Strategy China DB Access China Conference Strategy...

Deutsche Bank Markets Research

Asia China

Strategy

DB Access China Conference

Date 19 January 2018

Strategy Update

dbAccess China 2018: sector, company and tour highlights

________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong

Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU.

Michael Tong, CFA

Research Analyst

(+852 ) 2203 6167 [email protected]

Luka Zhu

Research Analyst

(+852 ) 2203 6173 [email protected]

Deutsche Bank’s Access China 2018 conference, held in Beijing on 8-12 January, was attended by 650+ investors, 180+ corporates from China/HK, 50+ industry experts and macro speakers. We also organised 15 field trips and site visits across the country on 11-12 January. This document consolidates the research published by our analysts, which includes the macro tracks, companies, industry experts and tours.

Macro highlights During the Access China conference, 27 invited guest speakers presented their views on the economic sector and policy issues.

Autos/Infrastructure/Industrials/Transport Minth Group, Geely Auto, SAIC Motor, Yutong Bus, Zhongsheng Group, JONHON Optronic, CRSC, CRRC, NARI Tech, CNBM, Conch Venture, Anhui Conch Cement, Shenzhen Inovance, Beijing Cap Int'l Airport, and Sinotrans.

Banking/Finance Agri. Bank of China, Bank of China, Bank of Communications, China Cinda, China CITIC Bank, China Construction Bank, China Life, China Merchants Bank, China Minsheng Bank, Chongqing Rural Bank, CEB, CPIC, Ping An Bank, ICBC, NCI, PICC Group, PICC P&C, Ping An, CITIC Securities – H, China Galaxy Securities – H, and Far East Horizon.

Consumer/Lodging/Leisure/Healthcare China Mengniu Diary, China Modern Dairy, Hengan Intl, Gome, Shanghai Jahwa, Tingyi, Yili, Samsonite International S.A., Wuliangye Yibin, China CYTS Tours, BTG Hotels, China Travel, TravelSky, 3SBio, CSPC Pharma, China TCM Hengrui Medicine, Jointown Pharmaceuticals, Sinopharm Group, Sino Biopharmaceutical, Tonghua Dongbao, and The United Laboratories.

Oil &Gas/Power/Utilities/Property China Oilfield Services, CNOOC Ltd, PetroChina, Sinopec, Sinopec Engineering Group, SPC, BEWG, Beijing Enterprises, China Gas Holdings, China Everbright Int'l, China Everbright Greentech, Guangdong Investment, CR Gas, ENN Energy, Huadian Fuxin, Huaneng Power Int’l, Longyuan Power, Yangtze Power, China Vanke, COLI, Aoyuan, Logan, KWG, and Sunac.

Telecom/Internet/Technology/Metals & Mining China Mobile Corp Ltd, China Telecom Corp Ltd, China Unicom, Hikvision Digital, O-Film, Sunyway, Kstar, Tencent, Angang Steel, Baosteel, China Coal Energy, BBMG, Tianqi Lithium, and West China Cement.

Industry experts During the conference, 50+ industry specialists presented their views on the outlook for and issues facing various sectors, including automobiles, banking/finance, consumer, energy, Industrials, metals & mining, property, power and environmental, technology, and transportation.

Distributed on: 18/01/2018 17:09:28 GMT

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19 January 2018


Deutsche Bank AG/Hong Kong

Table Of Contents

Research Team Facebook ................................................... 6

Macro Highlights ............................................................... 16 Highlights of Macro Presentations ................................................................... 16

Automobiles & Components ............................................. 20 Minth Group (0425.HK, TP HKD 47.60, Buy, HKD 48.15) ................................. 20 Geely Auto (0175.HK, TP HKD 29.30, Hold, HKD 27.75) .................................. 21 SAIC Motor (600104.SS, TP CNY 30.50, Hold, CNY 33.88) .............................. 22 Yutong Bus (600066.SS, TP CNY 26.60, Buy, CNY 24.24) ................................ 23 Zhongsheng Group (0881.HK, TP HKD 15.7, Hold, HKD 20.85) ....................... 24

Banking / Finance .............................................................. 25 Agri. Bank of China (1288.HK, TP HKD 4.73, Buy, HKD 3.97) .......................... 25 Bank of China (3988.HK, TP HKD 5.25, Buy, HKD 3.99) ................................... 25 Bank of Communications (3328.HK, TP HKD 7.29, Hold, HKD 6.03) ................ 26 China Cinda (1359.HK, TP HKD 3.75, Buy, HKD 3.02) ...................................... 27 China CITIC Bank (0998.HK, TPHKD 5.28, Hold, HKD 5.44) ............................. 28 China Construction Bank (0939.HK, TP HKD 8.87, Buy, HKD 7.58) .................. 28 China Life (2628.HK, TP HKD 28.50, Hold, HKD 24.35) .................................... 29 China Merchants Bank (3968.HK, TP HKD 31.38, Hold, HKD 32.85) ................ 30 China Minsheng Bank (1988.HK, TP HKD 8.68, Hold, HKD 8.07) ..................... 31 Chongqing Rural Bank (3618.HK, TP HKD 7.00, Buy, HKD 5.91) ..................... 32 CEB (6818.HK, TP HKD 3.72, Hold, HKD 3.74) ................................................. 33 CPIC (2601.HK, TP HKD 51.00, Buy, HKD 37.35) ............................................. 34 Ping An Bank (000001.SZ, TP CNY 10.89, Hold, CNY 12.96) ........................... 34 ICBC (1398.HK, TP HKD 7.52, Buy, HKD 6.53) ................................................. 35 NCI (1336.HK, TP HKD 74.60, Buy, HKD 53.30) ............................................... 36 PICC Group (1339.HK, TP HKD 4.50, Hold, HKD 4.09) ..................................... 36 PICC P&C (2328.HK, TP HKD 16.60., Hold, HKD 15.80) ................................... 37 Ping An (2318.HK, TP HKD 104.10, Buy, HKD 82.25) ....................................... 38 CITIC Securities - H (6030.HK, TP HKD 21.10, Buy, HKD 17.54) ...................... 39 China Galaxy Securities - H (6881.HK, TP HKD 8.70, Buy, HKD 6.13) .............. 40 Far East Horizon (3360.HK, TP HKD 8.80, Buy, HKD 7.15) ............................... 40

Consumer .......................................................................... 42 China Mengniu Diary (2319.HK, TP HKD 26.80, Buy, HKD 24.20) .................... 42 China Modern Dairy (1117.HK, TP HKD 1.70, Hold, HKD 1.48) ........................ 42 Hengan Intl (1044.HK, TP HKD 97.29, Buy, HKD 81.35) ................................... 43 Gome (0493.HK, TP HKD 0.82, Hold, HKD 0.97) .............................................. 44 Shanghai Jahwa (600315.SS, TP CNY 30.04, Hold, CNY 35.16)....................... 45 Tingyi (0322.HK, TP HKD 13.28, Hold, HKD 15.50) .......................................... 46 Yili (600887.SS, TP CNY 35.00, Buy, CNY 34.62) ............................................. 46 Samsonite International S.A. (1910.HK, TP HKD 39.80, Buy, HKD 35.00) ........ 47 Wuliangye Yibin (000858.SZ, TP HKD 98.00, Buy, HKD 88.90) ........................ 48

Lodging/ Leisure ................................................................ 49 China CYTS Tours (600138.SS, TP CNY 20.00, Hold, CNY 21.86) .................... 49 BTG Hotels (600258.SS, TP CNY 35.00, Buy, CNY 29.35) ................................ 49 China Travel (HK) (0308.HK, TP HKD 3.10, Buy, HKD 2.79) .............................. 50 TravelSky (0696.HK, TP HKD 25.70, Buy, HKD 25.10) ...................................... 51

Healthcare ......................................................................... 52 3SBio (1530.HK, TP HKD 19.00, Buy, HKD 16.70) ............................................ 52 China TCM (0570.HK, TP HKD 4.70, Hold, HKD 4.55) ...................................... 52 CSPC Pharma (1093.HK, TP HKD 19.10 Buy, HKD 17.98) ................................ 53 Hengrui Medicine (600276.SS, TP CNY 78.10, Buy, CNY 71.25) ...................... 55 Jointown Pharmaceuticals (600998.SS, TP CNY 30.00, Buy, CNY 19.01) ........ 55

19 January 2018



Table Of Contents (Cont'd)

Sinopharm Group (1099.HK, TP HKD 34.30, Hold, HKD 34.20) ........................ 56 Sino Biopharmaceutical (1177.HK, TP HKD 16.80, Buy, CNY 14.10) ................ 57 Tonghua Dongbao (600867.SS, TP CNY 26.80, Buy, CNY 24.16) ..................... 59 The United Laboratories (3933.HK, TP HKD 6.30, Hold, HKD 6.27) .................. 59

Infrastructure / Industrials ................................................. 61 JONHON Optronic (002179.SZ, TP CNY 43.00 Buy, CNY 38.55) ...................... 61 CRSC (3969.HK, TP HKD 8.30 Buy, HKD 6.31) ................................................. 62 CRRC (1766.HK, TP HKD 9.00 Buy, HKD 8.45) ................................................. 63 NARI Tech (600406.SS, TP CNY 20.20, Buy, CNY 17.81) ................................. 64 Shenzhen Inovance (300124.SZ, TP HKD 34.30, Buy, HKD 28.30) ................... 65

Oil & Gas ............................................................................ 67 China Oilfield Services (2883.HK, TP HKD 9.13, Sell, HKD 8.80) ...................... 67 CNOOC Ltd (0883.HK, TP HKD 13.82, Buy, HKD 12.00) ................................... 68 PetroChina (0857.HK, TP HKD 5.77, Hold, HKD 5.80) ...................................... 69 Sinopec (0386.HK, TP HKD 7.44, Buy, HKD 6.23) ............................................ 69 Sinopec Engineering Group (2386.HK, TP HKD 9.40, Buy, HKD 8.37) .............. 71 SPC (0338.HK, TP HKD 5.20, Buy, HKD 4.78)/ (600688.SS, TP CNY 5.30, Sell, CNY 7.05) ......................................................................................................... 72

Utilities / Renewable / Environmental................................ 73 BEWG (0371.HK, TP HKD 7.40, Buy, HKD 6.06) ............................................... 73 Beijing Enterprises (0392.HK, TP HKD 53.80, Buy, HKD 46.15) ........................ 74 China Gas Holdings (0384.HK, TP HKD 23.80, Hold, HKD 21.55) ..................... 74 China Everbright Int'l (0257.HK, TP HKD 13.50, Buy, HKD 11.14) .................... 75 China Everbright Greentech (1257.HK, TP HKD 7.90, Buy, HKD 7.46) ............. 76 Guangdong Investment (0270.HK, TP HKD 13.2, Buy, HKD 10.38) .................. 76 CR Gas (1193.HK, TP HKD 35.40, Buy, HKD 26.25).......................................... 77 ENN Energy (2688.HK, TP HKD 65.50, Buy, HKD 52.20) .................................. 78 Huadian Fuxin (0816.HK, TP HKD 2.20, Buy, HKD 2.03) .................................. 79 Huaneng Power Int’l (0902.HK, TP HKD 6.00, Buy, HKD 5.10)......................... 79 Longyuan Power (0916.HK, TP HKD 7.40, Buy, HKD 5.67) .............................. 80 Yangtze Power (600900.SS, TP CNY 18.30, Buy, CNY 15.98) .......................... 81

Property ............................................................................. 82 China Vanke (2202.HK, TP HKD 41.38, Buy, HKD 37.75)/ (000002.SZ, TP CNY 34.53, Buy, CNY 35.99)..................................................................................... 82 COLI (0688.HK, TP HKD 30.63, Buy, HKD 29.05) ............................................. 82 Aoyuan (3883.HK, TP HKD 30.00, Hold, HKD 27.16) ........................................ 83 Logan (3380.HK, TP HKD 9.66, Buy, HKD 8.66) ............................................... 84 KWG (1813.HK, TP HKD 12.88, Buy, HKD 11.54) ............................................. 85 Sunac (1918.HK, TP HKD 46.00, Buy, HKD 39.05) ........................................... 86

Technology ........................................................................ 87 Hikvision Digital (002415.SZ, TP CNY 43.00, Buy, CNY 41.62) ......................... 87 O-Film (002456.SZ, TP CNY 23.00, Hold, CNY 20.33) ...................................... 88 Sunyway (300136.SZ, TP CNY 60.00, Buy, CNY 48.87) .................................... 89 Kstar (002518.SZ, TP CNY 21.00, Buy, CNY 17.38) .......................................... 89

Telecom ............................................................................. 91 China Mobile Corp Ltd (0941.HK, TP HKD 112.00, Buy, HKD 77.40) ............... 91 China Telecom Corp Ltd (0728.HK, TP HKD 4.55, Buy, HKD 3.76) ................... 91 China Unicom (0762.HK, TP HKD 15.50, Hold, HKD 10.74) ............................. 92

Internet .............................................................................. 94 Tencent (0700.HK, TP HKD 450.00, Buy, HKD 438.60)..................................... 94 Technology: China e-commerce ....................................................................... 95 Technology: China Internet ............................................................................... 96

19 January 2018




Technology: China Online Travel ...................................................................... 98 Ctrip meeting takeaways .................................................................................. 98 Tuniu meetings takeaways ............................................................................... 99 Technology: China Live Broadcasting ............................................................. 100 YY meeting takeaways ................................................................................... 101 Momo meeting takeaways ............................................................................. 102

Transportation ................................................................. 103 Beijing Cap Int'l Airport (0694.HK, TP HKD 12.30, Buy, HKD 12.68) .............. 103 Sinotrans (0598.HK, TP HKD 6.60, Buy, HKD 4.12) ........................................ 104 Transportation: Air China ................................................................................ 105

Basic Materials / Mining .................................................. 106 Angang Steel (0347.HK, TP HKD 8.00, Buy, HKD 7.49) .................................. 106 Baosteel (600019.SS, TP CNY 9.30, Buy, CNY 9.10)....................................... 106 China Coal Energy (1898.HK, TP HKD 5.35, Buy, HKD 4.01) .......................... 107 BBMG (2009.HK, TP HKD 5.62, Buy, HKD 4.10) ............................................. 108 CNBM (3323.HK, TP HKD 8.21, Buy, HKD 8.31) ............................................. 109 Conch Venture (0586.HK, TP HKD 25.75, Buy, HKD 21.20) ............................ 110 Anhui Conch Cement (0914.HK, TP HKD 46.00, Buy, HKD 42.90) ................. 111 Tianqi Lithium (002466.SZ, TP CNY 70.70, Hold, CNY 58.10) ........................ 113 West China Cement (2233.HK, TP HKD 2.25, Buy, HKD 1.29) ....................... 114

Industry experts ............................................................... 115 Automobiles & Components: China Auto Sector ............................................ 115 Consumer: China Education ........................................................................... 116 Consumer: China home appliances ................................................................ 117 Healthcare: China Healthcare ......................................................................... 118 Energy: China Oil & Gas ................................................................................. 118 Metals & Mining: Lithium battery industry ..................................................... 119 Energy: Asia Petrochemical ............................................................................ 120 Industrials: China Containerboard .................................................................. 121 Industrials: China Industrial Automation......................................................... 122 Industrials: China Infrastructure Construction ................................................ 123 Industrials: China Rail Equipment ................................................................... 124 Utilities/Renewable/Environmental: China Gas Utilities .................................. 125 China Renewables .......................................................................................... 126 Utilities/Renewable/Environmental: China Environmental .............................. 129

Tour: Energy – China Oil & Gas tour takeaways .............. 130 Trip takeaways: major refiners over teapots in 2018 ...................................... 130 Comp sheet .................................................................................................... 132 Trip Photos ..................................................................................................... 133 Key Charts ...................................................................................................... 134 Comments from teapot refiners ...................................................................... 135

Tour: Metals & Mining tour takeaways ........................... 138

Tour: Utilities – China Environmental tour takeaways .... 141 Tongzhou PPP project of Beijing Enterprises Water (371 HK) ........................ 142 Huaiyuan biomass treatment plant of China Everbright Greentech (1257 HK) and China Everbright Intl (257 HK) ................................................................. 143 Zhenjiang hazardous waste treatment project of New Universe Environmental (436 HK) .......................................................................................................... 144

Tour: Utilities – China Gas Utilities tour takeaways......... 145 AccessChina 2018 coal-to-gas trip takeaway ................................................. 145 ENN Langfang project .................................................................................... 146 Bestsun Energy ............................................................................................... 148

19 January 2018




Tianjin Jinran (1265 HK).................................................................................. 150 Binhai Investment (2886 HK) .......................................................................... 151

Tour: Global luxury trip in China ...................................... 153 Chinese luxury consumption: strong and getting more and more local ......... 153 1. Malls and landlords are more rational and mature as partners. Consolidation is expected ..................................................................................................... 153 2. Most brands notice that customers are different from the past. They are younger in age and know what they want ..................................................... 154 3. Most note a decline in ASP versus a few years ago ................................... 155 4. The daigou luxury market is believed to be USD50bn, according to iResearch ....................................................................................................................... 156 5. China should be a profitable business. ....................................................... 157 6. Online luxury spending by Chinese is mainly via tmall and jd but most brands prefer their own website ................................................................................. 157 7. Companies: the quick takeaway ................................................................. 158

Tour: Auto tour takeaways .............................................. 160 Remaining upbeat on premium brands and SUVs .......................................... 160 Great Wall Motor's (2333.HK, Sell; 601633.SS, Sell) Xushui plant visit .......... 162 SAIC Motor's (600104.SS, Hold) Lingang plant visit ...................................... 162 Great Wall’s management meeting ................................................................ 162 SAIC Motor's management meeting .............................................................. 163 Meeting with a new energy vehicle (NEV) industry expert ............................. 163 Yongda Auto's (3669.HK, NR) Roewe 4S store visit ....................................... 164 Geely Auto's (0175.HK, Hold) Lynk & Co showroom visit .............................. 164 Brilliance China ............................................................................................... 165 Zhengzhou Yutong Bus .................................................................................. 165 Great Wall Motor ............................................................................................ 166 Geely Auto ...................................................................................................... 166 SAIC Motor ..................................................................................................... 166 Sector risks ..................................................................................................... 166

Tour: China Handset field trip highlights ......................... 168 Sunway: a positive 2018 outlook and long-term prospects ............................ 169 O-Film: a positive growth outlook, but fairly priced ........................................ 169 AAC Technologies: the most diversified smartphone component play with multiple drivers ............................................................................................... 170 Valuations and risks ........................................................................................ 171

Tour: Takeaways of Chinese semiconductor trip ............ 172 SMIC’s 14nm operating loss to be higher than 28nm operating loss ............. 173 Catalysts and company risks .......................................................................... 173

19 January 2018



Research Team Facebook

19 January 2018



China/Hong KongMichael Tong, CFA China/Hong Kong HoR / Power / Equity Strategy+852 2203 6167

[email protected]

Michael Spencer, PhD Economics+852 2203 8303

[email protected]

Zhiwei Zhang, PhD Economics+852 2203 8308

[email protected]

Yi Xiong, PhD Economics+852 2203 6139

[email protected]

Michael Tong is head of Deutsche Bank's China/Hong Kong research team and also head of the RegionalUtilities/Renewable/Environmental Research team (ranked No.3 in Institutional Investor 2012/16 and Runner Up inother years since 2010). Before joining Deutsche Bank, he was a China utilities and equipment analyst in Hong Kong,and before that was part of another financial institution's global energy and utilities team, based in London. Michaelstarted his banking career in 1997; before that, he was a lecturer at Shanghai University. Michael has an MBA fromCambridge University, an MA in economics from the Shanghai University of Finance & Economics and a BSc inelectronic engineering from Tianjin University.

Michael Spencer is the Global Head of Economics Research and the Chief Economist and Head of Research in AsiaPacific. He manages all of the bank's economists world-wide and oversees the bank's equities, fixed income, credit,foreign exchange and economics research throughout the Asia Pacific region. Prior to joining Deutsche Bank in 1997,Michael was Senior Economist in the Research Department of the International Monetary Fund, which pioneered theIMF's surveillance of capital markets and financial system soundness in all its member countries. Michael has a Ph.D. and BA (Hons) from Queen's University, Canada and an MA from the University of Toronto and has publishednumerous articles on different aspects of financial economics in both academic and policy fora.

Zhiwei Zhang joined Deutsche Bank in October 2014 as Chief China Economist and Head of China Equity Strategy.Before moving to investment banking, he was from 2008 to 2010 the head of China macro research at the HongKong Monetary Authority. He was an economist at the International Monetary Fund from 2002 to 2008, workingmostly in the Research Department and the Asia and Pacific Department. He started his career as an economist atthe Bank of Canada in 2001. He has published widely in academic journals, including the Quarterly Journal ofEconomics, the Review of Economics and Statistics, and China Economic Review. He has a Ph.D. from theUniversity of California, San Diego, and a BA from the University of International Business and Economics in Beijing,China.

Yi Xiong joined Deutsche Bank in October 2017 as China Economist. Prior to joining Deutsche Bank, he was aneconomist at the International Monetary Fund from 2009 to 2017, working in the Asia Pacific, African, and EuropeanDepartments, the Strategy, Policy and Review Department, as well as at the Resident Representative Office inChina. Yi has a Ph.D. degree in Economics and a Bachelor of Science degree from Peking University in Beijing.

19 January 2018



China/Hong Kong (cont'd) Vincent Ha, CFA Autos & Auto Parts / Transportation

+852 2203 6247

[email protected]

Fei Sun, CFA Autos & Auto Parts / Transportation+852 2203 6130

[email protected]

Yuki Lu Autos & Auto Parts / Transportation+852 2203 5925

[email protected]

Hans Fan, CFA Banks+852 2203 6353

[email protected]

`

Franco Lam Banks / Credit Strategy+852 2203 6226

[email protected]

Vincent Ha joined Deutsche Bank in June 2007. He is a member of the Asia autos research team and the Asiatransportation research team, covering Greater China auto and aviation stocks. Vincent has worked in the financialsector since 2003 as both a buy-side and a sell-side analyst covering various sectors, including the autos. Vincenthas an MBA from Cornell University, a BSc in civil engineering from the University of Texas at Austin, and is a CFAcharterholder.

Fei Sun joined Deutsche Bank in October 2013 as a member of the Asia autos research team and the Asiatransportation research team. He has worked in the financial sector since 2009 as sell-side research analyst coveringvarious sectors. Fei holds an MSc from The University of British Columbia and a BBA from Shanghai Jiao TongUniversity, and is a CFA charterholder.

Yuki Lu joined Deutsche Bank in July 2015 through the Graduate Program and is a member of the Asia Industrialsteam. She has bachelor degree in Quantitative Finance from the Chinese University of Hong Kong.

Hans Fan joined Deutsche Bank in Oct 2013 as a financial analyst with a primary focus on Chinese banks, Chinesebrokers and Chinese asset management companies. He has 5 years of equity research experience covering Chinesefinancials and 3 years of corporate banking experience in China. Hans is a member of Deutsche Bank's Asian banksteam, which was ranked #2 by Institutional Investors in 2013, 2014 and 2015. He is a CFA and has a MSc(Economics) from Hong Kong University of Science and Technology and a B.A. (Economics) from Sichuan University.

Franco Lam joined Deutsche Bank in June 2013 to cover the Hong Kong, Singapore and Taiwan banks, withsecondary coverage of Malaysia banks. He has more than ten years of equity research experience and is part of theAsia Pacific Regional Financials team, which has been ranked No. 1 in the Greenwich Associates Survey for 2011and 2012, and No. 2 in the Institutional Investor Survey for 2013 and 2014. In addition to his equity research role, hehas expanded his coverage into credit research since 2016, with primary coverage of the Chinese leasing space.Franco is a CPA and obtained his Bachelor and Master's degrees in Accounting and Finance from WashingtonUniversity in St. Louis.

19 January 2018



China/Hong Kong (cont'd) Jacky Zuo, CFA Banks

+852 2203 6255

[email protected]

Edward Du Banks+852 2203 6185

[email protected]

Yan Lin Banks+852 2203 5929

[email protected]

James Kan Basic Materials / Oil & Gas+852 2203 6146

[email protected]

Sharon Ding Basic [email protected]

Jacky Zuo joined Deutsche Bank in July 2013 through the Graduate Program and is a part of Asia Pacific RegionalFinancials team. He has bachelor degree in Quantitative Finance (first-class hons.) from the Chinese University ofHong Kong.

Edward Du joined Deutsche Bank in July 2017 as a member of the Asia Pacific Regional Financials team, based inHong Kong. Prior to joining Deutsche Bank, Edward had 5 years of experience on the sell side, focusing on Financials and also the Technology sector. Edward holds a Bachelor Degree in Finance from National Taiwan University.

Yan Lin joined Deutsche Bank in August 2016 and is part of the Asia Pacific Regional Financials team. Prior to joiningDeutsche Bank, Yan had six years of experience in both London and Hong Kong in the Banking industry includingfour years on the sell side focused on the Basic Materials sector. Yan holds an MEng in Mechanical Engineering fromImperial College London.

James Kan is Head of Asia Commodities (Company Research). He joined Deutsche Bank's research team inSeptember 2009 as the Taiwan non-tech sector analyst and later moved to the China/Hong Kong research team asthe metal and mining analyst. Before his career in equity research, he was a business strategy consultant and an ITsales manager. James was a Fulbright Scholar and has an MBA from UCLA's Anderson School. He also has BA fromNational Taiwan University. Deutsche Bank's Asia Basic Materials team was ranked No.1 in the 2014 II Survey andhas remained in the top 3 since then.

Sharon Ding joined Deutsche Bank in April 2014 and is part of the Asia Metals & Mining research team. Prior tojoining Deutsche Bank, she worked as a research associate focusing on HK/China Metals & Mining for 4 years.Sharon has a bachelor degree from Shanghai Fudan University, majoring in Finance.

19 January 2018



China/Hong Kong (cont'd)Neil Sun Basic Materials / Oil & Gas+852 2203 6136

[email protected]

Anne Ling Consumer+852 2203 6177

[email protected]

Mark Yuan Consumer+852 2203 6181

[email protected]

John Chou Consumer+852 2203 6196

[email protected]

Louise Li Consumer+852 2203 6152

[email protected]

Neil Sun joined Deutsche Bank in August 2017 as a member of the Asia Pacific Metals and Mining Research team.Neil has six years of experience in the Banking industry: five years on the buy-side focused on the Industrials andUtilities sectors, and one year on the sell-side covering the Automobiles sector. Neil holds a B.B.A. in Finance fromNational Taiwan University.

Anne Ling joined Deutsche Bank in May 2004 as Regional Sector Head of Asia Consumer and Media Research. Shehas more than ten years of experience as a research analyst covering consumer/media sectors. Anne was previouslyvoted No.1 in Regional Consumer Discretionary in AsiaMoney and the Greenwich Survey and also previously wasnamed No. 3 in the Institutional Investor survey.

Mark Yuan joined Deutsche Bank's Consumer team in August 2015. Prior to joining Deutsche Bank, he worked as aresearch analyst covering the Consumer sector in China for four years on the sell-side. He also has four years ofexperience in M&A advisory and two years of experience in auditing. He graduated from Fudan University with aBachelor degree in Accounting.

John Chou joined Deutsche Bank in July 2010 through the Graduate Program and is part of the Asia Consumer andMedia research team. His research focus include textile & sportswear, restaurants and China pay-TV. He hasbachelor degree in Finance from National Taiwan University.

Louise Li joined Deutsche Bank in September 2017 as a member of the Asia Pacific Consumer Research team,based in Hong Kong. Before joining Deutsche Bank, Louise spent more than four years working in sell-side researchcovering the HK/China Consumer sector. Louise holds a Master's degree in Strategic Marketing from ImperialCollege London.

19 January 2018



China/Hong Kong (cont'd) Karen Tang Gaming & Lodging / Industrials

+852 2203 6141

[email protected]

Tallan Zhou Gaming & Lodging / Internet+852 2203 6464

[email protected]

Yoanna Wang Gaming & Lodging+852 2203 6197

[email protected]

Jack Hu, PhD Health Care & Pharmaceuticals+852 2203 6208

[email protected]

Megan Xu Health Care & Pharmaceuticals+852 2203 5928

[email protected]

Karen Tang is our Head of Asian Gaming & Hotels Research. She also covers the Hong Kong conglomerate stocks.For the past three years, she has been voted the No.1 Gaming & Lodging Analyst in the Institutional Investor survey.In 2011, she was also named Best Analyst in the Travel & Leisure sector by the Wall Street Journal for her stock-picking skills. Karen joined Deutsche Bank in 2003 and has more than 10 years of experience as a research analyst,previously covering the Hong Kong property sector. She graduated from the University of Cambridge, UK, with aMaster's degree in economics.

Tallan Zhou joined Deutsche Bank to cover the China Tourism and Leisure sector in March 2015 . Tallan has sevenyears of experience in the Consumer sector including four years on the sell-side based in Hong Kong and three yearsas an industry consultant. Tallan obtained his MBA at the Hong Kong University of Science and Technology.

Yoanna Wang joined Deutsche Bank in January 2018 as a member of the Asia Pacific Gaming & Hotels Researchteam, based in Hong Kong. Before joining Deutsche Bank, Yoanna had five years of experience in the Bankingindustry including two years on the sell side focused on the Gaming & Hotels sector. She holds a Bachelor's degreeof Economics and Finance from the Hong Kong University of Science and Technology.

Jack Hu joined Deutsche Bank in June 2010 and is Head of APAC Healthcare Research. Jack was ranked No. 1 in theInstitutional Investor All-China survey in 2015-2017. Previously, Jack worked for a hedge fund and was also a sell-side research analyst covering the U.S. biotech industry. In addition, Jack has worked in oncology marketing in thepharmaceutical industry. He has a Ph.D. in molecular genetics from the University of Texas M.D. Anderson CancerCenter.

Megan Xu joined Deutsche Bank in July 2017 as a member of the Asia Healthcare team. Prior to joining DeutscheBank, she had two years of Investment Banking experience in New York. Megan graduated from Cornell Universitywith a B.S. in Operations Research and Engineering.

19 January 2018



China/Hong Kong (cont'd) Sky Hong, CFA Industrials / Transportation

+852 2203 6131

[email protected]

Nick Zheng, CFA Industrials+852 2203 6198

[email protected]

Esther Chwei Insurance / Banks (Brokers)+852 2203 6200

[email protected]

Lexie Zhou Insurance / Banks (Brokers)+852 2203 6180

[email protected]

Han Joon Kim Internet / Tech-IT Services & Software+852 2203 6157

[email protected]

Sky Hong joined Deutsche Bank in August 2007, covering regional transport. Subsequently, Sky has expanded hiscoverage into the industrials space and currently heads DB's industrials research for Asia ex Japan. Previously, Skyworked as a sell-side analyst covering Hong Kong-listed stocks for about two years, and before that he was aconsultant. Sky has an MBA from Dalhousie University, Canada.

Nick Zheng joined Deutsche Bank in August 2015 to cover the China Industrials sector. Before joining DeutscheBank, Nick worked as a sell-side analyst covering China Infrastructure & Industrials for three years as a key memberof the top ranked research team in the Institutional Investor survey (#2 in 2012 & 2013 and #4 in 2014). Nick holds anMSc from Case Western Reserve University and a BEng from Shanghai Jiao Tong University.

Esther Chwei joined Deutsche Bank as Head of Asia Insurance research in July 2011. She has 11 years of equityresearch experience, having worked at both buy-side and sell-side, mainly covering insurance stocks in Asia. Prior toequity research, Esther worked as an actuarial consultant in New York for 3 years. Esther has an undergraduatedegree in Actuarial Science from University of Nebraska-Lincoln and a MBA from New York University.

Lexie Zhou joined Deutsche Bank in May 2014 as a member of the Asia Insurance research team. She has one yearof equity research experience covering insurance sector. Lexie obtained her Master degree in Financial Engineeringfrom University of Michigan, Ann Arbor and Bachelor degree in Finance from University of International Business andEconomics.

Han Joon Kim joined DB in September 2011 after working in corporate development at a leading internet company inKorea and five years of sell-side analyst experience covering the TMT industry before that. He had worked on thecorporate side prior to that, and also has entrepreneurial experience in the education consulting business. Han Joonhas a Bachelor of Arts degree from Columbia University in New York. He currently has regional coverage of NorthAsian internet stocks across China, Japan and Korea.

19 January 2018



China/Hong Kong (cont'd) Eileen Deng Internet / Tech-IT Services & Software

+852 2203 6227

[email protected]

Johnson Wan Oil & Gas / Basic Materials+852 2203 6163

[email protected]

Vitus Leung Oil & Gas+852 2203 6158

[email protected]

Eric Cui Oil & Gas / Basic Materials+852 2203 7443

[email protected]

Thomas Zhu, CFA Power+852 2203 6235

[email protected]

Eileen Deng joined Deutsche Bank in August 2015 and is part of the Asia TMT research team with a focus on theInternet sector. Prior to joining Deutsche Bank, she had more than four years of experience spanning both the sell-side and the buy-side focusing on the Internet, and one year of experience as an auditor at a Big Four accountingfirm. She received her Bachelor's Degree in Accounting & Finance and her Master's Degree of Finance from TheUniversity of Hong Kong.

Johnson Wan has been with DB for 9 years, leading coverage of Asia Oil and Gas equity research where the teamwas awarded RU in the 2015 Insitutional Investor survey. He is also in charge of Cement and Paper industryresearch, co-leading four consecutive Top 2 rankings for Basic Materials in the Institutional Investor survey between2013-2016. Johnson began his career in investment banking first as an equity sales trader and later as a fixed incomesales, before joining DB's top ranked property research team. Prior to DB, Johnson spent three years as amanagement consultant. Johnson has an MBA from the London Business School, a MA in Statistics from theUniversity of Michigan and a BSc in Mathematics and Computer science from the University of Toronto.

Vitus Leung joined Deutsche Bank's Asia Energy and Chemicals Research team based in Hong Kong in November2015. Prior to joining Deutsche Bank, Vitus had about nine years of equity research experience with primary focus onOil & Gas, Chemical, and Utility sectors. He was recognized as No.3 Top Earnings Estimator by StarMine in 2014 forEnergy & Chemical sector for both Asia and Hong Kong & China categories. Vitus graduated from University ofOregon with a Bachelor of Science degree.

Eric Cui joined Deutsche Bank in September 2017, assisting in the coverage of the Asia Oil & Gas and BasicMaterials sector, based in Hong Kong. Prior to joining Deutsche Bank, Eric had five years of sell-side researchexperience in Hong Kong, covering the China Industrials and Auto industries as well as Financials. He holds a MAdegree in Economics and a BE degree in International Shipping, both from Shanghai Jiao Tong University.

Thomas Zhu joined Deutsche Bank in August 2016 as a member of the Regional Utilities & Environmental Researchteam. Prior to joining Deutsche Bank he worked for seven years in sell-side research with a focus on theenvironmental sector in China. Thomas holds a Master's degree in Business and Bachelor's degree in Finance fromTsinghua University. He is also a CFA charter holder.

19 January 2018



China/Hong Kong (con'td) Hanyu Zhang Power

+852 2203 6207

[email protected]

Luka Zhu Power / Equity Strategy+852 2203 6173

[email protected]

Jeffrey Gao, CFA Property+852 2203 6256

[email protected]

Jason Ching, CFA Property+852 2203 6205

[email protected]

Stephen Cheung Property+852 2203 6182

[email protected]

Hanyu Zhang joined Deutsche Bank in April 2016 as a member of the Regional Utilities / Renewable / EnvironmentalResearch team. Prior to joining Deutsche Bank, he had four years of experience in sell-side research covering the oil& gas and utilities sectors. Hanyu holds a ,Masters degree in Financial Mathematics from Stanford University anddual Bachelor Degree of Finance and Applied Mathematics from Peking University.

Luka Zhu joined Deutsche Bank in April 2015 and is part of the Regional Utilities / Renewable/ EnvironmentalResearch team. Prior to joining Deutsche Bank, she had one year experience in buy-side research and one yearexperience in sell-side research covering utilities and energy sectors. Luka holds a Bachelor's degree of Accountingand Finance from the University of Hong Kong.

Jeffrey Gao joined Deutsche Bank as the Head of China/HK Property Research in February, 2017. He has over 11years of experience as a research analyst based in HK/Shanghai with a primary focus on the China property sector.Jeffrey has a master degree in Finance and Investment from The University of Nottingham and bachelor degree ofEconomics from Zhejiang University. He is also a CFA Charterholder.

Jason Ching joined Deutsche Bank's Hong Kong/China property research team in August 2010. He has ten years ofexperience as an equity analyst with a primary focus on China property. Before that, he was working at a privateequity fund focused on the Hong Kong/China property sector. Jason graduated from the University of Auckland inNew Zealand with a Bachelor of Property/Bachelor of Commerce in finance, and is a CFA charterholder.

Stephen Cheung joined our China/HK Property Research team in March 2017. Prior to joining DB he had three yearsof experience as a research analyst based in Hong Kong with a primary focus on the China property sector. Stephenhas a Master's Degree in Real Estate from The National University of Singapore and a Bachelor's Degree inQuantitative Finance from The Chinese University of Hong Kong. He is also a CFA charter holder.

19 January 2018



China/Hong Kong (con'td)Foo Leung Property+852 2203 6239

[email protected]

Peter Milliken, CFA Telecommunications+852 2203 6190

[email protected]

James Wang Telecommunications+852 2203 6145

[email protected]

Joe Liew, CFA Transportation+813 5156 6725

[email protected]

Foo Leung joined Deutsche Bank's Hong Kong/China property research team in April 2015. He has three years' sell-side research experience, with one year on Hong Kong/China property and other two years in small-mid capcompanies. Foo holds a Bachelor Degree of Social Science from City University of Hong Kong.

Peter heads Deutsche Bank's Asia-Pac telecom research team. He has direct coverage of Greater China and Japan,and indirect coverage of the rest of the sector. Prior to joining Deutsche Bank in August 2013, he worked as both ananalyst and investment manager including primary telecom coverage in Australia, China, Hong Kong, Indonesia,Singapore and Taiwan. He worked extensively on the sell-side until 2006, when he headed Asian developed markettelco research in the number 1 ranked Institutional Investor, Asia Telecoms Team. His experience also includesfundamental & quantitative prop trading plus four years at an Asian event fund.

James joined the Asian telecoms team in May 2015, having previously spent five years in DB's Australian researchteam covering banks and telecoms. Before joining DB James worked as a consultant in one of the Big Fouraccounting firms for five years. James was a qualified actuary and has also completed all three levels of the CFAcourse.

Joe Liew joined Deutsche Bank in May 2006, and assumed the role of Regional Head of Transportation Research inMay 2007. He led the regional transport team to a No.1 ranking in the 2010-2013 Greenwich survey, and the RUranking in the 2011-2013 & 2015 Institutional Investor surveys. In September 2016, he was appointed Head of JapanEquity Research, Deutsche Securities Inc. and continues to lead the Asian Transportation research team from Tokyo.Joe is a CFA charterholder and has a bachelor of commerce (first-class hons) in accounting and finance from theUniversity of New South Wales in Sydney, Australia.

19 January 2018



Macro Highlights

Highlights of Macro Presentations

Zhiwei Zhang, Ph.D, [email protected], (+852) 2203 8308

The 16th dbAccess China Conference was held on 8-12 January 2018 in Beijing, China. 27 speakers presented their views on China's economy from different aspects. Guest speakers included Shuli Hu (Caixin Media Founder and Editor in Chief), Jun Ma (Tsinghua University, Former Chief Economist at the PBOC Research Bureau), Vijay Vaitheeswaran (US Business Editor and former China Business Editor of the Economist), Xianchun Xu (Tsinghua University, former Deputy Head at the National Bureau Statistics of China), and leading experts from the policy circle, academia, industry, and the financial sector.

Key takeaways:

China's economic growth will slow down in 2018 as policymakers focus shift to growth quality.

GDP will likely be revised up in 2019 as a result of the economic census. This could provide room for lower growth in the next few years while maintaining the goal to double GDP by 2020.

Monetary policy will remain tight. PBoC's OMO rates will be higher in 2018. There is some chance that the benchmark rates may be hiked too.

Fiscal policy will tighten. Local governments will face tight constraints on its financing platforms and PPP projects.

Inflation will become more of a concern. In a live survey, more than 1/3 of the participants think that CPI will reach >3% in 2018. Price reform in public utilities and services may add to inflation pressures.

Real estate market will cool down. Smaller real estate developers will face tight financing pressures.

Innovation has great potential, where China is already at the forefront in some areas, including FinTech and green technology. Pearl River Delta will act as a hub for innovation.

Supply-side reform will continue its momentum in 2018, while SOE reform may gradually gain speed.

Main themes in the macro track Most speakers see a modest growth slowdown in 2018. Shuli Hu views 2017 as a key turning point for China, when government bodies and regulators reach consensus to prioritize quality growth over quantity. The most likely outcome for 2018 is a slight growth slowdown with some improvement in growth quality. Jun Ma expects a modest slowdown to 6.5% in 2018 owing to lower real estate and infrastructure investments. He is positive on manufacturing investment. Other speakers also concurred that growth will be lower in 2018, including Weichuan Xu, Bin Gao and Zhihui Huo.

19 January 2018



An important issue related to growth outlook is the likely GDP revision in 2019. Xianchun Xu, former deputy head of the National Bureau of Statistics, mentioned that China will conduct an economic census this year. The result will be released in 2019. Both of the past two rounds of census resulted in upward revision of GDP growth. In 2014 the cumulative GDP growth from 2009 to 2013 was revised up by 0.6%. In 2009 the cumulative GDP growth from 2005 to 2008 was revised up by 3.5%. As the new economy has been growing rapidly and has not been well covered by the current GDP accounting framework, the census will likely lead to another upward revision. If we assume the cumulative growth from 2014 to 2018 be revised up by 0.5%, it would only require GDP growth of 6.1-6.2% per year from 2018 to 2020 to reach the government's 2020 growth target. This would lead to more policy room for the government to tighten policies if necessary.

Policy wise, tightening is expected on almost all fronts. Jun Ma expects monetary policy to remain tight owing to continued deleveraging, US rate hikes, and forward-looking inflation pressures, though he is not sure whether benchmark rates will be hiked, given its complicated decision making process involving various agencies. Bin Gao thinks that repo rates will go up, and there is a risk that benchmark rates may be hiked too to contain property prices. Financial sector regulations will also be further tightened to curb shadow banking and reduce property market speculations, according to Bin Gao and Weichuan Xu.

On fiscal policy, tightening is expected especially for local government activities. Jun Ma expects the budgetary fiscal deficit to be reduced to below 3%. The new regulations on PPP projects, if strictly enforced, will have significant impact on the existing 4trn PPP projects as well as any new projects (Yongxiang Jin). City investment enterprises also faces higher debt burden and increasing financing pressures, with 0.9tn debt falling due in 2018 (Zhihui Huo).

The real estate market is expected to cool down. A number of speakers pointed out that real estate developers have the highest leverage ratio among all companies (Jun Ma, Xiaofen Tan, Zhihui Huo). With tightening financial conditions and deleveraging in shadow banking, Zhihui Huo expects meaningful credit default risk by smaller real estate developers in 2018, while large developers will further gain market share.

Inflation risk is on the rise. An live survey conducted on one conference session shows that 37% of the participants believe CPI inflation will be 3% or higher in 2018. An important policy change on this front, according to Yongxiang Jin, is an NDRC policy document issued in November (Doc. 1941) that points to price flexibility/liberalization in the area of public utilities and public services.

Speakers are generally optimistic about innovation in China. Conventional wisdom that China tech companies' success are based on "copy to China" and "just good enough" business models are out of date. Instead, Vijay perceives China as rapidly embracing innovation and is today amongst the leading countries in new technology entrepreneurship. China is at the forefront of FinTech, green technology, and many other fields. The Pearl River Delta is a hub for innovation and produces 10% of China's output and 25% of exports. China's advantages in innovation, in Jun Ma's view, is the world's largest population of tech professionals, and large amount of big data. Tao Sun suggested that Ant Financial has provided micro-financing to 6 million SMEs in China by utilizing big data and minimizing human labor involved in loan approval.

19 January 2018



Supply-side reform continues in 2018. In the steel industry, China is at about 2/3 of reaching the capacity reduction goal by 2020. This is faster than expected, and by end-2018 the goal could more or less be reached. After that, reform will continue in the area of replacing and upgrading the remaining capacity (Chen Yu). Environmental protection policy is also being forcefully implemented, with some 170 thousand firms affected in 2017 (Shuying Yang).

SOE reform may gradually speed up, starting with the pilot cases. China Unicom's mixed ownership reform sets a good example as the state gives out a large share of ownership in the reform. Challenges remain in balancing among various interest groups, introducing meaningful governance reform, and preventing loss of state-owned capital (Zhengjun Zhang).

List of macro track guest speakers Keynote speakers

Shuli Hu, Caixin Media Founder and CEO;

Jun Ma, Professor, Tsinghua University, Former Chief Economist at the PBOC Research Bureau;

Vijay Vaitheeswaran, US Business Editor of the Economist;

Xianchun Xu, Professor, Tsinghua University, former Deputy Head at the National Bureau Statistics of China.

Other Macro track speakers

Frank Ding, CIO, Fountaincap Research & Investment;

Weichuan Xu, China Hub Leader, International Finance Corporation;

Bin Gao, CIO, Invealth Capital;

Peter Weiss , Head of Economic & Financials Affairs Section, European Union to China;

Thomas Notheis, Representative in China, Deutsche Bundesbank;

Adam Cagliarini, Chief Representative, China, Reserve Bank of Australia;

Chen Yu, Senior Analyst, Mysteel;

Shuying Yang, Deputy Director, Policy Research Centre for Environment and Economy Ministry of Environmental Protection;

Zhengjun Zhang, Founding Partner & Chief Executive Officer, King Parallel Consulting;

Tao Sun, Senior Director, Ant Financial Services Group;

Shu Li, Partner & Managing Director, Boston Consulting Group;

Bin Xu, Vice Dean, Global Innovation Exchange Institute of Tsinghua University;

Hanming Fang, Class of 1965 Term Professor of Economics, University of Pennsylvania;

Yongxiang Jin, General Manager, Dayue Consulting;

Xiaoming Li, Professor, Peking University;

19 January 2018



Yongmiao Hong, Ernest S. Liu Professor of Economics and International Studies, Cornell University; Dean of Wang Yanan Institute for Studies in Economics, Xiamen University;

Zhihui Huo, Vice Director of Rating Technology, China Bond Rating Co.;

Xiaofen Tan, Professor and Associate Dean, School of Finance, Central University of Finance and Economics.

DB analysts, including Zhiwei Zhang (Chief China Economist), Juliana Lee (Chief Asian Economist), Hans Fan (China Financial Analyst), Michael Tong (Head of China/HK Research) and Linan Liu (Greater China FIC/Asia Rates Strategist) also provided their latest views.

19 January 2018



Automobiles & Components

Minth Group (0425.HK, TP HKD 47.60, Buy, HKD 48.15)

Fei Sun, CFA, [email protected], (+852) 2203 6130

Minth attended our Access China Conference on 8-9 January. The following are the key takeaways from investor meetings:

- FY17 update: Management commented that business operation has been tracking in-line with their expectation last year. For full-year FY17, the company maintained its 15% revenue YoY and 20% net profit growth. Despite a slight margin dip in 1H17, management still target to achieve 34-36% gross margin for FY17.

- Gross margin trend: The company attributed its decent gross margin to 1) mix improvement due to faster growth in aluminum products; 2) global platform orders; and 3) diversified customer base. Minth expects gross margin for aluminum products to remain robust going forward. The major raw materials are steel and aluminum. Management believes that the impact of raw material price increases on margin will be less than 1% given Minth's strong vertical integration capability.

- New orders: Minth targets to record RMB4.5bn new order intakes last year and the company is confident to achieve the target. For 2018E, management believes the company is able to record a higher new contract value vs. 2017.

- Capex: Management attributed the increase in capex in 1H17 to 1) increasing new order wins; 2) capacity expansion at Huai'an, Jiaxing and Mexico plants; and 3) production facilitates automation. Therefore, FY17 capex is expected to reach RMB1.6bn vs. RMB1.2bn in 2016. In addition, FY18E capex is expected to remain at high level, according to Minth.

- Minth's new products radome for ACC (adaptive cruise control) radar is expected to contribute a small amount of revenue this year and the margin of radome is higher than the company's average margin thanks to tight global supply.

Deutsche Bank view - Buy on aluminum growth and upward margin trend Maintain Buy on strong growth of aluminum products, an improving product mix, robust new order intake and a secure order backlog of RMB86.5bn. Our target price is set at FY18E P/E of 18.0x, c.60% above its mid-cycle P/E of 11.4x to reflect our optimistic view on strong growth in aluminum products. This is justified, in our view, since we expect the company to deliver a 21.8% three-year EPS CAGR in FY16-19E.Key downside risks: 1) weaker auto sales volume; 2) inability to acquire new customers; 3) any market share loss of existing clients; and 4) unexpected increase in raw material prices.

19 January 2018



Geely Auto (0175.HK, TP HKD 29.30, Hold, HKD 27.75)

Vincent Ha, CFA, [email protected], (+852) 2203 6247

Geely attended our Access China Conference on 8-9 January. The following are the key takeaways from investor meetings:

- In 2017, the growth rate of China vehicle market slowed down to about 3.5% while the sales performance discrepancy between better players and underperformers widened. As amongst the top performers in sales growth, Geely sold 1.25m passenger vehicles in 2017, up 63% YoY, mainly thanks to the popular models like the Boyue SUV.

- Management remains conservative on China auto demand in 2018E and expects auto sales growth to stay at low single-digit level due to the end of the purchase tax cut for small-engine cars. Geely is confident on gaining more market share with more new launches, with its 2018 sales target set at 1.58m units as announced on 8 January.

- Geely will strive for Lynk & Co’s breakeven (or slight profitability) in 2018E, despite high initial costs. The JV just launched the “01” SUV in December 2017, and will launch the “02” crossover/”03” sedan in 2018.

- The company’s export should improve as its first overseas CKD plant in Belarus has reccently commenced production and will supply to Eastern Europe. Geely will also attempt to penetrate into the ASEAN market with its Malaysian partner.

- Longer term, Geely remains confident in achieving 2m units of annual sales (including the Lynk & Co brand) by 2020E, also with an increasing proportion of new energy vehicle sales.

- The company foresees relatively flattish capex YoY in FY18 (excluding potential acquisition of capacities from the parent).

- Geely will consider increasing its payout ratio going forward, as the company is no longer restrained by a dividend payout ratio limit after early repayment of the USD300mn debt facility.

Deutsche Bank view – sector-leading operational performance in the price Geely announced on 9 January that its FY17 net profit is expected to surge by about 100% YoY, which is marginally higher than our expectation. The company's FY18E targets seem attainable to us, considering the strong sales of the new models. We base our target price on an aggressive 18.0x FY18E P/E. This is justified, in our view, by Geely's FY17-19E two-year core EPS CAGR of 22%. We have a Hold rating given limited share price upside. Key upside risks would be better-than-expected new model sales and margins. Key downside risks would be slippage in sales momentum and margin pressure.

