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China Strategy

18 January 2012

Bill Belchere, Global Chief Economist, 852 3653 8620, bill.belchere@miraeasset.hk Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk

China Strategy: tackling uncertainties


The Chinese economy grew by 9.2% in 2011, suggesting that China has until now, proven to be resilient. Yet we still worry about the uncertainties in Europe, and believe that China has room to ease accordingly if such downside risks materialize. We believe that with inflation trending down and policies more accommodative, Chinas energy, property, internet, utilities and Macau gaming will likely outperform other sectors.
An uncertain outlook calls for policy flexibility Despite a relatively strong 4Q2011, we are still concerned about the huge uncertainty in the euro zone, and its significant spillover to China and other Asian economies. Luckily, if such downside risks materialize, China does have the capacity to ease more aggressivelyincluding possible interest rate cut, particularly in 2Q when inflation is expected to drop sharply (see page 2: An Interest Rate Cut: Can? Should? Will?). China has somewhat eased already, and the uncertainty overhanging on our baseline scenario of a soft-landing calls for more flexible and forward-looking policy responses. Chinas energy, property, internet, utilities, and Macau gaming are likely to outperform With inflation trending down and policy being more supportive of growth, we believe that investment opportunities lie in the following sectors. We see possible domestic oil price/tariff hikes and continued energy reforms benefiting the energy and the utility sectors. In addition, the property sector is likely to see a turning point in 2Q as Chinas policy focus has shifted from tight to gradual relaxation, and similarly Macau gaming will benefit too. Bedsides, after severe sell offs in late 2011, value has emerged in the Internet sector while the long-term trend of Internet as the more vibrant sector of the telecommunication value chain remains intact. (See more details below) Additionally, we believe some other stocks have upside potential too These include China Construction Bank (0939, BUY, TP HK$ 6.6): Bank of China (3988, BUY, TP HK$3.96), GCL-Poly (3800 HK; TP HK$3.50), Trina Solar (TSL US; TP US$11.60), Ports (589 HK, TP HK$16.4), CRE (291 HK, TP HK$29.3), China Mobile (941 HK, TP HK$94) and Comba (2342 HK, TP HK$9.4). (See more details below)

Figure 1 China 2012: Top Picks

Preferred Sectors Energy PetroChina CNOOC Sinopec COSL Property CR Land Longfor Utilities China Power International HK & China Gas Internet Qihoo 360 Youku Netdragon Websoft Gaming SJM Holdings Melco-Crown MGM China

Other Top Picks CCB GCL-Poly Bank of China Trina Solar


Source: Mirae Asset Research

Ports CRE

Comba Communication China Mobile

See the last page of this report for important disclosures


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Bill Belchere, Global Chief Economist, 852 3653 8620, bill.belchere@miraeasset.hk Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk

China Strategy

An Interest Rate Cut: Can? Should? Will?


In terms of Chinas possible policy responses to support growth in 2012, the market reached its consensus that: 1) additional RRR cuts are in the pipeline; 2) the new lending quota will be increased; and 3) fiscal policy stimulus will be the major active tools (please refer to our recent reports Policy Outlook in 2012 and 2012 Inflation Projection). Yet, it seems that many have not factored in interest rate cuts this year. In our view we dont exclude such possibilities. What makes us confident? Simply look at Figure 2. In the past decade, China cut the interest rate on two occasionsthe Tech Wreck Crisis and the recent Global Recession. On the other hand, it hiked the interest rate when the real interest rate turned negative, and overheating pressures were rising. Looking at this year, we ask three questions: can Chinese policy makers cut the interest rate? Should they? And will they? Our answers are: Yes they can: as inflation drops below 3.5% in March/April, the window for easing opens wider and China does have room to cut the interest rate. Yes they should: for two reasonsthe Europe crisis will likely remain unsolved in 2012, and the negative spillover to Asian and other emerging markets will lead more central banks to aggressively lower rates. Likely they will: an interest rate cut will help reduce the refinancing burden on the local governments who need to roll over their large amount of debt this year.

