Jefferies Global Footprint
Jefferies Hong Kong Limited
22nd Floor
Cheung Kong Center
2 Queen’s Road Central
Central, Hong ...
China | Equity Strategy
China 20 November 2013
China
The Year of the Horse: China Gallops into a
Historic Bull Run
EQUITYR...
Table of Contents
The Year of the Horse: China Gallops into a
Historic Bull Run
Clearing the Path to Prosperity 3
Getting ...
Clearing the Path to Prosperity
We believe President Xi will usher in a new era of profound change in China,
rivaling that...
Exhibit 1: China’s household income 2010 (Rmb)
Source: CHFS, Jefferies
Gini Coefficient unusually high
We diagnosed that e...
The Kuznets curve hypothesis has been stretched beyond its original emphasis on
economic inequality and applied to all sor...
its Gini coefficient from 0.49 to 0.38 through progressive taxation and transfer
payments.
More wealth = more redistributi...
Exhibit 6: Gov’t spending as % of GDP vs. per capita GDP
Source: World Bank, Heritage Foundation, Jefferies
Exhibit 7: Con...
Unprecedented economic reforms
Pessimism over the Third Plenum's vague initial communiqué was premature, in our
view. We f...
Growth-at-all-costs to growth-for-employment
Two years in a row, China targeted 7.5% GDP growth, abandoning the double-dig...
Party organ to push reform
We believe economic reforms stalled during the Hu-Wen administration as power
became fragmented...
Table of Contents
The Year of the Horse: China Gallops into a
Historic Bull Run
Clearing the Path to Prosperity 3
Getting ...
JEF 2013 Top Picks Performance
Review
Since we introduced Jefferies China 2013 Top Picks on Feb 24, 2013, our investment
p...
Exhibit 12: JEF Top Sell portfolio initiated on April 24
Stock Price
China Cosco 3.38
China Shipping Dev. 3.45
CNBM 9.81
P...
Jefferies China 2014: Sector Allocation
We like auto, energy, financial, healthcare, retail property, and staples
In 2014,...
Oil/Gas (Fundamental Positive; asset allocation Over-weight)
We expect three themes to drive energy stocks: 1) market pric...
Jefferies China 2014 Top Picks
In 2014, we recommend investors to overweight autos, financials, healthcare, retail
propert...
TOP BUYS
Baidu (BIDU US, BUY, TP US$222)
Our positive outlook on Baidu is built upon its faster than expected mobile searc...
PetroChina (857 HK, Buy, TP HK$12)
PetroChina has the best oil & gas assets among the three oils. We believe 2014 energy
p...
Digital China (861 HK, UNDERPERFORM, TP HK$8)
Despite management’s best efforts, we see ongoing structural challenges in D...
Baidu (BIDU US, BUY, TP US$222)
Key Takeaway
Our positive outlook on Baidu is built upon its faster than expected mobile
s...
Bank of China (3988 HK, Buy, TP HK$4.9)
Key Takeaway
We believe BOC will benefit from greater RMB internationalization, an...
CITIC Securities (6030 HK, Buy, TP HK$22)
Key Takeaway
As the No.1 China broker with a strong investment banking (IB) fran...
China Resources Enterprise (291 HK, Buy, TP
HK$32.5)
Key Takeaway
We believe CRE’s consolidation will bear fruit in the lo...
CapitaMalls Asia (CMA SP, Buy, TP SG$2.4)
Key Takeaway
A mass-end mall operator, CapitaMalls Asia is a choice of defensive...
Dongfeng (489 HK, BUY, TP HK$15.3)
Key Takeaway
Dongfeng is an obvious beneficiary of the set of reforms introduced after
...
Fosun Pharma (2196 HK, BUY, TP HK$25)
Key Takeaway
As a leading Chinese diversified healthcare company, Fosun Pharma has a...
Huaneng Renewable (958 HK, BUY, TP HK$4.3)
Key Takeaway
We are in a structural growth story for wind farm operators, and H...
PetroChina (857 HK, Buy, TP HK$12)
Key Takeaway
PetroChina has the best oil & gas assets among the three oil and gas
compa...
Ping An (2318 HK, BUY, TP HK$83)
Key takeaway
Ping An is our top pick in the China insurance sector. It is the only listed...
Shanghai Industrial (363 HK, Buy, HK$30)
Key takeaways
We like SIHL’s balanced portfolio, stable earnings and attractive v...
Sinopharm (1099 HK, BUY, TP HK$26.5)
Key Takeaway
Sinopharm is our favourite Chinese pharma distributor, given its
unsurpa...
Agile (3383 HK, Underperform, TP HK$7.8)
Key takeaway
We maintain Underperform on Agile as we consider its aggressive land...
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Jefferies China Year of the Horse 2013

  1. 1. Jefferies Global Footprint Jefferies Hong Kong Limited 22nd Floor Cheung Kong Center 2 Queen’s Road Central Central, Hong Kong Jefferies.com Investment Banking Equities Fixed Income Commodities Wealth & Asset Management The Americas New York (Global Headquarters) +1 212.284.2300 Albany +1 518.447.7941 Atlanta +1 404.264.5000 Boston +1 617.342.7800 Charlotte +1 704.943.7400 Chicago +1 312.750.4700 Dallas +1 972.701.3000 Denver +1 303.524.1625 Houston +1 281.774.2000 Jersey City +1 212.284.2300 Los Angeles +1 310.914.6611 Nashville +1 615.963.8300 Orlando +1 407.583.0855 San Francisco +1 415.229.1400 São Paulo +55 (11) 3728 9323 Short Hills +1 973.912.2900 Silicon Valley +1 650.573.4800 Stamford +1 203.708.5980 Toronto +1 416.572.2440 Washington, DC +1 202.639.3980 Europe & The Middle East London1 (European Headquarters) +44 (0) 20 7029 8000 Dubai +971 4 376 3200 Frankfurt +49 69 719 187 0 Hamburg +49 40 341080 Milan +39 (0) 2 3601 1900 Paris +33 1 5343 6700 Zurich +41 4 4227 1600 Asia Hong Kong2 (Asian Headquarters) +852 3743 8000 Mumbai +91 22 4356 6000 Shanghai3 +86 21 5111 8700 Singapore +65 6551 3950 Tokyo +81 3 5251 6100 © 2013 Jefferies LLC 1. Jefferies International Limited and Jefferies Bache Limited are authorised and regulated by the Financial Conduct Authority. 2. Jefferies Hong Kong Limited, Licensed by the Securities and Futures Commission of Hong Kong with CE number ATS546. 3. A representative office of Jefferies LLC China The Year of the Horse: China Gallops into a Historic Bull Run China 2014 | Equity Strategy Asia Equity Research | November 2013 • Baidu (BIDU US) • Bank of China (3988 HK) • CITIC Securities (6030 HK) • China Resources Enterprise (291 HK) • CapitaMalls Asia (CMA SP) • Dongfeng (489 HK) • Fosun Pharma (2196 HK) • Huaneng Renewable (958 HK) • PetroChina (857 HK) • Ping An (2318 HK) • Shanghai Industrial (363 HK) • Sinopharm (1099 HK) Jefferies Hong Kong Ltd. Christie Ju, CFA Laban Yu Julian Bu Venant Chiang Sean Darby Jessie Guo, PhD Johnson Leung Jessica Li, PhD Rong Li Cynthia Meng Ming Tan, CFA Jefferies China 2014 Top Buys: JefferiesResearchNovember2013China2014
  2. 2. China | Equity Strategy China 20 November 2013 China The Year of the Horse: China Gallops into a Historic Bull Run EQUITYRESEARCHCHINA Christie Ju, CFA * Equity Analyst +852 3743 8012 cju@jefferies.com Laban Yu * Equity Analyst +852 3743 8047 lyu@jefferies.com Julian Bu * Equity Analyst +852 3743 8058 jbu@jefferies.com Venant Chiang * Equity Analyst +852 3743 8013 venant.chiang@jefferies.com Sean Darby * Chief Global Equity Strategist +852 3743 8073 sdarby@jefferies.com Jessie Guo, PhD * Equity Analyst +852 3743 8036 jguo@jefferies.com Johnson Leung * Equity Analyst +852 3743 8055 jleung@jefferies.com Jessica Li, Ph.D. * Equity Analyst +852 3743 8010 jessica.li@jefferies.com Rong Li * Equity Analyst +852 3743 8014 rli@jefferies.com Cynthia Meng * Equity Analyst +852 3743 8033 cmeng@jefferies.com Ming Tan, CFA * Equity Analyst +852 3743 8752 ming.tan@jefferies.com * Jefferies Hong Kong Limited Key Takeaway The Year of the Horse will see China unleash its full potential, as President Xi ushers in a new era of profound change. A journey of a thousand miles begins with the first step. With a clear path to prosperity in sight, we believe China will gallop into a historic multi-year bull run. Reform has reached consensus. In our China 2025: A Clear Path to Prosperity report, we wrote that economic reforms are required, well understood and will develop organically with rising wealth. The Third Plenum has provided a set of specific, substantial, comprehensive and actionable reforms. We believe President Xi has consolidated power, removed obstacles and established the political mechanisms to push through reforms. Bold steps in political reform. We believe the political reforms highlighted by the Third Plenum are myriad, substantial, and likely to be dismissed by Western observers. Political progress in China (and for all nations) is better judged through the lens of effectiveness rather than on a contrived authoritarian-democratic scale. We believe China is recreating Singapore writ large. Government power is being centralized; priority will shift from economic participation to social administration; SOEs will act less as levers of economic planning and more to maximize value of the nation's assets. Central Committee to drive implementation. We believe economic reforms stalled during the Hu-Wen administration as power fragmented between ministries, SOEs and local governments. The NDRC, the government entity responsible for economic reform, has become sclerotic, unable to cut through vested interests. We believe the creation of a Central Reform Committee (likely to be chaired by Secretary Xi) under the Party (not the government) is critically important. We believe this committee will be able to cut through calcified bureaucracies and vested interests to get things done. China gallops into a historic bull run. We believe President Xi is a determined reformer. After consolidating power, he now has the political capital to rapidly implement bold and myriad policies, in our view. We expect capital markets to gradually gain confidence in China’s ability to drive fundamental reforms and expect Chinese stocks to enter a historic multi-year bull run. Jefferies 2014 Sector Allocation. As the market comes to terms with China’s new growth trajectory, we expect the HSI and HSCEI to close 2013 on a high note. We believe the indices will test new highs in 2014 with increasing policy and implementation clarity. We recommend investors buy airlines, autos, banks, brokers, consumer staples, healthcare, insurance, Internet, clean energy and retail property, and sell industrials, metals & mining, residential property, shipping, tech and telecoms. Jefferies 2014 Top Picks. We believe investors should focus on domestic reform plays in 2014. Our Top Buys are Baidu, BOC, CITIC Securities, CRE, CMA, Dongfeng, Fosun Pharma, Huaneng Renewable, Sinopharm, PetroChina, Ping An and Shanghai Industrial. Our Top Sells are Agile, Belle, China Cosco, China Coal, CNBM, Digital China, Longfor, Zhaojin, Zijin and Yanzhou Coal. Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies 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. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 221 to 226 of this report.
