Asia Pacific Equity Research                                                                                              ...
Sunil Garg                                                 Asia Pacific Equity Research(852) 2800-8518                    ...
Sunil Garg                               Asia Pacific Equity Research(852) 2800-8518                          18 October 2...
Sunil Garg                             Asia Pacific Equity Research(852) 2800-8518                        18 October 2012s...
Sunil Garg                                                 Asia Pacific Equity Research(852) 2800-8518                    ...
Sunil Garg                                 Asia Pacific Equity Research(852) 2800-8518                            18 Octob...
Sunil Garg                                    Asia Pacific Equity Research(852) 2800-8518                               18...
Sunil Garg                                                      Asia Pacific Equity Research(852) 2800-8518               ...
Adrian Mowat                                  Asia Pacific Equity Research(852) 2800-8599                               18...
Adrian Mowat                                   Asia Pacific Equity Research(852) 2800-8599                                ...
Adrian Mowat                                              Asia Pacific Equity Research(852) 2800-8599                     ...
Haibin Zhu                              Asia Pacific Equity Research(852) 2800-7039                         18 October 201...
Nick Lai                               Asia Pacific Equity Research(886-2) 2725-9864                      18 October 2012n...
Josh Klaczek                          Asia Pacific Equity Research(852) 2800-8534                       18 October 2012jos...
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
Jpm china view 121018
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Jpm china view 121018

  1. 1. Asia Pacific Equity Research 18 October 2012JPM China ViewBuy BanksDemand metrics continue to downshift. While headline October macro Director of Asia Pacific Equitydata appears encouraging, details are uninspiring. Discretionary Researchconsumption has weakened further and across the board, pricing power Sunil Garg ACremains elusive, suggesting a volume-margin trade-off. Earnings (852) 2800-8518expectations for 2013 (JPMe 6.5%/ consensus 9%) appear high amidst sunil.garg@jpmorgan.comthe backdrop of continuous macro forecast reductions. In a growth- J.P. Morgan Securities (Asia Pacific) Limitedstarved world, companies that can deliver growth, with visibility, should Rajiv Batracontinue to outperform, despite what may appear as expensive (91-22) 6157-3568valuations. Amongst the major sectors, banks offer that possibility – on rajiv.j.batra@jpmorgan.combetter NIM outcomes in 3Q and on better asset quality outcomes in 2013. J.P. Morgan India Private Limited Signs of Optimism – A rebound in liquidity metrics (money supply, Asia Pacific Equity Strategy AC loan growth, and deposit growth), railway capex are the only signs of Adrian Mowat optimism in our view. Stabilization in pricing in some sectors such as (852) 2800-8599 adrian.mowat@jpmorgan.com steel reflects supply cuts rather than demand revival. J.P. Morgan Securities (Asia Pacific) Limited False Signs of Optimism – A pick-up in export and import growth in Oct has prompted calls for a bottoming out. We would be cautious - Greater China Economist trade to US/EU actually worsened and import pick-up appears to have Haibin ZhuAC (852) 2800-7039 been led by “re-stocking” without visible demand increases. haibin.zhu@jpmorgan.com Signs of Deterioration – Discretionary consumption, automobiles, tech, JPMorgan Chase Bank, N.A., Hong Kong internet revenues, airlines, property, energy, are all showing signs of incremental demand deterioration, suggesting risks to earnings estimates. Investment Strategy – While we see risks to 2013 headline EPS estimates, the one sector that has potential upside, at least in the near- term is banks. Weaker NIM forecasts and asset quality deterioration had led estimates lower for China banks. While we continue to recognize structural challenges, better pricing discipline in 3Q may support NIMs and easier liquidity could support asset quality. Buy ICBC and CCB.Table 1: Our highest-conviction recommendations Company Ticker Rating Price Target Company Ticker Rating Price Target Top Picks Stocks to Avoid 21Vianet. VNET US OW 12.0 16.3 Anta Sports 2020 HK UW 6.9 3.6 Baidu BIDU US OW 113 200 CHALCO 2600 HK UW 3.4 2.7 Beijing Capital Int. Airport 694 HK OW 5.2 8.3 China Merchants Holdings 144 HK UW 24 20 Beijing Enterprises 392 HK OW 49 60 Glorious Property 845 HK UW 1.15 1.00 China Shenhua Energy 1088 HK OW 31 35 New China Life Insurance 601336 CH UW 23 25 China Shipping Cont. Lines 2866 HK OW 1.9 2.9 PetroChina 857 HK UW 11 8.75 China ZhengTong Auto 1728 HK OW 4.7 5.5 Country Garden 2007 HK OW 3.1 3.6 Golden Eagle Retail 3308 HK OW 17 20 ICBC - H 1398 HK OW 4.9 5.8 Nine Dragons Paper 2689 HK OW 4.8 5.3 Ping An Insurance 2318 HK OW 61 65 Sinopec 386 HK OW 7.8 9.0 United Labs 3933 HK OW 4.2 4.5 ZTE 763 HK OW 10.9 16.0Source: J.P. Morgan estimates, Bloomberg, Pricing date is 16 October 2012See page 38 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that thefirm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor inmaking their investment decision. www.morganmarkets.com
  2. 2. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.com Table of ContentsFigure 1: China Banks Forward PE Macro Sectors...........................................................................3 24.0 Consumption ............................................................................3 22.0 20.0 Investment ................................................................................4 18.0 +1SD Trade..........................................................................................4 16.0 14.0 Energy & Utilities......................................................................4 Average 12.0 China leadership change .........................................................9 10.0 8.0 Economics ..............................................................................12 6.0 -1SD 4.0 Automobiles............................................................................13 05 06 07 08 09 10 11 12 Banks.......................................................................................14Source: J.P. Morgan, IBES, MSCI, Datastream. Cement ....................................................................................15 