

190

210


(US$/tonne) China CIF spot price

China CIF Australia contract price

0

1

2

3

4

5

6

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000


(m tonnes)(US$/tonne) Inventory of exchanges

LME 3M aluminium price (LHS)

0

100

200

300

400

500

600

700

800

900

0

2,000

4,000

6,000

8,000

10,000

12,000


(US$/tonne) Inventory of exchanges

LME 3M copper price (LHS)

('000 tonnes)

70

75

80

85

90

95

100

105

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000


(US$/oz) Gold price (LHS)

US$ index

Commodity boom is nearing an end




Industrials Power consumption has been a proxy for GDP growth, but the link is getting

weaker due to overcapacity at industrials and ongoing industry consolidation.

Industrial production versus power output Power production

Purchasing Managers Index (PMI) NBS PMI inventory subindices

Cement production Steel-products production


(15)

(10)

(5)

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012

(%)

Value Added of Industry

Electricity production

(20)

(10)

0

10

20

30

40

50

100

200

300

400

500

600

700

2007 2008 2009 2010 2011 2012

Electricity production

Power growth (RHS)

(YoY %)(bn kWh)

35

40

45

50

55

60

65

2007 2008 2009 2010 2011 2012

NBS Markit

38

40

42

44

46

48

50

52

54

2007 2008 2008 2009 2010 2011 2012

Finished goods

Materials

0

10

20

30

40

2

3

4

5

6

7

8


(m tonnes) (YoY %)Daily cement production

YoY growth (RHS)

0

10

20

30

40

1.5

2.0

2.5

3.0


(m tonnes) (YoY %)Daily steel production

YoY growth (RHS)

Weaker link between

economy and power consumption




Money & banking The A-share market has strong correlation to money growth. The PBOC wants

to control money growth as there is excessive liquidity as measured by

M2/GDP. A primary focus on financial reform is to promote stock and bond

financing and reduce reliance on bank loans.

Money growth M2/GDP

Monthly new loans

Total social financing


0

5

10

15

20

25

30

35

40

45

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

(YoY %) M1 growth

M2 growth

M2 average growth

50

75

100

125

150

175

200

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

12C

L

13CL

(%)

(400)

(200)

0

200

400

600

800

1,000

1,200

Jan 1

1

Feb 1

1

Mar

11

Apr

11

May 1

1

Jun 1

1

Jul 11

Aug 1

1

Sep 1

1

Oct

11

Nov 1

1

Dec 1

1

Jan 1

2

Feb 1

2

Mar

12

Apr

12

May 1

2

Jun 1

2

Jul 12

Aug 1

2

Sep 1

2

Oct

12

(Rmbbn)

Others unexplained

Long-term corporate

Bill finance

Short-term corporate

Long-term household

Short-term household

(500)

0

500

1,000

1,500

2,000

Jan 1

1

Feb 1

1

Mar

11

Apr

11

May 1

1

Jun 1

1

Jul 11

Aug 1

1

Sep 1

1

Oct

11

Nov 1

1

Dec 1

1

Jan 1

2

Feb 1

2

Mar

12

Apr

12

May 1

2

Jun 1

2

Jul 12

Aug 1

2

Sep 1

2

Oct

12

Implied others

Non-financial equity

Corp debt

Banks acceptance bill

Trust loans

Entrusted loans

FX loans

Rmb loans

(Rmbbn)

Need to control excess

liquidity and reduce reliance on bank loans




Appendix 2: CLSA China/HK coverage Our China/HK coverage universe

Company Code Sectors Rec Mkt cap (US$m)



Financial services: Kevin Chan/Patricia Cheng/Derek Ovington/Chen Huang

HSBC 5 HK Financial services U-PF 183,345 10.5 9.1 16.6 15.7 1.1 1.0 10.7 11.5 4.6 5.2

Standard Chartered 2888 HK Financial services BUY 55,691 9.3 8.0 38.7 15.8 1.2 1.1 13.6 14.4 4.0 4.5

ICBC 1398 HK Financial services U-PF 220,989 6.5 5.9 2.1 6.6 1.1 1.0 18.6 17.4 4.6 5.1

CCB 939 HK Financial services O-PF 190,678 5.7 4.9 8.3 11.4 1.1 0.9 20.4 19.7 5.3 6.1

Agricultural Bank 1288 HK Financial services O-PF 135,271 5.6 4.8 6.6 13.6 1.0 0.8 19.2 19.1 5.4 6.3

Bank of China 3988 HK Financial services BUY 121,510 5.3 4.8 2.3 7.1 0.8 0.7 15.9 15.5 6.0 6.6

