JP Morgan China 2010

Asia Pacific Equity Research
19 December 2009
China Insights & Strategy

Views from the Bund
‘Views from the Bund’ is a monthly publication that gives clients a value- China
added view on China macro, strategy, and industry insights. Equities Research Team
• Key investment theme: In FY10, the China equity market may offer Frank Li
AC
good investment opportunities but also presents many uncertainties and (852) 2800-8511
risks. On one hand, we believe Chinese equities could stage a rally frank.m.li@jpmorgan.com
between now and 1Q10, driven by: 1) the government’s recent J.P. Morgan Securities (Asia Pacific) Limited
reiteration of its “proactive fiscal policy” and “relatively loose monetary
policy” for 2010, which should help alleviate the market’s concerns Relative index performance
about possible earlier-than-expected monetary tightening; 2) the upward
earnings estimate revision momentum for MSCI China; 3) a marked
sequential improvement in liquidity from Dec-09 to 1Q10; and 4) the
expectation that Rmb will resume appreciation in FY10. On the other
hand, we could start to see an increase in market volatility for MSCI
China if and when the government starts to tighten its monetary policy
(possibly in 2Q10). We could see de-rating pressure for sectors that are
highly correlated with fixed-investment growth as we approach mid-
2010, when the equity market is likely to start pricing in a potential sharp
slowdown in fixed asset investment growth in 2011. Our major Source: Bloomberg.
investment strategy lies in focusing on defensive growth stocks—stocks
with good earnings visibility, low penetration rate, strong secular growth,
and those that should be least affected by a potential tightening kicking in
as of 2Q10 and a downshift in FAI growth in 2011.
• What is changing: We highlight our two key investment themes for
FY10: 1) accumulating consumption–related stocks to benefit from
China’s growth rebalance; and 2) identifying undervalued China
companies, which are likely to report record high earnings in FY09, but
are still trading at a decent discount to their highs in FY07, and are free
from major multiple contraction pressure.
• Information: We continue to see short-term trading opportunities for
media and airline stocks, and food inflation plays.
• China model portfolio adjustment: We stay positive on: A) China
banks; B) the coal sector; and C) defensive growth names—internet,
tissue and diapers, gas, selected consumer staples, and healthcare. We are
negative on: A) property on tightening concerns; within the sector, we
favor those with the most exposure to Tier 2-3 cities; B) telecoms; C)
FAI–related plays, including downstream commodities, commercial
vehicles and construction; and D) IPPs.
China: Top picks
Reuters Mkt cap Avg. dly TOEPS Y/Y growth (%) P/E (x) P/BV (x) ROE (%) Div. yld (%)
Rec ticker (US$MM) (US$MM) 2009E 2010E 2009E 2010E 2009E 2009E 2009E
China Citic Bank - H Share OW 0998.HK 42,410 39.9 13.6 52.4 14.7 9.6 2.1 15.2 1.7
China Construction Bank OW 0939.HK 198,050 236.7 14.2 30.1 12.8 9.8 2.6 21.3 3.5
China Gas Holdings Limited N 0384.HK 1,588 5.4 NM NA 25.6 NA 3.4 14.3 0.0
Sinopharm OW 1099.HK 8,032 NA 42.1 15.3 47.2 40.9 4.7 12.7 0.5
Sina Corp N SINA US 2,796 53.3 -24.2 29.5 45.7 35.3 3.5 8.7 0.0
Source: Bloomberg, J.P. Morgan estimates. Prices and valuations are as of December 16, 2009.
See page 153 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, 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.
Frank Li Asia Pacific Equity Research
(852) 2800-8511 19 December 2009
frank.m.li@jpmorgan.com
Table of Contents
Macroeconomic views .............................................................3
Market strategy .......................................................................16
Autos .......................................................................................66
Consumer................................................................................84
Energy .....................................................................................93
Financials: Banks ...................................................................99
Financials: Insurance...........................................................109
Healthcare .............................................................................128
Real estate ............................................................................130
Transportation ......................................................................136
Telecom.................................................................................138
Utilities and infrastructure...................................................142
2
(852) 2800-8511 19 December 2009
Qian Wang Macroeconomic views

(852) 2800-7009
qian.li.wang@jpmorgan.com
Upbeat economic momentum
Grace Ng
(852) 2800-7002 Latest economic indicators confirmed that the upbeat momentum in China’s
grace.h.ng@jpmorgan.com economic activity carried on well into 4Q09. Along with the positive tone from latest
J.P. Morgan Securities (Asia Pacific) Limited manufacturing PMIs, industrial activity continued with the solid expansion in
November, with industrial production rising at a faster-than-expected 19.2% oya (J.P.
Morgan: 19.0%; consensus: 18.2%), compared with 16.1% in October. Seasonally
adjusted, IP rose an impressive 1.7% m/m in November, adding to the 1.4% gain in
October, with the sequential trend rising at 16.7% 3m/3m, saar.
The strong momentum in industrial activity continued along with a steady and broad-
based recovery in exports. On the domestic front, the pace of fixed investment
growth eased modestly in November, which may help to ease some of the concerns
about the buildup of excess capacity in some industries, in our view. Meanwhile, data
about retail sales, which had shown an impressive gain in recent months, were rather
mixed in November, underscoring the leadership’s decision to renew support for
Chinese consumers. Overall, the latest data flow and policy tone are consistent with
our GDP outlook of a 9.5% rise next year.
Figure 1: China—Real IP growth

%oya, 3mma %3m/3m, saar %3m/3m, saar
20 %oya, 3mma 50
40
15 30
20
10
10
5 0
-10
0 -20
2003 2004 2005 2006 2007 2008 2009
Source: CEIC, J.P. Morgan Economics.
Overall tone on macro policy still growth-friendly

China’s annual Central Economic Work Conference, which sets the overall tone of
the macro policy for the coming year, ended this week. The tone for 2010 was
largely in line with the Politburo statement released earlier, reiterating stability and
continuity, and focusing on supporting domestic demand, particularly private
consumption, going into next year. As expected, the description of “proactive fiscal
policy” and an “appropriately accommodative monetary policy” stance were
unchanged in the statement after the conference. Policymakers emphasized that the
foundation of the current economic recovery is yet to fully firm up, and uncertainty
over the global recovery going into next year lingers. On the domestic front, the labor
market and employment conditions were highlighted as areas of policy concern.
Meanwhile, along with the steady recovery in GDP growth, the focus on macro
policy going into 2010 will gradually turn to structural adjustment and rebalancing of
the economy, the quality and sustainability of the recovery, and managing inflation
expectations, in our view. In particular, in the fiscal policy, we expect public
3
(852) 2800-8511 19 December 2009
expenditure to focus on education, social security, economic housing, agriculture,

and environmental protection, among other areas.
With regard to the fixed investment cycle, it is well recognized that public sector
investment spending, especially infrastructure investment, has been the major force
behind the economy’s impressive recovery this year. The conference highlighted that
going into 2010 the macro policy should ensure an appropriate pace of growth in
fixed investment, with the focus on completing ongoing investment projects, while
closely monitoring the number of new ones.
On monetary policy, while the conference emphasized the continuity and stability of
the policy stance, it also highlighted the importance of flexibility, suggesting that the
pace of credit expansion should be managed and adjusted according to changes in the
global and domestic economies. Also, credit support should be channeled to sectors
with greater impact on employment, new strategic industries, and small- and
medium-sized enterprises.ok.
We believe such adjustments in monetary conditions are already taking place. As we

highlighted recently, the sequential trend growth rates in the M2 money supply and
total bank loans have moderated notably. Meanwhile, the part of credit creation,
which is more relevant for real economic activity, has remained largely supportive of
growth. We believe such a fine-tuning of overall monetary and credit conditions is
likely to continue well into next year.
Policy focus on domestic consumption

The conference highlighted domestic demand, especially private consumption, as an
important driver of economic growth next year. Particular focus was placed on
improving the distribution of national income and enhancing the consumption
capability of lower-income groups. The continuation of policies supportive of
consumption, especially those promoting purchase of autos and household electronic
appliances, was emphasized as well.
For the property sector, policymakers focused on the provision of housing and the
fulfillment of genuine household demand for home purchases. The conference also
highlighted the policy target of speeding up the urbanization process, with emphasis
on encouraging the rural migrant population to settle in urbanized areas, especially in
medium-sized and smaller cities.
For the export sector, the conference suggested that in fostering steady recovery in
exports, it is important to encourage further upgrading of the value-added content of
exports. Again, policy continuity and stability with regard to the export sector were
stressed, along with the need for developed economies to consolidate the market and
further explore exports market.
Overall, the general macro policy tone coming out of the Economic Work
Conference was largely consistent with our view on the growth and macro policy
outlook for 2010. Our forecast for 2009 full-year GDP growth stands at 8.6% with
the 2010 GDP growth forecast at 9.5%. We expect the PBoC to begin raising
benchmark policy rates moderately by mid-10 with a total of two 27bp hikes over the
second half of next year. On the currency front, we expect the continuation of the
gradual appreciation of the Rmb exchange rate to begin sometime in 2Q10 and
expect Rmb/US$ to reach 6.5 by end-10.
4
(852) 2800-8511 19 December 2009
Figure 2: China—GDP and household income

%oya Real urban household
Real rural household per per capita disposable
20 capita cash income income
15
10
5
Real GDP
0
2006 2007 2008 2009
Source: CEIC and J.P. Morgan Economics.
Broad-based export recovery

China’s November trade reports confirmed further steady recovery in trade activity.
September exports declined modestly at 1.2%oya (J.P. Morgan: +2.0%; consensus:
+1.4%), translating into a modest gain of 0.7% m/m, sa, but backed by the
impressive gain of 3.1% m/m and 6.3%m/m in October and September, respectively.
The sequential trend growth accelerated further, to rise at 46.9% 3m/3m, saar by
November. Besides, the General Administration of Customs commented that,
adjusting for the number of working days, exports declined marginally at 0.3%oya in
November. Meanwhile, imports rose notably at 26.7%oya in November, translating
into a gain of 2.4% m/m, sa, with the sequential trend rising at 38.1% 3m/3m, saar.
November trade surplus was at US$ 19.1 billion, which was the lowest trade surplus
registered since 2005. For the first 11 months of the year, trade surplus was at $179.6
billion, compared with $250.7 billion for the same period last year.
Overall, China’s November trade figures continued to show steady sequential

improvement in exports. This was consistent with the notable recovery in the global
manufacturing cycle and the steady upturn in aggregate final demand, in developed
as well as developing markets. In addition, on the domestic front, on-the-ground
evidence continues to suggest an upturn in export orders and rising demand for labor
at coastal manufacturing regions. Looking ahead, we expect further steady recovery
in China’s exports, in line with our global team’s expectation of sustained above-
trend growth for the global economy through 2010.
• In further details, exports in the important category of mechanical and

electrical products (59% of total exports) rose 3.3% m/m, sa in November,
with the sequential trend rising at 34.3% 3m/3m, saar. Meanwhile, high-tech
exports stayed flat in November, but that was due to the 7.9% m/m, sa jump
in October, with the sequential trend rising at an 38.9% 3m/3m, saar. In
addition, exports of low-end consumer goods stayed flat in November, with
the sequential trend rising at 19.4% 3m/3m, saar. Further details suggest that
exports of textile products (up 3.6% m/m, sa) increased in November, while
exports of clothing (down1.3% m/m, sa), footwear (down 1.5%) and toys
(down 6.0%) all weakened. Meanwhile, exports of steel products (in volume
terms) surged again, rising at 12.0% m/m, sa in November, following the
sharp rise in October (16.9% m/m, sa) and September(18.1% m/m, sa).
5
(852) 2800-8511 19 December 2009
• A breakdown by destinations shows a broad-based improvement in demand.

Shipment to neighboring Asian markets, including ASEAN (+100.4%
3m/3m, saar by November), Taiwan (+152.7% 3m3/m, saar) and Korea
(+65.1% 3m/3m, saar) rose strongly. For advanced markets, exports also
increased steadily in recent months, including those to the US (+21.9%
3m/3m, saar by November), EU (+37.1% 3m/3m, saar) and Japan (+36.7%
3m/3m, saar), in line with the improving growth picture in these economies.
• On the import side, it appears that the solid import gain in November was
largely driven by imports of mechanical and electrical products (up 7.8%
m/m, sa, and 40.9% 3m/3m, saar). With regard to commodities, in volume
terms, imports of crude oil fell 13.8% m/m, sa in November, to record 17.1
million tons (nsa). On the other hand, imports of refined oil products rose
4.1% m/m, sa in November, to reach 2.4 million tons (nsa). Meanwhile,
sequential trends in the import of a number of major industrial metals are
either showing a notable slow pace of gain, or outright decline, including
imports of iron ore (+11.4% 3m/3m, saar by November), copper (-60.1%
3m/3m, saar) and aluminum (-85.9% 3m/3m, saar), reversing from the
elevated pace of growth during 1H09.
Figure 3: China—Merchandise trade

%oya Exports Imports
50
25
-25
-50
2002 2003 2004 2005 2006 2007 2008 2009
Figure 4: China—Exports of steel products and low-end consumer goods

%3m/3m, saar both scales Steel
s
450 Low-end consumer products 60
goods 40
300
20
150 0
-20
0
-40
-150 -60
2006 2007 2008 2009
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(852) 2800-8511 19 December 2009
Figure 5: China—Exports of mechanical and electrical products

%3m/3m, saar
Mechanical & electrical
100 Hi-tech products
products
75
50
25
0
-25
-50
-75
2001 2002 2003 2004 2005 2006 2007 2008 2009
Figure 6: China—Exports by region

3m/3m, saar
EM Asia
100 EU
75
50
25
0
-25 US
-50 Japan
-75
2007 2008 2009
New loan creation is stabilizing

China’s M2 money supply growth edged up again in November, to rise at 29.7%
over-year-ago (J.P. Morgan and consensus: 29.0%), compared with the 29.4%oya
growth in October. Seasonally-adjusted, the monthly rise in M2 moderated to 1.4%
m/m, sa in November, with the sequential trend growth easing further from the
elevated pace in 1H09, to rise at 19.0% 3m/3m, saar by November. New loan
creation rose moderately in November, to Rmb294.8 billion, compared with Rmb253
billion in October. Notably, a breakdown of November new loan creation showed a
continuous decline in bill financing. In addition, new loans to the corporate sector
eased modestly in November, while new loans to the household sector rose in
November, supported by solid mortgage loan demand.
Bank loans rose at 33.8%oya in November, compared with the 34.2%oya growth in
October, with the sequential trend rising at 22.0% 3m/3m, saar. New loan creation
was at Rmb294.8 billion (-38.2%oya) in November, compared with Rmb253 billion
for October. For the first 11 months of the year, new loan creation was at Rmb9.21
trillion, compared with Rmb4.14 trillion during the same period in 2008.
A significant amount of bill discounting was matured in November, with total bill
discounting falling by Rmb108.5 billion. Besides, short-term corporate loans also
declined modestly by Rmb20.5 billion in November. On the other hand, new
7
(852) 2800-8511 19 December 2009
household loans increased in November, to reach Rmb237.7 billion (compared with

Rmb157.6 billion in October), largely supported by the strong mortgage loan demand.
Besides, medium-to-long term corporate loans eased modestly, to reach Rmb201.2
billion in November (compared with Rmb272.5 billion in October), which was
consistent with the modest easing in fixed asset investment growth in November.
Overall, new loan creation and net of short-term bill financing was at Rmb403 billion
in November.
The central bank’s weekly open market operations suggest that Rmb299 billion was
drained from the banking system in November, though the net amount of liquidity
withdrawal has slowed lately. Along with PBoC’s steady withdrawal of excess
liquidity through open market operations, the sequential trend growth rates in M2
money supply and total bank loans have been steadily moderating from the elevated
pace in 1H09, rising 22.0% 3m/3m saar through November (chart below). Looking
ahead, we believe that the central bank will continue to rely on open market
operations to manage overall liquidity.
Figure 7: China—Money supply and loan growth

%oya change
Loan
35
30 M2
M1
25
20
15
10
5
2002 2003 2004 2005 2006 2007 2008 2009
Figure 8: China—New loan creation

billion yuan, nsa
2000
2008
1500 2009
1000 2007
500
0
Jan Apr Jul Oct Jan
CPI inflation turns positive

For consumer prices, November CPI inflation turned into the positive territory, rising
at 0.6% oya, compared with the 0.5% decline in October. Seasonally-adjusted,
headline CPI rose 0.5% m/m in November, compared with the 0.2% m/m rise in
October. The rise in November headline CPI again reflects the rise in food prices, at
8
(852) 2800-8511 19 December 2009
3.2%oya, translating into a rise of 1.0% m/m, sa, with the particular impact of heavy
snow on food prices during the month. Excluding the food component, non-food CPI
continued to fall at 0.7% oya in November, compared with the 1.6% decline,
translating into a modest gain of 0.2% m/m, sa. Overall, we expect headline CPI to
rise at a moderate 3.0% in 2010.
In addition, PPI declined at 2.1% oya in November, compared with the 5.8% decline
in October, translating into a rise of 1.0% m/m, sa. Among major PPI categories, the
pace of %oya decline narrowed most notably for mining (-4.1%oya in November,
compared with -16.3%oya in October) and industrial raw materials (-1.7%oya in
November, compared with -8.3%oya in October). Meanwhile, the PPI for consumer
goods fell modestly at 0.2%oya in November, compared with the fall of 1.4%oya in
October.
Figure 9: China—Headline CPI, food prices and non-food CPI

%oy a, both scales
Headline CPI - food
10 CPI 25
prices
8 Non-food 20
6 CPI 15
4 10
2 5
0 0
-2 -5
2002 2003 2004 2005 2006 2007 2008 2009
PMI indicates solid momentum in industrial activity

China’s two separate manufacturing PMIs stayed at levels well above the
expansionary threshold of 50 in November, indicating that the sequential expansion
of industrial activity continued at a solid pace. The official NBS manufacturing PMI
series remained unchanged at 55.2 in November, the highest level since April 2008.
The Markit PMI rose 0.3% to 55.7 in November, registering the highest level since
the survey started in April 2004.
Putting the two separate PMI series together suggests that the sequential trend in
China’s manufacturing sector remains in a solid expansion phase, supported by
steady and broad-based demand growth on the domestic front as well as improving
external orders. In addition, the manufacturing order-to-inventory ratio remained at
the highest level since April 2008, suggesting that with further steady recovery in
final demand conditions, the solid growth in the manufacturing sector will continue.
• The output component rose again to 59.4 in November in the NBS series
(from 59.3 in October), the highest level since April 2008. The further
increase in the PMI output component was led by industries, including
textiles, garment and footwear, transportation equipment, electric machinery
and instruments, and tobacco processing, while the output component for
sectors including petroleum processing and coking, beverage manufacturing,
and paper making and printing eased in November.
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(852) 2800-8511 19 December 2009
• Among forward-looking components, new orders edged down marginally

by 0.1%, but still registered an elevated 58.4 level in November in the NBS
series. On the domestic side, public spending growth will likely moderate as
the government becomes more cautious about approving new investment
projects amid concerns about overcapacity and inefficient spending, in our
view. Meanwhile, the growth in private real estate investment continued
with a significant rebound, and consumer spending showed a further solid
expansion. On the external side, export order components picked up steadily
to reach 57.5 in the Markit series in November (from 55.6 in October), the
highest level since March 2005. Meanwhile, export orders component in the
NBS series eased somewhat to 53.6 in November (from 54.5 in October).
• The inventory component rose modestly to 45.4 in November in the NBS

series (from 43.4 in October). Together with the solid improvement in
orders, the orders-to-inventory ratio has improved steadily in recent months.
Though the ratio eased modestly to 1.29 in November (from 1.35 in
October), it remained at around the highest level since April 2008.
• With regard to labor market conditions, the employment component of the

NBS series declined to 51.1 in November (from 52.4 in October), the sixth
consecutive month that the index stayed above the threshold of 50. The
rebound in the export sector is crucial for the recovery in the labor market
and the outlook on household consumption. In particular, as export orders
recover steadily, manufacturing employers may increase hiring, especially
for coastal export-intensive regions. Hence, the employment component in
the Markit PMI series, which is generally seen as focusing more on private
sector corporates, stayed elevated at 54.3.
• The PMI input price components rose again in November, after easing in
September and October. For the NBS series, the input price component rose
to 63.4 (from 56.9 in October), the highest level since July 2008, with a
broad-based increase in input costs across most industries. Corporate input
costs increased along with the gain in global crude oil and coal prices, while
the heavy snow and natural gas shortage in the country in November put
further pressure on input costs.
Figure 10: China—Manufacturing PMIs

index, sa
60 NBS PMI
50
Markit PMI
40
30
2004 2005 2006 2007 2008 2009
10
(852) 2800-8511 19 December 2009
Figure 11: China—PMI export orders and merchandise exports

