Yum Cha 飲 茶 July 31, 2013

DIARY NOTES FOR THIS WEEK

July 29 Leading Index (Jun) [previous: 99.6]

August 1 Manufacturing PMI (Jul)

[previous: 50.1]

August 1 HSBC Manufacturing PMI (Jul)

[previous: 48.2]

August 3 Non-Manufacturing PMI (Jul)

[previous: 53.9]

August 5 HSBC Services PMI (Jul)

[previous: 51.3]

Source: Bloomberg

CEMENT: Anhui Conch [0914.HK]; BBMG [2009.HK]

BANKS: Industrial and Commercial Bank of China [1398.HK];

China Construction Bank [0939.HK]; Bank of China [3988.HK]

PROPERTY: Kaisa Group [1638.HK]; China Overseas Land

[0688.HK]

SECURITIES: China Galaxy Securities [6881.HK]

ENERGY: China Longyuan [916 HK]; Anton Oil [3337 HK]; ENN

Energy [2688 HK]

RETAIL: Intime [1833.HK]; Belle [1880.HK]; Daphne [210.HK]

TEXTILES: Pacific Textile [1382.HK]; Shenzhou [2313.HK]

FOOD AND BEVERAGE: Uni-President China Holdings

[0220.HK]

MACAU GAMING: Galaxy Entertainment [0027.HK]; Sands Chi-

na [1928.HK]

TMT: TCL Multimedia [1070.HK]; Lenovo Group [0992.HK]

INDICES Closing DoD%

Hang Seng Index 21,954.0

0.5

HSCEI 9,669.6

0.3

Shanghai COMP 1,990.1

0.7

Shenzhen COMP 938.9

(0.3)

Gold 1,327.3

0.1

BDIY 1,067.0

(0.7)

Crude Oil, WTI(US$/BBL) 103.1

0.0

Crude Oil, BRENT(US$/BBL) 106.9

(0.5)

HIBOR, 3-M 0.4

0.1

SHIBOR, 3-M 4.7

(0.1)

RMB/USD 6.13

(0.0)

Analyst: John Mulcahy, Managing Director, Research

CHINA STRATEGY: ―Likonomics‖—good for economy;

challenging for market

As the interim earning reporting season approaches, China’s equity mar-ket remains unsettled. Data shows a distinct slowdown, at best, and if the doomsayers have their way, a meltdown. Our view is that the new gov-ernment is taking a firm grasp of the many challenges facing China’s economy, leading it to a more stable, if unspectacular growth trajectory. The strategy, accompanied by a posset of policies, has led to a startling squeeze on liquidity in the interbank market, and crackdown on corruption and excess spending by government departments, and above all a clear statement that the objective is sustainable growth, rather than growth at any price. A full report with more detailed industry and stock analysis will follow today.

TOP SECTOR PICKS:

THE GOVERNMENT’S STRATEGY – BIGGER MARKET, SMALLER GOVERNMENT?

China has become one of the world’s key economic talking points, but instead of awe at the sheer scale of this giant coun-

try’s population and its rapid emergence from behind the ―bamboo curtain‖ to become the second biggest economy in the

world, there is anxiety about the severe headwinds, and speculation about whether China will have its own version of the

Global Financial Crisis (GFC).

In response to the GFC, and to fend off the impact on China, former Premier Wen Jiabao launched a RMB4trn (US$640bn)

stimulus programme in 2009, which led to a credit binge in China, with total credit expanding from less than RMB60trn

(US$9.6trn) in 2008 to RMB150trn (US$24.5trn). In a sense, the medicine proved to be worse than the ailment, as China is

now grappling with a massive credit crisis that is threatening the stability of the overall banking sector, and has distorted the

interest-rate environment.

The new leadership, both before and after coming to power, stressed that their economic strategy would be based on re-

form, although initially the precise definition of that was not clear. In sequential moves, the government has cracked down

on corruption and excess spending by government departments, and in a broader sense it has disappointed those who had

become accustomed to the ―Wen Jiabao Put‖, by which every setback in the economic cycle would generate another round

of stimulus, or so it seemed.

By now, there can be few who do not believe that the current government is serious about reform, and the questions are

whether the economy can be guided into a lower growth trajectory without a more serious adjustment – Premier Li Keqiang

has signaled that the target for this year remains a gross domestic product (GDP) growth rate of 7.5%, and that 7% is the

baseline that will be protected.

If anyone was in any doubt about the government’s intentions, the June squeeze on interbank liquidity was a clear signal

that nothing was sacred, and the peak 28% interbank repo rate was unprecedented, and has taken much of the heat out of

the off-balance sheet, or shadow banking sector.

The long-term strategic objectives of rebalancing – reducing the reliance on exports – and also of urbanisation – shifting the

ratio of urban residents from around 50% to 70% over the next 15-20 years – remain key targets, but there will be many

twists and turns in that road.

In this brief assessment of China’s prospects, we consider the winners and losers in the strategy. A full report including

more detail on specific stock recommendations will follow later today.

THE GOVERNMENT’S STRATEGY – BIGGER MARKET, SMALLER GOVERNMENT?

Shanghai Composite—rarely cheap-

er...

HSCEI—following the A-share guide

HANG SENG Index—caught be-

tween China and Bernanke

Source: Wind and CGIHK Research

Shanghai Composite

Index

Forward PER

HSCEI

HSCEI Forward PER

HANG SENG INDEX

HANG SENG Forward PER

Premier Li Keqiang has taken responsibility for bringing China’s economy under control,

and we believe he is doing this by way of a superficially simple equation:

Consumption (C) + Investment (I) + Government expenditure (G) + Net exports

(NX) = GDP

Given all the variables in each of these facets of the economy, a complex matrix of poli-

cies, sometimes appearing contradictory, is being rolled out. These policies are focusing

on increasing private consumption and investment; reducing government expenditure;

and increasing net exports, or:

C (↑) + I (↑) + G (↓) + NX (↑) = GDP

In pursuit of this simple objective the new leadership appears to be concentrating on four

major principles/objectives:

Pro-market reforms;

Mild economic stimulus (maintaining baseline GDP growth of 7% - for now);

Boosting/encouraging consumption/improving living standards;

Controlling government spending.