Therefore, we do see an interest rate cut as possible this year, and the most likely window for that is probably 2Q, when inflation drops sharply and bottoms at about 1.6% in July.
Figure 2 Interest rate policy in China

5 4 3 2 1 0 -1 -2 -3 -4 -5 Jan-00

Tech Wreck Crisis

Global Recession

Troubled Euro??? 5 4 3 2 1 0 -1 -2 -3 -4 -5

Jan-01

Jan-02

Jan-03 Rate Cut

Jan-04

Jan-05 Rate Hike

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Real Interest Rate

Projection 2012

Source: CEIC, Mirae Asset Research Note: one-year deposit rate is used to

Preferred sectors
Energy: We are overweight the China energy sector during 2012 for its superior earnings visibility and robust dividend yields, in what could still be another year of pain for most global financial names. PetroChina (857 HK; TP HK$13) is our big cap top pick in terms of share price upside. Share price catalysts include further news flow about natural gas pricing reform and windfall profit tax reductions. CNOOC (883 HK; TP HK$18) is our favorite to hedge against the upside tail risks for crude oil prices in the event of a supply disruption in the Persian Gulf. Share price catalysts include potential stock buybacks and news flow about deepwater oil/gas discoveries in offshore China. Sinopec (386 HK; TP HK$10) is our favorite to hedge against the downside tail risks for crude oil prices in the event of a worse-than-expected slowdown in Chinese economic growth. Share price catalysts include potential upstream asset injection and domestic fuel pricing reform.

Bill Belchere, Global Chief Economist, 852 3653 8620, bill.belchere@miraeasset.hk Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk

China Strategy

COSL (2883 HK; TP HK$15.5) is our mid cap top pick in terms of share price upside to our TP of HK$15.5. Share price catalysts include customers upstream oil/gas spending budget announcements and the domestic Ashare placement.

Property: The weaker global economic outlook will push Chinas policy focus from tight to gradual relaxation. We expect easing to be more obvious through credit loosening, especially for mortgage policies. The key window to position for China property counters is from March to May when buyers have digested price cuts news, as developers have announced FY11 full year results, and investors have waited out all potential policy negative news from Marchs CPC meeting. CR Land (BUY, TP HK $13.3) for its SOE backing and recurring income stream as an earnings cushion. Longfor (BUY, TP HK $11.36) as its strong brand should allow it to shine further in the 2012 physical market.

Utilities: The on-grid tariff hike in December 2011 of around 6% could improve the profitability of Chinese IPPs. Despite limited further downside for the spot coal price, the recent drop of Qinhuangdao spot coal price to around Rmb800/ton could be a positive catalyst to Chinese IPPs. For the gas sector, more imported natural gas could boost the volume gas sales of city gas distributors. Although we think the margin risk is higher after the trial natural gas city gate pricing mechanism in Guangdong and Guangxi, their margin risk remains lower than Chinese IPPs in our view. China Power International (2380 HK, TP HK$2.35) due to the more balanced generation portfolio with a higher hydropower proportion. HK & China Gas (3 HK, TP HK$21.50) due to good management and relatively more defensive as supported by Hong Kong business.

Macau Gaming: The biggest potential catalyst for the Macau gaming stocks is Chinas easing as VIP gaming benefits from increased liquidity available to junket operators, and therefore we overweight the Macau gaming sector for 2012. We forecast Macau gaming revenue will grow 20% in 2012with this years new casino attraction Sands Cotai Central scheduled to start operation before May Golden Week holidays. Our buy recommendations are SJM Holdings (880 HK; TP HK$16.7), Melco-Crown (MPEL US; TP US$11.92) and MGM China (2282 HK; TP HK$13.52).

Internet: After severe sell offs in late 2011, value has emerged in the Internet sector while the long-term trend of Internet as the more vibrant sector of the telecommunication value chain remains intact. The Internet sector is experiencing technology evolutions from PC Internet to mobile Internet, e-commerce, Internet TV and HTML5. We believe incumbents like Tencent and Baidu have sufficient time to migrate their user base to new platforms. New hardware platforms also offer the opportunity to generate returns in the likes of Tencent and Baidu, which have returned 38x and 64x since IPO. Our top picks of the sector include (12M): Qihoo 360 (QIHU US, BUY, US$40), Youku (YOKU US, BUY, US$31.5), and Netdragon Websoft (777 HK, BUY, HK$8).