%oya NBS PMI export index, sa
orders Merchandise
50 exports 65
40
30 55
20
10 45
0
Markit PMI export
-10 35
orders
-20
-30 25
2004 2005 2006 2007 2008 2009
Figure 12: China—Manufacturing PMIs’ input prices

%oya index, sa
NBS PMI
15 input prices 100
PPI (NBS)
10 80
5 60
0 40
Markit PMI
-5 input prices 20
-10 0
2004 2005 2006 2007 2008 2009
Information
Rmb NEER and movement in major currencies
In the People’s Bank of China’s 3Q monetary policy report, the central bank, as usual,
stated that the exchange rate will be managed in a proactive, controlled and gradual
manner, and “based on international capital flows and movements in major
currencies”. The last phrase caught widespread market attention with regard to the
potential for a major near-term move in Rmb. However, in our view, the central
bank’s latest statement on Rmb should be read more as a forward-looking statement,
rather than suggesting that the Rmb will in the near-term play catch-up with major
developed and developing currencies’ rise against the US$ since early this year.
On a trade-weighted basis, through the ups and downs in the greenback over the past
year, the Rmb NEER, as well as the NEER for other currencies which have seen a
significant rally this year, such as A$ and Brazilian real, are all roughly back to the
levels prior to the beginning of the financial crisis (chart below). Hence, while we
expect a resumption of gradual appreciation in the Rmb exchange rate, in terms of
timing, our view has always been that this will likely begin sometime in 2Q10, when
the export sector resumes positive over-year-ago growth rates and as officials
become convinced that the global recovery is on a sure footing. Our Dec-10 estimate
for Rmb/US$ is 6.5.
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(852) 2800-8511 19 December 2009
Figure 13: Comparison of nominal effective exchange rates

index, Jan 2008=100
Global financial
120 crisis
CNY
110
BRL
100
90 AUD
Appreciation
80
70
2008 2009
Figure 14: China—Exports and real effective exchange rate

%oya, 3mma index, 2000=100, + = appreciation
60 Exports 90
REER
40 95
100
20
105
0
110
-20 115
-40 120
2003 2004 2005 2006 2007 2008 2009
Cyclical case for Rmb’s movement

On a cyclical basis, it is interesting to compare the current macro backdrop with the
situation in 2005, when the Rmb regime change took place. Back then, the Chinese
economy was in the midst of a significant export boom. Figures from the National
Bureau of Statistics suggest that, on an average, net exports contributed 2.4% to
headline GDP growth during 2005-07 (chart below). Nonetheless, for the first nine
months this year, net exports declined 3.6% from headline GDP growth. Not
surprisingly, for policymakers, the export sector is still seen as the weaker link in the
economy’s recovery at this juncture, in our view.
Going forward, our global team is looking for a moderate recovery in the US
consumer demand (J.P. Morgan expects the US consumer spending to rise 2.0%y/y
in 2010) and a sustained and synchronized expansion of the global economy through
2010. Hence, we expect net external trade to show a moderate positive contribution
to China’s headline growth next year, which would support the resumption of a
gradual appreciation of Rmb. Timing-wise, it will more likely begin sometime in
2Q10, when exports turn decisively positive (in %oya terms), and as officials become
convinced that the global recovery is on a sure footing, in our view.
12
(852) 2800-8511 19 December 2009
Figure 15: China—contribution to headline GDP growth

%-pt contribution to headline GDP oya growth Gross capital Net
Total consumption formation exports
8
expenditure
6
4
2
0
-2
-4
2003 2004 2005 2006 2007 2008 2009ytd
Figure 16: US retail sales and China’s exports to the US

%3m/3m, saar, both scales
15 75
China exports to
10 50
the US
5
25
0
US retail sales ex motor 0
-5
vehicles, parts and gas
-10 -25
-15 -50
2005 2006 2007 2008 2009
Current account adjustment

Structurally, as the US economy gradually adjusts its over-consumption (under-
saving) growth pattern, there have been early signs of the long-awaited global
rebalancing, with adjustments in the respective current account deficit/surplus for the
US and China (chart below). As exports declined due to weak external demand since
late last year, China’s import demand had held up better, especially with the
investment boom under fiscal stimulus leading to a notable adjustment in China’s
trade balances. For the first time in five years, China’s current account surplus
declined (by 30%yoy) in 1H09. With such notable changes already taking place in
external balances for both the US and China, we believe fundamentals would argue
for the resumption of some gradual appreciation of the Rmb/US$ exchange rate to
support further steady and smooth adjustments.
13
(852) 2800-8511 19 December 2009
Figure 17: China and US current account balances

% of GDP JPM forecasts
12
China
8
-4 US
-8
98 00 02 04 06 08 10
Capital inflows back in the limelight

With regard to the central bank’s reference to “international capital flows” in its
latest currency policy statement, we believe the indication is that once the gradual
Rmb appreciation trend resumes, capital inflows would likely become one of the
major macro policy concerns next year. There have recently been growing signs of
renewed domestic expectation about Rmb appreciation, with a notable rise in onshore
forex loans and slowing in forex deposit growth (chart below), as Chinese corporates
and households look to reduce their net forex asset exposure.
Hence, concerns about capital inflows would likely constrain the extent of the rise in
China’s policy rates (we look for two 27bp hikes in benchmark rates next year),
especially considering that the China-US interest rate differential is already at the
highest level since 2004 (chart below), and as the US Fed is expected to hold policy
rate close to zero through the course of next year.
Figure 18: China’s forex deposits and loans and Rmb deposits in Hong Kong
%oya, 3mma, both scales
Accelerating CNY Yuan deposits
60 in Hong Kong 200
appreciation
FX deposits 150
40
FX loans 100
20
50
0
0
-20 -50
2004 2005 2006 2007 2008 2009
Non-consensus call
Market concerns about policy tightening is overdone
Financial market investors have been concerned about policy tightening in Asia,
including China, as the economic activity continues with steady recovery, with
growing concerns about an asset bubble. In this regard, latest statement from China’s
top leadership is in tune with our view that authorities will be cautious regarding an
14
(852) 2800-8511 19 December 2009
“exit strategy,” even as the real economy continues to show a solid recovery,
especially as policymakers are not yet convinced that the global recovery is on a sure
footing. At a meeting with senior European officials recently, Premier Wen
commented that a premature “exit” from macro policy stimulus could risk derailing
the global economic recovery. Authorities’ latest decision to extend a series of
consumption-related stimulus measures, including those for auto and home electrical
appliances, into next year, while at the same time to re-impose the 5.5% tax on
transaction of residential properties which have been held for less than five years, in
order to curb property speculation, highlights the authorities’ latest approach to
continue supporting domestic consumption, while fine-tuning sectoral policies to
contain asset inflation.
We believe China’s fiscal spending plans have largely been laid out through 4Q10
and are unlikely to be reversed. On monetary policy, the PBoC is likely to move in
stages, relying on open market operations to withdraw excess liquidity, combined
with sector-specific actions such as a partial withdrawal of the stimulus provided to
real estate late last year to reduce the risk of an asset bubble and inflation. Overall,
going into 2010, if the new loan target comes in at Rmb7-8 trillion, and if the M2
growth target comes in at about 17% (compared with our forecast of a nominal GDP
growth of 12.2%), we believe monetary conditions should remain largely supportive
of the economy’s recovery. We expect the PBoC to begin raising policy rates
moderately by mid-10, with a total of two 27bp hikes over the second-half of next
year. On the currency front, we expect a resumption of the gradual appreciation of
the Rmb exchange rate beginning sometime in 2Q10, looking for the Rmb/US$ rate
to reach 6.5 by end-10.
15
(852) 2800-8511 19 December 2009
Market strategy
AC From beta to alpha: Searching for hidden value in China
Frank Li
(852) 2800-8511
equities
frank.m.li@jpmorgan.com (Extracted from the note, “China Strategy: From beta to alpha: Searching for hidden
Peng Chen value in China equities,” published on 18 December 2009. Please see the original
(852) 2800-8507 note for pricing dates.)
peng.p.chen@jpmorgan.com • The China equity market may offer good investment opportunities but also
Lan Deng present many uncertainties and risks in FY10: On one hand, we believe
(852) 2800-8520 Chinese equities could stage a rally between now and 1Q10, driven by: (1) the
lan.x.deng@jpmorgan.com government’s recent reiteration of its “proactive fiscal policy” and “relatively
loose monetary policy” for 2010, which should help alleviate the market’s
J.P. Morgan Securities (Asia Pacific) Limited
concerns about a possible earlier-than-expected monetary tightening; (2) the
upward earnings estimate revision momentum for MSCI China; (3) a marked
sequential improvement in liquidity from Dec-09 to 1Q10; and (4) the
expectation that Rmb will resume appreciation in FY10. On the other hand, we
could start to see an increase in market volatility for MSCI China, if and when
the government starts to tighten its monetary policy (possibly in 2Q10). We
could see de-rating pressure for sectors that are highly correlated with fixed-
investment growth as we approach mid-2010, when the equity market is likely to
start pricing in a potential sharp slowdown in fixed asset investment growth in
2011.
• Entering an alpha year in FY10: Our major investment strategy lies in
focusing on defensive growth stocks—stocks with good earnings visibility, low
penetration rate, strong secular growth, and those that should be least affected by
a potential tightening kicking in as of 2Q10 and a downshift in FAI growth in
2011. We highlight our two key investment themes for FY10: (1) accumulating
consumption-related stocks to benefit from China’s growth rebalance; and (2)
identifying undervalued China companies, which are likely to report record-high
earnings in FY09, but are still trading at a decent discount to their highs in FY07,
and are free from major multiple contraction pressure.
• Sector views: We stay positive on: (A) China banks, as we believe the recent
correction on fund-raising concerns creates a good opportunity to accumulate
bank shares; (B) the coal sector; and (C) defensive growth names—internet,
tissue and diapers, gas, selected consumer staples, and healthcare. We continue
to see short-term trading opportunities for media and airline stocks, and food
inflation plays. We are negative on: (A) property—on tightening concerns;
within the sector, we favor those with the most exposure to tier 2-3 cities; (B)
telecoms; (C) FAI-related plays, including downstream commodities,
commercial vehicles and construction; and (D) IPPs.
Table 1: China: Top five picks
Reuters Mkt cap Avg. dly TOEPS Y/Y growth (%) P/E (x) P/BV (x) ROE (%) Div. yld (%)
Rec ticker (US$MM) (US$MM) 2009E 2010E 2009E 2010E 2009E 2009E 2009E
China Citic Bank - H Share OW 0998.HK 42,410 39.9 13.6 52.4 14.7 9.6 2.1 15.2 1.7
China Construction Bank OW 0939.HK 198,050 236.7 14.2 30.1 12.8 9.8 2.6 21.3 3.5
China Gas Holdings Limited N 0384.HK 1,588 5.4 NM NA 25.6 NA 3.4 14.3 0.0
Sinopharm OW 1099.HK 8,032 NA 42.1 15.3 47.2 40.9 4.7 12.7 0.5
Sina Corp N SINA US 2,796 53.3 -24.2 29.5 45.7 35.3 3.5 8.7 0.0
Source: Bloomberg, J.P. Morgan estimates. Prices and valuations are as of December 16, 2009.
Figure 19: Relative index performance
16
(852) 2800-8511 19 December 2009
Source: Bloomberg.
Investment summary
After the one-directional bull market for most of 2009, the China equity market may
offer good investment opportunities as well as present many uncertainties and risks
in FY10. The rationale for our view is summarized below:
On one hand, we believe Chinese equities may stage a rally between now and 1Q10,
driven by:
1. The government’s recent reiteration of its “proactive fiscal policy” and

“relatively loose monetary policy” for 2010 in China’s Central Economic
Work Conference; this should help alleviate the market’s concerns about a
possible earlier-than-expected monetary tightening.
2. An upward earnings estimate revision momentum for the MSCI China

in FY10, in view of an acceleration in the economic recovery and
improving industrial profit growth outlook for FY10; we note the
consensus’ FY10 MSCI-China EPS forecast has been lifted by 20% since
June 2009.
3. A marked sequential improvement in liquidity from December 2009 to

1Q10, with the estimated monthly new loans rising from around Rmb250
billion for December 2009 to above Rmb800 billion for January 2010.
4. The expectation that Rmb will resume appreciation in FY10, given an

export recovery and the rising inflationary pressure.
On the other hand, we could start to see an increase in market volatility for the MSCI
China, if and when the government starts to tighten its monetary policy (possibly in
2Q10). Meanwhile, we could see de-rating pressures for sectors that are highly
correlated with fixed-investment growth as we approach the middle of 2010. By then,
the equity market should start pricing in the potential sharp slowdown in fixed asset
investment growth in 2011, as the two-year (FY09E and FY10E) economic stimulus
policies fade away.
Key investment themes and sector views

While FY09 has proven to be a “recovery trade” year, with high-beta and bombed-
out stocks generating the most return, we could enter an alpha year for FY10. Our
major investment strategy lies in focusing on defensive growth stocks—stocks with
good earnings visibility, low penetration rate, strong secular growth, and those that
17
(852) 2800-8511 19 December 2009
should be least affected by a potential tightening kicking in as of 2Q10 and a

potential downshift in FAI growth in 2011.
We highlight two key investment themes for FY10: (1) accumulating consumption-
related stocks to benefit from China’s growth rebalance: from an investment and
export-driven economy to a domestic consumption driven economy; and (2)
identifying undervalued China stocks, which are likely to report record-high
earnings in FY09, but are still trading at a decent discount to their highs in FY07 and
are free from major multiple contraction pressure.
With regard to the sector allocation, we maintain our overweight stance on:
• China banks, as we believe the recent correction on fund-raising concerns

creates a good opportunity to accumulate bank shares, because: (1) the
prospective fund-raising by China banks are meant not to repair their balance
sheets, but to fund their growth; (2) we believe many China banks may choose to
use rights issue rather than issuing additional new shares to raise money, which
would cause minimum dilution for the existing shareholders, sharply reducing
the amount of money to be raised from the secondary market investors. The
government-owned investment entities hold the lion’s share of the major China
banks, and are expected to come up with most of the fund-raising; and (3) their
1Q10 results are expected to surprise on the upside.
• Coal names, because (1) coal prices have started to rally, with Qinghuangdao
coal prices up 30% as of the end of August 2009; (2) the supply-side discipline
on the consolidation of small coal mines; and (3) the transportation bottleneck at
the Daqing railway line.
• Defensive growth names – companies that are positioned in sectors with low
penetration rate and strong secular growth, and companies with good earnings
quality--internet, tissue and diapers, gas, selected consumer staples, and
healthcare.
Meanwhile, we continue to see short-term trading opportunities for media and

airline stocks, as well as food inflation plays.
• Media as a late cycle recovery play and with stronger earnings growth in FY10
than FY09.
• Airlines stand to benefit from (1) the rising cargo and passenger traffic on
domestic and international routes on the back of the strong economic recovery
and (2) Rmb resuming appreciation as of 2Q10.
• Food inflation plays on continued rising food prices.
We have an underweight stance: A) Property on tightening concerns. Within the

property sector, we favor those companies with the most exposure to tier 2-3 cities,
which stand to benefit from the government’s prospective relaxation of the control
over the so-called “Hukou” system in medium and small cities, as per China’s
Central Economic Work Conference, and those with exposure to commercial
property space. B) Telecom due to the sector’s lackluster 2G subscriber growth in
China and that the 3G business has yet to take off in China. C) FAI-related plays,
18
(852) 2800-8511 19 December 2009
including downstream commodities (cement and aluminum), commercial vehicles

and construction, which could be negatively affected by the downshift in China’s
fixed asset investment growth in FY11, with the fading away of China’s economic
stimulus program, which largely focuses on FY09 and FY10; and (D) IPPs, which
are suffering from the rising market-based coal cost and the government-regulated
power tariff.
Figure 20: Price movements in basis points (as of December 14, 2009)
300
250
200
150
100
50
0
27-Oct- 27-Nov - 27-Dec- 27-Jan- 27-Feb- 27-Mar- 27-Apr- 27-May - 27-Jun- 27-Jul- 27-Aug- 27-Sep- 27-Oct- 27-Nov -
08 08 08 09 09 09 09 09 09 09 09 09 09 09
MSCI EM MSCI China
Source: Bloomberg.
Figure 21: MSCI China P/E

x
35
30
Current=16.7x
25 +1 std dev = 20.5x
20
long term av g PE=15.8x (since y ear 2000)
15
10
-1 std dev = 11.1x
5
0
Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09
Source: Bloomberg and J. P. Morgan.
Figure 22: MSCI China P/BV
19
(852) 2800-8511 19 December 2009
x
5
Current=2.5x
4.5
4
+2 std dev = 3.7x
3.5
+1 std dev = 2.9x
3
long term av g PB=2.2x (since y ear 2000)
2.5
2
1.5
-1 std dev = 1.5x
1
-2 std dev = 0.8x
0.5
0
Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09
Figure 23: 2009 YTD MSCI-China price performance by sector
UTILITIES -5%
Telecom -5%
INDUSTRIALS 45%
HEALTHCARE 48%
BANKS 68%
ENERGY 70%
INSURANCE 74%
MATERIALS 85%
DIV FIN 96%
REAL ESTATE 97%
CONS STAPLES 109%
CONS DISCR 146%
IT 204%
-50% 0% 50% 100% 150% 200% 250%
Source: Bloomberg.
20
(852) 2800-8511 19 December 2009
Favorable macro conditions from now until 1Q10E

We believe there is still 22%% upside for the MSCI China, with our end-FY10
MSCI China index target of 78. We believe the sweet spot will fall in 1Q10, boosted
by the positive factors detailed below:
(1) The government has reiterated its “proactive fiscal

policy” and “relatively loose monetary policy” for 2010 in
the Central Economic Work Conference
China’s Central Economic Work Conference, concluded on December 7, 2009, noted
that the central government will maintain its “proactive fiscal policy” and “relatively
loose monetary policy” to ensure stable and rapid economic growth in FY10.
Among others, the government is still concerned about (a) the sustainability of the
world economic recovery; (b) the domestic employment conditions. Meanwhile,
inflation does not appear to be the government’s top concern for the moment, even
though the report does mention about the management of inflationary expectations.
The overall monetary policy stance is in line with our base-line scenario that the
central government is unlikely to make major adjustments to the monetary policy in
the near team. In our view, the central bank will not begin raising benchmark policy
rates until mid-2010, when inflation pressure finally builds up (around 3-4%oya) and
export recovery is on a more solid footing (with the headline growth rate returning to
around 20%oya).
We believe this is positive for China’s stock market as it helps alleviate the market’s
concerns about possible earlier-than-expected tightening measures, thus creating a
favorable environment for the stock market from now to 1Q10.
Figure 24: China—Benchmark interest rates

% per annum
1-year working J.P. Morgan forecasts
9 capital lending rate
8
7
6
5
1-year time
4
deposit rate
3
2
1
2004 2005 2006 2007 2008 2009 2010
Source: CEIC, J.P. Morgan estimates.
21
(852) 2800-8511 19 December 2009
(2) The upward earnings estimate revision should continue

in FY10, in view of an acceleration in the economic
recovery and improving corporate profit growth outlook for
FY10
China’s strong economic recovery seen this year likely to continue into 2010
After a remarkable turnaround in 2009, we expect China’s strong economic growth
momentum to continue in 2010, with the major source of growth coming from a
broad-based improvement in private consumption, and further strengthening in
private housing investment, and a solid recovery in exports.
Now that we have more pillars for the underlying economic strength, we expect
China’s 2010 GDP growth to accelerate to 9.5%oya, after an estimated 8.5% growth
in 2009. Based on our forecasts, the three components—consumption, investment
and net trade—are expected to contribute 4.6ppt, 4.7ppt and 0.2ppt, respectively, to
the headline GDP growth in 2010. Notably, we expect the net trade’s contribution to
GDP to swing from -2.6ppt in 2009 to +0.2ppt in 2010.
Table 2: China’s GDP composition

2008 2009E 2010E
Real GDP, % change 9.0 8.6 9.5

Consumption¹ 4.2 4.4 4.6
Investment¹ 4.6 6.8 4.7
Net trade¹ 0.2 -2.6 0.2
Source: J.P. Morgan Economics. Note 1: Contribution to growth of GDP.
Figure 25: China—Real GDP and industrial production

%q/q, saar, both scales
Real IP JPM forecast
20 40
Real GDP
30
15
20
10
10
5
0
0 -10
2000 2002 2004 2006 2008 2010
Source: CEIC, J.P. Morgan.
A broad-based pickup in private consumption: we believe increasing confidence

in the economic recovery, improving labor markets, rising wage growth, and further
government supportive policy will continue to support household spending. The
rebound in the export sector is crucial to the recovery in labor markets and household
consumption.
22
(852) 2800-8511 19 December 2009
Figure 26: China—Retail sales value and urban income