Bocom 3328 HK Financial services O-PF 52,080 5.6 4.9 (3.4) 11.4 0.7 0.6 14.0 13.8 2.1 2.5

CMB 3968 HK Financial services SELL 35,760 7.1 5.9 4.3 17.2 1.2 1.0 17.5 17.9 3.5 4.3

CNCB 998 HK Financial services BUY 26,452 4.4 3.8 5.0 11.4 0.7 0.6 15.5 15.4 5.7 6.5

Minsheng 1988 HK Financial services SELL 27,672 6.0 6.3 (18.5) (7.0) 0.9 0.8 16.2 13.8 3.1 3.2

Bank of China (HK) 2388 HK Financial services BUY 32,881 11.7 10.3 7.2 13.9 1.7 1.6 14.7 15.7 5.4 6.3

Hang Seng Bank 11 HK Financial services SELL 28,989 12.1 11.0 4.1 10.4 2.3 2.1 20.0 20.0 4.4 4.4

BEA 23 HK Financial services O-PF 8,066 14.1 13.6 (23.9) 3.8 1.1 1.0 7.7 7.5 3.4 3.5

Wing Hang Bank 302 HK Financial services BUY 3,109 10.7 9.4 12.6 13.5 1.2 1.1 11.6 12.0 2.4 2.7

AIA 1299 HK Insurance SELL 47,170 15.1 14.0 16.2 7.9 1.7 1.5 12.1 11.6 1.3 1.3

China Life 2628 HK Insurance U-PF 81,160 18.0 15.4 24.5 13.3 2.1 1.8 12.0 12.4 0.0 0.0

CPIC 2601 HK Insurance U-PF 26,346 21.6 19.2 72.7 9.2 1.7 1.5 8.4 8.3 1.7 1.7

Ping An 2318 HK Insurance U-PF 52,520 14.0 12.1 16.1 12.7 2.0 3.4 15.2 14.8 1.0 0.6

PICC 2328 HK Insurance U-PF 15,974 9.2 8.9 1.0 0.6 1.7 1.3 20.4 16.6 0.0 0.0

China Taiping 966 HK Insurance U-PF 2,879 13.2 10.8 45.0 22.5 1.3 1.1 11.5 12.1 0.0 0.0

New China Life 1336 HK Insurance U-PF 10,141 15.9 13.5 12.5 13.9 1.5 1.3 9.8 9.9 0.0 0.0

HK Exchanges 388 HK Financial services SELL 17,906 29.2 26.8 9.8 8.9 13.2 12.5 46.2 47.8 3.1 3.4

Haitong 6837 HK Financial services BUY 13,191 17.1 13.8 41.1 20.6 1.2 1.1 7.6 8.6 2.0 2.5

Everbright Ltd 165 HK Financial services O-PF 2,473 8.0 6.6 26.8 21.0 0.6 0.6 7.9 8.9 4.4 5.3

China property: Nicole Wong/Susanna Leung

Coli 688 HK Property O-PF 23,571 9.9 8.2 24.5 20.5 2.0 1.7 21.5 22.3 2.0 2.4

Vanke 200002 CH Property BUY 15,013 7.7 5.9 3.2 25.8 1.5 1.3 17.7 23.5 1.9 2.5

CR Land 1109 HK Property O-PF 15,115 14.5 10.8 16.4 34.4 1.7 1.8 12.9 16.1 1.7 2.3

Evergrande 3333 HK Property U-PF 7,090 5.7 5.5 (9.4) 0.2 1.1 0.9 18.9 16.8 4.4 4.5

Country Garden 2007 HK Property O-PF 8,257 6.7 5.9 4.7 10.5 1.2 1.0 18.2 17.4 6.0 6.9

Soho China 410 HK Property U-PF 3,696 5.6 17.2 15.6 (68.4) 0.6 0.5 12.5 2.9 5.4 5.6

Agile Property 3383 HK Property BUY 4,358 5.1 3.9 27.1 27.0 1.0 0.9 24.1 27.2 4.9 6.4

Shimao Property 813 HK Property U-PF 6,964 7.8 5.6 17.0 36.2 1.4 1.2 22.3 25.8 3.3 4.4

Guangzhou R&F 2777 HK Property BUY 4,574 7.0 5.6 0.2 21.6 1.1 1.0 18.6 19.7 5.7 7.2

Cogo 81 HK Property BUY 2,427 6.8 5.5 34.5 24.9 2.0 1.5 35.6 31.8 0.9 1.1

KWG Property 1813 HK Property BUY 1,844 4.9 4.1 23.2 16.4 0.7 0.6 15.2 15.8 6.4 7.6