19 January 2018



SAIC Motor (600104.SS, TP CNY 30.50, Hold, CNY 33.88)


SAIC Motor attended our Access China conference on 10 January. The following are the key takeaways from investor meetings:

- SAIC expects China passenger vehicle (PV) sales volume to grow by about 3-4% YoY in 2018 and commercial vehicle (CV) to decline by 6-8% YoY. In total, China vehicle sales volume will grow 2-3% YoY in 2018. The company thinks ASP will continue to go up given mix improvement.

- SAIC expects the SUV segment to remain the growth driver and will make up half of total PV sales in the next 2-3 years. To benefit from the faster growth, the company will launch more SUVs in FY18E, and expects SUV to account for at least 30% of its total sales. Meanwhile, management thinks price competition in the SUV segment will intensify, especially for low-end SUVs.

- SAIC sold 60k new energy vehicles (NEV) in 2017 and target to double that this year. To support this goal, the company will launch 7 NEV models, 4 of which will be pure electric cars and 3 will be plug-in hybrids. SAIC will continue to be a local brand leader in NEV technologies, such as for the battery management system, and will implement a flexible strategy in R&D while complying to the national standard. Going forward, the company will also widen its battery supplier base.

- SAIC is one of the biggest auto financing groups in China. By 2020E, its auto financing business will probably contribute c. RMB6.5bn net profit (FY16: RMB3bn). The company's auto finance business is mainly operated by two subsidiaries, namely the 100%-owned SAIC Finance and the SAIC GMAC JV. The total loan balance at yearend 2017 is c. RMB200bn.

- SAIC sold 520k local brand vehicles and expects to sell 650k-700k units in 2018. The gross profit margin of the local brand is around 20%. Excluding R&D, operating profit improved in 9M17. The company expects profitability to continue to improve going forward.

Deutsche Bank view In 2017, SAIC achieved 6.8% YoY vehicle sales growth. Going forward, we expect SAIC Motor's sales momentum to be sustained with further product mix improvement. On a high base, we envision a stable earnings growth trajectory for the company, which should support its generous dividend payout. We maintain Hold on SAIC Motor because we think the current valuation is fair. Key downside risks include: 1) a weak reception for its new models from various SAIC brands; 2) pricing pressure amid industry competition; and 3) worse-than- expected local brand profitability. Key upside risks include: 1) better-than- expected sales volume and pricing; and 2) better-than-expected local brand profitability.

19 January 2018



Yutong Bus (600066.SS, TP CNY 26.60, Buy, CNY 24.24)


Yutong Bus attended our Access China Conference on 8 January. The following are the key takeaways from investor meetings:

- Yutong sold 67,568 units of buses in 2017 (-5% YoY), including c.25k units of new energy (NEV) buses. Among the total NEV bus sales volume, c.90% was public buses. According to Yutong, it recorded over 10% YoY NEV bus volume growth in 4Q17. However, pricing has been trending lower in 4Q17.

- Management expects the company to achieve a 27-28% market share in NEV bus market in 2017 (33% in total bus market including conventional buses), a slight YoY increase with industry NEV bus sales declining more than 10% YoY.

- For 2018E, the company believes it will continue to outgrow the overall market and remains positive on NEV bus sales in 1Q18 given the delay of the subsidy cut.

- The company will strive to maintain the relatively stable profitability of its NEV buses and expects to partially mitigate the negative impact from the reduced NEV bus subsidy through raising net-subsidy selling price and supplier cost reduction (i.e. battery cost).

- Management comments that about 60% of the public transportation bus sold in 2017 were NEV buses. Despite the cuts in NEV bus subsidy in 2018-20, the company believes that the public transportation field would still be government’s main focus to promote the country’s vehicle electrification in future.

- Yutong believes the recently announced new subsidy policy provides great opportunities to industry leaders with advanced technology, such as Yutong, to further gain market share in the NEV bus market. It has been investing in NEV field for many years already and its NEV products offer better user experience and lower full life cycle maintenance costs compared to competitors.

Deutsche Bank view - maintain Buy on increasing contribution from NEV bus Despite the impact on margin due to possibly lower subsidies in 2018, we believe that major NEV makers such as Yutong can probably mitigate this in the long run by lowering production costs (e.g. battery and scale effects). Maintain Buy given our optimism on Yutong's increasing profit contribution from NEV bus segment. Our target price is based on 14x FY18E P/E (unchanged), c.30% above Yutong's mid-cycle P/E of 11x to reflect our optimism on increasing profit contribution from the new energy bus. Key downside risks include: 1) unexpected changes in the Chinese government's new energy bus subsidy policy; 2) weaker-than-expected new energy bus demand; and 3) market share loss in new energy buses.

19 January 2018



Zhongsheng Group (0881.HK, TP HKD 15.7, Hold, HKD 20.85)


Zhongsheng attended our Access China conference on 10 January. The key takeaways are as follows:

- New cars sales – In FY17, Zhongsheng sold c.340k new cars, out of which luxury brand contributed more than 40%. YTD, the trend of new car sales have been positive and the company expects its new car sales volume to grow c.15% YoY and revenue to grow c.20% YoY at its existing 4S store network.

- Store network – At yearend 2017, Zhongsheng had 286 stores, with the number of luxury stores surpassing that of mid-to-high end stores. The company plans to open at least 10 new stores in FY18, while remaining on the radar for M&A targets with payback period of less than 5 years.

- After-market business – Zhongsheng continues to expect strong after-market sales revenue growth, mainly driven by throughput increase.

- Margins – Management is optimistic that there is still upside on new car margins, although It would be tough to return to historical high level in 2012. For luxury brands, Zhongsheng targets to achieve gross margin of more than 4.5% in future. The company also expects its net profit to grow as it is expanding businesses like auto finance referrals and used car sales. In the long run, Zhongheng aims to achieve c. 4% net profit margin.

- Inventory – Zhongsheng successfully controls its inventory turnover days at around 1.1 months in general, down from the 2015 peak level of 2 months.

- Auto financing – The penetration rate of auto financing of Zhongsheng is around 40%. The company mostly earns commissions from auto financing business, without extending much leasing services using its own balance sheet.

- BMW stores – Currently Zhongsheng has 15 BMW 4S stores, located in first-tier and second-tier cities. In 2018, the company expects to expand to over 20 BMW stores.

- Audi stores – Zhongsheng expects growth potential within Audi brand to improve. Besides, the contribution of used car sales at Audi stores is higher than company average.

Deutsche Bank view We maintain our Hold rating as we think Zhongsheng's strong earnings growth momentum would normalize a bit in FY18-19E with limited further upside to new car sales margin after a substantial rebound in FY17E. Key downside risks: 1) weakening demand for Japanese OEM products; and 2) weaker-than-expected premium brand sales growth. Key upside risks: 1) strong sales from both Japanese and premium brands, and the consequent margin enhancement; and 2) more value-accretive M&A.

19 January 2018



Banking / Finance Agri. Bank of China (1288.HK, TP HKD 4.73, Buy, HKD 3.97)

Hans Fan, [email protected], (+852) 2203 6353

Agricultural Bank of China (ABC) attended our Access China 2018 conference in Beijing today, and below are key takeaways: Revenue ABC's NIM is likely to expand modestly in 2018. Fee income growth in 2017 was actually quite good, if one-off impact is excluded, and the growth may continue in 2018.

Asset quality The bank's NPL balance may continue to drop, with lower formation and higher write-offs. ABC has geared up efforts to dispose NPLs. The better asset quality is underpinned by better corporate profitability, especially in mining, manufacturing, retail and wholesale trades. Due to countercyclical considerations, provisioning has room to go up.

Loans Loan demand stayed strong. The bank will focus on high-quality corporate loans and individual loans. The mix is likely to be similar to 2017.

Deutsche Bank view ABC is one of our top picks, as we see it as a key beneficiary of: 1) higher market rates, given its strong deposit franchise; 2) better corporate financial health; and the bank is likely to be the target of Southbound buyers, due to it having the highest dividend yield and a wide A-H premium.

Bank of China (3988.HK, TP HKD 5.25, Buy, HKD 3.99)


Bank of China (BOC) attended our Access China 2018 conference; we list the key takeaways below: NIM Management expects NIM to go up modestly, as there are more positive factors than negative ones. Positive factors include: 1) new bond yield will go higher and stay elevated in 2018; 2) loan pricing should increase, as new bond issuance is falling, thus pushing up loan demand; 3) the asset yield of overseas business will go up, likely growing faster than CNY-denominated business; 4) on the liabilities side, funding cost increases are lagging behind asset yields, as market-based funding makes up only c.10% of liabilities. This is partly offset by fast-growing market-based wholesale funding.

Loans It is unlikely to change the loan mix much. Loans to manufacturing sectors may make up the majority of corporate loans. Mortgage loans remain attractive assets for banks. Overcapacity sector loans will modestly decline.

19 January 2018



Asset quality The bank is likely at the bottom of the asset quality cycle. Over the medium to longer term, asset quality pressure should be relieved. Near term the NPL ratio may be stable or trend down, as corporate financial health and macro trends are resilient. Provision wise, during good times banks normally increase provision coverage.

“Belt and Road” related lending BOC is on track to extend US$100bn credit to “Belt and Road” projects. The bank is not only looking at financing products, but also at financial advisory services. Asset quality here remains stable, as it is mainly about sovereign risk and completion risk. Project risk is low, due to cooperation with large local companies and government.

Deutsche Bank view BOC is one of our top picks (the other one is ABC [1288.HK, HK$3.92, Buy]), as it is a key beneficiary of: 1) improving corporate financial health due to its highest exposure to industrial enterprise; 2) US rate hikes, leading to faster NIM recovery for BOC than for its peers; 3) “Belt and Road” strategy. The bank trades at the lowest valuation among all four big banks (0.6x 2018E P/B). If we strip out BOCHK (1.6x 2018E P/B), the rest of BOC is valued at only 0.5x P/B versus a 12% ROE.

Bank of Communications (3328.HK, TP HKD 7.29, Hold, HKD 6.03)


Bank of Communications (BoCom) attended our Access China 2018 conference in Beijing today, and below are key takeaways: NIM BoCom sees NIM as flattish or going up slightly in 2018 and it might go up faster if the PBOC hikes the benchmark rate (faster loan repricing). The loan repricing should more than offset the slightly rising deposit rate. Major banks currently price deposits at 1.3x benchmark rate and this should not change much going forward. The bank may lift deposit growth in 2018 and cut interbank liabilities modestly. Funding duration should go higher, with lower growth in demand deposits.

Loan/asset growth Asset growth and loan growth may slow down in 2018, but there is no balance sheet contraction pressure. The absolute new loan increase should be similar to 2017 and retail loans should account for over 50% of the new loan mix (more credit card/consumer loans and few mortgage loans). On corporate lending, SME loans may grow faster. Overall loan duration may contract in a rising interest rate environment.

Credit cost and asset quality Credit cost should be similar to 2017, if IFRS 9 impact is not considered. The bank expects stable asset quality and the difference between overdue loans beyond 90 days and NPLs should be reduced. They are still in the process of assessing IFRS 9 impact.

19 January 2018



Fee income BoCom expects fee income growth to accelerate in 2018 with credit card fees running at 20%-30% growth and no impact anymore from VAT. Agency fee growth is likely to rebound, but WMP fees might decline.

WMP The bank had around Rmb1.6trn WMP balance, of which 40%-50% is on balance sheet, booked under retail/corporate/interbank deposits. In 2017, WMP growth at the bank was higher than the industry average. 80% of WMPs were invested in the bond and interbank market, 10% in non-standardized credit assets and the rest in equity and overseas investment. BoCom had around 10% NAV-type WMP, ranking the top among peers. The bank sees that the WMP demand from retail is still strong and they are waiting for the final version of asset management guidance to assess the business impact.

China Cinda (1359.HK, TP HKD 3.75, Buy, HKD 3.02)

Jacky Zuo, [email protected], (+852) 2203 6255

China Cinda attended our Access China conference today in Beijing. The key takeaways are as follows:

On NPL acquisition, Cinda expects that the overall NPL supply in 2017 from banks may be slightly higher than the previous year. In 2016, total bank NPL supply in the open market was Rmb550bn with Rmb480bn transacted amount, according to Cinda’s data. However, the NPL pricing has been rising – the average transacted price was 37 cents in 1H17 for the primary market (34 cents for Cinda), higher than ~30 cents in the past years. This was mainly due to 1) better quality NPLs sold from banks and 2) more participants in the NPL market such as local AMCs. Cinda will be cautious in bidding new NPLs with an expected IRR target at 15%-20%.

On new distressed business opportunities, although banks’ NPL ratio has moderated, the absolute NPL amount was still elevated, and the company sees increasing distressed asset supply from corporate receivables on the back of supply side reform.

On synergies with NCB, the company views this bank license as improving its comprehensive servicing ability to corporate customers. NCB can help achieve full life cycle service to distressed corporates after they return to normal operation. Cinda also requires corporate customers to open accounts at NCB as a custodian bank to monitor cash flow.

On a new round of market-oriented debt-to-equity swap (DES) business, Cinda will be selective in finding target companies. For the recently conducted 5 DES deals, Cinda will send board members to the DES companies and set detailed terms in the contract to ensure smooth implementation. No guaranteed return is promised in these deals.

On new capital rules, Cinda sees very limited impact as it already followed the initial window guidance document released in 2016 to manage capital and maintained sufficient buffer at each level of capital requirement. They see the new capital rules encouraging AMCs to focus back on distressed asset management businesses.

On IFRS 9, Cinda is still assessing the impact internally and may release capital impact numbers in the 2017 financial report in March. IFRS 9 will be fully applied to 1H18 reporting.

19 January 2018



China CITIC Bank (0998.HK, TPHKD 5.28, Hold, HKD 5.44)


China CITIC Bank (CNCB) attended our Access China 2018 conference in Beijing today; we list the key takeaways below:

Loans Loan demand is expected to be stronger than in 2017. The bank will scale up lending exposure to high-quality corporates; meanwhile, credit card and personal consumption loans will remain major drivers on the retail banking side. Regarding loan pricing, largely two-thirds of loans were priced above the benchmark rate and this portion has increased.

Deposits Management expects deposit growth to rebound in 2018 as 1) part of the funds in off balance sheet WMPs might flow back to deposits; and 2) it turned more aggressive on supply chain financing development, helping to attract deposits from corporate clients’ upstream/downstream customers.

Asset allocation strategy CNCB contracted RMB450bn-worth of assets in 9M17, including: 1) RMB250bn low-efficiency assets; 2) RMB150bn interbank WMPs; and 3) RMB40bn NSCA (non-standard credit assets). Management indicated the asset adjustment is currently almost complete, and it expects the asset base to see mild yoy growth in 2018. The main driver is the loan business.

Regulations The document with the greatest impact in 2018 will be the asset management guideline, which is pending for the final version to be released. Management indicated that if investment in NSCA is restricted, the solution for banks’ WMPs would be 1) transferring NSCA to Non-NSCA; and 2) shifting credit demand back onto the balance sheet loan book. CNCB’s WMP balance is currently c.RMB1.3tr, among which off balance sheet WMPs are RMB910bn. NSCA accounted for c.30% of total WMPs. If NSCA is excluded from qualified investment, WMP investment’s credit rating requirement in bonds will gradually be lowered down, and the equity investment portion might be enlarged, aiming at maintaining yield.

Asset quality Overall asset quality has trended better. But concerns remain on the existing corporate loan book.

China Construction Bank (0939.HK, TP HKD 8.87, Buy, HKD 7.58)


China Construction Bank (CCB) attended our Access China 2018 conference; we list the key takeaways below: NIM Management expects NIM to expand further on a qoq basis. The key driver is higher asset yield, especially higher loan yield. While funding cost is also on the rise, CCB’s liabilities are mainly deposit-funded and funding cost increase may lag asset yield. The bank has been very strictly containing funding cost; this is now one of the lowest among peers.

19 January 2018



Loans The new loan amount may be slightly smaller than in 2017, as economic growth and M2 are slowing. Mix-wise the bank will continue to focus on the infrastructure, mortgage, emerging strategic sectors, and environmental protection, etc. Meanwhile, consumption loans and credit card installment loans are now strategic focuses, with decent yield and asset quality. In general, the mix between retail and corporate customers will be more balanced. Non-loan asset-wise, the bank may increase investment in municipal bonds (due to lower tax and stronger deposit attractions), but may decrease investment in corporate and policy bank bonds.

Residential rental financing This new business will focus on two elements: 1) construction financing, including investment banking, ABS, and bond issuance for corporate customers; 2) financing provided to tenants. This business should strengthen CCB’s ability to acquire new customers. The credit risk should be relatively low. For example, individual customers under tenant financing are good-quality customers, mainly junior staff in high-tech sectors and who should have promising career outlooks.

Asset quality The bank’s asset quality has stabilized since 2016 and management sees a stable or better asset quality trend in 2018. Credit cost is likely to increase slightly due to IFRS9 implementation. However, in 2018 credit cost may remain stable or decline mildly.

Other highlights The cost-to-income ratio is unlikely to go down too much, as it is already one of the lowest globally. While the key regulations remain under consultation and it is still too early to assess the impact accurately, it is clear that banks may bring more off-balance-sheet items onto on-balance-sheet, which is good for banks to boost returns. The implementation of IFRS9 will increase credit cost due to wider scope and life-cycle approach. However, banks with relatively less off-balance-sheet commitment and stricter NPL classification, including CCB, should be less impacted.

China Life (2628.HK, TP HKD 28.50, Hold, HKD 24.35)

Esther Chwei, [email protected], (+852) 2203 6200

China Life representatives attended our Access China conference on Monday . Key takeaways were as follows:

On jumpstart (JS) sales, the company sees challenges in growing volume this year and expects yoy decline. The main reasons include: 1) more competition from bank WMPs, which are yielding ~5.5% and are more attractive than insurance products, 2) impacts from No.134 regulations, new savings products can only pay interest/dividends starting year 6, which are less attractive to customers and are more difficult to sell, and 3) a later start of jumpstart sales preparation than peers in Nov-Dec. The company estimates that JS accounted for ~1/3 of full year’s FYP and ~10-15% of VNB in 2017.

19 January 2018



On 2018 growth outlook, the company will increase its focus on protection business. It targets to double its protection business to Rmb30bn in 2018 (vs. Rmb15bn in 2017), which should make up for the lower NB margin from this year’s JS products (at 30-40%). The company also expects 17-20% premium growth in 2018, based their new 5-year plan.

On agency, the company’s focus has shifted to agent productivity instead of agency growth. The company has an agency force of ~1.63mn currently, and expects single digit growth going forward. The company has removed the target on 10yr+ premium payment from their KPI, instead has included a sales target for protection business.

On investment, the company’s stocks and funds (market sensitive assets) accounted for 13-14% of investments as of 3Q17, with Rmb30bn investment in H-share through SHSC. It has increased its NSI steadily in 2017, with an average yield of 6%. Among NSI, the company has PPP inv of ~Rmb20bn with duration as long as 20 years. The company has overseas inv of US$7bn, ~2% of total inv, which is quite low because of the strict FX regulations.

China Merchants Bank (3968.HK, TP HKD 31.38, Hold, HKD 32.85)


China Merchants Bank (CMB) attended our Access China 2018 conference; we list the key takeaways below: Retail banking remains the focus CMB stays strategically focused on retail banking, with the profit and loan contribution above 50% of total. Among peers, the bank recorded the largest private banking AUM, the largest credit card transaction volume and the second largest wealth management AUM. Fintech will be the key driver for its retail banking, as CMB invests 1% of profit before tax in fintech.

NIM The bank expects NIM to remain flattish this year under a normal case, while management does not exclude the possibility of potential fluctuation. The bank's NIM of 2.4% is higher than most of its peers. The qoq decline in NIM in 3Q17 was due mainly to RMB10bn credit card NPL ABS; it also issued another ABS in 4Q17, which might be slightly negative to NIM. Funding cost in 2018 may increase, but the magnitude of increase should be smaller than in 2017.

Asset and liability: The new loan amount in 2018 is expected to be less than in 2017. Mix-wise, management expects two-thirds of new loans to be made to retail customers, and the other one-third to corporate, which is similar to the distribution in 2017. Among corporate loans, 70% is likely extended to strategically focused customers. Deposit growth in 2018 may increase. The qoq decrease in the deposit balance in 3Q17 was due mainly to intensified short-term deposit campaigns by peers. The bank aims to scale back the balance of interbank CDs.

19 January 2018



Asset quality NPL formation is currently running at c.100-110bps of average loan balance, versus 224bps in 2016. The continual asset quality trend is likely to be sustained into 2018. SML/overdue loans have declined in both volume and ratio, underpinned by improving corporate financial health.

Other highlights On the new asset management guidelines, the new rules will be positive for the banking industry by cracking down on some bubbles. CMB has just completed a preference share issuance, and management indicated there are no plans for further capital raising in the near term.

Deutsche Bank view In our view, CMB is fundamentally a solid bank and we like its retail banking franchise and private company-centric loan book. However, the 80% valuation premium of CMB over big-four banks does not seem to be justified by the fundamental difference.

China Minsheng Bank (1988.HK, TP HKD 8.68, Hold, HKD 8.07)


China Minsheng Bank (MSB) attended our Access China 2018 conference and the key takeaways are as follows: MSE lending MSB has started to re-emphasise MSE lending (micro and small enterprises) due to: 1) higher loan yield (7%-8%), 2) good loan demand, and 3) better asset quality management. It had Rmb350bn MSE loans (13% of loan book), up Rmb30bn from year-beginning, and the growth rate may accelerate further in 2018. The definition of an MSE loan is a loan size less than Rmb5mn and the current average MSE loan size is only Rmb1.2mn at MSB. With the increasing MSE exposure, MSB is likely to be a beneficiary of a targeted RRR cut. The NPL formation ratio of MSE loans in MSB was quite high before 2015 but now approaches a similar level as overall loans. The bank has been asking MSE borrowers to add collateral in the past few years and now 73% of MSE loans are collateralised (most with property). It targets a 90% collateralised ratio in the future. The bank had over 3mn MSE customers, and 70% of new MSE customers in 3Q17 were acquired through referral by existing customers.

New loan allocation and bond investment In 2018, over half of new loans will be extended to the retail segment including MSEs, credit card and consumption loans (mortgage growth may be moderate), with less than half going to the corporate segment. Overall loan growth at the bank is restrained by funding and liquidity requirements. For other asset allocation, the bank will continue to control overall bond investment and interbank assets.

Funding cost and NIM The company will continue to improve its deposit structure by getting rid of high cost wholesale funding/structural deposits and seeking more deposit business from private companies and listed companies (instead of SOEs, as was the case during 2015-16). The bank does not think major banks will compete on deposit pricing. It expects NIM to continue rising from the 3Q17 level in 2018, driven mainly by loan repricing. Single-month NIM in September 2017 was already higher than 2Q17.

19 January 2018



Fee income MSB remains positive on fee income growth with credit card fees likely to sustain at 20%-30% growth. In 2017, fee income growth slowed down due to weak agency fees.

WMP The balance was Rmb1.1trn-1.2trn. ~30% of WMPs were invested in non-standardised credit assets such as infrastructure and transportation projects with 3-5 years' duration. On new asset management rules, the bank sees the actual impact may be smaller than expected, given the grace period.

Capital The bank still has Rmb20bn preferred share quota and will issue Rmb50bn convertible bonds (pending approval).

Chongqing Rural Bank (3618.HK, TP HKD 7.00, Buy, HKD 5.91)


NIM trend Management expects NIM to expand in 4Q17 and in 2018, due to stable retail funding. Chongqing Rural Commercial Bank (CRCB)’s deposit rates are already the highest in rural Chongqing vs. other peers, so the threat from deposit competition would be insignificant.

Loan Management sees new loan amounts in 2018 as likely to remain stable. In the past few years, CRCB has lent out all the annual loan quota approved by the regulator, given intact loan demand in Chongqing district. Sector-wise, loans to manufacturing, infrastructure and water resources are still the main focus of 2018. Although consumption loan demand has risen in Chongqing recently, the contribution may be small, given the relatively smaller scale.

Asset quality Its overdue loan ratio, which surged to 2.92% in 1H17 vs. 1.53% at end-2016, was mainly from a few SOEs’ delayed payment. Management indicated the ratio has declined, with those SOEs' interest/principal repayment. It was also mentioned that overall asset quality in Chongqing is stable. As of 3Q17, the bank's coverage ratio came in at 435%, the second highest among listed banks. Management is still looking to building up reserves, to weather any potential downturn.

Other highlights (IFRS9, fundraising, regulation) Management expects to see further tightening of scrutiny of the overall financial sector; financial de-leverage will be further focused and strengthened, in relation to which some smaller banks will notably suffer. Normalised credit cost will see a yoy decline in 2018 if excluding the impact from IFRS 9. CRCB has already applied for A-share listing on 5 January 2018, targeting to issue RMB1,357m shares.

19 January 2018



Duetsche Bank view We upgraded CRCB to Buy on 2nd January 2018, as: 1) we see it as a key beneficiary of higher market rates, due to its solid deposit franchise; 2) capital concern was recently removed on the back of the completion of a private placement; and 3) the valuation is attractive at 0.7x PB against 15% ROE.

CEB (6818.HK, TP HKD 3.72, Hold, HKD 3.74)


NIM Management mentioned that NIM trended better qoq in 4Q17 vs. a qoq decline in 3Q17, and it expects NIM to be stable or slightly higher yoy in 2018. On the asset side, management also expects the yield to see a yoy increase.

Loans Overall liquidity conditions will remain tight in 2018. The bank completed a HKD31bn fund-raising at end-2017, so the overhang capping loan growth from the low capital ratio will be removed. Sector-wise, CEB will continue to follow the government’s instruction to support the real economy, i.e., lending to the infrastructure, medical, education, consumption, and environmental protection sectors.

Asset quality Regarding credit cost, apple-to-apple credit cost might see a yoy decline in 2018, if excluding the impact of IFRS9. NPL formation continued to see a decline in the past year, so management believes overall asset quality will trend better into 2018. On the other hand, CEB still see pressure from over-capacitied industries and zombie companies, while management also mentioned systematic risk is less likely.

Other highlights Double-digit yoy growth in fee income is set to continue in 2018, underpinned by rising consumption demand, wealth effect and so on. The slower fee income growth in 3Q17 (only +3% yoy) was due mainly to seasonality and some accounting treatment. For IFRS9, there is no impact to the bank's 5-category loan classification. The overall impact of IFRS9 on the bank is expected to be positive given the higher coverage ratio should enable it to weather the downturn. Regarding the new guideline on the asset management sector, management expects the impact on CEB’s funding to be manageable, once all WMPs are asked to be shifted off-balance sheet.

19 January 2018



CPIC (2601.HK, TP HKD 51.00, Buy, HKD 37.35)


CPIC representatives attended our Access China conference on Tuesday. Key takeaways are as follows:

On jumpstart (JS) sales, similar to peers, the company also confirmed a relatively weak JS this year, but noted that it is still early stage as the JS season will last until end-March. Besides rising competition from bank WMPs and tightened regulations, the company also highlighted its own high base effect (Jan-17 FYP growth of 70-80%, leading the industry) and relatively later start of pre-sales (with more time spent on agency training). This year, the company will focus on annuity savings products (flat NB margin vs. 2017 JS) in Jan, and will shift focus to LT protection business for the whole year. Historically, JS accounted for ~40% of full year FYP and ~1/3 of VNB.

On 2018 outlook, the company will continue to drive value growth, and continue to target higher-than-industry-average VNB growth. The company expects to maintain stable growth in 2018 and thinks it is unlikely to repeat the exceptionally strong growth momentum achieved in 2017.

On agency, the company has ~1mn of total and does not set any target for agency number. Instead, it will focus on improving agency productivity and income in 2018. Despite the likely weakness in JS sales, the company encourages agents to increase income by optimizing product mix (products with higher NB margin generate higher commissions) and by cross-selling (auto, health and health management products). The company maintains a decent LT policy activity ratio of ~50-60% and 13M retention rate of ~40%. With advantages in tier 2-3 cities, CPIC is now making more efforts to penetrate urban areas, as a way to increase productivity.

On P&C business, the company’s key focus is underwriting profitability and will start to increase growth once satisfactory underwriting profitability is achieved. Given its business restructuring in 2014-16, the company’s growth is still below industry-average. After the second auto premium reform, the company’s expense ratio remains high though there has been improvement in loss ratio. The company expects competition to remain intense in auto insurance with upward pressure on combined ratio. In terms of non-auto, agriculture ins will be a key focus. CPIC has seen strong growth and is now the third largest agriculture insurer, after PICC and China United.

Ping An Bank (000001.SZ, TP CNY 10.89, Hold, CNY 12.96)


Ping An Bank (PAB) attended our AccessChina 2018 conference and we set out the key takeaways below: Retail banking In addition to online expansion, its 1,000 banking outlets will be fully transformed into retail-focused outlets. The management is very focused on strengthening technological ability. The bank’s capex in IT infrastructure rose by 20% yoy versus peers’ yoy decline in general. Meanwhile, the bank’s IT team has increased from 100 people to 1,800, who are mainly focused on developing the retail business.

19 January 2018



Asset quality Management still sees pressure in relation to asset quality, and will continue to lift provision expenses in 2018. The NPL ratio is set to be maintained at the current level (ie. 1.75% in 3Q17). PAB will gradually exit overcapacity sectors once lending exposure matures going forward. The bank has established an asset management division, dedicated to NPL disposal/recovery themselves, instead of selling NPLs to AMCs. Management mentioned its corporate banking business is still in a transition period, and overall asset quality is likely to bottom out by end-2018.

Capital raising The bank has announced it is to issue Rmb26bn in convertible bonds, which will enhance its CET1 by 1.38% per the bank's calculation. Besides, it also has a tier 2 bond issuance plan, aimed at collecting Rmb30bn and boosting CAR by 1.3%.

Deutsche Bank view We have a Hold rating on PAB, as we think it will still take some time for the bank to realize fundamental recovery. The challenges now, in our view, are mainly on asset quality and rising funding costs, even though we see its retail banking franchise as a sweet spot.

ICBC (1398.HK, TP HKD 7.52, Buy, HKD 6.53)


ICBC attended our Access China 2018 conference; we list the key takeaways below: Revenue Asset yield is on the rise in 2018, driven by higher loan and bond yields. Funding cost is also increasing but only a bit. So, net net, ICBC’s NIM is likely to expand modestly. Fee income may come under pressure, as WMP fees are likely to be affected by new, tighter regulations. But the magnitude is pending until the regulation details are known.

Loans and asset allocation In 2018, ICBC plans to issue domestic loans largely at the same scale as in 2017. Its corporate loan book will focus on infrastructure, manufacturing, logistics, education, medical care, tourism, etc. In terms of the individual loan book, mortgage loans will see decent growth. Mortgage pricing is also on the rise, with a low default rate. For non-loan assets, the bank plans to invest more in the bond market, especially local government bonds, whose after-tax yield is actually higher than that of loans. The bank is less impacted by bond price correction, as the majority of its bond investment is in the held-to-maturity category.

Asset quality The bank expects stable asset quality with possibly a lower NPL ratio. Region- wise, asset quality pressure is mainly concentrated in western and northeastern areas. Provision coverage will go above 150%, but is unlikely to go too high.

Impact from IFRS 9 With wider scope for provision charges (including off-BS guarantee) and changes in methodology, IFRS9 will drive up the provision and lower capital base. But management expects this to have only a mild impact.

19 January 2018



NCI (1336.HK, TP HKD 74.60, Buy, HKD 53.30)


NCI representatives attended our Access China conference on Tuesday. Key takeaways are as follows:

On jumpstart (JS) sales, the level of decline has moderated to <20% currently. As it is at the early stage of JS, there is still time to adjust product mix depending on sales development. The company noted while there is little change in product margin vs last year, its product mix has improved with protection business accounting for ~33% of JS sales so far (vs 25% in 2017 JS).

On 2018 outlook, the company will focus on growth this year and is cautiously optimistic on the outlook. The key focus will be on health business, rider attachment, agency growth and productivity improvement. The company targets Rmb3bn of rider sales in 2018 and expects this to help increase premium per policy, agent productivity, and customer stickiness (annual rider renewal). Riders as % of main policy was ~1/3 in 2017, with premium per rider of Rmb800 and commission rate of ~10-30%.

On agency, the company targets to achieve 450k agents in 2018 (vs 350k in 2017) with an increased focus on activity ratio. Their agents’ monthly average activity ratio is around 48% currently, and the company expects this to be stable/slightly increase in 2018. Currently, new agents account for ~55% of total agency force with 13M retention rate of ~35% and 25M of 16-17%. Monthly average agent income has exceeded Rmb5k as of 3Q17, with manager level income at >Rmb13k. The company expects agent income to continue to increase drive by better product mix (20yr+ payment policies have commission rate of >50%) and higher premium per policy.

On core KPI, in addition to VNB, VNB growth, net profits and % of 10yr+ regular FYP, the company has added new KPI for 2018 which includes: 1) premium growth, 2) ROE and 3) VNB growth vs. peer average. The company also expects expense to continue to improve, with more flexible arrangement in expense structure.

PICC Group (1339.HK, TP HKD 4.50, Hold, HKD 4.09)


PICC Group representatives attended our Access China conference on Monday. Key takeaways were as followed:

On jumpstart (JS) sales, the company recorded a yoy decline during the first few days of Jan-18, which is an industry-wide phenomenon. Besides the impact from No. 134 regulations and rising bank WMP yield, the company also noted tighter regulations on agency sales activities announced on Dec 29, 2017, which has also had a negative impact on sales. The company has held a meeting to increase resource allocation to JS sales, and expects the sales to continue towards end-March. JS sales has usually accounted for ~40% of full year premium for PICC Life.

19 January 2018



On 2018 outlook, the company has not set any target on premium volume, and sees flat growth as a reasonable outcome. However, it has set a target for regular FYP at Rmb30bn in 2018 (vs. >Rmb20bn in 2017) and expects a smaller scale of single FYP. In terms of agency force, the company aims to achieve 350k agents in 2018, vs. 250k in 2017.

On investment, the company has over Rmb800bn of inv assets currently. Fixed income asset accounts for 70% of investments, of which finance bond accounted for ~12% and corporate bond for ~18%. NSI accounted for 23% of total inv (1H17). The duration of life assets is ~5+yrs and liability is ~8 yrs.

Figure 1: Forecasts

Source: Company data, Deutsche Bank estimates

PICC P&C (2328.HK, TP HKD 16.60., Hold, HKD 15.80)


PICC P&C representatives attended our Access China conference on Monday. Key takeaways were as followed:

On the second auto insurance reform, all three top players have experienced similar trends: 1) a decline in premium per policy and 2) a relatively stable combined ratio. Smaller players may continue to use high commissions to compete for market share in some regions. However, according to the company PICC has been sensible and has put stronger focus on profitability.

On the outlook for auto insurance, the company will continue to focus on three aspects: 1) to maintain an industry average premium growth, 2) to maintain a better-than-industry average combined ratio, and 3) to make sure its premium increase is higher than that of Ping An.

On the business transformation, the company held a transformation conference in Jun-17, highlighting 4 key focuses:

To strengthen its relationships with intermediaries to increase its bargaining power;

To cut costs in both operation and management, including cutting staff cost through a more efficient and flat organization structure, and to lower operating expenses by adopting new technology;

To optimize customer service by allocating more expenses towards improving customer services, which could be funded by its efforts to lower sales commissions;

To increase customer stickiness. The company expects new car sales to moderate, hence the key to future growth will increasingly be from renewal business.

19 January 2018



On agriculture insurance, the company is unlikely to see a repeat of the exceptionally low combined ratios (in the 80’s %) seen in the past, as this is a business heavily reliant on government subsidies. Nonetheless, the company has always seen this as a strategic business and is devoted to building a comprehensive rural network. Agriculture insurance recorded an 11ppt yoy increase in 1H17 expense ratio, mainly on the establishment of rural networks and IT support.

Ping An (2318.HK, TP HKD 104.10, Buy, HKD 82.25)


Ping An representatives attended our Access China conference these two days. Key takeaways are as follows:

On jumpstart (JS) sales, Ping An has led listed peers so far in terms of sales performance as the company is well prepared for regulation 134 transition. Its new JS products have a higher NB margin vs last year and the company has increased agency training to sell more complicated policies. Its strong agency expansion, with 1.43mn agents as of 3Q17 (+8.2% qoq) should also help. Ping An management remains confident that it could achieve double-digit value growth for 2018.

On the life business, the company has focused more on the sales of protection business, and has started pushing sales of Ping An Fu earlier than previous years. The company aims to achieve higher contribution from protection business in 2018 (vs. 73% of agency VNB or 66% of total VNB in 1H17). The company will continue to monitor its agency growth and productivity improvement, and sees agency income growth as the key indicator for business development. The monthly average salary of Ping An agents grew 14% to RMB7,200, which is ~1.2x national average wage. The company expects to achieve double-digit agency growth in the next few years, and to achieve 2mn agents in the next 3-5 years. It targets agents' monthly average salary to reach 1.5x of national average wage.

On technology, the company focuses on technological application in financial businesses specifically to: 1) lower customer acquisition cost, 2) improve customer acquisition efficiency, 3) improve customer service experience and 4) upgrade risk management. The SAT (Social-Agent-Telcom) model in its life business leverages on two social media sites, i.e. Wechat and Ping An Jin Guanjia, to increase agent-customer interaction. The company believes technologies has helped increase the frequency of customer interaction and improve customer stickiness. Ping An acquired 20mn new customers in 9M17, of which 6mn were from online ecosystem.

On investments, the low rate environment in the past 2 years has had a limited impact on the company’s overall investment yield, thanks to their allocation to longer duration assets. The company sees good reinvestment opportunities amidst current rising yields and tighter liquidity environment. For equities investment, the company increased allocation to stocks and funds in 1H17 and had identified some good opportunities in H-shares. It will continue to seek good investment with low valuation, decent dividend and stable earnings.

19 January 2018



CITIC Securities - H (6030.HK, TP HKD 21.10, Buy, HKD 17.54)

Lexie Zhou, [email protected], (+852) 2203 6180

CITICS CFO, Mr. Ge, attended our Access China conference today. Key takeaways are as follows:

On business mix, the current mix of balance sheet-related vs fee based is around 4:6. In terms of fee-based business, the company’s brokerage commission rate has been declining over the past few years to a net commission rate of 3.5bps currently. The company expects the decline to continue going forward. The company sees great growth potential in wealth management (WM) business, i.e. the business with high net worth customers. The company has ~50k customers with investable assets of >Rmb100bn but the current service provided is quite simple. It will seek to provide more customized value-added services to better service this segment and to cater to their risk appetite going forward.

On ROE, current ROE is ~8%, though management deems >10% to be a satisfactory level. The company attributed current low ROE to 1) low profitability of overseas assets, which has a balance of Rmb100-110bn, 2) relatively low efficiency in the use of assets, with lending assets accounting for ~80% of domestic self-funds, which are stable but haves a low margin. Assets with low risk and high profitability, such as direct inv and OTC options, are still small. 3) Low leverage with ample room to leverage up. ROE could improve if leverage were to increase from 3.5x currently to 4.5x in the next two years.

On business outlook, as the dependence on index and turnover continues to decline, the company sees key growth drivers as WM business for HNW customers, FICC and overseas business. It continues to see sustained pressure in fixed income (FI) market in 2018, but notes the limited size of FI prop trading assets of <Rmb20bn. The company has focused on shorter asset duration and a longer liability duration strategy, with average FI asset duration of 1 year. For every 100bps increase in bond yield, the impact is manageable at ~Rmb-300mn. In terms of margin financing and stock repo, the company will continue to expand the business while keeping credit risk in check. The target is to maintain the market leading position at 7-8% market share. The company also looks to diversify trading, especially in overseas markets.

On asset management (AM) business, despite a large AUM of Rmb1.7trn currently, the company acknowledged the relatively low quality, with ~Rmb1trn channel business charging 2-3bps fee rate. The company recorded a slight increase in active AUM to Rmb730bn, however, ~90% is in fixed-income assets, which charges a low fee. Going forward, the company doesn't aim for AUM growth, but will look to improve AUM mix, with an increase in active AUM and equities assets.

19 January 2018



China Galaxy Securities - H (6881.HK, TP HKD 8.70, Buy, HKD 6.13)

Lexie Zhou, [email protected], (+852) 2203 6180

Galaxy representatives attended our Access China conference on Wednesday. Key takeaways are as follow:

On brokerage, the current industry average commission rate was ~3.9bps, which is still well above the breakeven point. The company believes sector-wide commission rate will continue to decline. Galaxy has a breakeven point of ~2.5bps and it has been able to achieve a commission rate that is consistently 8-10% higher than industry average since 2014, thanks to its continued improvement in service diversity and quality.

On investment banking (IB) business, the company recorded 50-60% yoy decline in 9M17 IB fees, mainly dragged by debt underwriting. Moreover, weak market demand and intensified competition (and thus lower fee rate) had also contributed to its lower underwriting fees. The company is actively reforming its IB segment. Key initiatives include: 1) a new management team and new recruits of IB staffs, which have been in place in 2017; 2) introduction of market mechanism with flat management structure; and 3) higher focus on project pipeline, with IPO pipeline introduced as an important KPI. The company expects improvement in its IB business in 2018, and targets to achieve higher market position in the long run.

On asset management (AM) business, the company recorded strong growth in 1H17 and has reached AUM of >Rmb300bn currently. The increase was mainly driven by entrusted business from both banks and corporates (higher fee rate). Although the company proactively moderated AUM growth in 2H17, it was still able to achieve positive growth (despite a sector-wide decline) thanks to its relatively low AUM contribution from channel business. The company expects its AUM expansion to continue in 2018.

On prop trading business, the size of the company’s equities prop trading assets was Rmb10bn, and fixed-income assets was Rmb30-40bn (mainly in bonds rated AA and above with relatively short duration of 2-3 years). However, the company noted a relatively weak prop trading performance in 2017, mainly due to 1) impacts from bond market volatilities, especially since Oct-17 and 2) below-industry average equity performance on the back of government mandated investments.

Far East Horizon (3360.HK, TP HKD 8.80, Buy, HKD 7.15)

Jacky Zuo, [email protected], (+852) 2203 6255

Far East Horizon (FEH) attended our Access China conference today in Beijing. Key takeaways are as follows:

On asset growth, it guided ~25% on-balance sheet asset growth in 2018, driven by strong leasing demand and moderate ABS issuance. Meantime, the company will continue issuing perpetual bonds to lower leverage. We estimate 1H17 asset-to-equity leverage dropped to 6x if all perpetual bonds issued in 2H17 are considered. FEH said the new asset management rules may affect the private ABS issuance, which accounted for around 20% of total ABS issuance.

19 January 2018



On funding, the borrowing cost for new bank loans has risen to over 5% (5%-10% premium over benchmark rate) due to rising market rates. Nevertheless, the company remained confident of passing through higher funding costs to leasing customers. The company will continue to raise overseas funding, given the elevated domestic rate environment.

Asset quality was stable as it now mainly focuses on dealing with the top 60% corporate customers in each industry.

On hospital operations, the company plans to expand hospital bed numbers to 20k in 2018 from 10k-12k currently, and to spin off and list the hospital segment in 2019-2020. The improving margin in the hospital business mainly comes from: 1) expanding hospital capacity, and 2) declining operating costs. On school operations, it plans to open at least 70 high-end kindergartens in the next three years, from five as of 1H17.

On regulatory change, there is ongoing discussion to switch regulators from MOFCOM to CBRC. Although there is no final decision yet, the company thinks regulation tightening would have a limited impact on FEH, given its leading position in the industry. In fact, it may trigger sector consolidation, which would benefit FEH in the medium to longer run. A recent update is the Shenzhen Finance Office took over supervision responsibility of all leasing companies in the city but has not issued any new regulation yet.

19 January 2018



Consumer

China Mengniu Diary (2319.HK, TP HKD 26.80, Buy, HKD 24.20)

Mark Yuan, [email protected], (+852) 2203 6181

Sales growth improvement on track Management expects sales growth in 2H17 to have been better than in 1H17 (8% yoy in 1H17), helped by recovering industry demand and improving operating efficiency. For 2018, management expects an equal or higher number than in 2017. The growth would be driven by volume resilience and stabilized pricing. The company will launch several new products in 2018, such as new flavors of UHT yoghurt, the A2 children's milk. Meanwhile, a more balanced supply in the upstream could ease the competitive environment.

Visibility in margins remains low due to rising raw material costs On gross margin, there will be cost pressure in 2018 due to rising raw milk and packaging costs. The management has no plans yet to raise prices, as competition remains intense. It will try to offset the cost hikes through a mix upgrade and firmer control of price promotions. On selling expense ratio, the company will allocate more of the budget from promotion to branding, especially in view of 2018 World Cup related events. G&A expense ratio should be stable in 2018.

Yashili and CMD: sequential earnings recovery Management expects sales growth at Yashili, its main infant formula subsidiary, to recover from 2H17. It targets double-digit top-line growth and a break-even in the bottom line in 2018. As for China Modern Dairy (CMD), its main upstream associate, their cooperation on branded products is on track and the rising raw milk price could support its earnings recovery in 2018.

Our view: further growth recovery in 2018 We expect Mengniu to sustain its sales growth recovery in 2018, driven by improving industry demand, easing competition and improving operating efficiency. While management is prudent in margin, we think it should be able to pass through the cost pressure with a mix upgrade and by reducing promotions. We reiterate Buy on the stock with a target price of HK$26.8 (based on the DCF method, factoring in 3.9% RFR, 5.6% ERP, 1.0 beta, a debt-free structure and 2% terminal growth). The next catalyst will be its results release. Downside risks: food safety issues and oversupply.

China Modern Dairy (1117.HK, TP HKD 1.70, Hold, HKD 1.48)


Raw milk price to recover gradually Management indicates the industry herd size declined 16% in 2017, following 10% decline in 2016. With benefit from cow yield improvement, the national raw milk supply could decline by around 10% yoy in 2017. Management indicated the raw milk price was at Rmb3.8/kg in 2017, implying an HoH improvement from Rmb3.6/kg in 1H17 to Rmb3.9-4.0 in 2H17. It forecast the raw milk price to increase 3% yoy to Rmb3.9/kg in 2018.

19 January 2018



Upstream: resilient volume growth; stable feeding cost Management expected that annual per cow output volume ("cow yield") have increased 3% yoy to 9.7 tons in 2017. It targets to increase the cow yield by 3% to 10tons in 2018. Meanwhile, helped by increasing milkable cow ratio, management targets a 9-10% yoy production volume growth in 2018. On cost side, the US drought weather might impact in alfalfa supply in the near term, but management do not expect major feeding material price to increase in 2018.

Downstream: cooperation with Mengniu to help margin improvement From 2H17, CMD begin to sell its downstream branded products to Mengniu on a 3% fixed market up. Mengniu's sale team will take responsibility of distribution and marketing. Therefore CMD's loss in branded segment could be reduced from 2H17. In future, the company are planning to setting up a JV with Mengniu in branded business and it will sell its branded products to the JV directly.

Target to achieve break even and positive free cash flow in 2018 Management target to achieve break even in 2018, based on its budgeted raw milk price at Rmb3.9/kg (before considering potential impairment of account receivable). On free cash flow, it does not have expansion in near term and the maintenance Capex will be Rmb1bn per year, and it target to achieve positive free cash flow in 2018.

Hengan Intl (1044.HK, TP HKD 97.29, Buy, HKD 81.35)

Anne Ling, [email protected], (+852) 2203 6177

Hengan attended our China conference and the following are the key takeaways:

2018 to continue with its amoeba strategy launched in 2Q2017 Management believes that its amoeba strategy is tracking close to its expectation so far on sales growth and opex reduction. Thus, for 2018, it hopes that for sanitary napkins and tissue, it will be able to resume its better than market sales growth momentum. For baby diaper, it hopes to resume sales growth after a weak 2017 performance (as seen in its 1H17 results). Apart from the existing products, it will also launch cotton puff and tampons in 1H18.

Raw material cost trend and opex ratio With wood pulp price increased from USD620/tonne to currently ~ USD800/ tonne, there is continued pressure on GPM as experienced in 1H17. However as it raised its effective ex-factory price in Oct 17 through fewer promotion rebates to distributors, its GPM pressure in 2H is likely to narrow vs 1H17. For 2018, based on the current cost trend, GPM pressure will continue in 1H18 for tissue. However, management hopes that it will be offset by the lower opex to sales ratio if sales growth is in line with expectation. Opex in absolute dollars might increase in 2018 with higher A&P and despite the staff cost reduction.

Deutsche Bank view We believe our 2018 sales estimate of 10% sales growth, of which around 8ppt is for existing product categories and 2ppt is new products, is broadly within management’s expectation. Our 2017 sales growth estimate is 4.2%, which we believe might be slightly on the high side, based on our recent channel checks. Our opex ratio forecast is 24.8% for 2018 and 24.9% for 2017.

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During the conference, investors also raised the concern of higher oil price based on the current trend, which might affect the cost of petroleum-related products, which are the key raw materials for sanitary napkins and baby diapers. These type of raw materials accounted for ~ 69% of COGS for both sanitary napkins and diapers. According to management, such cost also increased in 2H17 and product mix upgrade was able to offset the cost increase. We believe there is a risk here but if the market recovers, brand owners can either through increase in ex factory prices, reduce promotion or mix shift.

Gome (0493.HK, TP HKD 0.82, Hold, HKD 0.97)


The CMO of Gome attended our Access China and delivered a presentation related to Gome’s new retail strategy. As mentioned in 3Q results meeting, the company launched “Home + Living” strategy in 3Q17. The key highlights of this strategy are as below.

It targets to extend its business scope from CE retailer to a home-related retailer, i.e. its market potential will extend from RMB1.4tri CE products to RMB10tri home-related products market (including home appliance, home decoration, household, home service, etc). For now, decoration business is seeing the best growth due to better synergy.

Its new business will expand to 400 cities including all country-level stores.

It is mainly technology that empowered this new strategy. It integrated different shopping scenarios, supply chain and full circle after-sales service.

Supply chain: Differentiated products contributed 47% of sales for Gome, which is much than peer and helped to lift its GPM from 16.1% in 2016 to 17.8% in 1H17.

Integrated Omni-Channel retail: Gome fully integrated its offline and online channel with different roles.

After-sales service: Big data, cloud computing and other technologies created a “five- in-one” platforms (i.e. physical retail, ecommerce, service platforms, social platform such meimei, Meixin and Circle, and sharing platform, such as ME shop) to improve consumers’ shopping experience. Among all, ME shop is what it is focusing on and it tried to reduce traffic acquisition via this platform as it is a C2C platform. The GMV generated from this shared platform amounted to RMB1bn during 9M17. It also targets to serve 100m households in three years.

19 January 2018



Shanghai Jahwa (600315.SS, TP CNY 30.04, Hold, CNY 35.16)


Shanghai Jahwa attended our China conference and the following are the key takeaways:

2017 was a transitional year for Jahwa. Their business structuring mainly focused on brand building, new product launch and channel restructure.

Brand equity. Its focus in 2017 was on Liushen ( for 1H17) and Herborist (for 2H). It appointed brand endorsers Mr Hua Chenyu for Liushen and Ms Liu Tao for Herborist which helped refresh the brand image and increased brand awareness effectively. It also invested more on digital advertising to cater for new consumer behavior trend. In 2018, it plans to allocate more budget to other potential brands, including GF, HomeAegis and others.