Consumer................................................................................16Figure 2: China Banks Trailing PB Energy (O&G)..........................................................................17 5.0 Gaming ....................................................................................18 4.5 4.0 Healthcare ...............................................................................19 +1SD 3.5 Infrastructure ..........................................................................20 3.0 Average 2.5 Insurance ................................................................................21 2.0 Internet ....................................................................................22 1.5 1.0 -1SD Metal & Mining ........................................................................23 0.5 Real Estate ..............................................................................24 05 06 07 08 09 10 11 12 Ship Building ..........................................................................25Source: J.P. Morgan, IBES, MSCI, Datastream. SMID-Caps ..............................................................................26 Technology hardware ............................................................27 Telecom...................................................................................28 Transportation ........................................................................29 Utilities & Power Equipment..................................................30 Q-Profile for China..................................................................31Table 2: China Sector Valuation Price MSCI P/E (X) EPS growth P/B (X) Dividend yield P/E EPS CAGR PEG Risk Adj 15 Oct Wts 2012E 2013E 2012E 2013E 2012E 2013E 2012E 2013E 2011 (12-14) Ratio PEGMSCI China 57.4 100% 10.1x 9.5x 1% 7% 1.5x 1.3x 3.2% 3.2% 10.1 10.1 1.0 0.64Consumer Disc. 188.9 5% 12.7x 11.7x -4% 8% 2.0x 1.8x 2.0% 2.3% 12.4 18.7 0.7 0.88Cons. Staples 1,196.1 6% 25.4x 20.7x 6% 23% 3.4x 3.1x 1.5% 1.8% 26.7 19.7 1.4 6.38Energy 720.9 18% 9.8x 9.8x -2% 0% 1.5x 1.4x 3.5% 3.1% 9.4 6.2 1.5 2.06Financials 407.1 37% 7.4x 7.2x 7% 2% 1.2x 1.1x 4.0% 4.2% 7.9 7.9 1.0 0.25Health Care 128.5 1% 35.7x 31.0x 9% 15% 3.7x 3.4x 0.6% 0.7% 27.3 20.5 1.3 0.75Industrials 116.0 6% 12.3x 9.7x -13% 27% 1.0x 0.9x 3.0% 2.8% 10.8 18.9 0.6 1.46IT 133.3 7% 27.6x 19.4x -9% 42% 4.4x 3.7x 0.7% 0.8% 24.3 25.6 0.9 1.60Materials 714.7 5% 12.5x 9.2x -34% 36% 1.2x 1.1x 2.8% 2.5% 8.4 21.7 0.4 0.17Telecom 136.6 13% 12.6x 12.1x 1% 4% 1.6x 1.5x 3.4% 3.5% 12.5 6.5 1.9 2.62Utilities 413.58 3% 12.9x 10.9x 44% 19% 1.5x 1.4x 1.7% 2.4% 18.7 15.9 1.2 3.67Source: J.P. Morgan estimates, Bloomberg, MSCI. Note: For all sectors forecast numbers are derived from bottom-up calculations of each individual MSCI constituents using J.P. Morgan estimatesfor covered stocks and Bloomberg estimates for the rest. Companies with different yearends are calendarised to December yearends and are free float adjusted for aggregation2
  3. 3. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comMacro Sectors ConsumptionEconomy – Weak Recovery Passenger Vehicles – Low/Mid marketSmall, sequential improvements in PMI, trade data, loan Overcapacitygrowth and imports suggest that a weak recovery is Nick’s demand/supply model for passenger vehicles inunderway. However, Haibin and team have pared back China suggests that while growth rates will moderatemonetary easing expectations (now only 1 RRR cut of across the board, the luxury segment (34% CAGR 2004-50bp before year end) and GDP growth forecasts for 15E) will continue to grow 3-4x of the general market2013 to 8% (previous 8.3%). and within the luxury market, ultra-luxury brands will have growth rates 1/3rd higher (c43% CAGR) thanOutlook: Policy making continues to be in a holding aggregate luxury market. Pressure on volume growth andpattern ahead of the leadership change. Provincial pricing for low-mid market players is expected to drivegovernments have announced investment projects ROEs lower in this segment. Amongst the automakers,aggregating nearly Rmb20trn (in many case well over Nick is bullish on the SUV segment. Top Picks: Geely,100% of GDP). We see gaps in funding besides the Great Wall.extended time frame over which these investmentswould be made - making us less than excited about Consumer – Tough for Discretionarythese announcements. A lack of discounting is hampering sales recovery and on a like-for-like basis, Ebru fears that 4Q for discretionaryFinancials – Liquidity Led Optimism consumer business may be worse than 3Q’12. Within theBanks – A revival in monetary aggregates (M1 growth retailer space, Ebru sees loss of competitiveness for7.3% vs. <5% for over 8 months/ M2 growth 14.8%/ department stores as other channels (outlet malls,Loan growth 16.3%/ Deposit growth 13.3%). Easier shopping malls and online stores) gain. However playersliquidity conditions should ease credit quality concerns such as Golden Eagle are seen as having the ability toand Joshs positive stance on ICBC and CCB is premised increase share in a fragmented market.on superior capitalization and liquidity metrics, helpingdeliver industry leading ROEs as well as ability to Staples growth rates are holding up and pressure frommaintain dividend payouts. Top Pick: ICBC. input prices is yet to be felt. There are selected cases of overcapacity though, for example in tissues.Property – Reduce ExposurePrimary sales fell 7%m/m (to 7.22mn sqm, below Despite the promise, discretionary growth remainsexpectations) in Sep as developers opted to protect elusive while staples stocks, albeit expensive, have seenmargins, sacrificing volumes in the process. Lucia steady upward earnings revisions. Top Pick: Goldenbelieves that developers still lack pricing power and Eagle. Stock to Avoid: Anta Sportsexpects a price-volume trade-off for now withexpectations of quieter primary volumes until Chinese Gaming – Growth ModeratesNew Year. Meantime, inventories in major cities have Sep revenue fell 9%m/m (to MOP23.9bn) with VIPrisen (highest since Feb ’12). Lucia’s expectation is for segment down 7%m/m (YoY growth rates in Sep’12inventories to remain high in tier 2/3 cities and relatively benefited from a typhoon impacted base in Sep’11 andlower in tier 1 cities. Our property team is higher weekend days in Sep12). While mass marketrecommending switching out of property stocks in view (higher margin) should continue to stay strong, inof volume growth expected to slacken, lack of further particular due to expected infrastructure improvements,monetary easing signals and the fact that sector Ken sees slower growth rates in the short-term, thusperformance has been solid. Top Picks: Country expecting stocks to consolidate after a 15% ptGarden, Franshion. outperformance since Aug’12. Top Picks: Wynn Macau (below HK$20), Galaxy(in low 20s) and Sands (at HK$25-26). Technology – Growth Moderation TV and smartphone sales during golden week have accelerated from 1H levels but fell short of market expectations. Alvin and team have also revised down PC 3