%oy a %oy a, 6mma
Retail sales value
25
18
20
15
15
12
10 Urban income 9
5 6
2002 2003 2004 2005 2006 2007 2008 2009
A solid expansion in private housing investment as well as other private sector

investment: Following strong sales and low investment growth earlier this year,
inventory in the property market remains low, paving the way for rising private
housing investment going ahead. We also look for a gradual stabilization in export-
related investment, following the sharp declines earlier this year.
Figure 27: China—Fixed asset investment

%oy a
Real (adjusted
60 Nominal
by PPI)
50
40
30
20
10
0
-10
2001 2002 2003 2004 2005 2006 2007 2008 2009
Figure 28: FAI growth breakdown by industry

%, Y/Y
3Q08 4Q08 1Q09 3Q09 Oct-Nov 09 Series6
70%
60%
50%
40%
30%
20%
10%
0%
Total Mining Non-ferrous Electronics Infrastructure Real estate
metal
23
(852) 2800-8511 19 December 2009
Figure 29: Real estate investment growth and floor space started
%oy a Real estate FAI
80
60
40
20
0
Floor space started
-20
-40
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
A decent recovery in exports: We continue to expect solid gains in exports, in line

with the recovery in G-3 domestic demand and the marked upturn in the global
manufacturing cycle. As our global team is looking for sustained above-trend growth
into 2010, this should further support exports, with headline export growth rate
returning to around 20%oya around mid next year.
Figure 30: China—Merchandise trade: Sequential trend

%3m/3m, saar Exports Imports
80
60
40
20
0
-20
-40
-60
-80
2002 2003 2004 2005 2006 2007 2008 2009
Risks to the economic outlook for FY10 are on the upside

In view of the more solid-than-expected domestic demand and earlier-than-expected
export recovery as reflected in recent macro releases, the Street has been actively
revising up its 2010 economic growth forecasts for China since mid-2009.
Consensus is now looking for 9.6%Y/Y FY10 GDP growth for China, compared to
the forecast of 8.4% made in June 2009. (Source: Consensus Economics Inc.)
Similarly, we have also raised our FY10 GDP growth forecast to 9.5% Y/Y, from our
8.5% forecast published in June, to capture the expected larger contributions from
private consumption, private housing investment and export.
Table 3: J.P. Morgan and consensus GDP growth forecasts

Forecasts made in June 09 Current forecasts
J.P. Morgan forecast 8.5% 9.5%
Consensus estimates 8.4% 9.6%
Source: Consensus Economics Inc, J.P. Morgan estimates.
24
(852) 2800-8511 19 December 2009
Even so, the latest developments in stimulus-related investment as well as export

activities suggest that there is still room for further upward revisions to the consensus
estimates and our economic growth outlook for FY10:
• As the government is undershooting its fiscal allocation in 2009, the money

left for fiscal spending in 2010 could exceed the previously planned amount.
Of the Rmb4 trillion stimulus package, Rmb1.18 trillion comes from the
central government. It is further distributed into a few phases: Rmb120
billion for 4Q08; Rmb480 billion for 2009, and Rmb580 billion for 2010.
Following the progress so far suggests that the total spending from the
central government may only amount to Rmb360 billion in 2009. Hence,
there could be as much as Rmb700 billion left to be spent in 2010, which
could result in higher public investments for 2010 than we currently expect.
• On the export front, we are currently looking for a gradual recovery in 2010.
However, a stronger-than-expected global consumer demand recovery, as
implied by the elevated orders/inventory ratio of our global PMI and the
notable moderation in job contraction in the US November non-farm
payroll, could lay the foundation for upside surprises for China’s exports in
coming quarters. Indeed, the return of export orders, as suggested by the
steady pick-up in the export orders components of China’s PMI in recent
months, pointed to a sooner-than-expected coming-back in external demand.
Figure 31: China—PMI export orders and merchandise exports

%oy a NBS PMI index , sa
Merchandise
export orders
50 exports 65
40
30 55
20
10 45
0
-10 Markit PMI 35
-20 export orders
-30 25
2004 2005 2006 2007 2008 2009
Industrial profits on the rise

As the company earnings cycle in general follows the economic cycle, the sustained
economic recovery since early this year leads to a notable turnaround in corporate
China’s earnings conditions. The recent data on China’s industrial profits indeed
supports this argument:
Industrial profits in 22 key provinces and municipalities across China declined 3.4%
Y/Y in the first ten months of this year, compared to -9.1% in the first nine months of
this year. In October alone, industrial profits amounted to Rmb232.2 billion for the
22 key provinces and municipalities, rising 65.2% Y/Y, marking October the third
consecutive month with Y/Y growth rate staying above 60%. It is worth noting that
the historical monthly average for industrial profits for the whole country is Rmb300
billion, translating into a monthly average of Rmb235 billion for 22 provinces.
Hence, industrial profits have largely returned to the trend level as of October 2009.
25
(852) 2800-8511 19 December 2009
The improvement in industrial profit growth was broad-based across major industrial
sectors. Of the total 39 sectors, 34 have seen either a rising Y/Y growth or a
narrowing Y/Y decline in their profits for January-October 2009, compared to only
14 sectors in the 2Q09. Among all, the best performers include chemical fiber, rubber
and transportation equipment, which all registered higher Y/Y growth rate for 10M09
than 9M09. On the other hand, steel, non-ferrous metals and electric and telecom
products still recorded Y/Y decline in 10M09, although the rate of decline moderated
in 10M09 versus 9M09.
Figure 32: Industrial profits in 22 provinces and municipalities across China on the rise
6.0% 0.0%
4.0%
-10.0%
2.0%
-20.0%
0.0%
-2.0% -30.0%
-4.0% -40.0%
Jan/09 Feb/09 Mar/09 Apr/09 May /09 Jun/09 Jul/09 Aug/09 Sep/09 Oct/09
Industrial Enterprises' rev enue grow th (LHS) Industrial Enterprises' profit grow th (RHS)
Source: Wind, J.P. Morgan estimates.
Figure 33: Industrial profit growth by industry in 22 provinces and municipalities across China
200.00%
150.00%
100.00%
50.00%
0.00%
-50.00%
-100.00%
Steel Nonferrous Metals Electronic Chemical Fiber Rubber Transportation
Equipment
Jan-Sep Jan-Oct
Source: Wind, J.P. Morgan estimates.
Upward earnings estimate revision could continue in FY10

In light of the improved economic and industrial profit growth outlook as highlighted
above, we have observed a consistent upward estimate revision trend for the MSCI-
China’s EPS forecast since mid-2009, with consensus’ FY10 EPS turning notably
higher in recent months. Consensus has raised the MSCI China FY10 EPS forecast
by 20% since June 09.
Even so, we believe there is still room for further upward earnings estimate revisions,
as consensus’ FY10 EPS estimate is still well below the level seen prior to the fallout
from the Lehman Brothers bankruptcy.
26
(852) 2800-8511 19 December 2009
Figure 34: Continued upward revisions in consensus earning estimates (EPS in Rmb)
7
6.5
Lehman Brothers went bankrupt in Sep08
6
5.5
5 2010
4.5
3.5
2008 2009
3
Dec/07 Feb/08 Apr/08 Jun/08 Aug/08 Oct/08 Dec/08 Feb/09 Apr/09 Jun/09 Aug/09 Oct/09 Dec/09
(3) A marked sequential improvement in liquidity from

December 2009 to 1Q10
Early each year, commercial banks in China always have the incentive to front-load
loans under approved quarterly loan quota to maximize their annual interest income.
Historically, 1Q loans have tended to account for around 30-45% of the full year’s
new loans. Indeed, new Rmb loans lent out in the first quarter by all Chinese banks
accounted for 39.1%, 27.1% and 45.8% of the total new loans created in 2007, 2008
and 2009 (assuming that total new loans would reach about Rmb10 trillion this year),
respectively.
Unless there is any sudden structural change in the lending business in China, this
front-loading pattern will be repeated in 2010, in our view. We forecast average
monthly new lending in the system for 1Q10 to be above Rmb800 billion (we expect
new loan creation in 1Q10 to account for roughly 35% of the estimated total new
lending in FY10, based on the seasonal pattern), compared to a monthly average
lending of Rmb420 billion in 3Q09 and an estimated Rmb250 billion for December
2009.
Table 4: Chinese commercial banks have incentives to front-load new lending early each year
Monthly new Rmb loans (in billions)
2007 2008 2009
Jan 567.6 803.6 1620.0
Feb 413.8 243.4 1070.0
Mar 441.7 283.4 1890.0
Apr 422.0 463.9 591.8
May 247.3 318.5 664.5
Jun 451.5 332.4 1530.4
Jul 231.4 381.8 335.9
Aug 302.9 271.5 410.4
Sep 283.5 374.5 516.7
Oct 136.1 181.9 253.0
Nov 87.4 476.9 294.8
Dec 48.5 771.8
27
(852) 2800-8511 19 December 2009
Table 5: New loan creation and total loan growth forecasts (Rmb loans only)
2008A 2009E 2010E
Loan outstanding at the end of the year (Rmb in trillions) 30.3 40.3 47.3
Annual new loan creation (Rmb in trillions) 4.9 10.0 7.0
Total loan growth (% Y/Y) 18.7 33.0 17.4
Naturally, the expected rise in newly created bank loan in early 2010 should warrant
a more favorable liquidity condition than in 4Q09. This, in turn, should help boost
China’s equity market in 1Q10. There seems to be some correlation between China’s
stock market performance and the change in monthly new loan creation, as shown in
figures below.
Figure 35: MSCI China’s performance and the change in monthly new loan creation
2,300 13% 15%
1,890 13%
2,000
10%
1,700 9% 1,530
1,400 4% 5%
-1% 0%
1,100 0%
-1%
800 592 665 -2%
517
-5% 410 -5%
500 356 253 295
200 -10%
Mar/09 Apr/09 May /09 Jun/09 Jul/09 Aug/09 Sep/09 Oct/09 Nov /09
New loan (Rmb bn) MSCI China index 's 1m performance follow ing loan data releases
Source: CEIC, Bloomberg.
Figure 36: A-share performance and the change in monthly new loan creation
2,300 15%
13%
1,890
2,000 6% 10%
9%
1,700 7%
6% 1,530 5%
1,400 2%
-3% 0% 0%
1,100
665 -10% -5%
800 592 517
410 -10%
500 356 253 294.8
200 -15%
Mar/09 Apr/09 May /09 Jun/09 Jul/09 Aug/09 Sep/09 Oct/09 Nov /09
New loan (Rmb bn) SHCOMP index 's 1m performance follow ing loan data releases
Source: CEIC, Bloomberg.
28
(852) 2800-8511 19 December 2009
(4) Rmb will likely resume appreciation in FY10, given an

export recovery and the rising inflationary pressure
Figure 37: J.P. Morgan and consensus Rmb forecasts
8.4
8.0
7.6
Forward
J.P. Morgan forecast: Consensus
7.2
end Dec 09: 6.75
6.8 end Mar 10: 6.70
end Jun 10: 6.65 J.P. Morgan
6.4
6.0
Sep 04 Dec 05 Feb 07 Apr 08 Jul 09 Sep 10
Source: Bloomberg, J.P. Morgan estimates.
While we expect the Rmb to be stable for the rest of the year to reflect Chinese
authorities’ attempt to support the export-related jobs, we believe the government
will resume Rmb appreciation in FY10 (J.P. Morgan forecasts Rmb/US will reach
6.5 by end-10), as:
(1) The gradual recovery of exports should reduce the government’s concern about
Rmb appreciation on export-related jobs. Notably, the sequential trend growth for
China’s exports has come out of the negative territory entering 2H09 and hovered
above 40% 3m/3m, saar in November 2009.
%3m/3m, saar Exports

80
60
40
20
0
-20
-40
-60
-80
2002 2003 2004 2005 2006 2007 2008 2009
(2) Inflationary pressure is building up, making Rmb appreciation a powerful tool to
counter inflation for the medium term. The rising food inflation since mid-09, and
the recent hike in gasoline and diesel, electricity, and water prices, as well as the
widely anticipated price liberalization for gas and power, all suggest that rising
inflationary pressure is emerging.
29
(852) 2800-8511 19 December 2009
Figure 39: Consumer price inflation
Consumer price inflation

JPM forecast
%oy a
9
7
5
3
1
-1
-3
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Figure 40: Rmb NEER, REER and CPI inflation

CNY NEER, REER and CPI inflation headline inflation will emerge mid next
index , 2000=100, +=appreciation year; RMB appreciation a crucial tool %oy a
to temper this pressure
120 10
Headline CPI
115 REER 8
NEER inflation
110 6
105 4
100 2
95 0
90 -2
2003 2004 2005 2006 2007 2008
Figure 41: CPI—Food prices—Sequential trend growth
%3m/3m, saar
40
30
20
10
0
-10
2003 2004 2005 2006 2007 2008 2009
Rmb appreciation is positive for Chinese equities

Overall, in our view, Rmb appreciation is positive for Chinese equities as it enhances
the attractiveness of Rmb assets, especially for foreign investors, who hold foreign
30
(852) 2800-8511 19 December 2009
currencies. Meanwhile, the expectation of faster Rmb appreciation could draw more
liquidity inflows into China, which could provide an additional impetus to asset
prices in China.
Potential winners and losers from the resumption of Rmb

appreciation in 2010
(A) Sector-wise, beneficiaries include: (1) Steel, paper and refinery names, which
import their raw materials abroad using US$ but sell their products domestically in
Rmb; (2) airlines and IPPs, which have massive foreign debt and future capex
denominated in US$; and (3) internet companies, which record their revenue in Rmb
but purchase foreign equipments in US$.
Steel
The resumption of Rmb appreciation would have a positive impact on the China steel
sector in general.
The Rmb appreciation will reduce purchasing costs of imported materials, especially
iron ore, which account for around 30% of total steel production cost. China
imported 566 million tons of iron ore from January to November FY09, with a total
value of US$44,785 million. A 1% appreciation in Rmb will thus have a large impact
on the cost of steel products.
The negative impact on steel exports is largely offset by the cost-saving on imported
materials, as China’s steel net exports plunged 88% Y/Y to only 5.11 million tons
from January to November 2009, accounting for less than 1% of China’s total crude
steel production. We don’t expect steel exports to recover until 2011. As a result, we
believe the Rmb appreciation’s impacts on steel exports should be limited. In our
calculation, every 1% Rmb appreciation will boost Angang’s and Maanshan’s FY10
earnings estimates by 4.1% and 12.2%, respectively.
Table 6: Earnings sensitivity on steel names

2010E EPS impact - 1% Rmb appreciation
Company name Ticker (BBG) Total (Rmb) Incl: recurring Non-recurring
Angang Steel 347 HK 4.1% 4.1% n/a.
Maanshan Iron and Steel 323 HK 12.2% 12.2% n/a.
Source: J.P. Morgan estimates.
Paper
The paper industry would be a big winner from currency appreciation because nearly
all of the sales are denominated in Renminbi and the majority of its costs (importing
pulp and recovered paper) and capital expenditures is in US dollars.
Within this sub-sector, we believe Nine Dragons Paper has a further advantage in
that it has a significant amount of US$-denominated debts as well as an aggressive
expansion plan which requires purchasing imported equipment denominated in
foreign currencies.
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(852) 2800-8511 19 December 2009
Airlines
A stronger Rmb will be positive for Chinese airlines:
Airlines’ U.S. dollar-denominated costs—mainly international fuel, aircraft lease

rental expenses, some maintenance and airport-related charges—exceed their US$
revenue. In addition, they will also book foreign exchange translation gains due to
their large US$ debt as well as their future aircraft capex, which will predominately
be in US$.
Table 7: Rmb appreciation impact on airline sector

2010E EPS impact - 1% Rmb appreciation
Company Excluding FX Gains/Losses Including FX Gains/Losses
Air China 3% 11%
China Southern 4% 142%
IPPs
The potential impact of Rmb appreciation will be from two fronts: (1) one-off gain
on the depreciation of foreign currency debts; and (2) cheaper coal costs from
overseas markets (e.g. Newcastle).
(1) Our calculations suggest that 1% Rmb appreciation will lead to a potential 0.5-
5.1% one-off gain on 2010E earnings for Huaneng/Datang/CRP/Huadian. (2) Given
that imported coal only accounts for a very small portion of total coal consumed
(<5%), we believe the earnings impact will be minimal.
Table 8: Rmb appreciation impact on Chinese IPPs

EPS impact - 1% Rmb appreciation
Company name Ticker (bbg) Total (Rmb) Incl: recurring Non-recurring
China IPPs
Huaneng 5.1% 0.0% 5.1%
Datang 0.8% 0.0% 0.8%
CR Power 1.3% 0.0% 1.3%
Huadian 0.5% 0.0% 0.5%
Internet
We expect U.S.-listed Chinese internet shares to benefit from the potential Rmb
appreciation versus the US dollar.
We believe the sector will see higher US$-based earnings, mainly through direct
translation gains, as well as slight margin improvements. Hence, should the average
Rmb-US$ exchange rate rise by 5% in 2010, as we currently expect, we could see
5% earnings accretion in the sector.
Margins improvements mainly come from lower capex in Rmb terms (computer-
related capex is typically linked to US$), and lower games licensing upfront payment
(for games licensed overseas, upfront payment is typically signed in US$).
Many of the Chinese internet companies have positive cash sitting in their bank
accounts generated from operations and majority of the cash is in Rmb. Hence, some
companies could see translation gains.
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(852) 2800-8511 19 December 2009
In the sector, we like Baidu, Sohu and NetEase.
(B) Sectors that will be negatively affected by Rmb appreciation are mainly
export-related sectors, such as shipping and container manufacturers, as Rmb
appreciation could hurt China’s export volumes, hence the top-line, which will not be
completely offset by higher import volumes given the trade imbalance.
Shipping
A stronger Rmb will be negative for shipping companies.
The negative impact on shipping companies’ predominantly US$-denominated

revenue is largely offset by their largely US$-denominated costs (mainly bunker fuel,
charter expenses), leaving the net EPS impact fairly negligible.
That said, a bigger downside risk is that Rmb appreciation/revaluation could hurt
Chinese export volumes which will not be completely offset by higher import
volumes given the trade imbalance. Every 1% reduction in container volume could
increase CSCL’s and China Cosco’s FY10E losses by 5% and 4%, respectively, on a
full-year basis.
Infrastructure contractors and power equipment producers

For Chinese infrastructure contractors and power equipment producers, the potential
impact on Rmb appreciation could come from: (1) one-off gains/losses on the
depreciation of foreign-currency debts/bank deposits; and (2) overseas business (FX-
denominated construction revenue but Rmb-denominated costs).
(1) Our calculations suggest that 1% Rmb appreciation will lead to a potential 1.1%
FX gain to a 2.2% one-off FX loss on 2010E earnings. (2) Our calculations suggest
that 1% Rmb appreciation will lead to a potential 0.2-1.0% recurring FX loss. Net-
net, a 1% Rmb appreciation will result in a potential 0.4% gain to 3.2% loss on their
2010E EPS.
Table 9: Rmb appreciation impact on China infrastructure contractors and power equipment
producers
EPS impact - 1% Rmb appreciation
Company name Ticker (bbg) Total (Rmb) Incl: recurring Non-recurring
China Infrastructure contractors
CRCC -3.2% -1.0% -2.2%
CRGL -0.4% -0.6% 0.2%
CCCC 0.1% -1.0% 1.1%
China Power Equipment Producers
Shanghai Electric -0.9% -0.9% 0.1%
DF Electric -0.5% -0.5% 0.0%
Harbin Power 0.4% -0.6% 1.0%
China High Speed -0.1% -0.2% 0.1%
(C) For other sectors, such as banks, consumer staple/discretionary, telecom and
autos, whose earnings, assets and liabilities are largely denominated in Rmb
terms, the impact of Rmb appreciation should be rather limited if not neutral, in our
view.
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(852) 2800-8511 19 December 2009
Banks
Banks are not a major beneficiary of Rmb appreciation, even though indirectly banks
indeed benefit from Rmb appreciation, especially from overseas investors who hold
foreign currencies and are buying Rmb assets. For domestic investors who already
hold Rmb on hands, however, an appreciation means very modestly negative (almost
immaterial) impact on banks.
Table 10: Rmb appreciation impact on banking sector