Longfor 960 HK Property O-PF 9,848 8.5 7.2 14.7 13.8 1.8 1.5 24.8 23.0 2.4 2.8

HK property: Nicole Wong/Susanna Leung/Danie Schutte/Jackson Hui

SHKP 16 HK Property U-PF 38,413 15.9 13.8 (3.6) 15.7 0.9 0.8 5.3 5.8 3.1 3.6

Cheung Kong 1 HK Property O-PF 35,059 10.2 9.4 (0.5) 8.9 0.8 0.7 7.7 7.9 3.0 3.2

Hang Lung Prop 101 HK Property O-PF 15,935 17.1 21.0 64.6 (18.7) 1.0 0.9 6.1 4.6 2.5 2.7

Wharf 4 HK Property BUY 22,516 15.3 12.7 15.8 20.2 0.7 0.6 5.2 5.6 2.6 3.1

Henderson Land 12 HK Property SELL 17,061 22.7 21.7 (5.2) 4.8 0.7 0.7 3.7 3.7 1.8 1.8

Hongkong Land HKL SP Property O-PF 15,405 17.5 18.7 14.9 (6.4) 0.7 0.7 4.0 3.6 2.8 2.8

Swire Properties 1972 HK Property O-PF 18,948 24.3 21.1 (12.0) 15.1 0.8 0.8 3.5 3.9 2.1 2.4

Sino Land 83 HK Property U-PF 10,466 11.4 13.1 (28.5) (12.8) 0.8 0.8 7.6 6.1 3.3 3.3

Kerry Properties 683 HK Property U-PF 7,288 10.4 12.6 (1.2) (17.5) 0.7 0.7 7.8 6.1 2.2 2.2

New World Dev 17 HK Property O-PF 9,834 11.0 10.7 (40.5) 2.1 0.5 0.5 6.2 5.6 3.1 3.1

Hysan 14 HK Property O-PF 5,048 20.8 18.9 29.7 9.7 0.7 0.6 3.4 3.5 3.4 3.7

Great Eagle 41 HK Property U-PF 1,939 9.7 9.4 3.9 4.0 0.4 0.4 4.5 4.5 2.7 2.8

Midland 1200 HK Property U-PF 335 7.4 5.3 21.1 40.2 1.3 1.1 18.5 21.9 6.7 7.0

CSI Properties 497 HK Property BUY 381 2.0 2.9 (27.5) (30.4) 0.4 0.3 19.5 11.4 6.0 4.2

Continued on the next page




Our China/HK coverage universe (cont’d)




Oil & gas: Simon Powell/Nelson Wang

PetroChina 857 HK Petro/Chems BUY 249,518 8.9 7.8 14.1 11.1 1.3 1.1 14.7 14.8 5.0 5.8

Sinopec 386 HK Petro/Chems BUY 86,187 7.3 6.5 21.4 7.5 1.0 0.9 14.7 14.3 4.3 4.7

CNOOC 883 HK Petro/Chems U-PF 95,292 9.7 10.2 (6.7) (7.5) 1.6 1.4 17.8 14.6 2.6 2.5

COSL 2883 HK Petro/Chems U-PF 10,499 10.1 9.7 17.5 0.8 1.5 1.3 15.4 13.8 2.0 2.1

Antonoil 3337 HK Petro/Chems BUY 720 19.8 13.4 93.5 43.5 2.8 2.4 15.4 19.7 1.8 2.7

Shanghai Petrochem 338 HK Petro/Chems SELL 4,604 15.4 12.2 0.0 22.9 0.8 0.7 5.1 6.1 2.6 3.3

Resources: Andrew Driscoll/Daniel Meng

Shenhua 1088 HK Materials BUY 71,709 10.4 10.1 0.1 (0.1) 1.7 1.5 17.9 16.0 3.8 4.0

China Coal 1898 HK Materials U-PF 14,311 8.9 8.4 7.1 3.2 0.9 0.8 9.2 8.9 2.8 3.0

Chalco 2600 HK Materials SELL 9,095 (27.0) (33.4) 0.0 0.0 0.8 0.8 (2.9) (2.3) 0.0 0.0

Rusal 486 HK Materials U-PF 8,823 9.6 6.9 233.9 40.5 0.8 0.7 8.4 10.7 0.0 3.6

Yanzhou Coal 1171 HK Materials SELL 10,955 15.3 11.1 (45.5) 34.1 1.0 0.9 7.3 9.9 2.0 2.7

Jiangxi Copper 358 HK Materials U-PF 10,392 9.0 8.9 13.3 (0.9) 1.1 1.0 13.2 12.0 4.1 4.2