  4. 4. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comgrowth forecasts (5-10% y/y in 4Q vs. 10-15% expected players have gained share. Coalmine machinery FAIearlier) due to delayed energy efficiency subsidies and rebounded 19% y/y in Aug (vs. 3% in Jul).awaiting Win-8 launch (Oct 26th). Karen is positive on infrastructure E&C, and cautious on construction machinery. Top Picks: CRG, CRCC.An important issue that is brewing is the outcome forZTE’s operations in the US. While the US is a relativelysmall 5% of ZTE’s operations –prospects of similar Metals & Mining – Bottoming Outactions by other countries as well as potential Sentiment is improving in the China metals & miningretaliation within China make the outcomes volatile at space, with a bottoming in commodity prices continuingthe minimum. As such, investors seeking value in Top to play out (thermal coal, steel) and improving near-termPick ZTE, should factor this in. supply/demand dynamics. Stimulus measures - either monetary or fiscal, are likely to remain a key catalyst forTelecom- 3G Migration = ARPU Boost the domestic market. Daniel remains selectively OW with preferred beta exposure in steel for Angang (TopUnderutilized 3G networks (20-30%) along with Pick).proliferation of cheaper smartphones (15-20% of 2Gusers have smartphones) is expected to increase Cement – Oversupply Caps Pricingmigration from 2G to 3G, hence boosting ARPUs. Lucy, Nick estimates a surplus of 150mn tones of capacity thatMichelle and team expect that the upper end of 2G is significant (2x of entire US consumption) enough tosubscriber base presents an upgrade opportunity and they cap cement prices in China (down 12% in Jan-Sep12).see CT and CU as major gainers with CU in particular Within the space, Nick continues to recommend marketgiven its competitive advantage in the low end leader Anhui Conch (Top Pick) and UW on smaller CRsmartphone market. Top Pick: China Unicom. Cement.Internet – Advertising Outlook WorsensDick is incrementally even more cautious on advertising Tradeoutlook following conversations with TV and online ad Shipping – Positive on Bulk Shippersagencies. Dick thus sees downside risks to 3Q earningsand 4Q12 guidance. Dick continues to see resilience in Corrine’s constructive view on Bulk shipping isthe online gaming market. Top Picks: Baidu and Youku. supported by only moderate growth in global bulk fleet (+0.4% m/m in Sep) making annualized 12% growthAirlines – Overcapacity Woes rates at 2/3rds of projected 18% supply growth. Corrine thus continues to believe that supply growth as impliedOvercapacity, higher fuel prices and FX losses will all by the orderbook is over-estimated. Meantime, Chinacombine to depress Airline profitability in China, Cosco and CSCL’s plans to cooperate on domesticaccording to Corrine. As such, she expects substantial container shipping routes is a positive marketdownside to consensus estimates (Corrine’s forecasts are development. Top Pick: CSCL.58% below consensus). Corrine’s long-term view onChina’s passenger aviation market remains Infrastructure – Port Pick Upconstructive. Top Pick: Air China. Port sector – Yantian’s 3Q run-rate is up 19% q/q supporting Karen’s Sep expectations of high singleInvestment digits-low teens growth. Karen Li likes Hutch Ports in this space.Infrastructure – Railway BoomContinues Tollroads – Latest data suggests bottoming out in September.Railway FAI rose 93% y/y in Sep (to Rmb73bn) withcivil works spend rising faster at 111% y/y. Meantime,2012 infrastructure spend target (civil works focused) hasbeen raised a fourth time in three months (aggregate 30% Energy & Utilitiesabove initial target). Oil & Gas – Overcapacity = ExportsMachinery – Sequential excavator sales decline appears Demand for petroleum products in China is growing atto be moderating (-5% m/m in Aug) although domestic very low rates, around 2% ytd. Diesel in particular is weak, driven by weak exports and industrial production.4
  5. 5. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comGasoline is slightly better, possibly due to the lower fuel prices. Demand for gas and water utilitiesclassification of products used in the gasoline pool. remains resilient. Boris recommends switching out of outperformers that lack incremental catalysts. InWhile demand growth is weak, Chinese companies are particular, further gains from lower coal prices areexpanding refining capacity at a greater rate. Post 2012 unlikely. Top Picks: Beijing Enterprises, ENN.Brynjar expects a product demand growth rate of 4%,which compares to refinery capacity build in the range of6-7%. This will result in a combination of lower Quantitative Strategies/ Valuationscapacity utilization, higher exports and closure of Cheap Value – Following a c10% rebound of earlysmaller inefficient refineries. Brynjar is assuming 80% Sep’12 lows, MSCI China is now trading on 2013E PEutilization as the absolute low, and our demand picture of 9.5x and PB of 1.3x – both 1 standard deviation belowhence results in increased exports from China. Top Pick: vs. historical average. PE multiples are balanced by aSinopec 10% EPS CAGR over next 2 years. Within MSCI China, lowest PEG at 0.4 is for Materials and highest 1.9 is forUtilities – Weak Demand, Better Margins Telecom stocks. Our risk-adjusted PEG metric suggestsChina IPP demand and hence capacity utilization should financials as amongst the most attractive sectors.remain under pressure according to Boris, but earningsare helped by better margins, in turn a beneficiary ofFigure 3: PEGs and Stability of Growth EPS CAGR / Std dev = Stability of Growth 5.0 Banks 4.5 4.0 Financials 3.5 3.0 2.5 Materials 2.0 PEG China Healthcare 1.5 Real Estate 1.0 Cons. Disc. Energy 0.5 Insurance Telecom Industrials IT Utilities 0.0 Cons. Staples 0.00 0.20 0.40 0.60 0.80 1.00 1.20 1.40 1.60 1.80 2.00Source: IBES, MSCI, Datastream, J.P. Morgan. 5
