CN Strategy 2014 Jun 26 GS

June 26, 2014

3Q14 China A-share Strategy

Better prospect on targeted

loosening & reform

Portfolio Strategy Research

Market may stabilize in 3Q14E; 10% upside by end-2014E

We believe the China onshore market may rebound slightly in 3Q14. Our

CSI 300 end-3Q target of 2,250 implies a 5% return from current levels,

driven by stabilizing fundamentals and more targeted loosening policies.

Our new CSI 300 end-2014 target of 2,350 (was 2,600) translates to a 10%

return, based on stable fundamentals and the reforms agenda in 2H. We

believe senior government officials are focused on the effective

implementation of existing loosening policies, which should help to boost

market sentiment. Meanwhile, the Shanghai-Hong Kong Stock Connect

scheme should help increase liquidity and improve market sentiment.

Property market – a down cycle, not a collapse

Our analysis of the China property market suggests: 1) China’s housing

market may see a two-year downturn; 2) stabilizing fundamentals and the

relaxation of related policies would boost both end-user and investment

demand; 3) tail risks: lower-tier cities may see structural imbalances, but a

systemic crisis is still unlikely, given potential policy offsets.

Overweight reform beneficiaries and pro-cyclical sectors

Our Overweight (OW) sectors for 3Q are: (1) long-term reform beneficiaries

with reasonable valuations and stable earnings: media, consumer durables,

healthcare; (2) beneficiaries of SOE and other reforms: transportation, oil &

gas; (3) pro-cyclical sectors: brokers, insurance. We also screen for stocks

with exposure to two implementation themes for 3Q14: (1) attractive picks in

OW sectors in 3Q; 2) beneficiaries of global macro recovery.

We expect 10% CSI 300 return in 3Q14E; our key implementation ideas

Source: Wind, Gao Hua Securities Research, Goldman Sachs Global Investment Research.

Chenjie Liu, Ph.D +86(10)6627-3324 [email protected] Beijing Gao Hua Securities Company Limited

Ben Bei +852-2978-1220 [email protected] Goldman Sachs (Asia) L.L.C.

Kinger Lau, CFA +852-2978-1224 [email protected] Goldman Sachs (Asia) L.L.C.

Timothy Moe, CFA +852-2978-1328 [email protected] Goldman Sachs (Asia) L.L.C.

Charles Fang, Ph.D. +852-2978-1585 [email protected] Goldman Sachs (Asia) L.L.C.

Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investorsshould be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investorsshould consider this report as only a single factor in making their investment decision. For Reg AC certification and otherimportant disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed bynon-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc. Global Investment Research

2,250, +5%

7.0

7.2

7.4

7.6

7.8

8.0

8.2

8.4

2,000

2,200

2,400

2,600

2,800

3,000

3,200

Jun/12 Dec/12 Jun/13 Dec/13 Jun/14 Dec/14

2,350, +10%

CSI300 (LHS)

GDP yoy (RHS)

(%)

- Global macro recovery beneficiaries

Implementation Themes

- Top shares in our 3Q OW sectorsMedia OW

Health Care OW

Consumer durables OW

Oil&gas OW

Transportation OW

Brokers OW

Insurance OW

Sector Allocations

June 26, 2014 China

Goldman Sachs Global Investment Research 2

Executive Summary: Market to stabilize in 3Q14E on targeted

policy easing and external demand recovery

We are constructive on the China onshore equity market in 3Q14E. Our CSI 300 end-3Q

target of 2,250 implies 5% return from current levels, on the back of the targeted policy

easing, recovering external demand, and a gradual build-up in reform confidence.

Macro backdrop: Sequential pickup on policy and exports

We forecast China GDP growth yoy at 7.5% in 2Q14 and 7.3% in 3Q14 (7.4% in 1Q14), with

annualized qoq GDP growth of 6.9%/8.4% in 2Q/3Q (5.4% in 1Q14). We expect the moderate

sequential growth improvement in 3Q to be driven by three factors: 1) targeted easing,

with stronger policy implementation; 2) external demand recovery driving China exports;

3) gradual bottom-up loosening of property policy.

China property: Downside pressure, but not a collapse

Our analysis of the China property market suggests: (1) a two-year downturn: China’s

housing market may see a two-year downturn but we do not foresee an imminent collapse

given still ample demand and policy flexibility; (2) but not a collapse: Stabilizing

fundamentals and relaxation of related policies should boost both end-user and investment

demand, by our estimates; (3) Tail risks: lower-tier cities may suffer structural imbalances,

but the chance of a systemic crisis is still relatively low, given potential policy offsets.

Liquidity

We expect stock market liquidity to increase moderately in 3Q, due mainly to: 1) continued

targeted monetary easing; 2) moderate IPO resumption; 3) stable unlocking pressure; and

4) the Shanghai-Hong Kong Stock Connect scheme should help increase liquidity and

improve market sentiment.

Earnings/valuation/index targets

We forecast CSI 300 earnings growth of 5%/6% in 2014E/2015E, vs. 11% in 2013E, against a

slower macro backdrop (GDP growth 7.3% in 2014E vs. 7.7% in 2013). Our CSI 300 target of

2,350 by end-2014 implies an end-2014E P/E of 8.3X vs. the current level of 7.7X. We expect

3Q monetary policy will continue to ease moderately in order to maintain growth.

We estimate an approximate 5% return for the CSI 300 index in 3Q14 (to 2,250) driven by

targeted policy easing and external demand recovery.

Sector picks and implementation

Introducing our revised three-factor sector selection framework

We have rebuilt our sector selection framework to adapt to the changing backdrop for

China equities. Our three preferences are for: 1) Reform beneficiaries; 2) Controlled

exposure to rising credit risks; and 3) Valuation discipline.

Our current Overweight sectors are:

Long-term reform beneficiaries with low valuations and stable earnings: Media,

Consumer Durables (home appliances), Healthcare;

Beneficiaries of SOE and other reforms: Transportation, Oil & Gas (both sectors

upgraded to Overweight from Neutral);

June 26, 2014 China


Pro-cyclical sectors: Brokers, Insurance.

We also highlight two screens (Exhibits 44 and 45) to leverage our major themes in 2014:

Top names in our 3Q14 Overweight sectors (on average, these offer 35% upside to our

analysts’ share price targets, have EPS growth of 32% in 2014 and 23% in 2015, trade at

17.7x 12-month forward P/E valuation and 3.0x P/B).

Global macro recovery (>50% of revenue from overseas and market cap >Rmb4bn,

excluding certain stocks based on rating, EPS growth and PEG).

3Q macro backdrop: Targeted easing, export recovery, and

property policies relaxation

Overview: Sequential pick up on back of policy easing and exports

We forecast China GDP growth yoy at 7.5% in 2Q14 and 7.3% in 3Q14 (7.4% in 1Q14), with

annualized qoq GDP growth of 6.9%/8.4% in 2Q/3Q (5.4% in 1Q14). We expect the moderate

sequential growth improvement in 3Q to be driven by three factors:

1) Targeted easing, with strengthening of policy implementation. Premier Li Keqiang has

emphasized the importance of effective policy implementation, and the State Council

plans to dispatch supervisory groups to key provinces/ministries to ensure the

implementation of targeted easing policies (such as railway, shantytown, information

and health care consumption, anti-pollution infrastructure investment, etc.). We believe

more policies would be undertaken to protect the growth target of ‘around 7.5%’, if

needed.