  3. 3. Table of Contents The Year of the Horse: China Gallops into a Historic Bull Run Clearing the Path to Prosperity 3 Getting from here to there 9 China 2014: Sector Allocation & Top Picks 2013 Top Picks Performance Review 12 China 2014: Sector Allocation 14 China 2014: Top Buys and Top Sells 16 Our Journey Starts with China 2025 A review of Jefferies’ key China Strategy reports 43 Jefferies China 2014 Sector View China Macro 80 Agriculture 92 Conglomerate 101 Consumer 107 Energy 112 Financials (Bank, Insurance and Broker) 124 Gaming 141 Healthcare 148 Industrials 154 Metals & Mining 163 Property 179 TMT (Internet, Telecom and Tech) 187 Transportation 208 Utilities 215 Equity Strategy China 20 November 2013 page 2 of 228 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFA Please see important disclosure information on pages 221 - 226 of this report.
  4. 4. Clearing the Path to Prosperity We believe President Xi will usher in a new era of profound change in China, rivaling that of Deng Xiaoping's opening of China in 1978. The Third Plenum has provided a set of specific, substantial, comprehensive and unprecedented reforms, in our view. We believe President Xi has consolidated power, removed obstacles and established the political mechanisms to push through reforms. We believe markets will gain strength in 2014 with confident implementation. Reform is consensus In China 2025: A Clear Path to Prosperity, we wrote that economic reforms in China are required, well understood and will develop organically with rising wealth. Reforms such as economic rebalancing, reducing inequality, financial liberalization, environmental protection, liberalizing rural land transfers etc. have become boilerplate, discussed by various government entities in many different forums. We believe the necessity of reform has won the argument at many levels of China's government to avoid the "middle-income trap". The challenge has been overcoming inertia and vested interests. We believe China's old growth model has run its course, revealing vulnerabilities in an unbalanced economy. As expected, policy uncertainty has made 2013 challenging for equities. In our China 2013: Transformation and Volatility in the Year of the Snake published February 2013, we wrote: We see 2013 as a year of transformation and a new beginning for China. This will be the year that Secretary (and soon to be President) Xi Jinping puts his policies on track. We believe China’s new leaders have the will, the power and the strong support from the 1.3 billion people to embark on its critical transformation. On the other hand, we expect 2013 to be a volatile year for China equities, as the market comes to terms with the developing policy trajectory. We would not be surprised if China stocks ended the year not far from where they began. 2014 will be different, in our view. We believe policy consensus has been reached and markets will gain strength with reform clarity and confident implementation. Consumption – an inequality problem It is almost universally acknowledged that China’s export/investment driven economic growth model is not sustainable. The central government has repeatedly tried to jump- start domestic consumption in hopes of transforming the growth model, but with limited success. Many blame China’s high savings rate for low consumption, and policies have been set up to discourage savings. We believe the real reason for low consumption is China’s alarming income and wealth inequality, of which a high savings rate is merely a natural consequence. With first-hand data provided by the China Household Finance Survey (CHFS), we believe the key to boosting domestic consumption is to reduce income/wealth inequality. We believe markets will gain strength in 2014 with confident implementation The real culprit for low consumption is inequality Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 3 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  5. 5. Exhibit 1: China’s household income 2010 (Rmb) Source: CHFS, Jefferies Gini Coefficient unusually high We diagnosed that economic inequality, rather than a cultural propensity to save, is the root cause of persistent weakness in China’s consumption growth. We concluded that the key to addressing this unbalanced economy is income redistribution through transfer payments, a process that happens organically as societies become wealthier. Based on the CHFS, China’s Gini Coefficient was 0.61 in 2010, one of the highest in the world. The high Gini reflects disparity in labor income, business income and investment income. It is consistent with the vast income and wealth disparity among Chinese households and reflects a lack of state-mandated transfer payments. Given poorer households’ higher propensity to consume, we believe significant transfer payments are necessary to reduce the high Gini, narrow the wealth gap and boost domestic consumption. Exhibit 2: GINI coefficient, select countries Source: World Bank, OECD, Jefferies The Kuznets curve, development self-corrects In the 1930s, Simon Kuznets, a Russian American economist, developed a theory regarding wealth disparity which has later been applied to other undesirable outcomes of economic development. The Kuznets curve is an optimistic hypothesis which stipulates that there is a natural trend of economic inequality, determined by market forces, driving up inequality during early periods of industrialization and urbanization, which, in time, will be corrected as economies mature and human capital accrues. 17.5 28.0 10.6 559 664 275 0 100 200 300 400 500 600 700 Nationwide Urban RuralThousands Median Household income Top 1% Household income 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 Norway,late2000's Finland,late2000's Hungary,late2000's Germany,late2000's S.Korea,2000's Poland,late2000's Greece,late2000's OECD,late2000's Spain,late2000's Canada,late2000's Japan,late2000's N.Zealand,late2000's Italy,late2000's UK,late2000's US,late2000's Thailand,2009 Russia,2009 Philippines,2009 Uganda,2009 Argentina,2009 Malaysia,2009 DominicanRep,2010 Mexico,late2000's Nigeria,2009 Peru,2009 Ecuador,2010 Chile,late2000's Swaziland,2009 Panama,2009 Paraguay,2009 Brazil,2009 Colombia,2010 Honduras,2009 China,2012 SouthAfrica,2009 GINI China’s Gini Coefficient was 0.61 in 2010 Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 4 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  6. 6. The Kuznets curve hypothesis has been stretched beyond its original emphasis on economic inequality and applied to all sorts of undesirable by-products of economic growth. It is often used to analyse the relationship between economic development and environmental protection. In the China context, we believe it can also be applied to corruption, an unbalanced economy and personal freedoms. Exhibit 3: Theoretical Kuznets curve Source: Simon Kuznets, Jefferies Transfer payments and the modern economy Simon Kuznets developed his curve in the 1930s, based on the experience of US and European nations during industrialization. The Kuznets curve, where market forces push back against undesirable externalities of economic development, is not a concept new to China. Every developed nation, in fact, has travelled the same path. Empirically, every developed economy has established sophisticated transfer payment systems, redistributing a significant portion of societal income. Overall, taxes and transfer payments within the OECD economies lower total Gini coefficient from 0.46 to 0.32. Exhibit 4: GINI coefficient before and after taxes and transfers, OECD countries Source: OECD, Jefferies Ideology plays a role, wealth level plays a bigger role Using taxes and transfer payments, the Scandinavian cradle-to-grave welfare states have lowered their Gini coefficient to ~0.25 from ~0.43. Turkey, Mexico and Chile, lower income members of the OECD, have the least developed transfer payment systems. The US, the world’s leading champion of free-market principles, has still managed to lower 0.00 1.00 2.00 3.00 4.00 5.00 6.00 1930 1940 1950 1960 1970 1980 1990 2000 2010 Income per capita Undesireableexternality 0.24 0.25 0.25 0.26 0.26 0.26 0.26 0.26 0.26 0.27 0.29 0.29 0.29 0.30 0.30 0.30 0.31 0.31 0.31 0.31 0.32 0.32 0.32 0.33 0.33 0.34 0.34 0.34 0.35 0.37 0.38 0.41 0.48 0.49 0.42 0.42 0.41 0.44 0.42 0.47 0.47 0.43 0.47 0.47 0.48 0.48 0.43 0.50 0.38 0.41 0.47 0.44 0.34 0.46 0.46 0.46 0.44 0.46 0.46 0.47 0.53 0.51 0.52 0.50 0.49 0.47 0.49 0.53 0 0.1 0.2 0.3 0.4 0.5 0.6 Slovenia Denmark Norway CzechRep SlovakRep Belgium Finland Sweden Austria Hungary Luxemb… France Netherla… Germany Iceland Switzerl… Poland Greece Korea OECD… Estonia Spain Canada Japan N.Zealand Australia Italy UK Portugal Israel US Turkey Mexico Chile GINI After taxes and transfers Before taxes and transfer Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 5 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  7. 7. its Gini coefficient from 0.49 to 0.38 through progressive taxation and transfer payments. More wealth = more redistribution Empirically, the extent of a nation’s income redistribution appears to be a function of its income level at least as much as its stated or perceived ideological disposition. The comparison between the US and China is especially stark. In recent years, Communist China’s “capitalism with Chinese characteristics” has taken on the distinct historical flavor of the “robber baron” capitalism experienced by the US at the turn of the last century. The free market champion of the US, while certainly no Scandinavia, has adopted an extensive social welfare system (now including universal healthcare) far more extensive than communist China’s. Exhibit 5: Government spending and tax burden as a percentage of GDP, 2011 Source: Heritage Foundation, Jefferies Among 46 major representative economies we tracked, there is a clear positive correlation between per capita GDP and government spending as a percentage of GDP. Government spending in under-developed nations is often below 20% of GDP while topping 50% among European welfare states. As seen in the OECD data, much of this spending is transfer payments used to redistribute income. The fact that China’s government spending constitutes only 21% of GDP (vs. 39% for the US), despite having a declared communist ideology, is largely understandable given its comparably low per capita GDP. Social welfare spending constitutes only 21.2% of China’s government budget compared to 46.7% in the US. As a percentage of GDP, social welfare spending constitutes 4.4% compared to 18.2% in the US. 0% 10% 20% 30% 40% 50% 60% France Sweden Denmark Belgium Belarus Finland Hungary Austria Italy Ukraine UK Greece Portugal Netherlands Germany Poland CzechRep Spain Brazil Norway Canada US Japan Australia Russia Egypt Venezuela Kenya Nigeria SouthKorea SaudiArabia Vietnam Iran SouthAfrica India Malaysia Argentina Mexico Turkey Chile China Pakistan Indonesia Thailand Philippines Bangladesh Government spending as percent of GDP Tax burden as percent of GDP There is a clear positive correlation between per capita GDP and government spending as a percentage of GDP Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 6 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  8. 8. Exhibit 6: Gov’t spending as % of GDP vs. per capita GDP Source: World Bank, Heritage Foundation, Jefferies Exhibit 7: Contribution to GDP by spending Source: Heritage Foundation, CHFS, Jefferies Stronger and more comprehensive than our prescription In our report, we had identified eight basic policies that China would adopt to reduce inequality. All eight are covered by the Third Plenum report. By design, our prescription was academic in nature, focusing on development paths more than the nitty-gritty mechanics of specific policies and targets. The Third Plenum report is much more comprehensive, giving specific targets, policy prescriptions and administrative changes required to achieve reforms. Exhibit 8: Reform policies Jefferies China 2025 Third Plenum Economic Increase SOE dividend pay-out Increase SOE dividend pay-out to 30% Progressive taxation Impose property tax, luxury tax, close loopholes Market to play “decisive” resource allocation Accelerate Rmb convertibility Promote “mixed ownership” of SOEs Transfer some state assets to social security fund Lower entry barriers for private/foreign investors Accelerate Rmb convertibility Strengthen protection of intellectual property Support the Free Trade Zones Establish unified rural/urban land market Social Relax one child policy Relax one child policy Strengthen pension system Strengthen pension system Strengthen social healthcare system Strengthen social healthcare system Strengthen education and vocational training Strengthen education and vocational training Increase supply of social housing Increase supply of social housing Promote and ease urbanization Promote and ease urbanization Deficit spending Increase spending on welfare Political Strengthen judicial system Abolish reeducation through labor Strengthen anti-corruption efforts Strengthen environment regulations Source: China Communist Party, Jefferies France Sweden Denmark Belgium Belarus Finland Hungary Austria Italy Ukraine UK Greece Portugal Netherlands Germany Poland CzechRep Spain Brazil Norway Canada US Japan Australia Russia Egypt Venezuela Kenya Nigeria SouthKorea SaudiArabia Vietnam SouthAfrica India Malaysia Argentina Mexico Turkey Chile China Pakistan Indonesia Thailand Philippines Bangladesh R² = 0.4374 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 Per capita GDP, US$2005 PPP 4.4% 18.2% 16.4% 20.7% 79.2% 61.1% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% China US Non government spending Other government spending Social welfare spending Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 7 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  9. 