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2H18 Hong Kong Market Strategy

June 22, 2018 Equity Research | Investment Strategy

This is a summary of a report originally written in Chinese. Please contact us for more information of the original report. The Chinese version shall prevail in the event of any discrepancy between the two versions.

Focus on stocks related to domestic demand amid volatility

Ou Yafei SFC CE No. BFN410 [email protected] +86 20 8757 3009 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Divergence across markets in 1H18 Volatility in global assets is likely to continue, and

we expect global stock markets to see divergent performance. The strengthening of the US dollar has weighed on emerging markets. The Hong Kong market has been more resilient but with bigger fluctuations, with market momentum weakening after large swings, and investment opportunities limited to specific sectors. Concerns about the US stock market over the long term The US stock market has

seen an increase in earnings and a correction in valuation, while rising US bond yields have also added to concerns about valuations. Looking at the historical trend for the US term spread, the US stock market is still in a “sweet spot”, but is moving closer to a peak. Hong Kong market investment strategy Conditions for a rebound in 3Q18: 1) External

risks have temporarily weakened and risk appetite has improved. The correction in oil prices and the fall in inflation expectations has provided a temporary pause in the upward movement of the US Treasury yield. Moreover, the narrowing of US-Europe interest rates is likely to slow the rise in the dollar index. Pessimistic sentiment on emerging markets is therefore likely to be calmed. 2) The most pessimistic stage for the mainland market has passed, and we expect fundamental performance posted in interim results to support a recovery in market sentiment. Volatility in the US stock market has added potential risks US bond and stock markets

will be sources of risk for the Hong Kong market in the medium term. As the US term spread and Treasury yield approach threshold value, we expect volatility in the Hong Kong market to increase rapidly, therefore impeding the valuation re-rating process. We recommend stocks related to domestic demand amid a highly volatile market

1) In the short term, with upcoming interim earnings releases, we recommend leading China property companies with sound fundamentals, and leading industrial companies (heavy duty trucks, construction machinery and building materials). 2) From a medium term perspective, we continue to recommend stocks related to the domestic consumption upgrade. We recommend leading companies in gaming, airline services and textiles & apparel for 2H18. In addition, given reform in the HKEX this year, we are bearish on technology stocks in the short term but bullish over the long term. Risks Downside risks in the Chinese economy, liquidity risks driven by higher-than-

expected rise in the US dollar and US Treasury yields, credit risks in USD-denominated bonds.

mailto:[email protected]

June 22, 2018

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Investment Strategy

Figure 1: Based on historical experience, the US stock market is still in an upward trajectory, but getting closer to its peak

Sources: Wind, GF Securities Development & Research Center

Figure 2: US stock market valuation will face pressure when the 10Y US Treasury yield exceeds 3%


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Figure 3: CFF for A-share listed companies has been affected, especially private companies

Figure 4: CFF for A-share listed companies has been affected, especially private companies

Sources: Wind, GF Securities Development & Research Center Sources: Wind, GF Securities Development & Research Center

Figure 5: CFF for HSCEI constituents has not been affected by credit tightening

Figure 6: Limited impact on cash flow for constituent stocks of Hang Seng SCHK


Figure 7: Southbound funds, M2 growth in Hong Kong, and arbitrage trading

Figure 8: Southbound net buying and changes in exchange rate


A-share excl. financials: cumulative YoY of cash inflow from borrowing

A-share excl. financials: cumulative YoY of cash outflow for debt repayment

A-share private companies: cumulative YoY of cash inflow from borrowing

A-share SOEs: cumulative YoY of cash inflow from borrowing

HSCEI: cumulative YoY of cash inflow from borrowing

HSCEI: cumulative YoY of cash outflow for debt repayment

Hang Seng SCHK: cumulative YoY of cash inflow from borrowing

Hang Seng SCHK: cumulative YoY of cash outflow for debt repayment

Southbound net buy volume (Rmb100m)

M2 YoY (RHS) Libor 3M-Hibor 3M (x10, RHS)

With narrow US-HK interest rate spread,M2 growth in HK was highly related tosouthbound funds