2) Solid external demand to drive China exports. Our economists forecast annualized qoq

US GDP to grow from -1% in 1Q to 3.4%/3.3% in 2Q/3Q14, which would benefit China

exports.

3) Gradual bottom-up loosening of property policy. We expect more easing of bottom-up

policies, such as relaxation of home purchasing restrictions (mainly in tier 2-3 cities),

as well as credit-related policies, by reducing minimum down payments and offering

more favorable interest/mortgage rates.

We expect the government to unveil further reforms in 2H to support growth and market

sentiment, possibly including:

1) Fiscal reforms: municipal bond insurance; some local debt for public welfare included

under budget management.

2) ‘Shanghai-HK Stock Connect’ scheme: to increase liquidity and boost market sentiment.

3) SOE reforms (see SOE reform series I – New plan and new beneficiaries, June 9, 2014)

and Hukou reforms.

China property: Downside pressure, but not a collapse Key points of our analysis on the China property market are:

1) A two-year downturn: China’s housing market may see a two-year downturn but

we do not foresee an imminent collapse, given still ample demand and policy

flexibility.

June 26, 2014 China


2) But not a collapse: Stabilizing fundamentals and relaxation of related policies

should boost both end-user demand and investment demand, based on our

models (principal component analysis (PCA) and state space);

3) Inventory and affordability: Assuming GFA new starts of 17%/14%/0% in

2014E/15E/16E and GFA sold down of 15%/0%/0%, inventory ratio would return to

normalized level in 2016E. By assuming 10% income increase pa and mild 5%

housing ASP drop pa, tier 1 and tier 2 cities’ affordability ratio would come down

to below 80% and 60%, respectively, in 2016E, similar to the trough levels of the

last downturn in 2011-2012.

4) Tail risks: Lower-tier cities may suffer structural imbalances given rapid property

FAI growth (over-population growth), high inventory levels and lack of demand

(especially in areas with net population outflow). China’s property down-cycle may

trigger pressure on GDP growth (10pp deceleration in property sales may impact

GDP growth by 0.2-0.4pp, according to our economists) and credit stress, but we

consider the chances of a systemic crisis to be relatively low, given potential policy

offsets.

For more details, see Stay tactically positive on targeted/reform loosening, June 23, 2014.

Overall, we expect China’s economic fundamentals to improve moderately qoq in 3Q14E,

supported by implementation of targeted easing policies, export recovery and relaxation of

property policies. Relatively low inflation should also provide space for further policy

accommodation. See our Global Macro Research team’s report Revising growth forecasts

for China, March 20, 2014, for details.

Exhibit 1: Our economists expect growth to recover in

most DM economies in 2014 and 2015

Exhibit 2: We expect a sequential growth pickup in China

in 2Q14 and 3Q14

Source: Consensus Economics, Goldman Sachs Global Investment Research.

Source: CEIC, Goldman Sachs Global Investment Research.

GS Consensus GS ConsensusAsia ex-Japan 6.3 6.1 6.1 6.6 6.2

China 7.7 7.3 7.3 7.6 7.1India 4.7** 5.5** 5.4** 6.5** 6.0**South Korea 3.0 3.7 3.6 3.8 3.7Hong Kong 2.9 3.7 3.3 4.4 3.5Taiwan 2.1 3.5 3.2 3.9 3.6ASEAN 5.0 4.0 4.5 5.0 5.2

Singapore 4.1 3.7 3.8 4.2 4.0Malaysia 4.7 5.1 5.3 5.2 5.1Thailand 2.9 -0.5 1.3 3.8 4.1Indonesia 5.8 5.3 5.3 5.3 5.7Philippines 7.2 6.3 6.4 6.5 6.3

USA 1.9 2.1 2.5 3.1 3.1Euro area -0.4 1.1 1.1 1.5 1.4Japan 1.5 1.5 1.5 1.2 1.2*GS estimates for annualized growth rate of potential output from 2013-16

**Fiscal year basis, 2013 is India FY14 (Q2 2013-Q1 2014).

1.1

0.8

2.3

7.76.0

3.84.0

3.7

4.05.0

4.56.0

6.0

2013 2014 2015 Potential Growth*

0

2

4

6

8

10

12

14

16

18

20

0

2

4

6

8

10

12

14

16

18

20

Ma

r-0

8

Ma

r-0

9

Ma

r-1

0

Ma

r-1

1

Ma

r-1

2

Ma

r-1

3

Ma

r-1

4

% chg

GDP (yoy)

GDP (qoq sa ann)

% chg

GS Forecasts

June 26, 2014 China


Exhibit 3: We note a strong ‘pro-growth’ bias from the recently announced policies, from both cyclical and reform

perspectives Summary of policies since March 2014

Source: CSRC, CBRC, PBOC, MOF, MIIT, Sina.com, Xin Hua Net, Goldman Sachs Global Investment Research.

Exhibit 4: We expect more reform measures to be rolled out in coming quarters

Source: Goldman Sachs Global Investment Research.

Pro-growth cyclical policies Growth positive reforms Growth neutral reforms Near term growth negative reforms

Increase railway investment targetPreferred shares issuance pilot

programShanghai-HK equity link

Stricter interbank activities regulation

from CBRC

Reduce tax burden for SMEs Municipal bond pilot programNew nine rules on capital market

reform

Accelerate shantytown renovation

progress and provide financial

support

More infra projects open to private

capital

Potential establishment of

nationwide telecom tower company

Rural financial institution RRR cut Detailed urbanization planReduce telecom service tariff

regulation

HPR loosening in select citiesSOE reform progress in oil

companies

Introducing tiered natural gas

pricing for residential use

Increase water projects investmentFurther reduce govt administration

interference and charges

Acceleration of budgeted fiscal

expenditure

Targeted RRR cut (need to fulfil SMEs

and agriculture sector lending

requirement)

Raise the amount of 1) relending to

support small and micro enterprises;

2) bonds issued by financial

institutions and 3) asset

securitization

L/D calculation methodology is under

CBRC's review

Major policies/reforms since Mar 2014

Potential reforms in next 12 months Potential beneficiaries Potential laggards

Fiscal /tax reform

Inclusion of local govt debts into budget management Banks

Expansion of BT/VAT reform Property

Adjustment of consumption tax (scope and rate) Mass consumption Luxury goods

Expansion of property tax trial Property

Introduction of environmental taxEnvironmental

protectionPollutive industries

Financial reform

Progress in interest rate /exchange rate liberalization Banks

Stricter interbank/shadow banking regulation Banks

Innovative/more efficient financial products/capital markets Brokers, insurance

Encourage private capital to set up financial institutions Banks

SOE reform (mixed capital management, reduce govt interference)Oil, telecom, transport,

select local SOEs

Expansion of using domestic IT equipment IT

Hukou reform

Mass consumption,

education, healthcare,

media, entertainment

Rural land system reformAgriculture technology

and supply chain

June 26, 2014 China


Exhibit 5: Our framework for analyzing the Chinese property sector: Direct linkages and major ripple effects