9. Unprecedented economic reforms Pessimism over the Third Plenum's vague initial communiqué was premature, in our view. We find the 60-point follow-up document to be specific, substantial, comprehensive and unprecedented. The detailed paper is not a boiler-plate reiteration of required reforms but an internally consistent document that recognizes the complexity of China's problems and matches them with holistic solutions, in our view. Key economic reforms include: Market pricing. The initial Third Plenum communiqué stated that the markets will play a "decisive" role in allocating resources. The previous language was that markets would play a "basic" role. We believe this formulation has profound implications for China's energy industry, where regulated prices have been the norm. Details in the 60- point follow-up document specifically called for market pricing of petroleum, natural gas, water, electricity, transportation and telecommunications. SOE restructuring. The initial Third Plenum communiqué reiterated the central role of SOEs in China's economy, giving fodder to the reform pessimists. The 60-point follow- up document, however, has changed the mandate of SOEs from being levers of central planning to value maximizers of state assets, a profound change, in our view. Financial reform. The initial Third Plenum communiqué did not mention financial reform. This, we believe, more than anything else led to the initial pessimism and the market sell-off. Financial reform, however, is a major theme of the 60-point follow-up document. Among them, allowing private capital to enter banks, accelerate full convertibility of RMB and market pricing of FX/interest rates. Free trade zones. The 60-point follow-up document specifically mentioned support for the Shanghai Free Trade Zone as well as to accelerate the formation of other free trade zones. The Shanghai Free Trade Zone captured the excitement of China watchers this Fall which has, to some degree, waned as details and high-level political support appeared unforthcoming. We believe Free Trade Zones will be used as spring boards of economic reform and should be closely watched. Environmental regulations. The key environmental regulatory concept contained in Third Plenum reforms is that negative externalities of resource consumption must be priced and borne by consumers. Resource taxes, emission trading and stricter emissions standards are mechanisms that can reduce environmental damage. Invigorated environmental regulations will negatively affect the economics of highly polluting resources, with limited scope for emissions reduction and significant substitution potential by alternatives. A political transformation The political reforms mentioned in the document are myriad, substantial and we believe very likely to be dismissed by Western observers. Political progress in China (perhaps for all nations) is better judged through the lens of effectiveness rather than on a contrived authoritarian-democratic scale, in our view. Singapore writ large We believe China is recreating Singapore writ large. Government power is being centralized; priority will shift from economic participation to social administration; SOEs will act less as levers of economic planning and more to maximize the value of the nation's assets. The foreign media will highlight their hobby horses – relaxation of the one-child policy, abolishing the reeducation through labor system and overhauling the judicial system to enhance the independence of courts. We do not disagree that these are important political and social reforms but getting less press but perhaps more significant are administrative changes and a reprioritizing of government goals. China will change the way it evaluates local officials by focusing less on GDP growth and more on debt management, innovation, the environment, public health and social welfare. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 8 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  10. 10. Growth-at-all-costs to growth-for-employment Two years in a row, China targeted 7.5% GDP growth, abandoning the double-digit growth rates of years past. Maintaining employment has forced the government to rely on substantial FAI in 2013. Premier Li Keqiang stated that China needs GDP to be ~7.2% to keep unemployment in check. This "growth-for-employment" is a significant departure from "growth-at-all-costs." We believe economic reforms will help drive organic job creation alleviating required FAI stimulus. Getting from here to there The 60-point Third Plenum document looks very good on paper, removing initial market doubt that President Xi and Premier Li are serious about reform. We believe confident implementation of myriad policies throughout 2014 will further strengthen markets. Quick consolidation of power With some credit to his predecessor, Xi Jinping successfully consolidated power in a short period of time. Xi Jinping assumed the offices of the General Secretary of the Party, the Presidency and Chairman of the Military within six months. In a break from tradition, outgoing President Hu Jintao gracefully relinquished all official posts on retirement. This auspicious start allowed President Xi to hit the ground running. Anti-corruption campaign clearing obstacles China's anti-corruption campaign has surprised us in intensity and duration. Party cadres at all levels have been called to the carpet to account for past deeds (or misdeeds). Investigations have brought down the top management of PetroChina, the head of SASAC, the director of the NEA and have reportedly reached into the Standing Committee of the Politburo. Anti-corruption drives are nothing new but Secretary Xi has conducted this one with an energy and style that wholly eluded his predecessors. We believe this anti-corruption campaign has sufficiently rattled the Party's rank-and-file, priming them to accept significant reforms. Xi Jinping gives anti-corruption efforts a shot in the arm China’s anti-corruption efforts appear to have been given a shot in the arm since Xi Jinping took over as Party Secretary. To be fair, exiting President Hu Jintao warned the Communist Party in his valedictory address that failing to rein in corruption “could prove fatal to the party and even cause the collapse of the state”. Anti-corruption efforts started the New Year strongly with a series of developments both large and small. Banning elaborate red carpet ceremonies, banquets and pompous speeches in routine government business Removal of Li Chuncheng, deputy Party secretary Sichuan, for breach of party discipline Removal of Liu Tienan, Director of the National Energy Administration, for accepting bribes, misrepresenting academic qualifications and transgressions in his personal life Conviction and life imprisonment of Bo Xilai for corruption and abuse of power. Investigation of and dismissal of five top PetroChina executives for serious violations of discipline Investigation of and dismissal of Jiang Jiemin, Director of SASAC and former Chairman of CNPC/PetroChina, for serious violations of discipline Tacit approval for online muckrakers who have exposed a parade of officials for illicit and inappropriate behaviour Xi Jinping publicly stated that the Party should welcome “sharp criticism” “Corruption could prove fatal to the party and even cause the collapse of the state” – President Hu Jintao Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 9 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  11. 11. Party organ to push reform We believe economic reforms stalled during the Hu-Wen administration as power became fragmented among ministries, SOEs and local governments. The NDRC, the government entity responsible for economic reform, has become sclerotic, unable to cut through vested interests, in our view. We believe the establishment of a Central Reform Committee (likely to be chaired by Secretary Xi) under the Party (not the government) is critically important. We believe this committee will be able to cut through calcified bureaucracies and vested interests. Economic reform has calcified under the NDRC Before 2003 (when reforms start to stall) the State Council Office for Restructuring the Economic System (SCORES) was the government department dedicated to driving economic reforms. This department was independent of the State Planning Commission (SPC) which was responsible for the nuts and bolts of China’s planned economy. In 2003, these two government departments were merged to form the National Development and Reform Commission (NDRC). At the time, the idea was that the reformers from SCORES could be more effective working closely with the central planners at SPC. In actuality, it appears that the reformist vitality of SCORES was diluted by the conservatism of the SPC. The dual mandate of the NDRC, economic planning and economic reform, were in conflict, stalling economic reforms for a decade. Breaking the gridlock We believe the Central Reform Committee, with support from the highest levels of the Party, will recapture the reformist vitality of SCORES. The team will be in charge of designing reform on an overall basis, arranging and coordinating reform, pushing forward reform as a whole, and supervising the implementation of reform plans. Expect confident implementation in 2014 Within days of the release of the Third Plenum’s 60 point document, government agencies in China have floated coming policy changes through the press. We believe we will see rapid implementation of policies giving credence to the reformist agenda of the Xi-Li administration. So far, the media has given us a taste: President Xi declared through the press that implementation will be priority and must be conducted with courage. NDRC official commented that the next phase is to open up fuel prices to the market. PBOC governor Zhou Xiaochuan affirms that Rmb trading band will be widened and the PBOC will gradually exit FX intervention. In a media interview, NDRC chairman Xu Shaoshi declared the commission is drafting a paper to lead reforms by the nose. These include initiatives to reduce administrative approvals for investment, accelerate price reform and initiate investment projects in finance, oil and gas, power, railways, resources and utilities which are open to private investors. We believe government entities in China are now on the same page and are lined up to implement Third Plenum reforms. We expect bold, myriad and confident policies to be announced in 2014. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 10 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  12. 12. Table of Contents The Year of the Horse: China Gallops into a Historic Bull Run Clearing the Path to Prosperity 3 Getting from here to there 9 China 2014: Sector Allocation & Top Picks 2013 Top Picks Performance Review 12 China 2014: Sector Allocation 14 China 2014: Top Buys and Top Sells 16 Our Journey Starts with China 2025 A review of Jefferies’ key China Strategy reports 43 Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 11 of 228 Please see important disclosure information on pages 221 - 226 of this report. Jefferies China 2014 Sector View China Macro 80 Agriculture 92 Conglomerate 101 Consumer 107 Energy 112 Financials (Bank, Insurance and Broker) 124 Gaming 141 Healthcare 148 Industrials 154 Metals & Mining 163 Property 179 TMT (Internet, Telecom and Tech) 187 Transportation 208 Utilities 215
