China

In this briefing:

1. Shenwan Hongyuan (申万宏源) A+H: No Reason for a Valuation Premium
2. So-Young (新氧) Pre-IPO Review – Au Naturel
3. Keytruda Approved for Lung Cancer Treatment in China – A Review of PD-1 Battle Field
4. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China
5. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL

1. Shenwan Hongyuan (申万宏源) A+H: No Reason for a Valuation Premium

Shenwan Hongyuan started institutional book building today. We have covered the fundamentals of the company in our previous insight (Shenwan Hongyuan (申万宏源) A+H: A Commoditized Broker Business). In this insight, we will discuss:

• Valuation comparison with peers
• A-H premium history of Chinese brokers
• Key metrics of past Chinese brokers listing in the H-share market
• Concerns of liquidity

2. So-Young (新氧) Pre-IPO Review – Au Naturel

So-Young (SY US) is looking to raise US$150m in its upcoming IPO. The company filed its prospectus with the SEC on Monday.

The company operates online platforms (mobile, website, and WeChat mini program) for discovering, evaluating, and reserving medical aesthetic services in China. It helps medical aesthetic service providers acquire customers through user generated content and other creative content format.

In this insight, we will look at the company’s business model, analyze its financial and operating performance, review the competitive landscape and point out some questions for management.

3. Keytruda Approved for Lung Cancer Treatment in China – A Review of PD-1 Battle Field

Anti-PD-1 monoclonal antibody (mAb) is a hotly contested immunotherapy area in China, with seven companies working on clinical trials covering various lines of treatment for more than a dozen indications. Out of these indications, we have highlighted in our previous coverage on Chinese biotech companies that the most critical indication is the first line treatment of lung cancer, particularly non-small cell lung cancer (NSCLC). Valuation of PD-1 related drugs anchors many of the Hong Kong-listed biotech companies, such as Innovent Biologics Inc (1801 HK), Shanghai Junshi Bioscience Co. Ltd. (1877 HK), BeiGene Ltd (6160 HK), CStone Pharma (2616 HK)  and China A-share listed Jiangsu Hengrui Medicine Co., (600276 CH). 

In March, Merck’s Keytruda (generic name pembrolizumab) was approved by NMPA for the first line treatment of EGFR and ALK-negative non-squamous NSCLC. This marks Keytruda the first approved PD-1 drugs for the first line treatment of NSCLC in China.

In this insight, we will review the status and targeted indications of clinical trials of PD-1 candidates by domestic players. 

4. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China

Incremental technical developments continue to be of the bullish variety as more and more countries/regions begin to participate in the rally. These ongoing improvements further cement our positive overall outlook, and we continue to believe that global equities (MSCI ACWI) are poised for additional strength moving forward. In our April International Strategy, we highlight various themes which lead to our overall positive outlook, along with areas within the world’s markets where we see immediate opportunity.

5. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL

• Asset Quality recognition is something of a black art with varied definitions for non-performing loans (“NPLs”).
• Firstly, we analyse what a NPL is.
• We then evaluate provisioning changes across Asia. We rank countries.
• We further analyse specific underlying NPL recognition issues in China.
• We then rank a sample of regional banks and countries by NPL recognition.
• Later, we take a look at how different systems come under NPL stress and how they cope often in a crisis environment.
• Finally, we wrap things up with some concluding insights about the cultural backdrop which defines systemic asset quality.

In this briefing:

1. Raw Materials and Retail Pricing
2. Trade During Lunar New Year
3. Why China’s Stimulus Will Disappoint

1. Raw Materials and Retail Pricing

What the pricing data seems to imply is that consumer prices remain relatively steady but trending slightly downward, likely from weakness in household consumption that mirrors the broader economic trends. Corporate and producer sector data is driven by weakness in commodities and raw materials that seem hard pressed to accelerate in 2019 given the high base effect from 2018. 

2. Trade During Lunar New Year

An underlying issue regarding February data is just how pressurized it is. Between cross armed speculations about trade talk negotiations and the biggest Chinese holiday, it should come as no surprises that February data is underwhelming. Chinese markets are still grappling with a way forward in the trade talk quagmire, but February numbers are in many ways seasonal, due to the holiday snapshot it encompasses.