Exhibit 6: For the broad residential housing market, we believe end-user demand is

underpinned by demographic effect, wealth effect, and replacement effect


Policy impact

VS

Potential outcome

Impact on real economy

Tail risks

Supply vs demand status

Land salesInventory

Supply

GFA under

construction

End user

demand

Demand

Investment

demand

Tier-1 / tier-2 Nationwide

2 year down

cycleSupply demand

imbalance

Lower-tier cities

Affordability and inventory level restore

to normal level

Potential write off of existing

investment+ new investment

reduced

Wealth effect on

consumption

Property and

upstream

investmentCredit impact

Local govt infra

spending

Vicious economic

feedback cycleCredit crisis

Policy effectiveness

CreditExpectation

managementAdministrative

0.2-0.4% GDP growth cut

for every 10% of property

sales deceleration

But China has substantial policy flexibility to avoid this tail risk

Boosted by urbanization

IMF projects China GDP per capita tocontinue to grow steadily

Low penetration of

modern housing

(less than 50%)

Starting

population

Population

growth rateUrbanization

rate

Urban

population

Occupants

per household

Units

demand

Avg unit

size

GFA per capita

GFA demand

Total

population

GD

P p

er

ca

pit

a

(PP

P, IM

F d

ata

)

Positively correlated

Govt target

60%@2020 (vs. 54%@2013)

Negatively correlated

Demographic effect

Wealth effect

Very slow: about 0.5%

(projected to 2020)

Ne

gati

ve

ly

co

rre

late

d

Replacement

demand

Replacement effect

June 26, 2014 China


Exhibit 7: Urban population will likely grow at 2.1% pa

Exhibit 8: Commodity housing penetration is still low

Source: Wind, Euromonitor, Goldman Sachs Global Investment Research.

Source: 2010 population census, Euromonitor.

Exhibit 9: We constructed a state space model to gauge

investment demand

Exhibit 10: We estimate investment demand has dropped

to below 20% since 2012


Source: Wind, Soufun, Goldman Sachs Global Investment Research.

Exhibit 11: WorldUnion (a leading property agent in

China) survey result is consistent with our model results

Exhibit 12: Investment demand and property price are

positively correlated

Source: WorldUnion, NBS, Goldman Sachs Global Investment Research.

Source: NBS, Goldman Sachs Global Investment Research.

0.5%

0.9%

2.1%

CAGR of total population

Avg increase of urbanization rate per year

CAGR of Urban population

From 2014 to 2020

0%

10%

20%

30%

40%

50%

60%

70%

-

200

400

600

800

1,000

1,200

1,400

1,600

19

80

19

83

19

86

19

89

19

92

19

95

19

98

20

01

20

04

20

07

20

10

20

13

20

16

E

20

19

E

Total population

Urban population

Urbanization rate (RHS)

mn

1% 0% 1%4%

16%

35%

43%

0%

10%

20%

30%

40%

50%

Be

fore

194

9

19

49

-195

9

19

60

-196

9

19

70

-197

9

19

80

-198

9

19

90

-199

9

Aft

er

200

0

Urban households distribution by housing construction date

Potential upgrade demandOver 50% urban households

living in houses before

1998 housing reform

(1) GDP

(2) Urbanization rate

(3) Urban household income

End user demand

(4) Consumer surplus (income-

consumption)

(5) Wealth allocation (mutual

fund+WMPs, etc.)

(6) Excess liquidity (M2-GDP)

Investment demand

Main factors Principal component analysis + state spacemodel to estimate the elasticities of these 6 factors to housing demand

Elasticity 1+2+3 regarded as from end user demand; Elasticity 4+5+6 regarded as from investment demand

24%27%

25%

30%31%

40%

28%

34%

38%

29%

18% 18%

10%

15%

20%

25%

30%

35%

40%

45%

0

200

400

600

800

1000

1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Speculative demand

End user demand

Speculative demand as % of total demand (RHS)

Residential housing sales(GFA mn) (%)

24%

27%25%

30%31%

40%

28%

34%

38%

29%

18% 18%

10%

15%

20%

25%

30%

35%

40%

45%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Investment demand as % of total (WorldUnion survey)

Investment demand as % of total demand (based on our model)

Investment demand ratio (model results vs. WorldUnion survey)

(%)(%)

WorldUnion survey is conducted in over 30 cities and 400,000 people have

responded since the survey started in 2007.

24%

27%

25%

30%

31%

40%

28%

34%

38%

29%

18% 18%

10%

15%

20%

25%

30%

35%

40%

45%

-5%

0%

5%

10%

15%

20%

25%

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Property ASP growth

Speculative demand as % of total demand (RHS)

Speculative demand vs. Property ASP growth (%) (%)

Correlation=40%

Speculative demand vs. Property ASP growth (%) (%)

Correlation=40%

June 26, 2014 China


Exhibit 13: We believe government is incentivized to stabilize the property market


Exhibit 14: Policymakers have turned more supportive towards the property market

Source: Various media reports (Sina.com, Xinhua Net, Hexun.com).

Exhibit 15: Lower-tier cities appear to have structural imbalances

Tier 1 cities: Beijing, Shanghai, Shenzhen, Guangzhou; Tier 2: Nanjing, Suzhou, Hangzhou, Xiamen, Qingdao,

Chengdu, Changsha, Dalian, Tianjin, Chongqing, Wuhan, Xi’an; Tier 3: Dongguan, Nanchang, Ningbo, Fuzhou,

Huizhou, Yangzhou, Hefei, Hohhot, Beihai, Dandong, Jinzhou, Jiujiang, Zhanjiang, Nanchong

Source: NBS, Soufun, Wind, Goldman Sachs Global Investment Research.

Potential actions

Administration support Credit support Expectation management

Loosen HPR in select cities and lower downpayment requirements

Ensure adequate mortgage lending to fulfil end user demand and lower mortgage rate

Stabilize economic growth and maintain growth at a reasonable level

Accelerate urbanization process via Hukou reform etc

Loosen debt/equity financing requirements for developers

Date Govt entity/ Cities Policy details RemarksCentral Government

12-May PBOCPBOC urged 15 banks to grant mortgages to qualified buyers and give priority to the

borrowing needs of first home buyers and strengthen monitoring to prevent any credit risks.Confirmed

30-May State CouncilRRR will be cut 50bp for those banks that meet the PBOC's required level of new additions

and balance for either agriculture-related or SME loans.