Other Top Picks


China Construction Bank (0939, BUY, TP HK$ 6.6): Among the banks, we like large-cap ones with high dividend yields and reasonable upside potential. CCB has the strongest capital position among large-cap banks with 10.6% tier-1 CAR compared with 10% industry average. In addition, the removal of material share overhang following BoFAs recent stake disposal makes it even more attractive, and its undervalued now as suggested by its 6.7x 12E P/E, 1.3 x P/B, and 5% dividend yield. Bank of China (3988, BUY, TP HK$3.96): BOC is the cheapest large-cap bank with 6x forward P/E, 0.9x P/B with 5% dividend yield. Its downside earning risks are limited, as 2012E ROE of 15% reflects the normalized returns that other Chinese banks could deliver in a few years time. Additionally, BOCs diversified business profile will help it better cope with the challenges of interest rate deregulations. GCL-Poly (3800 HK; TP HK$3.50): Due to its low production cost, healthy balance sheet and good expansion strategy. We expect it to increase its market share during the market consolidation. Trina Solar (TSL US; TP US$11.60): Owing to its lean cost structure and flexibility to expand capacity quickly on the back of the stronger balance sheet. We expect upcoming Honey Module line could be margin accretive.
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Bill Belchere, Global Chief Economist, 852 3653 8620, bill.belchere@miraeasset.hk Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk

China Strategy

Ports (589 HK, TP HK$16.4): The stock's share price has been resilient when the sector's share prices have been volatile in the past few weeks. SSS growth recovered in 3Q11 while network expansion resumes its growth in FY11. Therefore, Ports can deliver one of the strongest earnings growth among the discretionary companies in FY12. CRE (291 HK, TP HK$29.3): Kirin JV beverage product sales will see better critical mass in 2012. Starting from scratch, it should capture market share from existing leaders that have been troubled by plasticizer issues (ie mainly the Taiwanese brands). As management is very focused on business expansion, we believe that CREs earnings growth can be one of the strongest in the staples space in FY12. Comba Communication (2348 HK, TP HK$9.4): Benefiting from China Unicom and China Mobiles wireless network optimization initiatives in 2012. China Mobile (941 HK, TP HK$94): Benefiting from the TD-LTE progress.

Previous reports
China Macro (Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk) 12 Jan 2012 - China Macro: CPI beats on the low side again View report 19 Dec 2011 - Macro Matters: China Policy outlook for 2012 View report Energy (Gordon Kwan, Head of Oil/Gas Research 852 3653 8646 gordon.kwan@miraeasset.hk) 15 Dec 2011 - China/Oil & Gas: Ten predictions for 2012 View report China Property (Stephanie Lau, China Property Analyst, 852 3653 8609 stephanie.lau@miraeasset.hk) 12 Dec 2011 - China/Real Estate: Relief on the way View report Macau Gaming (Adrian Lowe, Gaming and Conglomerates Analyst 852 3653 8614 adrian.lowe@miraeasset.hk) 4 Jan 2012 - Macau Gaming: 2012 outlook and picks View report Internet/Telecom (Eric Wen, Head of Telecom/Internet/Media/Equipment 852 3653 8631, eric.wen@miraeasset.hk) 17 Jan 2012 - China/Internet Services: Mirae Business Forecast Tour: BUY when sentiment is low View report China Banks (Stanley Li, Analyst 852 3653 8619 stanley.li@miraeasset.hk) 19 Dec 2011 BOC: Management meeting feedback View report Utilities (Ricky Ng, Regional Utilities/Green Energy Analyst, 852 3653 8634 ricky.ng@miraeasset.hk) 16 Jan 2012 - China/Green Energy: Is this rally for real? View report Consumer (Selina Sia, Head of Consumer Research, 852 3653 8640 selina.sia@miraeasset.hk) 26 Sep 2011 - Hong Kong & China/Consumer: Consumer sector reality check View report

Bill Belchere, Global Chief Economist, 852 3653 8620, bill.belchere@miraeasset.hk Joy Yang, Chief Economist for Greater China, 852 3653 8620 joy.yang@miraeasset.hk

China Strategy

Recommendations
By stock (12 months) Buy: A target price + 10% or more above the current price, Hold: Target price within - 10% to +10% of the current price Reduce: A target price of 10% or less below the current price Hong Kong Compliance Disclosure
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By industry Overweight: over +10% of the current industry index Neutral: -10% to +10% of the current industry index Underweight: -10% or less than the current industry index

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