Product upgrade. It launched a new series which was positioned in premium segment (RMB600-1000) in 4Q17 for Herborist and it has been well received. According to Jahwa, ASP hike is the major driver for Herborist’s growth in 2017. To recap, the brand recorded double digit growth in 9M17 in department store channel. In 2018, Herborist will launch high end colour cosmetics products. It will also upgrade its basic series to attract the younger generation. For other brands, premiumization also remains as the key growth driver, e.g. Liushen. It will diversify the flavours of Liushen and add more fragrance elements to de-emphasize its seasonality.

Channel restructuring. Its channel restructuring in 2017 mainly focused on ecommerce. Firstly, it transferred its Tmall supermarket and JD supermarket channel from wholesales to direct-run in the middle of the year. Secondly, it tried to use ecommerce service provider to operate its Tmall flagship stores in 4Q17, which is the No.1 online channel for the company. This transition will be fully in place in 2018. This business model adjustment is expected to optimize its online channel in longer term. It might create some short-term hiccups like slower sales growth yoy but better profitability should be expected.

2018 and onwards

It has not finalized its 2018 operation target. It is however more comfortable with its sales trend , while more pressure will come from profitability. The new plant which is supposed to be in operation from beginning of 2018, might be delayed. Once it starts to operate, it needs to book a higher D&A expense. This has been our concern as well as the market’s.

Excluding D&A, it targets to reduce its opex as % of sales to below 50% in long run, from 60% of current level.

It reiterated its RMB10bn sales target in three-five years, including RMB3bn from Herborist, RMB2bn from Liushen and Tommee Tippee respectively, RMB1bn, RMB0.5bn from Maxam and Giving respectively and RMB0.3bn for HomeAegis, Mr Yu and VIVE.

19 January 2018



Tingyi (0322.HK, TP HKD 13.28, Hold, HKD 15.50)


Tingyi attended our China conference and the following are the key takeaways:

A change in management’s focus As mentioned in the previous 3Q17 results analyst meeting, management admits that in the past, the company’s focus has been on production, i.e. it focused on manufacturing and sell through via traditional channels.

However, in the last couple of years, it has revamped its strategy and shifted its focus to: 1) product upgrades (with better soup base, seasonings, the use of ingredients and texture for noodles; and new product focus on health and products at different price ranges for beverages) and 2) channel restructuring (e.g set up of business units focusing on B2B, KA accounts and segmenting the market into 20 small regions and to reach out to 2nd tier distributors directly through delayering.

2018 – focus on beverage segment as noodle is trending towards the right path Given the low base in 4Q16 as well as market recovery, we believe it has satisfactory growth in its noodle performance. Its ex-factory price hike of 3% was accepted by the market. It did not comment if there is future price hike. Based on the current trend, we share with management’s view that noodle recovery will continue in 2018.

On beverages, despite a strong 3Q17, the outlook is still challenging in a couple of areas. As mentioned during the 3Q17 analyst meeting, management wants to strengthen its higher-priced segment. On the cost side, rises in raw materials continue to pressure GPM. In 2018, it will consider offering new products at different price points as with the noodle segment. While it believes product upgrades is the trend, it will not ignore the mass segment. Channel diversification is another trend, apart from traditional channels, KA, special channels and B2B are the areas that management will explore.

Yili (600887.SS, TP CNY 35.00, Buy, CNY 34.62)


4Q sales growth slowing down due to late Chinese New Year Management expects sales growth in 4Q17 to slow down from 18% in 3Q17, due to shorter peak season falling in 4Q17 with a later 2018 Chinese New Year season. For the full year 2017, it expects sales growth to achieve double digit, core margins (exclude government subsidy) to expand, and net profit to achieve positive growth. The sales growth has been mainly driven by increasing demand and increasing market share in the lower tier region. The management indicates that the industry sales grew by 7% in 2017, with 8-10% growth in lower tier region and 5-6% in high tier regions.

Industry competition could ease down in 2018 Management expects the good demand growth to continue in the near-term. The key sales driver will be UHT yoghurt and high end UHT milk. The competition could ease down thanks to a more balanced raw milk supply. Yet there will be increasing cost pressure due to rising raw material cost. Unless

19 January 2018



there is a sharp increase in raw milk price, the management does not expect a like-for-like price hike, but it will reduce price promotion to partly offset the cost increase.

Soy milk contribution is still limited in early stage Yili launched soy milk with the brand "plant selected" in January. It currently has two SKUs for soy milk , the original taste priced at Rmb4.0/pack and the black soy bean priced at Rmb4.6/pack. The company is positive on the sector and estimate the industry market size to be Rmb100bn. In 2018, it expects soy milk sales should be a few hundreds million, and think it is still too early to achieve break even due to initial marketing spendings.

Our view: growth story intact Yili's guidance is in line with our expectations. We expect its market share could continue to increase in 2018 with industry competition slowing. Meanwhile, the soy milk and new SKUs continues to be key sales drivers. As industry leader, we believe Yili could pass through the cost inflation by reducing price promotion and ultimately price hikes. We reiterate Buy on Yili. Downside risks: food safety, and oversupply.

Samsonite International S.A. (1910.HK, TP HKD 39.80, Buy, HKD 35.00)


Samsonite attended our China conference and the following are the key takeaways:

4Q17 trend is likely to be better than that of 3Q17, as mentioned in the post results analyst meeting. This is mainly thanks to a recovery in its brands like Speck, AT and High Sierra in the US and a recovery in the three underperforming markets in Asia (namely, Hong Kong, India and South Korea). Overall sales growth for Samsonite (ex Tumi) will be mid single digit as they guided in 3Q17 results announcement. Meanwhile, Tumi’s growth in N America is likely to normalize given the high base in 4Q16 but higher growth will be expected from its overseas market with the acquisitions of franchisees in Korea and China/HK in 1Q/2Q17.

2018 outlook 2018 trend is likely to be similar to 4Q17 trend. Thus, as mentioned in previous analyst meetings, management continues to look for a mid single digit to high single digit sales growth for Samsonite ex Tumi. For Tumi, a teens growth in sales in LCY is expected. GPM is expected to improve on both Samsonite and Tumi but part of this will be offset by higher distribution expense.

In our earnings model, we expect an overall sales growth of 10% for the whole group with EBITDA margin improved by 0.6ppt from 15.6% in 2017 to 16.2 % in 2018.

Comment on US tax benefit Regarding the benefit from the US tax reform and based on the current assessment, although management believes there will be benefit from the tax reduction, it is likely to be partially offset by 1) the deductibility of the interest

19 January 2018



expense; there will be a cap on the interest expense reduction based on the new tax reform and 2) treatment of foreign income and treatment of transfer pricing, as the company is incorporated in Luxemburg and there has been a global tax system in place

However, for 4Q17, there will be a non-cash deferred tax adjustment to reflect the new rate as the tax law was signed in end of 2017. But the yoy impact will be smaller as it has a one off income tax benefit of USD 57m in 4Q16.

Wuliangye Yibin (000858.SZ, TP HKD 98.00, Buy, HKD 88.90)


Still needs more time before next price hike Investors' questions focus on whether Wuliangye will raise its ex-factory prices. Management did not rule out the possibility of an increase in time, especially after Moutai's price hike. However, it thinks that more time is needed, given that channel profit has only been stable for one year. The company's priority currently is to maintain channel profit margins and to strengthen the retail price stability.

Target 30% yoy sales growth in 2018 Management is confident it can reach its target. Key sales drivers will be: 1) mainstream Wuliangye to grow by 18% from 17,000 tons in 2017 to 30,000 tons in 2018; 2) price increase through raising the portion of "out of plan" volume from 10% in 2017 to 50% in 2018, implying a 5% price increase; and 3) incremental sales of mass market sub brands to RMB10bn in 2018 – it targets to build up one sub brand with RMB2bn sales, and 2-3 sub brands with RMB1bn sales by the end of 2020.

To increase channel penetration through its "10 thousand project" Management aims to increase its penetration through a “hundreds of cities, thousands of counties, and ten thousand stores” program. By the end of 2017, it had built up 7,000 core POS and 1,000 Wuliangye specialty stores. It targets to increase to 8,000 core POS and 1,500 specialty stores in 2018. The channel expansion will be a key driver for its 30% growth target. Meanwhile, through installing IT systems at the retail end, the company will have stronger control in channel inventory and better understanding of the market.

Our view: don't leave the party too early We like Wuliangye for its lower risk in channel de-stocking, especially after Moutai price increase and with the approach of Chinese New Year. We expect the company to enter a secular growth period in 2018-19, and its earnings to register 29% CAGR in 2018-20E, driven by management’s strong incentives for growth and expanding the high end liquor market after the increase in Moutai price. We reiterate our Buy rating with TP of RMB98 based on DCF approach. Downside risk: channel de-stocking in the high-end liquor sector; food safety; worse-than- expected macro FAI slow down.

19 January 2018



Lodging/ Leisure

China CYTS Tours (600138.SS, TP CNY 20.00, Hold, CNY 21.86)

Tallan Zhou, [email protected], (+852) 2203 6464

CYTS Tours (600138.SS) attended our dbAccess China Conference today. Key takeaways from the conference are as follows: Ancient town traffic update - Wuzhen attracted a total of c.10 million visitors in 2017 (vs. c.9 million in 2016). In its third year of operation, Gubei attracted a total of c.2.8 million visitors in 2017 (vs. c.2.5 million in 2016). This is mainly due to more sight-seeing projects and entertainment facilities to the site and marketing campaigns.

Ancient town revenue breakdown update - Management disclosed the rough breakdown of current Wuzhen’s top line that c.50% comes from tickets, c.30% comes from hotels and dining and c.10-20% comes from others (including retailing and transportation fee). As for Gubei's topline, c.40% of toatal comes from tickets, c.50% comes from hotels and dining and c.10% comes from others (including retailing and transportation fee).

Ticket price hike - Management pointed out that the price hike in the past was only from tickets. There was a Wuzhen ticket price hike in 2017 (East Gate’s will be adjusted from RMB100 to RMB120, a 20% increase and West Gate’s ticket price will be adjusted from RMB120 to RMB150, a 25% percent increase). Management also disclosed that there is a difference in ticket pricing between Wuzhen and Gubei. Wuzhen's ticket price is subject to government approval, while Gubei's ticket price is market-adjusted.

Revenue from real estate - The real estate income of Gubei is not recurring. Gubei generated revenue of c.RMB40 m as of 9M17 (vs. RMB80 m in 2016). The difference is due to the real estate income (Phase 1 was booked in 2016 and Phase 2 is expected to be booked in 2018E). Management guided that there will be almost no real estate income in 2017.

BTG Hotels (600258.SS, TP CNY 35.00, Buy, CNY 29.35)


BTG Hotels (600258.SS) attended our dbAccess China Conference today. Key takeaways from the conference are as follows: Accelerating RevPAR growth in 4Q17 - BTG Hotels disclosed that blended RevPAR yoy growth accelerated during 4Q17 (RevPAR yoy growth: Dec > Nov > Oct) and this trend also occurred at Jinjiang and China Lodging. This is mainly due to the super Golden Week in Oct 2017 (8 days of national holidays including Mid-Autumn Festival which drives more homecoming than traveling). As for the full year 2017, BTG's RevPAR growth is expected to show a similar trend to that of Jinjiang.

19 January 2018



Hotel expansion - Management was confident about fulfilling their target of adding 400-450 hotels in 2017 (guided at the beginning of 2017) and also guided that the company intends to add c.500 hotels every year over the next 4-5 years.

Mid-scale hotel proportion - The company guided that c.40% of additions will be mid-scale hotels. They expect there will be c.1,000 mid-scale hotels by the end of 2019, which accounts for c.20% of total hotels.

M/F hotels proportion - The company disclosed that 70% of total hotels are M/F hotels (Manachise or Franchise) currently. They expect M/F hotels' proportion will gradually reach to 90% over the next 4-5 years.

Hotel traffic breakdown - As for the hotel traffic, c.50% of total comes from their membership or centralized reservation system (including their website and APPs), c.15% comes from OTA, c.10% comes from corporate and c.10% comes from other channels (including walk-in).

China Travel (HK) (0308.HK, TP HKD 3.10, Buy, HKD 2.79)


China Travel (0308.HK) attended the dbAccess China Conference. The following are key takeaways from the conference: Positive profit in 2017 - Management guided that the net profit in 2017 is expected to record a yoy increase of more than 200% (vs. 2016). This is mainly due to 1) the growth in business operation; and 2) one-off gain derived from asset operations.

Aiming to continue streamlining of business - China Travel has positioned itself as a travel destinations operator. The company has been searching for acquisition opportunities, while disposing low-quality assets. China Travel has disposed four non-profitable and low-return assets in the recent years, and the management guides to continue streamlining of its business portfolio over the next two years.

Key regional markets - Management has guided that the company will focus on the development of following key regional markets: 1) Beijing-Tianjin-Hebei for building snow and ski, mountain; grassland and other specialty tourist resorts; 2) Eastern region for creating family-based island and vacation destinations, 3) Southwestern region for scenic resources in Yunnan and Sichuan; and 4) Southern region for theme park projects.

Progress on new business - The company also launched its asset-light model of tourism planning and management contract. Note that the company signed 10 new management contracts (tasks of system building, talent recruit and business development) in 1H17.

Developing new leisure products - In 2017, the company developed new leisure products: China Travel National Holiday Park and China Travel Resort Town.

19 January 2018



TravelSky (0696.HK, TP HKD 25.70, Buy, HKD 25.10)


TravelSky (0696.HK) attended our dbAccess China Conference today. Key takeaways from the conference are as follows: ASP update - Travelsky charges airline companies on the “transaction” fee of each flight. On average, ASP for domestic carrier’s domestic route per flight transaction is RMB 5-6, while the domestic carrier's international route is c.20% higher than the domestic route (the upper limit is RMB9.9). For international carriers, ASP on average is a little bit less than USD 4. Therefore, regardless how one airline ticket is distributed in China (travel agency, ticket agent, OTA or airline’s direct sales), Travelsky will not be impacted by charging the transaction fee. In addition, Travelsky’s major airline companies are also the shareholders. This “shareholder-and-customer” organization helps Travelsky further maintain its ASP and keep business stable from a long term perspective.

Margins - The company disclosed that Accounting Settlement enjoys the highest operating margin among its four major business segments, while the operating margin of System integration is the lowest.

System integration - Management shows confidence on the long term growth potential of the system integration business, mainly driven by the upcoming more than 40 new airports build and more than 100 existing airport expansions during 2016-2020 as per 13-5 plan guided.

Government grant - There was no government grant in 1H17 (vs. a RMB500m government grant in 1H16). Management disclosed that a government grant in 2H17 and 2018 is also unlikely.

Umetrip - The finalized capitalization plan is pending due to 1) seeking appropriate strategic investors and 2) deciding the shareholding proportion of management as incentive for Umetrip’s future development. Umetrip currently still focuses on optimizing user the experience and increasing the number of users (active users reached 30m in 2016 from 16m in 2015).

19 January 2018



Healthcare

3SBio (1530.HK, TP HKD 19.00, Buy, HKD 16.70)

Jack Hu, Ph.D, [email protected], (+852) 2203 6208

Guiding above 20% core profit growth for 2018 Management guided 30-35% topline growth and over 20% growth for core profit in 2018. On individual product breakdown, Yisaipu growth is guided at 20-25%, with EPO/ Humulin/ two GLP-1 products at 5-8%, 10% and 20% respectively in FY18. Regarding impacts from NRDL revision, company expects to see more pronounced changes from 1H18 onwards. As for the recently acquired business, deal closure for Therapure will be delayed till April 2018, due to slower-than-expected process with local authorities. We reiterate Buy on rich pipeline and solid growth momentum.

Healthy growth for flagship products, diabetes franchise adding another leg of growth The sales growth guidance for the TPO, Yisaipu, and the EPO franchise are 20-25%, 20-25%, and mid-single in 2018, respectively. As for tender pricing trend, 3SBio anticipates mild price cut of 3-5%/ 3-5%/ 5-8% for these three products. On diabetes MBU, management indicated that 150 people have been acquired from AstraZeneca, with another 300-400 newly added. 3SBio estimated peak sales of RMB200-300m and RMB700-800m respectively for Byetta and Bydureon. As for the second-generation insulin, executives are optimistic on its growth outlook given NRDL class A status and differentiation of MNC branding. The company targets to promote GLP-1 to core and high-tier channels, while Humulin will be promoted to the broader market in China.

Pipeline updates and other key takeaways The company targets to refile the application of Ipterbin in 1Q18, with approval expected in 2019. The biosimilar drug is currently in final stage of data verification with hospitals/ physicians, executives highlighted that over 80% of the data has been verified by a third-party agency. On therapeutic area, 3SBio targets to obtain approval for HER2+ mBC first, with plans for indication expansion after market launch. According to the company, it is likely to be the first domestic Herceptin biosimilar. Management also expect the launch of pre-filled Yisaipu in 2018, and long acting EPO in 2020. On debt repayment schedule, the company guided earlier repayment of RMB10bn, vs. the current debt level of RMB5bn.

China TCM (0570.HK, TP HKD 4.70, Hold, HKD 4.55)


Growth momentum to continue in 2018 For 2017, the company maintained guidance of high single digit sales growth for finished drugs and 20-25% growth from TCM granules. TCM decoction could see significant growth in 2017, supported by consolidation from Tongjitang. As for TCM services, it is estimated at RMB50m, with net profit close to RMB10m. Growth momentum in 2018 is likely to continue with high single/ 20-25%/ 10-20% for finished drugs/ granules and services franchise

19 January 2018



respectively. Going forward, management expects TCM granules and decoction to be main drivers, on the back of policy tailwinds and sector outlook.

Granules to fuel future growth We highlight that hospitals are incentivized to prescribe more TCM products supported by 1) TCM granules are excluded from the 30% drug sales limit; 2) a maximum of 25% mark-up is allowed vs. zero mark-up for chemical compounds. According to the management, growth acceleration of TCM products is underway as healthcare reform continues. The company have introduced dispensing machines into hospital channels for efficiency improvements, we anticipate mild margin expansion as utilization improves. Regarding the granules deregulation policy, executives see little near-term threats from competitors such as Kangmei and Jiren Pharma as it takes time/ techniques to develop product offerings. In comparison, CTCM has invested in the entire TCM chain from raw material sourcing to final production. We remain optimistic on the near-term outlook of its granules franchise.

On hospital reform and other key takeaways Since the zero mark-up policy implementation, CTCM is optimistic that more TCM products (granules and decoction pieces) will be prescribed. To facilitate the prescription process and physician awareness, Rx samples of TCM description are installed into hospital systems, tailored specifically for common cold or minor disease symptoms. On geographical sales breakdown, strong footprints have been established in eastern and southern China regions with 39% and 19% revenue contribution respectively. Management believes that regional concentration trend may continue due to stickiness and exclusivity of setting up dispensing machines with end customers.

CSPC Pharma (1093.HK, TP HKD 19.10 Buy, HKD 17.98)


Guiding for 20-30% growth in 2018 Management guided for 20-30% revenue growth for 2018. Major drivers include NBP, oncology portfolio and three key drug launches, while the API franchise is likely to remain stable. We highlight that nab-paclitaxel is at the final stages of the regulatory process, and the company expects to receive production approval before Chinese New Year, likely contributing RMB200m revenue in 2018. Production approvals for clopidogrel and metformin are also expected around mid-2018, while four additional key drugs are likely to launch in 2019. Management expects a continued increase in R&D expenses, in support of a strong pipeline going forward.

NBP and oncology portfolio to drive growth The company is targeting 30% growth for NBP in 2018, where IV/capsules can exceed 40%/15% growth, respectively. In addition, key products Xuaning and Oulaining are likely to reach 25% and 10-15% growth, respectively. According to management, the oncology portfolio is expected to grow at 50% in 2018, where Jinyouli would be the biggest revenue driver to achieve the 60% growth target. On API, management expects stable performance for caffeine, with high single-digit growth and little price increase. VC is likely to grow at 10% for both revenue and profit, while glucose can see single-digit growth given a stable market.

19 January 2018



Three key drugs to launch in 2018, four additional to follow by 2019 The company expects production approval for nab-paclitaxel before Chinese New Year, with RMB200m sales guidance in 2018 and estimated peak sales of RMB1.5bn. Besides, clopidogrel and metformin are both expected to receive production approval around mid-2018. For clopidogrel, management expects RMB100m sales in 2019 and peak sales of RMB1bn with 10% market share, while the numbers may not be substantial yet in 2018. For metformin, the company estimates peak sales of RMB500m. In 2019, management expects four additional drugs to launch, namely tricagrelor, dasatinib, bortezomib and dronedarone. On R&D expenses, the company estimates RMB700m in FY17, while expecting up to RMB1bn in 2018. The rise in R&D expenses in 2017 was due to higher spending on BE studies and biologics.

Growth outlook The company guided towards 20-30% overall topline growth in 2018, while the biggest drivers are NBP and Jinyouli. In the foreseeable future, it also expects financial impact from the ramp-up of three key products to be launched in 2018, plus four additional drugs in 2019. R&D expenses are on the rise, in line with the company's long-term pipeline strategy. We summarize below additional details on the growth outlook.

On NBP, the company expects IV growth to be driven by coverage expansion to a much greater extent than by NRDL, as penetration in existing large hospitals is already quite high; however, ramp-up in new accounts should be easier. On network, NBP IV covers over 800 hospitals, where Hebei accounts for 25% of total NBP IV sales and Beijing/Zhejiang/Shandong/Henan together make up an additional 20-30%. NBP capsules are sold to over 1,700 hospitals, with less concentrated sales in top provinces including Hebei, Beijing and Zhejiang. Amid implementation of NRDL, cannibalization of capsules by IV can be expected but moderate at most.

On nab-paclitaxel, management is confident of a smooth tendering process and initial promotion, due to high conviction in FTM status, positively leading to very high growth later in 2019. On clopidogrel, however, the company has a less aggressive target of reaching 10% market share, as hospitals usually work with only two suppliers for one compound and tend to be sticky in their choices.

On the long-term R&D strategy, the company aims to focus on four key therapeutic areas including oncology, CCV, diabetes and neurology. On timeline, early-to-market generics usually take 3-4 years to receive production approval from scratch, while innovative drugs may take longer than 7-8 years. The company has recently started to establish a presence in biologics, which typically takes five years to receive production approval.

On January 8, the company announced that it has entered an agreement for the acquisition of a 39.56% interest in Wuhan Youzhiyou (YZY), with RMB204m upfront payment and additional milestone payments of up to RMB55m. According to management, CSPC has partnered with YZY on the discovery of two products, one of which is indicated for breast cancer while the other is for effusion. Both drugs are expected to commence phase 1 studies this year, in China and the US.

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On revenue mix, management believes innovative drugs will account for over 50% of total revenue in three years, though also depending on the growth of API. The company does not intend to increase capacity for API and is rather comfortable with the existing scale of the segment.

Hengrui Medicine (600276.SS, TP CNY 78.10, Buy, CNY 71.25)


Solid growth to continue with multiple catalysts ahead The two key take-aways include 1) Hengrui already filed PD1 application in 4Q17. We believe the indications are cHL and esophageal cancer, which is earlier than street consensus. This led to stock rally on Tuesday. Additionally the company expects approval in 2018; 2) Hengrui expects growth acceleration in 2018. We believe this might be a combination of delayed booking of export profit and other unspecified elements. For 2017, Hengrui reiterated 18-20% domestic sales growth and 20% exports growth. As for the products breakdown, traditional oncology/ anesthetics/ contrast agents should reach 10-15%, 20% and over 30% growth respectively in 2017. In addition, lower pricing erosion could be witnessed in FY18 compared with FY17, as secondary negotiations and tenders are largely concluded.

Apatinib growth likely to accelerate in 2018; 4Q17 hiccup The company indicated that apatinib sales was below expectation in 2017, due to slowdown in 4Q17 stemming from NRDL settlement/ implementation delays and budget controls. Hengrui remains optimistic on 2018 outlook driven by reimbursement coverage. Despite the 36% nominal ASP cut of apatinib, management believes the upside could very well outweigh pricing erosion. As such, management welcomes negotiations for NRDL/ PRDL rolling inclusion for key innovative products. In addition, indication expansion studies for liver cancer and NSCLC are both progressing to final stages, with approval expected in 2H18-2019.

Updates on pipeline and other key takeaways Four blockbusters are likely to be approved including nab-paclitaxel, 19K, pyrotinib and PD-1. Hengrui commented on bigger addressable market for pyrotinib vs. apatinib, on the back of longer treatment duration, without offering any color on pricing strategy. On nab-paclitaxel, Hengrui and CSPC are both on priority review list, with the possibility of obtaining approvals simultaneously. As for R&D spending, the ratio is likely to remain at current level, as expense increase will synchronize with sales growth. On management incentive, the company implemented 3 rounds in 2014/16/17, with near-term plan of another round, using 3m reserved shares.

Jointown Pharmaceuticals (600998.SS, TP CNY 30.00, Buy, CNY 19.01)


Maintaining FY17 guidance Management continues to guide RMB73bn revenue for 2017, on track to reach the RMB100bn target by 2019. Net profit / core net profit excluding

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extraordinary items in 2017 likely have reached RMB1.3-1.4bn / RMB1.0bn, respectively. Major drivers include expanding network coverage, increasing product offerings, and better DS penetration. Going forward, the company expects to reach core net profit of RMB1.3bn in 2018, while RMB1.4bn might be possible.

Updates on DS / IDS and coverage Indirect sales (IDS) now accounts for 42% of total sales, down 2% from 44% in October 2017. Medical institutions, drug stores, non-drug channels account for 29%, 22%, 6-7% of total revenue, respectively. Medical institution sales grew at above 30% rate for 2016-2017, while drug store sales grew at 31-32% in 2017 vs. 15-16% in 2016 due to two-invoice. On coverage expansion, the company's core strategy is to acquire local distributors. During 9m17, Jointown acquired over 40 distributors, though 80 more are needed to reach target coverage at the national level. On average, each acquired distributor was valued at RMB20-30m with over RMB200-300m revenue and net profit of RMB4-5m, while Jointown typically acquires up to 60% of interest only. In addition, each acquired asset undergoes a 3-year transition period, where operational and financial IT systems need to integrate with Jointown's, though financial statements are not consolidated yet. The practice would add some but not much profit growth to Jointown, as most acquired assets were already clients, though volume typically will rise once in a cooperative relationship. As of now, Hubei / Henan / Beijing / Guangdong are Jointown's largest markets, with 2017 sales of RMB10bn/8-9bn/7bn/6bn respectively.

Margins and other key takeaways On margins, sales to medical institutions typically lead to 7-8% GM, where tier 2 and above are 9%, and below tier 2 have 7%. Chain drug stores typically have 5-6% GM, and independent ones have a bit over 7%. Overall GM for Jointown is about 8% at present. The company is seeing worsening receivable days, on average about 10 days longer in 2017 compared to same period in 2016. For 2017, the major nonrecurring items were proceeds from land sales of a distribution center in Wuhan, estimated at RMB400m pre-tax and RMB360m after-tax.

Sinopharm Group (1099.HK, TP HKD 34.30, Hold, HKD 34.20)


Guiding above industry growth in 2018; recovery starting 2019 Management guided sales growth in 2018 to be 1-3% higher than expected industry growth of 7-8%, though 2-3% lower than what the company achieved in 2017. In practice, management believes two-invoice has only been fully effective in 4 provinces, including Fujian, Anhui, Shaanxi and Hunan. Anhui started to see growth recovery already, though many additional provinces are yet to follow the path. IDS as of YE17 accounted for 20% of total revenue, and the company can lose 10-20% of IDS while more than 80% of the IDS would be converted to DS in the mid/long term. Management expect two-invoice to be fully effective nationwide by YE18 and growth recovery to start in 2019. Meanwhile, the company expects retail, devices and leasing to support growth in 2018.

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Margins likely to improve Starting 2018, management expect margins to improve with a good chance, driven by conversion to DS as well as outperforming high-margin businesses. According to the company, net profit margin for IDS is below 1% vs. 7% for DS, despite shorter AR days. Retail business reached RMB2bn sales in 2017 with around 2% net margin, while the company has conviction in sustaining over 30% sales growth in 2018. GM for retail is typically 25-30%, and 400-500 new drug stores are expected to open each year, as the industry is highly fragmented and Sinopharm has only 4% share as the market leader. On medical equipment, the company achieved RMB20bn sales in 2017 at over 30% growth rate, while management still expect notable growth acceleration in 2018. Lastly, SG&A expense ratio is expected to continue the downward trend, driven by economies of scale.

Other key takeaways On financial leasing, over RMB100m profit was achieved in 2017, while management consider to introduce more strategic investors to help grow the segment. On improving stickiness of hospital clients in the process of converting IDS to DS, the company has started to provide bundled services including in-house logistics, sterilization and cleaning. On financing, debt ratio is expected to remain at similar level in 2018 vs. in 2017, and the cost is always below market rate given strong credit rating. Though the Board pre-approved issuance of asset-backed securities, this may not be the best option given similar interest rate (around 5%) and longer time to issue vs. bank loans.

Sino Biopharmaceutical (1177.HK, TP HKD 16.80, Buy, CNY 14.10)

Expecting growth acceleration in 2018 Management guided for 2018 revenue growth of 15%/20% for CTTQ/Tide respectively, vs. 9%/16% in 2017. A minimum of 15% total revenue growth was guided for SBP in 2018, while bottom-line growth can likely exceed that given well-managed costs. Major drivers include: 1) anlotinib to undergo inspection on Jan 17, most likely receiving production approval around Chinese New Year, with estimated peak sales of RMB3bn; 2) four drugs newly included in 2017 NRDL, along with nationwide implementation of PRDL in Jan/Feb; 3) at least ten new drugs to launch in 2018, including four from Tide, four from Fenghai, and four to five from CTTQ; 4) Runzhong family can reach RMB4bn sales in 2018, as tablets return to 10% growth.

Tide: four products to launch in 2018, Board meeting on Feb 9 Management believes the launch of four products, along with Kaifen added to NRDL, will drive 20% revenue growth for Tide in 2018. Lidocaine is at the final stages of regulatory review and expected to receive production approval soon; SBP owns a China patent expiring in 2030 for the drug, peak sales of which is estimated to be at least RMB2bn. On diabetes, SBP's vildagliptin has a good chance to be FTM with estimated peak sales of RMB1-2bn, whereas Actos has already received production approval in Dec 2017. In addition, management expects the cold patch to receive approval in 2018. The Board meeting will take place on Feb 9 to finalize the details of the Tide deal; management has 95% confidence that voting will be in favor of the deal. A lock-up may not be of consideration, unless it is without additional costs. On the stock incentive plan, 20-40% of senior compensation would come from the trust; management expects the plan will certainly be executed within 2018, with no termination date specified.

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Margin trends and other key takeaways Management has high conviction for gross margins to improve, while selling costs may drop moderately and R&D expenses continue to rise. The company owns nine blockbuster drugs (with estimated peak sales above RMB1bn) with around 90% GM, including anlotinib, Runzhong family, Ganmei, Kaishi, Kaifen, lidocaine, Aisuping, tenofovir and paricalcitol. Excluding expenses related to sales team expansion for anlotinib (to exceed 1,000 by YE18), the selling cost ratio was actually lower in 2017. SBP will continue to increase R&D spending, in an effort to maintain a robust pipeline with innovative and generic compounds. On a separate note, the company aims to be included in the Hang Seng Index, raising visibility among both active and passive investors globally.

Growth outlook Management believes 2017 experienced a low in growth due to temporary deceleration in Runzhong as well as latency of the reimbursement cycle. With swift implementation of new NRDL/PRDL, an extraordinary drug pipeline, as well as additional interest in Tide, management has very high conviction in entering a new growth cycle starting 2018. We summarize the details of major growth drivers below.

On reimbursement, management emphasized that four key drugs including Zhiruo, decitabine, imatinib and dasatinib were newly added to the 2017 NRDL. All but two provinces have set plans of PRDL, and nationwide implementation is scheduled to take place between January and February.

With regard to the late-stage pipeline, SBP expects at least ten drugs in addition to anlotinib to receive production approval in 2018, with four from Tide, four from Haifeng and four to five from CTTQ. Management trusts that Tide is a strong franchise to exceed CTTQ in terms of topline growth over the coming five years, with four products including lidocaine, vildagliptin, Actos and cold patch set to launch in 2018. Notably, Tide recently discovered an innovative compound, marking the first time SBP utilized its in-house facility alone; the company aims to file the potentially multi-billion drug through the accelerated process.

On the hepatitis franchise, management is highly confident of Runzhong family achieving RMB4bn revenue in 2018, while tenofovir can contribute an additional RMB500m within the first 12 months of launch. Runzhong tablets are expected to reach 10% or above topline growth, whereas Tianding can grow at 15%.

For the oncology franchise, the company expects anlotinib to receive production approval around Chinese New Year, launching in March at the latest. The drug is estimated to reach RMB3bn peak sales with the sales team exceeding 1,000 people by YE18, which should also drive growth for the rest of the oncology portfolio.

On the innovative pipeline besides anlotinib, CTTQ owns 13 blockbusters in phase 2 studies, with nine/two/one for the oncology/hepatitis/diabetes therapeutic areas, respectively. SBP aims to file Class 1.1 IND for 10-20 compounds each year. Among the ten key existing IND compounds, management affirms one is PDL1 while the rest is to be disclosed later, in an effort to protect regulatory progress of the drugs at this stage.

Management sees Aisuping/esomeprazole as a rising star to exceed RMB500m in 2017, vs. over RMB400m in 11m17.

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Tonghua Dongbao (600867.SS, TP CNY 26.80, Buy, CNY 24.16)


Guiding for 30% net profit growth in 2018 Management guided for revenue growth of 20% and net profit growth of 30% in 2018. On insulin glargine, production approval is expected in 4Q18 while reaching RMB300-400m sales in 2019 is likely. For insulin needles, the company is aiming at over 30% growth. Management continues to expect margin expansion, driven by improving product mix and SG&A ratio.

Insulin glargine to reach RMB300-400m sales in 2019 Management believes insulin glargine is likely to reach RMB300-400m sales in 2019, and over RMB2bn sales in 2020. Market penetration of insulin glargine will be driven by existing sales team. According to management, the coverage network for 40R already reached 1000 hospitals in 2017, on track to exceed 2018 target of 2000 hospitals. Similarly for insulin glargine, coverage can reach 1000 hospitals by YE20, likely growing comparable with Ganli within 3-4 years of launch. Though hospitals usually work with only 2 suppliers for each drug, management expects maximum of 20-30% hospitals to be affected with regards to promoting insulin glargine.

Margins and other key updates Management expects continued margin expansion given higher gross margins of third generation insulin products, though substantial volume growth may take time. In addition, the company plans to utilize existing sales team for promoting insulin glargine, leading to lower SG&A ratio going forward. Sales per representative ranged widely at RMB3-10m in 2017, and the company would be cautious in incremental hiring in 2018 given expansion of the team in 2017.

The United Laboratories (3933.HK, TP HKD 6.30, Hold, HKD 6.27)


Insulin business remains solid, API outperformed on policy tailwinds Management expects to see 10-15% YoY growth for the finished drugs franchise in 2018, while guiding for 25% for the insulin business. On API products, United is optimistic about near-term growth prospects, as two main competitors Kelun Pharma and Weijida have seen production suspension in an attempt to fight air pollution. Management believe the production from Kelun might have resumed, but recovery to its previous production level of c.5,000 ton per annum could take some time. As for the insulin arm, executives guided for 30% YoY volume increase for second generation insulin, with glargine sales estimated at RMB60-80m in 2018. United expects to see growth recovery as the tender process accelerates in 2018.

Insulin glargine adding another leg of growth We highlight that Sanofi and GanLee are the only two players with glargine launched in China (prior to United Lab), with about RMB3bn and RMB1.4bn, respectively in 2017. Management maintained revenue guidance of RMB60-80m of insulin glargine in FY18, at which breakeven could be achieved.

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Following the market launch in May 17, United already entered 7 provinces via public tenders, with ASP ranging from RMB140 to RMB180. As for hospital penetration, channel breakdown was 50/50 for high and low tiered hospitals, while more tier 1 cities/ hospitals are expected to be covered soon. On human insulin, the company expects to see healthy volume growth, estimated at 15m vials compared to 12m vials in 2017, as effects of NRDL/ PRDL kicks in starting 4Q17.

On API and other takeaways As a reminder, 6-APA saw price improvements from RMB140 in 1H17 to recent highs of over RMB200 per kilogram, the pricing eased to RMB175-190 in 4Q17 but remains at a high level. Management is confident that ASP could stay at current levels for 2018, on the back of interrupted production of its main competitors and slower-than-expected resumption. On utilization rates of 6-APA products, United reached over 80% on average for FY2017, compared to 96% in 1H17 and 63% for FY2016. The company guided for a similar level of utilization (80%) for FY18 on average, with improved profitability.

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Infrastructure / Industrials

JONHON Optronic (002179.SZ, TP CNY 43.00 Buy, CNY 38.55)

Nick Zheng, [email protected], (+852) 2203 6198

Jonhon Optronic attended our Access China Conference 2018 on 9 January in Beijing. We summarise below our key takeaways:

Recent development and outlook by end-market Defense: Jonhon sees limited impact from China's military reform in

the form of tenders for military-grade connectors as it has already adopted open bidding in the past. That said, due to organizational reshuffling within the military headquarters due to the reform and the fact that order flows are typically slow in the first two years during a five-year-plan period, the company did see a slowdown in terms of defence order intakes in 2017. However, management expects new orders to improve in 2018 (2H in particular, given the seasonality) and to further take off in 2019-20.

Telecom: Management expects 5G to become a significant growth driver in 2019-20 as the capex cycle kicks off. Before that, management does see some pressure for its existing product portfolio as 4G capex continues to trend down. This, however, could be mitigated by the surging export orders, which saw 30%+ growth in 2017 (overseas customers include: Samsung and Nokia).

NEV: New order growth significantly picked up in 2H17 and the production schedule for 4Q17 was extremely busy. Overall, management expects this segment to continue to be a key growth driver in the coming years. Moreover, cooperation with Tesla has been progressing well, with its high-voltage connector product likely entering Tesla’s supplier catalogue, in addition to the existing EV charge coupler.

New capacity and new products New products: High-speed connectors and liquid-cooling systems are

the two major new products Jonhon is rolling out. For high-speed connectors, management estimates that China's market size is at the Rmb billion level, and it is currently dominated by foreign brands. For liquid-cooling systems, is estimates the total market size for defense application at around Rmb0.8-1bn p.a. while the market size for civil application could potentially reach the tens of millions level. The switch from fan-cooling to liquid-cooling will be a structural trend.

New capacity expansion: The Luoyang Phase III will be fully completed by 2019, with 50% of the capacity likely to be rolled out in 2018. Upon full completion and utilization, the plant will contribute Rmb1.3bn in revenue. This new plant will be mainly used for NEV, high-speed connectors and liquid-cooling systems. Moreover, the company recently announced its plan to build Luoyang Phase IV, which will likely kick off construction in 2018 and be put into use after 2020. The company estimates revenue contribution from this new plant to be up to Rmb1bn.

19 January 2018



Revenue target under management incentive plan implies a robust 2018 The first batch of incentive shares (issued in 2017) will be due for unlocking in 2019, when key financial metrics for the preceding years will be reviewed against its targets under the plan. In particular, the revenue target is set at a 15% CAGR for the preceding three years, which implies a significant acceleration from a relatively slow 2017.

CRSC (3969.HK, TP HKD 8.30 Buy, HKD 6.31)


CRSC attended our Access China Conference 2018 on 8 January in Beijing. We summarize below our key takeaways from the investor meetings:

New order growth indeed accelerated in 2H17 Railway: The full-year tender size of HSR signaling systems amounted

to c.2,700km in China, per CRSC's estimates. This implies 340% hoh growth in 2H17 from 1H17's c.500 km, likely bringing back full-year new order growth into positive territory (vs. -10% yoy in 1H17).

Urban transit: Despite an unexciting 1H17, when CRSC’s new orders for urban transit were up only +7% yoy, tendering for urban transit signaling systems regained vitality in 2H17. CRSC’s guidance of 20%-30% yoy for full-year new orders points to a significant acceleration in 2H17, with its domestic market share remaining solid at 45%.

Robust order growth to continue in 2018 Railway: According to CRSC's estimates, a total 3,000km of HSR lines

will launch biddings for signaling systems in 2018, representing over 10% yoy growth. Strong signaling bidding activity in 2017-18 also reconfirm our expectation that completion of HSR lines will accelerate in 2019-20, given that bidding for signaling systems typically kicks in 1.5-2 years ahead of length completion. In addition, the first batch of replacement/upgrade orders from HSR may come through in 2018 (e.g. Beijing-Tianjin and Wuhan-Guangzhou) after 10 years of operation, which should serve as a new growth driver going forward.

Urban transit: In 2018, CRSC estimated that a total c.1,200km (+c.50% yoy) of urban transit lines will be up for signaling system biddings. Robust order intakes offer high earnings visibility for CRSC's urban transit segment in the coming years.

Modern tram: CRSC has secured two modern tram projects in Western China, with revenue likely to be recognized in 2018. Besides that, the company expects to win 1-2 more projects this year.

Liquidity discount likely to narrow with multiple catalysts ahead According to CRSC, two cornerstone investors sold part of their shares via block trades, and the company has been working closely with other cornerstone investors on potential exit plans. Given the company's strong net cash position, management is discussing the possibility of raising its dividend payout ratio for 2017 (from 30% in 2016). We believe CRSC’s final 2017 dividend will likely consist of a regular dividend (at a payout ratio of 30%) and a special dividend (at an estimated payout ratio of 20%), translating into a dividend yield of 4-5%, based on the current share price. Moreover, now that CRSC is back to its IPO price of HKD6.3, cornerstone investors (controlling

19 January 2018



c.60% of CRSC's free float) might have more incentives to take profit with extra return from the special dividend, after holding the shares for over 2 years.

Moreover, we believe CRSC is among the potential companies under CSRC’s latest pilot program for the full circulation of H shares (its domestic shares accounted for 78% of CRSC’s total shares), which if implemented, could become an effective way to increase its trade liquidity, given that most other SOE parentcos hold only 50-60% domestic shares of the H-share listed companies.

Despite better growth visibility, CRSC has been trading at a discount to its H-share rail equipment peers, largely due to its low trade liquidity. With the liquidity overhang likely to be solved, we believe the discount will eventually narrow.

CRRC (1766.HK, TP HKD 9.00 Buy, HKD 8.45)


CRRC attended our Access China Conference 2018 on 9 January in Beijing. We summarize below our key takeaways from investor meetings:

Comments on CRC's 2018 capex target In light of CRC's recently announced 2018 capex target of Rmb732bn (vs. >Rmb800bn since 2014), there were some industry talks over the weekend that equipment procurement capex could also see a cut in 2018. CRRC noted that nothing has been confirmed yet at the moment as separate meetings will be held between CRC and relevant parties (civil work constructors, signaling system providers and rolling stock producers) within a week to convey the planned capex breakdown.

Moreover, CRRC believes lower capex budget by CRC in part also reflects the government's requirement for SOE deleveraging, given CRC's high gearing. However, given the 13th Five-Year Plan (FYP) target for railway length has just been reiterated, which implies significant increase in completion of railway length in the coming years (2019-20 in particular), the capex target does seem to have an upside. CRRC noted that CRC also gave out a low-ball capex target in 2014 (Rmb630bn), and later during the year the target was raised three times to Rmb800bn by CRC on enhanced government support.

Demand outlook for EMU CRC's target of 3,800 standard sets for EMU ownership by 2020 (coming out of the annual working conference) is simply a reiteration of the 13th Five-Year Plan rather than new news. CRRC confirms that this target does not include the demand for intercity EMUs. Management sees upside from current EMU procurement plan for 2019-2020 if the 13th FYP target for railway length is achieved. In addition, EMU density of the newly launched HSR lines in central and western China may be higher than expected, thanks to the HSR network effect which attracts passengers from eastern areas. 2018 guidance for EMU delivery is reiterated at 350-400 sets (vs. ~350 in 2017). New orders of the new 160km/h push-pull EMU may come in 2H18 at the earliest, while the tender for 250km/h CEMU will not be launched until 2019.

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Outlook for other rolling stock products Freight wagon: Last year's surge in demand was mainly driven by

CRC's container business expansion (hence massive procurement of the container models) which may not recur this year. CRC guides for 25,000 units of freight wagon, including 20,000 for replacement and 5,000 for new lines. While the volume will likely see a 50% drop in 2018, the impact on sales value may be smaller due to better product mix (i.e. higher contribution from high-ASP models).

Locomotive: Half of 2017 procurement was passenger locomotives, which may not be procured by CRC in 2018 with the upcoming launch of 160km/h push-pull EMU model (to replace 25T passenger trains). Such demand gap, however, could potentially be filled by CRC's procurement of the new push-pull train model.

Passenger carriage: Management expects demand recovery in 2018, with procurement size of around 500 units (vs. zero in 2017).

Rapid transit vehicle (RTV): Total tender size for RTVs amounted to 7,000 units domestically in 2017, beating CRRC’s projection of 3,000-6,000 units p.a. during 2016-2020. Management expects the procurement size for RTVs to be sustained at a high level domestically for the coming 8-10 years.

Cost reduction efforts Internal consolidation: CRRC recently initiated the consolidation of its

freight wagon business, where all the similar subsidiaries will be reorganized into two groups led by CRRC Qiqihar and Yangtze. On the locomotive side, similar consolidation took place. CRRC Lanzhou and Luoyang were absorbed by CRRC Dalian and Zhuzhou Locomotives, respectively, and have now become their respective maintenance centers.

Centralized procurement platform: A new online procurement platform has been launched by CRRC to reduce sourcing cost, shorten procurement period and enhance inventory management.

Intelligent logistics: A standardized and digital logistic system has also been introduced to save annual packaging expenses of several billions in Rmb.

NARI Tech (600406.SS, TP CNY 20.20, Buy, CNY 17.81)

Luka Zhu, [email protected], (+852) 2203 6173

NARI Tech attends Access China 2018 conference; our key takeaways are: Total order intake grew more than 10% in 2017 to c.Rmb42bn and brought order backlog to c.Rmb30bn now (vs. c.Rmb25bn as end-16). This should support earnings delivery in 2018, in which NARI targets 15-20% growth.

Power grid automation: For full-year 2017, management estimates that the power grid automation segment has grown c.20% yoy, in line with 9M17 performance. This was primarily driven by a 70% increase in grid distribution automation, riding on significant tender size expansion, while grid dispatch was flat and substation automation recorded mild growth (c.3-5%). Looking forward, management believes that grid distribution and utilization automation business lines will continue to see robust growth in next few years, as gridcos are now increasingly shifting investment towards smart automation equipment

19 January 2018



that are closer to the end-user side. State Grid recently announced that it would double the distribution automation centralized tender rounds to four in 2018. Grid dispatch and substation automation are expected to stay flat, until 2019-20 when the replacement cycle kicks in.

DC transmission and power electronics: Given that UHVDC project approval is slowing down, management reckons the risk of potential UHVDC sales contraction this year, especially for Purui Engineering. However, overall power electronics business is expected to rise steadily, thanks to: 1) enhanced efforts in growing non-DC transmission sales (e.g., Unified Power Flow Control), which has already exceeded DC; and 2) increasing exports. The delay in Zhangbei Flexible HVDC transmission project tender (to 1Q18 vs. planned 4Q17) leads to flat order intake for NR Electric last year, but earnings delivery is still expected this year. Management targets Rmb2.5bn orders from this project, out of est. Rmb5bn total tender size.

Power communication and information: This segment recorded c.20% revenue growth in 2017. Management holds an optimistic view on its outlook and expects its growth to further accelerate in next few years, given that State Grid plans to invest Rmb50bn in power communication by 2020, doubling from Rmb25bn now.

Shenzhen Inovance (300124.SZ, TP HKD 34.30, Buy, HKD 28.30)

Sky Hong, CFA, [email protected], (+852) 2203 6131

Shenzhen Inovance attended our Access China Conference 2018 on 8 January in Beijing. Below, we summarize our key takeaways from the investor meetings:

IA: a strong 2017; high growth likely to be sustained in 2018 General IA products (i.e., inverter and servo): Total new orders for

general inverter were up around 50% YoY in 2017 and management expects 40% revenue growth in 2018. Meanwhile, new orders for general servo rose >100% YoY in 2017 and the company is guiding for a YoY revenue growth range of 50-60% in 2018. Key growth drivers include: 1) broad-based manufacturing upgrades in China that require higher energy efficiency and precision, benefiting the demand for inverter and servos; and 2) continued market share gains through its "vertical-based" sales strategy, coupled with customization.

Specialized IA products (i.e., integrated elevator drive and PIMM servo): Total new orders for integrated elevator drive were up 15% YoY (revenue recognition likely in a range of 10-15%) as Inovance starts to increase its penetration in foreign brands (European and US brands in particular) while further strengthening its dominant position in local brands (70% market share). Revenue growth for this product is expected to remain at double digits in 2018. For PIMM servo, new orders were up 40% YoY, mainly driven by the additional contribution from servo motors, which the company started to sell in 2017. Growth would have been single digit on a like-for-like basis (i.e., excluding motors). For 2018, management is guiding for revenue growth of 20-30% YoY for PIMM servo (vs. projected industry growth of single digits).

19 January 2018



NEV: logistics NEV to become the key growth driver in 2018 Logistics NEV: Inovance estimates that its market share in China's

logistics NEV drive market reached 40% in 2017, with customers covering eight out of the top 10 logistics NEV producers in China. For 2018, management expects sales of logistics NEV to reach 150,000 units from 2017's 80,000 units (c.+90% YoY). On top of this, the company expects its share in the drive market to continue increasing in 2018.

NEV bus: The revenue contribution from NEV bus drive is estimated to have dropped to 60% of the NEV segment in 2017 vs. 90% in 2016. Moreover, the exclusive supply agreement with Yutong is due to be renewed by end-2018 and management expects the negotiation to kick off soon with results likely coming out in 1H18, along with a price cut for 2018. Preliminary assessment of the current situation suggests Inovance is inclined to renew the agreement. Overall, management expects the revenue contribution from NEV bus to remain steady in 2018, with the addition of motor products likely offsetting the drop in controller products.

Passenger NEV: Inovance invested half of its R&D expenses in the NEV segment, with 70-80% allocated to the development of passenger NEV drive products. Based on the current progress (i.e., it has secured 4-5 NEV models from tier-2 OEMs and 1 tier-1 OEM in 2017), management expects total new orders for passenger NEV drives to reach around Rmb100m. The target for 2018 is to secure more NEV models from tier-1 OEMs.

19 January 2018



Oil & Gas China Oilfield Services (2883.HK, TP HKD 9.13, Sell, HKD 8.80)

Johnson Wan, [email protected], (+852) 2203 6163

COSL attended DB’s Access China conference in the week of Jan 8. COSL sees an increase in workload for drilling and well services such as in Bohai Bay from CNOOC and also that from international clients. However, day rate recovery will still be challenging due to global oversupply and also old contracts rolling off with higher day rates. Well services will be the main earnings driver in 2018.

