HK/China Metals & Mining：Upgrade material sector; expecting six to nine months of outperformance

Deutsche Bank Markets Research Asia Hong Kong Resources Metals & Mining Industry HK/China Metals & Mining Date 30 May 2014 Recommendation Change Upgrade material sector; expecting six to nine months of outperformance Structural concerns overdone; expecting cyclical uptrend ________________________________________________________________________________________________________________Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 148/04/2014. James Kan Research Analyst (+852) 2203 6146 james.kan@db.com Top picks China Shenhua Energy (1088.HK),HKD21.30 BuyChina Hongqiao Group Limite (1378.HK),HKD5.71 BuyAngang Steel (0347.HK),HKD4.25 BuySource: Deutsche Bank TP change New TP Old TP % upside/(downside)Shenhua 25.4 24.0 20%China Coal 4.0 3.3 -8%Yanzhou Coal 5.8 4.4 -6%Fushan 2.4 2.3 19%Angang 5.9 4.7 37%Maanshan 2.1 1.9 36%Chalco 2.9 2.6 4%Jiangxi Copper 13.7 11.4 5%Source: Deutsche Bank, Bloomberg Finance LP. Share price upside/downside is based on 28 May 2014 Rating change New rating Old ratingChangeShenhua Buy HoldUPChina Coal Hold SellUPYanzhou Coal Hold SellUPFushan Buy HoldUPAngang Buy HoldUPMaanshan Buy HoldUPJiangxi Copper Hold SellUPSource: Deutsche Bank This report changes ratings, target prices and/or estimates for several stocks under our coverage. We believe investors should take advantage of potential weakness in material prices in the coming one to two months and build positions in Chinese material equities. China property sales YoY stabilizing and government expenditure picking up will let demand hit a cyclical bottom in the near term. This means we are looking for a cyclical inflection point and a potential outperformance of material equities in the coming six to nine months. We upgrade ratings of most material stocks and pick Hongqiao, Angang and Shenhua as our top Buys. Property cycle bottoming and structural concerns overdone Historically, China’s steel production YoY has continued to have a high correlation with China’s property sales (GFA) YoY. Steel production YoY generally lags property sales YoY for two to three months. Also, the property cycle duration has been about two years from trough to trough, and we are at about the trough. With property sales in May stabilizing, we believe steel (or general material) demand YoY in China will likely hit the bottom in June. After June, a significant deterioration in material demand is unlikely. We also agree with our property team’s view (in its recent note, Higher base, lower growth do not necessarily mean hard landing) that what is happening in the property market is not structurally destructive, but more of a cyclical event. Government expenditure picking up and plenty of policy upside risks Our data mining exercise demonstrates that China’s government fiscal expenditure YoY has lagged China’s government deposit YoY by about 10 months historically. China’s economy should experience an acceleration, as China’s government deposit YoY hit a bottom in 4Q12 and has continued to accelerate since then. China’s government deposit YoY has also broken the correlation with nationwide land sales YoY in recent quarters. As such, the fears about China’s government expenditure will slow, with land sales in China exaggerated. We also see plenty of potential policy upside risks for the material sector, including eliminating overcapacity/relaxing monetary policies. Upgrade material sector; prefer aluminum/steel over coal/copper Commodity price weakness in June will create a window for investors for positions in the very underweight material equities. The cyclical recovery of the property market, together with stronger government expenditure, should accelerate demand for materials in at least the next two to three quarters. Historically, in the previous three cycles, material stocks have generally outperformed the HSCEI by 5-20%