Shougang Fushan 639 HK Materials U-PF 2,039 14.4 13.5 (27.1) 6.9 0.8 0.7 6.2 6.4 3.1 3.3

SouthGobi 1878 HK Materials U-PF 376 (23.1) 39.2 0.0 0.0 0.6 0.6 (2.6) 1.6 0.0 0.8

Hidili Industry 1393 HK Materials U-PF 528 12.4 6.4 (6.2) 88.5 0.4 0.4 3.3 6.0 1.6 3.1

Mongolian Mining 975 HK Materials U-PF 1,822 10.3 6.7 136.3 53.3 1.8 1.4 19.4 23.9 0.0 0.0

Conch 914 HK Materials O-PF 14,648 13.2 11.8 40.8 8.2 1.9 1.6 15.0 14.3 1.2 1.3


Sinoma 1893 HK Materials SELL 1,111 7.5 6.6 32.2 10.9 0.6 0.5 9.1 9.0 2.0 2.2

CR Cement 1313 HK Materials SELL 4,004 16.1 14.0 37.3 15.6 1.4 1.3 8.8 9.4 0.5 0.6

Zijin 2899 HK Materials SELL 11,842 7.8 7.9 38.6 (3.5) 1.5 1.2 21.9 17.9 2.8 2.8

Zhaojin 1818 HK Materials O-PF 4,980 15.8 15.7 7.5 (2.4) 3.3 2.8 23.3 19.3 1.7 1.7

G-Resources 1051 HK Materials U-PF 891 49.6 4.0 0.0 1,134.2 1.0 0.8 2.2 23.6 0.0 0.0

Conglomerate: Danie Schutte/Jonathan Galligan

Hutchison Whampoa 13 HK Conglomerates BUY 43,435 11.6 10.1 18.9 15.5 0.9 0.8 8.5 9.0 3.2 3.6

Jardine Matheson JM SP Conglomerates O-PF 38,885 12.2 11.4 11.8 7.0 1.1 1.0 11.4 11.5 2.4 2.5

Jardine Strategic JS SP Conglomerates O-PF 39,564 11.5 9.9 11.0 16.2 0.9 0.8 9.7 9.8 0.7 0.8

MTRC 66 HK Transport U-PF 22,603 20.6 19.0 12.9 8.1 1.3 1.2 6.4 6.6 2.7 2.9

Swire Pacific 19 HK Property U-PF 18,042 13.7 12.3 20.5 11.6 0.6 0.6 4.9 5.4 3.6 4.1

Hopewell Hldgs 54 HK Capital goods O-PF 3,350 22.7 20.5 (67.0) 11.1 0.8 0.8 4.1 4.5 3.4 3.4

Hopewell Highway 737 HK Infrastructure U-PF 1,642 17.1 16.5 (28.4) 3.4 1.5 1.5 8.5 9.0 5.7 6.0

First Pacific 142 HK Conglomerates O-PF 4,136 8.6 8.0 5.7 8.3 1.1 1.0 12.6 12.2 3.3 3.8

Telecoms: Elinor Leung

China Mobile 941 HK Telecoms O-PF 228,120 10.9 10.1 2.9 4.5 1.8 1.6 17.1 16.2 3.9 4.2

China Telecom 728 HK Telecoms BUY 45,848 13.5 11.1 35.0 18.0 1.0 0.9 7.4 8.2 2.4 2.9

Unicom 762 HK Telecoms U-PF 37,586 19.8 13.1 64.1 46.2 1.0 0.9 5.3 7.4 1.4 2.1

Internet & media: Elinor Leung/Jialong Shi/James Lee

Baidu BIDU US Internet BUY 33,637 15.9 11.7 33.2 31.7 5.5 3.7 40.7 36.6 0.0 0.0

Tencent 700 HK Internet BUY 61,236 23.3 18.5 27.5 22.1 6.6 4.8 32.7 29.5 0.5 0.6

Sina SINA US Internet O-PF 3,128 50.6 23.7 0.0 113.4 1.9 1.7 4.7 9.3 0.0 0.0

NetEase NTES US Internet BUY 5,639 8.2 7.0 20.9 13.5 2.3 1.9 28.6 28.6 0.0 0.0


Focus Media FMCN US Media BUY 3,170 10.3 9.1 32.9 12.8 1.6 1.3 17.4 16.1 0.0 0.0

Sohu SOHU US Internet U-PF 1,441 11.1 8.6 56.3 29.4 1.3 1.1 18.2 19.8 0.0 0.0

Changyou CYOU US Internet BUY 1,261 3.9 3.5 17.4 11.5 1.0 0.8 30.8 26.1 0.0 0.0

Giant Interactive GA US Internet BUY 1,270 5.7 5.0 12.5 11.8 2.0 1.7 42.2 38.8 0.0 0.0