  13. 13. JEF 2013 Top Picks Performance Review Since we introduced Jefferies China 2013 Top Picks on Feb 24, 2013, our investment portfolio, combining Top Buys and Top Sells, has generated a total return of 12.6% as of Nov 19, beating HSI and HSCEI by 8.8ppt and 12.2ppt, respectively. Exhibit 9: Jefferies Top Picks Performance (Top Buy & Sell combined) Source: Jefferies, Bloomberg, priced as of Nov 19, 2013 In our China 2013: Transformation & Volatility in the Year of Snake (February 24), we introduced 10 Top Buy stocks. These picks reflected our positive view on the growth outlook for banks, consumer, natural gas, retail property, internet and IPP. Exhibit 10: JEF Top Buys initiated on February 22 Price on Feb 22 Price on April 24 % change AIA 31.95 33.25 4.1% CapitaMalls Asia 2.09 1.97 -5.7% CCB 6.29 6.27 -0.3% CR Enterprises 25.4 25.8 1.6% CR Land 22.15 23 3.8% COLI 22.3 23.2 4.0% Guangdong Investment 6.58 7.61 15.7% PetroChina 10.7 9.56 -10.7% Intime 9.5 9.05 -4.7% Tencent 264.4 254.4 -3.8% Average 0.4% Source: Jefferies, Bloomberg, prices in trading currencies In April (China 2013 (II): Tough Tasks Call for Brave Leaders), we replaced Guangdong Investment and Intime with China Unicom and Shanghai Industrial as Top Buys, and also introduced a list of six stocks as Top Sell ideas. Exhibit 11: Rebalancing of JEF Top Buy portfolio on April 24 Addition Price on Feb 22 Price on April 24 % change China Unicom 10.82 Shanghai Industrial 24.25 Deletion Guangdong Investment 6.58 7.61 15.7% Intime 9.5 9.05 -4.7% Source: Jefferies, Bloomberg, prices in trading currencies 75 80 85 90 95 100 105 110 115 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 HSI HSCEI JEF TOP BUY & SELL Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 12 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  14. 14. Exhibit 12: JEF Top Sell portfolio initiated on April 24 Stock Price China Cosco 3.38 China Shipping Dev. 3.45 CNBM 9.81 PICC Group 3.95 Yanzhou Coal 8.72 Zoomlion 8.26 Source: Jefferies, Bloomberg, prices in trading currencies as of April 24 Sticking to our theme of defensiveness with visible growth and low valuation, we adjusted our Top Buys in July (China 2013 Mid-Year Review: “Xi-Li New Deal” Building Momentum), replaced COLI and CCB with Dongfeng and ENN. We also removed PICC Group and Zoomlion from our Top Sell portfolio and added Agile, Daphne and Lonking. Exhibit 13: Rebalancing of Jefferies Top Buy/Sell portfolio on July 16 Top Buy portfolio Price on Feb 22 Price on July 16 % change Addition Dongfeng Motor 9.65 ENN 44.35 Deletion COLI 22.30 21.35 -4.3% CCB 6.29 5.47 -13.0% Top Sell portfolio Price on April 24 Price on July 16 % change Addition Agile 7.9 Daphne 5.26 Lonking 1.55 Deletion PICC Group 3.95 3.51 11.1% Zoomlion 8.26 5.11 38.1% Source: Jefferies, Bloomberg, prices in trading currencies As of Nov. 19, 2013, our Top Buy portfolio (equal-weighted) generated an absolute return of 12.7% since Feb. 24, beat HSI and HSCEI by 8.9ppt and 12.3ppt, respectively. Our Top Sell portfolio (equal-weighted) provided an absolute return of 9.2%, outperforming HSI and HSCEI by 5.4ppt and 8.8ppt since introduction on April 24. Exhibit 14: Jefferies Top Buy Portfolio Performance Source: Jefferies, Bloomberg, priced as of Nov 19, 2013 Exhibit 15: Jefferies Top Sell Portfolio Performance Source: Jefferies, Bloomberg, priced as of Nov19, 2013 75 80 85 90 95 100 105 110 115 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 HSI HSCEI JEF TOP BUY 80 90 100 110 120 130 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 HSI HSCEI JEF TOP SELL Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 13 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  15. 15. Jefferies China 2014: Sector Allocation We like auto, energy, financial, healthcare, retail property, and staples In 2014, we are Overweight on secular growth sectors including healthcare, passenger auto, consumer staples, and Internet and commercial property. We prefer energy as we believe energy price reform will drive its profitability. Pending financial reforms should benefit insurers and brokers the most. We continue to prefer banks as reform will address the critical issue of local government debt and improve transparency. We also prefer airlines and ports in the transport sector; airlines are leveraged to consumption growth while ports will benefit from recovery in the developed world. Lastly, we like renewable energy as China moves to cleaner energy. Negative on industrials, metals & mining, residential property, shipping & tech On the flipside, we are Underweight on FAI beneficiaries, including coal, metals & mining, and industrials. We believe a unified rural/urban land market and property tax legislation will hurt residential demand. We are bearish on container shipping due to rapid capacity growth. We are cautious on tech as smartphone demand growth is decelerating and PC hardware demand recovery will be slow. Exhibit 16: JEF China 2014: Sector Allocation Source: Jefferies Agriculture (Fundamental Neutral; asset allocation Equal-weight) We are neutral on the sector and expect farmland transfer to increase, as China begins to embrace large-scale farming to raise food production. This will benefit agricultural machinery/high-tech farming. We are cautious on fertilizer on limited volume growth. Auto (Fundamental Positive; asset allocation Over-weight) We are bullish on Passenger Vehicles but cautious on Heavy Duty Trucks. We expect rising income to drive passenger vehicle penetration in China, especially in the lower tier cities. We prefer Compact to Luxury. We expect HDT names to continue to face headwinds as China moves away from investment. Consumer (Fundamental Positive; asset allocation Over-weight) We are positive on consumer staples on potential margin improvement. We are neutral on department stores as over-expansion and market share erosion by e-commerce are balanced by low valuation. We are bearish on footwear & apparel due to over- expansion and threats from e-commerce, while valuation is yet to become attractive. Conglomerates (Fundamental Neutral; asset allocation Equal-weight) We are neutral on the sector, and expect SOE reform to generate ample opportunities for consolidation of state-owned assets. On the other hand, reforms will lead to rising competition and gradually take away certain privileges enjoyed by SOEs. Over-weight Equal-weight Under-weight Airlines Agriculture Footwear & Apparel Autos Conglomerates Industrials Banks Department Stores Metals & Mining Brokers Gaming Residential Property Consumer Staples IPP Shipping Healthcare Jewellery Tech Insurance Natural Gas Distribution Telecom Internet Oil/Gas Ports Retail Property Wind Farm / Solar Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 14 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  16. 16. Oil/Gas (Fundamental Positive; asset allocation Over-weight) We expect three themes to drive energy stocks: 1) market pricing, 2) SOE reform, and 3) environmental regulations. We believe market pricing will improve sector profitability while SOE reform can clear out a lot of the undesirables and improve efficiency. Financials (Fundamental Positive; asset allocation Over-weight) We are most positive on insurance and brokers. We like insurance given growing agency business, broadening of investment channels and policy support. We expect brokers to benefit from capital market reforms (a register-based IPO). For banks, we believe reforms will lead to stronger local gov’t finances, greater transparency, and better-quality growth. Gaming (Fundamental Positive; asset allocation Equal-weight) We are fundamentally positive on Macau Gaming and expect a 15% GGR growth in 2014, driven by rising demand from both the fast expanding high-net-worth-individual class in China and mass visitations. For asset allocation we commend equal-weight due to rich valuation and limited catalysts in 2014. Healthcare (Fundamental Positive; asset allocation Over-weight) We are positive on Chinese pharmaceuticals given the sustainable mid-teens growth, defensive characteristics, and undemanding valuation. We prefer the leading pharma companies to distributors. Industrials (Fundamental Negative; asset allocation Under-weight) We remain cautious on the Industrials space. In the rail sector, we prefer contractors to equipment makers on a relative basis, and diversified contractors over their rail peers. In machinery, we are structurally cautious on construction and coal machinery. Metals & Mining (Fundamental Negative; asset allocation Under-weight) We are cautious on coal, gold and steel in 2014. As China moves toward clean energy, coal will face increasing headwinds. We are bearish on gold price and believe gold stock’s valuation is expensive. On steel, we believe its margin will be squeezed. We are relatively positive on cement given limited capacity growth. For strategic allocation we recommend underweight the entire sector given multiple headwinds in 2014. Property (Fundamental Negative; asset allocation Under-weight) Residential property sector is facing tough headwinds, with softening demand and rising policy concerns. We expect increased affordable housing to curb demand, and expect property tax in Tier 1/2 in next 12 months. We continue to like retail property sector, as urbanization and domestic consumption will drive robust growth of this subsector. Transport (Fundamental Neutral; asset allocation Under-weight) Airlines have the least capacity issues and are set to rebound. Crude tankers could prove a contrarian investment for long-term investors. We are constructive on dry bulk shipping as freight rates could move higher, and are cautious on containers on surplus capacity. Internet, Telco & Tech (Fundamental Positive; asset allocation Over-weight) We are bullish on Internet, especially the four key segments: 1) E-Commerce, 2) Mobile games, 3) Search and performance-based ads, and 4) Online travel. We are fundamentally neutral on telecom, as earnings growth is likely to be slow or negative but 4G launch may provide some boost after 2014. We are cautious on tech, given the secular slowdown in consumer PC and deceleration in smartphone growth. Utilities (Fundamental Positive; asset allocation Over-weight) China will provide policy support and encourage investment in natural gas, wind, and solar infrastructure to address environmental issues. We are fundamentally positive on IPPs as coal prices could continue to slide. For asset allocation we recommend overweight wind over natural gas and IPPs, on valuation concerns and risk of potential tariff cut. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 15 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  17. 17. Jefferies China 2014 Top Picks In 2014, we recommend investors to overweight autos, financials, healthcare, retail property, staples, and clean energy sectors. Our Top Buys are Baidu, BOC, CITIC Securities, CRE, CMA, Dongfeng, Fosun Pharma, Huaneng Renewable, Sinopharm, PetroChina, Ping An and Shanghai Industrial. We advise investors to avoid stocks with high FAI exposure. Our Top Sells are Agile, Belle, China Cosco, China Coal, CNBM, Digital China, Longfor, Zhaojin, Zijin and Yanzhou Coal. Our Top Buy portfolio is skewed towards financials (25%) and healthcare (16.7%) and has equal weighting (8.3%) on retail properties, utilities, Internet, energy, consumer staples and conglomerates. The Top Sell portfolio is concentrated in metals & mining (50%). Exhibit 17: Top Buy portfolio weighting by sector Source: Jefferies Exhibit 18: Top Sell portfolio weighting by sector Source: Jefferies Exhibit 19: Valuation metrics for top picks Mkt Cap Price PE PB Div Yield Company Ticker Rating US$ mn trading 2012 2013E 2014E 2012 2013E 2014E 2012 2013E 2014E Top Buy Baidu* BIDU US Buy 56,995 162.87 33.2 31.5 25.4 13.3 9.2 6.6 0.0% 0.0% 0.0% Bank of China 3988 HK Buy 130,403 3.70 5.8 5.5 4.9 1.0 0.9 0.8 6.0% 6.5% 7.6% Citic Securities 6030 HK Buy 23,457 18.88 39.0 33.0 20.6 1.9 1.9 1.7 2.0% 1.2% 2.0% CR Enterprises 291 HK Buy 8,307 26.80 38.0 35.3 29.5 1.6 1.5 1.5 1.1% 1.1% 1.1% CapitaMalls Asia CMA SP Buy 6,322 2.02 14.4 33.7 28.9 1.2 1.2 1.1 1.6% 1.6% 1.6% Dongfeng Motor 489 HK Buy 13,782 12.40 9.2 8.5 7.2 1.6 1.3 1.1 1.5% 1.7% 1.9% Fosun Pharma 2196 HK Buy 6,693 20.95 20.6 24.2 20.8 2.5 2.5 2.2 1.3% 1.3% 1.3% Huaneng Renewable 958 HK Buy 3,607 3.31 39.4 18.6 13.7 1.9 1.6 1.5 0.6% 1.0% 1.3% PetroChina 857 HK Buy 234,969 9.49 11.8 10.4 7.9 1.3 1.2 1.1 3.8% 4.2% 4.4% PingAn 2318 HK Buy 60,255 69.90 21.7 15.4 12.8 2.7 2.4 2.0 0.8% 1.3% 1.6% Shanghai Industrial 363 HK Buy 3,717 26.65 8.4 10.1 9.3 0.9 0.8 0.7 4.1% 4.1% 4.1% Sinopharm 1099 HK Buy 7,702 23.25 22.3 19.4 16.3 2.6 2.0 1.8 1.4% 1.5% 1.7% Average 22.0 20.5 16.4 2.7 2.2 1.9 2.0% 2.1% 2.4% Top Sell Agile 3383 HK UNPF 4,069 9.15 5.0 5.8 5.1 1.0 0.9 0.8 4.3% 4.2% 4.2% Belle 1880 HK UNPF 10,412 9.57 14.6 15.0 15.0 2.8 2.5 2.3 2.1% 2.1% 2.1% China Cosco 1919 HK UNPF 5,141 3.66 NM NM NM 1.2 1.6 2.5 0.0% 0.0% 0.0% China Coal 1898 HK UNPF 10,460 4.86 5.7 13.2 12.7 0.6 0.6 0.5 5.5% 3.1% 2.8% CNBM 3323 HK UNPF 5,641 8.10 6.2 6.9 6.6 1.1 1.0 0.9 2.4% 2.2% 2.5% Digital China 861 HK UNPF 1,450 10.28 8.0 8.0 8.7 1.4 1.3 1.1 3.8% 3.5% 3.9% Longfor 960 HK UNPF 8,521 12.14 8.0 8.3 6.6 1.7 1.5 1.2 2.1% 2.1% 2.4% Yanzhou Coal 1171 HK UNPF 6,744 7.85 4.9 14.7 23.7 0.7 0.7 0.7 4.6% 1.4% 2.1% Zhaojin 1818 HK UNPF 1,993 5.30 6.3 9.1 11.3 1.5 1.3 1.3 5.8% 4.1% 3.4% Zijin 2899 HK UNPF 7,763 1.85 6.1 12.1 13.2 1.1 1.0 1.0 6.9% 3.4% 3.4% Average 7.2 10.3 11.4 1.3 1.2 1.2 3.7% 2.6% 2.7% Source: Jefferies estimates, Bloomberg, priced as of Nov 19, 2013. *Priced as of Nov 18, 2013. Internet 8.3% Consumer staple 8.3% Auto 8.3% Energy 8.3% Utilities 8.3% Retail property 8.3% Conglomerate 8.3% Healthcare 16.7% Financials 25.0% Metals & mining 50% Residential property 20% Consumer discretionary 10% Transport 10% Tech 10% Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 16 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  18. 