Mon, 13 Mar 2017
Equity Research
China Securities Sector Securities / China
A year for opportunists
Change is the only constantAs history repeats itself in similar patterns, we
believe market volatility will increase in 2017, synchronizing the 10 year-cycle of
volatility spikes as occurred in 1987, 1997 and 2007. Driven by (1) the rising
protectionism in economic policies in US (2) potential new policies after the 19th
National Congress of CPC and (3) change in global liquidity after interest rate
hike by FED, we believe the brokerage sector is the best proxy to capture
opportunities in the shifting dynamics of the financial markets.
Market turnover is a lagging indicatorIn contrast to the general perception of
the strong link between market turnover and brokerage sector performance, we
have this other-worldlyview that the market turnover is lagging behind the
actual sector performance. We believe the change in market turnover is more
about a result from, not a reason for, the change in the market performance and
volatility. Thus, as the brokerage sector normally offers higher than 1 beta
(relative change against market return) we think investing in market leaders of the
brokerage sector will offer investments with efficiency, leverage as well as
liquidity.
Exploiting the divergenceDespite the market is building up momentum with
MSCI China up 10.1% YTD, the brokerage sector has been underperforming the
index by 8.1% since the average daily turnover (“ADT”) of A-shares market
dropped 30% yoy in 2M17 or 20% compared to the ADT of 2016. However, in
addition to a lagging indicator, we think ADT is only one of a few factors behind
the earnings of the brokerage sector, which is also dependent on market returns
and the bond market. With (1) the SHCOMP up 3.4% in 2M17 VS down -18.2% in
2M16, (2) robust growth in AUM (3) reactivation of IPO market and (4) liberation
of bond issuance, the brokerage sector's total revenue and net profits jumped
44% and 161% with higher income from asset management, investment banking
as well as net gains from investment in 2M17. By seeing through the market
concern on lower profitability of the brokerage sector in FY17E, we believe it
creates decent opportunities to invest in the brokerage sector to capture the
divergence between the market performance and the high beta of the sector.
What we pickIn order to capture the opportunities from (1) higher adaptation of
mobile platform (2) robust growth in investable assets in China and (3)
reactivation of IPO market and development of bond market, we prefer brokers
with the core competitive advantages of (1) strength in technology integration (2)
high exposure in asset management business and (3) better client mix and
innovation in investment banking. Thus, we initiate our coverage on HTSC, GF
Securities and CITIC with BUY ratings and Haitong with a HOLD.
Bruce Yeung, CFA
+852 2135 0214
bruce.yeung@oriental-patron.hk
Daisy Wang
+852 2135 0212
daisy.wang@oriental-patron.hk
Sector Report
Exhibit 1: Recommendations summary
Company Stock code Rating TP Close
FY17E
PE
FY17E
PB
FY17E
Yield
Upside
(%)
HTSC 6886 HK BUY HK$19.10 HK$15.30 14.2 1.12 2.1% +25%
GF Securities 1776 HK BUY HK$20.60 HK$16.90 10.6 1.32 2.8% +22%
CITIC Securities 6030 HK BUY HK$19.40 HK$16.50 14.1 1.19 2.1% +18%
Haitong Securities 6837 HK HOLD HK$14.80 HK$13.94 14.5 1.22 2.1% +6%
Galaxy Securities* 6881 HK NR n.a. HK$7.38 11.4 1.00 2.2% n.a.
Source: Bloomberg, OP Research, *Consensus estimate
Mon, 13 Mar 2017
China Securities Sector - A year for opportunists
Page 2 of 68
Table of Contents
Table of Contents ..... 2
Investment summary3
Why invest in brokerage sector ...... 7
What makes a better broker to invest ........16
HTSC (6886 HK) – Leading technology integration .25
GF Securities (1776 HK) – Leading in asset management ..36
CITIC Securities (6030 HK) – Leading in investment banking .........46
Haitong Securities (6837 HK) – Leading in diversification ...56
Investment risks ......66
Mon, 13 Mar 2017
China Securities Sector - A year for opportunists
Page 3 of 68
Investment summary
The art of differentiation
We initiate our coverage on the brokerage sector as we think the sector is the best
proxy to capture the opportunities arising from higher market volatility in 2017. We
expect this market volatility to increase in 2017 because of (1) higher international
political tensions after the US presidential election (2) potential new policies
announced after the 19th National Congress of CPC in China (3) change in
liquidity driven by the interest rate hike in FED and (4) 10-year cycle in market
sentiments where spikes in volatility occurred in 1987, 1997 and 2007.