  6. 6. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comTable 3: Investment view on our highest-conviction recommendationsCompany, Sector, Analyst Analyst CommentaryTop Picks21Vianet Group Inc. Selling shovels: Weve written many times that data is extremely hard for telecom operators to monetize profitably. Given that, play the major increase in data usage throughSector: Internet Infrastructure infrastructure providers. We think VNET is the best regional example of this theme.Analyst: James R. Sullivan, CFA EPS forecasts + valuation now supportive. We had previously stated that VNET shares may stall for a period of time due to a lack of earnings upgrades and no longer ‘cheap’ valuations. Since that time, EPS forecasts were reduced too aggressively in our view (cut 44% since 2Q earnings despite in line guidance), we are now 20% ahead of street forecasts for 2012 EPS.Baidu.com Leveraged to potential macro improvement. Attractive valuation good corporate governance and long-term search market growth. We believe Qihoo impact is small to Baidu, and BaiduSector: Internet to gradually increase its market share. In addition, we think concerns over mobile usage growth are overdone, and expect mobile search to boost profits for the company..Analyst: Dick WeiBeijing Capital International Airport We believe BCIA is now reaching an inflection point with compelling valuation of EV/EBITDA <10x and11% EBITDA growth in the next 3 years, on our estimates. Key value drivers: (1)Sector: Airports After taking into account potential capex related to the BJ #2 airport project but no incremental benefit, BCIA still looks undervalued to us. We think the stock has possiblyAnalyst: Karen Li, CFA factored in all potential concerns on capex front. Removing all capex associated with new airport project could raise our PT to HK$13 by Dec-12. (2) BCIA aims to restore payout level of 2011, maintain consistent record in future. By FY14E, we estimate BCIA could potentially offer 7% yield with payout ratio of 45% all else being equal.Beijing Enterprises Strong resilient gas demand from new gas fired power plants in Beijing thanks to the newly imposed “Environmental Air Quality Standards”, where big cities have to impose moreSector: China Utilities stringent control on concentration of small particles (PM 2.5).We have seen more evidence of increased demand, as Beijing Jingneng (579 HK, NR) has recently raised its 2013 targetAnalyst: Boris Kan gas-fired power capacity to ~4,600MW (from ~3,400MW previously) by fast-tracking its 1,200MW Beijing Shijingshan Co-Generation Plant. Overall, we expect a >30% gas sales volume CAGR in Beijing from 2012-15E. Other upsides include (1) strong gas demand on mid stream pipelines from newly connected areas in Shandong (2) BJE Water (earnings up (up 27% Y/Y, 8% of total) thanks to margin improvement on sewage operations (up from 49% to 54%). Overall, we expect a >25% EPS CAGR from 2012-14E..China Shenhua Energy - H Shenhua is the lowest cost coal producer in China, unique for its horizontally integrated rail and port infrastructure assets while its vertically integrated power assets (c25% of revenue)Sector: Mining reduce exposure to the volatile spot price. We forecast organic volume growth of over 5%pa through to 2015 (+10% in FY12E) from existing operations with the potential of furtherAnalyst: Daniel Kang parent asset acquisition growth. Shenhua currently trades at a significant valuation discount to historical PE levels (c13x) on our estimates.China Shipping Container Lines CSCL provides unique exposure as the largest player in the domestic China shipping trade. Overcapacity risks are lower as CSCL’s newbuild vessel deliveries will be more than offsetSector: Shipping by the return of chartered-in vessels. CSCL also has a lower unit cost structure than sector average. We expect CSCL to be profitable in 2H12 and expect margins to expand by 300bpsAnalyst: Corrine Png in 2013 and see no equity-raising risk. Valuations at 0.6x FY12E P/B are attractive and have overly discounted the challenging industry outlook, in our viewChina ZhengTong Auto Our recent visit in China suggests that overall inventory and pricing pressure among dealers have gradually eased, thanks to automaker trimming sales target, providing for support forSector: Auto dealers and also a sequential improvement in car sales. Margin as a result is expected to improve in 2H12 vs. the bottom in 2Q12. Momentum in luxury vehicle remains intact with BMWAnalyst: Nick Lai and Audi’s volume, for instance, both up by over 30% YTD vs. overall passenger vehicle of 8%. In the near term, 4Q is peak season in China; we expect a strong sales volume toward year end.Country Garden We like Country Garden because of its relatively strong balance sheet, which gives them the warchest to expand when its peers are deleveraging. Country Garden has bought plenty ofSector: Property land in 1H2012, utilizing the money they raised in share placement, and this should allow them to gain market share under the current market. We expect Country Garden’s contractedAnalyst: Ryan Li, CFA sales to outperform its peers in 4Q2012 and 2013Golden Eagle Retail Golden Eagle’s 1H result was weak on the back of new store openings and also weak SSSG. We do not expect a major recovery in 2H but given the long term bottom up drivers for thisSector: Consumer name and given that short term weakness is priced in we reiterate our OW rating for Golden Eagle. The stock is trading at 17x 1-yr forward P/E, pricing in the short-term weaknessAnalyst: Ebru Sener Kurumlu already in our view. We believe it is one of the best-positioned department stores in China (given the positioning, regional dominance and property ownership) and we are looking for c25% earnings CAGR post 2012 driven largely by new store additions and SSSG (around 14% post 2012).ICBC - H ICBC is our top pick in the sector given its leading deposit franchise (50% demand deposits), strong capital position (T1 10.3%), and prudent growth, which produces leading ROEsSector: Banks through the cycle. ICBC is less affected by the recent rate cuts, yet we still see material NIM compression from easing and deregulation, alongside higher credit costs. We think the stockAnalyst: Josh Klaczek offers significant value at 1.1x book and 6.4x FY13E earnings, as prices increasingly reflect the structural challenges ahead.Nine Dragons Paper Nine Dragons Paper (NDP) is the largest producer of containerboards in China and second largest globally. We see a good entry point in NDP following poor FY (June 12) results whichSector: SMID-Caps showed a record low gross margin of 16%. We believe that demand from containerboards, which is mainly driven by packaging for domestic consumer goods, is starting to be boostedAnalyst: Leon Chik by more government stimulus and credit easing in China. There has been no strong incentive to start new production capacity since early CY11 and therefore we see very few new lines being completed in 2013 (a new line takes 2 years to build). NDP has already lifted its price of containerboards by 2% in September despite stable-to-falling costs which is a key signal to us that the oversupply that has plagued the industry for over 12 months is coming to an end. We see the potential for further price hikes before year-end and improving margins for FY13 as key catalysts for a re-rating.6