With active arbitrage for USD-denominated assets, M2 growth in HKwas related to southbound funds andHK-US interest rate spread

Southbound net buy volume

RMB/USD (RHS)

Southbound net buy volume

RMB/USD (RHS)

RMB depreciates,HKD/USD stable

RMB appreciates,HKD/USD appreciates

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Figure 9: With the decline in industrial profits, we expect profits for HSI constituent stocks to decline

Figure 10: With the decline in industrial profits, we expect profits for HSI constituent stocks to decline


Figure 11: Net gearing ratio for leading property companies is not particularly high

Figure 12: Better CFF in the industrial sector


Figure 13: In the short-term, we are positive on heavy duty trucks, construction machinery and building materials



HSCEI constituents: earnings growth

HSI constituents: earnings growth

Industrial enterprises: total profit: cumulative YoY

Gross margin Sales margin Debt-to-asset ratio Asset turnover ratio ROE

Dec 2017 April 2018

Leading property companies

Property sector

Others Cumulative net CFF as % of revenue: energy sector

Cumulative net CFF as % of revenue: raw materials sector

Cumulative net CFF as % of revenue: industrial sector

Commercial vehicles and trucks: ROE

Commercial vehicles and trucks: ROE

Commercial vehicles and trucks: fixed assets turnover (RHS)

Heavy machinery: ROE

Heavy machinery: debt-to-asset ratio

Heavy machinery: fixed assets turnover (RHS)

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Figure 16: Expected EPS for gaming, airline services and textiles & garments revised up but valuation has seen a correction


Building materials: ROE

Building materials: debt-to-asset ratio

Building materials: fixed assets turnover (RHS)

Changes in PE

Changes in expected EPS

Re

vising u

p e

xpecte

d

earnin

gs

Valuation expandingHotels and resorts

Non-alcoholic beverage

Agricultural products

DrugsDairy products

Livestock feedLeisure and recreational facilities

Supermarket and convenience stores

Biotech

Public transportation

Airline service

Fabrics and textiles

Film & entertainmentAuto components

Automobile III

Health care facilities

clothing

Tourism

Casino and gaming

Jewelry and watch

Consumer electronicsHousehold appliances

Poultry and meat

Packaged foodsFootwear

Alcoholic beverage

Food additives

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Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.

Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.

Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or recommendation for investment in, any securities. The research report is intended solely for use of the clients of GF Securities (Hong Kong). The securities mentioned in the research report may not be allowed to be sold in certain jurisdictions. No action has been taken to permit the distribution of the research reports to any person in any jurisdiction that the circulation or distribution of such research report is unlawful. No representation or warranty, either express or implied, is made by GF Securities (Hong Kong) as to their accuracy and completeness of the information contained in the research report. GF Securities (Hong Kong) accepts no liability for all loss arising from the use of the materials presented in the research report, unless is excluded by applicable laws or regulations. Please be aware of the fact that investments involve risks and the price of securities may be fluctuated and therefore return may be varied, past results do not guarantee future performance. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. The report is not to be taken in substitution for the exercise of judgment by respective recipients of the report, where necessary, recipients should obtain professional advice before making investment decisions. GF Securities (Hong Kong) may have issued, and may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented in the research report. The points of view, opinions and analytical methods adopted in the research report are solely expressed by the analysts but not that of GF Securities (Hong Kong) or its affiliates. The information, opinions and forecasts presented in the research report are the current opinions of the analysts as of the date appearing on this material only which may subject to change at any time without notice. The salesperson, dealer or other professionals of GF Securities (Hong Kong) may deliver opposite points of view to their clients and the proprietary trading division with respect to market commentary or dealing strategy either in writing or verbally. The proprietary trading division of GF Securities (Hong Kong) may have different investment decision which may be contrary to the opinions expressed in the research report. GF Securities (Hong Kong) or its affiliates or respective directors, officers, analysts and employees may have rights and interests in securities mentioned in the research report. Recipients should be aware of relevant disclosure of interest (if any) when reading the report. Copyright © GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. © GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk

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