18. TOP BUYS Baidu (BIDU US, BUY, TP US$222) Our positive outlook on Baidu is built upon its faster than expected mobile search ramp- up and monetization potential, driven by increasing mobile search demand and incremental mobile ad budget from Baidu’s customers. Newly launched “Zhixin” interim landing page may see more upside on both PC and mobile platforms. Bank of China (3988 HK, Buy, TP HK$4.9) We believe BOC will benefit from greater RMB internationalization, and is less susceptible to RMB interest rate (IR) deregulation as it has the highest proportion of non-interest income & overseas assets, which may also benefit from potentially stronger USD & higher Fed rates. In our view, valuation is compelling. CITIC Securities (6030 HK, Buy, TP HK$22) As the No.1 China broker with a strong investment banking (IB) franchise, CITICS is likely to deliver strong earnings growth after A-share IPOs resume and be the top beneficiary of disintermediation in China in the long term. CITICS’ strong capital position after aggressively leveraging up its balance sheet may better support the growth of its credit-related business, and the acquisition of China AMC and CLSA may improve its asset management and overseas businesses meaningfully. China Resources Enterprise (291 HK, Buy, TP HK$32.5) We believe CRE’s consolidation will bear fruit in the long term. Its retail business delivered industry leading SSS growth in the recent quarter; beer saw rising market share and margins. We think NT margin pressure from M&As with Kingway and Tesco will be offset by LT benefits. CapitaMalls Asia (CMA SP, Buy, TP SG$2.4) A mass-end mall operator, CapitaMalls Asia is a choice of defensiveness and resilient growth. Driven by urbanisation and consumption, CMA could continue to benefit from its first mover advantage on reversion from existing malls and new mall openings. Its financing advantage stemming from a strong background and a vertical capital recycle model will underpin further growth potential through future acquisitions. Dongfeng (489 HK, BUY, TP HK$15.3) Dongfeng is an obvious beneficiary of the set of reforms introduced after the 3rd plenum. Investors should remain positioned for further market share and margin recovery in 2H13 and 2014. With the lowest valuation in the space at 7.5x forward PER, Dongfeng remains a low-risk name, in our view. Fosun Pharma (2196 HK, BUY, TP HK$25) As a leading Chinese diversified healthcare company, Fosun Pharma has a strong presence in all key segments of the healthcare industry value chain. The company has the most impressive M&A track record among its peers. In a cost containment environment, we believe Fosun’s diversification and superb M&A capability should allow it to better mitigate pricing risk and deliver strong growth that outpaces the industry average. The company’s new incentive plan also sets commendable sales and profit targets with implied 2013-15 CAGR of at least 18% and 25%, respectively. Huaneng Renewable (958 HK, BUY, TP HK$4.3) We are in a structural growth story for wind farm operators, and Huaneng Renewable is our top pick among the wind farm operators. We are forecasting a 2013-15 EPS CAGR of 33% as earnings should continue to benefit from improving utilization hours and new installed capacity adds. The company’s historical discount to industry leaders should disappear as Huaneng Renewable continues to execute. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 17 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  19. 19. PetroChina (857 HK, Buy, TP HK$12) PetroChina has the best oil & gas assets among the three oils. We believe 2014 energy policy will favor PetroChina from 1) market pricing, 2) SOE restructuring and 3) environmental regulations. We believe PetroChina will benefit from accelerating natural gas production growth and pricing reform. Ping An (2318 HK, BUY, TP HK$83) Ping An is our top pick in the China insurance sector. It is the only listed insurer that has limited exposure to bancassurance, with almost pure focus on agency distribution. We believe its life insurance NBV growth rate can be maintained at 7-12% for the next few years. In addition, we believe its strong P&C operation and improving banking business will also help with its re-rating going into 2014. Shanghai Industrial (363 HK, Buy, HK$30) We like SIHL’s balanced portfolio, stable earnings and attractive valuation. We believe the company is well-positioned to benefit from Shanghai’s robust outlook as the Free Trade Zone becomes a key growth driver. Thanks to strong government support, SIHL has ample opportunities to acquire quality state-owned assets in infrastructure utilities and real estate, therefore enhancing its potential. Sinopharm (1099 HK, BUY, TP HK$26.5) Sinopharm is our favourite Chinese pharma distributor, given its unsurpassed dominance in the space. While the company’s distribution business should sustain high- teens% organic growth in the next several years, significant opportunities lie in its retail pharmacy business longer term. Trading at 16x our 2014e EPS against our 3-year EPS CAGR of 18%, the stock’s valuation is attractive. TOP SELLS Agile (3383 HK, Underperform, TP HK$7.8) We maintain Underperform on Agile as we consider its aggressive land banking unjustified on lagging sales and rising inventories. Given the policy headwind, weakening market sentiment and tightening credit ahead, we believe the contribution from new cities remains highly uncertain. Compared to peers, Agile may be exposed to higher risk from stricter tax collection as its current tax liability is Rmb9.5bn. Belle (1880 HK, Underperform, TP HK$8.2) In 2014, we expect Belle to continue facing challenges from B2C e-commerce, while the sales from department store channel will demonstrate slow SSSG and operating deleverage. We expect the company to deliver flat YoY EPS growth in 14e, and reiterate Underperform on Belle. Cosco (1919 HK, Underperform, TP HK$1.9) A series of disposals this year including Cosco Logistics, CIMC, and some office buildings could save Cosco from a potential A-share suspension. However, challenges remain for container shipping, and valuation looks rich for an operationally challenged company. China Coal (1898 HK, Underperform, TP HK$2.8) We believe coal price will continue to fall next year due to China’s economy rebalancing and low cost coal capacity debottlenecking. Our 2014 earnings estimates for China Coal are 22% below consensus, which appears to believe coal prices will recover appreciably from present levels. Under our negative coal price forecast, we believe the company is in danger of ruining its pristine balance sheet with its intense capex program. CNBM (3323 HK, Underperform, TP HK$6) The 1H13 call was significant in that CNBM’s management confirmed it will focus on deleveraging its balance sheet in the next few years. This means CNBM has lost its most effective growth engine: acquisitions. We slash our 2013/14 earnings forecasts to 20%/30% below consensus which will slowly adjust downwards. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 18 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  20. 20. Digital China (861 HK, UNDERPERFORM, TP HK$8) Despite management’s best efforts, we see ongoing structural challenges in Distribution and Systems, the two most profitable businesses at Digital China. We see the recent share price recovery, driven by the market value of Shenzhen Techo Telecom, as unwarranted. Longfor (960 HK, Underperform, TP HK$11) Aggressive expansion has not yet been proven to boost presales. Instead it undermines the balance sheet on rising capex pressure. Chongqing still contributes 1/4 of presales and a 15% down payment is provided to attract homebuyers. Weakening market demand, policy overhang and credit tightening raise our concerns about Longfor’s financial health. Yanzhou Coal (1171 HK, Underperform, TP HK$3.6) Yanzhou Coal’s previous success was achieved based on high coal prices. We believe coal prices will continue to fall in 2014 and our earnings estimate for Yanzhou Coal is 42% below consensus. We believe its cost saving in 3Q13 is unlikely to sustain as a significant contribution came from a one-off provision of obligation items on the balance sheet. Zhaojin (1818 HK, Underperform, TP HK$5) Between the two gold companies, we have a relative preference for Zhaojin over Zijin given its proven track record in volume growth and cost control. More importantly, it doesn’t have the resource depletion issue in its core mine that Zijin is facing. However, we believe valuation to be expensive based on our LT gold price assumption of US$1,250/oz. Even under a bull case assumption, the stock’s valuation seems demanding. Zijin (2899 HK, Underperform, TP HK$1.4) On top of the risk of falling gold price, we are concerned about Zijin’s stagnant mined gold production growth, steep rise in production costs and transition risks at its flagship Zijinshan mine, where it’s moving from mined gold to copper production. We see high executional risk as the company ramps up copper production to offset the decline in gold, which accounts for at least 30% of the company’s gross profits. Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 19 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  21. 21. Baidu (BIDU US, BUY, TP US$222) Key Takeaway Our positive outlook on Baidu is built upon its faster than expected mobile search ramp-up and monetization potential, driven by increasing mobile search demand and incremental mobile ad budget from Baidu’s customers. Newly launched “Zhixin” interim landing page may see more upside on both PC and mobile platforms. Increasing mobile search demand Our checks with search ad agents reveal that advertisers are increasingly allocating at least 10-15% incremental ad budget to mobile search. We estimate that mobile queries already account for 40% of total queries at Baidu, and the cost per click (CPC) gap between mobile and PC has narrowed over the past few months. Starting from Dec 1st , all Baidu mobile search customers are required to have a mobile landing page. New product helps drive monetization Baidu launched “Zhixin” search on four verticals including education, finance, travel and medical in July, presenting search results in an easy to use format on an interim landing page. Our channel checks indicate that Zhixin has improved click through rate (CTR) and conversion rate for Baidu’s search. According to management, iwan.baidu.com, Baidu’s PC-based online gaming portal, has delivered 50% increase in ROI since its integration with “Zhixin”. We hold the view that further upside exists if Zhixin is expanded successfully to other verticals, and onto mobile search. Laying out a mobile ecosystem with strong app distribution capability Baidu has enhanced its mobile apps distribution capability with the acquisition of 91Wireless, making it a close #2 with 20.5% in aggregate market share. Baidu is beefing up its LBS offering (over 140mn MAU, up from 120mn last quarter) with the integration of Nuomi and Baidu Map, an important mobile gateway of local search which enables transactions to be completed within Baidu ecosystem, such as hotel booking, movie ticket purchase, group buy and taxi booking. Valuation Maintain Buy with PT at USD222, based on 25x FY15 PE, 7% above peer average, with an implied 35x FY14 P/E. We believe investors will look through given mobile search upside and expected margin expansion in FY15. Risks include execution in the transition to and potential monetization of mobile, and stronger than expected competition. Exhibit 21: Mobile search traffic market share (3Q13) Source: Sootoo Research, Jefferies Exhibit 22: App distribution platform market share by number of times used in Sept 2013 Source: iResearch Oct 2013, Jefferies App Distripution Platfrom Market Share % 360 Mobile Assistant (Qihoo) 21.7% Wandoujia 15.3% Tao App Store (Alibaba) 10.6% 91 Mobile Assistant (Baidu) 9.2% HiMarket (Baidu) 6.5% Baidu Mobile Assistant (Baidu) 4.9% MIUI App Store (Xiaomi) 6.0% Anzhi Market 3.4% PP Mobile Assistant 4.7% Tencent Myapp 1.8% Others 15.9% Total 100.0% 20.5% Exhibit 20: Share price Source: Bloomberg, Jefferies 0 20 40 60 80 100 120 140 160 180 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Nov-13 Cynthia Meng +852 3743 8033 cmeng@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 20 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  22. 