3. Why China’s Stimulus Will Disappoint

By Lawrence Brainard, Chief Emerging Market Economist at TS Lombard

• In a Chinese version of QE the PBoC is flooding markets with liquidity
• Commercial banks will be slow to use it to boost lending to SMEs

In this briefing:

1. Raw Materials and Retail Pricing
2. Trade During Lunar New Year
3. Why China’s Stimulus Will Disappoint
4. Dongzheng Auto Finance (东正汽车金融) Pre-IPO Review – Dependent on Dealership Network for Growth

1. Raw Materials and Retail Pricing

What the pricing data seems to imply is that consumer prices remain relatively steady but trending slightly downward, likely from weakness in household consumption that mirrors the broader economic trends. Corporate and producer sector data is driven by weakness in commodities and raw materials that seem hard pressed to accelerate in 2019 given the high base effect from 2018. 

2. Trade During Lunar New Year

An underlying issue regarding February data is just how pressurized it is. Between cross armed speculations about trade talk negotiations and the biggest Chinese holiday, it should come as no surprises that February data is underwhelming. Chinese markets are still grappling with a way forward in the trade talk quagmire, but February numbers are in many ways seasonal, due to the holiday snapshot it encompasses.

3. Why China’s Stimulus Will Disappoint

By Lawrence Brainard, Chief Emerging Market Economist at TS Lombard

• In a Chinese version of QE the PBoC is flooding markets with liquidity
• Commercial banks will be slow to use it to boost lending to SMEs

4. Dongzheng Auto Finance (东正汽车金融) Pre-IPO Review – Dependent on Dealership Network for Growth

Dongzheng Automotive Finance (2718 HK) is looking to raise approximately US$300 – 500m in its upcoming IPO. 

DAF is a fast growing auto finance company which acquires customers through a network of dealership around China. Its net interest income grew by 66% CAGR from FY2016 to FY2018 while net fees/comms income and profit grew by 39.6% and 61% CAGR over the same period.

However, most of its growth originated from ZhengTong dealers and joint promotion arrangement. Excluding loans from joint promotion arrangement, gross outstanding loan had only grown by 12% CAGR.

In this insight, we will look at the company’s business, analyze the competitive landscape, provide thoughts on valuation, and some questions for management.

In this briefing:

1. Keytruda Approved for Lung Cancer Treatment in China – A Review of PD-1 Battle Field
2. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China
3. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL
4. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way
5. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued

1. Keytruda Approved for Lung Cancer Treatment in China – A Review of PD-1 Battle Field

Anti-PD-1 monoclonal antibody (mAb) is a hotly contested immunotherapy area in China, with seven companies working on clinical trials covering various lines of treatment for more than a dozen indications. Out of these indications, we have highlighted in our previous coverage on Chinese biotech companies that the most critical indication is the first line treatment of lung cancer, particularly non-small cell lung cancer (NSCLC). Valuation of PD-1 related drugs anchors many of the Hong Kong-listed biotech companies, such as Innovent Biologics Inc (1801 HK), Shanghai Junshi Bioscience Co. Ltd. (1877 HK), BeiGene Ltd (6160 HK), CStone Pharma (2616 HK)  and China A-share listed Jiangsu Hengrui Medicine Co., (600276 CH). 

In March, Merck’s Keytruda (generic name pembrolizumab) was approved by NMPA for the first line treatment of EGFR and ALK-negative non-squamous NSCLC. This marks Keytruda the first approved PD-1 drugs for the first line treatment of NSCLC in China.

In this insight, we will review the status and targeted indications of clinical trials of PD-1 candidates by domestic players. 

2. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China

Incremental technical developments continue to be of the bullish variety as more and more countries/regions begin to participate in the rally. These ongoing improvements further cement our positive overall outlook, and we continue to believe that global equities (MSCI ACWI) are poised for additional strength moving forward. In our April International Strategy, we highlight various themes which lead to our overall positive outlook, along with areas within the world’s markets where we see immediate opportunity.

3. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL

• Asset Quality recognition is something of a black art with varied definitions for non-performing loans (“NPLs”).
• Firstly, we analyse what a NPL is.
• We then evaluate provisioning changes across Asia. We rank countries.
• We further analyse specific underlying NPL recognition issues in China.
• We then rank a sample of regional banks and countries by NPL recognition.
• Later, we take a look at how different systems come under NPL stress and how they cope often in a crisis environment.
• Finally, we wrap things up with some concluding insights about the cultural backdrop which defines systemic asset quality.

4. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way

In our latest Asian Tower Trends report, Chris Hoare looks at the listed telecom tower industry across the region. During 4Q18, we became more optimistic on the Asian tower space. 

• China: Last December, we upgraded what is by far the largest towerco globally, China Tower (788 HK), after it became clear the story was much better than disclosed at the time of the IPO (still a mystery as to why this happened),
• The Indian tower business has been buffeted by rapid industry consolidation but we think it is now near a bottom, and recently raised Bharti Infratel (BHIN IN) to Neutral, and
• Growth is improving in Indonesia with increased investment ex Java from the smaller operators. Protelindo (TOWR IJ) our preferred name, but Tower Bersama (TBIG IJ) has lagged badly recently and may be due some catch up. 

With the 5G investment cycle a key theme for coming years, we are now more constructive on the telecom tower space in general. 

5. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued

China Meidong Auto (1268 HK) has been a great success story for its investors in the last two years. I first wrote about the company in May 2017 when shares were trading at 1.53 HKD. This week shares traded over 4.7 HKD. While the share price has gyrated wildly the past 24 months the underlying earnings of the company have been increasing steadily and shareholders have been rewarded with solid dividends.

FY18 results were released last month which showed strong growth in revenues (+44%) and net profits (+31%). With the importance of Lexus and Porsche increasing, FY19 should be another year of growth. The performance of BMW remains a wild card.

With the stock up 59% YTD shares are now fairly valued and trading at a 30% premium to its peers. Meidong remains a long-term favorite but has now exceeded my fair value estimate of 4.4 HKD (10x 2019 EPS). I suggest waiting for a better entry point.

In this briefing:

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

In this briefing:

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry
2. REIT Discover: Sasseur Sizzles with 9% Yield

1. NIO (NIO): NIO Is Essentially a Distributor, Not an OEM…3 Things to Keep in Mind at Lock-Up Expiry

NIO’s 6-month Lock-up expires today and as of the time of this writing the stock is down by 6.6% from the closing price on Friday, March 8.  The stock’s share overhang issue have been well covered on the Smartkarma platform by other analysts (see NIO Post-CBS Rally Making TSLA Valuation a Grand Bargain (Price Target =$3) , NIO (NIO US): Lock-Up Expiry – This Could Get Messy) so while we do not see a need to rehash those details in this insight, here are 3 things that we believe every NIO investor and would-be investor should keep in mind about the company especially if one wants to play the Tesla vs. NIO scenario:

1. Licensing/Regulatory Risk – NIO has an autonomous driving testing license but no EV manufacturing license.  An EV manufacturing license issued by the NDRC is required for EV manufacturers to market and sell their products but a 100k unit scale is a main prerequisite.  This is a key reason why NIO entered into a 5-year outsourcing relationship with JAC.  While this relationship was assumed to be temporary, there could be many hurdles for NIO to actually obtain a license in the coming years should it decide to invest in production facilities again.
2. Core IP Held by Suppliers – Powertrain technology is held by CATL and the State-owned JAC is listed as the ES8’s manufacturer on the Ministry of Information and Technology website.  Continental AG designs NIO’s vehicle suspension and chassis.  It is also unclear how much actual development work other than exterior/cockpit design is done in-house at NIO based on publicly available information.  Without scale and IP we believe NIO’s bargaining position with its suppliers is weak and displays stronger characteristics of a distributor than a final assembler. 
3. Low ASP, low margins – NIO’s ASP on the ES8 from what we have seen was $64k per unit in 2018 and $63k per unit in 1Q19 while Tesla’s Model X ASP is about $100k per unit.  There is a reason why gross margin at NIO is razor thin and it has more to do with low price point than low volumes in our view.   

Given differences between the U.S. and China operating environment for EV makers, we believe Tesla is not a good equity valuation comp for NIO, which is basically a distributor in our view.  As such, long term value drivers would most likely come from aftermarket and service revenues, while short-mid term value drivers seem elusive especially in the aftermath of the company’s decision to scrap its production plant investment plans in Shanghai.