  7. 7. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comPing An Insurance Group - H Ping An continues to have the best life insurance franchise in China in our view which is agency dominated. We think its non-life operation should weather the rise in combined ratioSector: Insurance better than its close peers as it gains further economies of scale. The plan to raise up to Rmb26 billion of convertible debt should help to satisfy near-term capital need, alleviating theAnalyst: Bao Ling Chan need for equity capital raising.Sinopec Corp - H We expect lower oil/higher product prices will turn refining losses to profits, generating good earnings growth. Increased likelihood of more frequent price adjustments will also benefitSector: Integrated Oils Sinopec and possibly rerate the stock on top of earnings growth. Petchems is very weak now, but next year if the global economy picks up, we don’t expect further weakness. SinopecAnalyst: Brynjar Eirik Bustnes, CFA trades at 1.0x 2013E book and should generate close to 13 pct roe going forward on our estimates, which indicates to us it is undervalued.The United Laboratories Commodity prices are trending or stabilizing around 2012 high. With TUL highly levered with sales of commodity prices due to large fixed costs and high capacity, the businesses ofSector: Pharmaceuticals intermediates and bulk medicines can become very profitable quickly especially TUL has announced a price increase of 20rmb/kg for 6-apa and amoxicillin bulk medicine. We thinkAnalyst: Sean Wu Antibiotics restriction is already priced in and finished product sales are rebounding back to 2H11 levels when price cuts and restriction of antibiotics use were not in effect. Current valuation does not reflect the great potential of the company’s human insulin franchise, in our view.ZTE ZTE is trading at 1x forward P/B, almost 3 std. below its historical mean, and such valuation is on par with the worst point of Global Financial Crisis. The stock has come off by 10% inSector: Technology last 2 trading sessions on the back of perceived US political risk, which we see as limited given 1) ZTE does not sell infrastructure telecom equipment in the US; 2) US handset revenueAnalyst: Qin Zhang accounts for only 7%/4% of 1H12 revenue/OP. We expect the acceleration of LTE deployment of China Mobile will help the stock re-rate to 1.5x P/B, or 2 std. below mean. TD-LTE spectrum allocation announcement has confirmed that TD-LTE infrastructure build could happen soon, and further clarity on CM’s TD-LTE capex budget for 2013 in Nov-Dec could present the next catalyst. Our Dec-13 PT is HK$16.Stocks to AvoidAnta Sports Products Ltd. We maintain our UW rating. We believe the sportswear sector is still struggling with inventory problems and heavy discounting. We have not yet seen any major consolidation takingSector: Footwear place in the sector and expect more shake-up as franchisees will in our view find it difficult to run profitable businesses given high discount levels. As partially seen in 1H result weAnalyst: Ebru Sener Kurumlu believe current margins of the company are not sustainable and expect margin erosion to continue in 2012 and 2013.Aluminum Corporation of China - H We think Chalco will struggle to return to profit this year — we forecast a loss of Rmb4.6bn. The company’s diversification strategy (coal, iron ore and power) will add further pressure toSector: Metals an already stretched balance sheet. Meanwhile, Indonesias recent policy changes to bauxite exports have impacted Chalco’s operations, forcing alumina output cut. With valuations stillAnalyst: Daniel Kang well above historical trough levels, we recommend an UW position.China Merchants Holdings Intl China’s weaker-than-expected industrial activity in May with a sharp decline in new export orders a key driver for de-rating. We view CMHI as a proxy for China’s industrial activity andSector: Conglomerates & Multi-industry containerized trade flow, with its key ports located in Shanghai (SIPG), Hong Kong (MTL) and Western Shenzhen. China’s NBS PMI eased more than expected to 50.4 in May, nearlyAnalyst: Karen Li, CFA 2.0-pt below market expectations and a sharp deceleration from the April reading (53.3). CMHI’s valuation–at 13x P/E FY12E and 50% premium to COSCO Pacific (“CP”)–does not look cheap to us. Despite the richer valuation compared to its peers, CMHI’s FY12E ROE is only on par with our estimate for CP, while dividend yield is lower than HPH Trust (CMHI at 3% vs. HPHT’s 10% on a 1-year forward basis).Glorious Property Chairman of Glorious Property is alleged by US SEC to have engaged in potential insider trading. We expect the litigation to drag on for a period and would be a major investor concern.Sector: Property Although contract sales run rates improved in Jun/Jul, Glorious would still need to roll-over Rmb5B of bank borrowings due in 2H12. We think the potential litigation may affect theAnalyst: Lucia Kwong, CFA companys access to loans especially offshore borrowings.New China Life Insurance Company Ltd - A We think New China Life likely to stay under pressure despite the recent de-rating in view of weak monthly premium growth trend with restructuring currently underway and overhangSector: Insurance - Life concern from possible stake disposal by existing shareholders (including Baosteel) when lock-up period expires in mid-Dec. Its capital position remains more vulnerable than peers givenAnalyst: Bao Ling Chan limited room to issue subordinated debts. It also appears to be using a relatively aggressive set of investment yield assumptions in view of its weak investment track record.PetroChina Petrochina trades at a 30 pct premium to Sinopec, meaning it is already pricing in refining profit turnaround and natural gas price reform in our view. Nat gas price reform is unlikely inSector: Integrated Oils the next 1-2 years, hence with increased imports of loss generating nat gas, we think Petrochinas earnings are capped. On top of this, we estimate an increase in capex which isAnalyst: Brynjar Eirik Bustnes, CFA already at very high levels will likely result in 13-14 pct ROE. The stock trades at 1.3x 2013E book, which is overvalued, in our viewSource: J.P. Morgan Lan Deng’s role has been limited to assisting in gathering information for this report 7