Others (overseas earnings/FX
2010E EPS impact - 1% Rmb appreciation position)
Company Ticker Total Incl: Net FX
name (BBG) (Rmb) recurring Non-recurring position Overseas earnings
BOC 3988 HK -0.4% -0.4% US$7B US$2.9B
ICBC 1398 HK -0.1% -0.1% US$2B US$1.0B
CCB 939 HK -0.1% -0.1% US$1.6B US$630MM
BoComm 3328 HK -0.2% -0.2% US$1.5B US$240MM
• For most banks in the sector, earnings, assets and liabilities are
predominantly in renminbi, so does equity. Hence, overall this is good for
foreign investors who currently hold foreign currencies. Indirectly, more
liquidity inflows into China would be positive for asset prices, which are
good for banks overall, at least in the near term, although the risk of
bubbling asset prices is worth monitoring or guarding against.
• In Rmb terms, however, most H-share banks will experience very modest
and immaterial impact from translation loss on their non-structural net FX
opening position (i.e., the FX-denominated assets minus FX-denominated
liabilities). Some banks may also have some foreign-currency/overseas
earnings from their overseas operations, which are also subject to translation
loss.
• However, since 2007 most banks, including BOC, have controlled their net
FX position to a relatively low level; so that translation losses have been
largely immaterial since 2007. As given in the table above, due to legacy
issue, only BOC still has a large net FX position. However, even in BOC’s
case, every 5% Rmb appreciation affects earnings by only 2% at the
maximum in Rmb terms.
• It is also important to realize that the FX position is changing on an ongoing

basis, and thus our analysis can only be done on a relatively static basis. The
actual impact could be even less than what is shown here.
Relatively speaking, BOC will see slightly more negative impact. But even in this
case, the impact should be very modest and could be more than offset by potential
upside surprise in overseas impairment write-back.
Autos
The impact on autos—Neutral.
On one hand, producers will benefit from the US$-denominated cost, even though
the impact will be very limited due to the high localization rate for most listed
34
(852) 2800-8511 19 December 2009
vehicles except for Brilliance China, whose BMW JV only has a 40% localization
rate.
Potential winner: DongFeng Motor – DongFeng’s exports account for less than 1%
of its total sales income, which, we expect, to have a very limited impact on its
bottom line. However, DongFeng will benefit from the Rmb appreciation as about
20% of its costs are denominated in US$.
Potential losers: Great Wall Motor, Sinotruk, Weichai and Qingling – as exports
account for 7% of Great Wall Motor’s sales, 8% of Sinotruk’s sales, 8% of Weichai’s
sales and 3% of Qingling’s sales. None of these companies have US$-denominated
costs to hedge the negative impact of Rmb appreciation on their sales income.
On the other hand, medium and high-end auto producers will be subject to increased
competition from imports. With the Rmb appreciating, imported vehicles’ purchasing
cost will be lower, thus increasing the pricing pressure for medium- and high-end
vehicles. Hence, Denway, which gets a large part of its earnings from its upper-
medium Accord models, and Brilliance China, which could record around 60% of its
FY10 earnings from BMW cars, will be negatively affected. In comparison, around
55% of DFM’s cars sold are small cars, which will be less affected, in our view.
Telecoms
As all three operators have all revenues, costs and capex denominated in Rmb terms,
there would be very little effect on these items if Rmb appreciates.
China Unicom has 6% of its total debt denominated in US$ terms with an Rmb value
of Rmb511 million. If Rmb rises to 6.5 versus US$ by the end of 2010, interest-
saving would be roughly Rmb1.5 million/year, which is immaterial compared to its
operating profits. China Mobile’s and China Telecom’s debt, borrowed from state-
owned banks, is therefore all in Rmb terms.
In summary, we see CU as the greatest beneficiary among Chinese telcos of Rmb

appreciation because of its US$ debt, but even so, the impact would be very minor.
Table 11: The impact of Rmb appreciation on debt, revenue, costs and capex for China telcos
Debt
CM All of CM’s debt is denominated in Rmb, so no impact
CT All of CT’s debt is denominated in Rmb, so no impact
CU has 6% of total debt denominated in US$ with current value of Rmb511MM. A 6% appreciation of the currency will see this marked-to-market
CU debt value falling from Rmb511 million to Rmb480 million (around Rmb30MM)
It may also result in small interest savings of roughly Rmb1.5 million a year which would be immaterial
Revenues, costs and capex
CM Almost all of CM’s revenues, costs and capex are denominated in Rmb. Some international interconnect settlement costs in US$ but this is immaterial
CT Almost all of CT’s revenues, costs and capex are denominated in Rmb. Some international interconnect settlement costs in US$ but this is immaterial
CU Almost all of CU’s revenues, costs and capex are denominated in Rmb. Some international interconnect settlement costs in US$, but this is immaterial
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(852) 2800-8511 19 December 2009
China’s Central Economic Work Conference and policy

outlook for 2010
China’s most important annual official economic conference—the Central Economic
Work Conference—was held from December 5 to December 7, in which the central
government set the overall tone of its macro policy for 2010.
The key messages conveyed from the conference include: (1) maintaining the
“proactive fiscal policy” and “relatively loose monetary policy” to ensure stable and
rapid economic growth in FY10; (2) switching its growth mode to achieve quality
and sustainable growth, balanced regional development, and energy conservation; (3)
focusing on boosting domestic consumption, by promoting urbanization and
improving national income distribution
In our view, we believe the key policy tone is largely conducive to China’s stock
market, with consumer sector and banks being the major potential beneficiaries.
However, the growth mode adjustment could be negative for FAI related plays.
(1) The government to maintain the “proactive fiscal policy” and “relatively
loose monetary policy”
As discussed earlier, the relatively accommodative monetary conditions should be
intact in early next year, creating a favorable environment for the stock market from
now to 1Q10. (For more details, please refer to the section, Favorable macro
conditions from now to 1Q10, on page 7).
That said, we could see volatility and de-rating pressure kicking in 2H next year for
sectors such as commodities (aluminum, steel and cement), infrastructure and
machinery, commercial vehicles and construction, which are highly correlated with
fixed-asset investment growth and could be negatively affected by the onset of the
monetary tightening kicking in as of mid-2010.
(2) The government to change its growth mode to achieve quality and
sustainable growth, with the focus being placed on boosting domestic
consumption
This is consistent with the government’s long-held policy orientation that China
should change its economic growth mode from an investment and export-driven
economy to a domestic consumption-driven economy. Looking ahead, we expect
more stimulative measures from the government to boost private consumption.
Hence, we believe this official commitment is very positive to consumption-related
stocks. (For more detailed discussion, please see the section, OW domestic private
consumption-related stocks, on page 26).
(3) The government to promote urbanization process

In order to boost domestic consumption, the central government also highlighted the
policy target to speed up the urbanization process, with the emphasis on encouraging
rural migrant population to settle in urbanized areas, especially in medium and
smaller cities. Notably, the conference noted that China could relax the control over
the so-called “Hukou” system, i.e., the residential card system in medium and small
cities and towns, to loosen the household registry policies in medium and smaller
cities.
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(852) 2800-8511 19 December 2009
In our view, the policy initiative should be very positive to boost domestic
consumption as more farmers come to the urbanized areas to earn more money and
spend more money. We note that this is the first time that the central government
officially proposes the relaxation on the “Hukou” system in medium and small cities
and towns on a national level.
That said, we notice that the government has realized the problems of the congestion,
and the high property prices in big cities. Hence, it does not want to lift the “Hukou”
system in big cities to worsen such problems.
In fact, the conference suggested that China should use public spending to build more
economic housing for low income households. Indeed, Premier Wen recently noted
that China’s housing policy should now be devoted to building economic housing, to
inhibiting the speculative investments in the property market, and to supporting
residents’ real demand for first home purchase and housing upgrades.
However, the supply of economic housing so far this year has come well below the
original plan. As a result, the economic housing project has failed to play an active
role in cooling down the red hot property market in China. Hence, the government
policy for the property market in 2010 should focus on: (1) inhibiting the speculative
demand; (2) accelerating the supply of economic housing in the market; and (3)
supporting the real residential housing demand.
(4) The government to encourage energy conservation and emission cuts

The Central Economic Work Conference set the tone of policy endorsement for
encouraging energy conservation and emission cuts. Besides, the latest official
announcement that China would cut its carbon dioxide emissions per unit of GDP in
2020 by 40-45% from the 2005 level , plus the recently released subsidy to buyers of
new energy cars, all show the government’s commitments to this policy direction.
Hence, we believe relevant companies in alternative energy and emission cut-related

industries should find near-term catalysts on the back of these favorable policy
announcements. For the longer term, an inevitable shift of China to a more
environmental-friendly and energy efficient development model bodes well for the
secular growth for these sectors.
(5) The government may be backing away from the policy of leveraging on the
fixed asset investment to boost China's economic growth.
While the government-led infrastructure investment has been the major force in
bringing about a “V-shaped” economic recovery this year, the work conference noted
that China should aim at an appropriate growth rate for fixed asset investment, given
the existing capacity overhang in many industries.
Against this backdrop, the government will carefully review any new investment
projects, although it will warrant properly completion of the on-going investment
projects.
In our view, going forward, China’s public spending is expected to focus more on
social benefits, such as social security, education, environment protection, economic
housing, rather than on the infrastructure projects, which consume a large amount of
aluminum, steel, cement, trucks.
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(852) 2800-8511 19 December 2009
With the fading away of the current economic stimulus package, we believe China’s
FAI will slow from 33% Y/Y in 2009 to only 18% Y/Y in 2011. If we strip out the
pricing effect (using PPI as a proxy), the real FAI growth in 2011 would slow more
notably to only 15% Y/Y in FY11, from 38.6% in FY09, given that J.P. Morgan
expects negative PPI of -5.6% Y/Y in 2009 but positive PPI of 3% Y/Y in 2011.
Hence, we believe this policy signal of relying less on FAI growth should be
negative for China’s fixed asset investment-related sectors such as downstream
commodities (aluminum, steel, and cement), trucks, engineer machinery.
Table 12: J.P. Morgan FAI and PPI forecasts

2009E 2010E 2011E
Nominal FAI growth 33% 25% 18%
PPI -5.6% 3.2% 3%
Real FAI growth 38.6% 21.8% 15%
Figure 42: China—Fixed asset investment and growth
%oy a RMB mn
35.0 30,000,000
30.0 25,000,000
25.0
20,000,000
20.0
15,000,000
15.0
10,000,000
10.0
5.0 5,000,000
0.0 0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Fix ed asset inv estment Grow th rate
Source: CEIC, J.P. Morgan..
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(852) 2800-8511 19 December 2009
Key investment themes

While FY09 has proven to be a “recovery trade” year with high-beta and bombed-out
stocks generating the most return, we could enter an alpha year in FY10, for which
our major investment strategy lies in focusing on defensive growth stocks—stocks
with good earnings visibility; low penetration rate; strong secular growth; and those
that should be least affected by a potential tightening kicking in as of 2Q10 and a
potential downshift in FAI growth in 2011.
We believe two key investment themes for FY10 should be: (1) accumulating
consumption-related stocks to benefit from China’s growth rebalance: from an
investment and export-driven economy to a domestic consumption-driven economy;
and (2) identifying the under-valued China companies, which are expected to
report record-high earnings in FY09, but are still trading at a decent discount to their
highs in FY07 and are immune from major multiple contraction pressure.
Positive on domestic private consumption-related stocks

We believe domestic consumption should see strong growth in FY10, supported by a
series of positive factors, which include: (1) more stimulative measures from the
government to boost private consumption in 2010; (2) decent household disposable
income growth to enable a rapidly increasing private consumption; (3) accelerating
progress in urbanization; and (4) improving consumer sentiment.
These tailwinds, in our view, should further bolster the earnings visibility of
domestic consumption-related companies, such as auto, home appliance, domestic
retailers, and hence pave the way for a broad-based rally for these names in FY10
(1) More stimulative measures from the government likely

to boost private consumption in 2010
Exports and investments used to be the driving forces for China’s economy.
However, the rapidly changing economic environment has made the Chinese
authorities understand that they cannot solely rely on export or fixed-investment to
achieve 8-9% growth for the medium term, as: (1) export is becoming a less
powerful engine of China’s growth, given the ongoing, sharp balance-sheet
adjustments in the developed economy after the most severe recession in half a
century; and (2) over-stimulating investments is infeasible, as this will result in over-
capacity in many industries.
Hence, boosting domestic consumption, which only accounts for 35% of China’s
GDP composition, has clearly become the good choice for China. While China has
flagged the importance of this transition, it is only until the outbreak of the economic
crisis that China finally realized the urgency of this switch and started to come out
supportive measures to boost domestic consumption.
Notably, for the first time, the Central Economic Work Conference, concluded on
December 7, noted that the government should place boosting domestic consumption
as its top agenda for the next year. Hence, we believe the government will mostly
come up with more supportive measures to boost private consumption in coming
months.
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(852) 2800-8511 19 December 2009
Figure 43: China GDP composition (as % of nominal GDP)

100%
80%
60%
40%
20%
0%
2002 2003 2004 2005 2006 2007 2008
Priv ate consumption Gov ernment consumption Inv estment & change in inv entories Net ex ports
Source: CEIC.
In fact, China has clarified its stimulative policies on auto, property and home
appliance recently; the implications are summarized below:
1) Auto
News: (1) China to renew the preferential vehicle purchase tax for cars with an
engine size of 1.6 liters and below in FY10, but will lift it to 7.5%; (2) China to
maintain the policy to provide financial subsidy to help farmers upgrade from three-
wheeled and/or low-speed agricultural vehicles to light trucks and minivans; (3)
China to maintain the policy to provide financial subsidy to encourage people to
scrap old vehicles for new ones in 2010 and increase the subsidy from Rmb5,000 to
Rmb18,000 per vehicle; (4) China to expand the number of cities to promote new
energy vehicles from 17 to 20 and choose five pilot cities in which the government
will provide financial subsidy to the buyers of new energy cars.
Implications: Mildly negative for China autos, because: (1) the renewal of
preferential policies is largely within our and the market expectations; (2) the
government fails to expand the scope of vehicles to receive the preferential tax to
those with an engine of 2.0 liters and below; (2) the market had expected the 5%
preferential tax to be maintained rather than lifted to 7.5%.
(2) Property:
News: China to withdraw a preferential policy for the property sector introduced late
last year: China will impose a transaction tax (5.5%) on houses sold within five years
of holding period, virtually terminating the temporary incentive started since
December 2008, which give a tax free bracket for houses held for more than two
years.
Implications: Mildly negative for Property developers. (1) The withdrawal of the
preferential policy suggests that the government is fine-tuning its accommodative
policy stance on the property sector, implemented late last year. Premier Wen
recently noted that the policy focus for FY10 in property market should be (a)
inhibiting the speculative demand; (b) accelerating the supply of economic housing
in the market; and (c) supporting the real residential housing consumption. (2) We
note that this is not the first time the government starts to adjust its accommodative
stance. Under the guidance from the authorities, banks in several cities have already
40
(852) 2800-8511 19 December 2009
started to tighten the mortgage policies and cancel the preferential lending for the
2nd home purchase since a few weeks ago.
(3) Home appliance:

News: (1) China to renew the national subsidy program for rural households to buy
electric appliances, with the subsidy remaining at 13% of the selling price, and lift
the cap of the maxim purchase price of the appliances. (2) China to renew the home
appliance replacement program after its expiry in May 2010, and further extend the
pilot regions from a total of 9 provinces under the current program.
Implications: Positive for home appliance producers. Now that these stimulus
programs have been successful in lifting the sales of home appliance so far this
year—sales of household electric and video appliances rose 47% Y/Y in the first ten
months of 2009—a renewal and expansion of the existing supportive policies will
likely continue to unleash rural households’ demand for such home appliance and
boost the volume growth for home appliance producers.
Table 13: China—The stimulative measures introduced this year and their impact on respective sectors
Sector Policy Impact
Home The rural home appliance promotion campaign was implemented This policy has driven a strong growth in the sale of Household Electric &
appliances nationwide in February 2009. Starting in May, more products, including Video Appliance. For instance, the sales of Household Electric & Video
energy-efficient air conditioners, were in the subsidy list. Export tax Appliance rose 47% Y/Y in the first ten months of 2009.
rebates were raised for most household appliances in June. The home
appliance trade-in program was carried out on a trial basis starting from
August.
Automobiles (1) Reduction in vehicle purchase tax from 10% to 5% for cars with an This policy has driven a strong growth in the sale of passenger vehicles with
engine size of 1.6 liters or below from January 20 to December 31, 2009. an engine size of 1.6 liters or below. For instance, the sale of PVs with an
engine size of 1.6 liters or below rose 63% Y/Y in the first ten months of
2009. On the other hand, the sale of PVs with an engine size of above 1.6
liters increased only 15% Y/Y in the same period.
(2) Providing a financial subsidy totaling Rmb5 billion to help farmers This policy has driven a strong growth in China’s mini van sales and mini
upgrade from three-wheel and/or low-speed agricultural vehicles to light truck sales. For instance, minivans’ sales volume grew 77% Y/Y and mini
trucks and mini vans. trucks’ sales volume rose 80% Y/Y in the first ten months of 2009.
(3) Providing a financial subsidy totaling Rmb5 billion to scrap old vehicles This has helped boost vehicle sale in FY09 through encouraging the
for new ones. consumers to scrap the old vehicles before their assessed usage life before
replacing such old vehicles with new ones. The policy is expected to add
1MM vehicle replacement demand.
Real estate (1) In October 2008, the Ministry of Finance released a circular to lower Primary sales volume in the eight major cities we track increased 90% Y/Y in
the property deed tax rate from 1.5% to 1% for <90sqm homes, eliminate the first ten months of year 2009.
land VAT and stamp duty on second-hand home sales, lower the
mortgage rates to 70% of benchmark lending rates for owner-occupied
homes, and reduce the minimum down payment ratio to 20%
(2) In November 2008, the Ministry of Housing and Urban-Rural
Development proposed to invest Rmb900B in low-rent housing for
7.47MM urban low-income families in three years: home leasing for
2.87MM and financial subsidies for the rest 4.6MM. In addition, 4MM units
of affordable housing will be built in China in the next three years; houses
in danger of collapse will be renovated for employees from state-owned
forestry/coal/agricultural organizations, approximately 2.2MM units.
(3) In December 2008, the State Council decided that second-hand home
sales are exempt from the business tax (or face a reduced business tax
rate) if the home has been held for two years by the original owner, down
from five years in the past. In addition, the government would promote
financial/credit support to property developers and encourage M&As.
(4) Effective May 25, 2009, the minimum equity capital requirement was
changed to 20% for policy/ordinary housing projects and 30% for other
property development projects.
Source: Ministry of Finance, State council, J.P. Morgan.
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(852) 2800-8511 19 December 2009
We expect more stimulative measures to boost private consumption

We expect more new policies initiatives to be released next year to speed up the
unleashing of private consumption. For example, the government will accelerate the
development of the consumer finance sector to help domestic consumption, in our
view. We believe China’s consumer finance is currently in its early development
stage and hence has substantial growth potential. For instance, in FY08, only 8% of
people who buy cars used auto loans, versus 85% in the US, thus leaving the door
open for the government to come up with new auto financing regulations that will
make it easier and cheaper for consumers to get auto loans from banks and auto
financing companies.
Figure 44: China—Auto loan as a percentage of total consumer loans

20% 4,000
15% 3,000
10% 2,000
5% 1,000
0% 0
2000 2001 2002 2003 2004 2005 2006 2007 2008
Consumer Loan (Rmb bn, RHS) Auto Purchasing loan as % of consumer loan ( LHS)
Table 14: Percentage of car sales financed by auto credit in different countries/regions
2008
China 8%
India 70%
EU 80%
Germany 71%
Italy 87%
France 78%
UK 87%
Spain 89%
US 85%
LatAm 60%
Meanwhile, pilot personal income tax-deferred pension insurance is likely to be

introduced in Shanghai soon, with an intention to speed up insurance coverage in
China to reduce the need for precautionary saving and hence support consumption.
Besides, we expect the government to increase public spending on healthcare to

provide a better safety net to China’s households, as healthcare expenditure is just
less than 5% of GDP in China, compared to over 10% for most developed nations. In
fact, in the final draft of healthcare reform approved early this year, the government
has planned to expand the medical insurance network to cover 90% of the population
and increase the annual subsidy for each person covered by the system to Rmb120 by
2011. We expect a total investment of Rmb850 billion to be spent on carrying out
this reform.
42
(852) 2800-8511 19 December 2009
Table 15: More supportive measures likely to be released next year to boost domestic consumption in China
Types Policies
Auto The government will likely accelerate the development of the consumer finance sector to help domestic consumption, in our view. We
believe China's consumer finance is currently in its early development stage and hence has significant growth potential. For instance,
in FY08, only 8% of people who bought cars used auto loans, thus leaving the door open for the government to come up with new
auto financing regulations that will make it easier and cheaper for consumers to get auto loans from banks and auto financing
companies.
Insurance Pilot personal income tax-deferred pension insurance is likely to be introduced in Shanghai soon, with an intention to speed up
insurance coverage in China to reduce the need for precautionary saving and thus support consumption.
Healthcare We expect the government to increase public spending on healthcare to provide a better safety net of China’s households, as
healthcare expenditure is just less than 5% of GDP in China, compared to over 10% for most developed nations.
(2) Decent household disposable income growth should

lead to a rapidly increasing private consumption
We believe a decent rise on household’s real disposable income, which equals to
increasing purchasing power, always lays the foundation for a notable gain in private
consumption. In our view, this is happening in China at this moment: household
income growth has stayed solid since late last year, benefiting from the substantial
fiscal stimulus, the recovery in export business, and the acceleration in domestic
demand.
In particular, YTD real urban household disposable income rose 10.4%oya,

outpacing YTD real GDP growth of 7.7%oya. Meanwhile, YTD real rural household
cash income also outpaced YTD real GDP growth, rising 9.5%oya. The improving
household purchasing power undoubtedly leads to rising domestic consumption this
year.
Figure 45: China—Urban household’s real disposable income growth versus real GDP growth
%oya
18
Real GDP grow th
15
12
9
6
Real disposable incom e of
3 urban household
0
2003 2004 2005 2006 2007 2008 2009
43
(852) 2800-8511 19 December 2009
Figure 46: China: Rural household’s real cash income growth versus real GDP growth
%oya Real cash incom e of rural household