Effective on

6/16

6-Jun CBRCVice Chairman of CBRC said CBRC will strongly support first set of individual housing needs

through implementation of differentiated housing loan policy.Confirmed

Local Government

1-Apr Nanchang, JiangxiHousehold registration is being relaxed, such as progressively granting rural migrant urban

hukou by 2018.Confirmed

22-Apr Wuxi, JiangsuThose who buy a house in Wuxi larger than 60 square meters in size will be eligible for a

Wuxi hukou, down from 70 square meters previously.Confirmed

28-Apr Nanning, GuangxiResidents in an economic zone near Nanning now have the right to buy homes in the city,

expanding the pool of potential buyers to beyond the city's dwellers.Confirmed

29-Apr Tianjin BinhaiAllow residents to buy one commercial apartment in this district even if they already own

properties elsewhere in Tianjin or other cities.

News

circulating

5-May Tongling, AnhuiLower downpayment for 1st time homebuyers using housing provident funds to 20% from

30%.Confirmed

7-May Zhengzhou, Henan Allow policy institutions to guarantee mortgage for home buyers. Confirmed

6-May Ningbo, Zhejiang

Those who do not have a property in Ningbo can buy a house in the city. Previously, buyers

need to show that they do not already own a property in their hukou city, or primary place of

residence.

News

circulating

23-May Hangzhou, ZhejiangProhibited commodity buildings sales if final sales price is lower than filing price by more

than 15%.Confirmed

26-May Wuhu, Anhui Easing housing accumulation fund loan application criteria to support housing demand. Confirmed

10-Jun Shenyang, LiaoningAllowing families owning two or more properties to purchase multiple properties by one-time

payment with no loan granted.

News

circulating

11-JunZengcheng,

Guangdong

Home buyer could now directly sign one home purchase contract with restricted sales price

of lower than $10,000/sqm instead of one contract with sales price lower than $8,000/sqm

plus a renovation contract worth $2,000/sqm.

Confirmed

Tier

No. of cities

in our

universe

Sellable

area (mn

sqm)

Inventory

month

Affordability

ratio

Affordability

ratio vs 2012

trough

Population

growth

CAGR*

Population

as % of

nationwide

GDP as % of

nationwide

Tier 1 4 33 10 97% +21% 1.6% 4.7% 12%

Tier 2 12 159 16 71% +13% 1.5% 9.6% 19%

Tier 3 14 79 19 63% +6% 0.7% 5.6% 7%

30 271 16 1.3% 20% 38%

Note: *based on the latest available two years population data by cities

June 26, 2014 China


Exhibit 16: Less developed regions normally have a higher gap between property

investment growth and population growth, indicating higher supply issue

Source: NBS, Wind, Goldman Sachs Global Investment Research.

Exhibit 17: The property market has various direct and indirect linkages to the economy


(30,000)

(20,000)

(10,000)

-

10,000

20,000

30,000

40,000

50,000

60,000

0%

5%

10%

15%

20%

25%

30%

35%

40%

Hain

an

Sh

aan

xi

Gu

izh

ou

Qin

gh

ai

Inn

er

Mo

ng

olia

Xin

jian

g

Sh

an

xi

An

hu

i

Gan

su

Hen

an

Yu

nan

Sic

hu

an

Jilin

He

bei

Hu

bei

Lia

on

ing

Gu

an

gxi

Nin

gxia

He

ilo

ng

jia

ng

Hu

na

n

Fu

jia

n

Ch

on

gq

ing

Sh

an

do

ng

Tib

et

Jia

ng

su

Jia

ng

xi

Tia

njin

Zh

ejian

g

Gu

an

gd

on

g

Beijin

g

Sh

an

gh

ai

Difference of property FAI CAGR and population CAGR (2004-2012)

Difference between provincial GDP capita and national average (RHS, 2012)

National average: 24%

Rmb

Our economists estimate that the housing sector slowdown could

shave 0.2-0.4pp off GDP growth this year per 10pp deceleration in

property sales growth from 2H2013 levels

Wealth effect on

consumption

Non-metal

Metals

Tighten local gov revenue

for Infra spending

Machineries

Transportation

Mining

Chemicals

IMF estimates that each 10%

fall in property prices reduces

consumption by 0.7pp

Per

RM

B100 o

utp

ut

in t

he

co

nstr

ucti

on

secto

r

RMB31

RMB39

RMB32

RMB21

RMB26

RMB21

Land sales account for nearly

30% of total government

income; we estimate 18%

decline in infra spending this

year if land sales drop 20% in

value, but the government

may raise funding through

alternative channels (such as

municipal bonds)

Credit impact

Slowdown in

property

Investment

(~25% of total

FAI)

Our banks team estimates (based on PBOC

data) that total credit exposure of banks to

the property sector is RMB32.7tn

Inp

ut

req

uir

ed

June 26, 2014 China


Exhibit 18: A vicious property cycle could develop into an

economic hard landing and credit crisis in the absence of

timely policy response

Exhibit 19: Property-related credits account for about half

of system loans

Note: the credit exposure includes exposure from shadow

banking.

Source: Gao Hua Securities Research.

Source: CEIC, Wind, Goldman Sachs Global Investment Research.

CSI 300 index up 5% in 3Q14E; year-end target 2,350 (10% upside)

We expect the CSI 300 to rise 5% in 3Q14, and 10% by year end, due mainly to:

1) Increased market confidence due to potential growth stabilization measures, stabilizing

earnings outlook and market valuations.

2) Continued loosening of liquidity in 3Q, which would aid market valuation recovery.

3) Continued stabilization of the global economy in 3Q, driving further China export

recovery and helping ease market concerns about China’s growth outlook. Of course,

downside risk for property may increase, but local governments can enact targeted

policies to loosen purchase restrictions and credit limits.

4) Potential for further substantive reforms in 3Q14, affecting fiscal policy, finance,

environmental protection, national defense, SOEs and new urbanization, which should

help ease market concerns about China’s structural problems, and increase market

confidence.

Moderate increase in liquidity. Overall stock market liquidity may increase in 3Q, mainly

due to: 1) moderate IPO resumption; 2) stable unlocking pressure; and 3) the Shanghai-

Hong Kong Stock Connect scheme could increase liquidity and boost market sentiment.

1) IPOs have very little influence on stock market liquidity—On May 18, the CSRC

announced that approximately 100 IPOs were planned between June and the end

of the year. We assume 100 companies will be listed, and estimate total potential

IPO volume for 2014 of Rmb50 bn (Rmb0.5 bn per IPO on average, based on

publically announced information from Wind) vs. near-zero for 2013. This potential

IPO size represents a very small proportion of market cap – just 0.2%, far lower

than the historical average of 3.0% since 2000, meaning the potential impact on

liquidity will be relatively small.