Shanda Games GAME US Internet O-PF 916 4.1 3.9 9.8 1.2 1.2 1.0 30.8 27.5 0.0 0.0

Perfect World PWRD US Internet U-PF 516 4.8 4.5 7.5 2.8 0.6 0.5 13.4 12.1 0.0 0.0

Dangdang DANG US Internet U-PF 362 (7.1) (26.4) 0.0 0.0 5.6 6.8 (56.0) (22.9) 0.0 0.0

VisionChina VISN US Media U-PF 22 (0.7) (1.3) 0.0 0.0 0.2 0.3 (29.6) (20.0) 0.0 0.0

Airmedia AMCN US Media O-PF 130 (135.5) 72.3 0.0 0.0 0.5 0.4 (0.3) 0.6 0.0 0.0

Technology: Nicolas Baratte/CK Cheng/Chitra Gopal

ZTE 763 HK Technology SELL 4,614 14.9 13.6 97.2 6.6 1.2 1.1 8.6 8.5 2.3 2.5

Lenovo 992 HK Technology O-PF 9,524 17.1 14.5 20.3 17.7 3.5 3.0 21.6 21.8 1.7 2.0

ASM Pacific 522 HK Technology BUY 4,603 17.0 12.4 114.0 37.6 4.2 3.4 27.5 30.6 2.5 5.2

AAC 2018 HK Technology O-PF 4,833 13.9 12.1 19.9 11.5 3.8 3.1 30.0 27.7 2.9 3.3

Digital China 861 HK Technology BUY 1,843 10.1 8.4 6.7 20.4 1.7 1.5 17.9 18.1 3.4 4.1

Sunny Optical 2382 HK Technology BUY 677 10.8 8.7 21.6 20.9 1.9 1.6 17.8 19.0 3.1 3.9






Company Code Sector Rec Mkt cap

(US$m) PE (x) EPS g (%) PB (x) ROE (%) Yield (%)


Steel & autos: Scott Laprise

Angang 347 HK Materials SELL 4,061 46.5 15.8 0.0 186.1 0.6 0.6 1.2 3.4 0.0 3.2

Magang 323 HK Materials O-PF 2,316 10.1 8.2 0.0 19.3 0.5 0.5 6.2 6.7 3.5 4.3

Shougang Intl 697 HK Materials BUY 491 5.2 5.5 209.5 (5.2) 0.3 0.3 6.5 5.3 3.8 3.6

Dongfeng 489 HK Autos SELL 11,741 10.1 10.2 (9.3) (4.2) 1.3 1.1 13.7 11.8 0.0 0.0

BYD 1211 HK Autos SELL 6,131 552.3 282.3 51.3 89.8 1.7 1.6 0.8 0.9 0.0 0.0

GAC 2238 HK Autos SELL 5,147 12.7 8.3 20.2 47.9 0.9 0.8 7.1 9.8 1.2 1.8

Great Wall Motor 2333 HK Autos BUY 9,263 11.2 10.1 26.0 7.5 2.6 2.1 23.9 21.3 0.1 0.1

Consumer staples: Xiaopo Wei/Dawei Feng

Tingyi 322 HK Consumer U-PF 15,770 27.3 21.2 12.3 29.3 5.9 5.0 23.4 27.3 1.8 2.4

Want Want 151 HK Consumer BUY 19,254 28.8 23.5 22.9 22.4 10.7 9.1 40.2 41.7 2.1 2.5

Hengan 1044 HK Consumer BUY 11,046 21.2 17.8 18.7 19.0 5.5 4.9 27.3 28.6 2.8 3.4

Vinda 3331 HK Consumer BUY 1,478 15.1 11.2 31.4 34.8 2.1 1.9 16.4 18.4 1.8 2.5

Yurun Food 1068 HK Consumer SELL 1,148 13.9 8.1 195.0 71.8 0.5 0.5 3.9 6.4 1.8 3.1

Sun Art 6808 HK Consumer SELL 13,935 34.2 27.6 18.6 19.9 4.9 4.2 15.5 16.7 0.9 1.2

CRE 291 HK Consumer O-PF 8,133 28.4 22.6 24.4 25.7 1.8 1.7 6.8 8.0 1.6 2.0

Tsingtao 168 HK Consumer U-PF 6,969 22.0 18.1 18.6 18.2 3.2 2.7 15.9 16.4 0.7 0.9