24
22
20
18
16
14
12
10
8
6
4 Real GDP grow th
2
0
-2
2005 2006 2007 2008 2009
We believe the upward trend in both urban and rural household income growth
should continue next year, given the improving labor market conditions, buoyant
asset market performance, favorable macro policies improving national income
distribution (such as lifting the personal income tax threshold).
In particular, rural household could benefit more from rising agriculture prices and
improved infrastructure in rural areas than urban households. And that is largely why
we see real rural household income rising at a faster pace than urban household
income as of 3Q09. (10.3%oya versus 9.6%oya)
Figure 47: China—Number of employees is on the rise since 1Q09
Source: CEIC and J. P. Morgan.
Figure 48: China—Average wage growth bottoming out

%oy a
22
20
18
16
14
12
10
2002 2003 2004 2005 2006 2007 2008 2009
44
(852) 2800-8511 19 December 2009
Figure 49: China—Asset prices

index , 19 Dec 1990=100 Property prices %oy a
6100 Shanghai stock exchange 12
10
5100
8
4100 6
3100 4
2
2100
0
1100 -2
2002 2003 2004 2005 2006 2007
Table 16: China—Personal income tax reform

Effective date Adjustments
1994-1-1 The threshold of personal income tax was revised up to Rmb800 from Rmb400.
2006-1-1 The threshold of personal income tax was revised up to Rmb1,600 from Rmb800.
2008-3-1 The threshold of personal income tax was revised up to Rmb2,000 from Rmb1,600.
Source: J. P. Morgan.
(3) Accelerating progress in urbanization

With urbanization ratio still below 50%, China has significant potential to facilitate
further urbanization to boost domestic consumption. It is against this backdrop that
the central government highlighted in the Central Economic Work Conference that
China would encourage rural migrant population to settle in urbanized areas,
especially in medium and smaller cities. The conference noted China could relax the
control over the so-called “Hukou” system, i.e., the residential card system in
medium and small cities and towns, to facilitate their migration.
Figure 50: China’s urbanization process

700 50%
45%
600
40%
500 35%
400 30%
25%
300 20%
200 15%
10%
100
5%
0 0%
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Urban population (person mm) (RHS) Urban population as percentage of total population (LHS)
In our view, the policy initiative should be very positive to boost domestic
consumption as granting farmers and migrant workers full resident status would
45
(852) 2800-8511 19 December 2009
enable them to enjoy the same public services and social welfare as the urbanites did,
thus reducing their precautionary savings and unleash their pent-up demand for
consumer goods. Indeed, farmers and migrant workers nowadays have a higher
propensity to consume than most urban residents given the need to upgrade their
living standard.
Figure 51: Rural and urban households’ propensity to consume

0.90
0.85
0.80
0.75
0.70
0.65
0.60
0.55
0.50
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Urban household propensity to consume YTD
Rural household propensity to consume
We note that the plan targets mid/small-sized cities and small towns rather than large
cities. This policy adjustment makes it a more effective initiative to boost private
consumption as farmers/migrant workers could have better affordability when
migrating to mid/small-sized cities and small towns than to large cities. The
disposable income gap between households in rural areas and tier 4-6 cities is the
narrowest in the rural/city comparison. (see the figure below)
Figure 52: Disposable income per capita for rural areas and tier 1-6 cities.
30000 tier 1 tier 2 tier 3 tier 4-6 rural areas
25000
20000
15000
10000
5000
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: CEIC, IDC and J. P. Morgan.
Meanwhile, the different life styles between cities and rural areas will cause farmers
and migrant workers to consume more when they move into cities and towns. For
example, the penetration rates for different home appliances in rural areas are well
below those in urban cities, which, to some extent, reflect less dependence on home
appliances in rural areas. This leaves great potentials for a sharp increase in home
appliance consumption, especially when rural households settle in urban cities and
get themselves accustomed to the urban life style.
46
(852) 2800-8511 19 December 2009
Figure 53: Home appliance penetration rates in urban and rural areas (unit per 100 households)
140
120
100
80
60
40
20
0
Air-condition Refrigeratory Washing machine Color TV
Urban Rural
(4) Improving consumer sentiment

The sequential improvement in headline retail sales, with its sequential trend growth
rising to 18.8% 3m/3m, saar in November 2009, has certainly helped shore up
consumer sentiment in China, as this reading is generally taken as a sign post for the
strength of domestic private consumption. Moreover, solid household income
growth, improved job market conditions, as well as a buoyant stock market, all help
hold up the consumer confidence well so far this year.
These favorable factors should be intact in 2010, based on our underlying scenario of
continued sequential improvement in domestic demand and gradual recovery on the
export front. Hence, improving consumer sentiment could lead to further gains in
private consumption.
Figure 54: China—Consumer confidence and expectations index

Consumer Confidence Index Consumer Ex pectation Index
105
100
95
90
85
80
75
6
9
06
07
08
09
6
9
r-0
r-0
t-0
t-0
r-0
r-0
t-0
t-0
l-0
l-0
l-0
l-0
n-
n-
n-
n-
Oc
Oc
Oc
Oc
Ju
Ju
Ju
Ju
Ap
Ap
Ap
Ap
Ja
Ja
Ja
Ja
Figure 55: China—PBoC diffusion index of urban resident confidence

% Current Income Sentiment Future Income Confidence
70
65
60
55
c
50
45
40
Mar-01
Sep-01
Mar-02
Sep-02
Mar-03
Sep-03
Mar-04
Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Mar-07
Sep-07
Mar-08
Sep-08
Mar-09
Sep-09
47
(852) 2800-8511 19 December 2009
Identifying under-valued China companies

The notable V-shaped recovery in China since late 2008 has significantly shot up
earnings for companies that are highly leveraged to the strong economic recovery.
Some of them are even expected to report record-high earnings this year, with their
consensus FY09E EPS exceeding their previous high in FY07.
Normally, the record-high EPS should sharply drive up their share prices. A number
of stocks with higher earnings in FY09 than FY07 indeed are trading above their
highs in 2007. We note that the companies in this group are mostly from auto,
consumer staple and healthcare sectors, which are all among the best performers
YTD.
Table 17: Companies with record-high share price and earnings in FY09E
Price performance (%) FY09E FY09E EPS higher than

Ticker Stock names since 30 Oct 2007 EPS FY07 EPS by % Sector
1211 HK BYD CO LTD-H 266% 1.5 84% Technology Hardware
700 HK TENCENT HOLDINGS LTD 128% 3.2 250% Internet
1044 HK HENGAN INTL GROUP CO LTD 98% 1.7 81% Consumer Staples
606 HK CHINA AGRI-INDUSTRIES HLDGS 80% 0.6 76% Consumer Staples
322 HK TINGYI (CAYMAN ISLN) HLDG CO 72% 0.5 99% Consumer Staples
763 HK ZTE CORP-H 68% 1.5 111% Technology Hardware
1068 HK CHINA YURUN FOOD GROUP LTD 63% 0.9 49% Consumer Staples
8199 HK SHANDONG WEIGAO GP MEDICAL-H 52% 0.7 116% Health Care
489 HK DONGFENG MOTOR GRP CO LTD-H 48% 0.8 71% Auto
168 HK TSINGTAO BREWERY CO LTD-H 46% 1.1 151% Consumer Staples
2338 HK WEICHAI POWER CO LTD-H 34% 4.5 156% Industrials
682 HK CHAODA MODERN AGRICULTURE 21% 1.3 71% Consumer Staples
336 HK HUABAO INTERNATIONAL HOLDING 10% 0.4 55% Materials
1109 HK CHINA RESOURCES LAND LTD 8% 0.7 70% Real Estate
392 HK BEIJING ENTERPRISES HLDGS 7% 2.2 27% Industrials
998 HK CHINA CITIC BANK - H 6% 0.4 83% Banks
658 HK CHINA HIGH SPEED TRANSMISSIO 3% 0.7 150% Industrials
688 HK CHINA OVERSEAS LAND & INVEST 2% 0.8 42% Real Estate
363 HK SHANGHAI INDUSTRIAL HLDG LTD 1% 2.6 32% Industrials
Source: Bloomberg, J.P. Morgan estimates. Priced as of 16 December 2009.
Past performance is not indicative of future results.
That said, certain companies are still trading below the highs in 2007 even though
they are likely to report record-high earnings this year.
We believe the above discrepancy could be due to two reasons: (1) this is due to the
de-rating kicking in for companies that have seen worsening fundamentals since
2007; and (2) the equity market has not fully factored in the rising profitability for
companies that possess solid fundamentals and are benefiting from the strong
recovery.
Apparently, companies in the latter group could provide potential share price
appreciation for investors looking for under-valued companies. As such, we believe
it is a very valuable exercise to generate a list for this kind of under-valued
companies in the China universe.
Identifying undervalued companies in the China universe

We take a two-step process here. First, we screen potential candidates using three
inputs: (1) MSCI-China components under J.P. Morgan coverage; (2) companies that
48
(852) 2800-8511 19 December 2009
are expected to report higher EPS in FY09 than in FY07; and (3) companies are
trading at a discount to the share price as of 30 October 2007. Hence, we get a
shortlist of 19 MSCI-China components matching these criteria.
We then review these companies one-by-one, in order to remove the names with
large de-rating pressure as a result of their weak fundamentals. Among these, we
believe companies in industrials, materials, utilities and real estate sectors would
likely face more headwinds going ahead as their earnings visibility could be hurt by
the likely monetary tightening kicking in as of 2Q10 and a potential downshift in
FAI growth in 2011.
After taking out these names, we find 15 companies under our coverage fit into the
category (shown in Table 18). Most of them are from China banks, sport wear, coal
and retailing sectors. Among these, we believe banks and coal names may offer good
investment value. (For more detailed discussion, please see “Sector
recommendations.”)
While China’s sportswear sector in overall are being de-rated on the concern of a
slowdown in their growth rate, we still like the leaders within this sector, such as
China Dongxiang. We believe that China Dongxiang already offers good value at the
current level, as it is likely to see rising growth momentum in FY10.
Table 18: Stock screen for undervalued China companies
Price performance (%) FY09E FY09E EPS Relatively free from

higher than
Ticker Stock names since 30th Oct 2007 EPS FY07 EPS by % Sector de-rating pressure
2331 HK LI NING CO LTD -8% 1.0 109% Sports Wear Yes
1398 HK IND & COMM BK OF CHINA - H -13% 0.4 77% Banks Yes
3818 HK CHINA DONGXIANG GROUP CO* -11% 0.3 76% Sports Wear Yes
939 HK CHINA CONSTRUCTION BANK-H -22% 0.5 68% Banks Yes
1088 HK CHINA SHENHUA ENERGY CO - H -23% 1.9 63% Energy Yes
3328 HK BANK OF COMMUNICATIONS CO-H -37% 0.7 57% Banks Yes
3988 HK BANK OF CHINA LTD - H -13% 0.4 56% Banks Yes
3368 HK PARKSON RETAIL GROUP LTD -19% 0.4 55% Retailing Yes
1800 HK CHINA COMMUNICATIONS CONST-H -68% 0.6 34% Industrials No
1898 HK CHINA COAL ENERGY CO - H -46% 0.7 31% Energy Yes
836 HK CHINA RESOURCES POWER HOLDIN -46% 1.1 31% Utilities No
914 HK ANHUI CONCH CEMENT CO LTD-H -34% 2.3 31% Materials No
3968 HK CHINA MERCHANTS BANK - H -32% 1.1 30% Banks Yes
1880 HK BELLE INTERNATIONAL HOLDINGS -20% 0.3 27% Retailing Yes
2319 HK CHINA MENGNIU DAIRY CO -17% 0.9 27% Consumer Staples Yes
177 HK JIANGSU EXPRESS CO LTD-H -22% 0.4 27% Transportation Yes
386 HK CHINA PETROLEUM & CHEMICAL-H -42% 0.8 17% Energy Yes
203 HK DENWAY MOTORS LIMITED -10% 0.3 13% Auto Yes
3383 HK AGILE PROPERTY HOLDINGS LTD -33% 0.6 12% Real Estate No
Source: Bloomberg, J.P. Morgan estimates. * Note: China Dongxiang Group’s share price reached its record high in January, 04, 2008 at HK$6.26. Hence, we use this price in the price
performance calculation. Priced as of 16 December 2009.
49
(852) 2800-8511 19 December 2009
Sector views
Table 19: Sector weighting matrix
Earnings Penetration Secular Affected by Affected by the
visibility FY10 rate growth tightening FAI slowdown in FY11 Affected by Inflation
OW
1, Banks High Medium Medium Medium Medium Medium
2, Coal names Medium N/A High Low Medium High (positively affected)
3, Defensive growth names

(1) Internet High Low High Low Low Low
(2) Gas High Low High Low Low Low
(3) Tissue and diaper High Low High Low Low Low
(4) Selected consumer
staples
(5) Healthcare High Low High Low Low Low
4, Media High Medium Medium Low Low Low

5, Food inflation plays High Medium High Low Low High (positively affected)
UW
1, Property Low Medium Medium High High Low
2, Telecom Low Medium Low Medium Medium Medium
3, FAI-related plays Low N/A Low High High Medium
4, IPP Low Medium Medium Medium Medium High (negatively affected)
We are positive on the following sectors:

(1) Banks: The correction on fund-raising concerns has created a good
opportunity to accumulate bank shares
We believe the recent correction on fund-raising concerns has created a good
opportunity to accumulate bank shares, because:
(1) The prospective fund-raising by China banks are meant not to repair their
balance-sheet, but to fund their growth.
(2) We believe many China banks may choose to use rights issue rather than issuing
additional new shares to raise money, which would cause minimum dilution for the
existing shareholders, sharply reducing the amount of money to be raised from the
secondary market investors. The government-owned entities hold the lion’s share of
the major China banks, and are likely to come up with most of the fund-raising.
(4) Banks’ 1Q10 results are likely to surprise on the upside, given the benign asset
quality outlook and the potential NIM expansion.
Within the banking sector, we favor China Citic Bank, a growth play with the
strongest estimated earnings and ROE momentum; and CCB, which we believe has
attractive valuations on a P/E basis and strong dividend yield support.
(2) Coal names: A beneficiary of the recent coal price increase

We stay positive on the coal sector, which is benefiting from the recent increase in
coal prices.
Indeed, recent sector statistics show that coal prices have started to rally, with
Qinghuangdao coal prices up 30% as of the end of August 2009.
50
(852) 2800-8511 19 December 2009
Figure 56:China Qinghuangdao coal prices vs. NEWC prices
Source: cctd.com and globalcoal.com.
Looking ahead, the sharp rebound in electricity usage, supported by continued

recovery in industrial and manufacturing activities alongside the gradual recovery in
exports business, is translating into solid coal products demand.
Moreover, the supply-side discipline on the consolidation of small coal mines, as

well as the transportation bottleneck at the Daqing railway line, should help drive
coal prices to rise further in coming month, in our view.
Figure 57: China: Real industrial production and electric power usage
%oy a
40 Real IP
30
20
10
0
-10 Electric Power
-20
03 04 05 06 07 08 09
51
(852) 2800-8511 19 December 2009
Figure 58: Domestic coal inventory level

(Number of days for right hand axis, ‘000 tones for left hand axis)
Source: SERC, J.P. Morgan.
(3) Defensive growth names

We stay positive on defensive growth names—companies that are positioned in
sectors with low penetration rate and strong secular growth, and that will likely be
least affected by a potential tightening in 2Q10 and a downshift in FAI growth in
2011.
In our view, internet, gas, tissue and diaper companies, selected consumer staples,
and healthcare fulfill these defensive features well and offer a good risk-reward
profile for the investors.
(A) Internet, tissue and diaper and gas names

As discussed in our September 2009 research note, Where to find the next ten-
baggers, we screened out three sectors—internet, tissue/diaper and gas, which all
have a much lower penetration rate than that in developed economies, thus
positioning themselves well for long-term secular growth.
Hence, we believe the leading companies in these sectors, with a low penetration rate
and strong secular growth, will offer investors good value in FY2010.
Table 20: China—Sectors that still have low penetration rates

2006 2007 2008 US
Internet sector (users per capita0 10.3% 15.9% 22.4% 75.0%
Tissue sector (KG per capita) 2.5 2.7 2.95 23+
Natural gas sector (% of population) 6.3% 7.7% N/A 60%+
(B) Selected consumer staples

As shown in Figure 40, historically, consumer staple companies have been able to
post strong earnings growth, while at the same time highly defensive in nature,
outperforming the overall market in several market downturns.
52
(852) 2800-8511 19 December 2009
Figure 59:China—Consumer staple names’ earnings growth over the last few years
Source: IBES and J.P. Morgan estimates.
Figure 60: Consumer staples have outperformed the MSCI China in the market downturns (basis
points = 30 Dec 2005)
400
350
300
250
200
150
100
50
0
Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09
MSCI China Consumer Staples
Source: Bloomberg and J.P. Morgan.
Hence, select staple names, with company-specific strength, could still deliver good
earnings next year, and therefore provide good value for investors.
(C) Healthcare
We believe leading healthcare stocks should benefit from the government’s
increasing public spending on this sector, given China’s current low spending per
capita on healthcare and the urgency for China to provide a better safety net to
Chinese households.
We note that the current spending per capita on healthcare is approximately US$92
per year in 2006, according to the World Health Organization, or just 1.5% of that of
the US. As a percentage of per capital GDP, the total healthcare spending in China is
about 5% or roughly a third of the proportion in the US.
Such an underdeveloped healthcare system reflects the necessity for the government
to increase its spending to foster greater access to healthcare by the population so as
to boost domestic consumption. It is against this backdrop that the government
decided to unveil the long-awaited healthcare reform in February this year. In the
final draft of healthcare reform, the government has planned to expand the medical
53
(852) 2800-8511 19 December 2009
insurance network to cover 90% of the population and increase the annual subsidy
for each person covered by the system to Rmb120 by 2011. A total investment of
Rmb850 billion is expected to be spent on carrying out this reform.
Therefore, we believe the investment in new healthcare facilities will continue to be

strong even after other stimulus related spending on infrastructure starts to fade away
in FY11. Moreover, given that healthcare is one of the few industries in China with
no excess capacity, very little demand for resources, and can employ a large number
of skilled workers, we could see strong secular growth for this sector in the long
term.
Our top pick in this sector is Sinopharm due to its simple growth story, comprising
strong pharmaceutical sales growth in China and market share gains by the largest
operator.
Table 21: Low per capita healthcare spending and higher growth rates
Source: World Health Organization.
(4) We continue to see short-term trading opportunities for media and airline
stocks and food inflation plays
(A) Media
As a late-cycle recovery play, media sector is likely to post robust earnings growth in
FY10, the second year of the ongoing economic recovery, after suffering severe loss
in FY09, the first year of the recovery. Consensus is looking for much higher
earnings growth from China’s leading advertising companies in FY10 than FY09.
This should provide an impetus for their share prices to move higher in the near term,
as the market is actively seeking companies with visible earnings.
Table 22: Revenue growth in China’s advertising market lagging China’s real GDP growth
2009E 2010E
Price movement since earnings earnings
Ticker Name 30 Oct 2007 growth growth
FMCN US EQUITY FOCUS MEDIA HOLDING-ADR -72% -66% 54%
SINA US EQUITY SINA CORP -20% -29% 34%
VISN US EQUITY VISIONCHINA MEDIA INC-ADR na -35% 39%
Source: Bloomberg. Note Vsionchina was listed on 5 December 2007.
(B) Airlines
We see trading opportunities for China’s airline sector, which stands to benefit from:
(1) the rising cargo and passenger traffic on domestic and international routes on the
back of the strong economic recovery; and (2) Rmb resuming appreciation in 2Q
FY10.
54
(852) 2800-8511 19 December 2009
(C) Food inflation plays