The vicious cycle

Property price

cut (10-15%) to

raise cash

Property sales

slowdown

Potential rise of unemployment,

capital outflow, and further asset

price declines lead to a negative loop

GDP/corp

earnings slow

Worse case: Policy

missteps lead to more

severe property/

GDP slow down

Property FAI slowdown

Banks' NPLs rise/

NIM decline

13

149

27

60

23 29 36 13

17

17

10

24 4 12 24

-

-

-

--

-

50

166

44

70

46 33

48

-

20

40

60

80

100

120

140

160

180

China US Japan Australia HK Taiwan Korea

Mortgage

Property developer/Commercial

LGFV(Quasi-property)

as % total system loan

June 26, 2014 China


2) 3Q unlocking pressure is not high—Based on the announced unlocking schedule

provided by Wind, we estimate unlocked market cap in 2014 will reach Rmb1.5 tn,

vs. Rmb1.6 tn in 2013 (excluding Agricultural Bank of China). The total scheduled

to be unlocked in 3Q14 is Rmb468.7 bn, near the 2014 quarterly average.

Unlocking pressure for the SME/GEM boards in 3Q14 is also relatively low.

3) Shanghai-Hong Kong Stock Connect estimates, progress will likely continue

for QFII/RQFII—On April 10, 2014, the CSRC and the Hong Kong SFC jointly

announced a pilot program to be launched after six months of preparation

(October 2014), allowing total SSE share volume of Rmb300 bn (Rmb13 bn/day)

and total SEHK volume of Rmb250 bn (Rmb10.5 bn/day) to be traded through local

Hong Kong/Mainland securities firms respectively. We believe the Shanghai-Hong

Kong Stock Connect scheme could improve A-share liquidity and market

sentiment. Given that China’s GDP growth is faster than the global rate, China

retains an important strategic role among emerging markets for global

institutional investors, despite the uncertainty that persists surrounding its

economic transformation.

We remain cautiously optimistic about the onshore market in FY14:

In terms of full-year earnings, we estimate CSI 300 index EPS growth of 5% (we lower

our non-bank growth estimate to 2.2% from 4.2%), and see significant downside risk to the

Wind consensus estimate of 14%. Although we see further policy loosening in 3Q to

maintain stable growth, our economists forecast 2014 GDP growth of 7.3% (down from

7.7% in 2013), and expect that yoy growth in 2H14 could face more pressure, due to the

higher base last year. Taking into account potential downside risk for property in 2H, we

lower our 2014 CSI 300 index full-year earnings growth estimate by 2 pp to 5%.

In valuation terms, we expect 5% expansion by end-2014 (up to 8.3X from the current

7.7X). Our CSI 300 target implies end-2014 P/E of 7.7X (non-banks 10.5X). This target P/E

ratio is slightly below some historical trough values—for instance, 9.1X in October 2008

(non-banks 10.5X), 9.0X in December 2012 (non-banks 11.8X) and 8.5X in June 2013 (non-

banks 11.2X). We use historical trough P/E values as a reference for our target P/E ratio,

and lower that slightly to reflect investor concerns about China’s structural issues. However,

we still believe the series of reforms currently being promulgated (SOE reform, tax reform,

financial reform, administrative reform, etc.) will gradually improve investor confidence

towards China. Furthermore, a potential round of growth stabilization measures could

steady market sentiment, helping valuations edge up to 8.3X from their current level of

7.7X.

Our year-end target for the CSI 300 index is 2,350 (implying 10% upside). We lower our

end-2014 CSI 300 target to 2,350 from 2,600 to account for a drop in earnings growth

estimates to 5% on the risk of a 2H property investment decline. We estimate the CSI 300

index will grow 10% by end-2014, driven by stabilizing earnings growth and mild valuation

expansion.

June 26, 2014 China


Exhibit 20: Most companies on the IPO waiting list are

targeting the SME or GEM boards

Exhibit 21: IPOs in China may resume in June 2014, but

we estimate they will remain a low percentage of total A-

share market cap



Exhibit 22: China’s A-share market unlocking pressure –

not high in 3Q14

Exhibit 23: SME/GEM board unlocking pressure is not

high in 3Q14



41.8%

33.5%

24.6%

Companies on IPO waiting list are mainly targeting SME/GEM boards

SME

GEM

Main board

0.2%

0%

1%

2%

3%

4%

5%

6%

7%

8%

0

100

200

300

400

500

600

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14E

Fund raising through IPO (Rmb bn)

IPO as % of A-share free float market caps (RHS)(Rmb bn)

0

100

200

300

400

500

600

700

800

2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2014-10

Value of A-share unlocking (Rmb bn)(Rmb bn)

(Rmb2.3 tn in 2013)Rmb1.6tn excl. ABC

(Rmb1.5 tn in 2014)

0

20

40

60

80

100

120

140

2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2014-10

Value of SME&GEM unlocking (Rmb bn)(Rmb bn)

(Rmb778 bn in 2013) (Rmb703 bn in 2014)

June 26, 2014 China


Exhibit 24: China’s QFII/RQFII quotas continue to increase

Exhibit 25: A-share mutual fund holdings are not high



Exhibit 26: We forecast +5% return in 3Q14; +10% return by 2014E year-end


0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

0

10

20

30

40

50

60

70

80

90

100

RQFII approved quota

QFII approved quota

Total approved quota as % of A-share float market cap (RHS)

USD

60.0

65.0

70.0

75.0

80.0

85.0

90.0

All types Equity focused Mixed

A-share mutual fund equity position(%)

7

7.1

7.2

7.3

7.4

7.5

7.6

7.7

7.8

7.9

8

8.1

8.2

2,000

2,200

2,400

2,600

2,800

3,000

3,200

Jun/12 Sep/12 Dec/12 Mar/13 Jun/13 Sep/13 Dec/13 Mar/14 Jun/14 Sep/14 Dec/14

CSI300 Index Path Forecasts

2,350(+10%,4Q14 end)

CSI300 (LHS)

GDP yoy (RHS)

(%)

GSe

2,250 (+5%, 3Q14 end)

June 26, 2014 China


Exhibit 27: CSI 300 earnings top-down forecasts: 5% EPS

growth in 2014E

Exhibit 28: We forecast 5% valuation expansion to 8.3X at

end-2014 for CSI 300 12-m forward PE



Exhibit 29: Most onshore sectors are trading at historical

trough levels

Exhibit 30: Our macro bridge index shows economic

fundamentals steadily improving in early 3Q14



GS Top-down

Estimates

Non-Financial

Revenue

Growth (%)

Non-Financial

Margin (%)

CSI300 EPS

Growth (%)

CSI300 ex.

financials EPS

Growth (%)

2012A 7.6 4.0 2.8 -8.0

2013A 4.0 4.3 12.0 9.0

2014E 5.2 4.1 5.0 2.2

2015E 5.6 4.2 6.0 3.5

Bottom-up Estimates

(Wind Consensus)

2012A 7.6 4.0 2.8 -8.0

2013E 4.0 4.3 12.0 9.0

2014E 9.1 4.5 14.0 16.1

2015E 7.6 4.8 12.3 15.2

1.0

1.5

2.0

2.5

3.0

3.5

8

10

12

14

16

18

20

22

24

26

28

30

Oct-

08

De

c-0

8

Feb

-09

Ap

r-09

Ju

n-0

9

Au

g-0

9

Oct-

09

De

c-0

9

Feb

-10

Ap

r-10

Ju

n-1

0

Au

g-1

0

Oct-

10

De

c-1

0

Feb

-11

Ap

r-11

Ju

n-1

1

Au

g-1

1

Oct-

11

De

c-1

1

Feb

-12

Ap

r-12

Ju

n-1

2

Au

g-1

2

Oct-

12

De

c-1

2

Feb

-13

Ap

r-13

Ju

n-1

3

Au

g-1

3

Oct-

13

De

c-1

3

Feb

-14

Ap

r-14

Ju

n-1

4

Au

g-1

4

Oct-

14

De

c-1

4

IBES CSI300 12m fP/E

IBES CSI300 12m fP/E exl banks

IBES CSI300 12m fP/B (RHS)