The concept of rebalancing China’s economy in favour of a domestically-driven model as

opposed to the export-oriented focus of the first 20-30 years of China’s ―open-door‖ strat-

egy has been the key for some years. The new leadership, led by President Xi Jinping

and Premier Li Keqiang, have highlighted two core elements of the long-term strategy—

rebalancing and urbanisation.

In striving for these objectives it is apparent that boosting (mass market) consumption is

the leadership’s first priority, in an effort to restore or create more balance. In the pro-

cess there will be a reduction in China’s savings rate, which is among the highest in the

world, and to increase domestic consumption, which should stabilize employment. In-

creasing consumption’s share of the economy would also relieve some of the pressure

for growth from the central government.

The government has taken every opportunity to stress that there will NOT be any fiscal

stimulus, but we take that to mean that the market and the population should not expect

a repeat of the previous government’s repeated and excessive use of government

spending to maintain growth. In the process that has led to a staggering acceleration in

credit, which will help rebalance the economic structure.

However, mild economic stimulus will be used in a targeted way to support employment,

examples being the exemption from value-added tax (VAT) of businesses with monthly

sales below RMB20,000.

The objective is clearly NOT to boost GDP growth to the 8%-10% range, but to reallo-

cate resources from the government to corporates and individuals, which will improve

the quality of GDP (smaller government expenditure).

CHINA’S NEW STRATEGY – BIGGER MARKET, SMALLER GOVERNMENT?

Simple formula, difficult execution

China opts for the market

Premier Li Keqiang’s repeated emphasis on the importance of mobilizing ―existing‖

credit and resources to avoid increasing the overall leverage ratio for the overall

economy even further. Finally, the purpose of the pro-market reforms is to facilitate

the reallocation process we discussed above.

We summarise some of the strategic and tactical measures as follows:

Pro-market reforms

Interest-rate reform;

One more step in gas price reform (raised natural gas price early this

year);

Removal of unnecessary administrative measures;

Consultation process for initial public offering (IPO) pricing reform;

Proposal to launch a new free trade zone (Shanghai).

Mild economic stimulus

Reform of financing mechanism of railway construction, and a state-

ment supporting expansion of central/western rail systems;

Issue 4G licenses by the end of this year, to encourage more IT-

related consumption;

Exemption of VAT for SMEs (monthly revenue < RMB20,000);

Continued support to the renovation of squatter settlements, dealing

with existing migrant workers.

CHINA’S NEW STRATEGY – BIGGER MARKET, SMALLER GOVERNMENT?

Li Keqiang emphasizes more effi-

cient use of existing resources

Boosting fixed asset investment

will not solve the problem.

Pro-market, but no big stimulus…

...instead, targeted towards smaller,

private businesses.

Source: IMF

Encourage consumption/Improve living standards

Advancement of medical insurance reforms (aimed at reducing one

impetus for China’s high savings rate);

Pharmaceutical pricing reform + crack down of corruption along the

distribution channel;

Forcing premium milk powder brand to cut prices;

Continued emphasis on environmental protection.

Government spending control

Control of entertainment expenses;

Cut general and administrative expenses by 5%;

Moratorium on new government offices—no more local emperors!

Ask government departments and local governments to mobilize exist-

ing resources (the hidden budget surplus/reserves in the past ten

years?)

CHINA’S NEW STRATEGY – BIGGER MARKET, SMALLER GOVERNMENT?

Some reforms are obvious, but

have been difficult to change...

…as the government is itself the

key to reform.

Consumption less than 40% of

GDP—needs to be above 50%.

DISCLAIMER

For private perusal only. This report (including any information attached) is issued by China Galaxy Internation-

al Securities (Hong Kong) Co., Limited, one of the subsidiaries of the China Galaxy International Financial

Holdings Limited, to individual addressee whether they are professional, institutional client or otherwise, in

good faith from sources believed to be reliable but no representation or warranty (expressly or implied) is made

as to their accuracy, correctness and/or completeness. Where any part of the information, opinions or esti-

mates contained herein reflects the personal views and opinions of the analysts who prepared this report, such

views and opinions may not correspond to the published view of China Galaxy International Financial Holdings

Limited and any of its subsidiaries. This report shall not be construed as an offer, invitation or solicitation to buy

or sell any securities of the company or companies referred to herein. All opinions and estimates reflect the

judgment of the analyst on the date of this report and are subject to change without notice.

Please take note that member companies of China Galaxy International Financial Holdings Limited (including

but not limited to China Galaxy International Securities (Hong Kong) Co., Ltd) and/or their directors, officers,

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China Galaxy International Securities (Hong Kong) Co. Limited, CE No.AXM459, Room 3501-3507, 35/F,

Cosco Tower, Grand Millennium Plaza, 183 Queen’s Road Central, Sheung Wan, Hong Kong. General line:

3698-6888.

John Mulcahy johnmul@chinastock.com.hk

Wong Chi Man, CFA cmwong@chinastock.com.hk

Eric Tomter, CFA erictomter@chinastock.com.hk

Wayne Fung, CFA waynefung@chinastock.com.hk

Frank Miao frankmiao@chinastock.com.hk

Angela Han Lee angelahanlee@chinastock.com.hk

Vicky Lai vickylai@chinastock.com.hk

CONTACT US