22. Bank of China (3988 HK, Buy, TP HK$4.9) Key Takeaway We believe BOC will benefit from greater RMB internationalization, and is less susceptible to RMB interest rate (IR) deregulation as it has the highest proportion of non-interest income & overseas assets, which may also benefit from potentially stronger USD & higher Fed rates. In our view, valuation is compelling at 2014E P/B & P/E of 0.78x & 4.9x resp., with dividend yield of 7%. Core business BOC is the 4th largest commercial bank in China, with 3Q13 assets of Rmb13.6 trillion. It is China's most internationalized bank, with 19% of its assets overseas. BOC owns 66% of Hong Kong listed BOC Hong Kong (Holdings) Limited (2388 HK, NC). The bank currently has 10,786 domestic branch outlets and 623 overseas outlets. BOC was originally the state-designated specialized foreign exchange and foreign trade bank after the founding of the People’s Republic of China. BOC was listed on the Hong Kong Exchange and Shanghai Stock Exchange in June and July of 2006, respectively. Huijin and SSF are the two major shareholders of BOC. Most diversified business model with potential overseas tailwind With its business and geographical diversification, BOC is less dependent on RMB interest spread and thus less vulnerable to RMB-IR deregulation, in our view. The bank’s 9M13A non-interest income accounted for 32% of total income, highest among the H- share banks (avg 21%). Non-RMB loans & deposits at BOC accounted for 25% of total loans & 19% of total deposits, vs. H-share avg of 8% of loans & 5% of deposits. Furthermore, its overseas business, which is mainly in Hong Kong, may benefit from potentially stronger USD and rising US interest rate cycle next year, potentially narrowing its ROE gap vs. peers. Financials and Valuation Our HK$4.90 PT is the wt. avg. of our 3-stage DDM (50%) & fair P/B model (50%), based on profit growth of 9%/6%/3% in stage 1/2/3, 35% dividend payout, 16.7% sustainable ROE, and 13.0% COE. Our PT-implied avg. 2014E P/B is 1.02x. Exhibit 24: 9M13A non-int. income % revenue – BOC least dependent on interest spread income Source: Company data, Jefferies Exhibit 25: BOC least affected by RMB interest rates Source: Company data, Jefferies 0% 5% 10% 15% 20% 25% 30% 35% ICBC CCB ABC BOC BCOM CMB CNCB MSB CQRCB 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% ICBC CCB ABC BOC BCOM CMB CNCB MSB CQRCB RMB % Loans RMB % Deposits Exhibit 23: BOC’s share price Source: Bloomberg 0.0 1.0 2.0 3.0 4.0 5.0 6.0 Nov-09 Nov-10 Nov-11 Nov-12 Ming Tan, CFA +852 3743 8752 ming.tan@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 21 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  23. 23. CITIC Securities (6030 HK, Buy, TP HK$22) Key Takeaway As the No.1 China broker with a strong investment banking (IB) franchise, CITICS is likely to deliver strong earnings growth after A-share IPOs resume and be the top beneficiary of disintermediation in China in the long term. CITICS’ strong capital position after aggressively leveraging up its balance sheet may better support the growth of its credit-related business, and the acquisition of China AMC and CLSA may improve its asset management and overseas businesses meaningfully. Core business CITIC Securities (CITICS) is the leading full-service investment bank in China. In 2012, CITICS ranked No. 1 in China in the investment banking business by total equity and debt underwritten, and No.1 in the brokerage business in terms of equity and fixed income trading turnover. It was also the largest investment bank in China in terms of total assets, equity and revenue in 2012. CITICS was established in 1995 and converted into a joint stock limited company in 1999. CITICS was listed on the Shanghai Stock Exchange on 6 Jan 2003 and the Hong Kong Stock Exchange on 6 Oct 2011. CITICS’ key shareholder is CITIC Group, which engages in a wide range of businesses with many subsidiaries. The No.1 China broker to ride the wave of disintermediation Since the trend of interest rate deregulation and disintermediation is unlikely to change, and the recent Third-Plenum report plans to promote a register-based IPO system, develop & standardize the bond market, and increase the proportion of direct financing, we believe investment banking will be a strong driver of brokers’ profit. Given its strong IB franchise, we expect CITICS to be the top beneficiary of disintermediation in China. CITICS aggressively increased its leverage (excluding customer cash) to 2.65x at end- Sep 2013 from 1.56x at end-2012 through bonds and commercial notes issuance, which will better support further development of its credit-related businesses (margin lending and stock repo). Also the acquisitions of CLSA and China AMC may help to improve its overseas and asset management businesses meaningfully, in our view. Financials and Valuation Our PT of HK$22.00 is the average of our 3-stage DDM model and Gordon Growth fair P/B model, based on profit growth of 35%/22%/6% in stage 1/ 2/ 3 (terminal), dividend pay-out of 40%, sustainable ROE of 16.9% and COE of 11.1% Our PT-implied 2014E P/B is 2.04x. Exhibit 27: CITICS' strong investment banking franchise Source: Wind, Jefferies Exhibit 28: Profitability improving Source: Company data, Jefferies estimates Market share Rank Market share Rank 2007 21% 2 10% 1 2008 20% 1 12% 1 2009 22% 2 8% 2 2010 14% 2 6% 1 2011 8% 2 6% 1 2012 12% 1 5% 1 Equity underwriting Debt underwriting 0% 2% 4% 6% 8% 10% 12% 14% 16% 0.00% 0.02% 0.04% 0.06% 0.08% 0.10% 0.12% 0.14% 0.16% 2008 2009 2010 2011 2012 2013E 2014E Net commission rate ROAE, adjusted Divestment of China AMC in 2011 Divestment of China Securities in 2010 Exhibit 26: CITICS’ share price Source: Bloomberg, Jefferies 0.0 5.0 10.0 15.0 20.0 25.0 Oct-11 May-12 Dec-12 Jul-13 Jaclyn Wang +852 3743 8746 Jaclyn.wang@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 22 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  24. 24. China Resources Enterprise (291 HK, Buy, TP HK$32.5) Key Takeaway We believe CRE’s consolidation will bear fruit in the long term. Its retail business delivered industry leading SSS growth in the recent quarter; beer saw rising market share and margins. We think NT margin pressure from M&As with Kingway and Tesco will be offset by LT benefits. We have a Buy rating with PT of HKD32.5 on the stock. Core business CRE is a leading consumer company with a focus on retail, beer, beverage and food processing and distribution. It is the largest domestic brewer with 24% market share, while its supermarkets/hypermarkets ranked third in China with 11% market share. CRE has stepped up acquisition recently with two major M&As on Kingway Brewery and Tesco. These M&As will yield benefits in the long term. The company is set to reap the benefits of scale economy once consolidation is completed. CRE has an SOE background with 51.4% outstanding shares owned by China Resources Holding (CRH). A long-term winner CRE is likely to outshine peers in the long run due to the following features: 1) it will secure a strong presence and market share in both beer and retail through consolidation. 2) It is likely to catch up with industry average margins. 3) Its growth is likely to be faster during the process of market consolidation. 4) SOE background brings long-term stability to the company. Recent business update 1) Revenue rose 14.5% yoy to HKD112.4bn and core net profit rose 6.5% yoy to HKD1,916m in 9M13. Core net margin dropped 0.1ppt. to 1.7% in 9M. 2) Retail sales reached HKD71.8bn in 9M13 (+14% yoy), mainly driven by new stores, acquisition and 6.5% SSS growth in 3Q13 vs. 8.3% in 2Q and 2.9% in 1Q. Core net margin down 0.2ppt yoy to 1% in 9M13, mainly due to rising staff cost. 3) Beer sales reached HKD27.4bn in 9M13 (+15% yoy), driven by 8% volume growth and 6.2% ASP rise (incl. forex). Core net margin expanded to 4.0% in 9M (+0.3ppt. yoy) on mix upgrade and scale economy. 2014 outlook We expect CRE to deliver 14% top line growth to HKD163.5bn in 2013e. While operating leverage in the retail business and synergy with Kirin JV is likely to lift its margins, the consolidation of Kingway Brewery, which is expected to turn around in 2-3 years, brought margin pressure, thus we expect OP margin of 3.3% in 14e (+0.1ppt yoy). We forecast core net profit of HKD2.2bn in 2014e (+21% yoy, 1.3% net margin). Valuation We have a Buy rating on the stock with PT of HKD32.5, based on SOTP method. CRE trades at 30x 14e core PE, vs. median forward PE of 31x in the past one year. It has outperformed HSCEI by 7% in the past six months. Exhibit 30: CRE’s sales 2010-2015e Source: Company data, Jefferies Exhibit 31: CRE’s 1-yr forward PE Band Source: Bloomberg, Jefferies estimates Jessie Guo +852 3743 8036 jguo@jefferies.com Edwin Fan, CFA +852 3743 8037 efan@jefferies.com Kevin Chee +852 3743 8022 kchee@jefferies.com Exhibit 29: CRE’s share price Source: Bloomberg Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 23 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  25. 25. CapitaMalls Asia (CMA SP, Buy, TP SG$2.4) Key Takeaway A mass-end mall operator, CapitaMalls Asia is a choice of defensiveness and resilient growth. Driven by urbanisation and consumption, CMA could continue to benefit from its first mover advantage on reversion from existing malls and new mall openings. Its financing advantage stemming from a strong background and a vertical capital recycle model will underpin further growth potential through future acquisitions. Company background CMA is one of the largest shopping mall developers, owners and managers in Asia with 103 malls across 52 cities in Singapore, China, Malaysia, Japan and India. CMA has an integrated shopping mall business model encompassing retail real estate investment, development mall operations, asset management and fund management capabilities. CMA is a subsidiary and the retail real estate platform of CapitaLand, a leading real estate conglomerate in Asia. Growth intact with robust pipeline ahead Driven by resilient necessity shopping, CMA’s tenant sales and shopper traffic still grow faster in the challenging China market, showcasing its capable management and proactive adjustment to withstand market slowdown and E-commerce competition. With a pipeline to open 2 malls each in China and in India, its earnings outlook remains intact and future expansion will continue. We regard CMA as a long-term winner in retail market restructuring, backed by its proven expertise, strong financing access and established income base. 2014 outlook We expect reversion from existing malls to continue to expand CMA’s rental base, and successful mall launches in China to contribute organic growth. Thanks to Singapore’s stable contribution and China’s extensive portfolio, CMA would enjoy visible recurrent rental income. Disposal of malls to underlying funds and further acquisitions are key catalysts for the counter. Valuation Our price target of SG$2.4/HK$15.1 is based on a 10% disc. to NAV of SG$2.6/HK$16.8. Key risks are 1) shortage of experienced local staff; 2) operational challenge in expansion in China. Exhibit 33: Core earnings growth (SGD mn) Source: Jefferies, company data Exhibit 34: NAV discount chart (CMA SP) Source: Bloomberg, Jefferies Exhibit 32: CMA share price Source: Bloomberg 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Nov-09Aug-10May-11 Feb-12 Nov-12Aug-13 Christie Ju +852 3743 8012 cju@Jefferies.com Venant Chiang +852 3743 8013 Venant.chiang@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 24 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  26. 