Food inflation plays have performed well since early September. For example, China
Yurun has risen more than 50% since 7 September, outperforming the MSCI China
by 44% for the period.
Even after such a notable run-up, we believe this trade should continue to perform
well in the near term, given the potential further rise in food prices in coming
months.
Figure 61: CPI food prices

%oy a
26 CPI food prices
22
18
14
10
6
2
-2
2003 2004 2005 2006 2007 2008 2009
We are negative on the following sectors:

1) Property
We are negative on this sector due to concerns about tightening.
While a broad-based monetary tightening is unlikely until 2H10, property sector-

specific tightening measures could be pushed forward ahead of that time, given the
recent adjustment to the policy tone in the sector.
Indeed, the latest withdrawal of the preferential policy implemented late last year
suggests that the government is fine-tuning its accommodative policy stance on the
property sector.
Notably, Premier Wen recently noted that the policy focus for FY10 in property
market should be: (a) inhibiting the speculative demand; (b) accelerating the supply
of economic housing in the market; and (c) supporting the real residential housing
demand.
Within the property sector, we favor those companies with the most exposure to tier
2-3 cities, which stand to benefit from the government’s prospective relaxation of the
control over the so-called “Hukou” system in medium and small cities, as per
China’s Central Economic Work Conference, and those with exposure to commercial
property space.
2) FAI-related plays
While the strong earnings recovery momentum seen this year for FAI-related
companies, including downstream commodities (cement and aluminum), commercial
vehicles and construction, may be carried over to early next year, we recommend that
55
(852) 2800-8511 19 December 2009
investors capitalize on the potential share price strength on the back of the likely
strong results to trim their exposure to these sectors.
This is because these companies could be negatively affected by two headwinds: (1)
the likely monetary tightening kicking in as of 2Q10, and (2) the potential downshift
in FAI growth in 2011.
Historical performance show their share prices seem to be correlated more closely
with China’s monetary and fixed investment cycles than their respective quarterly
earnings results.
Figure 62: FAI-related stocks performance and M2 growth (with 3-6 months leading)
% %, m/m, sa
60.0 4
50.0
40.0 3
30.0
2
20.0
10.0
1
0.0
-10.0
0
-20.0
-30.0 -1
-40.0
-50.0 -2
8
9
08
08
09
09
8
9
8
9
8
/08
9
/09
8
9
8
9
r/ 0
t/0
r/ 0
t/0
c/ 0
n/0
n/0
n/0
n/0
l/0
l/0
b/0
b/0
v/0
v/0
/0
/0
g/
p/
g/
p/
ar
ar
ay
ay
Ju
Oc
Ju
Oc
Ap
Ap
De
Ja
Ju
Ja
Ju
Fe
Au
Se
Fe
Au
Se
No
No
M
M
M
M
ALUMINUM CORP OF CHINA LTD-H (LHS) ANGANG STEEL CO LTD-H (LHS)
ANHUI CONCH CEMENT CO LTD-H (LHS) M2 growth (m/m, 4 months leading, RHS)
Source: Bloomberg and CEIC.
Figure 63: FAI-related stocks performance and FAI growth (with 3-6 months leading)
% % Y/Y
60.0 45
50.0 40
40.0
35
30.0
30
20.0
10.0 25
0.0 20
-10.0
15
-20.0
10
-30.0
-40.0 5
-50.0 0
8
9
08
08
09
9
8
9
8
9
8
08
9
09
8
9
/ 08
/ 09
r/ 0
t/ 0
r/ 0
t/ 0
c/ 0
p/ 0
n/0
n/0
l/0
n/0
n/0
l/0
b/0
b/0
v/ 0
v/ 0
ar/
g/
p/
ar/
g/
ay
ay
Ju
Oc
Ju
Oc
Ap
Ap
De
Ja
Ju
Ja
Ju
Fe
Au
Se
Fe
Au
Se
No
No
M
M
M
ALUMINUM CORP OF CHINA LTD-H (LHS) ANGANG STEEL CO LTD-H (LHS)

ANHUI CONCH CEMENT CO LTD-H (LHS) FAI growth (m/m, 4 months leading, RHS)
Source: Bloomberg and CEIC.

3) Telecoms
We stay cautious on this sector due to the lackluster 2G subscriber growth in China
and that the 3G business has yet to take off in China.
4) IPPs
We believe IPPs are suffering from the rising market-based coal cost and the
government-regulated power tariff, which should weigh on the sector’s performance
in FY10.
56
(852) 2800-8511 19 December 2009
MSCI China performance overview

Over the past month, the MSCI China index fell 4.4% to 64.25 points. Despite the
recent pullback, MSCI China has still risen 57% YTD. At the sector level, only three
sectors—consumer staples (+10%), consumer discretionary (+6%), and IT (+1%)—
gained over the past month. Of the eight sectors that fell in the past month, utilities
was the biggest loser, falling 9% over the past month.
On the earnings front, consensus continues to revise up its 2010 earnings estimates,
which validates a trajectory toward our 2010 EPS forecast of HK$4.6, implying
around 21.8% earnings growth.
Currently, MSCI China trades at 17x 2009E P/E and 13.9x 2010E P/E.
Table 23: Valuation for Indices and sectors
Price MSCI P/E (x) EPS growth P/BV (x) Dividend yield
16-12-09 weighting 2009E 2010E 2009E 2010E 2009E 2010E 2009E 2010E
MSCI China 64.25 17.0x 13.9x 14.68% 21.86% 2.4x 2.2x 2% 3%
H-share 12,691 16.2x 12.9x 23% 25% 2.4x 2.1x 3% 3%
3%
Sector (MSCI China):
Consumer Discretionary 280 5% 22.8x 19.5x 17% 17% 3.4x 3.0x 1% 2%
Consumer Staples 1,262 5% 21.4x 18.1x 54% 18% 4.3x 3.6x 1% 2%
Energy 657 18% 14.4x 11.8x -1% 23% 2.2x 2.0x 3% 3%
Financials 518 38% 16.2x 13.1x 23% 23% 2.6x 2.3x 2% 3%
Health Care 141 0% 38.2x 28.6x 28% 33% 8.2x 6.6x 1% 1%
Industrials 170 8% 23.8x 17.0x 36% 40% 1.8x 1.7x 2% 2%
Information Technology 105 6% 41.8x 29.1x 61% 44% 7.1x 5.8x 1% 1%
Materials 1,121 6% 27.1x 15.7x 45% 72% 2.4x 2.1x 1% 2%
Telecommunication Services 113 13% 12.2x 12.0x -7% 2% 1.9x 1.8x 4% 4%
Utilities 375 1% 12.8x 11.7x 817% 10% 1.4x 1.3x 3% 3%
Source: Bloomberg, J.P. Morgan estimates. Note: Updated as of December 16, 2009.
57
(852) 2800-8511 19 December 2009
Figure 64: One-month price movement Figure 65: Sector contribution to one-month MSCI China point change
Consumer Staple 10% Consumer Staple 0.3
Consumer Disc 6% Consumer Disc 0.2
IT 1% IT 0.1
Energy -3% Health Care 0.0
Materials -3% Utilities -0.1
Telecom -4% Materials -0.1
MSCI China -4% Industrials -0.3
Industrials -6% Telecom -0.3
Health Care -6% Energy -0.4
Financials -8% Financials -2.2
Utilities -9% MSCI China -2.9
-10% -5% 0% 5% 10% 15% -3.5 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5
Sources: Bloomberg, J.P. Morgan estimates. Note: Updated as of Dec 16, 2009.
Figure 66: 2009 YTD price movement Figure 67: Sector contribution to 2009YTD MSCI China point change
IT 217% MSCI China 23.4
Consumer Disc 146% Financials 10.1
Consumer Staple 107% Energy 4.8
Materials 85% IT 2.6
Energy 72% Consumer Disc 1.8
Financials 67% Consumer Staple 1.6
MSCI China 57% Industrials 1.6
Health Care 47% Materials 1.4
Industrials 43% Health Care 0.1
Utilities -5% Utilities -0.1
Telecom -5% Telecom -0.5
-50% 0% 50% 100% 150% 200% 250% -5.0 0.0 5.0 10.0 15.0 20.0 25.0
As shown in figures above, we look at sectors which had the highest impact on
moving the market since January 1, 2009. We observe that cyclicals (IT, consumer
58
(852) 2800-8511 19 December 2009
discretionary, consumer staples, materials, energy and financials) have outperformed

the MSCI China, while defensive sectors (utilities, healthcare, industrials and
telecom) have underperformed the index YTD. Sector-wise, the top contributor was
the financials sector, which contributed 10 points to the 23.4 points gain YTD, while
utilities and telecom dragged down the index by 0.1 and 0.5 points, respectively.
Figure 68: Top 20 YTD performers in MSCI China universe Figure 69: Bottom 20 YTD performers in MSCI China universe
CHINA AGRI-INDUSTRIES HLDGS 159% CHINA COMMUNICATIONS CONST-H -24%
CHINA MENGNIU DAIRY CO 166% HUANENG POWER INTL INC-H -22%
ZTE CORP-H 173% CHINA COMMUNICATIONS SERVI-H -21%
AGILE PROPERTY HOLDINGS LTD 175% DATANG INTL POWER GEN CO-H -20%
SHIMAO PROPERTY HOLDINGS LTD 181% CHINA RAILWAY CONSTRUCTIO-H -17%
GOME ELECTRICAL APPLIANCES 181% CHINA MOBILE LTD -8%
BELLE INTERNATIONAL HOLDINGS 193% CHINA RESOURCES POWER HOLDIN 2%
YANZHOU COAL MINING CO-H 196% CHINA ZHONGWANG HOLDINGS LTD 3%
CHINA DONGXIANG GROUP CO 206% GUANGSHEN RAILWAY CO LTD-H 7%
TENCENT HOLDINGS LTD 219% HARBIN POWER EQUIPMENT CO-H 8%
JIANGXI COPPER COMPANY LTD-H 227% CHINA UNICOM HONG KONG LTD 9%
ALIBABA.COM LTD 227% SHANGHAI ELECTRIC GRP CO L-H 11%
INNER MONGOLIA YITAI COAL-B 255% CHINA RAILWAY GROUP LTD - H 12%
HIDILI INDUSTRY INTL DEVELOP 283% CHINA TELECOM CORP LTD-H 14%
FUSHAN INTERNATIONAL ENERGY 286% SINOFERT HOLDINGS LTD 15%
CNPC HONG KONG LIMITED 292% SOHO CHINA LTD 19%
WEICHAI POWER CO LTD-H 335% JIANGSU EXPRESS CO LTD-H 21%
DONGFENG MOTOR GRP CO LTD-H 344% BEIJING CAPITAL INTL AIRPO-H 26%
BYD CO LTD-H 449% COSCO PACIFIC LIMITED 26%
GEELY AUTOMOBILE HOLDINGS LT 594% CHINA SOUTH LOCOMOTIVE - H 28%
0% 100% 200% 300% 400% 500% 600% 700% -30% -20% -10% 0% 10% 20% 30% 40%
Sources: Bloomberg, J.P. Morgan estimates. Note: Updated as of Dec 16, 2009 Sources: Bloomberg, J.P. Morgan estimates. Note: Updated as of Dec 16, 2009.
YTD, FY09 best performers are mainly concentrated in consumption-related sectors,

such as autos, property, bank, IT, and materials. In the MSCI China universe, 71
stocks out of 109 have outperformed the MSCI China index.
Model portfolio adjustments

As of December 16, 2009, China model Portfolio posted a YTD gain of 75.73%,
while the MSCI China rose 57% in the same period. Since the inception on 31
December 2004, our CMP has outperformed the MSCI China by 94.7%.
59
(852) 2800-8511 19 December 2009
Figure 70: J.P. Morgan China Portfolio vs. MSCI China since inception of J.P. Morgan China
%
500
450
JPM China Portfolio
400
350
300
250
200
150
MSCI China
100
50
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09
60
(852) 2800-8511 19 December 2009
Table 24: China Model Portfolio performance

Weightings % Performance YTD Performance from add in date Add in
Ticker Benchmark J.P. Morgan YTD vs. MSCI China % Abs % vs. MSCI China % Date Price (LC)
Consumer Discretionary 5.34 1.50 146.34 89.08 31-Dec-04
Li Ning Co Ltd 2331 HK 0.44 1.50 121.90 64.64 67.81 27.80 30-Apr-09 16.00
Consumer Staples 4.43 7.50 106.80 49.54 31-Dec-04
China Mengniu Dairy Co. Ltd. 2319 HK 0.68 1.50 166.37 109.11 21.49 18.15 30-Jun-08 22.10
China Yurun Food 1068 HK 0.49 2.00 123.38 66.12 103.50 63.77 30-Sep-08 10.00
Hengan International Group Ltd 1044 HK 0.86 2.00 128.92 71.66 28.81 20.48 4-Sep-09 44.25
Tsingtao Brewery 168 HK 0.29 2.00 147.53 90.27 29.40 28.51 15-Oct-09 30.95
Energy 17.59 22.00 72.03 14.77 31-Dec-04
CNOOC 883 HK 4.81 6.00 65.75 8.49 112.39 -11.48 21-Sep-05 5.65
Sinopec Corp 386 HK 2.41 2.50 43.50 -13.76 110.31 -43.54 31-Dec-04 3.20
China Shenhua Energy 1088 HK 2.78 5.50 134.15 76.89 328.28 209.97 10-Aug-05 8.97
Yanzhou Coal Mining - H 1171 HK 0.74 2.00 195.61 138.35 40.40 39.51 15-Oct-09 11.98
PetroChina 857 HK 4.45 4.00 38.44 -18.82 126.51 -27.35 31-Dec-04 4.15
China Coal Energy 1898 HK 1.10 2.00 127.55 70.29 0.00 0.00 16-Dec-09 14.04
Financials 38.01 37.50 67.17 9.91 31-Dec-04
China Life Insurance 2628 HK 6.46 4.00 64.54 7.28 645.19 491.34 31-Dec-04 5.20
China Overseas Land 688 HK 1.55 1.00 57.33 0.07 834.95 681.10 31-Dec-04 1.81
Ping An Insurance 'H' 2318 HK 1.97 1.00 82.80 25.54 419.63 269.92 14-Feb-05 13.19
ICBC - H 1398 HK 6.45 6.00 54.41 -2.85 46.85 26.04 30-Apr-07 4.29
China Merchants Bank - H 3968 HK 1.56 1.50 81.96 24.70 58.55 35.71 29-Dec-06 12.68
China Construction Bank 939 HK 6.61 8.00 54.35 -2.91 33.85 11.00 29-Dec-06 4.90
Bank of China -H 3988 HK 5.24 6.50 93.40 36.14 93.40 18.57 26-Feb-09 2.12
PICC Property & Casualty Co.Ltd 2328 HK 0.38 5.00 65.55 8.29 0.00 0.00 16-Dec-09 6.92
China Citic Bank 998 HK 0.72 1.50 144.15 86.89 0.00 0.00 16-Dec-09 6.47
Greentown China Holdings 3900 HK 0.17 3.00 296.91 239.65 0.00 0.00 16-Dec-09 12.86
Health care 0.00 3.00 31-Dec-04
Sinopharm 1099 HK 0.00 3.00 0.00 -57.26 0.00 0.00 16-Dec-09 27.40
Industrials 8.42 2.50 43.45 -13.81 31-Dec-04
China Cosco Holdings, Ltd. 1919 HK 0.51 1.50 73.84 16.58 30.50 9.69 30-Apr-07 7.18
China Southern Airlines 1055 HK 0.00 1.00 100.00 42.74 0.00 0.00 16-Dec-09 2.58
Information Technology 6.03 12.00 216.67 159.41 31-Dec-04
ZTE 'H" 763 HK 0.27 1.50 173.45 116.19 104.78 131.31 27-Sep-07 20.85
Netease NTES US 0.00 3.00 70.27 13.01 -11.50 -19.83 4-Sep-09 42.52
Alibaba.com Limited 1688 HK 0.51 3.00 224.01 166.75 -12.23 -20.56 4-Sep-09 20.60
Baidu.com BIDU US 0.00 2.50 226.46 169.20 24.18 15.85 4-Sep-09 343.27
Sina Corp SINA US 0.00 2.00 98.70 41.44 17.77 16.87 15-Oct-09 39.06
Materials 6.14 2.00 85.28 28.02 31-Dec-04
Maanshan Iron and Steel - H 323 HK 0.23 2.00 112.68 55.42 15.78 14.88 15-Oct-09 5.07
Telecommunication Services 12.20 7.50 -4.93 -62.19 31-Dec-04
China Mobile (HK) 941 HK 9.67 5.00 -7.91 -65.17 190.55 42.39 2-Mar-05 24.66
China Telecom Corp 728 HK 1.02 1.00 13.84 -43.42 -44.33 -31.32 25-Jan-08 5.91
China Unicom - H 762 HK 1.35 1.50 9.25 -48.01 -10.88 -33.73 29-Dec-06 11.40
Utilities 1.63 3.00 -4.66 -61.92 31-Dec-04
China Resources Power Holdings 836 HK 0.54 1.00 1.55 -55.71 -30.43 -17.42 25-Jan-08 21.36
Xinao Gas 2688 HK 0.32 2.00 134.27 77.01 54.35 46.03 4-Sep-09 12.40
China Gas Holdings Limited 384 HK 0.00 1.50 221.93 164.67 0.00 0.00 16-Dec-09 3.67
MSCI Total 99.79 100.00 57.26 0.00 154.00 0.00 31-Dec-04
Source: Bloomberg and J.P. Morgan. Updated as of December 16, 2009.
61
(852) 2800-8511 19 December 2009
CMP adjustments
We adjusted our banking exposure in our China Model Portfolio by taking profit on
Shanghai Pudong Development Bank, Shenzhen Development Bank and Bank of
Communications, and reduced the weighting of BOC to 6.5% from 8%. We added
Citic bank with a weight of 1.5%. Our banking analyst initiated coverage on Citic
Bank with a Dec-10 PT of HK$8.6, which implies 2.4x FY10E P/B and 12.7x
FY10E P/E.
China’s property sector suffered a sharp correction on the government’s new

measures to inhibit investment demand and to increase the supply of economy
housing. While we continue to maintain our underweight stance on the sector, we
believe many mid-cap property names with good exposure to Tier 2 and Tier 3 cities
already offer very good value. We believe the government’s new policy of relaxing
control over the residential card system in middle and small cities are positive for
property developers with exposure to Tier 2 and Tier 3 cities, and that the
government has reiterated its support for the residents’ genuine demand for the
property sector. Hence, we add Greentown into our model portfolio with a weight of
3%. We like Greentown, given the strong sales pipeline ahead. The company has
Rmb80 billion worth of properties available for sale in FY10. The company can
achieve contract sales of Rmb40 billion-Rmb64 billion based on 50%-80% sales rate.
Together with the sales of Rmb45 billion to be delivered in FY10-12, this would
render support to its strong earnings growth from FY11 onwards. Greentown has also
exposure to Hangzhou and most other second/third-tier cities in Yangtze River Delta
as well as selected Bohai Rim cities.
We continue to reduce the weight in the downstream commodities by taking out

Anhui Conch (-0.5%).
With the proceeds, we added to our weighting in the coal sector by 2% as we believe
coal names should be benefiting from the current coal price hike. We add China Coal
to CMP with a weight of 2%.
We continue to like gas sector with low penetration rate and strong secular growth.
Hence, we add China Gas with a weight of 1.5%.
We continue to reduce our exposure to telecom and utilities. We reduce the weight in
both China Telecom and China Resource Power to 1% from 1.5% and 3%,
respectively.
We reduce our exposure to consumer sector by taking profit on Parkson (-1%) and
Huabao (-1.5%) and reduce the weight of Yurun by 2.5% to 2%.
We take some profit on ZTE by cutting its weight to 1.5% from 3%, due to ZTE’s
less attractive valuations after its strong YTD price performance of 173%.
Meanwhile, we add China Southern Airline to our CMP with a weight of 1%. We
believe this company should benefit from 1) the rising cargo and passenger traffic on
domestic routes on the back of a strong economic recovery, and (2) Rmb resuming
appreciation as of 2Q10.
Our pharmaceutical analyst, Leon Chik initiated coverage on China’s healthcare

sector. We like the sector because we believe that healthcare will benefit from the
government’s increasing public spending on this sector, given China’s current low
spending per capita on healthcare and the urgency for China to provide a better safety
net to Chinese households. Hence, we add Sinopharm into our model portfolio with a
62
(852) 2800-8511 19 December 2009
weight of 3%. We like this name because its simple growth story, comprising strong
pharmaceutical sales growth in China and market share gains by the largest operator.
We also believe there is upside risk to the consensus forecast for the name.
Lastly, we add PICC to our portfolio with a weight of 5% because: (1) we expect its
core property insurance business to be lifted by the auto boom in China; (2) we
believe there is a possibility that its parent company might inject the life insurance
business into the listed vehicle.
63
(852) 2800-8511 19 December 2009
CMP return-risk profile