(X) (X)

GS target forward P/E: 8.3X; 2014E EPS growth: 5%

10.5X

7.7X

1.2X

CSI300 avg. 13.6X

+1 Stdev

-1 Stdev

★

7.7

28.5

24.0

17.919.5

17.7 16.213.9 12.9

10.412.5

9.3 10.78.8 8.7 7.3 8.4 7.9

5.3 4.1

0

10

20

30

40

50

60

CS

I30

0

Me

tals

/Min

ing

So

ftw

are

He

alt

h c

are

Me

dia

Ste

el,

alu

min

ium

Ha

rdw

are

Te

leco

Insu

ran

ce

Ch

em

ica

ls

Co

nsu

me

r sta

ple

s

Dis

cre

tio

na

ry

Oil

an

d g

as

Tra

nsp

ort

ati

on

Ind

ustr

ials

Bu

ild

ing

ma

teri

als

Uti

liti

es

Au

to

Pro

pe

rty

Ban

ks

12M forward P/E (X) +/- 1 Std.dev. CurrentHigh/low

5 years historical data used

-50

-30

-10

10

30

50

70

Jan/05 Jan/06 Jan/07 Jan/08 Jan/09 Jan/10 Jan/11 Jan/12 Jan/13 Jan/14

SHCOMP Index return (3-m return)

Macro Bridge Index (2-m leadning)

(%)

Correlation coefficient = 77%

June 26, 2014 China


Exhibit 31: Our economic cycle definition based on

GDP/CPI trends

Exhibit 32: Emerging sectors normally outperform during

stagflation phase and underperform during expansion


Note: “+” means valuation premium increase while “-“ means decrease. Source: Goldman Sachs Global Investment Research.

3Q14 sector restack: Prefer reform beneficiaries, select pro-cyclicals

We are optimistic on sectors that could benefit from structural reform and some pro-

cyclical sectors in 3Q14.

Our current Overweight sectors are:

1. Media, consumer durables (home appliances), healthcare – long-term reform

beneficiaries with low valuations and stable earnings;

2. Transportation, oil, gas & petrochemical – beneficiaries of SOE and other reforms;

3. Brokers, insurance – pro-cyclical sectors;

We are Underweight on the coal, non-ferrous metals and chemical sectors.

We highlight two screens for investors in 3Q14 in Exhibits 44 and 45: 1) top names in our

3Q14 Overweight sectors; 2) potential export recovery beneficiaries.

Introducing our revised three-factor framework

We have reconfigured our sector selection framework to adapt to the changing backdrop

for China equities:

1) Prefer reform beneficiaries: If we examine Chinese equity performance during the

past one to two years, reform has been an important influencing factor. For

example, the rallies in late 2012 and Nov 2013 were underpinned by reform

prospects brought by the successful leadership transition and Third Plenum,

respectively. Going forward, we expect reforms to be the leading role to drive the

market, because reforms (and the increase in longer-term confidence that these

entail) should be significant drivers of valuation. We reiterate our view to favor

sectors with reform tailwinds and associated re-rating potential. See Reforming

China- shifting into higher gear, May 27, 2013, for detailed sectoral reform

prospects.

CPI

GDP

Contraction Recovery Expansion Stagflation

Economic phases USA(1985-2012)

Korea(1990-1997)

China(2005-2013)

Stagflation(GDP down, CPI up) + + +

Contraction(GDP down, CPI down) - + +

Recovery(GDP up, CPI down)

+ - -

Expansion(GDP up, CPI up) - - -

Valuation premium warranted structurally and shifts cyclically

June 26, 2014 China


2) Control exposure to rising credit risks: Although we do not anticipate systemic

risks, credit concerns may still weigh on the equity market, especially macro/credit

sensitive sectors. We favor sectors with less exposure to the credit market and

potential higher funding cost triggered by defaults.

3) Valuation discipline: We are wary of highly-priced ‘concept’ growth stocks unless

their earnings path is visible and supportive of their valuation.

Based on the framework above, we remain Overweight (OW) on reform beneficiaries with

stable earnings such as media, healthcare, consumer durables (home appliances), as well

as cyclical sectors such as brokers and insurance in 3Q14. We are also overweight on SOE

reform beneficiaries such as transportation and oil, gas & petrochemical.

Media: We upgrade the media sector to OW from Neutral mainly because－

1) It should benefit from acquisition consolidation effects of the past year, with major

high growth media companies seeing faster earnings growth, many exceeding 40%.

2) M&A transactions announced last year have generally been completed by 1H14, with

major companies expected by our sector analysts to start a new round of M&A in 2H.

Meanwhile, a number of high quality movies, dramas and games are expected to be

released in 2H, potentially driving high box office, revenue and viewership catalysts for

stock prices.

3) The sector should benefit from the structural changes in China’s consumption and

healthy net debt/equity levels, in line with our three-factor sector selection framework.

4) Stable macro fundamentals, ample liquidity and subdued inflation could drive the

valuation premium of selective emerging sectors such as media to expand.

We see the Healthcare sector as a long-term beneficiary of reform. The current Wind

consensus estimate for 2014 earnings growth is approximately 20%, 12-month rolling P/E is

25X, and it has slightly outperformed the CSI 300 by 0.5pp since 2Q. We maintain

Overweight on healthcare, mainly because:

For healthcare services, the State Council reiterated its encouragement of private

investment in public hospital reform and the inclusion of private healthcare institutions into

the national insurance scheme. We see hospital reform remaining center stage in 2H14.

For Pharmaceutical names, we also expect a shift in business focus to: (1) R&D

pipeline/new product launches, (2) channel expansion, and (3) inorganic growth through

consolidation in the sector.

Consumer durables (appliances): we remain optimistic on the home appliance sector,

mainly because:

1. On the reform front, we expect home appliances will benefit meaningfully from

potential land reform, hukou reform, and social safety nets build-up given the mass

market consumption focus.

2. The sector’s performance was broadly consistent with the CSI 300 index in the last

month, and industry valuations are at historical lows (12-month rolling P/E ratio of

10.6X), while earnings growth is steady (Wind consensus 2014E earnings growth is

20%) and net debt/equity level is healthy.

3. The appliance sector could also benefit from SOE reform, including possible M&A

reorganization, increased private capital participation and mixed ownership reforms.

Export recovery in 3Q would also be positive for the appliance sector.