The key takeaways are as follows:

Semi-sub utilization averaged 40% in 2017 but based on new contracts secured for 2018, it's already close to 50% utilization. In North Sea, there were two new contract wins with Statoil but the day rate will be lower than the 2017 average day rate. Transocean recently signed a deep water semi-sub contract for USD150,000/day and COSL’s day rates are a little higher. Cash cost is c.USD110k/d for semi-subs for COSL.

Jack-up utilization will be 60% in 2017 and based on new contracts secured currently, the utilization rate may rise to 70% for 2018.

Cost savings. The target for COSL is to keep costs the same in 2018 flat yoy even though work volumes will increase. Variable costs such as labour, maintenance and raw materials cost could increase but the company will try to keep it flat.

Well Services. Work volume will increase in offshore China and more work in Iraq. Margins should be higher in 2018 than in 2017. The company will try to increase the contribution of Well Services to be about 50% of revenue and revenue is already 35% in 2017. The subsegments such as cementing, mud-logging and chemicals are delinked from the oil price and higher margins. COSL has also reduced the need to sub-contract work to others because there are fewer deep water wells being drilled globally and they are usually high pressure and high temperature.

Asset disposal. COSL sold two vessels last year to COOEC and will consider disposing older jack-up rigs that are above 30 years old to third parties. One-third of the current fleet is older jack-ups. COSL has converted one of the older rigs to a production platform instead for CNOOC. Most of the old rigs are in offshore China and they have already been fully depreciated, so their utilization is still high. The overseas rigs are on average 15 years old and average fleet age is 15 years.

19 January 2018



CNOOC Ltd (0883.HK, TP HKD 13.82, Buy, HKD 12.00)


CNOOC attended DB’s Access China conference in the week of Jan 8. They will also be hosting their strategy day on Feb 1 in HK. The key takeaways are as follows:

Production. Production will be at the high end of the range of RMB450-460mmboe and likely exceed this for 2017. DB estimates 465mmboe in 2017. By 2018, production growth will resume by c.2% mainly due to increasing gas contribution.

Costs. Costs will be higher in 2H17 and overall cost in 2018 will be higher than that in 2017. Exploration expense will likely be more in 2018. DD&A will likely be flat YoY. A higher oil price will lead to slightly higher lifting cost and also more taxes but All-in-costs will be c.USD35/bbl.

Capex. Capex will likely miss its guidance of RMB60b in 2017 since the 9M17 run rate was only at RMB33.2b. DB estimates FY17 capex is closer to RMB55bn. However, the unspent capex in 2017 will likely be brought forward to 2018. At the beginning of 2017, CNOOC guided for capex of c.RMB65bn in 2018 meaning capex could be closer to RMB70b in 2018, or up 27% yoy. CNOOC has also used an oil price of USD51/bbl to budget its 2017 capex and less than USD55/bbl for 2018 at the time. Capex spent will be on projects such as Liza phase 1, North Sea, Longlake SW, Libra, Lingshui gas field in China. Overall capex will be split between overseas and domestic projects at about 50/50.

Dividends. Historically, CNOOC’s dividend yield has been 4-5% which is one of the highest below CNOCCO Philips. CNOOC continues to target itself to be one of the best dividend payers among global E&P companies and are studying whether there is a more effective dividend policy.

Reserve life. Reserve life will increase substantially over the next few years as more new projects will be added versus 8.1 years in 2016. In 1H17, CNOOC forecast reserve life to rebound to c.9.5 years but reserve life will likely exceed 10 years by end 2017. This is due to a combination of economic writeback of its reserve in i.e. Nigeria and Longlake and new additions in Bohai Bay, Liza and Libra. Its safe to assume that 2017 RRR will rebound to 200-300% including the impact of the oil price revision.

Long lake. The asset has turned positive cash flow since Sep but earnings positive in 4Q17. The turnaround is due to higher oil price and oil blending being successful. Upgrader don’t have timeline when it will come back on fully because blending process has been good and there is no need to completely restart.

Tax. Tax impact from new US tax laws by adjusting corporate tax rate from 35% to 21%. The impact from the tax hit could be about a one-off RMB2.4bn for 2017. However, in 2018, the tax rate would be lower.

19 January 2018



PetroChina (0857.HK, TP HKD 5.77, Hold, HKD 5.80)


PetroChina attended our Access China 2018 conference; below are the key takeaways: Gas import surged to 57bcm in 2017, import loss widened but narrowed on per unit basis With gas shortage sustained in China on the back of strong demand, PetroChina's gas import increased to 57bcm in 2017 higher than the target import of 51bcm. The difference is satisfied by LNG spot import and 19bcm was imported in 4Q17. We expect PetroChina's gas import loss after VAT rebate widened to RMB23bn in 2018. With the gas price hike of 11-13% in 4Q17, PetroChina import loss of LNG had actually slightly narrowed QoQ with loss per cm of RMB1.0 / 1.18 / 0.78 / 0.60 in 1Q / 2Q / 3Q / 4Q, respectively. Management revealed the gas shortage situation eased after buying LNG from spot market, however, it has been difficult for signing long term contract as LNG exporters are timing for better pricing. PetroChina's LNG terminal is running at c.80% utilization rate. There is no news on pipeline reform from the company and reckon the net assets of pipeline is worth > RMB500bn.

Domestic gas production set to pick up; shale gas production targets more than triple by 2020E; oil flat in 2018 PetroChina expects its domestic gas production to improve by c.6-7% yoy in 2018E (1H +5% / 2H +8%). The average conventional gas production cost was below RMB0.8/cm and improving domestic production aims to curb LNG import getting out of control. Moreover, the company holds the vision on developing shale gas in Sichuan and Hubei area and target 2020E shale gas production to reach 10bcm by 2020 (3.6x of the 2.8 bcm production in 2016) before the shale gas production subsidy is taken away. Shale gas well drilling cost will reach RMB50mn per well in 2018, down 50% compared to 5 years ago. With RMB0.3/cm subsidy, shale gas profit was about RMB0.12/cm. Conversely, domestic oil production remains flat ahead with c.100mmton, per year unless oil price surge above US$70/bbl.

2018E capex is expected to +10-15% yoy budgeting at US$50-55 oil The company expects capex will increase by 10-15% in 2018 (vs. RMB191bn in 2017) in order to fuel its gas production ahead. We believe the 2018E budget was based on US$50-55/bbl (same with 2017) which was usually set in early 4Q. Hence, we see upside potentials on capex spending in 2018.

Dividend policy may be adjusted in the future Shareholders returns and dividend policy has been a key topic across oil & gas sector. PetroChina may consider amending its dividend policy from current 45% payout on profits to free cashflow basis, after M&A. In 1H17, PTR paid out 100% of its profits given its strong cash flow.

Sinopec (0386.HK, TP HKD 7.44, Buy, HKD 6.23)


Marketing spin-off target of 2H18; spreads rebound in 4Q The progress of the marketing IPO has been delayed, as regulators focused on the 19th CPC and have yet to make a decision on the pipeline company set-up and whether the product pipelines of Sinopec should be included. Sinopec has

19 January 2018



obtained most approvals, while they are still pending from NDRC and the State Council. Once the approvals are obtained, it will take 6-8 months for the IPO, which will likely take place in Hong Kong. The price war should persist in 2018 but the worst seems behind us with marketing spreads rebounding in 4Q17. Whether the spreads can improve in the future depends on the government's crackdown on tax evasion by teapots. Sinopec believes its fuel business will grow in the low single digits going forward, while its non-fuel business can grow much faster, with earnings growth of 60% in the last two years and also in the next two years. The target is for non-fuel sales revenue to reach RMB100bn and achieve an OPM of 10-15% by 2020E, in which case, non-fuel will account for 1/3 of its marketing EBIT versus less than 10% now.

Refining to be more healthy in China on balanced demand-supply Chinese demand for gasoline is expected to post a 10% CAGR in 2018E-20E, kerosene will keep double-digit growth, while diesel may witness annual growth of 2-3% after a turnaround in 2H17. The government granted more crude import quota to third-party refiners, which may not be a bad thing as that would allow the government to track the processing volumes of each refiner to ensure they pay proper taxes. There is also the phase-out of smaller refiners and the roll-out of bigger refiners, which will help improve the outlook for GRM and utilisation.

Upstream wouldn't break even until Brent reaches USD70/bbl and more growth on gas side Upstream will lose significantly less money thanks to the higher Brent price, but Sinopec is benchmarked more to the Dubai crude price, which is still a USD5-6/bbl discount. Upstream oil breakeven is at USD65/bbl, therefore USD70/bbl is required. However, the cost of production will be reduced in 2018 because of 1) potential impairments in 2017 and 2) lower DD&A, with more reserves being written back from a higher oil price. Crude oil production will be roughly flat in 2018, while natural gas will continue the high double-digit growth this year. The gas business is slightly profitable in 2017 after subtracting the import losses, which totaled RMB6bn for 9M17. In 4Q17, there were no import losses, as SNP sold more LNG to targeted customers, instead of through the pipe at around USD7/mmbtu. SNP doesn't procure expensive LNG from the spot market, as it has enough long-term contracts on hand. Import losses could widen in 2018 as the company imported 6-7mt of LNG in 2017 vs. 8mt in 2018. In order to secure China's gas supply, the company has been considering signing more long-term LNG contracts and even M&A overseas.

Capex at RMB100-110bn for 2018 with more focus on gas The capex may increase to RMB110bn this year from RMB98.5bn in 2017 and RMB29.1bn in 9M17, implying 12% yoy growth. Given an improving outlook on the gas side, the share of natural gas in total capex will also rise to 1/2 vs. an average 1/3 historically. Moreover, the company has realised the bottleneck of the gas business is in the midstream, therefore more money will be invested in pipelines and storage facilities.

19 January 2018



Sinopec Engineering Group (2386.HK, TP HKD 9.40, Buy, HKD 8.37)

Vitus Leung, [email protected], (+852) 2203 6158

New order target in 2018: RMB45-50bn SEG expects 2018E new orders to reach RMB50bn (China RMB40bn + oversea RMB10bn), represents c.10-20% yoy growth. We under the expression of new orders booked in 2017 would be RMB40bn+, beating guidance of RMB38bn. The company expressed that Zhenjiang Maoming project EPC agreement did not finalized in time for 2017, and phase 1 EPC contract would fall into 2018 new orders instead. The other 3 Sinopec refining petrochemical bases EPC contracts could be signed in 2018; the first one should be Nanjing base phase 1, followed by Zhenhai (ZRCC) brownfield expansion, then Shanghai. Also, Fujian Gulei project the EPC contract is likely to happen in early 2018. Management believes a strong new orders pipeline will carry over to 2019.

GPM margin stable at 11-13% level Management expressed overall GPM should maintain a level of between 11-13%; 16% GPM in 1H17 was unusually high due to higher contribution of enegineering and designed revenue recognized. Oversea project usually at about 8% GPM level, while the EPC+F could provide upside potential on oversea EPC projects. SEG is cautious on bidding new oversea projects, and avoids participating in low GPM projects which could result in a loss.

China private-own projects emerging Independent refining and petrochemical companies are ramping up capacity in China. The company is confident in securing EPC / design / licensing contracts, like previously independent refineries upgrade, Dalian Hengli, and Zhejiang Rongsheng EPC contracts. With strong oil prices, the potential for a CTO projects pipeline could be revived. Overall, China petrochemical consumption still heavily relies on imports; while some advanced and specialty petrochemical products completely rely on imports; assuming the capex spree continues in the long term.

Capex / M&A overseas SEG will spend about RMB400-500mn capex in 2018 on the newly acquired Sinopec Energy Saving Co, for efficiency and energy saving upgrades on BOT basis on refineries, with the first batch focusing on 10-20 projects. The company sees 60-70 project potentials within the Sinopec Group where there are also mutual interests from the refineries. The IRR handle is >20% and it should bring in meaningful contribution from 2019. The company also targets an extension of this operation into CNPC and CNOOC Group in the longer term with guaranteed creditability. Conversely, we note overseas M&A is not making much progress and we are under the impression that it could continue to be very tough.

Dividend payout / management incentive scheme Management sees there is room for lifting dividend payout ratio going forward and the payout ratio has been c.40% in the past, leading to slower increase in shareholders equities. The incentive scheme requires 10% ROE in 2018-2020 while SASAC set it as 10% because the SEG achieved it before. Conversely, management indicated paying a special dividend to boost ROE is not a preferred way at this stage.

19 January 2018



SPC (0338.HK, TP HKD 5.20, Buy, HKD 4.78)/ (600688.SS, TP CNY 5.30, Sell, CNY 7.05)

Vitus Leung, [email protected], (+852) 2203 6158

Sinopec Shanghai Petrochemical (SPC) attended our Access China 2018 conference, and we lay out the key takeaways below: Oil inventory gain could set a new high on earnings in 2017 With crude oil prices surging in 2H17, SPC will record an inventory gain in 4Q17. SPC holds 14 days of crude oil inventory, with a 45-day procurement time. Hence, there could be a US$5-6/bbl of inventory gain in 4Q17, and there could be some inventory gain on chemicals products, leading to a potential record high in earnings.

Refining outlook strong with better throughput in 2018 SPC expects its refining utilization rate to reach 95% in 2018E, with a throughput of 15.2mnton due to lack of a significant outage. Management believes that the China GRM outlook will continue to be strong, and pass-through is not an issue, if oil prices are below US$80/bbl. Already considered teapot refineries' utilization rates may surge as a result of their import crude oil quota surge. Moreover, SPC GRM has been improving by selling higher octane gasoline, which produces c.70% of #92 gasoline, c.20% of #95 gasoline and c.10% of #98 gasoline.

Strengthening refined products consumption tax collection efforts China State Administration of Taxation issued No#1 Document on 8 Jan stating that the government will strengthen its efforts on curbing consumption tax evasion by adding 22 categories of oil and products in order to prevent changing the receipt products. Hence, management believes teapot refineries' import quota utilization will not be significantly high considering the strengthening efforts on consumption tax collection. Environmental protection costs plus consumption tax collection could add pressures on teapot refineries.

Ethanol gasoline adoption could be a bumpy ride China plans to adopt E10 (10% of ethanol content) nationwide, although blending gasoline adoption could be difficult, as there are a few limitations. China gasoline demand is c.120mnton, which requires 12mnton of ethanol, while current production (c.2.6mnton) is far from those requirements. Currently, some provinces have already adopted E10 gasoline blending since the pilot program began in 2004.

Chemicals outlook remains healthy The company expects the 2018 chemicals market to continue to be strong and healthy, with the non-PE supply demand tightening while the new production volume of US ECC products are widely expected. Fiber will likely continue to be sluggish. Overall, chemical margins should maintain their high levels, and SECCO profitability should continue to be strong.

Capex and strategy ahead SPC plans for new ethylene plants to use blended feedstocks (naphtha + LPG + residuals blending) with 800ktpa capacity and a cost >RMB10bn on capex. However, we were under the impression that an expansion in the CDU / fiber business is unlikely.

19 January 2018



Utilities / Renewable / Environmental BEWG (0371.HK, TP HKD 7.40, Buy, HKD 6.06)

Thomas Zhu, CFA, [email protected], (+852) 2203 6235

Recent PPP policies: Management does not expect BEW’s projects to be significantly affected by the recent policies on PPP. BEW has recently secured a senior tranche fund contribution from the LPs to prepare for construction/investment over the next few months.

PPP orders: PPP project sign-ups were RMB50bn in 9M17, with some more sign-ups (but at a much slower pace) in 4Q17. Management expects less PPP project wins in 2018 versus 2017 as a result of the slowdown in overall PPP market, and also as sizes for individual projects getting smaller. However, management believes that project returns should be higher for the new projects, due to less intense competition following the Chinese government's recent restrictions on PPP participation of central government-owned construction companies. Management also believes that future PPP projects should be lower risk as China’s recent regulations make future PPP projects more compliant.

PPP booking: Management now expects to collect 3-5% of design fee (based on project investment ex-relocation expenses) on a cash-basis before the project commences construction. In addition, management expects to do 15% of EPC (also based on project investment ex-relocation expenses), but cash collection on this part may be tilted towards the later stage of construction (rather than on a percentage-of-completion basis.

19 January 2018



Beijing Enterprises (0392.HK, TP HKD 53.80, Buy, HKD 46.15)

Hanyu Zhang, [email protected], (+852) 2203 6207

BEHL attended our AccessChina 2018 conference and we set out the key takeaways below:

Gas sales: The management expects the sales volume of Beijing Gas to reach 14.7-14.8bcm in 2017, implying 2-3% yoy growth. This is better than 1H17, which recorded a 1% yoy volume decline due to a warm winter. In Nov-Dec 2017, Beijing cut back some gas usage from power plants in order to divert more gas supply to other provinces, to ease the winter gas shortage. The management estimates the pent-up demand to be 0.6-0.8bcm, which is likely to be released in 2018, as gas supply will be more abundant compared to this year.

Gas transmission: Management expects the ShaanJing pipeline to record volume growth of c.14% yoy in 2017, reaching full capacity. ShaanJing pipeline IV has been put into operation in Dec 2017, but the volume contribution is very limited. In 2018, management expects that the additions in transmission volume should be no less than in 2017 (5bcm), which will translate into volume growth of at least 12% yoy.

Impacts from winter gas shortage: All of BEHL’s gas supply is from pipelines and the company has passed through the cost increase via raising non-residential end-user prices by Rmb0.16/cm. So the winter gas shortage has very limited impact on the company.

Rural connection updates: Beijing plans to convert 0.5mn rural residences from coal to gas during 2017-19. In 2017, 0.15mn has been converted. Currently all the rural projects are supplied by pipelines, but in the future there will be some residences supplied by LNG. Beijing does not have a connection fee but the government will subsidize 30% of the related investment.

China Gas Holdings (0384.HK, TP HKD 23.80, Hold, HKD 21.55)


China Gas Holdings attended our AccessChina 2018 conference and we layout key takeaways below:

Impact from winter gas shortage: Overall management expects a mild impact from the winter gas shortage, with the key reason for the gas shortage being less supply from Central Asia and not enough gas filled in storage facilities in the summer time. The shortage eased meaningfully once Turkmenistan began increasing gas supply to China a few weeks ago.

According to management, 3-4% of China Gas’ total gas supply is from LNG and the company has signed contracts with CNOOC to partially secure LNG supply at lower-than-market prices. When market LNG prices shoot up to above Rmb8,000/ton, CNOOC is still selling at c.Rmb5,000/ton. Mgmt expects some mild margin impact from the winter shortage and the blended margin for

19 January 2018



FY18 (Apr 2017-Mar 2018) to reach Rmb0.62-0.63/cm (vs. Rmb0.65/cm in 1HFY18).

In the long run, management thinks the gas shortage is positive to downstream distributors as it will accelerate the inter-connections of oil majors’ pipeline networks and stimulate LNG terminals to open-up to third parties. China Gas will seek third party access to LNG terminals for its LNG import contract with Delfin starting in 2021 (MOU signed in Nov 2017).

Rural projects update: China Gas has almost completed the FY18 rural connection target of 1.1mn households by the end of Dec 2017. Management is confident to complete 2.0mn/2.5mn new rural connections in FY19/20 with 3.0mn contracts already signed with local governments. Up to now, China Gas already received 30% of the government subsidy and management expects a similar accounts receivable period of 9-10 months compared with urban projects.

Other key takeaways: China Gas recorded 37-38% yoy volume growth in 4Q17, on track to achieve its FY18 volume guidance of >35% yoy. Total capex guidance for FY18 is HKD5.5-6.0bn (HKD3.0-3.5bn for urban and HKD2.5bn for rural) and that for FY19 is HKD6.0-6.5bn. Currently around half of the rural investment is done under the clean energy funds.

China Everbright Int'l (0257.HK, TP HKD 13.50, Buy, HKD 11.14)


Capacity ramp-up: CEI had over 16,000tpd of waste-to-energy capacity coming into operation in 2017, the highest level in history. Management expects very strong operating cashflow growth as a result of the strong addition to operating capacity.

Funding: Capex in 2017 should be broadly in line with previous guidance. Given that China Everbright Group now holds only ~41% of CEI and that central government SOEs rarely reduce stake in listcos to below 40%, share placement is unlikely for CEI. CEI would consider other alternatives (e.g. debt financing, selling some holdings of securities) when fund-raising is needed.

Management change: Mr. Wang Tianyi has been appointed CEO of CEI following the retirement of Mr. Chen Xiaoping in December. Mr. Wang has been with CEI over the past few years and transition has been smooth.

PPP, subsidies: CEI has very little exposure to PPP projects and does not expect to be affected by the recent PPP policies from MoF. CEI did not issue PPP investment funds as its current funding cost (<4%) is lower than that of investment funds (>5%). CEI expects to receive power tariff subsidies for projects in the 7th batch renewable energy subsidy catalogue in end-1Q/early 2Q.

19 January 2018



China Everbright Greentech (1257.HK, TP HKD 7.90, Buy, HKD 7.46)


Subsidy collection: Biomass projects in the 6th batch are able to collect subsidy fully within a quarter. Biomass is prioritized in subsidy collection, as the power tariff subsidy (together with that of waste-to-energy) represents less than 9% of the renewable energy subsidy fund.

HWT: The treatment fee increases by 5-10% every year. Treatment fees could double in emergency treatments and the company is now seeing more and more emergency cases as environmental inspections become more stringent. The utilization rate of HWT projects is usually 90-100%, while the company could potentially achieve 120% on landfill projects (allowed by local government). The company expects to speed up the construction process in 2018 and has guided for 700ktpa operating capacity by the end of 2019. CEG now prefers to select HWT projects with high treatment difficulty, as such projects have higher profit margins. All new HWT incineration projects have now signed service concession contracts.

Biomass: CEG expects to have 990MW operating biomass capacity by the end of 2019. The raw biomass material cost is stable around RMB0.36-0.37/kWh as there is a biomass treatment alliance to help stabilize raw materials prices. Raw materials supplies are 3-4 times of CEG’s plant demand locally and therefore management is not concerned about any potential raw materials shortages even if some agricultural raw materials may be treated in ways other than incineration in the future. CEG does not see tariffs going down within the 13th Five-Year Plan Period, as the government now takes environmental protection quite seriously and also because biomass treatment is in line with the Chinese government’s policy to fight poverty in rural areas (as farmers get paid for supplying biomass raw materials). CEG is gradually upgrading its existing power-only projects to heat/power cogeneration projects. Management believes that co-generation projects are more profitable than power-only projects.

Capital funding. CEG currently has HKD3bn cash from the IPO and a HKD4bn credit line. Capex is around HKD4bn per annum. The current gearing ratio is 30% and it is expected to go up in the future.

Soil remediation. CEG is in the process of applying for soil remediation licenses.

Guangdong Investment (0270.HK, TP HKD 13.2, Buy, HKD 10.38)


Dividend GDI has HKD5-6bn/yr operating cash inflow, and net cash of HKD12bn on the 1H17 balance sheet. Cash on hand is used for investment first, and the rest will be considered for dividend payout. Management is confident it can maintain dividend CAGR of 20% over the next few years, although the growth cannot sustain in the long run.

19 January 2018



Water The cost of Dongjiang water is mostly fixed (depreciation, water resource fees, etc.) or with little change (electricity charges), and only 10% of the total cost is variable (labor and maintenance costs). Labor cost increases 5-10% per year, which could be offset by the 0.3% growth of HK water supply revenue. Management believes that Dongjiang water will have flat performance in the next three years, so segment growth will be driven by projects other than Dongjiang. The company has water supply capacity (other than Dongjiang) of 3.5mtpd, with some projects turning profitable after loss in the initial two to three years.

New projects GDI requires high single digit IRR for new projects. The company does not raise debt for its project investments as it has a large amount of cash on hand. GDI’s water assets have good cash collection because water supply projects are paid by users directly and WWT projects paid by governments represent a small portion of water projects. There is no construction profit for GDI’s projects, and the projects can usually turn profitable within three to four years, while there is positive cash flow from the second year.

Others GDI’s power segment was profitable in 2017. Two roads in Dongguan PPP projects started construction in December 2017, with more starting in 2018, but cash inflow is only achieved after completion of construction. Management expects Tianjin Teemall to turn profitable from 2018. Guangdong-Hong Kong-Macau Greater Bay Area related policy is not clear yet, but management believes that there will be new opportunities and GDI is advantaged to capture such opportunities in the future. Profit of the Property segment in 2017 was hit by lower yoy average RMB exchange.

CR Gas (1193.HK, TP HKD 35.40, Buy, HKD 26.25)


CR Gas attended our AccessChina 2018 conference and we layout the key takeaways below:

Impact from winter gas shortage: CR Gas expects the volume growth in 2017 to be 22% yoy, slightly lower than 25% in 10M17, mainly dragged by the supply shortage in this winter. CR Gas expects its gas sales margins to reach Rmb0.60-0.62/cm in 2017 (vs. Rmb0.64/cm in 1H17). The margin decline is primarily due to the incomplete pass though of cost increase in this winter. CR Gas bought c.10% of its total gas supply from SHPGX/LNG spot market in Nov-Dec 2017 at prices >50% higher than benchmark city gate prices. The remaining 90% is contracted piped gas whose winter price is c.10-20% higher than benchmark and it is relatively easy to pass through this part of cost hike to end users.

Margins outlook: Recently, the gas shortage in North China is eased but that in central China is still severe. If the gas supply shortage eased further in early 2018, it will be positive to both margin and volume. CR Gas also sees some margin pressure going forward as several provinces/cities are reviewing the gas prices. There are some risks of price cut although up to now no such cuts occurred after the NDRC announced the ROA cap of 7% in July 2017.

19 January 2018



Connection outlook: CR Gas expects the new connection to be flattish yoy in 2017. The company remains conservative towards rural project economics and the management thinks local governments will be less aggressive to do rural coal-to-gas as the pushes from central government may become less stronger than 2017. CR Gas has made 0.2mn rural connections in 2017 and plans to only connect 0.1mn in 2018. Management is aware that the central government is doing some survey on connection fee and believes they have no intentions to cancel it. In the future it is likely to encourage more competitions in this sector.

Other key takeaways: CR Gas maintains its capex guidance of HKD3-4bn (incl.M&A). The company plans to raise dividend payout gradually starting from 2017 (vs. 30% in 2016).

ENN Energy (2688.HK, TP HKD 65.50, Buy, HKD 52.20)


ENN attended our AccessChina 2018 conference and we lay out the key takeaways below:

Winter gas shortage impact: According to ENN's management, 1.18bcm gas sales volume was impacted by the source gas price hike in Nov-Dec 2017 (vs. c.14bcm total retail gas sales volume in 2017). Around 60% of the impacted volume saw a cost increase of 10%, another 20% of the volume had a cost increase of 15%, and the remaining 20% had a cost increase of 50-60%. On average, the cost hike was Rmb0.4/cm and ENN has already passed through 70% of it to downstream.

Overall, management expects the gas sales dollar margin to be Rmb0.63/cm in 2017 (vs. Rmb0.66/cm in 1H17). Management thinks the worst time has passed as gas imports from Turkmenistan have increased recently and the new LNG terminal in Tianjin has been put into use. LNG prices have already come down and therefore the dollar margin should improve in 1Q18.

Gas sales volume: Management expects retail gas volume growth to be >25% in 2017, in line with previous guidance. In Nov 2017, volume growth held up well at >25% even with the shortage in gas supply. In 2018, ENN expects retail volume growth to remain strong at c.20% yoy

New connections: ENN expects >1.9mn new connections in 2017. The company has completed 0.3mn rural connections in 2017 and may connect slightly more in 2018. ENN chooses to remain prudent and plans to stick strictly to its criteria for rural investments: 1) only focus on those villages inside a city whose concession is owned by ENN; 2) only focus on projects with visible and generous subsidy policy; 3) focus on those with potential C&I users.

Other key takeaways: ENN plans to settle the convertible bond (USD500mn due Feb 2018) via cash; up to now, 5% has been settled/repurchased. The North America LNG business is still experiencing difficulties with potential for further impairment or disposal. Zhoushan LNG terminal (under the parentco) is set to commence operations in 3Q18, and ENN (the listco) has signed c.2bcm/year LNG import contracts with international suppliers. At oil prices of USD60/b, the all-in cost of imported LNG is 5% lower compared to the city-gate price of Zhejiang.

19 January 2018



Huadian Fuxin (0816.HK, TP HKD 2.20, Buy, HKD 2.03)

Michael Tong, CFA, [email protected], (+852) 2203 6167

Huadian Fuxin attended our Access China 2018 conference and our key takeaways are below: Coal: In 2017, with Fujian power demand and supply recovering, Fuxin’s coal-fired output rose 28% yoy and the settled tariff also improved slightly. However, as the coal price is still hovering at a high of around RMB700 currently, the coal-fired segment recorded a mild loss last year. For 2018, management envisions better output and market-based tariff yoy on continued power demand and supply improvement and meanwhile a flat coal price.

Wind: Wind output rose 21% in 2017 with utilization hours recovering to over 1,800hrs (vs. 1,765hrs in 2016) and curtailment reduced to c.15-16% (vs. 19.5% in 2016). Wind capacity addition was around 400MW, falling short of the company's prior guidance of 500-600MW. This was primarily due to high curtailment, which jeopardizes the return of some planned projects. Fuxin currently has c.RMB4bn accounts receivable attributable to delayed renewable power subsidy payments. For 2018, management believes curtailment will see a further reduction, though the magnitude may not be as high as in 2017. Wind capacity addition could go slightly higher yoy. The 300MW Fujian offshore wind plant under construction is scheduled to operate in 2019 and management expects it to enjoy 4,000 utilization hours.

Nuclear: The tariff cut for Ningde 3/4 and Fuqing 2/3 will be retrospectively adjusted and booked in the 4Q financials, which will impact net profit by c.RMB100-200m. Without considering this, the nuclear profit contribution in 2017 should reach the prior target of RMB700m.

Capex and dividend: With wind capacity installation turning out to be lower than planned, capex also came in less than the guided RMB6bn. Management guided for capex in 2018 to stay stable at c.RMB6-7bn, mainly for wind installation and partially for gas-fired plants. This budget does not include potential clean energy acquisitions, either external or from parentco. On the dividend, management thinks the company will balance the payout with the cash needed for future company development and rising refinancing costs. Having said that, management affirmed the payout will be at least as high as in 2016.

Huaneng Power Int’l (0902.HK, TP HKD 6.00, Buy, HKD 5.10)


Huaneng Power attended our AccessChina 2018 conference and we lay out the key takeaways below:

Tariff outlook: The company is still waiting for the official decision from the central government for a potential tariff hike based on the fuel cost pass-through mechanism. Management believes that there are room for the transmission tariff cut to buffer the impact to end users.

19 January 2018



Coal price outlook: Huaneng is still negotiating with the coal companies for the coal purchase contracts in 2018. Currently the company has secured around half of the coal consumption plan for 2018 via contracts (70-80% was secured by this time last year). The negotiation with coal prices has become more difficult as the consolidation in coal sector has resulted in higher concentration in market share of coal producers. For land-transported coal, the contract is on a quarterly basis with price adjustments in every month. For seaborne coal, the price is set based on benchmark price of Rmb535/ton with adjustments according to the Bohai-Rim coal price Index

Power demand outlook: Management expect China’s total power demand growth to reach 6.4% in 2017 and expect a slower growth in 2018 due to potentially weaker momentum in GDP growth.

Capacity expansion and capex: Huaneng plans to add 2.0/4.14GW in 2018/19. Out of the 2GW in 2018, 945MW is gas-fired, 905MW is wind, 150MW is solar. Out of the 4.14GW in 2019, 2.74GW is coal-fired, 400MW is gas-fired, 850MW is wind and 150MW is solar. The company has budgeted a capex of Rmb26.9bn for 2018 and Rmb24.3bn for 2019.

Other key takeaways: In 9M17, 41% of Huaneng’s thermal power plants are loss-making. If the 2017 earnings of those assets injected from the parentco is lower than the guaranteed level, the parentco will pay the difference by cash, which will be reflected in 2017 earnings although the cash will be received in 2018.

Longyuan Power (0916.HK, TP HKD 7.40, Buy, HKD 5.67)


Capacity: Longyuan secured 1.78GW of approved capacity in 2017. It also added 1.05GW of wind capacity in 2017; this was less than expected due to a project delay as result of more stringent environmental and security requirements. The company expects capacity addition to be flattish in 2018.

Curtailment and market-based power: Curtailment was 10.4% in 2017, down 5.3ppt yoy (Dec: 9.0%). Management believes that curtailment of lower than 5% is achievable by 2020. The improvement should be driven by higher dispatch priority given to renewable energy and UHV lines commissioning. Market-based power was 21% of the generation in 2017, and the discount was narrower than in 2016. Management expects the percentage of power discounted to decline and the magnitude of discount to narrow in 2018.

Green Certificate: The mandatory Green Certificate mechanism is still under discussion, while the government seems reluctant to further burden thermal IPPs. Another potential solution to reduce the renewable energy subsidy fund deficit includes collecting (and even in a retrospective way) renewable energy surcharge on captive power plants.

Subsidy collection: Longyuan collected RMB4.6bn of tariff subsidy last year. Collection progress turned out to be smoother in 4Q17. Longyuan expects subsidy collect to continue to be smooth in Jan.

19 January 2018



Capex, finance cost and dividend: There is only moderate decline in unit capex as turbine price declines while construction cost goes up due to more stringent environmental requirements. Finance costs in 2017 should be within the previous guidance of 4.25%. The company is still able to get discounts for some loans. With less capacity addition and an improved operating cash flow, Longyuan plans to increase its dividend.

Yangtze Power (600900.SS, TP CNY 18.30, Buy, CNY 15.98)


Yangtze Power attended our AccessChina 2018 conference and we lay out the key takeaways below:

Power output: The water inflow improved much in 2H17 and the total generation in 2017 was up by 2.4% yoy (vs. 4% decrease in 1H17). Three Gorges/Gezhouba recorded 4.4%/4.1% generation growth while Xiluodu’s output remained flattish and Xiangjiaba’s output decreased slightly by 1.2%. According to the management, there are 6bn kwh power curtailment in 2017 (vs. 210.8bn kwh total power output) mainly in Xiluodu/Xiangjiaba and management expects it to decrease going forward. The synchronized dispatching among Yangtze’s four hydro plants has contributed 9.6bn kwh additional power output in 2017 and management believes there is still further room to improve.

Tariff updates: Yangtze Power just announced the tariff hike for its Xiluodu/Xiangjiaba (effective on Jul 2017) due to the mid-year tariff hike for thermal power. Tariff was raised by Rmb1.9/mwh to Rmb326.3/mwh for Xiluodu (Right) and was raised by Rmb4.6/mwh to Rmb300.6/mwh for Xiluodu (Left) and Xiangjiaba. Out of the total 210.8bn kwh power output in 2017, around 12bn kwh is market-based volume with a price discount of c.Rmb20/mwh.

Capital deployment: Yangtze has budgeted Rmb12bn/year for external investments for next 2-3 year. They will mainly focus on hydro/power retail sector in domestic market and are also interested in overseas opportunities in hydro/power retail/gas power sector.

Other key takeaways: The company is aware of the draft version notice by NDRC to reduce the VAT for hydro power, but they are still waiting for further official updates on this. Mgmt expects the financial cost to drop yoy in 2017 and remain flattish in 2018 with some reduction in total debt offset by higher effective interest rate. Yangtze will stick to its dividend policy of no less than Rmb0.65/sh for 2017-20.

19 January 2018



Property

China Vanke (2202.HK, TP HKD 41.38, Buy, HKD 37.75)/ (000002.SZ, TP CNY 34.53, Buy, CNY 35.99)

Jeffrey Gao, CFA, [email protected], (+852) 2203 6256

Vanke attended our Access China 2018 conference, and below are the key takeaways: Proactive landbanking to continue: Vanke has acquired 46mn sqm land in

2017 (about 30mn sqm was acquired in 2H). Management guides that the land acquisition this year will be at least 10% higher than last year, in terms of GFA. Management believes its fast asset churn model can support double-digit sales growth this year, despite its current landbank of 140mn sqm (including 40mn sqm it has pre-sold) seeming relatively small compared to peers.

Margin to trend up: Management estimates the post-LAT pre-sales gross margin is about 24% (vs. 20.3% in FY16), although the average land acquisition cost last year was >RMB7k/sqm (about RMB5.5k/sqm excluding the Guangdong Trust asset package, which is similar to the level in previous years).

Gearing to remain healthy: The company has collected >RMB500bn pre-sales proceeds (~90% cash collection rate) in 2017. Management guides the end-2017 net gearing ratio will remain healthy though slightly higher than the 26% in FY16.

Acquisition of CapitaMall assets: The total consideration of the acquisition is RMB8bn (based on a 6% cap rate valuation), and the total GFA of the malls is about 900k sqm. Management believes there is retail demand for these community malls in suburban districts, despite the fact there may be oversupply of commercial property in low-tier cities.

Railway projects making good progress: Management disclosed that Vanke has acquired 60 above-metro property projects in Shanghai/ Qingdao/ Zhengzhou/ Changchun, etc. Also, we expect the company to win the auctions of the two Shenzhen projects from Shenzhen Metro, as a near-term catalyst.

Policy to remain stable: Management expects property policies to remain stable in 2018F, and believes the stringent control on pre-sales permits has limited the supply in top-tier cities. Also, management does not expect the property tax to be introduced in the short term.

COLI (0688.HK, TP HKD 30.63, Buy, HKD 29.05)


COLI attended our Access China 2018 conference, and below are the key takeaways:

RMB400bn sales target by 2020 remains: Management confirmed that the previous sales target of RMB400bn by 2020 stays (implying ~20% sales CAGR). Management seems confident of achieving strong sales growth this year, given the new starts in 2017 were equal to ~3x the level in 2016.

19 January 2018



Proactive landbanking to continue: The company acquired about 70 projects for a total consideration of HKD160bn last year. Management aims to stay proactive on land acquisitions this year, and targets more of a balance with scale expansion, while maintaining the net gearing ratio at a healthy level (net gearing cap at 40%). However, management believes public land auctions and primary land development (in Beijing and top T2 cities) will remain the major landbanking channels for the company, due to complications with M&A projects.

Expansion in T3 cities: Management plans to expand its exposure in T3 cities as the current exposure in the low-tier market is relatively small vs. peers at the Group level. COLI intends to form a JV with COGO on large-scale T3-city projects, which COGO alone cannot afford financially.

Gross margin to stay at ~30%: Management guides the gross margin to stay at around 30% in the next three years, though it may gradually squeeze to 25% in the longer term (but should remain above the sector average).

Policy to remain stable: Management expects overall policy to remain stable this year. They believe the recent loosening in some cities is a marginal policy adjustment, and should not be interpreted as nationwide relaxation. Also, management agrees that the sales volume in T1/2 cities should rebound in 2018, given the low base.

Aoyuan (3883.HK, TP HKD 30.00, Hold, HKD 27.16)


Aoyuan attended our Access China 2018 conference; below are the key takeaways:

Targets RMB60-70bn sales in 2018: Management targets to achieve RMB60-70bn (likely to be at the high end) this year (vs. RMB45.6bn in 2017), given its rich saleable resources. Aoyuan aims to be one of the Top 30 developers by sales value in 2018, and achieve RMB100bn sales in 2019.

Aggressive landbanking in 2017: The company acquired 5m sqm of land in 2H to form full-year landbanking of ~9m sqm in 2017, with c.85% stakes on average. Out of these projects, 80% was acquired via M&A. Management plans to use 40-50% of the sales proceeds for landbanking this year (50% in the Greater Bay Area) with targeted margins of >25% gross and >10% net. In addition, the company has about 20-30 redevelopment projects in its pipeline. Management guided that two projects in Guangzhou and Zhuhai could be included in its land bank in 2018.

Strong FY17 earnings: Supported by its strong sales and large unbooked sales, management expects a significant increase in revenue and net profits in the next three years (we estimate a >50% earnings CAGR in FY17-19).

30-35% dividend payout ratio: Management is guiding for a 30-35% dividend payout ratio on its core net profits, implying 5-12% dividend yields based on our estimates.

19 January 2018



Financing cost to be lowered further: Management expects the average financing cost to be lowered to 7.5% by end-FY17 (vs. 7.6% in 1H17), and expects it to decline further to below 7% in 2018 after refinancing the USD250m bond (@10.875%) that is due to mature in May 2018. Aoyuan is also waiting for NDRC approval for a USD900m loan as well as preparing club loans for refinancing.

Net gearing remains decent: Given its back-end-loaded sales (>RMB10bn sales in December), management expects the full-year cash collection to be about 80% and the net gearing ratio to be about 70% by end-FY17 (vs. 63% in 1H17).

Overseas projects making good progress: Management expects the overseas projects to contribute RMB4-5bn sales this year, and 2-3 projects in Australia to be booked in FY18. In addition, the company is currently discussing some projects in HK and Macau.

Logan (3380.HK, TP HKD 9.66, Buy, HKD 8.66)

Stephen Cheung, CFA, [email protected], (+852) 2203 6182

Logan has attended our Access China 2018 conference, and below are the key takeaways:

Targets >RMB60bn sales in 2018F: Logan targets to achieve >40% sales growth to reach at least RMB60bn sales this year. Management also expects sales to exceed RMB100bn by 2020F, implying 32% CAGR over the next three years.

High margin sustainable: Management expects the gross margin to be sustained at >35% (vs. 31.9% in FY16), and core profits margin to be sustained in the mid-teens over the next few years, given their low land costs (especially the Shenzhen projects which enjoy ~40% gross margins).

Aggressive landbanking in Greater Bay Area: Management budgets 50% sales proceeds for land acquisitions in 2018F, and the main focus region of the company remains in the Greater Bay Area. The company has spent RMB35bn (including RMB25bn from land auctions and RMB10bn from M&As) on attributable basis for buying new projects in 2017.

Net gearing remains decent: The YTD cash collection of the company has stayed high at 80-90%. Management guides the net gearing ratio of the company will remain decent at 70+% by end-FY17F (vs. 83% in 1H17) due to more landbanking.

Stable payout ratio at 35%: Management targets to maintain the payout ratio stable at 35% in the next few years. This implies 4-7% dividend yields in FY17-19F based on our estimates.

Average financing cost to trend down: Management expects the year-end average financing cost will be lowered a bit further from 5.9% level in 1H17 given the refinancing of the high-yield bonds.

Overseas projects in good progress: Management believes the HK and Singapore projects will enjoy double-digit net margins (due to the low financing cost and low tax rate) and will be able to naturally hedge part of its offshore debt exposure. However, management expects the overseas investment to stay <10% of the company’s total investment.

19 January 2018



KWG (1813.HK, TP HKD 12.88, Buy, HKD 11.54)

Stephen Cheung, CFA, [email protected], (+852) 2203 6182

KWG attended our Access China 2018 conference; below are the key takeaways:

Targets >40% sales growth in 2018: Management is guiding that the gross saleable resources of the company have increased by >50% y-y to RMB100bn (25% for T1 cities, 75% for T2 cities and the T1/2 city satellites). Hence, management expects sales growth to exceed 40% this year. The new start target for this year has increased to 4m sqm (vs. 2.5m sqm in 2017).

Aggressive landbanking to continue: The company has budgeted RMB25-30bn for landbanking this year, and will mainly focus on the Greater Bay Area (centered on HK/ Shenzhen/ Guangzhou) and Yangtze River Delta (centered on Shanghai/ Hangzhou/ Suzhou).

Margins to stay high: Management believes its quality product, vintage landbank and more land acquisitions via M&A (accounting for ~50% of landbanking in 2017) can sustain its gross margins high at 30-35% and net margins at 15-20% in the next few years.

Profitable en-bloc sales making good progress: In addition to disposing of an en-bloc office in Shanghai for RMB2.5bn (ASP RMB73k/sqm, vs. RMB14k/sqm land cost) last year, and another one for RMB530m yesterday (ASP RMB30k/sqm vs. RMB12.5k/sqm land cost), the company is also in discussion to sell a further two offices in Guangzhou (target ASP of RMB28k/sqm) and Tongzhou (target ASP of RMB60k/sqm). Management believes that the net margin of all these sales will be >25%.

RMB3bn rental income by 2020: Management seems confident the company can achieve RMB3bn attributable rental income by 2020 (30% from rental apartments, 30% from hotels, 20% from offices and 20% from retail). The company targets to own 1.1m sqm of rental apartments in Guangzhou/ Beijing/ Shanghai/ Chengdu (all from existing landbank) by 2020, and believes the yield-at-cost can be high, e.g., 8-10%, due to the low land cost (commercial plots acquired years before).

35% payout for dividend: Management is guiding that the 35% dividend payout ratio on core profits is to remain, implying 4-7% yields on our estimates.

Net gearing to remain decent: Management is guiding that the net gearing ratio will increase to 75-80% by end-2017 (vs. 64% in 1H17) due to proactive landbanking, despite the cash collection rate remaining stable at ~80%.

19 January 2018



Sunac (1918.HK, TP HKD 46.00, Buy, HKD 39.05)


Sunac attended our Access China 2018 conference; below are the key takeaways:

Sales to reach RMB450bn in 2018F: Management targets at least 20% yoy sales growth to reach around RMB450bn in 2018F, even with no further landbanking.

Less landbanking budgeted: Management targets to further reduce the net gearing in 2018F via less landbanking, and will only focus on existing regions/cities for land acquisitions. They believe the maker consolidation will be further boosted this year, and M&A will remain as the major landbanking channel for the company.

Net gearing to drop to ~240% in end-2017F: Due to the back-loaded sales in 3Q/4Q last year (about RMB90bn sales proceeds are yet to be collected), management expects the net gearing will be ~240% in end-2017F. With less landbanking this year, management targets to further lower the net gearing to ~120% in 2018F.

Gross margin continue to recover: Management guides the FY17F gross margin to further recover to ~22% (vs. 19.6% in 1H17). They also estimate the gross margin of the current contracted sales to be around 22-25%.

Wanda projects are in good progress: Management guides that the acquisition of the 13 Wanda projects are in good progress, and there are four cultural/tourism projects already in operation. Management plans to form a JV with Wanda to acquire another two to three projects this year.

T1/2 markets will improve: Management is positive on the overall property market in 2018. They believe the sales volume in T1/2 cities will improve this year on low base, while that in T3/4 cities may retreat due to high base, resulting in a low single-digit decline in overall sales volume.

Earnings to release in FY18-19F: Due to the rapid sales expansion and write-down of Leshi investment, management expects that earnings will be released starting from FY18F.

19 January 2018



Technology

Hikvision Digital (002415.SZ, TP CNY 43.00, Buy, CNY 41.62)

James Chiu, [email protected]@db.com, (+886) 2 2192 2848

Maintain BUY and TP of CNY43 Hikvision attended DB's Access China Conference 2018 in Beijing on 10 January 2018. We summarize the key takeaways in this note. Maintain BUY.

Solid growth outlook with management guidance of 20-30% growth Management maintained its prior guidance of 20-30% sales growth each year in 2017/2018.The growth will stem from both the domestic and overseas market as the company continues to expand market share. Hikvision noted that the rising network transmission bandwidth with the lowering price for data transmission will continue enabling product upgrades with higher resolution and better image quality for the recorded image/video. Currently, we forecast Hikvision's revenue to grow 28%/27% in 2017/2018, respectively.

Long term GPM target of over 40%; DB expect margin stabilization Following years of margin decline, 1-3Q2017 GPM has reversed the trend. Management attributed to a) improving product mix with less contribution from low margin HDD sales, b) earlier payment discount to its suppliers, c) higher margin associated with AI products. We expect 4Q17 GPM to trend down, as with historical pattern, given the rise in the low margin construction revenue before the year ends. Compared to management's long term gross margin target of over 40%, we expect Hikvision's GPM to stabilize at 44% in 2018/19, driven by rising contribution from solution business and AI products.

AI: focus on applications with its "AI cloud" framework Much discussions focused on Hikvision's exposure to AI and the competitive landscape. The company believes the high price tag for AI-equipped products remains the hurdle for a widespread adoption. In addition to algorithm, Hikvision focuses on the AI applications with a complete product line from front-end camera to back-end recorders/servers. The management's strategy in its "AI cloud" targets edge cloud to filter unnecessary data and provide faster response given amount of image/video that each camera collects and the load on the data transmission network. Currently, the AI equipment were sold in a complete solution for mostly the public safety and transportation projects within the domestic China, to increase efficiency. On its AI exposure in the overseas market, Hikvision won a smart city project in Singapore in 2017. We estimate that AI products only has single digit contribution to Hikvision but the rising adoption of AI will be both revenue and profit accretive.

Valuation and risks Hikvision remains one of the top buys in the Asian hardware space. We reiterate our BUY rating with target price of CNY43, which is based on 30x FY2018E PE, supported by 34% profit CAGR in 2017-2019, and 36% average ROE. Risks: market share loss, weak demand in industry project orders.

19 January 2018



O-Film (002456.SZ, TP CNY 23.00, Hold, CNY 20.33)

Birdy Lu, [email protected], (+886) 2 2192 6822

Positive growth outlook, but fairly priced O-Film attended our DB Access China conference in Beijing. O-Film elaborate on key growth drivers in 2018, including the breakthrough in high-end dual cam projects (for Chinese OEMs), rising Apple sales (Touch panel ITO film and RX module in Face ID system) and potential 3D sensing module projects from Chinese OEMs. O-Film expects to see small volume adoption of 3D sensing in 2H18, before a bigger ramp in 2019. For longer term, O-Film will focus on smart vehicle solution (ADAS, entertainment system). Trading at 26x PER (or 0.8x PEG), we think it is fairly priced, despite the decent growth. Hold.

CCM – breakthrough in high-end dual cam projects O-Film views dual-cam as the key growth driver in CCM business, believing it will benefit from rising dual-cam penetration in China smartphones (from sub-20% to 30%-40%) and its share gain in high-end projects. O-Film has built monthly capacity of 15mn for dual-cam CCM now and expects to double this by end of 2018 (while single-cam CCM capacity could stay flat at 60-65mn units). For high-end projects, O-Film highlights that it had grown its share in Huawei's high-end products (P/Mate series) from almost nil in 1H17 to 10-15% in 2H17. Based on current order visibility, O-Film think it could get 30%+ or 40%+ market share in new projects. Particularly, O-Film believe it will be the key supplier for the globe's first trio-cam project (Huawei P20 Pro, in our view).

3D sensing – iPhone's RX module + initial adoption from Chinese OEMs O-Film targets to get RX (receiver) module of iPhone's Face ID system in 2H18, by leveraging its current iPhone front-cam capacity. The design and structure of RX module is familiar to that of front cam. Face ID adoption is expected to spread out from iPhone X to all new iPhones in 2H18, so Apple will need more suppliers. O-Film expects some Chinese clients to adopt 3D sensing module on few very high-end models, but also notes the volume will be very small, given the immature technologies and low production yield. O-Film believes this will be an important long-term growth driver, and has formed an exclusive partnership with Mantis Vision (a leading 3D sensing algorithm supplier) to target Chinese OEMs. Other partners include Himax in WLO lens and Finisar in VCSEL.

Apple's touch panel (TP) business – expanding from iPad to iPhone O-Film expects Android's TP business to stay stable, with the rising adoption of out-cell solution to offset the continued pricing pressure. But, O-Film is positive about i-device's TP business. The firm just penetrated into iPad's TP sensor + full lamination business in May 2017, and has quickly grown market share from zero to 20%-30% by the end of 2017. In 2018, O-Film expects it will continue to grow market share in iPad Tps, and is very likely to win iPhone TP orders as well (touch sensor + 3D touch + cover glass lamination).