To provide an all around picture of our CMP return-risk profile and justification of
the monthly adjustment for investors, we introduce the following four ex-post
(historical) measures:
• Return profile: Active return—Monthly portfolio return minus benchmark return.
• Risk profile: Active risk—Volatility/risk we undertake correspondingly.
• Integrated performance measure: Information ratio—A classical tool for
measuring the active return of an investment manager divided by the amount of
risk the manager takes relative to a benchmark.
• Micro performance attribution: Pure sector allocation return—To measure the
impact on performance attributed only to the sector-weighting decisions.
1. Within sector selection return: To calculate the impact on performance attributed
only to security selection decisions.
2. Allocation/selection interaction return: Involving the joint effect of assigning
weights to both sectors and individual securities.
We primarily focus on the first two measures.
The following table manifests the positive performance changes after adjusting our
model portfolio. The annualized information ratio has increased to 5.5 from 0.4, with
the annualized excess return increasing to 20.5% from 2.16%, and the active risk
falling to 3.73% from 5.62%. This implies that the new CMP is equipped with higher
return and lower risk.
Table 25: CMP return-risk checker

Performance checker CMP before adjustment CMP after adjustment
Annualized active return 2.16% 20.53%
Annualized active risk 5.62% 3.73%
Information ratio 0.38 5.50
Pure sector allocation return 0.90% 0.37%
Within-sector stock selection return 3.04% 3.13%
In order to get a deeper insight into our CMP performance, we also conduct a micro
performance attribution analysis. We categorize the active return into three parts: (1)
pure sector allocation; (2) allocation-selection interaction; and (3) within-sector stock
selection. The active returns contributed by pure sector allocation and by within-
sector stock selection over the last month, were 0.9% and 3.04%, respectively. This
breakdown indicates that the slight outperformance last month was mainly due to the
better portfolio components.
Besides ex-post measures, we can also forecast the new CMP return in an ex-ante
(prospective) way. By applying our analysts’ June-10/Dec-10 price targets to our
CMP components, we forecast our Dec-09 CMP monthly return of 0.6%.That
64
(852) 2800-8511 19 December 2009
Table 26: J.P. Morgan China model portfolio

Change (%) MSCI JPM Dev. PER PER DY ROE
Ticker Price Rating 4 Ytd Weight Weight (%) 2009 2010 2009 2009
Wk
Consumer Discretionary 280 6.5 146.3 5.3 1.5 -3.8 22.0 19.0 1.7 19.2
Li Ning Co Ltd 2331 HK 26.9 N 8.5 121.9 0.4 1.5 1.1 31.1 27.1 1.9 43.2
Consumer Staples 1262 6.9 106.8 4.4 7.5 3.1 18.8 15.9 1.5 20.4
China Mengniu Dairy Co. 2319 HK 26.9 OW 13.3 166.4 0.7 1.5 0.8 32.9 28.8 0.0 20.6
Ltd.
China Yurun Food 1068 HK 20.4 OW 10.6 123.4 0.5 2.0 1.5 21.5 18.9 1.2 23.7
Hengan International Group 1044 HK 57.0 N -1.3 128.9 0.9 2.0 1.1 32.5 29.7 1.9 27.3
Ltd
Tsingtao Brewery 168 HK 40.1 N 4.0 147.5 0.3 2.0 1.7 41.4 36.1 1.2 20.1
Energy 657 -3.7 72.0 17.6 22.0 4.4 15.6 13.2 3.0 15.6
CNOOC 883 HK 12.0 N -5.8 65.7 4.8 6.0 1.2 18.6 15.4 3.6 17.3
Sinopec Corp 386 HK 6.7 OW -2.3 43.5 2.4 2.5 0.1 9.1 8.8 2.8 18.2
China Shenhua Energy 1088 HK 38.4 N -3.0 134.1 2.8 5.5 2.7 23.4 22.0 1.5 20.9
Yanzhou Coal Mining - H 1171 HK 16.8 N 9.2 195.6 0.7 2.0 1.3 15.5 15.8 1.7 18.3
PetroChina 857 HK 9.4 UW -7.1 38.4 4.4 4.0 -0.4 15.4 13.9 2.9 13.6
China Coal Energy 1898 HK 14.0 OW 2.2 127.6 1.1 2.0 0.9 17.7 17.2 1.7 16.6
Financials 515 -7.5 67.2 38.0 37.5 -0.5 16.5 12.8 3.1 17.5
China Life Insurance 2628 HK 38.8 OW -0.8 64.5 6.5 4.0 -2.5 40.6 35.3 0.8 13.4
China Overseas Land 688 HK 17.0 OW -0.8 57.3 1.6 1.0 -0.6 22.8 17.5 0.9 16.2
Ping An Insurance 'H' 2318 HK 68.6 N -5.8 82.8 2.0 1.0 -1.0 49.0 36.7 0.4 11.1
ICBC - H 1398 HK 6.3 OW - 54.4 6.5 6.0 -0.5 16.1 12.4 3.1 20.4
10.3
China Merchants Bank - H 3968 HK 20.1 N -7.6 82.0 1.6 1.5 -0.1 22.3 17.4 0.6 17.4
China Construction Bank 939 HK 6.6 OW - 54.4 6.6 8.0 1.4 14.5 11.1 3.1 21.3
10.6
Bank of China -H 3988 HK 4.1 OW - 93.4 5.2 6.5 1.3 12.6 8.9 4.0 16.9
15.1
PICC Property & Casualty 2328 HK 6.9 UW 16.3 65.6 0.4 5.0 4.6 NM 64.6 0.0 -1.1
Co.Ltd
China Citic Bank 998 HK 6.5 OW -6.6 144.2 0.7 1.5 0.8 16.6 10.9 1.5 15.2
Greentown China Holdings 3900 HK 12.9 N 9.0 296.9 0.2 3.0 2.8 15.9 12.9 0.0 14.5
Health care 0.0 3.0 3.0 NA NA NA NA
Sinopharm 1099 HK 27.4 OW 9.4 0.0 0.0 3.0 3.0 53.5 46.4 0.4 12.7
Industrials 169 -5.2 43.4 8.4 2.5 -5.9 21.5 16.7 1.7 9.5
China Cosco Holdings, Ltd. 1919 HK 9.4 N - 73.8 0.5 1.5 1.0 NM 47.3 0.0 -6.3
16.3
China Southern Airlines 1055 HK 2.6 N -4.1 100.0 0.0 1.0 1.0 34.0 84.3 0.0 6.9
Information Technology 104 4.1 216.7 6.0 12.0 6.0 41.6 28.9 0.7 19.7
ZTE 'H" 763 HK 43 N -8.1 173.4 0.3 1.5 1.2 30.1 24.1 0.7 16.5
Netease NTES US 38 OW -7.5 70.3 0.0 3.0 3.0 18.4 12.7 0.0 27.7
Alibaba.com Limited 1688 HK 18 N -6.9 224.0 0.5 3.0 2.5 87.6 51.8 0.0 20.2
Baidu.com BIDU US 426 OW -2.0 226.5 0.0 2.5 2.5 69.5 46.6 0.0 37.1
Sina Corp SINA US 46 N 1.2 98.7 0.0 2.0 2.0 45.5 35.1 0.0 8.7
Materials 1121 -1.3 85.3 6.1 2.0 -4.1 27.2 16.5 1.6 12.9
Maanshan Iron and Steel - 323 HK 5.9 OW 9.9 112.7 0.2 2.0 1.8 NM 62.8 0.3 1.4
H
Telecommunication Services 113 -6.1 -4.9 12.2 7.5 -4.7 12.4 12.5 3.6 13.5
China Mobile (HK) 941 HK 71.7 N -5.9 -7.9 9.7 5.0 -4.7 12.6 12.7 3.4 22.7
China Telecom Corp 728 HK 3.3 N -8.4 13.8 1.0 1.0 0.0 19.7 18.0 2.3 6.1
China Unicom - H 762 HK 10.2 UW -5.0 9.2 1.4 1.5 0.1 26.5 38.3 1.7 4.4
Utilities 374 -8.8 -4.7 1.6 3.0 1.4 15.5 12.3 2.6 10.8
China Resources Power 836 HK 15 N -7.6 1.6 0.5 1.0 0.5 14.6 11.7 2.2 14.1
Holdings
Xinao Gas 2688 HK 19 OW 0.7 134.3 0.3 2.0 1.7 24.5 19.7 1.0 13.9
China Gas Holdings Limited 384 HK 4 N 5.5 221.9 0.0 1.5 1.5 118.0 25.6 0.0 3.3
MSCI Total 64 -4.3 57.3 100 100 0 17.2 14.1 2.7 15.3
Source: Bloomberg and J.P. Morgan estimates. Updated as of December 16, 2009.
65
(852) 2800-8511 19 December 2009
Autos
Frank Li AC (Extracted from the note, “Auto WIN: Regional auto industry highlights",
(852) 2800-8511 published on 4 December 2009; please see the original note for pricing dates)
Jin Luo What is changing

(852) 2800-8516
jin.j.luo@jpmorgan.com
Change 1: We raised our FY10 auto sales forecast
J.P. Morgan Securities (Asia Pacific) Limited We raised our FY10 auto sales forecast by 12% to 15.13 million (please see the
table below). Among these, we expect China’s passenger vehicle sales to rise 15%
Y/Y to 11.56 million, and commercial vehicle sales to increase 8% Y/Y to 3.58
million.
Table 27: J.P. Morgan forecasts for China auto sales

Sales unit ('000) 2004 2005 2006 2007 2008 2009E 2010E 2011E
Sedan 2,242 2,787 3,829 4,727 5,047 7,231 8,225 9,076
MPV 109 156 191 226 197 234 269 299
SUV 163 196 238 357 448 637 765 879
Minivan 757 831 918 988 1,064 1,947 2,297 2,573
Total PV 3,271 3,970 5,176 6,298 6,756 10,049 11,556 12,827
(Y/Y % change) 21% 30% 22% 7% 49% 15% 11%
Bus 183 179 191 247 253 340 357 382

Truck 1,121 1,163 1,317 1,516 1,641 2,173 2,390 2,558
Trailer 99 57 93 178 194 214 235 251
Van chassis 91 91 98 102 88 92 95 98
Truck chassis 307 298 341 450 450 485 500 515
Total CV 1,801 1,788 2,040 2,494 2,625 3,304 3,577 3,804
(Y/Y % change) -0.7% 14.1% 22.3% 5.2% 25.9% 8.3% 6.3%
Total vehicles 5,072 5,758 7,216 8,792 9,381 13,353 15,133 16,631
(Y/Y % change) 17.2% 13.5% 25.3% 21.8% 6.7% 42.3% 13.3% 9.9%
Source: CAAM and J.P. Morgan estimates.
Impact
We revised up our China vehicle sales forecasts for FY10 based on the following
factors:
1) Chinese government’s commitment to transform China’s economic growth mode

from an investment and export- driven economy to a consumption-driven economy
China’s Politburo, the top decision-making body in China, held a conference on
November 27, 2009 to set the tone for the Central Economic Work Conference to be
held in mid-December, 2010. The Politburo noted at the conclusion of the conference
that China would maintain its proactive fiscal and relatively loose monetary policies.
Also, the Politburo highlighted the importance of promoting the development of
consumption and private investment as a key driver of sustainable economic growth.
Meanwhile, Zhu Hong, the spokesperson of China’s Industrial and Information

Ministry recently stated that China would consider renewing the policies that have
been introduced this year to boost automobile consumption.
Hence, we expect the Chinese government to renew its preferential policies

introduced this year to boost vehicle consumption.
In fact, we believe the government may well expand the scope of the vehicles that
will receive the preferential vehicle purchase for FY10 to boost car consumption.
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Among others, we expect the vehicles with an engine size of 1.8 liters and below to
enjoy the 5% preferential vehicle purchase tax (versus the normal 10% tax rate).
Currently, only vehicles with an engine size of 1.6 liters and below qualify for a 5%
preferential vehicle purchase tax.
In addition, Chinese auto producers are lobbying for the removal of the vehicle
purchase tax for vehicles with an engine size of 1.4 liters or below.
Table 28: The impact of preferential policies introduced in FY09 to boost vehicle sales
Policies Impact
(1) Reduction in vehicle purchase tax from 10% to 5% for cars with an engine This policy has driven a strong growth in the sale of passenger vehicles
size of 1.6 liters or below from January 20 to December 31, 2009 with an engine size of 1.6 liters or below. For instance, the sale of PVs with
an engine size of 1.6 liters or below rose 63% Y/Y in the first ten months
of 2009. On the other hand, the sale of PVs with an engine size of above 1.6
liters increased only 15% Y/Y in the same period.
(2) Providing a financial subsidy totaling Rmb5 billion to help farmers upgrade from This policy has driven a strong growth in China’s mini van sales and mini truck
three-wheel and/or low-speed agricultural vehicles to light trucks and mini vans sales. For instance, minivans’ sales volume grew 77% Y/Y and mini trucks’ sales
volume rose 80% Y/Y in the first ten months of 2009
(3) Providing a financial subsidy totaling Rmb5 billion to scrap old vehicles for new This has helped boost vehicle sale in FY09 through encouraging the consumers
ones. to scrap the old vehicles before their assessed usage life before replacing such
old vehicles with new ones. The policy is expected to add 1 million vehicle
replacement demand.
Source: J.P. Morgan.
2) Additional new policies to be released next year to boost auto consumption:

Against the backdrop of promoting consumption as a key economic driver, we expect
the government to come up with two new policies to boost auto consumption. First,
we expect the release of new auto financing regulations that will make it easier and
cheaper for consumers to get auto loans from banks and auto financing companies. In
FY08, only 8% of the consumers who bought cars opted for auto loans. Second, we
expect the government to release new regulations for boosting the development of
the “new energy vehicles.” The Chinese government earlier set a target to increase
China’s electric car possession from an estimated 100,000 units by 2012 to 4 million
by 2020.
3) The current third auto boom is driven by the breakout of disposable income in
China’s tier-three cities.
At the beginning of this year, we forecast that China’s third auto boom would be
unleashed by the breakout of demand in China’s tier-three cities in FY10 when the
household average disposable income is forecast to reach Rmb40,199, when
discounted with China’s CPI figures. This is similar to the level of tier-two cities’
disposable income in FY06, and tier-one cities’ disposable income in FY03, which
fueled China’s previous two auto booms. China’s third auto boom kicked off in
FY09, i.e., one year ahead of our forecast, helped by a slew of government policies to
boost auto consumption.
With the strong economic recovery, we expect China urban residents' disposable
income growth to remain robust in FY10, helping to set the stage for robust car
demand.
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Figure 71: China urban residents’ per capita disposable income growth (quarterly)
17%
14%
11%
8%
5%
08
09
9
8
9
/08
/09
8
8
9
n/0
l/0
l/0
v/0
/0
/0
p/
p/
ar
ar
ay
ay
Ju
Ju
Ja
Se
Se
No
M
M
M
M
1-tier 2-tier 3-tier
Source: CEIC.
Figure 72: China urban residents’ per capita disposable income growth (yearly)
17%
15%
13%
11%
9%
7%
5%
2003 2004 2005 2006 2007 2008
1-tier 2-tier 3-tier
Source: CEIC.
We see the above upward revision in China’s vehicle sales forecast as a positive for
China’s auto sector, and see upside risks to the sector's 4Q09E and 1Q10E results,
given the huge operating leverage of the sector.
On the other hand, we have identified the following key investment risks for China
autos:
1) The impact of negative wealth effect to rise from the possible volatilities in
China’s stock and property markets on China’s vehicles sales in FY10. With the
acceleration in China’s economic growth, we expect the Chinese government to
resort to tightening measures, such as window guidance for the banks to slow down
the lending as of 2Q FY10, raising the banks’ required reserve ratio, and possibly
cracking down on the high-end property sector in 2Q FY10, which could result in
volatilities in China’s stock and property markets. This, in turn, could hurt car sales
in FY10.
2) Valuations of China’s auto stocks look reasonable to us but not very attractive
after the strong performance this year.
3) The strong car sales growth this year could be partly attributable to the advanced
purchase by some consumers, who thought that the preferential tax policies might not
be renewed next year;
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4) The supply of new paper. We believe a number of auto companies may capitalize
on the current cyclical upturn in China’s auto market to raise money in the secondary
market. We could see the existing listed auto companies raising money to expand
capacity and/or to do M&A activities. In addition, a number of unlisted auto
companies may also seek to do IPOs next year.
In conclusion, we now switch from a positive stance at the beginning of the year to a
neutral stance on China auto sector following the strong performance this year, and
recommend investors focus on those names that have company-specific strengths or
positive share price drivers. Among others, we like DongFeng Motor, a leading
company in China’s auto sector with a track record of expanding market share and
growing core earnings in both the upturn and the downturn of the cycle. Unlike
Denway, which is a red chip (i.e., Chinese company incorporated in Hong Kong),
DongFeng Motor is an H-share company (i.e., Chinese company incorporated in
China and governed by Chinese laws). DongFeng’s H-share status means that it is
much easier for the company to go for the listing in the domestic A-share market,
where stocks typically trade at a much higher multiple than that in the H share
market. It should help the sentiment of DongFeng Motor if the company decides to
do the A share listing.
Change 2: The impact of Rmb appreciation on China autos

U.S. President Obama’s visit to China in November 2009 re-ignited market
speculation on Rmb appreciation—an imminent one-off Rmb revaluation, expansion
of the daily trading band, or at least a resumption of Rmb appreciation in the very
near term—after Rmb staying largely stable since mid-09.
The recent notable downward movement of the one-year Rmb NDF suggests
heightened expectations of Rmb appreciation over the past month.
Figure 73: Rmb/US$ one-year non-deliverable forward (NDF) outright rate
7.2
7.1
7
6.9
6.8
6.7
6.6
6.5
6.4
1/1/2009
2/1/2009
3/1/2009
4/1/2009
5/1/2009
6/1/2009
7/1/2009
8/1/2009
9/1/2009
10/1/2009
11/1/2009
Source: Bloomberg.
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Figure 74: J.P. Morgan and consensus Rmb forecasts
8.4
8.0
7.6
Forward
J.P. Morgan forecast: Consensus
7.2
end Dec 09: 6.75
6.8 end Mar 10: 6.70
end Jun 10: 6.65 J.P. Morgan
6.4
6.0
Sep 04 Dec 05 Feb 07 Apr 08 Jul 09 Sep 10
While Rmb was largely stable versus U.S.$ in 2H09, we expect Rmb shall resume
appreciation in FY10 (J.P. Morgan’s economics team forecasts Rmb/US$ will reach
6.5 by end-10) due to:
1) The ongoing recovery of exports should reduce the government’s concern over
Rmb appreciation on export-related jobs. Notably, the sequential trend growth for
China’s exports has come out of the negative territory entering 2H09 and currently
hovers around 20% 3m/3m, saar.