26. Dongfeng (489 HK, BUY, TP HK$15.3) Key Takeaway Dongfeng is an obvious beneficiary of the set of reforms introduced after the 3rd plenum. Investors should remain positioned for further market share and margin recovery in 2H13 and 2014. With the lowest valuation in the space at 7.5x forward PER, Dongfeng remains a low-risk name, in our view. Read-through from 3rd plenum Pertaining to SOE reforms, the mandate is to increase dividend payout ratio to 30% by year 2020. We believe investors will benefit from this policy, as the company has an extremely healthy net cash pile of RMB19.8bn in 1H13 with just 14% payout ratio in FY12. In addition, Dongfeng has 57% exposure to the Compact segment in 1H13, which is a segment expected to benefit from rural land reform, and Hukou reform which encourages greater urbanization and income redistribution. Compact remains the best proxy to first-time car buyers’ demand. Recovery still underway Despite being affected by the anti-Japanese sentiment, PV volume growth of 3.4% in 1H13 represents a marked turnaround from the 8.3% fall seen in 2H12, during the peak of the crisis. In 2H13, volume growth is expected to see a big leg up, from the low base last year. Note the magnitude of the ASP fall has also narrowed, by 2ppt in 1H13 from 6.3% drop in 2H12. We continue to expect further recovery in margin in 2H13 and 2014, along with a better pricing environment. CV volume growth takes a U-turn For the first time in two years, the Commercial Vehicles (CV) segment showed positive growth in 1H13. And within the segment, heavy trucks showed striking recovery of 8.3% growth, reversing the trend from heavy declines seen in 2011-12. In 2H13, we expect y/y growth to improve further, given that Dongfeng HDT has grown 35% y/y in June – Oct 13. And recall, Dongfeng is due to introduce Volvo as a new partner in the CV business, which would allow access to top-notch technology in engines, transmission and alternative-energy vehicles. Partnering with the global leader in CV would enable the company to transcend in competitiveness over the longer term. New models pipeline exciting An intensive pipeline for 2014 will include new-generation Nissan X-trail, Infiniti, new gen Honda Spirior, Venucia SUV & sedan, Fengshen SUV, Peugeot 2008, new gen 408 and a Liuzhou MPV. There will be more new models in 2015 for each of the brands, including new gen Nissan Qashqai, new gen Murano, a new Honda compact SUV, second Infiniti model, new gen Citroen C4. For 2014 and beyond, the pipeline looks full and exciting, and this is also expected to raise profitability from current levels. Exhibit 36: Dongfeng PV market share recovery obvious Source: CAAM, Jefferies estimates Exhibit 37: 2012 Unit sales volume breakdown Source: PetroChina, Jefferies estimates 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Trucks 17% Buses 2% Basic passenger cars 58% MPVs 9% SUVs 14% Cross type 0% Exhibit 35: Share price Source: Bloomberg, Jefferies -4.0 4.0 12.0 20.0 Nov-07 Nov-08 Nov-09 Nov-10 Nov-11 Nov-12 Zhi Aik, Yeo +852 3743 8075 zyeo@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 25 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  27. 27. Fosun Pharma (2196 HK, BUY, TP HK$25) Key Takeaway As a leading Chinese diversified healthcare company, Fosun Pharma has a strong presence in all key segments of the healthcare industry value chain. The company has the most impressive M&A track record among its peers. In a cost containment environment, we believe Fosun’s diversification and superb M&A capability should allow it to better mitigate pricing risk and deliver strong growth that outpaces the industry average. The company’s new incentive plan also sets commendable sales and profit targets with implied 2013-15 CAGR of at least 18% and 25%, respectively. Leading Chinese pharmaceutical manufacturer with superior growth prospects We forecast that Fosun Pharma will deliver strong revenue and earning CAGR of 19% and 30% in 2013–16, above our estimate of industry average of ~15%. Key growth drivers include (1) Broad pharmaceutical product portfolio focusing on attractive therapeutic areas; (2) Demonstrated capability in strategic acquisitions and integration; and (3) Strong R&D and robust pipeline. First-mover in the attractive hospital segment We foresee strong growth for Fosun Pharma’s healthcare service segment and think that its strategy of focusing on premium medical services and specialty hospitals has the potential for good returns. The company has been rapidly growing its hospital franchise via acquisitions. Within the past two years, Fosun Pharma acquired three general hospitals and one cancer specialty hospital, operating a combined total of ~2,200 beds. The company plans to acquire 1-2 hospitals each year. By 2015, Fosun aims to own 10- 15 hospitals with combined sales reaching Rmb 1 billion. Leading Chinese pharmaceutical distributor a long-term winner By owning close to a third of Sinopharm, Fosun Pharma has established a significant presence in China’s pharmaceutical distribution industry with attractive growth prospects. We expect Sinopharm’s scale advantage to drive above-industry growth of ~20s over the next 3-5 years. Growth could accelerate with further industry consolidation and improving hospital financing. Attractive valuation We maintain our BUY rating, and 12-month TP of HK$25, based on 2014e PEG of 1.1, 3- year adjusted EPS CAGR of 28%, and 2014e adjusted EPS of HK$0.62. Our DCF analysis suggests that the current share price is attractive. Risks Key risks to our rating and price target include more severe pricing pressure for drugs and medical devices; less policy support for the development of private hospitals; slower M&A pace in pharmaceutical and medical services segments; failure to consolidate and integrate business operations post acquisition; and development setbacks on key drug candidates such as human insulin and insulin analogues. Exhibit 38: Fosun’s share price Source: Bloomberg 0 5 10 15 20 25 30 Oct-12 Feb-13 Jun-13 Oct-13 Jessica Li, Ph.D. +852 3743 8010 Jessica.li@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 26 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  28. 28. Huaneng Renewable (958 HK, BUY, TP HK$4.3) Key Takeaway We are in a structural growth story for wind farm operators, and Huaneng Renewable is our top pick among the wind farm operators. We are forecasting a 2013-15 EPS CAGR of 33% as earnings should continue to benefit from improving utilization hours and new installed capacity adds. The company’s historical discount to industry leaders should disappear as Huaneng Renewable continues to execute. Utilization hours set to improve further in 2014 2013 has been a good year for wind farm operators as utilization hours recovered on the back of improving curtailment and better wind resources. The recovery in utilization hours has beat our expectations as Huaneng Renewable reported 9M13 YTD power generation of 8,213GWh, +50% YoY. We expect 2014 to see incrementally higher utilization hours as curtailment should continue to ease, offsetting a possible normalization in wind resources. New installed capacity should accelerate modestly in 2014 The industry will look to increase their new capacity additions to varying degrees, albeit a return to the levels seen in 2010 is unlikely. Huaneng Renewable is looking to increase its new capacity additions from 1GW in 2013 to 1.5GW to 2.0GW p.a. over the next few years. We believe the company will also look at new solar projects as well. Concerns over a tariff cut overdone One lingering question that has dogged wind farm operators is the risk of a potential cut in feed-in tariff, especially in light of the recent cut in on-grid thermal power tariffs. Although we believe there is long-term risk to wind FiT as WTG costs decline, we do NOT believe it is a near-term risk. With curtailment negatively impacting profitability, we believe revisions to the FiT would be a mistake. New announcements should help sentiment We believe there are more environmental policies to come out in the coming months and years that should help the sentiment for alternative energy names. The Renewable portfolio standard could be announced next year and the emissions trading scheme could be rolled out nationwide in time. Furthermore, we expect local government to announce new policies, emission and zoning requirements in order to alleviate local air pollution. Discount to Longyuan should disappear We believe Huaneng Renewable should benefit from a continued sector re-rating and we believe its discount to Longyuan should narrow; Huaneng Renewable is trading at a 10% discount to Longyuan on a P/E basis. Exhibit 40: Geographical Exposure Source: Company data, Jefferies Exhibit 41: Utilization hours to recover to ~2,200 hours Source: Company data, Jefferies estimates Inner Mongolia 31% Liaoning 20% Shandong 15% Yunnan 8% Shanxi 7% Guizhou 5% Guangdong 5% Other 9% 0 500 1,000 1,500 2,000 2,500 2007 2008 2009 2010 2011 2012 2013 2014 2015 Exhibit 39: Share price Source: Bloomberg, Jefferies 0.0 1.0 2.0 3.0 4.0 Jun-11 Feb-12 Oct-12 Jun-13 Joseph Fong +852 3743 8074 jfong@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 27 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  29. 29. PetroChina (857 HK, Buy, TP HK$12) Key Takeaway PetroChina has the best oil & gas assets among the three oil and gas companies. We believe Petrochina will benefit from the 2014 energy policy in terms of 1) market pricing, 2) SOE restructuring and 3) environmental regulations. We believe PetroChina will benefit from accelerating natural gas production growth and pricing reform. Best oil & gas assets in China PetroChina’s oil assets are superb free cash-flow machines. Oil R/P ratio is 12.6 vs. 8.9 and 8.4 for Sinopec and CNOOC, respectively. We estimate PetroChina’s oil drilling is much more economical than CNOOC and Sinopec at the same prevailing oil prices. We believe PetroChina also has China’s best natural gas assets. The company controls ~70% of China’s natural gas reserves with double digit production growth expected for the next 5-10 years. 2014 policy to favor PetroChina We believe three themes will drive energy equities in 2014, 1) market pricing, 2) SOE restructuring and 3) environmental regulations. None of these themes are new, but Third Plenum reforms will provide the political cover and administrative structure to cut through inertia and vested interests, in our view. The poster boy of SOE reform We believe PetroChina will be the poster boy of SOE reform. The unprecedented corruption purge of senior management is not just an investigation into PetroChina, in our view, but a maneuver against entrenched SOE interests. We believe PetroChina may become a "pilot project" for SOE reform with experiments in "mixed ownership" structures and SOE-private sector partnerships — all geared towards optimizing efficiency, improving management, reducing corruption and maximizing value. With natural gas prices being reformed, we believe eliminating the inefficiencies and leakages plaguing the company will have a renewed urgency. Get free stuff According to the FAS69 disclosure, PetroChina's proved reserves were worth US$274B at YE12 (~HK$8.24/share less YE14 debt). Shareholders are getting probable/possible reserves, pipelines, gas price reform, refiners and chemical plants, more or less, for free. Natural gas story In China, we believe natural gas will be a substitute for fuel oil/LPG in the medium term and gasoline/diesel as vehicle fuel in the long term, forcing prices towards oil levels. A re-rating for PetroChina is warranted as the company controls the crown jewels of China’s upstream assets and as government intervention in upstream energy markets fade. Exhibit 43: PetroChina’s oil & gas production Source: PetroChina, Jefferies estimates Exhibit 44: China natural gas and refined product prices Source: PetroChina, Jefferies estimates Oil Gas 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 2000 2005 2010 2015E 2020E 2025E mboe/d 10.68 14.24 18.87 16.60 21.33 21.40 3.24 3.58 4.81 1.39 1.85 3.21 3.37 4.23 4.46 0 5 10 15 20 25 30 Pilot price (2010 subsitute prices) Implied pilot price @ current prices Current LPG import price Current fuel oil import price Current diesel price Current gasoline price US$/mmBtu VAT Consumption tax Price excl. tax 30.67 29.14 23.21 22.08 16.09 12.07 Exhibit 42: Share price Source: Bloomberg, Jefferies 0.0 4.0 8.0 12.0 16.0 20.0 Nov-07 Feb-09 May-10 Aug-11 Nov-12 Laban Yu +852 3743 8047 lyu@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 28 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  30. 