Deutsche Bank Markets Research Asia China Strategy China 1H16 Results Review Date 6 September 2016 Strategy Update Growth improved amid reflation; embracing more upgrades ________________________________________________________________________________________________________________ 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) 057/04/2016. Yuliang Chang, CFA Strategist (+852 ) 2203 6195 yuliang.chang@db.com Joseph Huo Strategist (+852 ) 2203 6251 joseph.huo@db.com MXCN EPS improved to -13% in 1H16 MSCI ChinaEPS growth (HKD)1H152H151H16vs. 2H152H16 impliedCons. Disc.-7%36%10%-6%Cons. Stap.-3%-0%-14%16%Energy-51%-81%-94%77%Financials12%-12%-13%-4%Real Estate-0%-25%-4%8%Health Care-1%44%13%12%Industrials43%-28%-26%41%Info. Tech.5%-3%32%20%Materials52%36%-26%184%Telecom.-2%-4%-6%-11%Utilities19%9%-12%-4%MSCI China4.1%-14.9%-13.3%3.9%Non-fin.-6.6%-20.1%-13.0%14.5%Non-fin. (ex. Energy)8.5%-7.5%-0.7%11.9%Cyclicals-12%-27%-18%27%Defensives3%3%-7%-5%Financials12%-12%-13%-4% Source: Bloomberg Finance LP, Deutsche Bank Strategy Research MXCN sector 1H16 run-rate vs. historicals AutoCons. durablesRetailingFood retailingDiv. Fin.InsuranceReal estateHealth equip.Cap. goodsCommercial svs.Road & portInternetGas utilitiesIPPsRenewablesCons. materialsF&BHH. productsBanksPharm.ChemicalsMetals & miningWaterCoal35%40%45%50%55%60%65%70%30%40%50%60%70%80%10yr medianrun-rate1H16earnings run-rate1H16 run-rate higher than 10yr median1H16 run-rate lowerthan 10yr median Source: Bloomberg Finance LP, Deutsche Bank Strategy Research 2H16 growth to strengthen off a very low base -12.0%8.2%-29.3%-23.9%7.1%0.4%-35%-30%-25%-20%-15%-10%-5%0%5%10%15%1Q152Q153Q154Q151Q162Q16A-share non-financial earnings growth (single quarter yoy) Source: Wind, Deutsche Bank Strategy Research 1H16 MSCI China EPS improved due to mid-/downstream sectors MSCI China headline growth edged up to -13% yoy in 1H16, from -15% in 2H15; non-financial growth recovered more noticeably, to -13% in 1H16 from -20% in 2H15, led by notable acceleration in mid-/downstream sectors. Excluding the 5% RMB depreciation, the underlying growth would be around -8% in 1H16. Top-line sales picked up to -2.2% in 1H16 from -5.4% in 2H15, thanks to higher nominal GDP growth. The 1H16 run-rate of 53% is largely similar to the historical median, while that of coal, utilities, banks and durables etc. is visibly better, making them likely targets of further upgrades. Sector-wise, upstream drag narrowed on coal earnings improvement, but the softness in oil & gas and metals prolonged. Mid-stream earnings saw widened divergence between the fast-growing new economy and the lukewarm old economy. In downstream, new economy internet & software continued to see acceleration in addition to the meaningful recovery of consumer durables (auto and property), while staples remained weak. Financials’ EPS declined 13%, dragged by non-bank financials off a very high 2Q15 base. Highlighting four key findings in 1H16 A-share results  1) Profitability expanded amid industrial reflation. Non-financial ROAE increased 1.5ppt to 7.6% in 1H16, thanks to a stronger profit margin, better asset turnover, and a slightly higher leverage. We believe the ongoing industrial reflation has played a key role, boosting sales growth and corporate profitability. We expect PPI to shoot up more and rise towards zero by end-2016, reviving corporate fundamentals further.  2) Destocking continued as mid-/downstream decelerated. Non-financial inventory growth dropped notably, to 8.3% yoy in 1H16 from 14.8% yoy in 1Q16, due to visible destocking in mid- and downstream sectors, while upstream inventory growth picked up. The property supply chain saw notable inventory slowdown, echoing the property destocking YTD.  3) Payables drove OCF pick-up; capex started to grow. Non-financial OCF grew 19% in 1H16, extending the recovering trend since 2014. We are encouraged to find the key driver has shifted to higher payables, as it generally indicates abundant liquidity and rising expectation for outlook. Capex growth turned positive to 1.4% in 1H16, a three-year high, thanks to stronger appetite in mid-/downstream; upstream continued to shrink.  4) Leverage edged up but solvency also improved. Non-financial leverage and net gearing edged up 0.5ppt and 0.1ppt qoq to 60.6% and 45.8% by 1H16 due to mid- and downstream, whilst upstream leverage dropped. Meanwhile,