19 January 2018



Sunyway (300136.SZ, TP CNY 60.00, Buy, CNY 48.87)

Birdy Lu, [email protected], (+886) 2 2192 2822

Positive 2018 outlook and long term prospectus Sunway attend our DB Access China event in Beijing (Jan 8-10). We summarize key meeting highlights in this note. The firm's guideline for strong 2018 growth and solid long term business outlook, driven by wireless charging, smartphone mechanical parts, 5G antenna, and etc. are in line with our positive view. Maintain Buy rating.

Antenna BU (ABU) – wireless charging/5G as near-/long-term drivers Sunway expects antenna and connector BUs will still constitute the majority of 2018 sales, while acoustic and semiconductor BUs remains important parts of the firm's long-term strategic business plan (as total solution provider for key clients). Sunway view wireless charging modules as key growth driver of ABU in 2018/2019 After achieving 20%-30% market share in Samsung's high/mid-end devices, Sunway sees a high chance it can penetrate into iPhone in 2H18, due to potential design change (from current FPC-based solution to copper coil-based solution). The TAM of wireless charging (RX) module could grow from sub-200mn in 2017 to 300mn+ in 2018 while ASP of wireless charging module will be ~USD3 (vs less than USD1 for its current core biz – Wi-Fi/GPS antenna). For long term, Sunway expects the arrival of 5G (likely in 2020) will increase the demand of antenna in a significant way (as it covers from low frequency band to ultra-high frequency band) which will serve as a new growth catalysts in long run.

Connector BU (CBU) – multiple projects from iPhone Sunway highlights multiple growth drivers for CBUs, include: Penetrating into Lightning connectors: Sunway's Lightning connector had

been qualified by Apple, with shipments to start in 2018. Initially, it will serve as the third suppler (after Hon Hai and JAE), but Sunway is confident it will gain shares in long run. Every new iPhone comes with three Lightning connectors in the box (one for power adapter cable, one for ear pod cable, and one for audio adapter cable).

Rising dual cam penetration on iPhone: Sunway expects all three new iPhones in 2H18 will have dual cam (vs only two models with dual cam in 2H17). Their camera related mechanical parts (dual cam supporting frames and VCM cases) will benefit from rising dual cam penetration

Rising market shares in iPhone EMI shielding cases: Sunway got into this business since late 2015, and expects to win more EMI shielding case slots in 2018 or gain higher market shares in current slots.

Kstar (002518.SZ, TP CNY 21.00, Buy, CNY 17.38)

Frank Lin, [email protected], (+886) 2 2192 2824

High investors interest on promising industrial growth Kstar is one of the largest uninterruptable power supply (UPS) brands in China and is gaining QF investors' attention recently due to its (30% EPS CAGR in 2017-2020E) industrial growth on robust data center setup in China. The company generates most of its UPS revenue from financial institutions (30-40% of UPS revenue), government agents, transportation infrastructure and IDC, which feature high entry barriers. Given its continued high-power UPS market share gain from international brands (Schneider), Kstar is confident of posting ongoing market expansion from its current 35% level. Investors also like Kstar’s solid balance sheet (net cash, positive FCF) and promising EV charging growth; reiterating Buy.

19 January 2018



Delivering 30% EPS CAGR in 2017-2020E on industrial growth (IDC UPS, EV charging) Kstar expects a 30% EPS CAGR in 2017-2020E driven by strong high-power (20kVA+) on-line UPS growth on IDC proliferation in China and robust EV charging demand. Propelled by its continued R&D investment in premium UPS and the support from the Chinese government, Kstar keeps gaining share from international UPS brands (eg. Schneider, Eaton) in China. Management anticipates its market share will expand from 15-16% now to 20-25% in two years, which supports a 20%+ UPS revenue growth in both 2018E and 2019E. Kstar has also begun to ship its integrated UPS (combining self-made high-precision air conditioner UPS battery into a cabinet) to IDC customers, which carries a 40% GPM, given its increased value-added.

Kstar is confident of sustaining 35%+ GPM from UPS (despite rising raw material cost) in the long-run due to continued product mix improvement (integrated UPS, large IDC).

Promising inverter + booming EV demand Kstar delivered a 100%+ YoY inverter revenue increase in 2017 due to its new poverty reduction projects win from the government. Management indicates that the local government keeps building inverter stations in rural regions (eg. hills), which is viewed as a long-term electric infrastructure investment with 3-5 years order visibility. Therefore, Kstar guides a 30-40% inverter revenue CAGR in 2017-2020. Kstar also enjoys strong EV charging demand in China by leveraging its power efficient charging pile (featuring 96-98% conversion efficiency ratio vs. the industry average of 91-93%). The company’s EV charging revenue ramped to RMB150m in 2017 vs. RMB70m in 2016. Management is confident of posting 100%+ YoY EV revenue growth in 2018 given the strong orders forecast from key customers. Kstar is also developing a vehicle carry charger with auto OEMs (Brilliance BMW, according to management), which will support its long-term EV growth.

Valuation and risks Our target price of RMB21 is still based on 30x one-year FW EPS, in line with the Asian cloud computing peer average. Risks: slower EV/UPS demand and unfavorable FX.

19 January 2018



Telecom

China Mobile Corp Ltd (0941.HK, TP HKD 112.00, Buy, HKD 77.40)

James Wang, [email protected], (+852) 2203 6145

Focused on investor returns China Mobile presented at DB’s Access China conference. The company was at pains to point out that the management team is focused on investor returns as reflected by the increase in FY16 dividend payout ratio (first time in 10 years) and the special dividend given out at the 1H17 result. On 5G, the company indicated that the investment cycle may be longer, though it will not blindly invest without viable business application scenarios. The company remains confident in its growth outlook despite the pick-up in competition and re-iterated its goal of achieving above-industry revenue growth.

Continue to forecast a 3 ppt increase in payout ratio in FY17 The company indicated that it constantly assesses its payout ratio and will look to maintain or slightly increase the payout this year. To reflect management’s desire to meet investor expectations, we continue to forecast a 3 percentage point increase for the FY17 payout. While CM also indicated that the 1H17 special dividend was one-off in nature to celebrate the 20th anniversary of the company listing, we forecast another HKD3.20/share special dividend at the 1H18 result after the company receives the cash owing from the TowerCo.

Competition picking up but CM holding its ground CM acknowledged that competition has picked up this year with the introduction of the unlimited data plans and video cards. While they have been broadly retaining their subscriber base, they have lost share in terms of mobile data consumed. Overall CM will look to strike a balance between competition and preserving value as it sees data as the key driver for its top line growth. At this stage it finds that customers are responding to the reduction in unit rates by consuming more data.

Broadband ARPU pick-up reflecting improvement in network quality CM’s broadband ARPU has improved this year as its network speed improved from heavy investments in prior years. We believe this is likely to continue given the significant ARPU gap vs peers. Furthermore the growth in the fixed broadband business will help with the enterprise business as well as in customer retention and in cross-selling their smart family products.

China Telecom Corp Ltd (0728.HK, TP HKD 4.55, Buy, HKD 3.76)


Confident in industry and company outlook China Telecom presented at DB’s Access China conference with a confident tone in the company and the industry’s growth outlook despite the pick-up in competitive intensity. The company believes its recent success in its mobile business can continue as it benefits from the improvement in its network quality (post the 800MHz refarm) and the proliferation of the six-mode

19 January 2018



handsets. It also sees the six-mode handsets (most of which are dual sims) as an opportunity for the industry to gain additional subscribers. While its fixed broadband business has been hurt by competition in recent periods, it will look to step up efforts to safeguard this business which can be augmented by improving its bundling rate.

Cautious on 5G CT acknowledged that China will play a leading role in the 5G technology. However the current applications can be mostly met by the 4G network and there are few 5G specific use cases. Hence 5G and 4G will co-exist for a long time and like its peers, it will not blindly invest in 5G in such a scenario. With CT indicating only 5G field trials to be conducted this year, we do not expect material 5G related capex in 2018.

Improved network capacity giving rise to the RMB99/mth plan With CT having completed the 800MHz refarm, the company believes it has ample capacity on its network which allows it to offer the unlimited mobile data plans at RMB99/mth. While we believe such pricing levels will remain supportive of industry ARPU as evidenced by the 9% growth in industry revenue growth seen in October and November, there is a risk of further price reductions as CT’s peers sought to match CT’s pricing.

Greater scrutiny on opex Sales and marketing expenses have risen as the company grew its top-line, particularly in mobile which saw 12% growth in 9M17. The company will look to place a greater scrutiny on cost control going forward and we expect some relief on network costs post the completion of the 800MHz refarm.

China Unicom (0762.HK, TP HKD 15.50, Hold, HKD 10.74)


2I2C business and improving fixed line offering to drive topline growth CU presented a confident outlook at our Access China conference early this week. The company remains firmly focused on its 2I2C business which is seeing strong growth (according to C114.net the number of Tencent data card customers is now close to 50m). Furthermore mobile customers are consuming significantly more data which is offsetting the impact of the decline in data unit rate. In fixed broadband, CU will renew its focus in 2018 by improving its content offering and resources deployed which may breathe some life back into this business. Coupled with a better cost and capex discipline, we see significant upside to CU’s share price.

Capex and cost discipline remains a key focus The company will look to look to lift profit margin over the next few years via: 1) greater sales in the online channel which will help control sales and marketing expenses, 2) focused capex spend in regions where the returns are the greatest, and 3) keep a tight lid on network maintenance expense though we suspect this is likely to increase from here after 18 months of decline. Compared with the other two operators, we see CU having the greatest potential to lift margins due to an inefficient initial cost base, a lower cost sales strategy and an alignment of employee and shareholder interests.

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A number of initiatives underway to drive growth CU also highlighted a number of initiatives currently underway, including in cloud (with Alibaba and Tencent), new retail store formats (Alibaba and JD.com), new capabilities in big data and artificial intelligence (KuangChi), and payments (Suning). While some of these co-operations may not directly result in a significant revenue uplift, we believe it does give CU a competitive edge / differentiated appeal to its retail and enterprise customers.

Mixed ownership process update The equity injection process is complete with the A-share equity injection and issuance of new shares to the parent BVI group. Board approval for the employee share scheme remains outstanding and we expect this to be finalized by the full year result in March.

19 January 2018



Internet

Tencent (0700.HK, TP HKD 450.00, Buy, HKD 438.60)

Han Joon Kim, [email protected], (+852) 2203 6157

We spent a few hours with Tencent management through the early part of our conference in Beijing, currently in full swing. We felt Tencent's message was very upbeat, particularly around the new initiatives surrounding WeChat use case improvements.

De-brief conference call, Friday 10AM EST We plan to host a conference de-brief call on China internet. Conference ID: 4992549. Dial-in: 800-309-8606 (US); 020-3107-0289 (UK); 800-8700-169 (China); 3011-4522 (Hong Kong); 6622-1010 (Singapore). Please contact your DB representative for local dial in.

HoK holding strong; flying car takes off We could sense Tencent's view on the survival shooting genre is evolving and now sees possibility of a few mobile iterations co-existing. At the same time, high level of R&D needed for the genre would create barrier to entry. We received impression Tencent's self developed versions could come out post Lunar New Year, so perhaps in March. Whilst there was some acknowledgement that there has been some users that shifted away from HoK to the new genre, the viral loop for survival shooting segment appears to be less than the viral loop for MOBA genre. Management highlighted that HoK monetization remains lower than LoL, while mobile RPG genre has higher monetization than PC counterparts, indicating room for ARPU growth for HoK even if DAU has peaked. QQ Speed was also highlighted as a new addition to game portfolio (currently top ranked on iOS) and genre diversification would continue including a new upcoming dancing game, QQ Dancer.

Superapp use case ramping up further Management seemed upbeat on improving use case for Weixin including broadening application of mini-programs as its integration into interface was enhanced. Social commerce was an area of active discussion, but management took time to discuss Kanyikan newsfeed and Souyisou search, which has recently graduated from laboratory stage to mass market deployment and could add meaningful ad inventory into 2H18, based on our impression from management's comments.

Active content investment, M&A , IPOs in 2018 While we received impression content investment could get higher in 2018, management was optimistic that online video, literature and music could see continued increase in subscription as joint investment effort by the industry into proprietary content would reduce supply of pirated content in the market. M&A could be more focused in China than overseas in 2018 and IPO pipeline for affiliates could continue.

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Technology: China e-commerce


We hosted JD.com and Vipshop and Baozun at our conference in Beijing to discuss e-commerce landscape outlook.

De-brief conference call: Friday, January 12, 10AM EST/11PM HKT We plan to host a conference de-brief investor call. Conference ID: 4992549. Dial-in: 800-309-8606 (US); 020-3107-0289 (UK); 800-8700-169 (China); 3011-4522 (Hong Kong); 6622-1010 (Singapore). Please contact your DB representative for local dial in.

JD.com (Not covered, last close: USD46.1) We felt JD spent more time focusing on the mid-term picture than the short term, highlighting apparel and FMCG/fresh food segment as area of growth in 2018. 4Q17 could mark the worst season for apparel in their view. Organic recovery of apparel merchant appears to be a gradual process and we received impression that company expected progress in 2H18 than in 1H. For FMCG, JD felt it was on more equal footing with key online competitors and that its strength in logistics and partnership with Yonghui would add to its core competency in gaining share in FMCG segment. On margins, JD aimed for 2%~4% non-GAAP net margin on 1P and 1%~2% of GMV for 3P in the long-term.

Vipshop (Not covered, last close: USD13.6) Timing-wise, Vipshop felt the partnership between Tencent/JD/Vipshop was formed now as the differing parties were able to reach a consensus on the need to cooperate with one another. As part of that, Vipshop believed it would be in a position to reap meaningful portion of the benefits accruing from the partnership as traffic is directed its way. Cost wise, Vipshop plans to reduce its user acquisition cost by lowering allocation to existing channels and use the incremental to give to JD as its share of GMV for channeling traffic. Traffic acquisition had run up to RMB100 from 50-60 historically; while acquisition cost may not decline immediately, company expected to see benefits to user acquisition cost over the mid term. Overall aim was to maintain blended margins in 2018. In a separate session by Questmobile on its research into D12 promotions, we noted QM data showed the lowest conversion rate from product page to order page for Vipshop among e-commerce players.

Rapid rise of social commerce An area of active discussion was the rise of social commerce, particularly in 2H17, with Pinduoduo (ranked #3 e-commerce player in MAU terms by Questmobile) highlighted as the success case in tapping into rising e-commerce demand by lower-tier city consumers and doing so successfully through social media channels such as WeChat mini-program. Average basket size is believed to be meaningfully low as of now and none of the existing larger e-commerce players saw the social e-commerce players as meaningfully threatening as of yet.

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Baozun (Hold) Baozun overall sounded very confident for 4Q17 sales growth despite e-commerce industry seasonal slow-down. Blended take rate has been increasing for both existing brands and new brands within the same category and same business model. GMV mix, however, should continue to shift towards lower take rate category in 2018, given smartphone brands are growing very fast (e.g. Huawei). The company maintained 2018 GMV growth guidance of 50%+. New brands in the pipeline focuses on high take rate category (e.g. apparel and cosmetics), and will likely see 10-20 brands addition each year. Baozun reiterated its IT capability and warehousing are two advantages over peers, enabling a one-stop solution to brand partners. International brands, who have multiple e-commerce platform stores, therefore face high switching cost. Baozun acknowledged that some small brands have terminated contract in the past and switched to cheaper Taobao partners, yet total GMV contribution is less than 1%. The company expects some margin improvement in the future driven by the operating leverage, and is dedicated to continue to improve the model mix, category mix and to create value-added services.

Technology: China Internet


We have concluded all of our meetings at our dbAccess China 2018 conference including a separate field trip involving various industry experts and companies. Separately, we have written on our takeaways for specific verticals (e.g. e- commerce, OTA); this note summarizes the various impression our team has gathered through and between various company and non-company specific meetings.

More finger in each other's pies While not necessarily a new phenomenon, we may continue to see the lines between newsfeed, social media, short video, and live streaming blurred as companies borrow from each others' business models. The company meeting update for Meitu, summarized further below, is emblematic of the blurring business model we heard throughout our conversations in various meetings. While the likes of Kuaishou, Toutiao venturing into live streaming could put some concern around live streaming names and Tencent's emphasis on social commerce may give some pause on whether Weibo's social media presence could be impacted. That said, we felt most of the incremental effort was placed on trying to create new value proposition, not eat each others' lunch, and create access points for lower-tier city consumers or niche demographics.

Fintech Our general impression was positive. We hosted several leading consumer lending operators as well as participants involved in the value chain. In general, the new regulations released towards the end of 2017 has disrupted the market and could impact loan growth in 4Q17, but is paving the way to industry consolidation and for larger compliant/licensed firms. If we paraphrase one speaker's comment "now that we know what the government wants, industry can work around it to do what it hasn't said it doesn't want".

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Online video An independent industry speaker felt that iQiyi offered differentiated value proposition to content holders as they were incrementally using better big data to measure performance of each content and equitably sharing its revenue with

content providers. On the other hand, Tencent (Buy, HKD440) had mentioned the competition for non-entertainment content, particularly sports, had come down more reasonably, thus helping make its overall content profitability better than before. Tied to overall improvement in content quality and investments, the speaker noted that they were seeing improving retention on paying subscribers. In 3Q17, their assessment was that 45% of monthly subscribers were returning as 3-6 month subscribers and 50% of half year subscribers would return as annual subscribers and 50% of annual subscribers would return to subscribe for another year. Membership ratio could temporarily dip in 4Q17 as there was no strong content but overall trend could continue its upward climb.

User acquisition cost Broadly speaking, there was a strong desire to continue investing for new user acquisition in tier 3 and 4 cities and we felt user acquisition cost, and in turn overall digital advertising spend, would go up. Not only was consumption rising in those regions but population migration from tier 1~2 cities to 3~4 cities meant there was need to improve servicing of consumers across broader geographic region.

Meitu (Not covered) Meitu has 80% female users, and mostly in tier 1-2 tier cities. The company has 40-45% iOS users vs industry 20%. Future user base expansion will target at lower tier cities, according management. The company will focus on optimizing Android app experience to penetration into lower tier cities. The company views its female centric user base as unique value proposition with monetization potential. The company tested 1P e-commerce business in 2017 with skin care and cosmetics products sale. It leverages AI skin detection technology to recommend products to users. Meitu expects the gross margin of this 1P e-commerce business to grow from mid single digit in 2017 to 10% in 2018 and 20% in 2019. Reaching operating level break even will require RMB200-300m GMV per month (current at RMB20m GMV per month).

The company believes advertising should have a lot of room to grow because of the expanding scale of the sales team. As of mid of last year, the sales team had expanded to 80 (from virtually none a few years ago). Ad format would shift from CPT type to in-feed in 2018 with the hiring of a new COO from Weibo. Meitu claimed to be dedicated to creating a more user engagement scenario and contents to users, such as fashion news, cosmetic product reviews and photo sharing. The company is open to collaborations with big internet players, but won't spend aggressively on traffic.

Meitu also felt Meipai had no direct competition in live streaming and short video as Meipai focuses on a niche female only audience while other platforms depend on male viewers. The company believes IVAS revenue (advertising, Meipai, e- commerce service) will surpass smart device in gross profit level in 2018, and will surpass in sales level in 2019. IVAS revenue contribution has been rising through the past year, to 15% for full year 2017.

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Technology: China Online Travel

Eileen Deng, [email protected], (+852) 2203 6227

We invited Ctrip and Tuniu to our dbAccess China conference 2018. Both companies sound confident at the industry long term growth in both domestic and outbound travel, and shared 2018 business outlook.

Ctrip stated that the PR issue (unbundling and kindergarten incident) impact should normalize from 2Q18 onwards; both revenue and margin should rebound since then. Ctrip views 2018 as a tough year, and looks forward 2019 being back on track to achieve the long term margin. Ctrp plans to do more marketing in lower tier cities in 2018 to build up the brand. The company maintains 13-14% non-GAAP op margin in 4Q17 and the overall revenue growth guidance.

Tuniu indicated that 2018 business focus is to expand direct procurement, enhance self-operation, expand sales network and enrich travel related content. The company plans to open offline stores, grow direct procurement (to 50% in 2018) and amplify product offerings in 2018. New product and service will focus on destination service such as local transportation, car pick-up services and hotels. The company targets to achieve non-GAAP operating breakeven in 2018, and maintains a 3-5 years non-GAAP op margin target of 10-15%.

Please refer to detailed takeaways on inner page

Ctrip meeting takeaways

Competition with Meituan Ctrip views Meituan as a player in different market. The company indicated that Meituan is growing their room nights and the coverage is across 1000 cities vs Ctrip 150 cities with a focus on city with GDP per capita USD1000. Meituan more on same city hotel. Ctrip sees some overlap on the hotel supply, but regards overall market to be big. Industry hotel take rate has maintained at 8-10%, not seeing great fluctuation. Ctrip believes the market is rational at pricing. Hotels also want to see stable pricing environment. Ctrip is dedicated to offer good hotel experience rather than attractive price.

Priceline investment in Meituan Ctrip believes Priceline, as a international OTA, is reasonable to have their resources being allocated among different channels. Meituan has been working with Agoda on inventory sharing even before the investment. Ctrip stated that Agoda is better positioned in Southeast Asia. Ctrip's cooperation with booking.com continues.

Tongcheng & eLong merger Upon the merger, the new company and strategic investor will have a simpler and clear focus. Tencent is driving the new company strategically, with continued support on traffic. The newly combined company will continue enjoy the access points on QQ and WeChat. Ctrip revealed the importance to stay in the BOD of the new company. All three parties will discuss more collaborations in the future.

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Skyscanner update Skyscanner is seeing 35-40% growth right now with better margin profile than Ctrip. The company largely uses meta search model on transportation. It launched direct booking in late 2017 and invited 10 partners (with 1-2% take rate) initially to get tested. The transaction conversion rate under direct booking model is as high as 50% as a result, higher than meta search. Direct booking model still represents a small portion of Skyscanner revenue.

AI efforts Ctrip has accumulated a lot of travel data on users. The company right now applies AI largely in call center, enabling 50% of consulting being automated. Gross margin therefore sees some leverage. Ctrip views AI as a continued theme given the application scenario and opportunity to understand the users and drive the conversion, across the vast travel products.

Employees The company has 30,000 employee right now with half of them sitting in call center. The company has built a big R&D team, followed by sourcing team. Ctrip claimed the hotel coverage is 95% in nationwide, and sees no pressure from inventory perspective at all. Yet, Ctrip claimed the branding in lower tier cities is weak, leading the company to target with more marketing activities in the coming year

Outbound travel Ctrip reiterates its confidence at long term growth of outbound travel, and ties to China GDP growth. Short term outbound travel market however sees fluctuations around currently appreciation or attack risk in destinations. Ctrip has 40-50% of the airline and package tour being outbound travel with 2000 destination cities covered.

Tuniu meetings takeaways

Outbound travel opportunity for Tuniu The company has greater domestic trips than outbound trip, yet GMV contribution (40%) is lower than outbound (60%) due to smaller ticker size. Domestic short haul trip ticket size is on average RMB 300-500, and long haul trip RMB 3000-4000, vs outbound travel RMB 7000-8000. Domestic travel growth was faster than outbound travel in the past year due to the outbound travel destination risks. Korea, Thailand, Taiwan were affected while Hong Kong and Macau has been stagnant. RMB depreciation added the risks to last year outbound travel. 2017 full year tour mix by destination is Europe 13-14%, island 13-14%, Southeast Asia 10%, Japan and Korea 9-10%, north America 5%. The Korea trip has shifted to Japan and domestic. The company is looking for RMB appreciation in 2018. Package tour designed for long haul travelers are adjusted into fewer countries to avoid the risks, e.g. 7-country Europe tour has been replaced by 3-country tour. China passport holder is only 7-8% of total population, vs 30-40% of western country, indicating 5x room for industry growth.

New marketing strategy in 2018 The company plans to explore 7 different marketing channels facing different user demographics in 2018, including Online, offline stores (increase marketing stores and reduce office building store), corporates (grew by 3x in 2017 to 10% contribution), marketing (more content investment rather than traffic

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investment). Repeat customer contribution grew to 60% of transactions in 2017 driven by improved service and product. Tuniu envision continued repeat customer growth in 2018. Direct procurement under the company's current plan will grow from 40% in 2017 to 50% in 2018. Marketing cost dropped dramatically in 2017 because of the optimization of cost structure. Each operation team has different KPI combination to acquire users. 2017 overall achieved 20-30m person time, with registration user of 60m. Top line growth is 50% driven by person time growth and 50% driven by ticket size growth.

Differentiation from traditional agency The company has 95% of GMV on a model of dynamics package, with 12-15% take rate in domestic travel, which it claimed absolute advantage over traditional agencies. The dynamic package allows travelers to group at the destination, and therefore offer more flexible flights and departing cities. The availability of dynamic package leverages on scale and technology. Tuniu has 300+ servers running to do the package pricing. Domestic travel has 95% of package tour being formed at destination rather than departing location. The company claimed to have 3ppt incremental gross margin if doing direct procurement model at destination, and to have another 3ppt incremental margin if doing self operation. The incremental margin is driven the reduced layers in the supply chain.

Technology: China Live Broadcasting

Eileen Deng, [email protected], (+852) 2203 6227

We invited China live broadcasting leading players YY and Momo to our dbAccess China conference 2018 in Beijing. Both companies shared the recent business update and strategic plans in 2018. YY indicated that 2018 should have a rich pipeline of new feature launch; every quarter should have some new features to launch. The company aims to re-shape YY Live, allowing the young generation to always have the chance to discover new things whenever open up the app. There should be more table games and PK games to launch in 2018. The strong feature, Happy Contest, will be upgraded in 2018. The company sounds confident at overall user growth and pay ratio improvement. The marketing plan seems to be aggressive at promoting short form video this year. Huya is facing intense short term competition on top host, yet the revenue and user growth is still robust driven by hit mobile game titles.

Momo revealed that one of the recent focuses is to enhance the relationship with guilds, encouraging more talent recruitment and the creation of quality contents. The company imagined 1.5-2% impact on gross margin in 4Q17 due to incentives to guilds during year end ceremony. The company expected better monetization on VAS features in 2018. Momo reiterated its top priority: user base expansion. The company has made some changes on marketing team KPI since 3Q17 in order to optimize the marketing methodology. The marketing team now is looking at a longer term retention (vs 7-day retention before) and pay ratio rather than simple registration. The 2018 marketing strategy, therefore, should be more effective, with less spending on branding and more on performance-based channels.

Please refer to detailed conference takeaways in the inner page.

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YY meeting takeaways

Young generations are driving the new features launch; YY indicates the future growth will be driven by lower tier city young generations. The majority of YY current users are from tier 3-4 cities, born after 1997. They are not traditional entertainment live streaming users. Therefore, YY has been making an effort to add new features to cope with the demand, such as AR-based games. The company revealed that tier 3-4 cities people are more relaxed with 5-6 hours spare time per day vs 1-2 hours for tier 1-2 citizens. The company has seen positive moves on active users since the launch of new features in 2Q, and saw 36.5m MAU for Mobil YY Live and 36.5m MAU for mobile Huya.

New features pipeline looks rich YY indicated that 2018 should have a rich pipeline of new features launched; with each quarter likely launching something new. The company will launch more table games and PK games which are easy to catch up on and easy to interact with unknown users on the platform. The company has turned the werewolf kill into a collection of smaller games including a table game and PK game.

The marketing effort will rise on short form video: YY's short form video strategy seems aggressive. The company claims to have an aggressive plan in 2018 in terms of marketing. The short form video embedded into YY Live acts as a traffic generator, and lead new hosts to build fan bases. The independent short form video app should have a unique position versus peers. Strong competitors Kuaishou and Toutiao are gaining a large amount of traffic. The monetization should come at a later stage.

Annual ceremony in 4Q17 drives growth The 4Q17 major driver is the annual ceremony, which lasts into Jan. YY made some rule changes to the event this year, with more diversified competition. Previously, top hosts were competing with each other (top female or top male) in an effort to gain more traffic and a recommended position on the YY cover page. The reward would be the best host in each vertical, such as outdoor, singing, dancing, talk show, ACG etc. Winning hosts receive a recommended position in the YY opening screen and enjoy more traffic. For the mid level of the paying user pyramid, i.e. spending at RMB1,000-10,000, their average spending has increased by 5% yoy in the year-end gala event.

The survival genre helps keep the growth momentum Huya used to have a quiet 4Q because of the school exam season. 4Q17, however, saw survival games being very popular, leading Huya to continuously gain attraction. The company has observed an interesting trend of increasing female users watching survival game broadcasting while not playing the game themselves.

Huya The company claimed that the Huya financial performance significantly improved, but Huya is facing intense competition on top hosts. Entertainment broadcasting is easier to get a host: one trip to China northern cities can garner a lot. However, the top game host supply is limited, given that they need to train themselves to play certain game very well and meanwhile need to be photogenic and humorous.

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Momo meeting takeaways

To work more closely with guilds The company imagines a 1.5-2% impact on gross margin in 4Q17 due to guilds incentives during the year end ceremony. Momo claimed to have the lowest payout ratio to hosts/guilds among competitors. The company made some adjustments on revenue sharing and they encourage guilds to work with Momo more closely on new talents recruitment, training, and content creation. Momo believes agency can add value to improve the host quality and content quality. In the past 2 months, the company launched a trial program to cooperate with guilds and is seeking better incentive program in 2018 based on the evaluation of the trial program.

3Q17 agency sponsored hosts generated 50% of live streaming gross turnover. The company expects to see a higher portion in 2018.

User acquisition outlook Momo reiterated its top priority: user based expansion. The company has made some changes on KPI since 3Q17 in an effort to optimize the marketing methodology. The marketing team is now looking at longer term retention (vs 7-day retention before) and a pay ratio rather than simple registration. The company claimed that the majority of the new users were still organic as of 3Q17, and saw gradual improvement on the retention rate throughout last year. The 2018 marketing strategy will follow the rule of less branding and more performance-based spending. The company will measure the reinvestment scale based on gross profit level. R&D is ranked as No.1 in the investment basket, followed by marketing. The company plans to add more R&D headcount in 2018.

Short video to generate traffic to hosts Short video is another entertainment contents apart from live streaming. The company views this as an important piece of content and encourage users to post and generate more short video content. Short video penetration reached 63% as of 3Q17, becoming the largest traffic generator and surpassing the nearby people function. Short video continues to keep the focus on further increasing user engagement. New hosts leverage short video to build up their fans base.

New use cases and better monetization in VAS Momo aims to explore more monetization efforts on VAS features, and expects better monetization in 2018. The company has confidence in its potential to ramp marketing revenue in the future, but maintains a cautious approach to adding ad slot to the platform to maintain the user experience. Momo plans to apply a moderate ads monetization approach to achieve a better user experience. The company is dedicated to continuing to launch new use cases to generate VAS revenue.

19 January 2018



Transportation

Beijing Cap Int'l Airport (0694.HK, TP HKD 12.30, Buy, HKD 12.68)


Beijing Capital Int’l Airport (BCIA) attended our Access China conference on 9-10 January. The following are the key takeaways from investor meetings:

- Flight slots: In order to improve on-time takeoff rate as required by the government, BCIA does not plan to add new time slots in the near future. Since October 2017, domestic time slots decreased by less than 1% while international slots increased by c.5%.

- Duty-free business: Starting from February 2018, BCIA will follow the new agreements for T2 and T3. BCIA estimates no less than RMB2.4bn revenue from duty-free business from Mar 2018 to Dec 2018 (as the first month and last month is rental free), calculated based on minimum rental.

- Non-aeronautical revenue: In the past, duty-free business accounts for c. 95% of retail business, which accounts for c. 30% of non-aeronautical revenue.

- Beijing New Airport: Beijing targets to have two transportation hubs, with Beijing New Airport mainly serving Xiong’an District. In the long run, both airports will achieve 100m passenger throughput. BCIA is not likely to be the operator of Beijing New Airport as BCIA finds it difficult to absorb the RMB80bn Capex and as BCIA needs to maintain its own market share.

- 2018E outlook: BCIA is expected to record higher maintenance fees, management concession fees and security fees in 2018E.

Deutsche Bank view - earnings upside from duty-free priced in; Hold Going forward, we expect BCIA to further improve the mix in aircraft handling and passenger throughput in FY18-19E on continuous inspiring traveling demand and route structure optimization. However, we believe the current share price has priced in the positives from the duty-free concession rate increase and airport fee raises, not to mention uncertainties from Beijing New Airport. Our DCF-based target price of HKD12.3 (unchanged) implies 15.2x FY18E P/E, which we believe is justified given a 26% FY16-19E three-year EPS CAGR. We note that the implied FY18E P/BV of 2.2x is also justified, with ROE of about 12-15% in FY17-19E. Key upside/downside risks include stronger-/weaker-than-expected traffic volume increases, slower-/faster-than-expected growth in travelers' spending at the airport, a failure to contain costs or the company attaining significant cost containment, and any potential capital commitments for the new Beijing airport in the future.

19 January 2018



Sinotrans (0598.HK, TP HKD 6.60, Buy, HKD 4.12)

Sky Hong, CFA, [email protected], (+852) 2203 6131

Sinotrans attended our Access China 2018 conference in Beijing and below are the key takeaways:

Robust organic growth across all segments Freight forwarding: The company estimates about 20% revenue growth in 2017, mainly due to the stronger-than-expected increase in sea freight rates. In 2018, management expects stable growth, which will be mainly driven by volumes.

Specialized logistics: Revenue growth from this segment has improved to 17-18% YoY in 2017 and management expects a better 2018 from continuing market share gain and synergies from the China Merchants Logistics (CML) asset injection. By sub-segments, management guided for 15%/20%/15% from the contract/project/chemical logistics sectors.

Storage & terminals: This segment’s performance was largely related to exports and imports. Managements expects its revenue to maintain stable growth in 2018.

DHL-JV: 1H17 was negatively affected by some cost issues and profit growth has resumed in 2H. For 2018, management expects growth of about 5%.

Pallet leasing: Loscam’s pallet business accounted for 60% of the Australia market, 80% of the SE Asia market and 100% of the HK market in 2017. Huge growth potential exists in China in light of the government’s standardization in the logistics sector, as per management.

CML injections done, synergies looming The CML asset injections were completed in Nov 2017 and Sinotrans has started integrating across segments such as contract logistics, cold chain logistics and so on. The management is pretty confident on the synergies due to: 1) Lower procurement cost. In some areas, the gap between Sinotrans and CML can be as high as 30% in terms of sourcing costs. Post combination, there’s significant cost saving potential. 2) Higher utilization and lower capex. For example, Sinotrans’ contract logistics could utilise CML’s, which would not only help to improve utilisation but also save costs/capex, etc.3) Lower labor cost. The combined business will only have one execution team, which should heavily drive down labor costs.

Aiming to be a whole supply chain logistics provider Compared to its peers, Sinotrans’ competitive advantages are in: 1) comprehensive network. Post injections, Sinotrans has about 6-7m sqm warehouses, which is the largest among China’s supply chain players as per management; 2) customers' resources. Sinotrans has solid relationship with various institutions and governments in China; 3) independence and experience. Sinotrans is a pure third-party logistics service provider and has good experience in overseas operations. Sinotrans is also aiming to strengthen their overseas networks and logistics technology such as automation by acquisition in the coming years, according to the management.

19 January 2018



We remain bullish on Sinotrans; Buy Our SOTP-based target price is HK$6.6, which implies a 13x 2018E P/E. We believe it looks conservative as the global peers, on an average, are trading at 20x forward P/E. Trading at 7.4x P/E, we believe this stock is undervalued given positive profit expectations, synergies, and robust growth outlook for Loscam.

The key macro risk is weaker-than-expected trade flows. On the company front, we see poor execution of the expansion strategy and lower-than-expected synergies with CML as major risks.

Transportation: Air China


Air China attended our Access China conference on 9 January in Beijing. The following are the key takeaways from investor meetings:

- Ticket fare liberalization impact – On 5 January, China’s regulator removed the full-fare price caps for routes which are served by at least five carriers (about 306 routes, including route between major cities like Beijing and Shanghai), with a maximum of 10% raise per season. Under the new policy, Air China thinks that they could be amongst biggest beneficiaries as it has meaningful exposure in popular routes that qualify for price increase, e.g. Beijing-Shanghai. While it is still premature to quantify on the impact, Air China sees upside to its original FY18 domestic yield growth expectation of 1-3%.

- Passenger yield trend – Domestic yield decreased while international yield increased in October, while the trend reversed in November. In December, both domestic and international yield improved. Going forward, Air China still expects softness in international yield given capacity growth, while being upbeat on domestic yield.

- Passenger capacity (ASK) – In 2018, Air China plans to add 49 aircrafts and retire 18 aircrafts. The airline will increase overall capacity by 9-10% YoY, with 5-6% YoY increase in domestic routes and c. 15% YoY in international routes. To elaborate, Air China will increase capacity faster in Australia routes on low base, and in South East Asia on the One Belt One Road theme. Korea route capacity is also planned for rebound.

- Others – The load factor of premium class increased high single digit YoY. Regarding USD debt exposure, Air China thinks 35-40% will be a stable ratio. The airline also target to achieve 50% direct sales contribution in future.

Deutsche Bank view We think Air China is the most fundamentally sound airline in China, with diversified growth in different routes and good yield management track record. What is more, the further airfare liberalization could imply revenue and earnings upside risk to our forecast. That being said, we think the positives are mostly priced in, which we are still cautious on Cathay Pacific’s earnings drag. Therefore, we maintain a Hold on Air China H shares. Meanwhile, we have a Sell rating on its A shares, given their significant valuation premium over the H-shares. Key downside risks include excessive new capacity on international routes, and weakening in Cathay Pacific's earnings contribution. Key upside risks are the reverse of the aforementioned points.

19 January 2018



Basic Materials / Mining

Angang Steel (0347.HK, TP HKD 8.00, Buy, HKD 7.49)

James Kan, [email protected], (+852) 2203 6146

Supply may remain stable in 2018 Winter steel production cut may continue to affect the industry production in 2018. Yet the full-year industry production may not decrease significantly because the capacity utilization rate may overall increase in 2018 after the completion of overcapacity cut. Also, Angang does not expect the nationwide production capacities to be boosted due to the strict standards of capacity replacements. Therefore, Angang guides the company's industry production capacities to remain stable in 2018.

Slow demand from property industry but resilient demand from infrastructure industry Angang is aware of the downward demand trend from property industry but was positive about the demand from infrastructure industry. In 2017, the sales volume of excavators in China was up 99.5% YoY, which indicated strong growth of the infrastructure industry. According to Angang, the government also has invested substantial effort into railway network development. Thus, the company expects steel demand to increase because of the promising trend in 2018.

Angang expects HRC price to fluctuate mildly but reserved about rebar price in 2018 The company guides HRC price to remain resilient in 2018 because of the well- balanced supply and demand relationship. HRC supply and demand should remain steady in 2018 due to the continuing impact from supply-side structural reform and the stable trends of downstream industries. Winter production cut may increase HRC price in Q1 2018. After the completion of winter production cut in March 2018, HRC price may mildly decrease but should remain relatively steady for the rest of the year. However, Angang is reserved about the rebar price in 2018. The rebar price increased largely in 2017, mainly due to the campaign to eliminate small players. Yet this campaign was completed in 2017 and should not impact the rebar price in 2018. Also, the downward trend of property industry will likely affect rebar demand in 2018. infrastructure industry in 2018.

Baosteel (600019.SS, TP CNY 9.30, Buy, CNY 9.10)


Production capacities may go up in 2018 Baosteel expected the steel industry to release more production capacities in 2018 because the de-capacity target for 2018 in China at 25mtpa is only half of the target for 2017 at 50mtpa. The company’s new EAF productions and the completed capacity replacement projects may drive its production capacities to go up in 2018 . The main capacity replacement projects are Phase I (c.4mtpa) and Phase II (c.4mtpa) of Rizhao steel mill in Shandong Province. Phase II will be put into operation in the second half of 2018 according to the company.

19 January 2018



Mild price correction and continually resilient spread in 2018 In 2017, overcapacity cut and winter production shutdown policy affected steel companies’ production capacities and the commencement of new construction, which drove the steel price to largely increase. The rebar price particularly exceeded RMB5,000/t in December 2017 with gross profit margin at c.RMB1,500/t. Thus, price correction began at end-2017 and may continue in 2018. Baosteel expected the rebar price to drop by RMB800/t from the current price level. As the effects of the government policies that were executed in 2017 may extend into 2018, the company expects a mild price correction and guided steel spread to stay relatively resilient with stable annual average selling price in 2018.

Long steel profits may not have premium over flat steel profits in 2018 Long steel was overall more profitable than flat steel in 2017. However, this situation is contradictory to the demand trends of long steel and flat steel. Market data showed a stable trend of flat steel demand from auto and home appliance industries and a declining trend of long steel demand from infrastructure and property industries. Thus, the outlook of flat steel in 2018 should be more positive than long steel. Long steel profits may not have premium over flat steel profits in 2018.

Ramping up EAF may become a trend In 2017, IF furnace was fully replaced by EAF and BF. Although the government has not promulgated policies to promote EAF, Baosteel started EAF production during 2017 (2mtpa in 2018). The industry’s EAF capacities should remain the same at 15mtpa in 2018. The company’s production output of EAF in 2018 will be higher than 2017 because of the full-year operation in 2018.

China Coal Energy (1898.HK, TP HKD 5.35, Buy, HKD 4.01)


Production may grow mildly in 2018 China Coal’s production volume guidance in 2017 was adjusted to 75mt from 80mt because of overcapacity reduction, geology changes and village migration. Geology changes and village migration may still exist in 2018. However, Muduchaideng Coal Mine (6mtpa) and Nalin River No. 2 Coal Mine (8mtpa) were approved in October 2017. The productions of these two coal mines will be included in its financial reporting in the fourth quarter of 2018. Considering the temporary negative influences from geology changes and village migration and new production capacities of these two coal mines, the company guided the production volume to increase mildly in 2018.

2018 average selling price will remain resilient China Coal will not adopt a monthly contract mechanism in 2018. The coal contract price in 2018 will still follow the “RMB535/t+50% index adjustment” mechanism. The spot price in 2017 was relatively high as the new production capacities released in 2017 were not strong. For 2018, the management board believes the spot price may increase in the first half while there will be downward pressure because of new production ramp-up in the second half of 2018. Additionally, the management board does not expect significant price correction as the supply-demand relationship should remain well-balanced. However, the company was reserved about releasing the ratio of the spot price to contract price.

19 January 2018



Production cost increased in 2017 The company shut down some coal mine projects with higher impairment losses in 2017. Therefore, the 2017 third-quarter report showed that the unit cost in Q3 increased by more than 20% YoY. The unit cost allocated to Q4 may increase based on the company’s historical trends. The company will give out 2018 production guidance in March.

The outlook of coal-chemical business is positive in 2018 The company's sales revenue of coal chemical operations in 2017 decreased because of overcapacity cut and its one-month equipment maintenance. However, the company has sufficient olefin production capacities for future growth. Currently, the company has methanol-based olefin with 0.6mtpa and coal-based olefin with 0.6mtpa. China Coal and Sinopec are also developing a new coal-to-olefin facility with 1.33mtpa. China Coal holds 38.75% equity interests in this project. Moreover, the olefin market price is increasing while the mine-gate coal price is relatively low. The gross margin of olefin products may increase by RMB1,000/t if the oil price goes up by USD10/bbl. The upward gross margin trend and stronger production capacities indicate a positive outlook for the company’s coal-chemical business in 2018.

BBMG (2009.HK, TP HKD 5.62, Buy, HKD 4.10)


BBMG-Jidong new asset restructuring proposed The structure of the M&A between BBMG-Jidong has changed from asset injection of BBMG's assets into Jidong to an establishment of a newly formed JV to avoid the so-called “double listing” issue. BBMG-Jidong has proposed a new solution whereby BBMG will inject their 22 cement plants into a new JV with Jidong owning 53% and the rest of the BBMG cement assets will be under custodian of the new JV. As such, BBMG will legally be separated from cement operation and will not constitute competition within same industry with Jidong. The first step would be injecting 11 cement plants into the new JV with the rest to be completed within 3 years. BBMG-Jidong reiterated that daily operation of cement business has been combined since the equity restructuring in 2016 and the new solution would yield similar effect to earnings while all assets will still be ultimately consolidated to BBMG balance sheets.

Cement demand to rebound in 2018; M&A still a priority BBMG expects the cement demand to stay flat to up in 2018 as cement demand in Bohai rim was artificially suppressed due to the 19th CPC meeting and tighter environmental controls which halted all construction activities in Tianjin half a month before the mandatory winter production halt on Nov 15. In addition, there are also anti-dumping measures adopted post BBMG-Jidong merger. In fact, BBMG saw decent growth of cement volume at c.5% yoy in the 2H17 and expect FY17 volume to fall c.10% yoy. Meanwhile, BBMG is also committed to further consolidating the Bohai rim market and highlighted that their actual market share by sales volume was only at 45% despite controlling 56% of the clinker capacity. While they have budgeted c.RMB6bn for M&A in the region, the current upcycle has discouraged asset owner to dispose their stakes but BBMG will continue to look for the right opportunities.

19 January 2018



Property development stronger than expected BBMG property sales for 11M17 has reached RMB25bn, which is already higher than its annual target of RMB23bn. In terms of GFA sold, it recorded 1.4m sqm, up 22% yoy. GPM for the 9M17 was at 29%. Current land bank stand at 8m sqm GFA with another 9m sqm land area of industrial land available for conversion. Besides, BBMG has phased out Qianjin cement production line in Beijing in early 2017, adding another valuable piece of land to its potential industrial land conversion project.

CNBM (3323.HK, TP HKD 8.21, Buy, HKD 8.31)


CNBM-Sinoma merger updates: More A-share restructuring coming The merger is now pending CSRC final approval and management appears confident that the merger will be complete before Chinese New Year. CNBM management expressed that the next steps would be restructuring the several sectors under CNBM and Sinoma using the A-share subsidiaries and that this would kick-start this year. Ultimately, CNBM should transform into a holding company with the three segments - cement, engineering and new materials - to be controlled by 1-2 A-share listed companies each in the future. The restructuring of the A-shares is to kick off in 1H18 post completion of the merger.

In all their segments, Sinoma and CNBM need to resolve the same industry competition issue. For cement, one possible solution is to inject CNBM's cement assets into 1-3 of Sinoma’s A-share subsidiaries. In the past, it was a deadlock as provincial governments were unwilling to delist the company from their provinces, but the new solution would be appreciated by both provincial governments and shareholders, where valuation of the CNBM assets could be rerated to A-share level.

In new materials, CNBM Group is reviewing several proposals, such as gaining controlling shares in China Jushi by injecting Sinoma’s fibreglass assets, leaving Sinoma Technology as a platform for all other non-fibreglass new materials, which would allow fibreglass business to shine under a separate platform, potentially unlocking its value. Alternatively, CNBM could simply combine all related subsidiaries to build a new material flagship company.

In engineering, given that Sinoma International is already a listed entity, an injection of CNBM's private engineering assets into the listco seems the easiest option.

Post-merger: Reducing CAPEX and Rapid deleveraging After the merger, reducing debt would become CNBM management's top priority. In 2017, CNBM and Sinoma spent c.RMB13bn and RMB4.5bn, respectively. In 2018, the combined CAPEX should be reduced to RMB15bn, leaving higher FCF for debt reduction. Proceeds raised from any asset restructuring could be used to pay down debt. Meanwhile, strategic investors newly introduced to buy 40% of China United Cement should also raise RMB8.5b.

19 January 2018



Operation updates – Strong cement pricing to prevail in 2018 CNBM is also optimistic about the current strong cement pricing nationwide and believes pricing will stay elevated in 2018. In the near term, prices could correct into the slow season but overall 2018 prices should be higher than in 2017. CNBM also saw GP/t rise from RMB85/t in Oct to RMB97/t in Nov and easily exceed RMB100/t in December. The full year average GP/t was RMB70/t+ while 11M17 volume reached 264mt, flat yoy. Management expects full-year volume to register c.1% growth versus 269mt in FY16. For the combined company, management expects they will see a 10% yoy hike in ASP, so GP/t should rise by about RMB20/t yoy to RMB80-90/t in 2018 with coal costs potentially declining.

Conch Venture (0586.HK, TP HKD 25.75, Buy, HKD 21.20)


Conch Venture (CV) attended DB’s Access China conference in 2018. Key takeaway are as follows:

Hazardous and sludge waste The capacity target has been upgraded to 5mt of capacity by 2020 from 3mt previously, with the cooperation by CNBM, where c.235k/2mt/3mt will be in WCC/Conch/CNBM’s clinker lines. Currently, 2.1mt capacity has been contracted on WCC and Conch’s lines. For 2018, CV’s lines that are attached to Conch facilities will generate c.RMB300m in NP, and Yaobai Environmental (three lines in Shaanxi) will contribute RMB120m in NP. The first line that was rolled out in Wuhu in Dec-17 is now in operation, and daily incineration volumes have reached c.150t/s, i.e. 50% utilization, based on local demand and a limited operation period. Management believes if the cross-province hazardous waste transportation limitation has been lifted, utilization could easily reach high levels. Currently, ASP stands at RMB3,000/t, and NP can be as high as RMB2,400/t.

The main competitive advantage of using a cement plant for hazardous waste treatment is its low treatment cost. The bulk of the cost will be safe transportation of hazardous waste, where CV will need to pay RMB1.2-2/t/km using its own logistics company or RMB3/t/km if it is outsourced. To cement producers, the waste will also lower the fuel and raw material cost of cement plants. Cement plants will also receive a RMB30-40/t of payment from CV for costs incurred and be exempt from peak shifting production halts, which will give them higher utilization rates.

The bottleneck in the acceleration of capacity growth is residents’ objections, as they fear these projects are hazardous to their health. In GD, CV has signed MOU with the local government and Conch lines, but that has faced some objection from citizens. As a result, Wuhu lines will serve as a demonstrative project to educate the general public and government officials that clinker line co-processing will not create an impact on the local environment nor their health.

Grate Furnace The capacity target remained the same at 2.8mt by 2020, of which 2.65mt has already been contracted. Typical capex for a 100kt line would be RMB150m. In a BOT contract, the local government will guarantee the minimum amount of

19 January 2018



annual processing fees, usually calculated at 80-85% of the utilization rate, to be paid to CV to prevent construction delay or insufficient garbage. During construction, 20% of the revenue will be booked as construction revenue, with GPM at around 25%. Upon construction completion, the grate furnace operating cost could be offset by the garbage processing fee, and the profit would be coming mainly from electricity sales at a preferential tariff of RMB0.65/t w/VAT for the first 280kWh/t and a standard tariff for the rest, implying an operating income of c.RMB15m for a typical 100kt line on full utilization. According to the experience of the first few lines, CV has achieved an actual power generation of 310-320kWh/t, but the actual utilization rate varies line by line.

Cooperation with Dongjiang Environmental DJE handles the waste mainly by landfill and incineration, where the resultant ashes are required to be buried as well. These traditional processing methods have high cost and limited capacity. Getting approvals for capacity expansion has been particularly expensive. Hence, DJE is only processing the most profitable waste in-house and will pass the rest to CV to handle. Clinker line co-processing also has its downsides and cannot handle every type of waste, thus CV will redirect some of the waste to DJE. The new line in Jiangxi Yiyang to be completed in Mar-18 will be first one under this cooperation arrangement, where DJE has a local presence.