Beta is more important than market turnover for brokers
The majority in the brokerage sector analysts is focusing on the change in
average daily turnover (“ADT”). However, in contrast to the mainstream opinion,
we believe market turnover is somehow a lagging indicator for the sector's market
returns. As the classic shift in market sentiments happened during 2015 – 2016,
Exhibit 8 clearly shows the sector performance always leads the change in
turnover. We believe that, as the investors always predicted the market
performance based on recent market momentum, market liquidity is always the
result of, but not the reason for, the change in the market performance. Thus,
even though both market turnover and market returns should have a positive
impact on broker earnings, we think correlation to the market returns (“beta”)
would be more crucial for investing in the brokerage sector. As shown in Exhibit 7,
when compared with the industry average market beta of 1.2, we believe the
market leaders in the brokerage sector with beta of 1.4 - 1.6 would offer higher
returns, liquidity as well as efficiency under positive market conditions, especially
in a higher volatility market in 2017E.
Differences in profit sensitivity
By breaking down the FY17E EPS sensitivity to the change of turnover and
returns in stock and bond markets, CITIC would have higher EPS sensitivity to
the change in market turnover as higher profitability through a client mix of more
institutional clients. Meanwhile, the profit of Haitong would have higher correlation
to the change in stock index as it has a higher investment proportion in equity.
However, in addition to the market angle, which only focuses on the stock market,
we believe bond markets have more significant impact on the brokerage sector's
profitability since brokers generally leverage up to invest in debt securities for
dividend income. The net gains from investments of brokers are generally more
sensitive to the change in the bond market index, while GF Securities showed
strong investment portfolio management capabilities by achieving higher
investment yields from financial assets held.
Exhibit 2:FY17E EPS sensitivity test
FY17E EPS change Stock turnover Stock index Bond turnover Bond index
+10% +5% +10% +1%
HTSC2.9% 0.0% 0.0% 5.2%
GFS 2.4% 0.2% 1.9% 0.1%
CITIC 5.0% 1.2% -0.1% 6.0%
Haitong 3.4% 1.4% 0.7% 4.2%
Source: Company, OP Research
We initiate our coverage on the
brokerage sector as it is the best
proxy to capture the opportunities
arising from higher market
volatility in 2017
Beta is more important indicator
than market turnover for
brokerage sector performance
Bond market has greater
significant impact on brokerage
sector profitability
Mon, 13 Mar 2017
China Securities Sector - A year for opportunists
Page 4 of 68
12%
22%
19%
7%
4%
9%10%8%
13%
5%6%
16%
0%
5%
10%
15%
20%
25%
HTSCGFSCITICHaitongGalaxySector
average
Asset ManagementInvestment Banking
(%)
Looking for alpha
Except for the market dependency factors, we believe (1) capability to capture
market share through technology integration (2) development in asset
management business and (3) innovation in investment banking business are
three key areas for brokers to outperform the market.
As shown in Exhibit 35, major brokers generally lose market share to smaller
competitors in the wake of freeing of multiple accounts for individual investors.
Unlike other industry peers, HTSC gained higher market share to rank first in the
total trading value though effective technology integration and having over 6.5mn
active users for their mobile APP with strong user stickiness. By owning majority
stake in GF Fund and China AMC, GF Securities and CITIC Securities are
expected to have 22% and 19% of total revenue contribution generated from
asset management business respectively, much higher than the industry average
of 9%. We believe strength in asset management development would offer better
growth for brokers given over 60% CAGR in asset management fees income in
China. With the reactivation of IPO market and more liberal bond issuance,
innovation in investment banking, such as green bond underwriting, would
provide strong growth in the segment. After the market stabilised with the
correction in mid-2015, we believe further controls with the policies on investment
banking business would be limited in the near future, favoring CITIC and Haitong.
Exhibit 3: Segment revenue contribution for asset management and
investment banking in FY16E
Source: Company data, OP Research,*1H16 results
HTSC, GFS, CITIC and Haitong
have a competitive edge in
technology integration, asset
management, investment banking
and diversification respectively
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