June 26, 2014 China


We remain Overweight on selective pro-cyclical sectors in 3Q14: brokers, insurance. We

estimate government policy loosening and export recovery will lead to gradual

improvement of China economic fundamentals in 3Q14, and that selective pro-cyclical

sectors would therefore outperform the market. Specifically:

Downgrade construction materials (cement) to Neutral. 1) As we discussed earlier, China’s

real estate sector may have entered a two-year adjustment period, with potential for

downside risks to construction materials due to high correlation with the real estate market.

2) High net debt/equity levels across the sector may make it vulnerable to potential credit

risks.

Remain Overweight on brokers. 1) We expect brokers to benefit from revenues brought by

IPO resumption. 2) The gradual development of the mutual trading link (Shanghai and

Hong Kong) should also broaden brokers’ business scope. 3) 2Q to date, the sector’s

performance has been broadly consistent with the market, and industry valuations are at

historical lows.

Remain Overweight on insurance. We believe the insurance industry will benefit from

potential increases in investment yields, because: 1) The preferred-share pilot scheme has

provided a potential high-yield investment channel; and 2) Asset-side investment limits are

being lifted at a reasonable pace, increasing participation in off-balance sheet activities and

raising investment yields.

Remain Overweight on transportation, oil, gas & petrochemical

For the transportation sector, we believe: 1) Port and shipping fundamentals may

improve in 3Q14 as Chinese exports improve. 2) We believe FTZ policies will likely be

expanded in 3Q-4Q14 based on news from SINA.com dated June 26, 2014, providing an

opportunity for sector valuations to increase. 3) Transportation should be a major

beneficiary of SOE reforms (see SOE reform series I – New plan and new beneficiaries,

June 9, 2014).

For the oil, gas & petrochemical sector, we believe: 1) 2014 earnings growth appears

stable and valuation is fair, with limited stock price gains year to date. 2) It should be a

major beneficiary of SOE reforms (see SOE reform series I – New plan and new

beneficiaries, June 9, 2014).

We highlight two screens for investors in 3Q14: 1) Top names in our 3Q14 OW sectors; and

2) potential export recovery beneficiaries.

The screening criteria for our first group are:

1) Shares in our 3Q14 Overweight sectors that are rated Buy by GS analysts;

2) Upside potential relative to current share prices is over 15%; and

3) 2014E P/E is lower than 35X, and 2014E EPS growth is positive.

Selection criteria for potential export recovery beneficiaries

For onshore stock selection, we considered the following key criteria:

1) 2013 overseas revenue exposure was over 50%;

2) Total market cap was above Rmb4bn given liquidity requirements;

3) We exclude those stocks under coverage rated Sell. For not covered companies, we

exclude those where Wind consensus rating is above 2.0 (meaning underperformance),

and/or with only one or no broker coverage (i.e. only company guidance) given earnings

estimates risks; and

4) We exclude those listcos with negative 2013-15E earnings growth and a PEG (2013-15E)

above 1.0, to factor in valuation requirements.

June 26, 2014 China


We note approximately 10 listcos were excluded due to the criteria # 3 and 4, including

several shipping listcos. Although most of these companies would eventually be

beneficiaries of an improving global economic outlook, consensus views are still sell or

hold given still-weak 2013E earnings or sectoral issues such as overcapacity.

We also note there are some listcos that could indirectly benefit from a global recovery,

e.g., some port and airport listcos where demand is driven by global factors, although

revenue may be booked to domestic intermediaries.

Exhibit 33: We prefer reform beneficiaries and pro-cyclical sectors – upgrade media to

Overweight; downgrade construction materials to Neutral


Media 0.8 OW Neutral

Health Care 6.9 OW OW

Consumer Durables 3.9 OW OW

Brokers 7.6 OW OW

Insurance 5.7 OW OW

Transportation 1.1 OW OW

Oil,gas& petrochemical 2.7 OW OW

Construction Materials & Others 1.1 Neutral OW

Banks 20.2 Neutral Neutral

Construction&Other Industrial Services 3.1 Neutral Neutral

IT&equipment/components 5.1 Neutral Neutral

Textile&Apparel 0.3 Neutral Neutral

Hotel &tourism&Others 1.1 Neutral Neutral

Auto&parts 3.3 Neutral Neutral

Retailing 2.7 Neutral Neutral

Utilities 3.7 Neutral Neutral

Telecom 0.9 Neutral Neutral

Food&beverage 6.2 Neutral Neutral

Airlines 0.7 Neutral Neutral

Property 4.3 Neutral Neutral

Capital Goods 8.5 Neutral Neutral

Transportation Infrastructure 0.9 Neutral Neutral

Steel 1.1 Neutral Neutral

Coal 2.4 UW UW

Non-ferrous metal & Others 3.9 UW UW

Chemical 2.0 UW UW

OW Sectors 29% 29%

Neutral Sectors 63% 63%

UW Sectors 8% 8%

SectorsIndex weighting

(%)

New

ratingPrevious rating

June 26, 2014 China


Exhibit 34: Reform outlook is one of key considerations when we pick sectors Sectoral prospects under various key reforms


Exhibit 35: Media, home appliances, retailing, food & beverage, auto, IT and healthcare

sectors face relatively less debt pressure

Source: Wind, Goldman Sachs Global Investment Research.

SectorsMarket driven

pricingSOE reform

Financial

reform/

innovation

Fiscal and tax

reform

Urban/rural

land/hukou/safety net

reform & demographics

Energy saving &

environmental

protection

Govt admin./

austerity and anti-

corruption

Net score

Oil & gas producers

Railway

Agriculture

Gas distributors

Health care

Alternative energy

Consumer staples

Internet/Media/Education

Insurance

Brokers

Retailing

Airlines

Utilities

Gaming

Auto

Banks

Telecom

Property

Materials

Coal

-30%

-19%

-13%

-10%

-9%

-7%

-5%

9%

10%

11%

20%

32%

34%

39%

42%

44%

51%

52%

64%

65%

73%

75%

79%

90%

128%

137%

-40% -20% 0% 20% 40% 60% 80% 100% 120% 140% 160%

Consumer Durables

Media

Retailing

Food&beverage

Auto&parts

IT

Health Care

Household Products

Hotel &tourism

Textile&Apparel

Capital Goods

Coal

Overall

Transportation Infrastructure

Oil,gas

A-share (ex. fin)

Telecom

Shipping&Other transportation

Chemical

Construction Materials

Non-ferrous metal

Construction

Steel

Property

Airlines

Utilities

Net debt/Equity (1Q14) (%)

June 26, 2014 China


Exhibit 36: 2Q to date various sectors’ earnings revisions

trend

Exhibit 37: Media sector’s earnings growth is strong



Exhibit 38: Media sector valuation does not look

expensive

Exhibit 39: Media sector slightly outperformed the CSI

300 recently



-18.5%

-17.2%

-11.3%

-10.6%

-10.3%

-10.1%

-8.9%

-5.7%

-5.0%

-2.5%

-2.4%

-2.4%

-2.4%

-1.7%

-1.6%

-1.6%

-1.2%

-0.6%

-0.5%

-0.3%

0.2%

0.8%

0.9%

0.9%

1.2%

1.9%

2.5%

3.4%

-20% -15% -10% -5% 0% 5%

Airlines

Non-ferrous metal

Retailing

Textile&Apparel

Chemical

Coal

Food&beverage

Capital Goods

Property

Brokers

Overall (ex. Financials)