Dividend policy All of Conch’s dividends will be distributed to CV shareholders, plus some additional from the NP of CV’s principle businesses.

Miscellaneous Conch Group sold down 50m shares of Conch Cement, meaning CV will directly own c.17.8% of CV, instead of 18% before. Grate furnace overseas expansion has stalled for the 4,000t/d line in Morocco and the 3,000t/d in Bali, but two projects in Vietnam with 200t/d and 300t/d are accelerating quickly.

Anhui Conch Cement (0914.HK, TP HKD 46.00, Buy, HKD 42.90)


Conch Cement attended DB’s Access China conference during the week of Jan 8.

The key takeaway are as follows:

2018 outlook Conch believes 2018 prices will stay elevated and continue to strengthen, as seen in 4Q. Conch highlighted that the current cycle is different from the 2010-2011 cycle, which was demand-driven and also due to the one-off impact from power cuts in 4Q10. The current driver is supply, underpinned by a much stronger environmental conservation and the lack of new supply, which was not the case in 2010-2011. Producers also have realized that the cement market is no longer growing at the same rate it used to, and therefore, they have realized that the only way to increase earnings is via higher pricing, even if it means lower volumes. The supply-driven factors also mean that cement prices will likely stay elevated throughout 2018 versus the sharp retreat seen in 2H11.

19 January 2018



Market update Entering January, there has been snowfall and bad weather, and therefore, demand has weakened to 600-700kt/d from 900kt/d previously. However, Conch still expects sales volume of 20-21mt for Jan, which is flattish yoy. Inventory levels have marginally risen to 40% from 35% of storage capacity as a result.

Risks are clinker imports Due to the high cement price and clinker being priced at RMB500/t in Eastern China, clinker imports from Vietnam have entered China. The CIF price of Vietnam clinkers is c.RMB400/t; therefore, Conch seems likely to cut prices before CNY in order to curb Vietnam imports. However, even after the price cut, the clinker price of RMB400/t is still significantly more expensive than clinker ASP in 2017.

Supply side reform China will introduce the new environmental levy effective 1 Jan 2018 to replace the old emission tax. Under the new environmental levy framework, 25%/75% of Conch lines qualify for a concessionary rate due to its low NOx and SO2 emissions, respectively. Conch paid c.RMB200m in emissions tax in 2017 and expects to pay a total of RMB250-270m under the new environmental levy framework, which is equivalent to c.RMB1/t. Smaller producers, particularly those in Northern China where the base levy is almost 8x higher, could end up paying RMB5-8/t. Overall, the cost structure between Conch and others will likely widen.

Conch also benefits from its superb limestone reserves, which are proving to be an extremely important factor under tighter environmental laws as some of their peers only secured their limestone for five years to save cost. The historical cost for Conch’s limestone reserves is as low as RMB0.3-0.4/t, but this has then increased to RMB5-6/t and in Zhejiang, RMB15/t.

32.5 removal The government is currently only considering the removal of 32.5R grade cement removal, but large producers, including Conch, have been lobbying the government to extend the removal to all 32.5 grade cement to prevent individual grinding stations falsifying ordinary low-grade cement into PS/PF32.5 cement. An alternative solution would be cancelling the VAT refund policy for 32.5 grade cement, which would discourage grinding stations to stop producing low grade cement, effectively increasing clinker demand. All these measures will also squeeze the profitability of marginal producers, incentivizing them to exit the market.

CAPEX plans Dividend payout set to rise. Conch maintained its capex guidance for 2018 at RMB5-7bn (RMB7bn in 2017) excluding M&A activities, in line with the revised guidance announced in 1H17. On the M&A side, Conch is still looking to acquire smaller players in West China, mainly where ASP is still low and it remains unprofitable for producers to avoid paying excessive premiums on assets to ensure the transaction is earnings accretive after synergies. In South China, where there are new capacities in the pipeline, Conch sees itself as a market consolidator as well. Given the much improved market condition, Conch expects the average acquisition cost will increase to c.RMB420/t vs. RMB360-380/t historically. Conch-WCC partnership is still on the table, but the current major handle would be finding a solution that could maintain WCC listing status while Conch could own>50% of the shares. Conch is also committed to increasing the dividend payout ratio to likely c.40% of the

19 January 2018



dividend payout, although the policy has not been disclosed yet and more M&A activities are expected.

Tianqi Lithium (002466.SZ, TP CNY 70.70, Hold, CNY 58.10)


Growth to continue till 2020 Mr. Bo Li, Deputy General Manager and Secretary of Tianqi Lithium's Board of Directors, attended our 2018 dbAccess China conference in Beijing this week. Mr. Li shared his view on industry development and the company’s expansion plan for Tianqi. We summarize below the key highlights from the investor meetings. Maintain Hold.

Expect relatively resilient pricing for high-quality battery grade lithium compounds in 2018 The battery grade lithium carbonate price corrected by RMB5k/t from its peak at over RMB170k/t by end-2017, but Tianqi does not expect meaningful correction of lithium compound pricing due to a supply shortage of high-quality battery grade lithium compounds with high purity levels. The company believes the incremental supply from brine extraction in Tibet/Qinghai will be limited, as several issues need to be resolved : a) utilities and infrastructure , b) access to pure water, c) extraction difficulties in high altitude, and d) SOE ownership in mining rights.

Better margin performance compared to industry peers Tianqi exhibits a superior gross margin at 70% vs. other industry players due to: a) in-house high quality spodumene supply from the Greenbushes mine, b) high exposure in battery grade lithium compounds, which charges a pricing premium compared to industrial grade or subpar battery grade lithium compounds, and c) onshore lithium pricing premium at RMB10-20k/t in China due to strong end demand. As the quality of battery grade lithium compounds is directly linked to the stability and performance of lithium batteries, Tianqi believes lithium compound converters that can provide meaningful and stable volume output will be the major beneficiaries riding the EV tide.

Kwinana expansion in Western Australia to fuel production volume growth till 2020 The 24ktpa Kwinana phase 1 lithium hydroxide plant is on track to commence production by YE18 with spodumene ore grading at 2.4%, with the utilization rate expected to reach 80% in 8-10 months after commencement and full capacity in 24 months. Another 24ktpa lithium hydroxide plant in Kwinana phase 2 is scheduled to complete construction by YE19 with spodumene ore grading at 1.7%. Coupled with the 20ktpa lithium carbonate capacity addition in Suining, Tianqi targets the company’s total processing capacity to reach 110ktpa in 2020, and lithium compound production volume to surpass 80kt (on LCE basis), implying a 3-year CAGR of near 40% from 32kt in 2017.

Open to asset acquisition opportunities overseas Although the annual volume of Greenbushes’ spodumene should nearly double to 1.34mt in 2019 from 740kt this year, the in-house spodumene volume might not be fully sufficient for Tianqi in 2020. The scheduled rapid production ramp-up has compelled the company to continually look for high-quality lithium resources overseas. After SQM turned down outside offers, Tianqi’s 2.1% SQM stake is currently considered to be a financial investment only. The company will seek more brine-based opportunities, potentially in South America.

19 January 2018



West China Cement (2233.HK, TP HKD 2.25, Buy, HKD 1.29)


West China Cement attended DB’s Access China conference in the week of Jan 8. Highlights of the key takeaways are as follows:

Recap of 2017. Shaanxi demand grew 2-3% but WCC volumes were at 5% mainly due to strength in South Shaanxi, Xinjiang and Guizhou. In central Shaanxi, demand remained flat. The biggest change was the price which has been on an uptrend since the beginning of the year. Therefore, WCC issued a profit alert for 2017.

Demand. 2018 will be extremely positive with demand expected to grow 5% due to strong infra demand. Two high speed railways will start construction in 2Q, i.e. Xi-an to CQ and Xi-an to Yanan. Also, four or five inter-city railways such as the Xian to Hancheng railway. Real Estate remains strong as inventories are very low in Shaanxi. The demand should be quite optimistic for the next few years and not just for 2018 as these projects will take a few years to construct.

Pricing. Oversupply still exists and utilization rate will remain at 65-70%. The pricing can be maintained at a high level in 2018 because: 1) no new supply, 2) market coordination is beneficial to everybody so no reason to break it, 3) environmental pressure by the government such as we have to stop kilns for 100 days. In 2018, profit will improve as we begin 2018 at a very high price level.

Aggregates. WCC has opened 8 quarries with capacity reaching 16mt by 2Q18. WCC believes a conservative sales number is 5mt for 2018 but hope to sell closer to 10mt. The ex-factory price for aggregates is high at RMB80-100/t with market price at RMB120/t. However, after they start selling, they don’t rule out price dropping maybe to RMB50/t. The gross margin is 60%+ so payback is less than two years. The total investment is RMB500m for 16mt and WCC has spent RMB200m in 2017 and likely another RMB200m in 2018.

USD400m bond. The expiry will be in Sep 2019 so WCC plans to do the refinancing in 2018 which will depend on the interest rate and current market conditions. Most likely will issue another bond in 2H18 to refinance the bond but the amount is not confirmed. 2H18 is good timing because after summer is a good timing to get a better rate. Also in March 18, there is a RMB400m STN that will expire so we will likely repay using own cash balance.

Strategy for the future. To diversify our earnings stream besides cement such as in aggregates but will look at opportunities in concrete, cement and concrete products which is what is done by global companies also.

Dividends Payout policy is 25% for WCC though there is still a chance to pay out higher dividends depending on the board. WCC also need to consider whether they need to conserve cash for debt repayment or to consolidate the market further.

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Industry experts

Automobiles & Components: China Auto Sector


Mr. Waili Li, Director of Information and Industrial Development Unit, State Information Center, presented at our Access China conference on 10 January. Key highlights:

In 2017, the growth rate of commercial vehicles (CV) was higher than that of passenger vehicles (PV) for the first time. Within the CV sector, truck growth (especially for heavy-duty) was higher than that of bus. This is driven by the crackdown on truck overloading being extended to provincial highways, but the impact might not be sustainable.

Meanwhile, weak PV sales growth is an aftermath of demand being pulled forward by tax stimulus. On the positive side, OEMs' supply discipline supports transaction prices.

The State Information Center still believes in the long-term growth potential of China's auto sector based on still-low ownership. Meanwhile, it expects China's PV wholesale to grow by c.3% in 2018.

Mr. Li thinks that, in the long run, the new energy vehicle (NEV) market will not only be driven by government polices but also by market demand. Currently, NEV sales in China are largely concentrated in cities with auto purchase restrictions, while the percentage of non-private purchases (52%) is higher than that of private (48%). However, with the functionality and quality improvements for mid-to-high- end NEVs, amid increasing foreign OEM participation, private demand should boom.

As artificial intelligence (AI) is a national strategy, intelligent connected vehicles (ICV) should grow fast in China, and the demand will probably be driven by the young generation. With more software being used in ICVs, software companies will be increasingly involved in the auto sector.

Management of Volkswagen Group China (VW China) also presented at our Access China conference on 10 January on China's auto sector outlook. Key highlights:

- While VW China has not yet set sales targets for 2018, it expects auto sales growth to stay mild. It expects mild and steady growth will become the new norm of the Chinese auto market. Imminent pricing pressure is unlikely given low inventory levels in the market. The company's future strategy will focus on SUV/ E-mobility/Connectivity. Currently, margins of SUVs are still attractive, despite fierce competition. By 2020, VW China will offer more than 10 new SUV models in China.

In the NEV space, VW China's new NEV JV with Jianghuai will roll out its economy NEV product in 2018. Currently, the company is able to meet China’s existing fuel economy requirements but the requirements will be tightened going forward. To tackle that and to

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meet NEV credit requirements, VW China will first roll out more EVs based on existing platforms besides the current plug-in hybrid (PHEV) models, then roll out EVs on specific EV platforms in the longer term.

VW China does not expect high auto manufacturing margins to be sustainable considering higher R&D costs going forward and increasing NEV mix.

In terms of auto financing, VW China cars’ auto financing penetration is about 40% with one-third of the share being handled by VW China’s financing arm. The company is keen to grow the business.

Deutsche Bank view In general, the industry experts' views echo our own. To elaborate, we expect overall China sales growth to stay mild while competition could intensify in the SUV segment and the NEV segment with many new launches. As such, we are cautious on names such as Great Wall Motor and BYD. Our Chinese OEM top Buys are BAIC Motor and Brilliance, given strong sales at their premium JV brands, while BAIC Motor will also benefit from its Hyundai JV recovery.

Consumer: China Education


Mr. Sinba Zhang (an education industry expert from Wenba Technology) attended our dbAccess China Conference today. Key takeaways from the conference are as follows: Education spending vs. market size - Education industry annual spending is c. USD 4.6trn (vs. market cap USD 0.1trn). The market size of China education in 2017 is c. RMB 9trn. Breaking this down: Government fiscal spending (RMB 4.23trn), Urban spending (RMB 2.25trn), Rural spending RMB 1.26trn and Fixed investment (RMB 0.78trn).

K-12 market size - The K-12 tutoring market size is c. RMB800bn, while the top 5 player accounts for a total of less than 5% market share (c. RMB30-40bn). K-12 tutoring market in China remains highly fragmented with plenty of headroom for both industry growth and market share consolidation. As for K-12 quality brands such as EDU/TAL, there will be a large opportunity for lower tier cities penetration.

EDU vs. TAL - The expert believes TAL is more reliant on the teaching system and framework, while EDU is more reliant on its experienced teachers.

Students number - The expert expect there will be c. 326 m students in China by 2020. Breaking this down: there will be 40mn (12%) pre-school students, 212mn (65%) K-12 students and 74mn (23%) higher/vocational education students.

AI technology - AI will become a powerful learning auxiliary for teachers/students and fundamentally shift the landscape of the education industry in China.

Big data analysis - Through big data, teachers will be able to precisely identify why certain students struggle with certain subjects, and address them accordingly - teachers almost become doctors-like in this sense. Data show that students using this system have displayed significant improvement in their academic performances.

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Consumer: China home appliances

John Chou, [email protected], (+852) 2203 6196

Some upside surprises on air con., lower-tier cities and multi-brand We hosted Robam, Midea and GFK industry experts during the dbAccess China 2018 conference. We believe investors are positively surprised by 1) Midea’s strong air con. installation in 4Q17 and relatively strong 2018 air con. revenue guidance, 2) Robam’s robust demand in tier 3 and 4 cities and 3) multi-brand expansions. We maintain our 2018 top picks of Midea and Qingdao Haier.

Robam: targets 20% revenue/ 20-25% earnings growth in 2018 Although the growth guidance was revised down, growth appears to be more sustainable (Robam now aims to grow at a 20% pace in the next 3-5 years). For 2018, Robam expects: a) range hood and cooking hob sales to grow 15-20% (10-15% volume growth and single-digit ppt YoY ASP) and b) embedded products up 50% YoY (mainly driven by volume). Within embedded products, dish washers and water purifiers failed to meet Robam’s 2017 targets due to unstable contract manufactures, which Robam aims to gradually solve in 2018 with the construction of its smart factory. By channel, Robam expects accelerating growth from branded stores in 2018 (especially the ones in tier 3 and 4 cities). Although sales slowdown in tier 1 cities appears inventible, Robam aims to expand its new cooking experience stores to grow the embedded product business. Robam views competitors, including Midea and Vatti, as positioned in the mid-end, and it will accelerate its mid-end brand MQ to counter competitors’ expansion in the mid-end kitchen appliances market.

Midea: 30% YoY air con. installation growth in 4Q17; reiterating “over 10%” sales growth target in 2018 (with air con. growing faster than overall) Midea further elaborated on its multi-brand strategy: a) it targets to turnaround Toshiba in 2018, b) it plans to introduce the premium AEG brand to China that will focus more on cleaning appliances (e.g., vacuum cleaners) and c) it may launch more brands to grow domestic and overseas markets. Midea expects some pressure with KUKA in 4Q17 due to a downsizing (which is KUKA management’s decision). For 2018, Midea set post M&A integration, brand image and product upgrades as its major targets, and indicated no major acquisitions in the next two years.

Interesting cross-reads on e-commerce, multi-brand and manufacturing Mindful of e-commerce’s bargaining power: Robam and Midea have

indicated that e-commerce will account for 50% of their distribution in the long-term (vs. less than 30% currently). At the same time, both are confident of controlling e-commerce platforms’ bargaining power through building balances among Tmall, JD, Gome, Suning and in-house websites.

Multi-brand strategy: we believe that Midea is turning more aggressive in developing a multi-brand strategy, partly incentivized by Haier’s success with Casarte. Robam also turned aggressive with its MQ brand, but is likely to suppress competitors in the mid-end.

Next generation production: Midea emphasized its conviction for pushing a “t+3” strategy as well as goals to reduce air con. production cycle time. Robam’s disappointment with dish washer OEMs also incentivized it to construct an advanced automated factory.

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Healthcare: China Healthcare

Jack Hu, Ph.D. [email protected], (+852) 2203 6208

Anticipate stable delivery in 2018; Hengrui/SBP guided growth acceleration We hosted executives from 18 listed companies during the DB conference and tour this week. Most executives remain constructive for 2018 and, despite the stock rally, have not become more bullish or bearish vs. 1H17. Additional takeaways: 1) most expect an acceleration of drug approvals and benefits from NRDL inclusion, although their views on the exact timeline of the latter were mixed; 2) their expectations of the pricing/volume trends after BE were mixed. We highlight that only two companies guided a growth acceleration for 2018 vs. 2017 – Hengrui and Sino Biopharm.

DB proprietary executive survey on the 2018 outlook We conducted our annual survey of executives from 16 listed companies to gauge views of key policies and sector catalysts. We highlight the following results: 1) on whether the executives have changed their views on the sector growth outlook in 2018 vs. 1H17, 37% indicated no change. We concur and remind investors that the fundamentals have not changed despite the significant stock rally; 2) on the growth outlook for the distribution sector, 2 distributor bellwethers voted 7-8%, one expected a high single digit and another said 6-7%, vs. 7.8% growth in 1H17; 3) on the timeline of the NRDL benefit on drug growth, the feedback was mixed, with 25% being uncertain; 4) on an acceleration of regulatory approvals in 2018, 56% of the executives expected one; 5) on the pricing trend after the BE study, the responses were mixed as well, with 25% anticipating a price erosion and 44% expecting stable prices.

DB view: more challenging to identify delta vs. consensus estimates From a valuation perspective, we believe most of the near-term catalysts have been reflected for large-cap stocks while new mid/long-term risks are likely to emerge. On fundamentals, while we could still identify meaningful differences in selective mid/long term growth drivers on a qualitative basis, we see fewer opportunities for consensus revisions of 2018 numbers. While it would be challenging to predict the sustainability of a large-cap stock rally, we now believe laggards may have more chances to outperform. We highlight Jointown and Universal Medical as our top picks. We also like IHH at this point.

Energy: China Oil & Gas


Wood Mackenzie (WM) attended DB’s Access China conference in 2018 and presented on the O&G industry for 2018. The key takeaways are as follows:

Oil price. WM holds a conservative view on the oil price with Brent expected to average USD56/bbl in 2018 and that holding above USD60/bbl will be more difficult than it seems. In the near term, the oil price is in equilibrium but global supply growth will outstrip demand growth for the rest of 2018, mainly with tight oil growing 1.2m b/d and large volumes coming out in deepwater Brazil. In addition, US tight oil plays can now convincingly hedge their positions at USD62/bbl WTI.

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Capex. Total upstream spend should remain flat at USD400bn only mainly because of a huge drop in LNG spend particularly in Australia. Deep water and unconventional will fill the gap and is expected to grow 15% yoy.

Cost curve. The pre-FID deepwater cost-curve breakevens have fallen from USD78/bbl in 3Q14 to USD64/bbl in 1Q17 to USD56/bbl in 3Q17. The lower cost in 1Q17 is mainly due to the removal of some expensive Angola projects. One will also see that in 2014, there was only 5b BOE of cashflow positive reserves versus 20 bn BOE in 2017.

Tight Oil. Output should rise 24% and 1.2m b/d to 6.2m b/d. Rapid growth will lead to challenges and rising costs. The key to success for tight oil is productivity. A 10% fall in production destroys 60% more value than a 10% in cost increase. Questions continue to be asked about whether tight oil can break even. The volume of undrilled liquid resource in the Permian has increased with 13b BOE under USD60/bbl WTI during 3Q17.

OFS. 2018 should still be a tough year and the business model for OFS companies needs to adjust to work in a USD50/bbl oil environment. The benefit will come from operators who have the best chance to lock-in rock-bottom OFS costs.

Resource capture. Asian NOCs need to get involved with 15b of boe up for grabs. 28b boe of discovered resource is up for grabs in Iran. In the UAE, 700k b/d ADMA concession expires Mar 2018 with remaining reserves of 7.4b bbl. Brazil aims to offer 10b boe of deepwater DROs.

Metals & Mining: Lithium battery industry


Expect more industry consolidation; positive medium-term outlook driven by Passenger Vehicles (PV) Mr Moke, founder of RealLi Research, attended our 2018 dbAccess China conference in Beijing. During the conference meeting with investors, Mr Moke shared his views on China’s EV battery direction and the outlook on industry consolidation, and gave a positive medium-term view. We summarize the investor meeting below.

Consumer-driven EV market post 2020 to be largely dependent on a) cost down; and b) energy density improvement Government policies have been driving the EV industry since 2009 through various levels of subsidies, but Mr Moke believes the target is to realize EV commercialization without support after 2020, assuming both of the government’s targets can be reached: a) the energy density level of a battery system to surpass 260wh/kg and b) battery pack cost to be lower than RMB1/wh. Thanks to high energy density and strong demand from the New Energy Vehicle (NEV) PV segment, NCM batteries, for the first time in history, commanded a market share similar to that of LFP batteries at c.45-48% in 2017.

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Narrowing technology gap between leading domestic and Korean battery makers The energy density level of overall battery pack is expected to reach 140wh/kg by end 2017 and increase to 175wh/kg in 2018 before reaching the government’s 2020 target of 260wh/kg ( a 3-year CAGR of 23%), mainly driven by subsidy requirements. Leading domestic battery makers, including CATL and Farasis, have made progress especially in the past two years, with energy density level achieving 220wh/kg, similar to that of LG Chem. In terms of manufacturing yield, there is still room for leading domestic battery makers to improve against Korean players.

EV battery and EV automobile OEM industries will likely see more consolidation in China The top 10 EV automobile OEMs account for 70% of battery demand in China, while the top 10 EV battery makers account for 90% of power battery supply. The consolidation and cost-down trends in the EV battery industry is expected to have forced c.30 marginal battery makers to exit the industry in 2017, compared with 109 battery makers in the prior year. Meanwhile, Mr Moke believes the Chinese government, in an attempt to produce several competitive EV models regionally, may implement policies to usher more consolidation in the EV automobile OEM industry in the next three years.

Future growth to be driven by pure Battery EV; expect PV to contribute 65% battery demand in 2020 Mr Moke believes EV bus is a saturated market in terms of annual shipment volume, as penetration rates in major tier 1 and tier 2 cities have reached the ideal level at c.40%, with each city having 60-70k units of EV buses on average. With the cost-down effort and improved energy density in NCM batteries, Mr Moke believes BEV (Battery Electric Vehicle) will be the key growth driver. In 2020, total NEV production is expected to surpass 2.5mn units in China, where 65% of EV battery installation would be contributed by PV, a meaningful increase compared with c.38% in 2017.

Energy: Asia Petrochemical

Vintus Leung, [email protected], (+852) 2203 6158

IHS Markit Vice President Mr. Paul Pang attended our Access China 2018 conference, and we lay out the key takeaways below: Bullish crude oil price view IHS Markit forecasts crude oil prices to rise further to US$80/bbl (in 2016 real terms) over the long term (2025) on the back of strong demand growth and a conventional production decline rate of c.2.5%p.a., which would require new tranches of supply, pushing up oil prices.

Healthy petrochemical demand growth continue in 2017-25 Petrochemical demand globally will continue to grow above GDP with 1.2x elasticity over 2017-25, of which methanol and propylene chains lead the way, while benzene and chlorine chains are weakest among commodity chemicals products.

2018 margins slightly dip from 2017 on olefins margin contraction The agency forecasts overall petrochemical margins to pull back by c.10% in 2018 due to olefins (mainly ethylene) spreads drops while partly offset by

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robust non- olefins margins. IHS Markit expects the majority of US ECC capacity to come on-stream in 2018, leading to a decline trend in global capacity additions for the medium-term over 2018-21.

Next petrochemical capex wave ahead; China opportunities Given tightening in supply-demand, IHS Markit expects capital investment to rebound in 2019. The China capex wave on petrochemicals will be driven by both private and SOEs, while still seeing a lack of foreign investment. Moreover, both conventional (ie. naphtha cracker) and unconventional chemicals (ie. CTO / CTP) should see a strong spending spree ahead, particularly on unconventional chemical capex with strong oil price expectations.

Stock implications; SEG & SPC-H Buy - SEG (2386 HK), as a key beneficiary of a petrochemical capex recovery, and upside potential in new order expectations if more CTO / CTP capacity in China gets approvals.

Buy - SPC-H (338 HK), with healthy outlook of petrochemical margins ahead, and strong exposure in non-PE products.

Industrials: China Containerboard


Imported OCC contaminant threshold fixed at strict levels of 0.5% On January 11, 2018 the Ministry of Environment Protection (MEP) released the "Environmental protection control standard for imported solid wastes as raw materials—Waste and scrap of paper or paperboard (GB16487.4 - 2017)", effective from March 1 this year. Ignoring protests by WTO, China has fixed the OCC contaminant cap at an extremely strict level of 0.5% versus 1.5% in the previous regulation, published in 2005 (GB16487.4 - 2005). This means the impurities included in the OCC (i.e. waste wood chips, glass, plastics, rubber, metals, paints) cannot exceed 0.5%. The final contaminant requirement is unchanged from the version submitted by China government to WTO on November 16, 2017, which attracted many protests from global recycling communities as they have to invest considerable sums to upgrade their collection and sorting facilities. Accordingly, we expect recycling/sorting costs to rise worldwide with US recyclers most affected since they are the largest supplier to China, accounting for 46% of waste paper shipped into China in 2016. Based on the current standard, US#11 waste paper shipped into China has a 1.0% contaminant standard, which would force China to buy more expensive US#12 or US#13 OCC, not to mention the lack of supply globally. The most immediate outcomes are as follows. 1) OCC #11 prices will plummet, benefiting global mills while Chinese mills will suffer from higher OCC prices through grade upgrading. 2) Margins will be squeezed for China mills since imports of finished paper will continue to flood China, with the global cost curve being lowered as they can use cheaper US#11 OCC. China still has the highest paper prices in the world, so raising domestic paper prices to pass through higher OCC costs will be difficult. 3) Large players' advantage to import cheap waste paper overseas will dissipate, putting them on equal footing with small mills, which primarily use domestic paper. This new rule clearly benefits box makers as opposed to paper mills.

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#3 batch import quota released On January 12, the MEP released the #3 batch of 2018 OCC import quota of 466kt to seven large paper mills, including Shenyang/Hebei/Quanzhou plants of NDP and Jiangxi plant of LMP. Including the 2.3mt in #1 batch and 344kt in #2 batch, China's government has approved 3.1mt of import quota, accounting for 11% of total recycled paper usage in 2016 or 13% excluding unsorted waste paper. On an apples-to-apples basis, the approved import quota implied a decline of 82% yoy from the first batch last year and would last for two months of production. The increased frequency of quota release has prevented speculation of waste paper price. At present, US#11 OCC is still RMB968, or 37% cheaper than domestic Grade A OCC, which means upcoming cheaper OCC overseas may lead domestic OCC prices falling further.

Paper mills' margins to stay low or be squeezed further in future According to our spread analysis, the NP/t of China's large paper producers, NDP and LMP, decreased by 3%/8% wow to RMB107/t and HKD440/t this week. At this level, smaller paper companies are just breaking even or are already loss making. Most paper mills want to increase paper price but it is proving very difficult because of sluggish demand. With imported OCC entering China at a higher price but falling paper price, we expect paper mills' margins to stay low or squeeze further in the future. We reiterate Sell rating on NDP with target price of HKD10.98/sh and Hold rating on LMP with target price of HKD8.30/sh.

Industrials: China Industrial Automation

Sky Hong, [email protected], (+852) 2203 6131

We invited Mr. Chen Ran, Deputy General Manager of Gongkong (a well-known third-party consulting firm specializing in China’s IA market) to be present at our Access China Conference 2018 on 10 January in Beijing. We summarize below our key takeaways:

2017 ended on a strong note; 4Q beats expectations Preliminary data from Gongkong shows that China’s IA market demand was up 15-16% YoY, with strong growth in 3Q sustained in 4Q. Such robust demand, in our view, beats expectations as the market previously expected 4Q growth to slow down on high comparison base. Also, Gongkong noted that due to already better- than-expected order intakes in 9M17, some industry players intentionally pushed some 4Q orders to 2018, leaving enough room for growth in the coming quarters. Therefore, strong demand growth will likely be sustained at least in 1H18.

Demand driver has shifted to industry upgrade... Gongkong believes the key drivers for the strong IA demand in 2017 include: 1) industry upgrades in low-to-mid-end manufacturing sectors; 2) rising labor costs; and 3) improvement in end-customers’ profitability. In the past, new capacity expansion used to be the key driver for China’s IA demand but now industry upgrade has become and will continue to be the predominant driver

...which means it’s structural and the cycle may last longer Although China introduced automation products 30 years ago, the real automation upgrade cycle in fact only started since 2014. Experiences from developed countries suggest it typically takes 10-15 years to complete an

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automation upgrade cycle but in China the cycle may last longer. This is mainly because China has a much more diversified and complicated manufacturing sector compared to most of the other developed economies. For example, automobile and electronic manufacturing, the two dominant verticals for IA demand in other developed countries, only drive 30-40% of China’s total IA demand. Sectors like textile machinery, metallurgy, public facilities, etc. used to be China’s manufacturing foundation and they will lead this round of automation upgrade. In fact, such a trend is really taking place in these verticals.

Government support will get even stronger Although Gongkong expects subsidies from the central government will likely be reduced going forward, funding support from local governments and financial institutions could more than offset such reduction. As a result, Gongkong sees stronger government support in 2018. In addition, a total of 97 IM demonstration projects were approved in 2017 (vs. 109 projects in 2015-16) and small-to- medium-size enterprises were bigger in the mix. Gongkong believes the whole purpose of the government’s promotion of IM demonstration projects is to set examples and spread the automation upgrade to the entire supply chain eventually.

Local leaders may fare better Gongkong believes having advanced technology alone is not enough to guarantee high market share in China. The ability to offer customization and price-to- performance ratio are becoming more important. With driver for automation upgrades gradually shifting towards low-to-mid-end sectors and traditional industries at the core of this round of upgrade cycle, Gongkong believes local players are better positioned vs. foreign players. In fact, local brands have started to take shares in foreign brands’ installed base market, suggesting end- customers are more willing to switch to local brands than before when upgrade or replacement cycle kicks in. In 1-2 years, Gongkong believes there will be 1-2 local players emerging that are capable of challenging MNCs’ market positions. Inovance seems to have a good chance, in Gongkong’s view.

Industrials: China Infrastructure Construction

Sky Hong, [email protected], (+852) 2203 6131

CCC, CSCI, CRG and CRCC attended our Access China Conference 2018 on 8-10 January in Beijing. We summarise below our key takeaways from investor meetings:

Stricter PPP regulation weighed on constructors’ order flow Following a series of stricter PPP regulations (Document 50, 87, 92 and 192) especially in 2H17, constructors have witnessed: 1) slower bidding activity for PPP projects in 4Q17; 2) extended negotiation periods for investment and financing arrangements; and 3) elimination of some unqualified projects from the national PPP project reserve.

Although constructors’ 2017 full-year targets for new orders were mostly achieved, the growth slowed substantially in 2H. Among the four constructors under our coverage, CSCI’s new PPP orders recorded the best performance (+26% YoY) in 2017.

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Looking into 2018, the constructors believe market concerns on constructors should gradually ease given: 1) the resumption of bidding activity for many new PPP projects after the revision of plans in response to the new regulation; 2) all relevant PPP participants have a better understanding of the new market situation after policy learning; and 3) SOEs will likely be favoured players for PPP projects in the national reserve, given these projects now impose a higher requirement with better quality after the unqualified ones have been eliminated.

That said, 1H18 may still be challenging in terms of new order growth, due to high comparison base. Moreover, the government’s push for deleveraging may force constructors to turn more selective on investment projects.

2018 new order outlook Most constructors see uncertainties in road and railway projects.

CRCC guides for 10% YoY growth for new orders in 2018, driven by urban transit, housing construction, municipals and property development.

CRG sees rising opportunities from the implementation of regional development plans as well as the overseas market.

CCC sees potential in urban comprehensive development projects.

Rail constructors’ comment on railway capex cut by CRC CRCC sees upside potential to CRC’s capex target of Rmb732bn for 2018 and believes Rmb800bn is highly likely in 2019-2020 in order to achieve CRC’s target for railway length by 2020 (i.e. 150,000km vs. 127,000km at end-2017). On the other hand, CRG views such budget cuts as reasonable during 2018-2020, as CRC, as a business enterprise, is now also subject to the deleveraging required by central government.

Industrials: China Rail Equipment


We invited Wang Huaixiang, Deputy Director of Transport Economics Research Center, he is an railway expert, to present at our Access China Conference 2018 on 9 January in Beijing. We summarize below our key takeaways from the presentation:

Positive on HSR ridership Thanks to the network effect, passenger traffic turnover recorded growth in 2017 across most trunk HSR lines, including routes launched many years ago (e.g. Beijing-Tianjin) and lines with ticket price hikes (e.g. Hangzhou-Shenzhen). Based on CRC’s calculation, more and more HSR lines have started to make profits from last year. Contrary to the common view that ridership is much lower for HSR lines located in western areas, the expert highlighted that HSR lines in Southwest China have proven to attract better-than-expected passenger traffic. For example, EMU density at the recently launched Xi’an-Chengdu HSR line rose rapidly in a short period, thanks to high population density in the region and attractive tourism resources.

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EMU demand outlook The expert confirms that the EMU ownership target of 3,800 standard sets does not include intercity EMUs and 160km/h push-pull EMUs. For the 160km/h push-pull EMU model, the expert expects the first batch of procurements to kick off in 2H18 with an estimated tender size of 50 sets and ASP of Rmb85-90mn/set. The expert also highlighted that a number of HSR lines to be launched in 2018 (CRC's target: 3,500km) are trunk lines located in Southwest China. Upon completion, the network effect in that region will likely be enhanced and tourism demand could drive upside to EMU density for the lines located in that region.

Railway capex outlook According to the expert, the railway capex budget of Rmb732bn for 2018 is not a surprise given the total capex required for railway lines to be completed in the coming years will gradually trend down, especially with civil work construction. In contrast, the expert sees potential upside for rail equipment spending on the back of encouraging operational results for HSR lines. In addition, Rmb60bn p.a. will be allocated for upgrades and renovation (including both infrastructure and equipment) over 2016-20, higher than our estimates of Rmb39-55bn p.a..

Outlook freight transportation Freight traffic for national railways has recovered since June 2016 and the volume in 2017 has reverted to a healthy level comparable to 2014. Starting from 2018, railway freight traffic should see stable growth as concerns over pollution force the government to divert more freight volume for commodity transportation to railways from highways. The ban on truck transportation for coals currently imposed in the Bohai Rim will likely be applied to the entire nation.

Pricing reform Based on the latest feedback, NDRC may retain its pricing power for hard seat tickets, as NDRC hopes to avoid the financial burden on low-income passengers. Government subsidies should cover CRC operating losses from sales of hard seat tickets. On the other hand, NDRC has agreed to transfer pricing power of hard sleeper tickets to CRC. Further details on pricing reform on this front are currently under discussion.

Utilities/Renewable/Environmental: China Gas Utilities


We invited Mr.Li Shaobin, the Manager of General Management Department in Shanghai Petroleum and Natural Gas Exchange (SHPGX) to give investors an update on the Progress & Outlook for China's Market-Based Reforms in the Natural Gas Sector. We layout the key takeaways below:

Latest progress of market-based price reform: Currently 50% of the total gas volume in China are fully deregulated, which includes LNG, unconventional piped gas, direct gas supply and gas sales in Fujian Province. 30% of volume is semi-regulated with prices set based on NDRC benchmark and a floating range (cannot exceed 1.2x of the benchmark). The rest 20% is residential gas sales which is fully regulated. With an ultimate goal of fully deregulation, the SHPGX is playing an increasingly important role. SHPGX now has an average monthly LNG trading volume of 0.15-0.25mn tons (or 0.20-0.35bcm) and has organized several bidding events for piped gas in 2H17.

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CNOOC plays an important role in stabilizing LNG prices in this winter: The expert thinks the trading LNG prices at SHPGX is a timely reflection of supply-demand dynamics. In Sep 2017 when PetroChina began to cut back piped gas supply to downstream in order to fill the storage facilities, the LNG prices surged temporarily. After that LNG prices fell for one month before surging again due to winter gas shortage. This winter, the CNOOC plays an important role in stabilizing the LNG prices as the company sticks to the offer LNG at Rmb5,200/ton in the SHPGX even if the market price shoots up to above Rmb8,000/ton.

Infrastructure reform is a key: The formation of truly market-based prices at trading hubs relies very much on the third party access of gas infrastructures including pipelines and LNG terminals. The interconnections among oil majors' pipelines are the key, but it still faces many obstacles as 1) the pressure in the trunk lines of PetroChina and Sinopec are different, so they need to realign with each other but this requires additional investments, 2) oil majors are reluctant to invest heavily into pipeline assets due to the divestment risks upon a potential establishment of the national pipeline company.

Storage will have further policy supports: The expert expects the winter shortage and the seasonality of gas prices will continue in China as there is limited room for a substantial increase in domestic gas production or piped gas imports. Therefore, the expert expects the storage facilities to enjoy more policy supports in the future.

China Renewables

Michael Tong, [email protected], (+852) 2203 6167

At our Access China 2018 conference last week, besides a few Deutsche Bank covered listed renewable players attending (Longyuan Power, Huadian Fuxin, Yangtze Power which we have published separate meeting notes), we also met 1) a renowned solar expert from the China PV Industry Association who presented a market update and the roadmap to grid parity at our industry tracks, 2) the director of the National Renewable Information Management Center in charge of green certificate mechanism during our environmental/renewable site tour, and 3) a leading A share solar equipment player, Longi Green Energy, holding group meetings with investors.

Overall, we flag several key messages with regard to China’s wind/solar development outlook, which include 1) green certificate trading under a mandatory basis is unlikely to start at end-2018 and the consultation document will be released in 3Q18 at the earliest, despite some details under mandatory basis that are taking shape; 2) China’s solar capacity addition can likely sustain around 40GW per year in 2018-20, but a rising tariff subsidy funding gap and delayed payment are still the main concerns; 3) compared to those countries using Chinese solar modules but with lower tariffs, China has higher land, grid connection, financing and quota transaction costs, other than lower utilization hours due to grid curtailment and less sun radiations; 4 ) there is room for further solar equipment price decline (esp. poly/wafer), supported by equipment makers’ aggressive capacity expansion and cost reduction efforts, and grid parity could be achieved at the end-user side in 2020. We provide more detailed takeaways below.

19 January 2018



Meeting with Director of National Renewable Information Management Center Related government agencies are still discussing details on the mandatory

Green Certificate (GC) mechanism – the consultation paper may be issued in 2H18 and implementation is unlikely any time before 2019 given the large amount of preparatory work to be done even after the rule is finalized

The mechanism is still in the principle of what was indicated earlier, i.e. setting RPS (renewable portfolio standard) to ensure mandatory GC traded to meet the RPS requirement. However, the level of RPS will make the GC a market where demand should be greater than supply, as the intention of the GC is not to reduce subsidy but to divert the source of subsidy from a national renewable fund to those who need to pay

Price ceilings on GC under a voluntary basis may be removed and price floors for GC may be introduced to safeguard project returns under the mandatory basis

It will probably be the power grid companies who will be responsible for buying GC, given IPPs are now financially stretched and have been over burdened by surging coal prices

Mandatory GCs are likely to be rolled out in batches. Newly completed projects after GC kicks off and existing wind projects that have paid off bank loans and are enjoying low curtailment, may be firstly included in the mandatory GC mechanism. Biomass and waste-to-energy will not be included in GC for now.

New connection for wind is unlikely to surpass 20GW p.a. by a large margin going forward. Though GC is not applicable to offshore wind, the government is unlikely to let it grow out of control given grid parity is still not in sight

The delay in approving the 7th batch of renewable subsidy catalogue is primarily due to the deficit of the renewable energy fund

Industry expert speech delivered by China PV Industry Association China PV industry is dominating the global landscape with poly/wafer/

cell/module manufacturing capacity representing >50%/87%/70%/75% of global capacity in 2017, while end-market demand represents c.50% of global market

Share of PV module exports has declined from 96% total production in 2010 to 29% in 2017 due to surging domestic demand from 0.5GW to 50GW during the period

Over the last ten years, prices of module, system, inverter have dropped by 91.6%, 88.3% and 92.5% respectively, while feed-in-tariff has come down by 81.3%

According to NEA’s guideline issued on 19 July 2017, there could be 250GW solar capacity at end of 2020, based on 78GW capacity at end of 2016 and total new capacity of 171.5GW in 2017-20 comprising 1) 86.5GW new ground-mounted capacity (of which 32GW front-runner project), 2) 60GW distributed capacity, 3) 25GW capacity from poverty alleviation.

After deducting 50GW estimated installation in 2017, there should be c.40GW annual installation in 2018-20. The objective of solar poverty alleviation initiative is to use solar to help 3mn poor households in 15 provinces to receive an annual stable income (around Rmb3000) from solar power sales to the grid for a period of 20 years;

Meanwhile, there is a growing gap of subsidy and the cumulative subsidy gap is likely to increase to Rmb300 bn in 2020 if solar capacity reaches 240GW

19 January 2018



Green certificate trading on a voluntary basis is not as good as expected, and a trading mechanism under mandatory basis is still under discussion

In the near term, a raising renewable surcharge appears to be difficult although the subsidy gap could be largely resolved if the surcharge is raised to 3 cents (1.9 cents currently)

Based on current technology, 40% cost reduction can be reached by PV system innovation including 1) raising PV-inverter ratio and Performance Ratio, 2) using solar trackers, 3) adopting intelligent monitoring and O&M system, 4) using 1500V systems.

Compared to other countries with lower solar tariff (UAE, Mexico), the scope of cost reduction in China mainly lie in the areas of 1) land cost, 2) grid connection, 3) financing, 4) curtailment and 5) quota transaction cost

Using E-W tracking and PV-Inverter ratio of 1.2/1.0, cost of solar generation in Germud, Qinghai can be lowered to Rmb0.38/KWh, similar to local coal fired power tariff of Rmb0.35/KWh.

Solar grid-parity at the user side could be achieved in 2020, and the fixed subsidy (Rmb0.42/kWh) for new “self-consumption” projects will likely be canceled from 2021 onwards. Solar grid-parity at the generation side could be achieved in 2025

Meeting with leading A share mono player – Longi Green Energy (601012 SS.NR) Solar capacity addition: Longi sounds optimistic on China’s solar capacity

addition outlook and forecasts c.50GW for 2018, comprising 14GW of ground-mounted, 5GW of front-runner, 4.2GW village-level poverty alleviation and 30GW of distributed PV. For the overseas market, it believes India and the Middle East will make up the decline in the US and Japan. As end-17, Longi had 15GW wafer capacity and targets to expand to 25GW by end-18.

Poly supply: Last year, c.55% of Longi’s poly supply were imported from OCI and Wacker, the rest were domestically procured, mainly from Xinte (1788.HK, NR), Daqo (DQ.US, NR) and Tongwei (600438.SS, NR). To satisfy the growing poly consumption along with capacity expansion, Longi has secured higher procurement volume from its major suppliers, e.g. OCI and Xinte. Their poly procurement price is now Rmb150/kg. Longi expects that poly price is unlikely to decline in 1H18 given tight supply but could trend lower in 2H, when more poly capacity expansion come into operation.

Pricing: Longi has cut its mono-si wafer price by Rmb0.2/piece and Rmb0.4/piece, respectively, in Oct-17 and Nov-17. Current average price is c. Rmb5.4/piece, which is Rmb0.8/piece higher vs. multi-si wafer that adopts diamond wire saw. Longi calculates that the price premium for mono-si wafer over multi-si ones that can achieve a similar cost- performance ratio is c. Rmb0.9-1/piece, assuming modules’ efficiency conversion rate of 18.5% for mono-si vs. 17% for multi-si. Having said this, management does not suggest any intention to initiate a price war.

Cost/margin: Longi currently targets to reduce its wafer cost by the same % term as that of price. Longi advised that its non-silicon wafer cost is c.Rmb1.4/piece and is confident to cut it to Rmb1/piece within 2 years, with lower cost of auxiliary materials. Silicon cost now accounts for c.60% of total cost, with unit silicon consumption reduced to 3.2-3.3g/w from prior 3.5g/w. In expectation of solar equipment price decline, Longi expects its blended GPM in the mid-long run to trend down from >30% to 20-25%.

19 January 2018



Utilities/Renewable/Environmental: China Environmental

Thomas Zhu, [email protected], (+852) 2203 6235

We invited Mr. Xue Tao, Executive Director of the E20 Environmental Industry Research Institute, to make a presentation at the dbAccess China conference. We summarize the key takeaways.

Impact from recent regulations on PPP Both MoF’s policy paper #92 and the new regulations on asset management will affect PPP projects financing. However he believes that most projects affected will be environment renovation projects, rather than projects with end-user payments (i.e. projects with significant operations revenue). Some environment renovation projects “signed-up” (under the definition of MoF) may not be able to obtain bank loans – in the case of Sichuan for example, only 30% of the signed-up projects have obtained bank loans. If the project cannot be executed, the project company will be fined (though the amount is unlikely to be significant). It is required in MoF’s policy paper #92 that part of the payments for construction should be done after evaluating project performance, and therefore actual receivables collection could take longer than previously expected.

PPP project database cleanup The cleanup of PPP project database is likely to be completed in March 2018. Xue expects most projects taken out of the database to be projects not yet signed up, and he expects strict scrutiny for future projects to be included. For some provinces, budgets for projects in the database have got close to the 10% limit of their financial budget.

Comparison of different environmental projects Waste to Energy. WTE is still the most popular project type in environmental among the companies. With the development of waste sorting, there will be more treatment projects specifically for particular types of waste (e.g. projects specifically for kitchen waste). China is likely to have sufficient WTE capacities after three years while most new project awards by then will be projects related to sludge treatment and kitchen waste treatment.

Environmental sanitation. This is the second most popular project type among the companies. Sanitation companies generally seek IRR of ~12%. Expenditure on sanitation by the government should increase one year after another on higher environmental standards. Most sanitation projects are paid by district level fiscal budgets rather than at city level. The price of long-term projects is based on negotiation, which rises if the government's requirements go up.

Air pollution treatment. Large-scale projects in desulfurization and denitrification have mostly been completed. Projects now are mainly small-scale projects in desulfurization and denitrification, as well as projects in VOC, which are normally also small-scale.

Hazardous Waste Treatment. The valuation in HWT M&A projects is complicated as projects vary from one to another, and thus the profitability of M&A project is difficult to forecast.

19 January 2018



Tour: Energy – China Oil & Gas tour takeaways Johnson Wan, [email protected], (+852) 2203 6163

Trip takeaways: major refiners over teapots in 2018

Three key findings from our teapot refiners' trip to Shandong; reiterate Buy on Sinopec-H and SPC-H During our Shandong teapot refiners' trip, which took place on 11-12 January after the DB Access China Conference, we visited three teapot refineries (Zibo Xintai Petrochemical - XTP, Qingyuan Group - QYG, and Wonfull Petrochemical - WFP) along with Shandong based oil market consultant (Longzhong). Our key findings are: 1) teapot refiners are seeking optimal profits rather than a maximum utilization rate; 2) the price war between teapot and major refiners is over; 3) tax collection efforts are increasing, which could lead to lower utilization rates and margins for teapots in 2018. Hence, the impact of the 55% surge in the teapot crude oil quota may not be fully utilized and China GRM should be sustained at the current high level in 2018. Thus, we reiterate Buy on Sinopec-H and SPC-H.

#1: Not much upside in teapot utilization rate Teapot refiners' utilization rate has limited upside potential given they were already running at high utilization rates in 2017. The teapots we visited ran at a c.70%-100% utilization rate in 2017, of which two of the teapots that we visited were granted new crude oil quotas in 2018. As scary as these new quotas may sound, we learned that the incremental quotas do not matter since these teapots were already sourcing crude via other means even before the quotas were granted last year, i.e., via traders. Further, utilization rates for teapots are unlikely to pick up significantly as: 1) they seek the optimal product mix between fuel products/ lubs/chemicals; 2) teapots lack proper marketing sales channels. In 2017, XTP and WFP were already running close to full capacity, while QYP is focused on lubricant production. Therefore, we do not see a surge in refined product exports out of China in 2018, <c.10% yoy despite the 55% increase in crude import quotas. DB's top regional refining pick is Reliance in India.

#2: Price war between majors and teapots unlikely to be repeated in 2018 We believe the price war between majors and teapots has largely concluded with the bulk of third-party service station contract renewals finished in 2017. The price war in 2017 started with Sinopec lowering refined petrol prices to prevent teapots from overbidding in an attempt to encourage third-party stations away from Sinopec. This price war ended in early 4Q17 with #92 gasoline retail spreads rebounding by RMB25/t and #0 diesel wholesale spreads rebounding by RMB150/ t in 4Q17. Teapot refiners are now selling c.30% of their refined products to major refiners (teapot refiners are now able to produce GBV and GBVI standards for 2+26 requirements), while WFP expects to raise the number of service stations from 30 to 100 (minimal impact on China's c.90k service stations market), but XTP and QYP do not plan to add service stations. WFP noted that the 30 gas stations accounted for <0.5% of its sales and that the service stations were merely used for marketing purposes to

19 January 2018



raise brand awareness only. Conversely, teapot refiners admitted it is difficult to add greenfield service stations given hefty upfront investment in city areas (particularly for land use rights ) and gaining premission from city planning departments. On the other hand, teapot refiners acknowledged the curtailment of refined product purchases from major refiners is a key risk to their sales volumes.

#3: Margin and tax collection effort response In 2017, teapot refiners earned an average of RMB200-350/ton of gasoline / diesel while some large-sized teapots were only breaking even since they paid the full consumption tax amount. The risks to 2018 are that the central government will step up the collection of taxes and therefore teapots are more conservative on their margin outlook for 2018. Should tax collection be strictly enforced, teapots will cut or reduce production to stem losses. QYP was the only teapot that claimed to have paid the consumption tax for gasoline & diesel in full given its focus is on the lubricants business in 2017. Conversely, we received the impression that XTP and WFP may not, and might have partly used "other" receipts to lower consumption tax payments. The Chinese State Administration of Taxes issued No#1 document on January 8, 2018 by adding 22 categories of oil and refined products in order to increase efforts in consumption tax collection. The increase in the import quota in 2018 is actually another way for the Chinese government to track the teapot refining yield more accurately.

