China Strategy Spotlight: PPP, SOE Reform and 3Q A-share earnings snapshot

Deutsche Bank Markets Research Asia China Strategy China Strategy Spotlight Date 5 December 2017 Strategy Update PPP, SOE Reform and 3Q A-share earnings snapshot Inflection point for PPP; SOE reform to accelerate; 3Q A-share earnings ________________________________________________________________________________________________________________ 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) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU Michael Tong, CFA Research Analyst (+852 ) 2203 6167 michael.tong@db.com Luka Zhu Research Analyst (+852 ) 2203 6173 luka.zhu@db.com The government is increasingly concerned that PPP is becoming a disguised borrowing vehicle to circumvent policy restrictions. Since May, the MOF has announced three major notices to strengthen PPP controls. The latest – Document 92 – provides more concrete guidelines for removing unqualified projects. Meanwhile, we believe SOE reform will accelerate further in 2018-19. In our first report on the SOE reform-related investment theme, we focus on the context, objectives, guidelines, progress, case studies and implications, with a basket of 20 stocks identified as likely beneficiaries. On 3Q earnings, A-share’s net income growth edged up to 23.8% yoy (14.9%/21.6% in 2Q/1Q). Performance and valuations: MXCI gained 1.6% while CSI300/HSCEI flat In the past four weeks, MSCI China gained 1.6%, outperforming A-shares (flat) and HSCEI (-0.3%). Insurance, IT and healthcare led, while transportation, capital goods, diversified financials and real estate posted losses. The MSCI China (ex. ADRs) 12m forward P/E stands on par with historical average at 11.5x while P/B is at 1.5x, or a 12% discount to the historical average. Non-financials’ 12m fwd P/E and P/B are at 15.6x and 2.0x, respectively. A-share CSI300 was flat in RMB terms in the past four weeks, with insurance significantly outperforming others. The index trades at 13.6x and 1.8x 12m forward earnings and book value, respectively. ChiNext’s valuation has declined to 24.2x 12m fwd P/E, nearly 1-STD below historical average. Macro and earnings: 3Q macro data weaker; insurance/IT led earnings upgrade Macro data came in slightly weaker than expected for October: 1) November NBS PMI rebounded slightly to 51.8 from the previous month’s 51.6 and remained in the expansion zone. Caixin PMI dipped to 50.8 vs. prior 51. October IP came in weaker than expected at 6.2% vs. 6.3% consensus estimate and is below last month’s 6.6%; 2) New loans and TSF also missed expectation. Adjusted TSF balance growth was stable at 14.7% yoy while corp. M/LT loan balance rebounded slightly to 17.8% yoy; 3) Investment decelerated as FAI growth slowed across the board, and property investment dropped 0.3ppt to 7.8% YTD yoy. On high-frequency data, thermal coal consumption declined to 1% yoy in November, significantly lower vs. last month’s 16%. In terms of commodity prices, cement and rebar trended higher while coal prices fell slightly. MSCI China 2018E consensus EPS expanded by 1.5ppt in the past four weeks, with insurance and IT leading the earnings upgrades. Liquidity and sentiment: H/A-share liquidity largely stable; onshore rates rising HK equities’ ADT averaged HKD117bn in Nov’ MTD, higher than the previous month and still strong compared to the YTD average (HKD86bn). Connect inflows continued both ways while volatilities subsided. A-share sentiment was stable. Onshore rates and credit spreads both expanded rapidly (10-yr treasury yield exceeding 4%, likely due to continued financial deleveraging). Risks Key downside risks: 1) tighter-than-expected monetary policy; 2) harsher-than-expected property tightening; 3) any disorderly deleveraging as China tightens shadow credit; and 4) sharper-than-expected RMB depreciation. Distributed on: 04/12/2017 20:00:51 GMT0bed7b6cf11c 5 December 2017 China Strategy Spotlight Page 2 Deutsche Bank AG/Hong Kong Table Of Contents PPP Part 4: An inflection point after three-year high growth (published on 22 November) ..............................................................................