Steel

Health Care

Construction Materials

Oil,gas

Telecom

Overall

Insurance

Hotel &tourism

Banks

Utilities

Construction

Consumer Durables

Shipping&Other transportation

Auto&parts

Media

IT

Transportation Infrastructure

CSI300 Index 2014E earnings forecast changes by sector (2Q to date)

-300%

-250%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

200%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

Mar-

07

Ju

n-0

7

Sep

-07

De

c-0

7

Mar-

08

Ju

n-0

8

Sep

-08

De

c-0

8

Mar-

09

Ju

n-0

9

Sep

-09

De

c-0

9

Mar-

10

Ju

n-1

0

Sep

-10

De

c-1

0

Mar-

11

Ju

n-1

1

Sep

-11

De

c-1

1

Mar-

12

Ju

n-1

2

Sep

-12

De

c-1

2

Mar-

13

Ju

n-1

3

Sep

-13

De

c-1

3

Mar-

14

A-share (ex. fin) net profits growth Media(%) (%)

0

20

40

60

80

100

120

Media 12-m PE valuation

mean

-1SD

+1SD

(x)

80

130

180

230

280

330

65

70

75

80

85

90

95

100

105

110

CSI300 Index

Media (Relative performance vs. CSI300 Index, RHS)

(Jan 1 2011=100)

June 26, 2014 China


Exhibit 40: Construction materials sector valuation does

not look expensive

Exhibit 41: 2Q to date construction materials sector

performance has been broadly consistent with the CSI

300



Exhibit 42: Healthcare sector has slightly outperformed

the CSI 300 recently

Exhibit 43: China’s healthcare reform agenda


Source: Gao Hua Securities Research, China National Health and Family Planning Commission.

0

10

20

30

40

50

60

70

Construction Materials 12-m PE valuation

mean

-1SD

+1SD

(x)

80

85

90

95

100

105

110

115

120

125

65

70

75

80

85

90

95

100

105

110

CSI300 Index

Construction Materials (Relative performance vs.

CSI300 Index, RHS)

(Jan 1 2011=100)

80

90

100

110

120

130

140

150

160

170

180

65

70

75

80

85

90

95

100

105

110

CSI300 Index

Health Care (Relative performance vs. CSI300

Index, RHS)

(Jan 1

2009-2012Make drugs affordable

• Re-adjust EDL/RDL price ceiling

• Expansion of EDL (2013)/RDL (2014)

• NDRC cost investigation

• More competition: differs from region to region

Drug price control

Hospital reform

Insurance reform

2013-2015Focus on healthcare service

• Lower entry barrier for private capital to invest

• “De-administration” in China’s public hospitals

• Changing revenue mix: drug/service trade-off

• Incentive scheme: improved efficiency

• Public/private service

2015-2020Efficient payment system

• Centralized control of three major healthcareinsurance

• Expansion of insurancecoverage to major illness and increasing use of private hospitals

• Payment shift from feefor-service to measurebased on performanceand patient outcomes

Universal insurance coverage, affordable healthcare

June 26, 2014 China


Exhibit 44: Stock screening in our 3Q2014 OW sectors


Exhibit 45: Stocks that could potentially benefit from global macro recovery

Source: Wind.

Ticker Name Sector Rating Price (Pricing

currency)

Potential

upside/downside

to target price

EPS growth

2014E (%)

EPS growth

2015E (%)

P/E CY

2014 (X)

P/E CY

2015 (X)

P/B CY

2014 (X)

P/B CY

2015 (X)

300058 CH BlueFocus Communication Media Buy* 25.99 58.7% 75.7% 29.2% 31.3 24.2 5.8 5.2300133 CH Zhejiang Huace Film & TV Media Buy 30.94 16.3% 101.3% 31.1% 34.6 26.4 6.1 5.0601318 CH Ping An Insurance Group Insurance Buy* 39.42 69.0% 19.5% 15.0% 9.3 8.1 1.5 1.2600030 CH CITIC Securities (A) Brokers Buy 11.27 21.6% 39.3% 16.8% 17.0 14.6 1.3 1.3601006 CH Daqin Railway Transportation Buy 6.27 54.7% 17.5% 28.2% 6.3 4.9 1.1 1.0601333 CH Guangshen Railway (A) Transportation Buy 2.50 32.0% 10.4% 48.1% 12.6 8.5 0.6 0.6600028 CH China Petroleum & Chemical (A) Oil&gas Buy 5.18 41.3% 14.9% 12.5% 7.9 7.0 1.0 0.9601857 CH PetroChina (A) Oil&gas Buy 7.53 20.5% 8.3% 3.1% 9.8 9.5 1.1 1.1600535 CH Tianjin Tasly Pharmaceutical Co. Health Care Buy 39.04 23.0% 32.1% 28.5% 27.7 21.6 8.4 6.7600196 CH Shanghai Fosun Pharmaceutical Health Care Buy* 19.31 31.5% 4.8% 18.5% 20.4 17.2 2.6 2.3

Average 36.8% 32.4% 23.1% 17.7 14.2 3.0 2.5Note: * denotes stock is on our regional Conviction List. Prices are as of June 25, 2014.

Stock screening in 3Q OW sectors

Wind

tickerCompany name Sector

GS rating

if any

Share

PriceMarket cap

(Rmb) (Rmb bn) 2014E 2015E 2014E 2015E 2014E 2015E

002444.SZ Great Star Consumer Durables NC 9.32 9.45 23.8 20.8 17.9 14.8 13.2 13.8

600261.SH Yankon Group Capital Goods NC 10.02 9.70 71.9 30.7 24.3 18.6 14.0 15.6

600978.SH Yihua Timber Consumer Durables NC 4.64 6.88 35.0 29.6 12.4 9.6 9.4 11.1

600337.SH Markor International Consumer Durables NC 5.63 3.64 30.9 28.8 16.2 12.6 7.8 9.3

002429.SZ SZ MTC Consumer Durables NC 7.29 11.68 24.7 26.7 14.7 11.6 18.5 20.7

000982.SZ Zhongyin Cashmere Textile&Apparel NC 7.22 7.24 21.2 52.4 21.3 13.9 11.8 14.9

002051.SZ CAMC Engineering Construction NC 15.42 11.93 21.6 20.8 13.7 11.3 15.9 16.6

Note: Prices are as of June 25, 2014.

Global macro recovery beneficiaries

Earnings growth

(%)PE (x) ROE (%)

June 26, 2014 China


Disclosure Appendix

Reg AC

We, Chenjie Liu, Ph.D, Ben Bei, Kinger Lau, CFA, Timothy Moe, CFA and Charles Fang, Ph.D., hereby certify that all of the views expressed in this

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June 26, 2014 China


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