Key beneficiaries: Sinopec and SPC; neutral on Kantons We see Sinopec/SPC as the key beneficiaries on our teapot trip findings with a better refining environment ahead. On the other hand, we see neutral impact on Sinopec Kantons given it is the most leveraged on China crude oil imports, meaning if teapot crude oil imports slow down, Sinopec will import more, offsetting the impact. We reiterate Buy on SPC-H with a target price of HK$5.2 (which we base on 5.5x / 5.0x EV/EBITDA on refining / chemicals) and giving a c.6.5% dividend yield; we reiterate Buy on Sinopec-H with a target price of HK $7.44 (which we base on SOTP: E&P segment by using DCF with 8.3% WACC and 2% terminal growth rate; other segments by using PB/ROE). Key risks include: higher/lower-than-expected oil & gas prices, regulatory changes including refined product pricing policy changes, any SOE reform, and unexpected cost inflation.

19 January 2018



Comp sheet

Asia comp sheet for oil & gas

Figure 2: Asia comp sheet for oil & gas

Name

Ticker Trading Curr DB Target 12-Jan Mkt Cap

Rating Price Shr price (USD mn) P/E (x) FY17E FY18E P/B (x)

FY17E FY18E ROE (%) FY17E FY18E Dvd yield (%)

FY17E FY18E EV/EBITDA (x) FCF Yield (%) FY17E FY18E FY17E FY18E

E&P 3 PetroChina 0857.HK HKD Hold 5.77 5.93 15,064 34.4 20.0 0.7 0.7 2.1 3.5 2.8 2.3 1.7 1.6 13.2 8.9 Sinopec 0386.HK HKD Buy 7.86 6.51 21,232 11.7 10.8 0.9 0.9 7.7 8.2 5.1 6.0 0.7 0.6 13.1 11.0 CNOOC Ltd 0883.HK HKD Buy 15.84 12.50 71,341 14.4 14.3 1.2 1.1 8.3 8.1 4.2 4.2 5.2 5.2 8.4 6.8 ONGC ONGC.BO INR Buy 214.00 199.70 43,455 14.2 10.2 1.1 1.1 9.8 10.7 3.3 4.2 6.8 4.4 NM 5.0 Woodside Petrol eum WPL.AX AUD Hold 34.75 34.48 22,719 21.5 19.1 1.5 1.5 7.1 7.8 3.7 4.2 9.9 8.4 6.3 7.8 INPEX 1605.T JPY Buy 1,485 1,491.0 13,039 30.6 29.8 0.6 0.6 1.6 2.1 1.9 1.4 3.6 4.6 NM NM PTTEP PTTE.BK THB Hold 85.00 100.50 11,113 19.5 10.8 0.9 0.8 4.5 7.9 1.9 2.1 2.8 2.4 11.0 9.2 Oil Search OSH.AX AUD Buy 8.55 7.97 9,495 31.6 32.8 1.9 1.9 6.2 5.8 1.4 1.2 12.3 13.6 6.3 4.0 Origin Energy ORG.AX AUD Hold 8.65 9.57 8,483 NM 21.6 1.1 1.4 3.6 6.6 0.0 0.0 7.9 8.3 5.5 12.0 Santos STO.AX AUD Buy 5.85 5.52 9,159 NM 22.7 1.3 1.2 4.1 5.6 0.7 1.8 8.7 7.5 8.1 8.6 Oil India OILI.BO INR Buy 375.00 383.25 3,536 14.8 10.3 0.9 0.9 5.8 9.1 4.7 4.7 1.2 2.4 4.4 NM Average 21.4 18.4 1.1 1.1 5.5 6.9 2.7 2.9 5.5 5.4 8.5 8.2 Integrated oil & gas Sinopec 0386.HK HKD Buy 7.86 6.51 21,232 11.7 10.8 0.9 0.9 7.7 8.2 5.1 6.0 0.7 0.6 13.1 11.0 Reliance Industri es RELI.BO INR Buy 1,040 945.1 50,330 11.3 17.7 1.6 2.1 12.1 12.5 1.1 0.7 11.5 12.7 NM NM ONGC ONGC.BO INR Buy 214.00 199.70 43,455 14.2 10.2 1.1 1.1 9.8 10.7 3.3 4.2 6.8 4.4 NM 5.0 PTT PTT.BK THB Hold 455.00 470.00 38,551 9.9 9.8 1.5 1.4 15.9 14.6 4.3 4.6 5.7 5.5 7.2 6.4 Average 11.8 12.1 1.3 1.4 11.4 11.5 3.4 3.9 6.2 5.8 10.2 7.5 Asia refining & chemicals Sinopec 0386.HK HKD Buy 7.86 6.51 21,232 11.7 10.8 0.9 0.9 7.7 8.2 5.1 6.0 0.7 0.6 13.1 11.0 Reliance Industri es RELI.BO INR Buy 1,040 945.1 50,330 11.3 17.7 1.6 2.1 12.1 12.5 1.1 0.7 11.5 12.7 NM NM IOC IOC.BO INR Buy 540.00 388.35 20,312 6.9 9.2 1.8 1.6 20.7 18.9 2.7 2.2 5.5 6.2 5.7 6.1 Industries Qatar (QAR) IQCD.QA QAR Buy 125.00 98.31 15,951 15.0 13.6 1.6 1.4 10.9 10.8 4.2 4.2 30.1 23.7 2.4 1.8 Formosa Plastics 1301.TW TWD NR NA 101.50 18,442 18.9 18.6 1.9 1.8 10.2 10.0 3.7 3.8 17.0 16.4 6.1 6.0 Nan Ya Plastics 1303.TW TWD NR NA 81.10 19,181 24.5 20.9 1.8 1.8 7.5 8.5 3.0 3.5 10.1 10.8 7.3 1.5 Formosa C&F 1326.TW TWD NR NA 108.50 18,203 20.0 23.8 1.9 1.9 9.5 7.9 3.5 2.9 10.3 10.7 4.4 3.8 BPCL BPCL.BO INR Buy 645.0 490.00 11,093 8.5 10.5 2.8 2.7 29.8 27.9 6.3 2.9 7.6 7.2 15.4 14.0 SPC - H 0338.HK HKD Buy 5.2 4.70 8,946 6.9 6.8 1.4 1.3 22.0 19.9 6.6 6.7 5.7 5.4 14.9 11.4 PTTGC PTTGC.BK THB Buy 95.00 92.50 11,544 10.3 10.2 1.4 1.3 14.4 13.6 4.4 4.4 6.6 6.4 9.7 3.3 Caltex Australia CTX.AX AUD Hold 36.55 35.50 7,134 15.4 13.5 3.0 2.8 21.5 21.6 3.4 3.7 8.4 8.2 9.2 5.8 HPCL HPCL.BO INR Buy 535.0 425.7 5,918 4.8 9.2 2.5 2.4 43.7 28.9 7.7 2.1 5.8 5.7 10.9 16.1 Indorama IVL.BK THB NR NA 57.25 5,256 14.2 12.7 1.9 1.6 13.7 14.4 2.5 2.8 7.5 6.1 10.6 6.6 Thai Oil TOP.BK THB Hold 99.00 102.00 6,580 9.5 10.1 1.8 1.6 20.0 17.0 4.5 4.5 6.4 6.0 10.8 3.5 IRPC PCL IRPC.BK THB Buy 7.90 7.50 4,342 13.0 10.2 1.6 1.5 13.0 15.4 3.7 4.7 8.5 6.8 4.7 10.3 Bangchak Petrol eum BCP.BK THB NR NA 43.25 1,391 7.5 7.0 1.1 1.0 15.5 15.1 5.3 5.7 6.4 6.1 NM NM Average 12.1 12.1 1.7 1.6 15.7 14.7 3.7 3.4 8.3 7.7 7.1 5.4 Fertilizers PTT GC PTTGC.BK THB Buy 95.00 92.50 11,544 10.3 10.2 1.4 1.3 14.4 13.6 4.4 4.4 6.6 6.4 9.7 3.3 QSLI 000792.SZ CNY Hold 11.66 15.99 4,567 NM 131.8 1.5 1.4 -0.9 1.1 0.0 0.1 19.5 16.3 NM 5.2 Coromandel Int'l CORF.BO INR Buy 543.00 570.00 1,168 16.4 21.5 3.2 4.4 18.0 22.0 1.9 1.4 10.1 13.0 5.3 6.3 China BlueChem 3983.HK HKD Buy 3.20 2.68 1,357 19.7 10.0 0.7 0.6 3.4 6.5 2.5 5.0 2.4 1.7 7.9 6.2 Sinofert 0297.HK HKD Hold 1.45 1.35 1,043 NM 69.8 0.8 0.8 -2.0 1.2 0.0 0.4 7.3 4.3 NM 3.8 Chambal CHMB.BO INR NR NA 153.80 757 11.4 10.4 1.8 1.6 17.2 16.7 1.9 2.3 14.5 15.1 NM NM Average 14.4 42.3 1.6 1.7 8.3 10.2 1.8 2.3 10.1 9.5 7.6 5.0 Logistics Sinopec Kantons 0934.HK HKD Buy 5.70 5.21 1,651 9.9 9.3 1.2 1.1 13.0 12.5 2.0 2.7 7.2 6.0 5.8 6.4 Oilfield services COSL 2883.HK HKD Buy 9.13 9.60 4,720 235.9 12.9 0.9 0.9 0.4 6.7 1.1 3.9 10.0 7.2 4.5 9.0 SSC 1033.HK HKD Hold 1.43 1.42 2,300 NM 51.6 2.1 2.0 -14.9 4.0 0.0 0.0 7.4 5.8 NM NM Aban Offshore ABAN.BO INR NR NA 262.75 165 4.1 3.3 0.2 0.2 4.4 5.2 2.0 2.0 6.9 6.5 2.2 84.8 Average 120.0 22.6 1.1 1.0 -3.4 5.3 1.0 1.9 8.1 6.5 3.4 46.9 Engineering SEG 2386.HK HKD Buy 9.40 8.36 3,856 12.9 7.8 1.0 0.9 7.7 12.0 3.1 5.1 5.6 2.5 4.9 20.1 COOEC 600583.SS CNY Hold 7.10 6.69 4,032 22.9 13.3 1.1 1.1 5.0 8.5 3.7 6.3 9.7 6.4 4.3 9.4 Average - Asia oil & gas 19.0 17.5 1.4 1.4 10.8 11.4 3.0 3.2 7.7 7.0 7.4 8.1

Source: Bloomberg Finance LP, Deutsche Bank estimates

19 January 2018



Trip Photos

Figure 3: Xintai PetroChemical: production facility Figure 4: Xintai PetroChemical: Oil tanks

Source: Deutsche Bank Source: Deutsche Bank

Figure 5: Wonfull Petrochemical: production facility Figure 6: Wonfull Petrochemical: production facility

Source: Wonfull Petrochemical Source: Wonfull Petrochemical

19 January 2018



Key Charts

Figure 7: China teapot and major refiners' run rates Figure 8: China teapot and major refiners' run rates vs.

GRM

Source: ICIS, Deutsche Bank Source: ICIS, Deutsche Bank

Figure 9: Gasoline spreads Figure 10: Diesel spreads

Source: NDRC, CEIC, Deutsche Bank Source: NDRC, CEIC, Deutsche Bank

19 January 2018



Figure 11: 2018 teapot crude oil import quotas

Source: NDRC, Deutsche Bank

Comments from teapot refiners

Zibo Xintai Petrochemical (XTP) - private refiner Capacity: CDU - 2.2mtpa currently with 3.5mtpa under construction to come on-stream after May 2018 and adding 1mtpa reformers. The expansion cost is RMB5.1bn including land cost.

Utilization rate: 100% in 2017 and will continue at this rate in 2018.

Key products: 15% gasoline, 40% diesel & kerosene, remainder are fuel oils and others, complying with China GBV / GBVI standards. Aromatics produced will be internally used for gasoline blending. The company plans to use reformers to further increase its gasoline yield.

Crude oil import quota: granted first quota in November 2017 for 2018. XTP applied for 2.2mtpa quota and was granted 2mtpa. Management believes getting the extra 3mtpa quota for 2019 will be tough as it does not have obsolete capacity for removal, while the company can only apply for it once the capacity is rolled out. After May 2018, the company is required to procure crude oil from oil traders, oil majors, or other teapots' quotas. The company believes there is no issue for securing the crude oil requirement.

Sales channel: XTP sells c.30% of products to PetroChina and Sinopec, mainly its gasoline and diesel; it sells 20% to Beijing Aviation Company, and 50% to industrial and third parties.

Refilling stations: the company does not plan to get into petrol refilling stations given it sells mostly diesel and other products to industrial users directly. Moreover, it is very difficult and expensive to invest in refilling stations nowadays with equipment costing RMB10m and not even for land usage; also acquiring refilling stations comes at a heavy premium.

19 January 2018



Comments on price war and competition: management believes competition will always happen, and teapot refiners do not have export channels while SOEs do, leading to sales to PetroChina and Sinopec. The company sees it as almost impossible for teapots to be granted refined product export quota licenses at the moment. The export quota for teapots in 2016 was only a pilot testing scheme.

Tax collection: the company sees a big impact on teapots from the new tax category introduction in 2018. The company likely did not pay consumption tax fully. If the government really fully enforces the tax collection, XTP will respond with production halts.

Margins and ASPs: XTP profit margins for diesel and gasoline are RMB260/t and RMB400/t. On the other hand, XTP sells #0 diesel at RMB30-50/t premium to PetroChina at RMB5,530/t and it is cheaper than PetroChina's own ex-factory price of RMB5,610/t. XTP is willing to sell diesel to PetroChina as PetroChina wishes. The company sells gasoline to both PetroChina and Sinopec.

Other comments: China can become a refined product exporting country under the One Belt One Road initiative. The environmental inspection is ongoing and the inspectors visit XTP once a week without notice. XTP has set up chimney meters connected to Ministry of Environment Protection (MEP), and MEP could monitor its emissions. The environmental levy has not started yet. Total Shandong teapot capacity is 180mtpa and will add a further 11mtpa in 2018.

Qingyuan Group (QYG) - privately owned 67%; LGFV owned 33% Capacity: CDU - 8.55mtpa at three refineries, of which the third refinery will start operation in 2018. QYP is adding a further 1.4mtpa of lubricants capacity and 800ktpa of specialty oil capacity in 2018 given strong demand for higher- quality lubricants which currently still rely on imports. Besides refining, it has four other segments, namely chemicals, logistics (railway, ports, and oil pipeline), machinery, and others.

Utilization rate: c.70%, staying flat in 2018, and secondary unit utilization rate is at 87%. Management see it as the optimal level for product mix.

Key products: 20% gasoline, 25-30% diesel, and others are lubricants. The company complies with GBV / GBVI standards.

Crude oil import quota: 2017 was 4.04mtpa, and 2018 is 7.04mtpa; the company also buys mineral oil in domestic as feedstocks. BP and Glencore also help to import crude oil as traders while using QYP's own quota. Unipec also helps to source domestically. However, it is cheaper to buy the crude oil itself rather than use oil traders.

Sales channels: QYP sells 60% to Chinese big four oil SOEs while selling only 5% through its own refilling stations, the rest to industrial users.

Refilling stations: QYP owns 11 stations while there are a further 44 franchise / JV stations. The company targets to add about two stations a year in the next few years, or 50% of the government quota of four a year.

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Tax collection: Stringent efforts in consumption tax collection will not impact QYP given it has paid in full. QYP paid a total RMB3.7-3.8bn in consumption tax (including Jingcheng Petrochemical shares).

Margins and ASPs: The company sells #92 gasoline at RMB7,000/t (wholesale), and #0 diesel at RMB5,850/t (wholesale #0). Since October 2017, the company has only produced GBVI standard fuels. The key profit comes from lubricant sales with GP RMB900-1,100/t and OP RMB400-600/t. QYP only at break-even for gasoline as all tax paid in full. The company sees other teapots paying RMB800/ t less in taxes.

Wonfull Petrochemical (WFP) - private refiner Capacity: CDU - 5.8mtpa, and totaling 15mtpa including reformers and petrochemicals. Besides refining and petrochemicals, there are another five

segments: refilling stations, logistics (including 10 railway lines), power, steams, and others.

Utilization rate: c.80% for CDU

Key products: Gasoline-to-diesel production ratio is at 0.9x. Since Oct 2017, diesel prices have gone up on demand revival, which led WFP to increase diesel production yield. The company also sells PE and PX.

Crude oil import quota: 2017 4.16mtpa (used 2.635mtpa), 2018 4.16mtpa. The rest was bought from domestic oil traders. The company reckons other teapot refiners may fully utilize import quotas for sale other than for processing.

Sales channels: 20% of product to PetroChina and Sinopec. The company sells 30kton of products to Sinopec Beijing uni, and only 0.5% of volume to own refilling stations. Total refined product sales were 4.5mtons in 2017 and it expects them to be flat in 2018.

Refilling stations: WFP has 30 refilling stations now and targets to reach 100 by the end of 2018. Management sees own refilling stations as marketing advertising rather than actual sales channels.

Comments on price war and competition: management believes the price war is already over, and not likely to recur in 2018 given the bulk of third-party refilling station contracts already had renewal in 2017.

Margins and ASPs: The company sells #92 gasoline at RMB6,900/t and #0 diesel at RMB5,800/t. Profit margins for diesel and gasoline are RMB200/t and RMB300/t. WFP refilling stations fuel prices are RMB1,300/ton cheaper than for Sinopec while it can still maintain marketing spreads of RMB700/t. The company's products are now profitable but management mentions uncertainties and things depend on how strict the consumption tax collection efforts are.

Other comments: management was surprised by 2017 profitability for teapot refiners, and claimed no one would have anticipated such a fruitful year. WFP sees mounting pressure on feedstock costs and labor costs. Moreover, retail affordability remains fine while wholesale affordability may not be as good if crude oil prices are sustained at US$70/bbl. The safety and environmental measures limit overall production volume, even for Sinopec Qilu Petrochemical, which is now under a production halt.

19 January 2018



Tour: Metals & Mining tour takeaways Sharon Ding, [email protected], (+852) 2203 5716

Proactive heating season cut across the board in Hebei and Henan provinces Following our China Access conference in Beijing, we organized a Metals & Mining trip, visiting Risun Group (one of China's largest coke and chemicals producers, 10mt coke capacity and 2.8mt chemicals), Delong Steel (steel mills with c.3mt capacity) and Zhengda Glass (c.2000t/d, 1% of total China glass capacity) in Hebei and China Central Property (major property developer in Henan) and Zhongfu Industrials (c.500kt aluminium capacity) in Henan. According to these industry participants, both provinces are proactively cutting capacity during heating season, and there are basically no social stability concerns on employment across the board. We have summarized the key take-aways below.

Steel - 66% capacity cut in Delong Steel and 75% cut in Xingtai Steel Delong Steel, listed on the Singapore exchange and located in Xingtai, Hebei, China, has c.3mt of steel capacity (three 1,080m3 blast furnaces) in total. According to management, the company is requested to shut two of three blast furnaces, meaning a 2/3 capacity cut during this heating season. Xingtai Steel, another steel mill nearby, has shut three blast furnaces (BF) of four in total, i.e. a 75% capacity shutdown during the heating season. Initially, the Xingtai government proposed only 30% capacity cuts but ended up cutting 60%+ because of the poor quality in Xingtai city (ranked bottom).

Moreover, the heating season cut in Xingtai starts early, on 1 Nov, and ends late, on 31 Mar - one additional month compared to the normal heating season, from 15 Nov to 15 Mar. Steel mills will likely kick off restart preparations in late Mar and deliver crude steel right away on 1 Apr.

Over the years, management has felt pressure associated with environmental protection. Delong spent more than RMB1bn on environmental facilities from 2012 to 2017. In 2012, per-tonne environmental operating cost was around RMB70/t; management mentioned about RMB150/t in 2016 and RMB180/t in 2017, respectively.

From an employee perspective, management does not believe this is an issue, with almost 1% of employees leaving by themselves every year. Delong had more than 4000+ employees when it had c.4mt capacity vs. the current 3600+ people in total.

Coke - 30% cut in Risun Group, but much worse in smaller players; quite a bit of environmental capex Mr. Gao mentioned the group has lowered volume in coke plants during the heating season by 30%. Also, smaller players are being cut by 50% and are even being 100% shut down. For instance, the government has shut 9mt of 30mt total in coke capacity in Handan City, and it plans to consolidate 4.5mt smaller players into 2mt. There is no subsidy for temporary shutdowns, but there is for permanent closure.

Regarding environmental pressure, the company has spent RMB2.6bn in the past three years on environmental facilities.

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Glass - 15% cut in glass players and formalities issue in environmental approvals in Hebei, but they should come back We met Mr. Pang and Mr. Zhuang, the general manager and manager, respectively, from the future department in Zhengda Glass. Zhengda Glass, with its 2000t/d float glass capacity, accounts for c.5% of Shahe's capacity and c.1% of China's total capacity.

According to Mr. Pang, Hebei province proactively requests glass producers to cut 15% capacity during the heating season. Moreover, the government also shut seven glass plants for environmental reasons (GlassInfo is talking about shutting down nine plants). However, Mr. Pang believes that the street has exaggerated the impact; he believes the capacity will come back once they finish formalities for environmental approvals. As far as he knows, Shahe Daguangming already obtained approval, and ChangHong will get it shortly (according to GlassInfo, Daguangming's two production lines have been doing cold repair at least since early 2016).

Figure 12: Shahe glass capacity shutdown summary table

Source: Deutsche Bank, Glass info

From a demand perspective, Mr. Pang is relatively positive, saying that channel checks in Tier 3 and Tier 4 cities show good momentum in residential but not in commercial buildings.

Environmental expert - generally happy about execution and expects it to continue We had dinner with the ex-environmental governor in Xinxiang, who was in charge of environmental inspections and any rectification measures immediately thereafter.

He shared that the government and people are generally happy with this heating season cut, as air quality is much better. It used to be quite difficult to execute, but this time is different, with full support from top governors in the town/city layer. Also, employment does not seem to be a major issue. While there are employees being cut temporarily during the heating season, some of them have landed in their hometowns and others can get new jobs elsewhere, for example in the consumer sector.

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Another topic is different pollutants including in water and soil. Mr. Li noted that even though we may not notice, water quality has been well controlled by putting sensors into rivers across different areas. However, improvements are required in soil. A key issue we have now is that it is too costly for industry players to lower humidity in waste and recycle it properly.

China Central Property - to boost revenue significantly in 2018, but expecting stable market size for Henan We visited China Central Property's project in Gongyi City, which does not have quota constraints but does have a price cap set by the local government. Downpayment is 30% for the first apartment and 60% for the second. Mr. Shi expects that China Central Property will boost its top line significantly in 2018, but that the overall property market size in Henan should be relatively stable, meaning a higher concentration rate.

China Central Property's projects have been almost sold out since they launched last year, but he anticipates weaker momentum. He expects low pure investment buying in projects but more regarding upgrading demand. He also mentioned that many people have bought 2-3 apartments already.

Zhongfu Industrial - 30% cut in aluminum and 50% cut in carbon anode in Henan, and extra cuts on air quality The procurement manager of Zhongfu Industrial noted a 30% cut in aluminium and a 50% cut in carbon anode in general. However, there are extra cuts in December in Henan, given the bad air quality.

The local government is strict regarding execution in heating season cuts; for instance, a 30% cut must be completed before 15 Mar, and restarts can begin only from 15 Mar. Management mentioned that they usually can restart 10 potlines per day, meaning c.15 days to resume all suspended potlines.

Regarding the price outlook, he expects the carbon anode price to stay at RMB2800-3000/t, the alumina price to be around RMB2700-2800/t and the aluminium price to be c.RMB16000/t, with the second half being stronger.

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Tour: Utilities – China Environmental tour takeaways Thomas, Zhu, CFA, [email protected], (+852) 2203 6235

Two-day Environmental tour in Beijing/Anhui/Jiangsu We hosted a two-day Environmental and Renewables tour in Beijing, Anhui and Jiangsu. For the Environmental part, we visited facilities including a sponge city PPP project, a waste collection (sanitation) management centre, a waste transfer station, a biomass treatment plant, and a hazardous waste treatment plant. We summarize the key takeaways below.

Tongzhou sponge city PPP project of Beijing Enterprises Water (371 HK) The sponge city project of Tongzhou is part of the Tongzhou PPP package that BEW won in 2016, which carries a total investment of ~RMB17bn. The sponge city project focuses on preventing waterlogging and diverting rain from sewage. BEW’s PPP projects are distinguished by its tailor-made solutions and superior design achieved by engaging first-class design institutes. The sponge city project should be completed by end 2018, while the completion timing for other projects in the Tongzhou PPP package is not yet finalized. If the government wants to add more projects to the package and if there is a cost overrun as a result, BEW believes that it can re-negotiate the terms with the government. BEW has yet not collected payment from the government as the sponge city project is still in the construction stage.

Huaiyuan biomass treatment project of China Everbright Greentech (1257 HK) and China Everbright Intl (257 HK) The Huaiyuan project achieved very high utilization in 2017 and management believes that it can consistently achieve stable utilization by properly blending agricultural waste with forestry residuals and wooded plates. Nominal raw materials cost rose slightly in 2017 (compared with 2016) as result of increased usage of straws, but effective raw materials cost was flat after taking into account government subsidies for straws. Management expects effective raw material costs to be flat compared with 2018. The Huaiyuan project has an exclusive right to operate biomass treatment within the county. The project is negotiating with local government to convert itself (from a power only project) to a power/heat co- generation project. Management believes that if such conversion takes place, it will become more profitable as thermal efficiency should improve. Management expects additional profit to cover the conversion capex in about three months.

Zhenjiang hazardous waste treatment project of New Universe Environment (436 HK) The hazardous waste treatment (HWT) incineration facilities run at 100% utilization and management expects the HWT landfill project to also run at ~100% if management has not intentionally refused waste from other cities (due to the scarcity of landfill capacities). Treatment fees have been stable over the past few years and management expects treatment fees to be flattish in the near future unless there is a change in government policy or components

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of the waste in-feeds. In the longer run, management expects the treatment fees to decline gradually as other treatment facilities within the province ramp up and as competition from new entrants intensifies. Management expects profitability to normalize to 25-30% (net margin) in the long run. Industrial customers usually prepay waste treatment fees.

Tongzhou PPP project of Beijing Enterprises Water (371 HK)

Tongzhou PPP overview: The Tongzhou PPP project involves an investment of ~RMB17bn. The project started construction in 2016, with a service period of 25 years, including construction, and a return of ~5%. The sponge city part of the PPP project focuses on resolving waterlogging and diversion of rain and sewage. BEW’s PPP projects are distinguished by its tailor-made solutions and superior design achieved by engaging first-class design institutes nationwide.

Project progress: Most of the sponge city part of the PPP project should be completed by the end of 2018 and will be assessed by the Ministry of Housing and Urban-Rural Development in early 2019. BEW has not collected payment from the government as the sponge city project is still in the construction stage.

Project investment: For the Tongzhou PPP project as a whole, the government did not give a fixed budget when signing the contract. If the government likes to add more content to the project or if the actual investment exceeds the original budget, BEW can negotiate with the government for higher payments.

Figure 13: Overview of sponge city project Figure 14: Equipment monitoring rain flows


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Figure 15: Permeable ground of sponge city project Figure 16: Permeable ground of sponge city project


Huaiyuan biomass treatment plant of China Everbright Greentech (1257 HK) and China Everbright Intl (257 HK)

Utilization hours. The Huaiyuan project achieved 7,800 utilization hours in 2017. The utilization hours should not be affected by harvesting of crops, since forestry residuals and wooden wastes can be used as a substitute, though straws are prioritized during harvest season.

Raw material costs. Raw material cost was RMB0.37-0.38/kwh in 2017. After deducting subsidies for straws, the raw material cost was RMB0.36/kWh. The Huaiyuan project aims to control raw materials cost within RMB0.37/kWh in 2018. Both straws and forestry residuals/wooden wastes prices have been stable. Power generation from straws requires more auxiliary power, so its cost per kWh is relatively higher, but this should be compensated with straw subsidies from the provincial government.

Subsidy collection and payment schedule. The approval of 7th batch catalogue was delayed because of CPC’s 19th National Congress, and the catalogue should be released soon. The Huaiyuan project signs straw utilization agreement with local government each year in Q1, when it estimates straw amount for the whole year. The government will prepay 70% of the subsidy calculated on the basis of straw usage, and it should be received within the year. The remaining 30% of the subsidy will be granted after Anhui NDRC checks the actual amount of straw usage.

Exclusive right. Generally, there is only one biomass plant in each county of Anhui. Every CEG biomass project has an exclusive right to operate biomass plants within its county.

Heat/power co-generation. Heat supply depends on the plan of the local government. The Huaiyuan project is negotiating with the local government to perform a heat supply upgrade. For this project, heat customers are mainly industrial companies, whose demand is more stable and the price is a bit higher

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than residential customers. Thermal efficiency will be improved from 30% to 60% after the upgrade, and no electricity will be sacrificed, as boilers still have some steam unused. Utilization rate will also be improved for the waste incineration project after the heat/power co-generation upgrade. As industrial customers prepay for heat supply and the profitability of heating is higher than that of power generation, heat generation will be prioritized when conflicted with power generation. The upgrade cost for biomass project is about RMB2-3m, which should be recovered in ~3 months.

Zhenjiang hazardous waste treatment project of New Universe Environmental (436 HK)

Project introduction: The project has two sets of HWT equipment with an incineration capacity of 26.4 ktpa and 100% utilization rate, capable of processing 27 kinds of hazardous waste. The company and the local government co-invested in a 270,000 m3 hazardous waste landfill project, which started operation in end 2012. The landfill has a designed capacity of 14 ktpa, but the company intentionally processes only 10-12 ktpa since it does not want to accept hazardous waste from other cities due to the scarcity of the landfill sites. The incineration plant on the other hand, receives waste from mega-size industrial customers in different cities within Jiangsu. Management believes that the net profit margin will return to the normal level of 25-30% due to more competition in the market in the future.

Treatment fee: Average treatment fee is RMB5,000/ton and RMB3,500/ton for incineration and landfill, respectively. This is higher than the provincial average but lower than that in Suzhou (RMB8,000/ton for incineration). The company can usually charge a ~RMB500/ton premium over peers because it has a professional management team and can execute contract (treatment of the hazardous wastes) on schedule. Management believes that the treatment fee will be stable in the near future unless there are significant changes in policy or hazardous waste components, but may drop in the longer run as a result of new entrants into the market and also competition from cement kiln (cement kiln primarily affects landfill since cement kiln primarily process inorganic waste). Industrial customers usually prepay waste treatment fees.

Processing costs: The company has been focusing on mega-size customers and therefore enjoys high utilization and low unit cost. The company currently has the lowest cost in Jiangsu because: 1) high utilization rate; 2) advanced technology; and 3) rich operations experience. Treatment cost may increase in the future as result of stricter discharge standards.

Business expansion: There is sufficient land for Phase II of the project since the current project only takes ~30 mu of the total 87 mu land that belongs to the company. The group may expand its business to comprehensive environmental services in the future.

HWT market in Jiangsu: Jiangsu has hazardous waste incineration demand of ~800 ktpa and an approved capacity of 1,000 ktpa because the government encourages competition to eliminate unqualified small players. According to management, the utilization was only ~30% and ~65% in 2016/17 because: 1) some facilities have not commenced operations; 2) some imported facilities faced

difficulties in treating Chinese waste; and 3) lack of professional management team

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Tour: Utilities – China Gas Utilities tour takeaways Hanyu Zhang, [email protected], (+852) 2203 6207

AccessChina 2018 coal-to-gas trip takeaway

In our two-day coal-to-gas trip, we visited four gas distributors in Hebei and Tianjin, including ENN (2688 HK), Bestsun (600681 SH), Tianjin Jinran (1265 HK) and Binhai investment (2886 HK). Besides meeting the management, we also visited several industrial users and rural villages and below are the key takeaways.

Coal to gas outlook: Management generally believes central government’s supportive stance on coal-to-gas conversion will not be affected by the gas shortage, but implementation by the local government will be in a more orderly manner going forward. Rural coal-to-gas was done aggressively in 2017 due to central/local government pushes, while the targets for 2018 have not been discussed or finalized for many local governments. For industrial coal-to-gas conversion, it is mandatory from many local governments and new plants are usually not allowed to use co

Coal to gas project economics: For ruaral residential coal-to-gas conversion, companies all prefer those projects near their own pipeline networks as it will provide better gas supply safety and require less investment. Management has all expressed their concerns over those projects supplied by LNG. Overall, management expects the return for rural projects is less than urban ones, and the return is likely to decrease gradually after those high-quality rural projects being converted.

Subsidy payment: For the industrial players we visited, the equipment cost for coal-to-gas conversion in Langfang is fully subsidized by the government. The newly built heating stations for Volkswagen industrial park in Tianjin receive no subsidy and it is mandatory to use natural gas. For rural projects, the connection fee subsidy is paid to distributors after the completion checks by local governments and the payment has been received for those projects we visited. Gas sales subsidy is transferred to distributors first before being refunded to end users.

Winter gas shortage: All of the companies have experienced supply shortage in Dec 2017 to different degrees but all think that the shortage is eased recently. Management generally expects a further mitigation of supply shortage in Beijing-Tianjin-Hebei area due to the commencement of Sinopec’s Tianjin LNG terminal and ShaanJing IV pipeline, as well as the increase in gas import from Turkmenistan.

Winter cost hike pass through: Gas distributors usually estimates a blended cost hike and then pass though it to end users. For Jinran Gas, the government allows a Rmb0.25/cm increase in C&I end user price, which is based on the estimated blended cost hike of the company. Bestsun and Binhai had a full cost pass through to C&I users according to the management.

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Stock implications: We like gas distributors with solid track record, high exposure to key coal-to-gas region, improving free cash flow and good capex discipline. We prefer ENN Energy within gas sector due to robust net profit CAGR (>15% over 2017-19E), strong volume growth boosted by coal-to-gas, potential cost saving from its LNG import contracts and rising dividend payout.

ENN Langfang project

For ENN Langfang project, we visited the distributed energy project in the headquarter, a centralized heating company that converted its coal boilers to natural gas, and an urban village that converted to natural gas one year ago.

Distributed energy project in headquarter Project overview: The distributed energy project located in ENN’s headquarter is a multi-functional industrial zone with total area of 3 square km and construction area of 22.1 thousand sm. There are two gas-fired Combined Cooling Heating and Power (CCHP) plants, 14 Photovoltaic power units, 14 heating pumps, and 27 Charging stations.

Operational details: The whole system can shift among different operational modes, such as Green Energy mode (to maximize the utilization of renewables units), Low Cost mode (to minimize the operational cost) and Energy Saving mode (to minimize the power consumption). Better coordination and dispatches have enabled an >60% utilization rate for renewable units and an energy cost saving of 20%.

According to the management, the advantage of its distributed energy system includes: 1) Dynamic operational system that can adjust the power output according to environment changes such as the change of room temperature,

2) Lower investment cost as less generators are needed due to more intelligent control system, and 3) Lower unit operational cost due to higher utilization.

Generally for distributed energy projects, the revenue source is the selling of power/heat/cooling to end users and currently there is no cost saving sharing contracts between ENN and end users. ENN’s distributed energy projects are currently adopted in some commercial zones, residential districts and many individual industrial customers including manufacturers and airports.

Investment return: ENN requires an equity IRR of no less than 12% for distributed energy projects. For those projects built for individual industrial users, the average investment cost is Rmb20-50mn. For those industrial zone projects, the investment will be larger at above Rmb100mn. The average investment cost for CCHP units are Rmb9,000-12,000/kw and ENN can reduce it to below Rmb9,000/ kw. For geothermal heating pumps, the construction cost in Langfang is around Rmb200-300/m2, and Rmb400/m2 in Qingdao..

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Figure 17: An introduction of ENN's Ubiquitous Energy

Management System

Figure 18: An overview of ENN's distributed energy

project in headquarter Tech Park

Source: ENN Energy Source: ENN Energy

Heating company that converted from coal to gas Project overview: The heating company owns three boilers including two boilers of 6 steam ton/hour (st/h) and one boiler of 10 st/h. The company is supplying heat in the winter to nearby schools and residential households. The boilers converted from coal to natural gas two years ago as required by the local government.

Gas usage: The gas usage only occurred in winter as they supply heat only in the heating season. Now the gas usage is around 5,000 cm/day, slightly higher than last year due to low temperature. Usually during one heating season the gas consumption is 420 thousand cubic meter. Gas supply is tight several days ago and it is now back to normal.

Investment and economics: The equipment cost for coal-to-gas conversion is c.Rmb0.1mn per st/h, and is fully subsidized by the local government. Now the gas price is Rmb3.42/cm (vs. Rmb3.24/cm last year). The heat price sold to nearby region is Rmb22/square meter per heating season for residences and Rmb38 for commercial users. The natural gas cost is higher than coal, but considering the cost saving of labor and other operational cost, the total cost is similar.

Urban village that converted from coal to gas Project overview: The village has around 500 residential households and it is one of the typical rural project that ENN invested in with the following characteristics:1) it is near the pipeline networks of ENN’s Langfang project so additional pipeline investment is relatively low, 2) the residential households are more affluent compared to average so the affordability is better, 3) Hebei’s government has a generous subsidy policy for coal to gas conversion.

Gas volume and price details: The gas sales price is Rmb2.4/cm and the government gives Rmb1.0/cm subsidy (up to Rmb1,200 per household per heating season). The gas sales subsidy of Rmb1,200 is transferred to ENN first and then will be refunded to the account of each households. We visited one retail shops in the village. The shop has an area of 160sm. According to the owner, the wall hanging heater is operated 24h per day and will consume >2000 cm natural

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gas per heating season at an average room temperature of 16-17 C. The owner estimates the heating cost to be >Rmb5000 (before Rmb1,200 subsidy) by using natural gas, which is more expensive than using coal (>Rmb3,000) but natural gas is more convenient and cleaner.

Figure 19: The gas-fired boiler in a heating company in

Langfang

Figure 20: The urban village in ENN Langfang project

Source: ENN Energy Source: ENN Energy

Bestsun Energy

We had a meeting with Bestsun’s mgmt and visited a rural project in Wuqing county (in Tianjin)

Company overview: Bestsun Energy is an A-share gas distributor whose concession area mainly covers suburban and rural area in Beijing-Tianjin-Hebei (BTH) area. It has also expanded its business to Hubei through M&A in 2017, and plans to invest in distributed energy projects and one LNG terminal in coming years.

The company has Rmb6.0bn total assets and Rmb3.5bn net assets. The net profit was Rmb550mn in 2016 and management expects it to reach >Rmb800mn in 2018. Current revenue mix is 46% from connection fee, 38% from natural gas sale, 14% from sale of natural gas appliances, and 2% form heating service. Gas sales volume mix was 30%/70% for industrial/residential in 2016 and 50%/50% in 2017. The management expects a net profit CAGR of 20-30% until 2020.

Suburban/Rural residential coal-to-gas: The company is actively engaged in the rural coal-to-gas projects within its own concession area in Hebei and Tianjin, with 0.3mn household converted in 2016, 0.35mn converted in 2017, and 0.10-0.15mn to be converted in 2018.

All the rural projects are connected to pipelines and the company does not do LNG-supplied projects as there are too much uncertainties for such projects: 1) The LNG price is very volatile and many such projects have made losses in this winter; 2) The operational cost in summer is high compared to piped gas projects

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as there are some additional fixed costs related to the re-gas equipments (labor, power).

The management believes that Bestsun’s concession area is among the best for suburban/rural coal to gas conversion as it is the key area of urbanization in BTH region. The company is prudent in investing in those rural projects outside of own concession area as they see worse project return.

The management thinks the pressure from central government for rural coal-to- gas conversion is milder in 2018 compared to 2017.

For a typical residential household of 100 sm, average daily gas usage in winter heating season is 10-15 cubic meter.

Margins: According to the management, the connection gross margin is 80% for urban projects and 70% for rural projects. For gas sales, the city gate price is Rmb1.88/cm (directly purchased from PetroChina). Gas sales price to residential user is Rmb2.4/cm and that for C&I users is above Rmb3.0/cm. Currently the blended dollar margin is about Rmb0.6/cm. In this winter, the company is able to pass through the cost hike to end users but has to cut back some gas supply to C&I users due to gas supply shortage.

LNG terminal: The company plans to invest Rmb3.5bn into an LNG terminal (2.6mtpa) in Suizhong (in Liaoning Province), which is expected to become operational by 2020. The approval process may be completed by the end of 2018. The company is negotiating some import contracts at overseas and believes it will have some cost advantage compared to the contracts signed by oil majors.

Rural village that converted from coal to gas We visited Bestsun’s rural village project in Wuqing County in Tianjin. For the residential household (area of less than 100sm) we visited, the daily gas volume usage is 12 cubic meter/day. The connection and installation of the wall-hanging heater are free for residential users as the government fully subsidizes it. Tianjin government also subsidizes 60% of the gas price (Rmb2.4/cm) so that end user only pays less than Rmb1.0/cm. With the subsidy, the natural gas heating cost is lower than coal.

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Figure 21: The gas meter in Bestsun's rural coal-to-gas

project

Figure 22: The pressure adjustment station in Bestsun's

rural coal-to-gas project

Source: Bestsun Energy Source: Bestsun Energy

Tianjin Jinran (1265 HK)

Company overview: Tianjin Jinran (1265 HK) is an H-share company that operates gas distribution business in the urban area in Tianjin. The Tianjin Energy Investment Group is the controlling shareholder of the company with a 71% stake. Total assets of the company is 2.3bn with 900 employee as of 2016. The company’s natural gas supply volume is 450 mcm in 2016 and its pipeline length is 2000km.

Tianjin Energy Investment Group overview: Tianjin Energy Group is an SOE with four major business segments, power, heating, natural gas and renewables. The Group owns 70% market share in gas sales business in Tianjin. Within the Group, Jinran CR Gas (i.e. CR Gas’ Tianjin joint venture) is the largest subsidiary and Tianjin Jinran (1265 HK) is a relatively small one that accounts for c.10% of total asset of the Group.

Gas sales volume in Tianjin: The Tianjin Energy Investment Group’s natural gas sales is 4.2 bcm in 2016, accounting for 70% of market share. The gas sales volume includes: 1.8bcm to gas-fired power plants, 800mcm to industrial users, 300mcm to commercial users, 370-380mcm to residential users, and 950mcm to centralized heating boilers.

Coal to gas: The management thinks the policy direction for coal-to-gas will continue to be supportive. While for rural residential coal-to-gas, it will be done more orderly in 2018 compared to 2017. The management is generally less optimistic about rural project economics with major concerns on subsidy payment, subsidy sustainability, and project investment return. In 2017, the company only completed coal-to-gas conversions for 1100-1200 households. The management thinks the major concerns are:

1) Higher connection cost: usually more than Rmb2000 per household and some exceed Rmb3000 (vs. Rmb1000 for urban)

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2) Gas meters are usually installed outside the house which are difficult to manage and may involve some additional cost.

3) Many uncertainties for subsidy payment and sustainability

Gas supply: 80% of Tianijn’s gas supply is from PetroChina, and the rest 20% is from CNOOC though its LNG terminal. Sinopec’s LNG terminal will also commence operations soon. Gas supply is tight in this winter in Tianjin but is still able to satisfy the demand, which is better than Hebei.

Gas procurement cost and sales price: Before Sep 2017 the C&I end user price is Rmb2.77/cm, during Sep-Nov 2017 the price is cut to Rmb2.66/cm following the cuts in city-gate prices. During Nov 2017 to Mar 2018 (heating season), the C&I end user price is raised by Rmb0.25/cm to Rmb2.91/cm to pass through the cost hike at city gate level. Also, the gas prices sold to heating company increase to Rmb2.51/cm during the heating season.

The Rmb0.25/cm end-user price hike is based on the estimated blended cost hike of the company during the heating season. The company has procured some gas from SHPGX at a cost as high as Rmb2.9/cm and they are still calculating how much is the actual blended cost hike.

Binhai Investment (2886 HK)

We have a meeting with management of Binhai investment, an H-share company under TEDA Investment holding company. It is a gas distributor mainly focus on C&I users in Binhai area in Tianjin, with some other projects in other parts of China. Mgmt expects the total gas sales volume to reach 700-800mn cm in 2017, up by 25% yoy and 70% of the volume is from Tianjin.

Industrial Coal to gas: The company mainly focuses on industrial users. Its current customers include chemicals, steel companies and some manufacturers. For newly built industrial plants in Tianjin, they must use natural gas. There are also potentials for coal-to-gas conversions of existing users, such as some paper manufacturing plants. In 2016, after connecting to natural gas, the coal-fired boilers are allowed to be kept for 1 year. In 2017 all the coal-fired boilers are dismantled.

The company also has two power plant customers, Nanjiang power plant (0.9GW) has started operations in 2H17. Junliang city power plant (1.2GW) is estimated to have test run in Mar 2018. The on-grid tariff for gas power plants is Rmb0.75/ kwh in Tianjin.

Rural residential coal-to-gas: The company only invests in rural projects with pipeline access. Last year they have done 80 thousand connections in Zhuozhou city in Hebei Province. According to the management, Hebei completed 2.68mn rural household coal-to-gas conversion in 2017, most of which was done in Jul- Dec 2017. Because of strong pushes by local government, many rural projects was done in a rush and management concerns that there may be some safety issues for some projects. Management thinks it is not economical to invest in rural projects that are not near their own pipeline networks and PetroChina is not very supportive as it will result in higher volume mix for residential gas sales whose city-gate price is lower than C&I ones.

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Gas supply: The company believes the gas supply shortage will be substantially eased after the commencement of Sinopec’s LNG terminal. The company has just signed a four-party agreement with PetroChina, CNOOC and Sinopec to build a pipeline to connect all the three parties’ existing pipeline together. This pipeline is c.4.7km with a transmission fee of Rmb0.12/cm. After the connection, there will be potential competitions among three oil majors and possibly to result in lower city-gate prices.

Gas sales margins: The company has fully passed through the winter gas price hikes to end users. Currently The gas sale margin for C&I users is Rmb0.7/cm for C&I users, and Rmb0.3/cm for heating company. In 2H17, the gas sales margin is similar with the first half and management expects a higher margin in 2018.

Volkswagen industrial park We visited Volkswagen industrial park in Binhai area in Tianjin and checked with the heating boiler station. The station has five 40st/h heating boilers which supply heat to the whole industrial parks. The capacity will be doubled in the next few years as the Phase II of the industrial park is under construction.

The total investment is Rmb160mn for the whole station (including Rmb40mn for boilers). Currently the gas supply is tight and the average daily usage is 100 thousand cm (150 thousand cm if the supply is abundant). The boilers are running 24 hours per day.

Figure 23: The heating station associated with

Volkswagen industrial park

Figure 24: Five gas-fired boilers in the heating station

Source: Binhai Invetsment Source: Binhai Invetsment

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Tour: Global luxury trip in China Anne Ling, [email protected], (+852) 2203 6177

Chinese luxury consumption: strong and getting more and more local

In our two day global luxury trip hosted on Shanghai on 11-12 Jan, we met management of Swatch Group, Hugo Boss, Coach, Moncler, Ray Ban (Luxottica), Hearts on Fire, Chow Tai Fook, IFC Mall and Ongoing department store. We also discussed the luxury consumption behaviour in different channels with CBN Data as well as a daigou operator. Earlier this week, we also met a retailer of Swiss watches. This report contains our key findings. Essentially Chinese luxury demand is solid and growing, driven by the expanding middle class, and trends towards greater sophistication and a broadening range of preferences continue. Of the companies visited, we have a Buy rating on CTF, Moncler and Swatch Group.

Valuation & Risks

We believe luxury investors should focus mainly on absolute valuations based on the specific prospects of each company. Our preferred methodology for this is discounted cash flow valuation. We base our DCF valuations on WACC varying from 8.0% to 10.0%, depending on capital structure and perceived risk (betas between 1.0 and 1.1). We use a risk-free rate of 3.5% and a risk premium of 4.5%. Our terminal nominal growth rates vary between 2% and 3%, depending on relative maturities, growth prospects and brand strength (ability to pass on inflation).

The biggest risk to the sector would be renewed turmoil in global financial markets, the persistence of concerns regarding sovereign debt, slowing world GDP growth, negative economic development, and continued geopolitical uncertainty and turmoil. The second key risk is if sector troubles are exacerbated by a slowdown in global tourist travel. The third risk would be a strengthening of the EUR vs. the USD and the JPY for euro-denominated luxury companies, as well as CHF and RMB evolutions. For China, which is a major engine of sector growth, decisions by the authorities that affect Chinese consumer spending and travel would also be significant, as is the pace of restocking and the health of Chinese tourist spending.

1. Malls and landlords are more rational and mature as partners. Consolidation is expected

Brands like Hugo Boss and Moncler commented that their retail partners are now showing a more rational behaviour and are not pursuing excessive expansion of new retail space. Instead, we find sophisticated mall or department store operators like IFC or Ongoing Department Stores continuously improving their brand mix to respond to increasingly more demanding consumers and to cater to a younger clientele. For IFC, for

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example, while catering space is expected to remain at ~20% of total retail space in 2018, it plans to introduce Michelin star restaurants, so as to improve the shopping experience for its affluent loyal customers. On the other hand, it requires all the brands to install LED screen in their stores, which is a way to attract younger consumers.

Most brands or retailers we spoke to expect a consolidation of retail space, as investment in malls shrank a few years ago. The watch retailer we spoke to commented that it will be more difficult to get good retail locations in the future. The regional management of the brands we have met generally feel that they have learnt by now who are the better mall/ retail space operators. This is a huge change compared to the past, when many players were dealing with all the new malls with much greater uncertainty. This makes it for a better operating environment, one where companies can plan for their future in a more rational, constructive and sustainable way, which is increasingly needed as companies are learning to deal with China as one large domestic consumers market.

2. Most brands notice that customers are different from the past. They are younger in age and know what they want

From gifting to personal spending In the past, a higher portion of sales came from gifting. The watch retailer estimates that 60% of the consumption in Swiss watches was gift related before the anti corruption measures in end of 2012. Although this seems a bit of an extreme estimate, based on conversations with companies over the last few years, we can say that depending on product categories and brands gifting could have been accounting for 35-50% of spending. Gifting did not go away completely after 2012/2013 but it has shrunk substantially. Although some have noted a mild return in gifting for the first time since the 2013 crackdown, it was noted that this has more to do with corporate or personal gifting and in any case is no longer a key driver. The overwhelming majority of the consumers purchase for themselves or for their close family. Maybe it is for this reason that our distribution specialists have observed in the last two years that jewelry has seen an incredible momentum especially western brands.

Middle class driving consumption Consumption upgrade or recovery does not necessarily come from wealth effect (ie higher property prices), according to the daigou operator and the watch retailer. The return in luxury spending is mainly coming from the emergence of the middle income class. This is a theme we have explored in our 2018 Luxury Goods Outlook (2018: the year of cash, published on 4 December 2017 by Francesca Di Pasquantonio) and in the Greater China Consumers 2018 Outlook (Anne Ling's 2018 outlook – a more widespread recovery, published on 4 January 2018. According to iResearch, Middle class households grew to 1.14m in 2015 and are expected to grow to 1.8m in 2020.