  8. 8. Sunil Garg Asia Pacific Equity Research(852) 2800-8518 18 October 2012sunil.garg@jpmorgan.comTable 4: Valuation comps for our highest-conviction recommendations Mkt cap Rating Price PT P/E P/B ROE DYCompany BB CMP (US$MM) target End date FY12E FY13E FY12E FY13E FY12E FY13E FY12E FY13ETop Picks21Vianet Group Inc. VNET US 12 677 OW 16.3 31-Dec-13 141.3 87.2 8.4 7.9 5.6 9.3 0.0 0.0Baidu.com BIDU US 113 39,370 OW 200 31-Dec-13 24.4 18.1 9.6 6.1 48.6 41.3 0.0 0.0Beijing Capital International Airport 694 HK 5.22 2,917 OW 8.3 31-Dec-12 13.1 10.6 1.2 1.1 9.3 10.5 1.1 1.4Beijing Enterprises 392 HK 49.4 7,250 OW 60 30-Jun-13 18.4 13.7 1.2 1.1 6.6 8.2 1.6 2.2China Shenhua Energy - H 1088 HK 31.45 73,309 OW 35 30-Jun-13 11.1 10.3 2.0 1.8 19.0 18.3 3.4 3.7China Shipping Container Lines 2866 HK 1.88 3,708 OW 2.85 31-Dec-13 NM 25.2 0.7 0.7 -1.0 2.7 0.0 0.0China ZhengTong Auto 1728 HK 4.71 1,342 OW 5.5 30-Jun-13 12.9 10.1 1.2 1.1 9.8 11.1 0.0 1.1Country Garden 2007 HK 3.06 7,197 OW 3.55 30-Jun-13 7.7 6.9 1.2 1.1 17.4 16.7 5.0 5.7Golden Eagle Retail 3308 HK 17.08 4,259 OW 19.5 30-Jun-13 21.7 19.1 5.2 4.6 25.4 25.4 2.3 2.6ICBC - H 1398 HK 4.88 214,727 OW 5.8 31-Dec-12 6.2 6.3 1.2 1.1 21.3 18.3 5.1 5.1Nine Dragons Paper 2689 HK 4.78 2,876 OW 5.3 31-Dec-13 13.1 9.7 0.8 0.8 6.7 8.6 1.8 2.4Ping An Insurance Group - H 2318 HK 61.35 56,678 OW 65 31-Dec-12 15.9 13.1 2.6 2.2 17.5 18.2 0.9 1.0Sinopec Corp - H 386 HK 7.82 85,238 OW 9.0 31-Dec-12 7.5 6.8 1.0 0.9 14.6 14.4 3.2 3.5The United Laboratories 3933 HK 4.15 871 OW 4.5 31-Dec-12 21.8 12.3 1.3 1.2 5.6 9.9 1.7 3.1ZTE 763 HK 10.94 4,949 OW 16.0 31-Dec-13 13.9 9.9 1.2 1.1 8.7 11.5 2.4 3.4Stocks to AvoidAnta Sports Products Ltd. 2020 HK 6.9 2,220 UW 3.6 30-Jun-13 9.6 14.4 2.0 2.0 21.9 13.9 6.4 4.3Aluminum Corporation of China - H 2600 HK 3.39 9,356 UW 2.7 30-Jun-13 NM 138.2 0.8 0.8 -9.3 0.6 0.0 0.0China Merchants Holdings Intl 144 HK 23.8 7,645 UW 20 31-Dec-12 13.4 12.8 1.3 1.2 9.9 9.9 3.3 3.4Glorious Property 845 HK 1.15 1,156 UW 1.00 31-Dec-12 5.0 5.3 0.4 0.4 8.0 7.4 0.0 0.0New China Life Insurance Company Ltd - A 601336 CH 23.24 11,192 UW 25 31-Dec-12 23.6 15.5 2.1 1.9 9.3 12.7 1.8 0.6PetroChina 857 HK 10.7 258,390 UW 8.75 31-Dec-12 10.4 10.1 1.5 1.3 14.6 13.9 4.3 4.5Source: J.P. Morgan estimates, Bloomberg. Pricing date is 16 October 2012.Figure 4: 2012 Earnings growth vs. Earnings revisions momentum 6 56 3 month back 1 month back Current 2012 EPS Growth (RHS) 49 3 42 0 35 -3 28 -6 21 -9 14 7 -12 0 -15 -7 -18 -14 Real Estate Cons. Staples Cons. Disc. Financials Healthcare Insurance Telecom Industrials Materials China Banks Utilities IT EnergySource: J.P. Morgan, IBES. Pricing date is 15 October 2012. Note: The bar shows the 3 month earnings revision (%) today, 1 month back and 3 month back. The red dots shows you 2012 earnings growth estimate as of today8
  9. 9. Adrian Mowat Asia Pacific Equity Research(852) 2800-8599 18 October 2012adrian.mowat@jpmorgan.com members; Hu Jintao, Wu Bangguo, Wenjiabao, JiaChina leadership change Qinglin, Li Changchun, Xi Jinping, Li Keqiang, He Guoqiang, and Zhou Yongkang).The 18th National Congress of the Chinese For the top position the expectations are: Xi JinpingCommunist Party (CCP) starts in Beijing on 8 succeeds Hu Jintao the general party secretary. LiNovember. The CPC meet every five years. It is the Keqiang succeeds Wen Jiabao as premier. It is likelymost important event in China’s political calendar this that the standing committee is reduced to seven. Theyear. The congress has two major tasks: election of other Politburo Standing Committee (PSC) members, politburo and Central Committee is still wide1. To report the work done by the party since the last open. party congress and elect new party leaders2. To set the guidelines for the coming five years. The 12th National People’s Congress (NPC) in March 2013 will elect the top leaders of the new government,At the top of the agenda is the election of new party including the president, premier and the state council.leaders, in four steps. The NPC is the highest state body and the only legislative house in China, and consists of nearly 3,000 The first step, which has already taken place, is to delegates. The NPC meetings occur at the same time as elect delegates for the party congress. A total of the Chinese People’s Political Consultative conference. 2270 delegates have been elected from Beijing, local areas, and the army. The election has become more Myths of leadership change competitive in recent years, although delegate The last leadership change was in March 2003. The candidacy is controlled by the Organization economy was suffering from deflation and the shock of Department of the party. SARs. These events were more important for the market The second step is the election of members of the and economy than leadership change. Events in 1989 led Central Committee of the party by these delegates. to Deng Xiaoping’s go for growth policies. In the early 1990s growth and inflation was high. In 1993 the PBoC The third is the election of the Political Bureau by eventually tightening policy and devalued the Renminbi the Central Committee. There are 24 members now, by a third. We find it shocking that commentators after removal of Bo Xilai. claim that leadership will result in specific economy or Finally the appointment of the Standing Committee market events based on historical relations. Two events of the Political Bureau. There are currently nine are not statistically significant and conditions were very different.Figure 5: Political Transition: important timelineSource: J.P. Morgan Economics 9
  10. 10. Adrian Mowat Asia Pacific Equity Research(852) 2800-8599 18 October 2012adrian.mowat@jpmorgan.com 3. With labor market healthy and inflation increasingWhat can we say? into 2013 the need and the room for stimulus is low.1. Clarity on membership of the standing committee should reduce political uncertainty. Figure 6: China CPI and Nominal GDP2. Current goals are likely to be restated. The new Nominal GDP (LHS, %oya) 40 30 leaders will reemphasize goals of building a Headline inflation (RHS, % oya) “harmonious society” and achieving balanced and 25 efficient economic growth in his new term. This 30 20 means improving the social safety network (e.g. 15 universal medicare and pension system), reducing 20 income inequality and developing the west, and etc. 10 And there may also be more aggressive economics 5 reforms including pushing forward China’s financial 10 and economic reforms and liberalization, capital 0 account liberalization, Rmb internationalization and 0 -5 interest rate liberalization. Amore cynical view is that 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 many of the goals were stated a decade ago. Since Source: CEIC. Note: Shaded area denotes deflation period then the economy is less balanced and income inequality higher.Figure 7: Political transition: 3-tier leadership structureSource: J.P. Morgan Economics10