Consumer discretionary: Aaron Fischer/Xiaopo Wei/Mariana Kou/Dawei Feng

Chow Tai Fook 1929 HK Consumer U-PF 13,524 19.7 15.1 (13.2) 30.7 3.3 2.8 17.8 19.9 1.0 1.3

Prada 1913 HK Consumer BUY 21,248 25.4 20.5 37.2 23.9 6.6 5.3 29.1 28.9 1.0 1.2

Samsonite 1910 HK Consumer BUY 2,902 15.0 13.7 20.1 9.7 2.6 2.4 18.7 18.1 2.6 2.8

Li & Fung 494 HK Consumer SELL 13,373 17.5 14.0 (6.4) 25.1 2.1 2.1 12.6 15.1 4.7 5.3

L'Occitane 973 HK Consumer O-PF 4,603 23.5 20.2 16.4 16.3 4.6 4.0 20.5 21.1 1.3 1.5

Esprit 330 HK Consumer SELL 3,061 796.4 28.5 (97.7) 2695.2 1.2 1.1 0.2 4.0 0.1 2.1

I.T 999 HK Consumer O-PF 517 8.0 6.3 4.0 27.2 1.5 1.3 20.4 22.6 4.0 6.4

Lifestyle 1212 HK Consumer BUY 3,682 11.4 10.2 22.7 11.2 2.4 2.1 23.2 21.9 3.5 3.9


Parkson Retail Grp 3368 HK Consumer U-PF 2,107 11.3 9.4 17.7 17.2 2.0 1.7 18.7 19.5 4.0 4.8

Intime 1833 HK Consumer O-PF 2,372 16.7 12.9 15.3 25.3 1.8 1.6 11.5 12.3 1.9 2.3

NWDS 825 HK Consumer U-PF 992 12.2 10.7 5.9 13.9 1.2 1.1 10.3 11.0 4.1 4.7

Gome 493 HK Consumer SELL 1,720 22.1 13.1 0.0 63.8 0.7 0.6 2.3 4.5 1.4 2.3

Anta Sports 2020 HK Consumer O-PF 1,876 9.5 7.8 (14.9) 17.3 1.6 1.4 16.9 18.4 6.4 7.7

Dongxiang 3818 HK Consumer U-PF 664 14.5 12.4 23.9 13.4 0.5 0.5 3.8 4.2 4.8 5.7

Li Ning 2331 HK Consumer SELL 550 64.9 14.5 0.0 334.6 1.0 1.0 2.4 7.3 0.6 2.8

Belle Intl 1880 HK Consumer BUY 17,088 19.3 15.8 19.0 18.2 4.1 3.3 22.6 22.8 1.6 1.9

Daphne 210 HK Consumer O-PF 1,988 15.2 12.9 20.3 18.1 3.3 2.5 22.3 21.8 2.2 2.7

Trinity 891 HK Consumer O-PF 1,214 15.1 12.7 14.4 19.6 2.5 2.3 17.1 19.1 4.6 5.5

Lilang 1234 HK Consumer U-PF 655 6.2 5.7 (3.0) 6.5 1.4 1.2 24.5 22.9 7.4 8.1

Evergreen Intl 238 HK Consumer U-PF 191 5.7 4.7 14.6 16.9 0.7 0.6 13.3 14.2 7.1 8.5

Hotels & leisure: Aaron Fischer/Richard Huang/Mariana Kou

Sands China 1928 HK Hotels & Leisure O-PF 34,246 19.1 16.0 53.3 19.5 6.3 5.8 33.1 37.7 4.2 5.0

Wynn Macau 1128 HK Hotels & Leisure BUY 14,560 18.2 16.6 (0.2) 9.6 17.7 14.6 107.0 95.8 4.4 4.8

SJM 880 HK Hotels & Leisure BUY 12,913 14.6 13.0 3.3 12.0 5.2 4.8 37.0 37.9 5.5 6.2

Galaxy 27 HK Hotels & Leisure O-PF 15,574 16.6 14.7 2.8 12.9 4.3 3.3 29.6 25.4 0.0 0.0

Melco Crown MPEL US Hotels & Leisure BUY 8,451 18.3 15.4 11.4 18.3 2.0 1.7 11.4 12.0 0.0 0.0

MGM China 2282 HK Hotels & Leisure BUY 6,728 13.6 12.6 (12.3) 8.3 7.8 6.7 62.1 57.0 5.9 6.4