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Young and sophisticated key customers The key luxury customers are aged ~ 30-35 on average. These consumers do not follow what the market tells them. In fact, they have their own mind and they have their own choice of brands. This is the reason why brands are investing in their brands' history and story-telling. Swatch Group management gave us a first glimpse of the art exhibition hall at the Swatch Peace Hotel which they were preparing for a big event the following day (related to the launch of Swatch on t- mall). As illustrated by this example, the aim is to create more content to associate with the product, excuses for the brand to receive coverage by all kinds of medias, including modern, digital media, and be associated with high profile events and people.

Most brands have remarked that the age range of 25-35 is the key target customer age range. The younger millenials clients are more demanding and mostly seek a personalization of their look and are therefore increasingly selective in what brands and styles they buy and extremely responsive to novelties and special editions and capsule collections. This also explains why for example Moncler has been experiencing good growth not only from its iconic products but also novelty products. And why Ray-Ban has launched a collection with celebrity Zhang Yixing which was very well received.

Having a Chinese influencer helps brand awareness and has an immediate impact on business. Whether it is using celebrities as testimonials or partnering and collaborations with influencers the response in terms of sales is always very favourable. All the brands we have visited in this trip use important local brand ambassadors (more below).

Customisation and service important drivers for consumer loyalty Customization and exclusive service is also a trend. For example, Coach set up craft counters in 3 of its 160 stores in China. The craft counter serves 4 purposes: 1) leather care which is for free ( a global policy 2) Monogram inscription on leather tag which is free of charge currently in China 3) repair and 4) Coach Create where customers can customize his/her purse. The company explained that Coach price positioning which is more affordable than other western/European brands is seen today as a less important driver: one of the key success factors of the brand today relies on its quality, design and level of service and personalization opportunities as described above.

Another common trend we noticed is that all brands we have met are emphasizing the critical importance of maintaining and fidelising the existing customer base while in the past the focus was almost only on recruiting new consumers . The development of global CRM systems, special events for its loyal clients, dedicated WeChat applications are useful in this direction.

3. Most note a decline in ASP versus a few years ago

We received this feedback for example from the watch retailer and the daigou operator. But also other brands have noticed a shift towards less expensive categories. They mainly attribute this lower ASP to a change in consumption pattern and consumption group. The daigou operator commented that due to lack of brand knowledge, consumers in the past would believe that the higher the price, the better the products. Also, gifting made consumers less price sensitive. However, these days, consumers buy increasingly for themselves, are more sophisticated and knowledgeable. Younger consumers especially will

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select brands / products that they like. In addition, as there is a wider group of middle income class, some will look for entry price products. Thus, it creates a demand for affordable luxury brands.

The daigou operator commented that although there is a demand for a wider selection of brands, some brands will last in consumers' mind as they may become only popular with one single product. Thus, the operator believes that some of the mainstream big brands like LV, Gucci or Chanel are more sustainable as they have a wider range of consistently popular products.

Another element in this direction is the increasing relevance of premium skincare and cosmetics (department stores are dedicating more and more space) and as IFC is suggesting, the success of more accessible contemporary design brands, including local brands (Ongoing Department stores is promoting local brands giving good locations within the selling floor).

4. The daigou luxury market is believed to be USD50bn, according to iResearch

The daigou luxury market is believe to be USD50bn, according to iResearch. Unlike the diaper, cosmetic and infant formula segments, it has not been affected by the new CBEC regulations in 2016.

The operator we met explained that this is because luxury daigou do not go through the bonded warehouse channel. It is mainly done through direct mail and hand carry. Despite the price harmonization enacted by the brands over the past two years, the operator does not think this has affected them that much in terms of sales and profitability.

While increasing demand for contemporary designer brands, which was also noted by IFC, is a general consumers trend which is translating into a lower ASP, higher ticket price remain very popular especially Chanel and Hermes with 20-30,000 RMB average price. Also geographical product allocation, mismatch in timing of new launches and in roll out of new brands/designs continues to create opportunities for daigou.

Recent trends see more fashion brands like Gucci being very in demand and generally more individual taste and less status symbol (No more the more expensive the better). Among the brands which have had less traction Prada and Bottega Veneta were mentioned which is not a surprise as we have seen the sales of both fall under pressure. For Prada they have seen more new products being launched and so they believe there might be a come back at some point In 2018.

While handbags were key in the past now there is more variety in the items purchased. For Watches and jewelry there is now no major interest on daigou channels given the strong price harmonization and the fact that supply is now more restrained leading consumers to go directly to the physical stores and in particular the brands' DOS (mentioning Cartier in particular). Rolex seems to be the standout. It has limited direct distribution and demand and supply unbalance which continues to create a window for daigou

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5. China should be a profitable business.

Price harmonization has shifted consumption to China and now healthy trends are developing locally. The market has recovered since last year and growth continues to be sustained in the country. Brands need to focus on educating consumers on the brand equity. Localized marketing is adopted and store presence and store space has been rationalized.

A more rational price harmonization strategy is adopted by most of the brands we met, from watch brand to apparel and accessories. In most cases there is still a price difference of 25-35% but this was substantially reduced from the highs of a couple of years ago. In our view, the Chinese government's various rounds of tariff cuts, lowering consumption tax and re-enforcing overseas spending caps on credit card (kept at USD15,000 per person per year) have all managed to achieve spending repatriation to China. This is becoming the new normal, with companies looking at China as a new sizeable local market which must be profitable. While consumers will continue to travel aboard, they will not just focus on shopping and will likely wait less and less to purchase until the next trip to overseas.

This is shifting the strategies on brand equity. Brands are doing more localized marketing. Apart from having a international spoke person, most of the brands will appoint local brand ambassadors. For example, Hugo Boss appointed Wallace Huo as Boss Man of Today since Mar 2016, while it appointed Chris Hemsworth internationally. The message is to show Chinese men that HB has good fitting for Asian men. In 2018, Coach appointed Xu Weizhou as the spokesperson for Coach Men in China while it appointed Selena Gomez as international spokesperson. Ray-Ban has launched a special collection with celebrity Zhang Yixing which was very well received.

Many brands are also expanding their merchandise and emphasising new categories to consumers (infants, shoes and knitwear for Moncler, apparel and smaller leader goods for Coach, shoes and accessories for HB). This will allow customers to buy more items per purchase and to become more regular customers.

Thus, from the brands' strategy viewpoint, brands are no longer managing stores in China as a showcase while waiting for consumption to happen overseas. Most aim at reaching or keeping high levels of profitability in China. For example, instead of operating mega duplex store in China (a common format in the early years) , brands like Hugo Boss and Lens Crafters have down sized their store network looking for an optimal size for its store profitability. IFC as a mall operator is also working on the same exercise and thus, its number of brands increased from 170 to 250 in just a few years.

6. Online luxury spending by Chinese is mainly via tmall and jd but most brands prefer their own website

Online sales is still a small percentage of sales for luxury brands in China. However, it has been growing fast. Many of the players operate a flagship website at Tmall and to a smaller extent, some also operate in JD.com. These days, most brand adopted a uniform pricing strategy between on and offline channels. In addition, more and more brands are offering full range products online too like Hugo Boss. Tmall is trying to attract international brands, helping to track and eliminate fake products and unauthorized products sold via tmall.

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We believe most brands will prefer their own websites (some operate online exclusively via their own ecommerce). In addition to brand control, it also allows companies to know their online customers more and fully implement omni- channel strategy.

7. Companies: the quick takeaway

We are summarizing below the key takeaways for each company store visite.

Chow Tai Fook/Hearts on Fire.

CTF acquired HOF in 2014 and the brand was introduced to Chinese consumers three years ago. It is famous for its perfectly cut diamond. It is CTF’s strategy to cater to fragmented consumption and consumption upgrade. Its target customers are 25-35 years old. Especially in tier 1 cities like Shanghai, management noted that customers have better knowledge on what they want when they walk into the store.

It now has 8 DOS stores, 14 shop in shops within CTF stores and 170 counters within CTF stores. Cartier and Tiffany are their competitors. Its price point is some where between CTF and Tiffany. According to the brand manager, a half carat diamond will cost RMB50,000 for HOF vs RMB80,000 for Tiffany. They believe the branded jewelry market is growing some 20% yoy. However, as its brand is still new in China, its sss trend might not be as good as the market. As the brand is still new to the market, it appointed Zhao Liying as CTF’s brand ambassador (including HOF).

As for its own CTF store, it is also upgrading its store format and image so as to attract younger age group. As 50% of its sales normally come from gold products, target age group for this segment is higher. These days, in tier one cities, youngsters do not buy gold as accessories. Gold products are mainly as gifts to new born babies or children. Youngsters prefer gem-set. As CTF has a long history in China, it can draw good traffic to the store. Thus, even for HOF, its sales per sm is higher for its counters or shop in shops within CTF’s counters/ stores, vs its own DOS stores.

Coach. We visited the Hong Kong Mall store which is in an important business area. Opened in 2010 it was renovated to the new global flagship format in 2015. This is one of 12 full price stores in Shanghai and c160 in China. The average customer age is 30-35 and getting lower while the percentage of repeat customers is going up. Coach price positioning which is more affordable than other western/European brands is seen today as a less important driver: one of the key success factors of the brand today relies on its quality, design and level of service and personalization opportunities (which include Coach create or an app allowing a direct chat with the favourite sales associate). The presence in store of a leather laboratory for alterations, repairs and personalization is a Wow factor driving both new and repeat customers.

Hugo Boss. HB operations are almost entirely retail in China. We visited the store in the Kerry center. While investments decisions were made in 2010 the store opened in 2014 after anti-corruption took hold. Since then the brand has renegotiated the store size to improve operations while maintaining impressive windows. Also in 2016, they have realigned the pricing in line with what other brands have done. With the new pricing strategy the business has shifted to

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more volumes and growth has nicely resumed. China has a big casual and sportswear business for Hugo Boss; however formal wear is also doing well growing at d-d also taking advantage of market consolidation with many players reducing their presence, but also of a growing pie. Shoes and accessories are also key in driving total transaction value through multiple units purchased.

Moncler. The store visit at Plaza 66 (one of 4 stores in Shanghai, 27 in China - ie a small footprint still) confirms our equity story and suggests that brand momentum remains strong. Moncler is trending very well with the young sophisticated client as well as with the more traditional buyer. Whatever is perceived as exclusive or popular sells very quickly whether it is Capsule collections, special editions or what is showcased in the windows. Merchandising diversification is helping drive the average unit per transaction in line with the global strategy. The store and more in general the brand in China is enjoying an increasing contribution to business from repeat customers which expand their purchase to also include the new categories like knitwear or shoes which are fastest growing within the mix.

Ray Ban. With the extensive cleanup of the wholesale market in China, Luxottica is now essentially a retailer in the region at least for now. Luxottica operates c 305 stores in China including 150 Lenscrafters, 55 SGH and c 100 Ray Ban stores. While the LC network remains, the Company has converted underperforming LC stores into RB successfully and has a plan for further openings. The store sells a full sun and optical offering branded Ray ban including contact lenses and prescription lenses. It intends to capitalise on the fact that it is the only player in optical in China with a premium positioning. To do this it keeps a tight distribution and pricing in stores and has stepped up efforts in monitoring counterfeits and grey market sales. The recent cooperation with Mr Zhang Yixing, a famous local singer, is producing very satisfactory results and is instrumental in spreading awareness on the brand and the store concept.

Swatch Group. We visited the Swatch Peace Hotel in Shanghai. A heritage site dated back to 1906, Swatch took it over in 2007 with the local partner JinJiang (still owning 10%) and after extensive renovation it started an art residency in 2011 with more than 200 artists hosted since and more than 400 pieces of art collected. This initiative is a key part of the group institutional marketing in China enabling high profile all round relations and reputation building with authorities, business partners and customers. The building is in fact extensively used for marketing purposes and in addition it includes three stores: Swatch, Omega and Blancpain. As we were visiting, preparation for a major event to be held the following day were ongoing, with the Company taking advantage of a favourable consumers environment (as confirmed by our watch retailer contact, watch demand especially for more premium brands is robust) with demand having picked up over the last few months, to continue to raise its profile.

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Tour: Auto tour takeaways Vincent Ha, CFA, [email protected], (+852) 2203 6247

Continual advancement by local brands; NEV sales boom to continue At our dbAccess China Conference last week, we spent two days visiting auto plants and 4S stores of leading local brands. We also met with a new energy vehicle (NEV) industry expert. In summary, we observed that the rapid development of a few local brands in recent years has made them more competitive but also means fiercer competition. Since we foresee only 4% overall auto sales growth in 2018, we recommend that investors look at the more resilient premium car segment, where we prefer Brilliance. We also prefer Yutong Bus for its NEV theme, in view of its sustainable electric bus leadership. This stems from our anticipation of the government’s push for NEV penetration being conducive to the emergence of many new players/passenger car models starting 2018E.

Local brands - significant advancement but competition intensifies We visited the plants of Great Wall Motor (GWM) and SAIC Motor. GWM reinstated its plan to sell c. 250k units of upscale WEY-branded vehicles in 2018, with WEY's current gross profit margins already higher than the company average. In 2018, GWM expects margin to further improve, thanks to VV5’s sales ramp-up. For SAIC, management commented that more than 40% of its popular Roewe RX5 SUV orders are embedded with Internet connectivity functions and the brand has benefited from an increasing SUV mix.

NEV – central government push is sales driver for now, but this could change The central government’s push for NEV development has given rise to many new entrants. However, the expert we met thinks it will take a long time for NEVs to replace traditional cars. She estimates annual NEV PV sales at 1.5m units and NEVs accounting for 2% of total car ownership by 2022. The dual credit system would be a major driver of the NEV market. The industry is getting more market- oriented as customers increasingly value functionality and low maintenance cost, along with a more established charging network in the future.

Local brand plays are not attractively valued; buy Brilliance and Yutong We value Chinese auto manufacturers mainly on a forward P/E basis, with reference to their earnings growth prospects. We do not have a strong Buy for local brands, considering the competition in various price segments, e.g. WEY vs. Geely’s Lynk & Co, but would rather recommend premium car OEMs such as Brilliance. Among NEV manufacturers, Yutong is our preference. Key sector upside risk: stronger-than-expected auto sales resilience. Key downside risk: a post-stimulus sales drop.

Remaining upbeat on premium brands and SUVs

We marginally lower our 2018-19 China vehicle sales forecasts on lower-than- expected 2017 sales, while keeping growth rates largely unchanged. While China’s passenger vehicle (PV) sales increased only 1.4% YoY in 2017, we expect the growth rate to improve to about 4% for 2018-19E, considering healthy inventory. We are more upbeat on the growth of premium brands and

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the SUV segment as we expect the continuation of strong upgrading demand and new models, together with a rise in auto financing penetration. We continue to expect a retraction in commercial vehicle (CV) sales, mainly due to the exhaustion of expansion demand for heavy-duty truck (HDT) fleets.

Figure 25: Deutsche Bank's China vehicle sales volume forecast

Source: China Association of Automobile Manufacturers (CAAM), Deutsche Bank estimates

We also raise our new energy vehicle sales forecast after factoring in stronger- than-expected 2017 sales.

Figure 26: Deutsche Bank's China new energy vehicle sales forecast

Source: CAAM, Deutsche Bank estimates

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Great Wall Motor's (2333.HK, Sell; 601633.SS, Sell) Xushui plant visit

GWM's three plants in Xushui are its newest plants. On 11 January, we visited Plant 2, which has an annual capacity of 250k units. The models it produces include Haval H2, H7 and WEY VV7. Their popularity has enabled the plant's utilization rate to surpass 100%.

The plant is highly automated and technologically advanced. For example, its stamping workshop has four automated production lines and the automation rate of its welding workshop has reached 100%.

SAIC Motor's (600104.SS, Hold) Lingang plant visit

We visited SAIC Motor’s Lingang production plant in Shanghai on 12 January. Total capex on the plant is c.RMB4.2bn. It produces various series of Roewe/MG vehicles, including the popular Roewe RX5 SUV. The model’s popularity keeps the plant well utilized.

Great Wall’s management meeting

GWM's December 2017 sales declined 16.6% YoY, which the company partially attributes to inventory management, i.e. no channel stuffing in order to reduce incentive level. That said, sales of the upscale WEY VV5 and VV7 both improved slightly MoM. Sales volume of VV7 is meeting its 10k monthly sales target and management hopes monthly sales volume of VV5 will ramp up to c. 15k units. In 1Q FY18E, GWM will launch the WEY P8 plug-in hybrid. Given a likely high selling price for this NEV, GWM does not expect a high sales volume. In 2H18E, GWM will launch WEY VV6, an SUV sized between VV5 and VV7. In terms of store network, GWM will more than double the number of WEY 4S stores in 2018 and phase out all WEY brand booths inside Haval 4S stores. To conclude, the company is comfortable about attaining 250k units of WEY band sales in 2018E, as mentioned earlier.

As of the end of Q3, gross profit margins of WEY VV5 and VV7 were higher than the company average, providing room to improve in 4Q17E. In 2018, GWM expects gross profit margin to further recover, thanks to 1) the ramp-up of VV5 and 2) a reduction in the discount level. To elaborate, selling prices of popular models like Haval H2 and H6 have improved by c. RMB8-10k YTD.

GWM is seeking all kinds of cooperation with both domestic and international players. Its potential cooperation with BMW's MINI is at an initial discussion stage, where one focus area is NEV development.

The average utilization rate of GWM is 80-90%. To solve the production bottleneck for the popular new generation Haval H6 at Xushui Plant 3, GWM will shift a portion of its production to the Tianjin plant.

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SAIC Motor's management meeting

SAIC PV Company has two brands: Roewe, which focuses on the domestic market, and MG, on overseas markets. In the forseeable future, SAIC will stick to these two major brands rather than launch multiple brands. Its future strategy for SAIC's local brands will center on technology, NEVs and Internet connectivity, which are based on market needs. For example, more than 40% of RX5 orders are embedded with Internet connectivity.

SAIC also sees opportunities in the NEV segment. Although a high proportion of current NEV sales are low-end models, the company's product pipeline focuses on the mid-to-high end to fill the void. Its current NEV production has a 600k design capacity at the Lingang, Nanjing and Zhengzhou plants. SAIC is investing heavily in NEV technology in order to build a complete supply chain. While possessing advanced technology in electric controls, SAIC used to outsource battery cells. In 2017, however, it established a JV with a leading battery producer to not only save cost but also be involved in the entire NEV battery manufacturing process.

As regards internet connectivity, SAIC launched Roewe RX5 in late 2016, equipping it with an operating system it co-developed with Alibaba. In November 2017, SAIC also rolled out internet connectivity car models in Thailand and received positive market feedback. Apart from connectivity, SAIC focuses on developing Advanced Driver Assistance System (ADAS) technology.

Meeting with a new energy vehicle (NEV) industry expert

On 12 January, we met with Ms. Liping Zeng, the former head of Gasgoo Research Institute and founder of NE Times, an information provider in the NEV industry. NEV sales have grown rapidly but Ms. Zeng thinks NEV will take a long time to replace ICE. One obstacle in promoting NEV is the high cost of NEV batteries. She forecasts that annual NEV PV sales will reach 1.5m units in 2022, when NEV will account for around 2% of total car ownership.

The dual credit system will be a major driver of the NEV market. Ms. Zeng believes that to meet the NEV credit requirement, NEV PV production volume will have to be at 700-900k units from 2019 to 2020. She thinks the actual sales volume will be higher than the theoretical production volume required by the credit system, thanks to the rise of new car making companies. She expects ownership of NEV to reach c.5m units in 2020-2021.

Ms. Zeng has conducted a thorough analysis of new auto manufacturing companies, and some provide better quality and quantity of patents than others.

Last but not least, she thinks that although Chinese NEV battery manufacturers have invested heavily in R&D, they still have a technology gap with Korean and Japanese producers.

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Yongda Auto's (3669.HK, NR) Roewe 4S store visit

We visited Yongda Auto's Roewe store in Shanghai on 12 January. The store aims to grow sales by c.10% this year. Its inventory level is very low amid strong demand.

In 2017, the number of Roewe 4S shops nationwide jumped from 200-plus to 400-plus. The store manager expects the network expansion rate to slow down in 2018.

The manager thinks that current strong demand for NEVs in Shanghai is driven by the free license plate policy and subsidies. The manager believes demand will also be supported by genuine interest from customers, considering advantages such as lower maintenance cost.

The store's after-market sales have been growing steadily. The retention rate of customers after the guarantee period expires is higher for car models with higher prices. Meanwhile, its auto financing business has been growing fast. Most of its auto financing products are provided by SAIC Finance. To attract more customers, the auto financing company offers interest-free products based on customers' credit

In terms of customer acquisition, the store allocates an equal amount of resources to different auto web portals. On average, about one out of five website visitors who submit personal information to book a 4S store visit shows up in the store, and about half of those who visit the 4S stores in person end up buying.

Geely Auto's (0175.HK, Hold) Lynk & Co showroom visit

We also stopped by a Lynk & Co showroom in a shopping mall in Shanghai's Lujiazui District. It showcased two 01 models, with one in a special edition color. The suggested retail prices of various trims range from RMB158.8k to RMB220.8k. In our view, the showroom differs from those of other local brands in having a trendier setting, similar to BMW MINI stores. It is interesting to note that the investors on the tour were in general positively surprised by the vehicles' design and craftsmanship.

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Figure 27: Geely Auto - Lynk & Co showroom in Shanghai Figure 28: Geely Auto - Lynk & Co showcases 01


Figure 29: SAIC Motor - Roewe E-RX5 in a 4S store Figure 30: Great Wall Motor - WEY VV7


Brilliance China

Our target price is based on 16.5x FY18E P/E, reflecting our expectation of an earnings rebound. This is justified, in our view, by Brilliance's FY17-19E two- year EPS CAGR of 33%. Our target price also implies a 3.4x FY18E P/BV, with a sustainable ROE of about 23-24%, which we regard as reasonable.

Key downside risks for Brilliance include a slowdown in older model sales, a weaker-than-expected reception to new models and an inability to improve margins.

Zhengzhou Yutong Bus

Our target price is based on a target benchmark of 14.0x FY18E P/E, about 30% more than Yutong's mid-cycle P/E of 11x, to reflect our optimism over Yutong's increasing profit contribution from the new energy bus segment. This

19 January 2018



is justified, in our view, as we expect the company to deliver a 7% three-year earnings CAGR in FY16-19. On a forward P/BV basis, the company's implied target FY18E P/BV of 3.1x is also justified, given our forecast sustainable ROE of 24-26%.

Key downside risks for Yutong include: 1) unexpected changes in the Chinese government's new energy bus subsidy policy; 2) weaker-than-expected new energy bus demand; and 3) market share loss in new energy buses.

Great Wall Motor

Our target price is based on 7.0x FY18E P/E, which is below Great Wall's historical H-share trading average, considering its lack of long-term EPS growth. We believe our target multiple is justified by our expected lower FY19E profit than the FY16 level despite a 27% two-year EPS CAGR over FY17-19E. Our target price implies FY18E P/BV of 1.0x, which seems well supported by a sustainable ROE of about 14-15%.

Key upside risks for GWM are stronger-than-expected new model sales and a margin rebound.

Geely Auto

We base our target price on an aggressive 18.0x FY18E P/E, reflecting our expectation of strong earnings growth. This is justified, in our view, by Geely's FY17-19E two-year core EPS CAGR of 22%. Our target price implies FY18E P/BV of 5.4x, which seems reasonable considering a sustainable ROE of about 30-31%.

Key upside risks are better-than-expected new model sales and margins. Key downside risks are slippage in sales momentum and margin pressure.

SAIC Motor

We value SAIC Motor at 9.5x FY18E P/E, above the company's historical trading average and close to the industry's long-term P/E average. We believe this is justified by our expected three-year net profit CAGR of 7% in FY16-19. On a P/BV basis, we believe the company's implied FY18E target P/BV of 1.5x is also justified by its forecast 16-17% sustainable ROE.

Key downside risks are: 1) weak reception to new models from various SAIC brands; 2) pricing pressure amid industry competition; and 3) worse-than- expected local brand profitability. Key upside risks are: 1) better-than-expected sales volume and pricing; and 2) better-than-expected local brand profitability.

Sector risks

Upside risks include better-than-expected vehicle sales If the macroeconomic environment grows more quickly than expected and boosts sentiment, the auto sales momentum could improve.

Any extra supportive measures, such as well laid out scrapping policies to stimulate replacement, could lead to an acceleration in growth.

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Downside risks include a sharp drop in auto consumption sentiment If the macroeconomic environment weakens for a prolonged period of time, and if policy headwinds turn severe, auto sales could stay suppressed.

A slowdown in sales and lower production capacity utilization could lead to worse-than-expected margin compression.

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Tour: China Handset field trip highlights Birdy Lu, [email protected], (+886) 2 2192 2822

The issue in iPhone is high expectation, not the rumored “order cuts” We met Sunway, O-Film and Everwin at our dbAccess China Conference and visited AAC at the field trip that same week. After this event/trip, we reiterate our preference for iPhone over the China smartphone supply chain for 2018. iPhone X production seems on track with our estimates (32mn/25mn for 4Q17/1Q18, as stated in our Nov 23 note), although it didn't live up to the street’s high expectations (which used to be ~30mn/40mn for 4Q17/1Q18). The street has been trimming expectations in the past month closer to ours. At this point, downside risks are limited. Even by our street-low forecast, iPhone X would help to lift iPhone BOM cost by 10%+ YoY, which is quite impressive.

…but China smartphone weakness is a real issue The supply chain indicated that orders from Huawei/Xiaomi have been fine, but OPPO /Vivo and some tier-two brands (Gionee, TCL, in our view) turned weak in 4Q17. The softness could last into Jan and Feb, followed by an anticipated order recovery in March (with new flagship model launches). However, the supply chain is not sure if that recovery is sustainable. As a result, O-Film, Everwin and Sunway all said they will increase the focus on overseas clients in 2018. O-Film expects contribution to rise from Apple (Face ID's RX camera and iPhone touch module) in 2018. Everwin expects Samsung Galaxy A/J metal casings and initial orders for MacBook casings to be non-China growth drivers.

Sunway: a positive 2018 outlook and long-term prospects Sunway is our top pick in our A-share coverage for its strong 2018E growth and solid long-term business outlook, driven by aggressive expansion from antenna/jumper cable to several new items inside iPhone, including wireless charging module, dual cam/VCM mechanical component, lightning connector, and EMI shielding case. Despite recent share price weakness and speculation that they may lose wireless charging orders, the company’s response is that iPhone-related component businesses are on track with their expectations.

AAC: the most diversified smartphone component play with multiple drivers AAC is our top pick in our HK-share coverage. We see multiple drivers to power its 2018 growth. On its iPhone business, we expect AAC to maintain a dominant market share in acoustics and haptics, while ASP improves slightly, driven by high-end specs spreading to more iPhone SKUs. Long-term, we expect Apple to deliver mini Fi-Hi sound quality in the iPhone, which would serve as a key ASP driver. Mini Hi-Fi is hard to achieve in small form factor devices like the iPhone. On the Android business, we see the following growth drivers: 1) SLS (super linear speaker) – shipments up from 10mn in 2017 to 150mn in 2018E, with USD1.5 ASP up to USD2; 2) rising haptic motor adoption among Chinese OEMs, along with an edge-to-edge display trend (the removal of the home button will trigger the haptic upgrade, in our view), and 3) a continuing market share gain in Android metal casings (expanding from Xiaomi/OPPO in 2017 to more projects from Huawei/Vivo/Samsung in 2018E).

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Sunway: a positive 2018 outlook and long-term prospects

Sunway expects antenna and connector BUs to still constitute the majority of 2018 sales, while acoustic and semiconductor BUs remain important parts of its long-term strategic business plan (as a total solution provider for its key clients).

Antenna BU (ABU) – wireless charging / 5G as near-/long-term drivers Near-term outlook: Sunway views wireless charging modules as the key

growth driver in 2018/2019. After achieving a 20%-30% market share in Samsung's high/mid-range devices, Sunway sees a high chance it can penetrate iPhone in 2H18, due to a potential design change (from the current FPC-based to a copper coil-based solution).

In addition, the TAM of wireless charging (RX) module could grow from sub-200mn in 2017 to 300mn+ in 2018 while ASP of a wireless charging module will be ~USD3 (vs less than USD1 in its current core business, Wi-Fi/GPS antenna).

Long-term outlook: Sunway expects the arrival of 5G (likely in 2020, in our view) will increase demand for antennas in a significant way. As it covers a whole range of antenna products from low frequency to ultra-high frequency bands, we see this as a new growth catalyst in the long run.

Connector BU (CBU) – multiple projects from iPhone Penetrating Lightning connectors: Sunway's Lightning connector is

qualified by Apple and shipments will start in 2018. Initially, it will serve as the third suppler (after Hon Hai and JAE), but Sunway is confident of increasing its share in the long run. Every new iPhone comes with three Lightning connectors in the box (one for the power adapter cable, one for the ear pod cable, and one for the audio adapter cable).

Rising dual cam penetration on iPhone: Sunway expects all three new iPhones in 2H18 to be dual cam (vs only two models in 2H17). Their camera related mechanical parts (dual cam supporting frames and VCM cases) will benefit from rising dual cam penetration.

Rising market share in iPhone EMI shielding cases: Sunway got into this business in late 2015, and expects to win more EMI shielding case slots in 2018 or gain market shares in current slots.

O-Film: a positive growth outlook, but fairly priced

O-Film expects to maintain high growth in 2018, driven by the breakthrough in high-end dual cam projects for Chinese OEMs, rising Apple exposure (touch panel ITO film, RX module in Face ID system) and potential 3D sensing module projects from Chinese OEMs. For the longer term, O-Film will focus on smart vehicle solutions (ADAS, entertainment systems).

CCM business – breakthrough in high-end dual cam projects 2018 growth drivers: O-Film believes it will benefit from rising dual-cam

penetration in China smartphones (from sub-20% to 30%-40%) and a share gain in high-end projects.

Capacity: O-Film has built monthly capacity of 15mn for dual-cam CCM now and expects to double this by end 2018 (while single-cam CCM capacity may stay flat at 60-65mn units).

19 January 2018



Progress in high-end projects: O-Film highlights that it grew its share of Huawei's high-end products (P/Mate series) from almost nil in 1H17 to 10-15% in 2H17. Based on current order visibility, O-Film believes it can get a 30%+ or 40%+ market share in new projects. In particular, O-Film believes it will be the key supplier of the globe's first trio-cam project (Huawei P20 Pro, in our view).

Touch panel (TP) business – expanding from iPad to iPhone Apple business: O-Film is positive about the i-device TP business. The firm

penetrated into iPad's TP sensor + full lamination business in May 2017, and quickly grew market share from zero to 20%-30% by the end of 2017. In 2018, O-Film expects to keep growing market share in iPad TP, and is likely to win iPhone TP orders as well (touch sensor + 3D touch + cover glass lamination).

Android camp: O-Film expects Android's TP business to stay stable, with the rising adoption of out-cell solution to offset continuing pricing pressure.

3D sensing – iPhone's RX module + initial adoption by Chinese OEMs Apple business: O-Film targets to get the RX (receiver) module of iPhone's

Face ID system in 2H18, given that 1) the design and structure of the RX module is familiar to a front cam, so O-Film can leverage its current iPhone front-cam capacity, and 2) Apple will need more suppliers as Face ID adoption is expected to spread from iPhone X to all new iPhones in 2H18.

Android camp: O-Film expects some Chinese clients to adopt the 3D sensing module in a few high-end models this year, but that the volume would be very small, given the immature technology and low production yield. O-Film believes it will be an important long-term growth driver, and has formed an exclusive partnership with Mantis Vision (a leading 3D sensing algorithm supplier) to target Chinese OEMs. Other partners include Himax in WLO lens and Finisar in VCSEL.

AAC Technologies: the most diversified smartphone component play with multiple drivers

AAC is confident of achieving 25% YoY growth in 2018 sales, driven by continual shipment growth and ASP improvement in acoustics, and rising contribution from new products. Key highlights from our field trip of Jan 11-12 are shown below:

Lens module business WLG (Wafer level glass) lens: AAC believes WLG is better than plastic lens,

in terms of higher temperature tolerance, has better light transparency and a better light refractive index. As a result, it could be a better fit for application to the 3D sensing lens or large lens aperture camera. The company plans to expand its monthly WLG capacity to 3-5mn by the end of 1H18 and to 5-10mn by the end of 2018.

Plastic lens: AAC indicated its 6P lens module (all plastics) project started mass production in 1Q18 and is shipping to Korean clients (rear camera). It expects this segment to continue to grow and to expand its monthly capacity from 20mn now to 30mn by the end of 2Q18.

Hybrid lens module: AAC thinks some handset clients may adopt a hybrid lens on one of the rear dual-cams and further on a 3D sensing camera in 2018. Compared with competitors’ molding glass lens (in a hybrid solution), AAC’s WLG has a cost advantage (its technology achieves good production yields) as it produces more than 30 glass lenses in a single wafer.

19 January 2018



RF mechanical and haptics business RF mechanical: Toward the 5G era, AAC is positive about the trend of

“metal frame + 3D glass” to replace the unibody casing, due to the shielding effect. In addition, the company indicates ASP of stainless frame (on China smartphones) is USD15-20, higher than that of an aluminum frame at USD10. Even GPM in this business is lower than the corporate average, and the company expects GPM to improve gradually via upgrades of automation production lines.

Haptics: AAC has only one client now (Google, in our view) but expects a wider adoption by Android smartphones, along with more of the edge-to-edge design. However, the company cautions on haptics ASP for Android clients and indicates the range will be USD0.8-3.5 (e.g. Meitu may adopt a USD3 solution).

VCM: AAC targets to branch out into the VCM business by leveraging its expertise in haptics. It doesn’t expect a meaningful contribution in the near term. For the long term, AAC sees a fair chance of this becoming a new growth driver, as both VCM and haptics are mini motors in mobile device applications and share some similarity in technology and manufacturing know-how.

Acoustic component business Super linear speakers (SLS): The company indicates that growth of its

Android acoustics could reach 30%+ in 2018, driven by SLS (small form factor, a decent performance, but at a much lower cost than iPhone’s stereo acoustic system). AAC expects most of its Android clients to upgrade their speakers and the SLS adoption could reach 50% in 2018.

Dual speaker structure: It indicated this design will be more common in tablets than mobile phones, given the space constraints. Mobile phones can achieve the same stereo sound quality by using a speaker box + a receiver box.

2018 outlook: AAC expects the ASP uptrend to continue, driven by 1) increasing speaker usage, 2) a design change from receiver to actuator, and 3) rising adoption of the high ASP super linear speaker.

Valuations and risks

Sunway (300136.SZ), Buy Our target price of RMB60 is based on 35x PER (or 0.8x PEG), in line with regional peers. We believe our target multiple is fair as we expect Sunway to post double digit profit growth in the coming year, driven by continual market share gain, rising penetration on VCM frame, lightning connector and WPC. Risks: order allocation loss, spec upgrade slowdown and iPhone weakness.

O-Film (002456.SZ), Hold Our target price of RMB23 is based on 26x PER (or 0.8x PEG), in line with the trading average of regional tech peers. Upside risks: 1) faster takeoff of the fingerprint sensor business; 2) a stronger smartphone camera upgrade trend; 3) a strong recovery in China smartphone demand. Downside risks: 1) intense price competition in the touch panel sector; 2) a more significant margin erosion in handset cameras due to the smartphone consolidation trend.

AAC Technologies (2018.HK), Buy Our target price of HKD180 is based on 22x forward PER, higher than the historical average of 18x. We believe a re-rating is justifiable, given the improved long-term outlook and greater EPS growth. Risks: weak iPhone sales, price cuts and forex fluctuation.

19 January 2018



Tour: Takeaways of Chinese semiconductor trip Michael Chou, [email protected], (+886) 2 2192 2836

A bumpy road ahead for SCM companies We hosted a Chinese semiconductor trip visiting several SCM (semiconductor contract manufacturer - foundry and assembly/testing) companies last week. We reiterate Sell on SMIC due to a challenging outlook for 28/14nm. We maintain Buy on TSMC given its enhanced technology/cost leadership in 2018/20. In addition, we believe it will take two to three years for Chinese OSAT companies to prove their supply reliability/stability for overseas customers. We believe ASE/SPIL will remain competitive in 2018/19 due to strong customer support, supply reliability/stability, and logistic advantage. We retain Buy on ASE based on the synergy of the SPIL acquisition.

Foundry - Chinese vendors’ structural challenges remain in 2018/20 We continue to expect higher 28nm operating loss for SMIC in 2018/19. This is attributable to TSMC’s continuous 28nm price cuts based on the completed depreciation for the majority of 28nm capacity. SMIC targets 14nm mass production in 2H20. However, our sensitivity shows that there could be higher 14nm operating loss than 28nm operating loss for SMIC in 2020/21. We attribute this to high 14nm capex requirement and TSMC’s competitive 16/12nm pricing based on depreciation completion for the majority of 16/12nm capacity in 1H21 and another 20% reduction in the production cycle time in 2017/20. The 28/14nm negatives should imply more downside risks to SMIC’s ROE ahead (DBe 4.0%/3.6% in 2018/19).

OSAT - Execution improvement and technology upgrade still take time The tier-one Chinese OSAT player has acquired flip-chip packaging/testing technology via the acquisition of a global vendor. Cost reduction, integration of two companies’ R&D operation, and improvement in supply reliability/stability for non-China customers could remain the focus in 2018/19. Tier-two Chinese OSAT vendors lack solid flip-chip technology and hence could face growth challenges in 2018/19 when they try to gain market share in non-China customers. ASE and SPIL should continue to gain market share in US customers from Amkor in 2018/19 based on cost and logistic advantages. Most 28nm and 16/12nm will be produced by TSMC in Taiwan in 2018/19, which should continue to provide logistic benefit for ASE and SPIL.

Demand outlook - 2Q18 may see a new inventory restocking cycle Chinese SCM companies indicate demand weakness in smartphone-related ICs for Chinese smartphones in the near term. However, SCM customers’ (fabless and IDMs - integrated design manufacturer) rolling forecasts suggest QoQ shipment growth for Chinese SCM companies in 2Q18. This echoes our view that Chinese smartphone makers could start a new inventory replenishment cycle and place some orders for SCM companies’ customers from end-1Q18 for new product introduction, albeit gradually. This should benefit Asian SCM sector in 2Q18 and 2H18.

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Valuation and risks; catalysts Sector risks include demand, currency, ASP, and capex (please see page 2 for company catalysts and risks).

SMIC’s 14nm operating loss to be higher than 28nm operating loss

Figure 1 lists our assumptions for SMIC’s 28nm and 14nm operating loss. We estimate its 14nm operating loss per wafer should be 11-23% higher than its 28nm operating loss per wafer. SMIC plans to enter 14nm mass production in 2H20. We expect SMIC’s 14nm performance to be 10% below TSMC’s 16/12nm performance in 2021. We assume SMIC’s 14nm yield rate could reach 85% vs. TSMC’s 100% for 16/12nm in 2021. This implies SMIC’s 14nm ASP per wafer will need to be below TSMC’s 16/12nm ASP per wafer by more than 20% in 2021 to attract foundry customers to adopt its 14nm. We estimate TSMC to cut its 16/12nm ASP per wafer to USD 4,600-4,800 in 2021. This should be attributable to 1) a fully depreciated 16/12nm capacity in 1H21 and 2) 20% reduction in the production cycle time from 2017-20. In our view, SMIC will have to cut its 14nm ASP per wafer to USD3,400-3,500 in 2021 to compete with TSMC. This could result in operating loss of USD326/USD244 per wafer for SMIC in 14nm, 11-23% higher than its 28nm operating loss per wafer. Consequently, this could lead to more margin downside for SMIC in 2020E. We estimate a 3.6% ROE for SMIC in 2019. If SMIC starts to produce 14nm in 2H20, this could weigh on its ROE to below 4% in 2020/21E due to the expected increased operating loss in 14nm vs. 28nm.

Figure 31: SMIC’s 14nm operating loss to be 11-23% higher than 28nm operating loss

28nm 1K/m capex (USDm) 80 80 14nm 1K/m capex (USDm) 140 140 Depreciation per year (7 years for dep.; USDm) 11 11 Depreciation per year (7 years for dep.; USDm) 20 20

Depreciation per wafer (USD) 952 952 Depreciation per wafer (USD) 1,667 1,667 Non-depreciation cost per wafer (USD) 962 962 Non-depreciation cost per wafer (USD) 987 987

28nm yield rate (%) 90% 90% 14nm yield rate (%) 85% 85% Total cost per wafer (USD) 2,020 2,020 Total cost per wafer (USD) 2,948 2,948

28nm ASP per wafer (USD) 2,300 2,400 14nm ASP per wafer (USD) 3,400 3,500 28nm GM (%) 12.2% 15.8% 14nm GM (%) 13.3% 15.8% Opex ratio (%) 18.8% 18.8% Opex ratio (%) 18.3% 18.3%

Implied OPM for 28nm -6.7% -3.0% Implied OPM for 14nm -5.0% -2.5% Operating loss per wafer (USD) (153) (72) Operating loss per wafer (USD) (170) (88)

14nm vs. 28nm operating loss per wafer (%) 11% 23%

Source: Deutsche Bank estimates

Catalysts and company risks

ASE (2311.TW; Buy; target price NT$43.5; current price NT$38.8) Positive catalysts include market share gain from Amkor and increasing demand for wearable device SiP (system in packaging for Apple watch). We use the Gordon Growth Model to generate our target multiple, assuming a long-term return on equity of 14.5%, cost of equity of 8.7% and a long-term industry growth rate of 2.5%. We base our target price on 2.0x 2018E average P/B. Downside risks: faster ASP erosion, weaker end-demand and a faster ramp-up of TSMC’s InFO (integrated fan-out) solutions.

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SMIC (0981.HK; Sell; target price HK$5.9) Negative catalysts for SMIC include downside risks to 2018/19 GM due to increasing 28nm operating loss and market share loss in 8-inch power management ICs to TSMC for US fabless. We base our target price on 0.5x 2018E P/B, in line with the fair PB generated by a Gordon Growth model. Our long-term ROE forecast is 5.0%, given our concerns over its 28nm outlook and our forecast of an average 5.3% ROE in 2016/19. Upside risks include better 8 inch demand pick up, faster-than-expected 28nm market share gain, and strong demand.

TSMC (2330.TW, Buy, target price NT$266) Positive catalysts are related to strong 7nm in 2H18, share gain in 8-inch power management ICs from SMIC, robust IoT demand, IDMs’ increasing outsourcing for automotive ICs, and growing semiconductor dollar content in automotive applications. We base our target price on 3.4x 2019E P/B, which is in line with the fair P/B of 3.4x generated by the Gordon Growth Model (22% ROE, 2.5% long-term industry growth rate and 8.24% cost of equity). Downside risks include 10/7nm progress, ASP, capex, NTD trend and demand.

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Appendix 1

Important Disclosures Additional information available upon request Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report. Michael Tong Equity rating key Equity rating dispersion and banking relationships

Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock.

Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock

Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell.

Newly issued research recommendations and target prices supersede previously published research.

57 %

33 %

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Buy Hold Sell

Asia-Pacific Universe

Companies Covered Cos. w/ Banking Relationship

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Additional Information

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Aside from within this report, important risk and conflict disclosures can also be found at https://gm.db.com on each company’s research page and under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. United States: Approved and/or distributed by Deutsche Bank Securities Incorporated, a member of FINRA, NFA and SIPC. Analysts located outside of the United States are employed by non-US affiliates that are not subject to FINRA regulations, including those regarding contacts with issuer companies. Germany: Approved and/or distributed by Deutsche Bank AG, a joint stock corporation with limited liability incorporated in the Federal Republic of Germany with its principal office in Frankfurt am Main. Deutsche Bank AG is authorized under

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German Banking Law and is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority. United Kingdom: Approved and/or distributed by Deutsche Bank AG acting through its London Branch at Winchester House, 1 Great Winchester Street, London EC2N 2DB. Deutsche Bank AG in the United Kingdom is authorised by the Prudential Regulation Authority and is subject to limited regulation by the Prudential Regulation Authority and Financial Conduct Authority. Details about the extent of our authorisation and regulation are available on request. Hong Kong: Distributed by Deutsche Bank AG, Hong Kong Branch or Deutsche Securities Asia Limited (save that any research relating to futures contracts within the meaning of the Hong Kong Securities and Futures Ordinance Cap. 571 shall be distributed solely by Deutsche Securities Asia Limited). The provisions set out above in the "Additional Information" section shall apply to the fullest extent permissible by local laws and regulations, including without limitation the Code of Conduct for Persons Licensed or Registered with the Securities and Futures Commission. . India: Prepared by Deutsche Equities India Private Limited (DEIPL) having CIN: U65990MH2002PTC137431 and registered office at 14th Floor, The Capital, C-70, G Block, Bandra Kurla Complex Mumbai (India) 400051. Tel: + 91 22 7180 4444. It is registered by the Securities and Exchange Board of India (SEBI) as a Stock broker bearing registration nos.: NSE (Capital Market Segment) - INB231196834, NSE (F&O Segment) INF231196834, NSE (Currency Derivatives Segment) INE231196834, BSE (Capital Market Segment) INB011196830; Merchant Banker bearing SEBI Registration no.: INM000010833 and Research Analyst bearing SEBI Registration no.: INH000001741. DEIPL may have received administrative warnings from the SEBI for breaches of Indian regulations. Deutsche Bank and/or its affiliate(s) may have debt holdings or positions in the subject company. With regard to information on associates, please refer to the “Shareholdings” section in the Annual Report at: https://www.db.com/ir/en/annual-reports.htm. Japan: Approved and/or distributed by Deutsche Securities Inc.(DSI). Registration number - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117. Member of associations: JSDA, Type II Financial Instruments Firms Association and The Financial Futures Association of Japan. Commissions and risks involved in stock transactions - for stock transactions, we charge stock commissions and consumption tax by multiplying the transaction amount by the commission rate agreed with each customer. Stock transactions can lead to losses as a result of share price fluctuations and other factors. Transactions in foreign stocks can lead to additional losses stemming from foreign exchange fluctuations. We may also charge commissions and fees for certain categories of investment advice, products and services. Recommended investment strategies, products and services carry the risk of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses and other documentation. "Moody's", "Standard & Poor's", and "Fitch" mentioned in this report are not registered credit rating agencies in Japan unless Japan or "Nippon" is specifically designated in the name of the entity. Reports on Japanese listed companies not written by analysts of DSI are written by Deutsche Bank Group's analysts with the coverage companies specified by DSI. Some of the foreign securities stated on this report are not disclosed according to the Financial Instruments and Exchange Law of Japan. Target prices set by Deutsche Bank's equity analysts are based on a 12-month forecast period.. Korea: Distributed by Deutsche Securities Korea Co. South Africa: Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register Number in South Africa: 1998/003298/10). Singapore: This report is issued by Deutsche Bank AG, Singapore Branch or Deutsche Securities Asia Limited, Singapore Branch (One Raffles Quay #18-00 South Tower Singapore 048583, +65 6423 8001), which may be contacted in respect of any matters arising from, or in connection with, this report. Where this report is issued or promulgated by Deutsche Bank in Singapore to a person who is not an accredited investor, expert investor or institutional investor (as defined in the applicable Singapore laws and regulations), they accept legal responsibility to such person for its contents. Taiwan: Information on securities/investments that trade in Taiwan is for your reference only. Readers should independently evaluate investment risks and are solely responsible for their investment decisions. Deutsche Bank research may not be distributed to the Taiwan public media or quoted or used by the Taiwan public media without

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written consent. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation to trade in such securities/instruments. Deutsche Securities Asia Limited, Taipei Branch may not execute transactions for clients in these securities/instruments. Qatar: Deutsche Bank AG in the Qatar Financial Centre (registered no. 00032) is regulated by the Qatar Financial Centre Regulatory Authority. Deutsche Bank AG - QFC Branch may undertake only the financial services activities that fall within the scope of its existing QFCRA license. Its principal place of business in the QFC: Qatar Financial Centre, Tower, West Bay, Level 5, PO Box 14928, Doha, Qatar. This information has been distributed by Deutsche Bank AG. Related financial products or services are only available only to Business Customers, as defined by the Qatar Financial Centre Regulatory Authority. Russia: The information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation. Kingdom of Saudi Arabia: Deutsche Securities Saudi Arabia LLC Company (registered no. 07073-37) is regulated by the Capital Market Authority. Deutsche Securities Saudi Arabia may undertake only the financial services activities that fall within the scope of its existing CMA license. Its principal place of business in Saudi Arabia: King Fahad Road, Al Olaya District, P.O. Box 301809, Faisaliah Tower - 17th Floor, 11372 Riyadh, Saudi Arabia. United Arab Emirates: Deutsche Bank AG in the Dubai International Financial Centre (registered no. 00045) is regulated by the Dubai Financial Services Authority. Deutsche Bank AG - DIFC Branch may undertake only the financial services activities that fall within the scope of its existing DFSA license. Its principal place of business in the DIFC: Dubai International Financial Centre, The Gate Village, Building 5, PO Box 504902, Dubai, U.A.E. This information has been distributed by Deutsche Bank AG. Related financial products or services are available only to Professional Clients, as defined by the Dubai Financial Services Authority. Australia and New Zealand: This research is intended only for "wholesale clients" within the meaning of the Australian Corporations Act and New Zealand Financial Advisors Act, respectively. Please refer to Australia-specific research disclosures and related information at https://australia.db.com/australia/content/research-information.html Where research refers to any particular financial product recipients of the research should consider any product disclosure statement, prospectus or other applicable disclosure document before making any decision about whether to acquire the product. Additional information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or published without Deutsche Bank's prior written consent. Copyright © 2018 Deutsche Bank AG

David Folkerts-Landau

Group Chief Economist and Global Head of Research

Raj Hindocha Global Chief Operating Officer

Research

Michael Spencer Head of APAC Research

Global Head of Economics

Steve Pollard Head of Americas Research

Global Head of Equity Research

Anthony Klarman Global Head of Debt Research

Paul Reynolds Head of EMEA

Equity Research

Dave Clark Head of APAC

Equity Research

Pam Finelli Global Head of

Equity Derivatives Research

Andreas Neubauer Head of Research - Germany

Spyros Mesomeris Global Head of Quantitative

and QIS Research

International locations Deutsche Bank AG Deutsche Bank Place Level 16 Corner of Hunter & Phillip Streets Sydney, NSW 2000 Australia Tel: (61) 2 8258 1234

Deutsche Bank AG Mainzer Landstrasse 11-17 60329 Frankfurt am Main Germany Tel: (49) 69 910 00

Deutsche Bank AG Filiale Hongkong International Commerce Centre, 1 Austin Road West,Kowloon, Hong Kong Tel: (852) 2203 8888

Deutsche Securities Inc. 2-11-1 Nagatacho Sanno Park Tower Chiyoda-ku, Tokyo 100-6171 Japan Tel: (81) 3 5156 6770

Deutsche Bank AG London 1 Great Winchester Street London EC2N 2EQ United Kingdom Tel: (44) 20 7545 8000

Deutsche Bank Securities Inc. 60 Wall Street New York, NY 10005 United States of America Tel: (1) 212 250 2500

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