The NIO ES8

2. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

In this briefing:

1. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China
2. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL
3. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way
4. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued
5. Shenwan Hongyuan IPO Preview: Struggling to Stand Out

1. Global Ex-U.S. Equity Strategy: Positive Outlook Intact; Remain Overweight China

Incremental technical developments continue to be of the bullish variety as more and more countries/regions begin to participate in the rally. These ongoing improvements further cement our positive overall outlook, and we continue to believe that global equities (MSCI ACWI) are poised for additional strength moving forward. In our April International Strategy, we highlight various themes which lead to our overall positive outlook, along with areas within the world’s markets where we see immediate opportunity.

2. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL

• Asset Quality recognition is something of a black art with varied definitions for non-performing loans (“NPLs”).
• Firstly, we analyse what a NPL is.
• We then evaluate provisioning changes across Asia. We rank countries.
• We further analyse specific underlying NPL recognition issues in China.
• We then rank a sample of regional banks and countries by NPL recognition.
• Later, we take a look at how different systems come under NPL stress and how they cope often in a crisis environment.
• Finally, we wrap things up with some concluding insights about the cultural backdrop which defines systemic asset quality.

3. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way

In our latest Asian Tower Trends report, Chris Hoare looks at the listed telecom tower industry across the region. During 4Q18, we became more optimistic on the Asian tower space. 

• China: Last December, we upgraded what is by far the largest towerco globally, China Tower (788 HK), after it became clear the story was much better than disclosed at the time of the IPO (still a mystery as to why this happened),
• The Indian tower business has been buffeted by rapid industry consolidation but we think it is now near a bottom, and recently raised Bharti Infratel (BHIN IN) to Neutral, and
• Growth is improving in Indonesia with increased investment ex Java from the smaller operators. Protelindo (TOWR IJ) our preferred name, but Tower Bersama (TBIG IJ) has lagged badly recently and may be due some catch up. 

With the 5G investment cycle a key theme for coming years, we are now more constructive on the telecom tower space in general. 

4. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued

China Meidong Auto (1268 HK) has been a great success story for its investors in the last two years. I first wrote about the company in May 2017 when shares were trading at 1.53 HKD. This week shares traded over 4.7 HKD. While the share price has gyrated wildly the past 24 months the underlying earnings of the company have been increasing steadily and shareholders have been rewarded with solid dividends.

FY18 results were released last month which showed strong growth in revenues (+44%) and net profits (+31%). With the importance of Lexus and Porsche increasing, FY19 should be another year of growth. The performance of BMW remains a wild card.

With the stock up 59% YTD shares are now fairly valued and trading at a 30% premium to its peers. Meidong remains a long-term favorite but has now exceeded my fair value estimate of 4.4 HKD (10x 2019 EPS). I suggest waiting for a better entry point.

5. Shenwan Hongyuan IPO Preview: Struggling to Stand Out

Shenwan Hongyuan Hk (218 HK) is a Chinese securities firm which is backed by Chinese state-owned investment firm, Central Huijin, a 57% shareholder. It listed on the Shenzhen Stock Exchange in January 2015 and seeking to raise $1.5 billion through a Hong Kong listing. Shenwan Hongyuan will start book-building on Thursday according to press reports.

In this briefing:

1. REIT Discover: Sasseur Sizzles with 9% Yield

1. REIT Discover: Sasseur Sizzles with 9% Yield

REIT Discover is an insight series featuring under-researched and off-the-radar REITs in an attempt to identify hidden gems and gems in-the-making. In this issue, we follow up on the first China outlet mall REIT listed in Singapore, Sasseur Real Estate Investment (SASSR SP) , whose share price is down 7.5% from its IPO price of S$0.80 since its debut on 28 March 2018. Its distributable income exceeded its IPO forecast for FY2018. Annualized distribution per unit (DPU) yield for FY2018 was 9.1% based on current price. Moving forward, FY2019 DPU projection is S$0.06, translating into a DPU yield of 8.1% compared to FY2018. It is likely that the DPU for the projection years are conservative and the REIT manager will endeavour to beat the IPO forecast for FY2019 and even the annualized DPU for FY2018.

Sasseur REIT’s business model differs from other typical retail malls which lease out assets and receive rental income based on an agreed rental rate. Instead, it has structured a complex form of master lease, called the Entrusted Management Agreement (EMA), where it received a percentage of tenants’ sales turnover as the rental. As such, income generated its portfolio of properties are mainly sales-driven and hence may be unstable.