Shun Tak 242 HK Conglomerates BUY 1,268 7.8 6.5 4.5 20.1 0.5 0.5 7.9 8.4 3.9 4.6

Nagacorp 3918 HK Hotels & Leisure O-PF 1,279 9.3 8.1 24.5 14.2 2.9 2.5 33.2 33.2 6.5 7.4

Utilities/power equipment: Rajesh Panjwani/Charles Yonts

CLP 2 HK Power SELL 20,819 14.2 13.4 24.7 6.0 1.8 1.7 13.2 13.1 3.8 3.8

Power Assets 6 HK Power SELL 18,811 14.6 14.0 2.3 4.4 2.2 2.0 15.4 15.0 3.8 3.9

Cheung Kong Infra 1038 HK Power SELL 14,912 11.7 10.9 4.9 6.9 1.7 1.6 15.4 15.1 3.8 4.0

Shanghai Electric 2727 HK Power SELL 7,424 10.3 11.2 (14.9) (10.9) 0.9 0.8 9.5 7.9 2.9 2.7

Dongfang 1072 HK Power SELL 3,876 9.7 10.9 (21.1) (13.6) 1.2 1.0 12.1 9.5 1.2 1.2

Harbin Electric 1133 HK Power SELL 1,153 8.9 10.6 (34.0) (19.1) 0.6 0.5 6.4 5.0 3.2 3.2

Huaneng Power 902 HK Power O-PF 14,021 7.8 8.7 48.0 (12.5) 1.1 1.0 15.3 12.0 3.8 3.5

Datang Power 991 HK Power U-PF 7,619 7.4 6.2 37.5 15.7 0.7 0.6 12.3 12.8 4.1 4.9

CR Power 836 HK Power BUY 10,514 8.3 7.3 55.2 14.5 1.4 1.2 16.4 16.6 4.2 4.8

Huadian Power 1071 HK Power O-PF 3,925 6.1 6.5 121.2 (8.9) 0.7 0.6 11.8 9.6 1.6 1.5

China Power 2380 HK Power BUY 1,504 6.2 5.8 18.0 2.8 0.6 0.5 11.0 10.4 5.3 5.7

ENN Energy 2688 HK Power O-PF 4,774 16.1 13.4 20.6 15.9 2.9 4.8 21.1 20.6 1.6 0.9

CR Gas 1193 HK Power BUY 4,528 16.6 13.7 22.8 21.4 3.2 2.8 19.6 20.4 1.5 2.1









Alternative energy: Charles Yonts

Longyuan Power 916 HK Power BUY 4,672 10.5 8.4 12.7 21.9 1.0 0.9 10.8 11.5 0.9 1.2

Datang Renewable 1798 HK Power SELL 762 9.6 5.6 (3.8) 67.7 0.5 0.5 5.8 7.8 0.0 0.0

HN Renewables 958 HK Power U-PF 1,234 7.0 5.7 (6.9) 20.4 0.6 0.5 9.7 9.8 0.0 0.0

Everbright Intl 257 HK Capital goods O-PF 2,058 11.7 10.3 5.2 13.1 1.6 1.4 14.4 14.2 0.4 0.4

Huadian Fuxin 816 HK Power BUY 1,448 5.0 3.5 13.9 39.4 0.7 0.6 15.7 17.9 2.0 2.9

GCL-Poly 3800 HK Power SELL 2,676 (1,273.6) 409.6 0.0 0.0 0.9 0.9 0.6 0.9 0.0 0.0

Trina Solar TSL US Power SELL 199 (2.5) (3.1) 0.0 0.0 0.3 0.3 (9.0) (8.0) 0.0 0.0

Suntech Power STP US Power SELL 148 (0.8) (127.8) 0.0 0.0 0.5 0.5 (48.9) (0.4) 0.0 0.0

Transport: Robert Bruce/Paul Wan/Nathan Snyder

Air China 753 HK Transport N-R 9,257

Cathay Pacific 293 HK Transport N-R 7,046

CSCL 2866 HK Transport SELL 3,846 50.1 9.9 0.0 392.7 0.8 0.7 1.7 7.3 0.0 0.0

OOIL 316 HK Transport SELL 3,896 11.5 9.3 49.2 23.8 0.8 0.8 7.4 8.5 2.2 2.7

Pacific Basin 2343 HK Transport N-R 1,010

CS Dev 1138 HK Transport N-R 2,113

Sinotrans Shipping 368 HK Transport N-R 968

China Cosco 1919 HK Transport N-R 6,443

Cosco Pacific 1199 HK Infrastructure N-R 3,940

China Merchants 144 HK Infrastructure N-R 7,614

HPH Trust HPHT SP Infrastructure BUY 6,575 24.3 0.0 (5.1) 0.0 0.8 0.0 3.8 0.0 7.1 0.0