  11. 11. Adrian Mowat Asia Pacific Equity Research(852) 2800-8599 18 October 2012adrian.mowat@jpmorgan.com Figure 8: Members of StandingCommittee of Political Bureau of the China Communist Party (CPC)Name PositionsSep 2002Jiang Zemin General Secretary of the CPC, President of PRC, Chairman of the Central Military CommissionLi Peng Chairman of the Standing Committee of the National Peoples Congress NPCZhu Rongji Premier of the State CouncilLi Ruihuan Chairman of the National Committee of the Chinese Peoples Political Consulative Conference (CPPCC)Hu Jintao Vice President of PRC, General Secretary of the CPC, Vice Chairman of the CPC Central Military CommissionWei Jianxing Member of the Secretariat of the CPC Central Committee, Secretary of the Central Commission for Discipline InspectionLi Lanqing Vice Premier of the State CouncilOct 2007Hu Jintao General Secretary of the CPC, President of PRC, Chairman of the Central Military CommissionWu Bangguo Chairman of the Standing Committee of the NPCWen Jiabao Premier of the State CouncilJia Qinglin Chairman of the National Committee of the Chinese Peoples Political Consulative Conference (CPPCC)Zeng Qinghong Vice President of PRC, General Secretary of the CPC, President of the Party School of the CPC Central CommitteeHuang Ju * Vice Premier of the State CouncilWu Guanzheng Secretary of the Central Commission for Discipline InspectionLi ChangchunLuo Gan State Councilor, Secretary of the Political and Legislative Affaires committee of the CPC Central CommitteeOct 2012Hu Jintao General Secretary of the CPC, President of PRC, Chairman of the Central Military CommissionWu Bangguo Chairman of the Standing Committee of the NPCWen Jiabao Premier of the State CouncilJia Qinglin Chairman of the National Committee of the Chinese Peoples Political Consulative Conference (CPPCC)Li Changchun Member of the Standing Committee of the Political Bureau of the CPC Central CommitteeXi Jinping Vice President, Vice Chairman of the Central Military CommissionLi Keqiang First ranked Vice Premier and deputy party secretary of the State Council of the PRCHe Guoqiang Secretary of the Central Commission for Discipline Inspection The Secretary of the Central Political and Legislative Committee, an organ directing Central Government legal policy and theZhou Yongkang legislative agendaSource: baidu website, * Huang Ju died in June 2007. 11
  12. 12. Haibin Zhu Asia Pacific Equity Research(852) 2800-7039 18 October 2012haibin.zhu@jpmorgan.com sequential growth by 0.30%pt in 4Q and 0.50%pt in eachEconomics quarter of 2013. As a result, our forecast of full-year GDP growth for 2012 stays at 7.6%oya and for 2013 it isChina’s September manufacturing PMI shows that the revised down to 8.0% from 8.3%. The dynamics ofeconomy is on the way of recovery, although the growth pattern remains similar. In the coming quarters,improvement in sequential growth momentum remains the economy should see moderate improvement on aweak. Both NBS and Markit manufacturing PMIs seasonally-adjusted basis. In yoy terms, we expectrecorded moderate improvement over the previous growth to weaken further and bottom in 4Q12.month, but still remained below the 50-point threshold.In addition, exports posted moderate growth in China: manufacturing PMIsSeptember, while the shipments to developed markets Index, sa NBS PMIremained soft. NBS PMI 60The acceleration in policy easing since May hassupported pickup in public investment in areas such asinfrastructure, railway, environmental protection and 50clean energy. However, the impact appears to bemoderate and has been offset by weakness in exports and Markit PMIthe manufacturing sector. In particular, industry profits 40continued to decline, falling by 6.2%oya in August, and 04 05 06 07 08 09 10 11 12 13profit margins eased to 5.3%. The weakness in industrialprofits, together with the high destocking pressure, has China: real GDP growthcontributed to the soft domestic demand. %oya %q/q, saar %oya 16 20Fiscal policy plays a more prominent role than monetary 14 %q/q, saarpolicy at this moment. In recent months, both the central 15and local governments have announced large-scale 12investment projects, with total value amounting to nearly 10 10CNY20 trillion. However, we expect the immediate 5impact on growth to be moderate, as most of these 8projects will span over the next several years, and local 6 0governments face funding difficulties. On monetary 05 06 07 08 09 10 11 12policy, since the two interest rate cuts in June and July,the PBoC appears to adopt a cautious attitude in China: real GDP and industrial productionmonetary easing. Policy rate has remained on hold since %q/q, saar, both scalesJuly, and reverse repos have been used to delay the 20 Real IP 40timing of widely expected RRR cuts. 15 30Looking ahead, the likelihood of further interest rate cuts 20in 2012 is diminishing. From economic perspective, we 10expect growth momentum to improve but inflation to 10 5 Real GDPpick up towards the end of the year as favorable base 0effect disappears. In addition, the busy political agenda 0 -10going ahead implies that the prospect of meaningful 04 05 06 07 08 09 10 11 12policy easing in the near term becomes more remote.We have revised our monetary policy forecast to Source: J.P. Morgan Economicsunchanged interest rate and one more 50bp RRR cut forthe rest of the year. This is one rate cut and one RRR cutless than our initial expectations. The shortage inmonetary easing implies that the recovery of growthmomentum could be weaker than we had initiallyexpected. Our model suggests that it will bring down12