Essentially, the EMA encompasses a set of obligations that binds the sponsor to a two-year income support to Sasseur REIT in exchange for a long-term master lease which limits DPU upside. This is because a large chunk of the portfolio’s potential revenue growth will go to the sponsor. 

We are not saying this is all bad; the master lease under the EMA provides income stability to the REIT given that gross revenue is sales-driven. Rather, we acknowledge the resilience of the outlet mall business model as seen from the long and successful track record of Tanger Factory Outlet Centers Inc (SKT US) in the United States and strong growth of Bailian Group’s outlet business in China.  What is striking is China’s small outlet market size relatively to the mature regions despite the sheer size of its growing middle to upper-middle class population. This suggests that China’s outlet industry could grow significantly.

At 29% gearing ratio, Sasseur REIT has additional debt headroom of S$283mn to tap on its right-of-first-refusal (ROFR) pipeline of assets to grow its S$1.5bn initial portfolio. Even without inorganic growth, two of its properties, representing 43% of total portfolio valuation, are relatively new assets in their third year of operation, suggesting strong potential for growth. Sasseur REIT looks promising based its results in the last three quarters. Sasseur REIT’s premium P/NAV of 1.03x at the point of listing was surprisingly expensive given that its properties are non-prime outlet malls in China’s Tier-Two cities. P/NAV has since fallen to an attractive 0.8x.  

In this briefing:

1. China Auto: New Incentives Bring New Demand
2. China’s New Semiconductor Thrust – Part 2: Commodities as a Quick Path to Success
3. China Minsheng: Unless There Is Opposing Wind, a Kite Cannot Rise.
4. Guotai Junan Securities Placement Quick Take – Might Be Too Big to Sail
5. China’s Greater Bay Area: The Essential

1. China Auto: New Incentives Bring New Demand

A speech from Ministry of Commerce last week represented that China would introduce a few incentives to boost auto consumption soon. Among these incentives, allowing re-use of key parts from scrapped cars might increase up to 25% of China’s annual passenger vehicle shipment. Removing restrictions on second-hand cars’ regional migrations could shorten the average length of time car owners keeping their cars, improve existing cars’ utilisation, and hence increase demand on new cars. Improving the market environment for car sales might release some auto dealers’ abnormal operating pressures. Promoting development of aftermarkets could benefit some auto dealers who are expanding business in aftermarkets.

2. China’s New Semiconductor Thrust – Part 2: Commodities as a Quick Path to Success

China’s current efforts to gain prominence in the semiconductor market targets memory chips – large commodities.  This three-part series of insights examines how China determined its strategy and explains which companies are the most threatened by it.

This second part of the series explains how China chose commodity semiconductors (DRAM and NAND flash memory chips) as the best technology to pursue.

3. China Minsheng: Unless There Is Opposing Wind, a Kite Cannot Rise.

Profitability at China Minsheng Banking A (600016 CH) in 2018 slipped. Similar to other Chinese lenders, rising Loan Loss Provisions exerted a negative pull on the bottom-line, testament to gnawing Asset Quality issues. In addition, similar to some banks, the top-line came under pressure from the rising cost of source of funding. Also the bank was not alone in juicing up its bottom-line with hefty trading gains. Thus Earnings Quality could have been better.

Given the underlying squeeze on core Income, it was encouraging to see management at least restrain OPEX.

Regarding Asset quality, write-offs soared by 153% YoY while substandard and loss Loans jumped by 68% YoY and 14%, respectively, and Loan Loss Provisions rose by 35.6% YoY. It is perhaps a little surprising then that coverage ratios decreased given the trend in credit costs, NPL migration, and charge-offs.

LDR remains quite high though credit growth last year was not gung-ho and broadly in line with Deposit expansion. We do note though a ratcheting up of CRE lending which jumped from 8.8% of the total Loan book to 12.3%.

4. Guotai Junan Securities Placement Quick Take – Might Be Too Big to Sail

Guotai Junan Securities (H) (2611 HK) plans to raise around US$350m via placing new H-Shares. We had earlier covered the IPO, you can find our coverage below:

• Guotai Junan Securities IPO: Second, if Not the Largest, China Security Broker, A-H Premium Examined
• Guotai Junan IPO: A Big Player but Relatively Less Liquid, How A-H Premium Plays

This is a large deal to digest and the shares seem to be trading at a relatively tighter A-H spread versus peers.