Small/Mid caps: Paul Quah/Zac Gill

VTech 303 HK Technology O-PF 2,945 14.2 13.3 6.3 6.8 5.2 5.2 36.8 39.0 6.9 7.4

Hengdeli 3389 HK Consumer SELL 1,581 14.3 11.2 13.7 23.3 1.7 1.5 15.2 16.7 1.9 2.4

Emperor Watch 887 HK Consumer BUY 711 9.7 7.1 23.4 36.9 1.3 1.1 14.3 17.5 3.2 4.3

Café de Coral 341 HK Consumer U-PF 1,672 28.0 25.6 9.6 9.2 4.1 3.9 14.7 15.7 3.6 3.0

Hollysys HOLI US Technology O-PF 591 10.2 9.4 10.5 9.0 1.6 1.4 16.9 15.9 0.0 0.0

Oriental Watch 398 HK Consumer BUY 189 9.2 9.1 12.0 0.9 0.8 0.7 9.1 8.5 2.9 2.9

Magnificent 201 HK Property BUY 439 9.5 8.1 32.9 17.2 0.8 0.7 8.5 9.1 0.6 0.7

EVA Precision 838 HK Technology O-PF 200 10.8 8.2 95.3 31.4 0.8 0.8 8.0 9.9 3.0 4.0

Dorsett Hospitality 2266 HK Hotels & Leisure BUY 496 14.0 13.0 21.4 8.4 1.1 1.0 7.8 8.1 3.6 3.9

Tiangong 826 HK Capital goods BUY 466 4.8 4.3 23.0 9.6 0.9 0.8 20.6 19.3 4.7 5.3

China Automation 569 HK Capital goods O-PF 245 7.2 6.3 26.1 9.3 0.7 0.6 11.4 11.5 0.0 3.2

LotSynergy 8161 HK Hotels & Leisure U-PF 113 5.1 0.0 39.3 0.0 0.7 0.0 28.5 0.0 0.0 0.0

Prince Frog 1259 HK Consumer BUY 399 7.7 5.8 10.8 28.1 1.6 1.3 22.3 23.8 2.6 3.8

Techtronic 669 HK Consumer U-PF 3,775 15.2 12.8 19.0 18.5 2.1 1.9 14.7 15.4 1.3 1.6

Haitian 1882 HK Capital goods O-PF 1,880 10.8 8.6 9.1 20.7 2.0 1.7 19.3 20.9 4.2 5.2

Minth 425 HK Autos BUY 1,168 8.2 7.2 8.9 10.5 1.0 0.9 12.8 13.0 3.7 5.6

Xinyi Glass 868 HK Materials O-PF 2,195 11.1 9.3 32.1 19.2 1.6 1.5 15.7 17.1 4.3 5.1

Yingde Gases 2168 HK Power SELL 1,739 11.7 9.1 29.0 24.6 1.8 1.5 15.9 17.3 2.1 2.7



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01/01/2012

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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.


Important notices

01/01/2012

© 2012 CLSA Asia-Pacific Markets ("CLSA") and/or Credit Agricole Securities (USA) Inc (“CAS”)

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

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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.


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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

Singapore CLSA Singapore Pte Ltd 80 Raffles Place, No.18-01 UOB Plaza 1 Singapore 048624 Tel: (65) 6416 7888 Fax: (65) 6533 8922

USA - Chicago Credit Agricole Securities (USA) Inc 227 W. Monroe Street Suite 3800 Chicago, IL 60606 Tel: (1) 312 278 3604

China - Shanghai CLSA Limited - Shanghai Rep Office Room 910, 9/F 100 Century Avenue Pudong New Area Shanghai 200120 Tel: (86) 21 2020 5888 Fax: (86) 21 2020 5666

Japan Credit Agricole Securities Asia BV Tokyo Branch 16/F, Shiodome Sumitomo Building 1-9-2, Higashi-Shimbashi Minato-ku, Tokyo 105-0021 Tel: (81) 3 4580 5533 (General) (81) 3 4580 5171 (Trading) Fax: (81) 3 4580 5896

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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

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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

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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

Malaysia (60) 3 2056 7852 Philippines (63) 2 860 4030 Singapore (65) 6416 7878 Taiwan (886) 2 2326 8124 Thailand (66) 2 257 4611 UK (44) 207 614 7260 US (1) 212 408 5800

© 2012 CLSA Asia-Pacific Markets ("CLSA"). Key to CLSA/Credit Agricole Securities 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. 16/10/2012

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