  13. 13. Nick Lai Asia Pacific Equity Research(886-2) 2725-9864 18 October 2012nick.yc.lai@jpmorgan.com Table 5: Demand/Supply dynamicsAutomobiles mn units; % Capacity 2009 2010 2011 2012E 2013E Total Capacity 12.3 15.0 17.5 19.6 23.0Demand for PVs – luxury boom for the next decade Incremental n/a 2.702 2.47 2.115 3.41 yoy change (%) n/a 22% 16% 12% 17%A multi-year theme in the auto sector for the next decade Production 10.6 14.1 15.1 16.1 17.2is now lying ahead - rising penetration. We reckon this yoy change (%) n/a 33% 7% 6% 7%rising tide will especially favour the luxury auto vehicles Utilization (%) 86.3 94.1 86.5 82.2 75.0 Net exports/(imports) -0.5 -0.5 -0.5 -0.5 -0.6as the spending power of the upper middle class in China Sales volumeis expected to grow rapidly with wealth accumulation Domestic sales 10.4 13.8 14.5 15.3 16.5and property market’s up-cycle. We estimate luxury cars yoy change (%) n/a 33% 5% 6% 8%(Mercedes-Benz, BMW, Audi and Lexus) to grow at Net exports/(imports) 0.7 0.8 1.0 1.2 1.2 yoy change (%) n/a 14% 25% 20% 0%34% CAGR in 2007-2015E, ultra-luxury cars Inventory 0.0 0.0 0.1 0.1 0.1(Lamborghini, Ferrari, Bentley and Rolls-Royce) to grow ROE (%) 19% 24% 19% 16% 16%at 43% CAGR, and broader PV market in the same Source: Company data, TEJ, and J.P. Morgan estimatesperiod to grow at merely 13% CAGR. The latest tensions Figure 9: YoY growth of new car sales by segmentbetween Japan and China also highlight some risk in the Luxury Ultra-luxury Total passenger vehicledemand for Japanese auto brands in China. 100% Growth of luxury 90% cars is 3-4 times 80%Supply for PVs – overcapacity being a key issue faster than overall 70% market in our viewUnder our assumption of a luxury boom ahead, imported 60%cars will still see demand over supply, but domestically 50%made cars will see some overcapacity risks. We forecast 40% 30%capacity utilization in PVs market to deteriorate from 20%87% in 2011 to 82% in 2012, and further down to 75% in 10%2013E. This imbalance implies: 1) declining operating 0%leverage and hence margin in the sector, and 2) price 2008 2009 2010 2011 2012E 2013E 2014E 2015E Source: CAAM, J.P. Morgan.competition is inevitable when auto makers face Figure 10: Market share of domestic made cars by source ofinventory pressures. We see this overcapacity risk to brands (i.e. Japanese, Korean, Chinese, European) in Chinaremain especially in the medium-end car segments from 100%2H12 onwards. Therefore auto producers that havehigher exposures to these segments might face a greater 80%margin pressure. 9% 14% 14% 13% 60% 12% 14% 17% 17% 15% 21% 23%Margins & Returns – luxury/non-Jap outperform 40% 23% 26% 29% 31% 25% 23% 23%From this angle, we are forecasting a better earnings 20% 40% 36%momentum/profitability for those companies that 29% 29% 29% 28% 28% 30% 32%dominate in the luxury auto market. Among auto dealers, 0%Baoxin (strong presence in luxury/ultra-luxury auto sales) 2004 2005 2006 2007 2008 2009 2010 2011 YTDis expected to make >25% ROE for 2012E/13E whilst Western Japan China Korea Others 2012Zhongsheng (Toyota’s major dealer) is expected to make Source: China Auto Market and J.P. Morgan11~13% ROE. Among automakers, Geely and Great Figure 11: Commercial vehicle sales growth by segment analysisWall are domestic auto makers that will benefit from 80% 68%technology advance and SUV sales whilst DFM is 60% Truck Trailerexpected to suffer from its high exposures to Japanesebrand, Nissan. 40% 37% 26%CVs on a downward trend 20% 9% 5% 5%We worry CV sector because of two structural challenges 2% 2% 0%and concerns: 1) China is transforming from a 2009 2010 2011 2012E 2013E -5%investment-heavy economy into a more balanced one, -20%And 2) substitution effect from the improving railway -27%network. Therefore we hold an UW stance on both of our -40%CV stock: Weichai Power and Sinotruk. Source: CAAM, J.P. Morgan estimates.. 13
  14. 14. Josh Klaczek Asia Pacific Equity Research(852) 2800-8534 18 October 2012josh.klaczek@jpmorgan.com Figure 12: China’s Policy Path Shows a Turn in M1, +7.3% Y/YBanks 3500 40% 35% 3000While it’s too early to call a turning point in onshore 30% 2500liquidity, the rise of M1 to +7.3% Y/Y, after 25%languishing below 5% for 8 consecutive months, helps 2000 20%temper the risk of a more acute rise in NPLs. We also 15% 1500see positives in lending data. While new loans came in 10%below estimates at RMB623bn (JPMe: 615bn), the 1000 5%increased mix of longer-term lending August (40%) and 500 0%September (46%) is +ve for the NIM outlook & possiblyreflects improving credit demand. FX Reserves ($bn) RRR Loan Growth M1 Growth Source: CEIC.Improved liquidity growth reflects both the increasing Figure 13: Boosted by Recent Liquidity Injections from PBOC -400 -3000use of OMO, with almost RMB1 trillion of net injections -300 -2500since May 2012, as well as the lagged impact from the -2000previous 3 RRR cuts in Dec-11, Feb-12, and May-12. -200 -1500The rise in M2 to +14.8% Y/Y in September from -100 -1000+13.5% in August could also reflect increasing credit 0 -500growth via bond issuance, which is up 85% Y/Y on a 100 0 500YTD basis. 200 1000 300 1500Some argue that bond growth matters less because banks 400 2000are the predominant buyer of supply, but this confusestwo points. From a leverage & credit perspective, Via Issuance Via Maturity Cum. Net Drain (+) / Injection (-) (RHS)buying bonds does add risk to bank balance sheets; Source: CEIC.but it also boosts money supply via the money Figure 14: Depedence on ST-Lending Also Looks to be Decliningmultiplier. This may be an important driver of credit 1,200 80%creation in spite of the LDR limit of 75%, allowing 70% 1,000China to further boost leverage without compromising its 60%prudential ceiling on LDRs. 800 50% 600 40%The key negative we see in recent data is the persistent 30%trade surplus, which shows an unwillingness and/or 400 20%inability to rebalance the economy. The key number is 200 10%not better growth in merchandise exports (+9.9% Y/Y) in 0 0%September (Aug: +2.7%), but persistently weak importgrowth, which rose just +2.4% Y/Y (Aug: -2.6%). Thecontinued rise in FX reserves, by $50bn in 3Q12 & Short-term Lending LT Corporate LT Personal ST as % of Total$109bn YTD, also likely limits the potential for further Source: CEIC.monetary easing going forward. Figure 15: The Key is Whether Banks Sacrifice Growth to Protect Pricing 70 (%)The muted outlook for future easing reinforces our viewthat ICBC & CCB remain our top picks despite better 60M2, M1, and export data. As a sidenote, export data is 50+ve as it relates to rising NPLs in the manufacturing & 40trade-related sectors (+5% H/H, +31%), which we 30reviewed in our 2Q report (see link). In contrast, CMB 20(UW) & Minsheng (N) remain constrained by both high 10LDRs (73%, 72%) & low core capital (8.3%, 8.4%).Moreover, these banks are already growing assets well- 0above loans (26/20% vs. 15/14%), which could bedilutive to long-term NIM & ROA, particularly from 10% Above 10-30% Above 30-50% Above 50-100% Above Above 100%interbank lending. Source: CEIC.14

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