5. China’s Greater Bay Area: The Essential

Executive summary

We launch our inaugural joint policy research on China’s Greater Bay Area (GBA) with the assistance from Joy Rich Securities Investment’s Guangdong-Hong Kong-Macau Greater Bay Area Academic Research Group. Here we highlight what comprises GBA, timeline, comparison against major economies and other bay areas, deep-dive research into key industries and policies toward each part of GBA. China is a Policy-induced story and GBA is in the Chinese government’s interest to prosper.

We believe the composition of 9 cities and 2 special administrative regions, together with policy support by the Chinese government provides a backdrop for rising credit growth backed by productivity. We will continue to monitor credits which either are based in GBA or will benefit from the GBA scheme (EXHIBIT 9). 

In this briefing:

1. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL
2. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way
3. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued
4. Shenwan Hongyuan IPO Preview: Struggling to Stand Out
5. Guotai Junan Placement: A Reasonable Price for Reasonable Performance

1. Asian Bank Asset Quality: “One Overdue, Two Bad” 一逾两呆 The Complex Journey of the NPL

• Asset Quality recognition is something of a black art with varied definitions for non-performing loans (“NPLs”).
• Firstly, we analyse what a NPL is.
• We then evaluate provisioning changes across Asia. We rank countries.
• We further analyse specific underlying NPL recognition issues in China.
• We then rank a sample of regional banks and countries by NPL recognition.
• Later, we take a look at how different systems come under NPL stress and how they cope often in a crisis environment.
• Finally, we wrap things up with some concluding insights about the cultural backdrop which defines systemic asset quality.

2. Asian Telecom Tower Trends: A General Improvement with China Tower Leading the Way

In our latest Asian Tower Trends report, Chris Hoare looks at the listed telecom tower industry across the region. During 4Q18, we became more optimistic on the Asian tower space. 

• China: Last December, we upgraded what is by far the largest towerco globally, China Tower (788 HK), after it became clear the story was much better than disclosed at the time of the IPO (still a mystery as to why this happened),
• The Indian tower business has been buffeted by rapid industry consolidation but we think it is now near a bottom, and recently raised Bharti Infratel (BHIN IN) to Neutral, and
• Growth is improving in Indonesia with increased investment ex Java from the smaller operators. Protelindo (TOWR IJ) our preferred name, but Tower Bersama (TBIG IJ) has lagged badly recently and may be due some catch up. 

With the 5G investment cycle a key theme for coming years, we are now more constructive on the telecom tower space in general. 

3. China Meidong (1268 HK): +59% YTD After Strong FY18 Results and Positive Outlook; Now Fairly Valued

China Meidong Auto (1268 HK) has been a great success story for its investors in the last two years. I first wrote about the company in May 2017 when shares were trading at 1.53 HKD. This week shares traded over 4.7 HKD. While the share price has gyrated wildly the past 24 months the underlying earnings of the company have been increasing steadily and shareholders have been rewarded with solid dividends.

FY18 results were released last month which showed strong growth in revenues (+44%) and net profits (+31%). With the importance of Lexus and Porsche increasing, FY19 should be another year of growth. The performance of BMW remains a wild card.

With the stock up 59% YTD shares are now fairly valued and trading at a 30% premium to its peers. Meidong remains a long-term favorite but has now exceeded my fair value estimate of 4.4 HKD (10x 2019 EPS). I suggest waiting for a better entry point.

4. Shenwan Hongyuan IPO Preview: Struggling to Stand Out

Shenwan Hongyuan Hk (218 HK) is a Chinese securities firm which is backed by Chinese state-owned investment firm, Central Huijin, a 57% shareholder. It listed on the Shenzhen Stock Exchange in January 2015 and seeking to raise $1.5 billion through a Hong Kong listing. Shenwan Hongyuan will start book-building on Thursday according to press reports.

5. Guotai Junan Placement: A Reasonable Price for Reasonable Performance

Guotai Junan Securities (H) (2611 HK), a Chinese securities firm, has launched a primary placement to raise HK$2.7 billion ($345 million) at a placing price of HK$16.34. The placing price is a 7% discount to the last close price of HK$17.64.