30. Ping An (2318 HK, BUY, TP HK$83) Key takeaway Ping An is our top pick in the China insurance sector. It is the only listed insurer that has limited exposure to bancassurance, with almost pure focus on agency distribution. We believe its life insurance NBV growth rate can be maintained at 7-12% for the next few years. In addition, we believe its strong P&C operation and improving banking business will also help with its re-rating going into 2014. Our TP of HK$83.0 implies 1.32x 14E P/EV. Life insurance recovered nicely in 2013: Ping An reported strong agency business growth momentum for 1-9M13, with agency new business up approximately 10%, translating to NBV expansion of 9-11% in our view (recall that Ping An Life delivered strong NBV growth of 14% in 1H13. As a result, we revised up our 2013 NBV growth assumption to 10% (from 7.5% previously). Strong product design leads the industry: On 16th Oct, Ping An launched its first post-deregulation product, called “Ping An Fu”, via its agency distribution. “Ping An Fu” is a protection driven whole-life policy, targeting critical illness/accident protections. The policy uses a guaranteed interest rate of 4.0%, higher than most other insurers’ common application of 3.5%. However, the policy is not cheap, and has comparable pricing vs. China Life’s “Kang Ning 2”, which uses 2.5% as guaranteed pricing. This gives us comfort that Ping An has not blindly started a pricing war; on the contrary, it has maintained good product margins and used 4% as a powerful marketing tool. The only one planning for e-commerce platform: Recently, Ping An has started preparing and launching various on-line platforms to prepare for the e-commerce era. Noticeable platforms include: Lufax (www.lufax.com); Wanlitong (www.wanlitong.com); Ping An Hao Che (www.pahaoche.com) and 24 money (www.24money.com). We understand that the probability of success is still unknown for some of these platforms, but we do not believe investors have assigned any meaningful valuations to such efforts. As a result, we see such e-commerce effort as an option on the company, which could help Ping An to achieve high quality sales of financial products in the future. Valuation and risks Ping An is currently trading at 1.1x 14E P/EV. Given its stronger agency growth momentum, limited exposure to bancassurance business, solid P&C operations, and recovery in banking business, we believe upside is attractive. Ping An remains our top pick in the sector. Our TP of HK$83.0 values Ping An at 1.32x 14E P/EV. Risks: 1) Negative A-share return; 2) Irrational pricing competition in life insurance products; 3) Deterioration in macro environment, which could cause concerns on Ping An Bank. Exhibit 46: Ping An has low bancassurance exposure (1H13) Source: Company data, Jefferies Exhibit 47: NBV growth returned to an uptrend Source: Jefferies estimates Agency NBV 92% Bancassurance NBV 5% Others NBV 3% 13% 40% 19% 38% 31% 8% -5% 14% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 2006 2007 2008 2009 2010 2011 2012 1H13 NBV growth Exhibit 45: Ping An’s share price Source: Bloomberg, Jefferies 0.0 20.0 40.0 60.0 80.0 100.0 Nov-09 Nov-10 Nov-11 Nov-12 Baron Nie, CFA, AIAA +852 3743 8747 Baron.nie@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 29 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  31. 31. Shanghai Industrial (363 HK, Buy, HK$30) Key takeaways We like SIHL’s balanced portfolio, stable earnings and attractive valuation. We believe the company is well-positioned to benefit from Shanghai’s robust outlook as the Free Trade Zone becomes a key growth driver. Thanks to strong government support, SIHL has ample opportunities to acquire quality state-owned assets in infrastructure utilities and real estate, therefore enhancing its potential. Its valuation is attractive at 0.8x P/B and 25% discount to NAV, with a 4% dividend yield. Buy. The listed flagship of Shanghai government. As the only overseas listed window company of Shanghai Municipal Government, SIHL is a good proxy for Shanghai’s vibrant economic growth outlook, in our view. We like its quality assets and a balanced portfolio across infrastructure, consumer and property, which are well positioned to benefit from the long- term growth of the city. Well-positioned to benefit from Shanghai FTZ. We believe the launch of Shanghai Free Trade Zone (FTZ) is poised to boost Shanghai’s outlook. SIHL’s infrastructure business should benefit from growing transportation demand as FTZ becomes a major economic growth driver of the region, while its property business should benefit from appreciation land value. The preferred consolidator of state-owned assets. Given its solid track record and strong government support, we believe SIHL will have ample opportunities to consolidate quality state-owned assets as SOE reform accelerates and enhance its outlook. We feel sewage treatment is an area in which SIHL has high M&A potential as Shanghai begins to privatize them. Its parent will likely inject stakes in Hangzhou Bay Bridge in 2014. Also, we expect SIHL to acquire real estate assets from its parent or through local state-owned asset consolidations. Stable earnings, valuation attractive; Buy. The infrastructure and consumer units contribute ~2/3 of SIHL’s core net profit, making it one of the most defensive names in the conglomerate space. The stock is trading at 0.8x P/B and 25% discount to NAV, with a 4% dividend yield. We believe the valuation is attractive; Buy. Valuation/Risks Our HK$30 price target is based on a 15% discount to our NAV estimate. Key risks include: 1) tightening policies could curb property demand; 2) slower-than-expected M&A or asset injection; and 3) weak execution on property. Exhibit 49: NAV breakdown – 2013E Source: Jefferies, company data Exhibit 50: Net profit breakdown (HKD$mn) Source: Jefferies, company data Christie Ju, CFA Equity Analyst +852 3743 8012 cju@jefferies.com Exhibit 48: Share price Source: Bloomberg, Jefferies 0.0 10.0 20.0 30.0 40.0 50.0 Nov-07 Feb-09 May-10 Aug-11 Nov-12 Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 30 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  32. 32. Sinopharm (1099 HK, BUY, TP HK$26.5) Key Takeaway Sinopharm is our favourite Chinese pharma distributor, given its unsurpassed dominance in the space. While the company’s distribution business should sustain high-teens% organic growth in the next several years, significant opportunities lie in its retail pharmacy business longer term. Trading at 16x our 2014e EPS against our 3-year EPS CAGR of 18%, the stock’s valuation is attractive. Expect above-industry growth amidst reform uncertainties While the health reform uncertainties will continue, we believe that Sinopharm’s competitive advantage as an industry leader should become increasingly apparent and benefit from the industry consolidation trend. We remain confident that Sinopharm will continue to outgrow the industry by 3~5%, given its scale advantage, most comprehensive national distribution network, and better ability to fend off pressures from reforms. We forecast that the company is capable of delivering sales and earnings CAGR of 18% over the next three years. Maintain margins with business optimization Despite increasing pricing pressure, we believe Sinopharm can maintain its margins by: 1) potentially monopolizing the distribution of certain products; 2) focusing on high end services such as cold-chain management and hospital pharmacy outsourcing; and, 3) exploring new business opportunities in healthcare services and dialysis. Sinopharm could also help improve its margins via minority interest (accounts for ~37% of net income) buyback. Pressure on cash flow a structural risk As public hospital reform deepens, the hospital payment cycle will likely continue to lengthen; a structural risk that pressures the company’s cash flow and tempers its growth. Sinopharm should be able to alleviate such pressure through better working capital management, receivables factoring and securing lower rate borrowings. Sinopharm could also issue a second tranche of corporate bonds with principal not less than Rmb4bn and coupon rate of 4.54% by September 2014 to lower its borrowing costs. Potential in pharmacy business underappreciated Contributing ~3% to its total sales and profit, Sinopharm’s #1 retail pharmacy business is much less visible. We see strong potential in this business segment in the long run as the pace of acquisition accelerates further. Potential collaboration with leading domestic and international players could lead to a jump in this business. There is room for significant margin improvement in the segment, which should lift overall company margin and help alleviate pressure on cash flow. Valuation We derive a 12-month price target of HK$26.5 based on a combination of DCF and the relative valuation approach. Trading at 16x 2014e EPS against our 18% 3-year CAGR projection and 2014 PEG of 1.1, Sinopharm’s valuation is attractive. Risks Risk to our view and price target include slower economic growth in China, less favorable government policy on healthcare spending, stiffer competition, a slower pace of M&A, failure to achieve any post-merger integration synergy in later years, and higher-than-anticipated working capital requirements. Exhibit 51: Sinopharm’s share price Source: Bloomberg 0 5 10 15 20 25 30 35 40 Sep-09 Dec-10 Mar-12 Jun-13 Jessica Li, Ph.D. +852 3743 8010 Jessica.li@jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 31 of 228 Please see important disclosure information on pages 221 - 226 of this report.
  33. 33. Agile (3383 HK, Underperform, TP HK$7.8) Key takeaway We maintain Underperform on Agile as we consider its aggressive land banking unjustified on lagging sales and rising inventories. Given the policy headwind, weakening market sentiment and tightening credit ahead, we believe the contribution from new cities remains highly uncertain. Compared to peers, Agile may be exposed to higher risk from stricter tax collection as its current tax liability is Rmb9.5bn. Disappointing sales performance continues Despite the booming property market, Agile reported sluggish presales with merely 70% locked-in ratio as of Oct (vs. 88% average for peers) mainly due to shortage of products with real demand, while inventory increased 42% to Rmb11.3bn in the interim. Although the company targets to launch 7 new projects in 4Q and reach Rmb5bn/6bn in Nov/Dec respectively, we are afraid its oversized units and aggressive pricing strategy may hinder sales contribution. Unjustified land banking on financial concern Despite sluggish sales, Agile accelerated expansion this year as it has allocated Rmb14bn (48% of its presales) to land acquisition, and entered into 9 new cities, including Yangzhou, Wuxi and Chuzhou. We are concerned about its management capacity during the expansion and expect its gearing to grow to 65% at the year-end vs. 58% at the interim. Moreover, Agile still has Rmb9.5bn current tax liabilities as of Jun-2013, equivalent to 63% of its cash on hand. Yunnan market uncertain Driven by the successful experience in Sanyan, the company entered into Yunnan aggressively to develop another tourism project. So far, its land reserves in Ruili, Tengchong and Xishuangbanna amount to 4.7mn sqm, accounting for 10% of its total land bank. As Agile targets to launch Tengchong project at Rmb6.4k-11k/sqm and Ruili project at Rmb4.8k/sqm at year end, we see sales performance as uncertain given the remote geographic region. Valuation Our price target of HK$7.8 is based on a 60% disc. to NAV of HK$19.4. Key risks are: 1) stronger-than-expected presales; and 2) substantial improvement in cash position. Exhibit 53: Core earnings growth(SGD mn) Source: Jefferies, company data Exhibit 54: NAV discount chart Source: Bloomberg, Jefferies 0 10,000 20,000 30,000 40,000 50,000 2009 2010 2011 2012 2013E -120% -95% -70% -45% -20% 5% 30% Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 -3.7% Peak -63.9% -1stdev -32.6% +1stdev -82.1% Trough -48.3% Avg Exhibit 52: Agile share price Source: Bloomberg 0.0 4.0 8.0 12.0 16.0 20.0 Nov-07 Feb-09 May-10 Aug-11 Nov-12 Venant Chiang +852 3743 8013 venant.chiang@Jefferies.com Equity Strategy China 20 November 2013 , Equity Analyst, +852 3743 8012, cju@jefferies.comChristie Ju, CFApage 32 of 228 Please see important disclosure information on pages 221 - 226 of this report.

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