%3m/3m, saar Exports Imports
80
60
40
20
0
-20
-40
-60
-80
2002 2003 2004 2005 2006 2007 2008 2009
2) Inflationary pressure is building up, making Rmb appreciation a powerful tool to

counter inflation for the medium term. The rising food inflation since mid-09, and
the recent hike in gasoline and diesel prices, as well as the widely anticipated price
liberalization for gas, water and power, all suggest that rising inflationary pressure is
emerging.
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Figure 76: Consumer price inflation

%oy a
9
7
5
3
1
-1
-3
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Figure 77: Rmb NEER, REER and CPI inflation

CNY NEER, REER and CPI inflation headline inflation will emerge mid next
index , 2000=100, +=appreciation year; RMB appreciation a crucial tool %oy a
to temper this pressure
120 10
Headline CPI
115 REER 8
NEER inflation
110 6
105 4
100 2
95 0
90 -2
2003 2004 2005 2006 2007 2008
Figure 78: CPI—Food prices: Sequential trend growth
%3m/3m, saar
40
30
20
10
0
-10
2003 2004 2005 2006 2007 2008 2009
Impact: Neutral on China’s auto sector

We hold that Rmb appreciation is largely neutral on China’s auto sector.
On one hand, Chinese auto producers will benefit from their US$-denominated cost,
although the impact should be limited due to the high localization rate for most listed
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vehicles, except for Brilliance China, whose BMW JV only has a 40% localization
rate.
On the other hand, medium and high-end auto producers will be subject to increased
competition from imports, in our view. Given an Rmb appreciation, imported
vehicles’ purchasing cost will be lower, thus increasing the pricing pressure on
medium- and high-end vehicles. Hence, Denway, which gets a large part of its
earnings from its upper-medium Accord models, and Brilliance China, which could
post around 60% of its FY10 earnings from BMW cars, will likely be negatively
affected.
Winners: DongFeng Motor—DongFeng’s exports only account for less than 1% of

its total sales income. This means that Rmb appreciation would have a very limited
impact on its bottom line. On the other hand, DongFeng Motor should benefit from
Rmb appreciation, as about 20% of its costs are denominated in US$.
Losers: Great Wall Motor, Sinotruk, Weichai and Qingling—as exports account for
7% of Great Wall Motor’s sales; 8% of Sinotruk’s sales; 8% of Weichai’s sales; and
3% of Qingling’s sales. None of these companies have US$-denominated costs to
hedge the negative impact of Rmb appreciation on their sales income.
Change 3: Gasoline consumption growth lagging passenger vehicles’ sales

growth
China sold 8,190,293 new passenger vehicles in the first 10 months of 2009, up 45%
Y/Y. Among these, sales of gasoline-fired passenger vehicles recorded 8,127,388, up
45% Y/Y.
On other hand, China’s gasoline consumption rose only 8% Y/Y in the first 10
months of 2009, well below the sales growth of new passenger vehicles.
This has caused many China bears to cast doubt over the authenticity of the new
vehicle sales in China. Some come up with the theory that maybe Chinese
government has bought a lot of cars this year before having them stored at
warehouses to boost the “nominal consumption”. We disagree with the above
cynical view, and help to explain the discrepancy between the sales growth of
passenger vehicles and that of gasoline consumption as follows
Impact
1) The change in sales mix toward cars with an engine size below 1.6 liters due to
the vehicle purchase tax cut for cars with an engine size below 1.6 liters.
The sales of cars with an engine size of 1.6 liters and below which qualify for the
preferential 5% vehicle purchase tax accounted for 70% of total passenger vehicle
sales in the first ten months of 2009.
On comparison, the sales of cars with an engine size below 1.6 liters accounted for
62% of total passenger vehicle sales in the same period of 2008.
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Figure 79: China autos—Sales of vehicles with an engine size below 1.6 liters as a
% of total car sales
Source: CEIC.
2) Gasoline consumption is driven by the vehicle fleet size rather than by the new
vehicle sales.
We believe it is reasonable to compare gasoline consumption growth with the car
fleet size increase rather than the new car sales growth,
The gasoline consumption, among others, is driven by the fleet size growth ( the old
fleet size plus the new vehicle sales minus the scrapped vehicles), and the average
cars’ mileage change.
Based on the new car sales of 8,190,293 in the first 10 months of 2009 and assuming
the average usage life of a passenger car be ten years, we estimate the total number
of cars running on the road rose 20% Y/Y in the first ten months of 2009. This is
apparently lower than the 45% sales growth of the new passenger vehicles during the
same period.
Figure 80: China autos—Cars on road vs. gasoline consumption per car
Source: CEIC.
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3) Fuel cost hike encouraging people to reduce their car usage

On November 10, 2009, China’s National Development and Reform Commission
(NDRC) raised gasoline and diesel prices by Rmb480 per ton, After the adjustment,
the benchmark gasoline and diesel retail prices will increase to Rmb7,100 per ton and
Rmb6,360 per ton, respectively.
Table 29: China—Price change for gasoline and diesel year to date
Gasoline price change Diesel price change
(Rmb/ton) (Rmb/ton)
15-Jan-2009 -140 -160
25-Mar-2009 +290 +180
1-Jun-2009 +400 +400
30-Jun-2009 +600 +600
29-Jul-2009 -220 -220
2-Sep-2009 +300 +300
10-Nov-2010 +480 +480
Source: NDRC, J.P. Morgan.
Table 30: Retail price increase for gasoline and diesel in Shanghai as of November 10, 2009
Before price hike After price hike Change
(Rmb/liter) (Rmb/liter) (Rmb/liter)
93# gasoline 5.9 6.61 0.71
97# gasoline 6.27 7.03 0.76
98# gasoline 6.85 7.61 0.76
0# diesel 5.64 6.5 0.86

We believe the continuous increase in fuel prices has caused people to reduce usage
of cars. Instead of driving their cars on a daily, some people may choose to take
public transportation modes such as the subway during the weekdays and to drive on
weekends so as to save costs. This should bring down the average mileage of the
vehicles.
By our estimates, the recent fuel price hike could increase the fuel bill of the owner
of a small car (Fit), and an upper-medium-end car (Accord) by Rmb548 p.a. and
Rmb1,186 p.a., respectively.
Table 31: China autos—Impact of fuel price hike on the recurrent usage cost of car owners
Fuel consumption Gasoline Expense rise on per Monthly Annual expense Annual expense Recurrent
(97#) liter gasoline mileage before fuel price after fuel price hike usage cost
hike increase
(Rmb/liter) (Rmb/liter) (kms) (Rmb) (Rmb) (Rmb)

Accord 13 liter/100 km 7.03 0.76 1,000 9,781 10,967 1,186
Parking expense 9,600 9,600 0
Maintenance expense 1,800 1,800 0
Insurance 6,000 6,000 0
Total 27,181 28,367 1,186
Fit 6 liter/100 km 7.03 0.76 1,000 4,514 5,062 548
Parking expense 9,600 9,600 0
Maintenance expense 1,040 1,040 0
Insurance 4,000 4,000 0
Total 19,154 19,702 548
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Change 4: China to expand the scope of vehicles that qualify for the preferential
vehicle purchase tax?
On November 28, 2009, Shanghai Securities News reported that China’s National
Development and Reform Commission and the Ministry of Finance had recently
reached an agreement to renew the preferential policies that were introduced this year
to boost car consumption, and that the government would consider expanding the
scope of vehicles that qualify for the 5% preferential vehicle purchase tax (versus
China’s normal vehicle purchase tax of 10%).
The report has brought about a strong rally for China auto stocks, with Denway up
21% and DongFeng up 10% since November 30, 2009, respectively.
Earlier this year, on November 17, FY09, Mr. Zhu Hong, the spokesperson for
China’s Industrial and Information Ministry, the direct governing authority of
China’s automotive industry, noted that China would consider renewing the
preferential policies introduced this year to boost car consumption.
Impact
We believe the positive impact should be very limited if the scope of preferential
vehicle purchase tax is only expanded to vehicles with an engine size of 1.8 liters and
below (versus the current scope of vehicles with an engine size of 1.6 liters and
below).
This is because:
1) The positive impact of the preferential vehicle purchase tax on China autos should
be through the boost in sales of the vehicles that receive the preferential vehicle
purchase tax. The vehicle purchase tax cut, which is charged at the consumer level,
will not directly affect the auto producers’ profitability.
On contrast, the change of the consumption tax, which is charged at the producer
level, will directly affect the auto producers’ profitability.
2) The medium-end cars (with an engine size of between 1.6 liters and 1.8 liters) sell
well in China even without the help of preferential vehicle purchase tax. Hence, the
marginal impact of applying the preferential vehicle purchase tax for this category is
rather limited, in our view.
3) The profitability of the medium-end cars and of low-end cars is well below that of
the upper-medium and high-end cars. For instance, Denway’s 50%-owned
Guangzhou Honda derived 84% of its 1H09 profit from its Accord and Odyssey
models, which are all fitted with engines of 2.0 liters and above. The low-end Fit
model and medium-end City model together accounted for 43% of its 1H09 sales
mix, but only 16% of its 1H09 profit.
Hence, the marginal impact of extending the preferential vehicle purchase tax to
include vehicles with an engine of 1.8 liters on Denway should be very limited.
Denway sold 7,158 City models with an engine size of 1.8 liters, and 42,389 City
models with an engine size of 1.5 liters in 1H09, accounting for 4% and 26% of its
1H09 total vehicle sales, respectively.
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Assuming the sales of its City model with an engine size of 1.8 liters would rise by
20% in response to the possible change in vehicle purchase tax to extend the
preferential vehicle purchase tax to vehicles with an engine size of 1.8 liters and
below, we could see only 1% upward revision in our FY10 earnings forecast for
Denway.
China autos should get a boost in profit only if China extends the scope of
preferential vehicle purchase tax to the upper-medium-end segment, i.e., vehicles
with an engine size of 2.0 liters to 3.0 liters.
We take Denway as an example: Accord with an engine size of 2.4 liters accounted
for 36% of Denway’s total Accord sales. We believe the likelihood of expanding the
scope of vehicles to receive preferential vehicle purchase tax to vehicles with an
engine size of 2.4 liters and below is small, as it conflicts with the government’s aim
of promoting fuel efficiency.
At most, we expect the government to expand the scope of vehicles that will receive
preferential vehicle purchase tax to vehicles with an engine size of 2.0 liters and
below. Under this scenario, Denway’s Accord model fitted with a 2.0 liter engine,
will benefit from the revised policy, in our view. Denway’s Accord model with 2.0
liter engine sold 51,108 units in 1H09, accounting for 31% of its 1H09 total sales and
around 42% of its 1H09 profit.
Assuming the sales of its Accord model with 2.0 engines and City model with 1.8
engines be given a 20% boost as a result of the possible extension of the preferential
vehicle purchase tax to vehicles with an engine size of 2.0 liters and below, we could
see a 7% upward revision in our FY10 earnings forecast for Denway
Table 32: J.P. Morgan forecasts: Vehicles with different engine sizes as a percentage of total vehicle sales of major auto producers in
China in FY10E
Denway DongFeng Great Wall Brilliance China
Cars with an engine size of 1.6 liters and below 41% 50% 57% 53%
Cars with an engine size between 1.6 liters and 1.8 liters (1.8 liters included) 3% 9% 0% 9.7%
Cars with an engine size between 1.8 liters and 2.0 liters (2.0 liters included) 32% 12% 0% 0.6%
Cars with an engine size above 2.0 liters 24% 29% 43% 36.8%
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Table 33: Impact on the FY10E earnings of major auto producers in China under two scenarios: 1) 20% rise in sales of vehicles with an
engine size between 1.6 liters and 1.8 liters; 2) 20% rise in sales of vehicles with an engine size between 1.8 liters and 2.0 liters
Denway DongFeng Great Wall Brilliance
Motor Motor China
Scenarios 1:
20% rise in sales of vehicles with an engine size between 1.6 liters and 0.5% 3% n.a. n.a.
1.8 liters (1.8 liters included)
Scenarios 2
20% rise in sales of vehicles with an engine size between 1.8 liters and 7% 5% n.a. n.a.
2.0 liters (both 1.8 liters and 2.0 liters included)
Source: J.P. Morgan estimates. Note: 21We expect Brilliance China to dispose of its Zhonghua sedan business in FY10. Thus, Brilliance China will not have models with engine sizes of 1.8 liters
and 2.0 liters. Scenarios 1 is based on the assumption that the vehicles with an engine size of 1.6 liter of 1.8 liters to 2.0 liters get a 20% growth in sales on the adoption of the assumed lower
vehicle purchase tax.
Information
Information 1: BMW JV expanding capacity in China
Brilliance China and BMW recently announced a plan to spend Rmb5 billion to
expand the capacity of their JV. According to the plan, the BMW JV will expand the
capacity of its first plant from 40,000 units currently to 75,000 units by the end of
FY10 before further expanding it to 100,000 units. Meanwhile, the JV plans to build
its second plant with an initial capacity of 100,000 units, which will further increase
to 300,000 units. Hence, the BMW JV will eventually have a total capacity of
400,000 units in China. In addition, the JV will also build an engine plant in China
for its BMW JV to help reduce the production cost of BMW cars in China. BMW
also confirmed Brilliance China as its sole and exclusive partner in China.
Impact: Positive for Brilliance China

We see the news as a positive for Brilliance China, which has emerged as a Chinese
auto company with strong growth potential in China after its recent restructuring.
After the sale of its loss-making Zhonghua sedan business to its parent company,
Brilliance China’s business is now mainly comprised of its minivan business, which
has the largest market share in China, and the 49.5%-owned BMW JV. Following its
efforts in the past few years to increase the localization content to above 40%, and
reducing the purchase cost of auto parts , Brilliance China’s BMW JV has entered
the “harvest time”, in our view. We expect the profit contribution from its BMW JV
to double H/H to over Rmb210 million in 2H09.
We expect the BMW JV to sell 42,000 units in FY09, which will likely rise to 50,000
units in FY10. We expect the profit contribution from its BMW JV to rise from
Rmb317 million in FY09 to Rmb514 million in FY11, driven by robust demand and
gradual improvement in its margins due to expanded economy of scale and reduced
production cost. In comparison, Brilliance China’s management has set a more
aggressive target of doubling the profit contribution from its BMW JV from FY09 to
FY11.
Information 2: China’s vehicle export was still weak in October

After a slight M/M rebound in September 2009, China’s vehicle exports fell again in
October 2009, reflecting the weak overseas demand.
China exported 28,859 vehicles in October 2009, down 5.26% M/M and 26.86%
Y/Y. For the first 10 months, China exported 248,600 vehicles, down 54.5% Y/Y.
Among these, China exported 106,935 passenger vehicles, down 65.38% Y/Y, and
141,665 commercial vehicles, down 40.46% Y/Y. China’s top three auto exporters
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this year are: Chery, Great Wall Motor, and Guangzhou Auto, which exported
31,899, 26,346, and 23,336 vehicles in the first 10 months of this year, respectively.
Impact: Negative for China’s auto exporters

We see the news as a negative for China’s auto exporters such as Great Wall Motor.
Great Wall Motor exported 25,000 vehicles in the first 10 months of this year, down
48% Y/Y. In 2009, we expect Great Wall Motor to export only 30,000 vehicles,
representing only 16% of its total forecast sale for FY09.
Non-consensus calls
Qingling Motors Co: Sacrificing margins for sales
(UW, 1122.HK, HK$2.26, PT: HK$1.95)
(Extracted from the note, “Qingling Motors Co: Sacrificing margins for sales,"
published on 13 November 2009; please see the original note for pricing dates)
• We expect Qingling’s sales volume to rise 22% to 43,000 in FY09: We expect

22% Y/Y growth in Qingling’s FY09E sales volume, to be driven by: a) rising
demand for commercial vehicles in China due to China’s robust fixed asset
investment growth; and b) the hefty 20% price cut for its light trucks fitted with
100 horse power engines in the beginning of 2009.
• Gross margin under pressure: Qingling Motors seems to have adopted a
strategy of boosting vehicle sales through competitive sales price reductions, i.e.
sacrificing gross margins for sales volume growth. It cut selling prices by 20%
for its pick-up trucks in FY08, and that of its light trucks fitted with 100 horse
power engines in FY09 to boost sales, bringing down its gross margin from
17.8% in FY07 to 17.2% in FY08, and around 15.3% in FY09. Going forward,
we believe it is likely to cut selling prices of its light trucks fitted with 600 horse
power engines, which will further erode its gross margins.
• We maintain UW: We cut our FY09 earnings estimates by 4% to Rmb252
million, to factor in the lower gross margin assumption. Unless it undertakes a
restructuring to shed its low-return businesses of heavy trucks and medium trucks
to focus on the light truck sector, and/or return excess cash to shareholders, we
continue to see Qingling as a valuation trap. We maintain our Underweight rating
given: 1) its gross margin could continue to be under pressure from rising
competition in China’s truck sector; 2) poor capital management and a diversified
product strategy; and 3) its low ROE of 4% in FY10E. Given the improved
demand outlook for commercial vehicles on the back of the rising economic
growth in China, we raised our Jun-10 price target from HK$1 to HK$1.95,
which is based on 0.6x FY10E P/B, or 20% above its average 0.5x P/B since
January 2002, when the company increased its shares outstanding by 22% to
2,482 million through the conversion of its CBs and option exercise by its parent.
Key risks to our price target are: 1) stiffer–than-expected pricing pressure; 2)
higher-than-expected steel cost hike; and 3) the possible failure of its new
products to be accepted by the Chinese market.
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FY09 sales volume to go up 22% Y/Y

We expect Qingling’s sales volume to rise 22% to 43,000 in FY09, of which light
trucks and pick-up trucks could account for 38,000, medium-sized trucks at 3,500,
and heavy trucks at 1,000.
Among other things, our FY09 sales growth estimate of 22% Y/Y for Qingling
Motor is due to:
1) The rising demand for commercial vehicles in China due to robust fixed asset
investment growth and the Chinese government’s policy of providing Rmb5 billion
financial subsidy to help farmers upgrade from three-wheeled and/or low-speed
agricultural vehicles to light trucks and mini vans.
In the first 10 months of this year, China’s light truck sales have risen 20% Y/Y to
1,264,685.
Figure 81: China’s fixed asset investment growth
Source: SSB, J.P. Morgan.
79
(852) 2800-8511 19 December 2009
Figure 82: Monthly sales of China’s light trucks in 2008 and 2009
180000
160000
140000
120000
100000
80000
60000
40000
20000
0
1 2 3 4 5 6 7 8 9 10 11 12
2008 2009
Source: CAAM.
2) The hefty 20% price cut for its 100 horse power light trucks in the beginning of
2009.
The 100 horsepower light trucks normally account for one-third of its total sales
volume.
According to management, Qingling recorded vehicle sales of 36,000 in the first 10

months of 2009. Qingling will need to sell 3,500 vehicles a month in both November
and December to meet our FY09 sales volume estimate of 43,000.
Gross margin on a downward trend

As mentioned above, Qingling Motors seems to have adopted a strategy of boosting
vehicle sales through competitive sales price reductions, i.e., sacrificing gross
margins for sales volume growth.
For example, the company cut the selling prices of its pick-up trucks by 20% in the
beginning of FY08 in an effort to maintain its market share under increasing
competition from other pick-up truck producers such as Great Wall Motor and
Jiangling Motors, which tend to produce pick-up trucks with a better price
performance ratio in China.
Entering FY09, Qingling Motors cut sales prices of its light trucks fitted with 100
horse power engines, which normally account for one-third of its total sales volume,
by 20% in an effort to boost sales.
Going forward, we expect Qingling Motors to cut selling prices of its 600
horsepower light trucks if it wants to maintain its current small market share of
around 2% in China’s light truck market.
80
(852) 2800-8511 19 December 2009
Hence, we expect Qingling’s gross margin to continue to come under continued price
cut pressure due to increasing competition.
In fact, Qingling’s gross margin has already declined from 17.8% in FY07 to 17.2%
in FY08, which, we expect, to drop further to 15.3% and 15% in FY09 and FY10,
respectively.
Table 34: Qingling Motors’ gross margins from FY07 to FY10E

FY07 FY08 FY09E FY10E
Gross margins 17.8% 17.2% 15.3% 15%

Source: Company data, J.P. Morgan estimates.
The export-oriented Isuzu JV is not expected to become a

major earnings driver in the foreseeable future
Qingling Motors has a 50:50 JV with Isuzu, which started operations in November
FY07.
The JV, with a registered capital of Rmb680 million and an investment of Rmb1.5
billion, is devoted to the production of engines for supply to Qingling and Isuzu and
other customers in China. According to its development plan, the engine JV should
boost its annual capacity from 100,000 units to 175,000 units by 2012.
Many investors have significant expectations on the JV to become a major earnings

driver for the company on expectation of strong export orders from Isuzu group.
In fact, its engine JV with Isuzu had contributed a profit of only Rmb9 million in
FY08.
The JV is expected to sell around 45,000 engines in FY09, which are mainly sold to
Qingling itself rather than exported to Isuzu’s other overseas operations. Given the
financial crisis, the export market remains rather weak.
Contrary to public belief, we do not expect the JV to become a major earnings driver
for the company in the foreseeable future, given the weak export market.
The sale of medium and heavy trucks below expectation

Management now expects its medium-sized trucks, which were launched in July
2008, to fetch sales volume of 3,500 in 2009, versus its original sales target of 4,000.
Medium-sized trucks are expected to be priced at Rmb120,000 per unit, versus its
domestic peers’ sales price of around Rmb80,000.
We do not expect its medium-sized trucks to become a major earnings driver for the
company, given its limited sales volume.
Meanwhile, its heavy truck sales continue to disappoint, with FY09 sales volume
expected to be flat at around 1,000. On comparison, its domestic competitors such as
Sinotruk and DongFeng Motor have started to see a sharp jump in heavy truck sales
due to rising fixed asset investment growth. We believe the weak sales of Qingling’s
heavy trucks are largely due to its high sales prices. While Qingling’s heavy trucks
81
(852) 2800-8511 19 December 2009
are sold at prices between Rmb350,000 and over Rmb400,000, Sinotruk’s heavy
trucks are priced around Rmb230,000 per unit.
Earnings estimate revision and PT hike

We cut our FY09 earnings estimates by 4% to Rmb252 million, to mainly factor in
our lower gross margin assumptions.
Going forward, we expect Qingling’s net profit to rise 13% Y/Y in FY10 before
rising 7% Y/Y in FY11.
Earnings-based valuation
At HK$2.26, Qingling’s stock is trading at 19.6x FY09E P/E, down to 17.3x in
FY10E, which still puts Qingling among the most expensive names in China’s auto
space.
Asset-based valuation
Meanwhile, on an asset basis, it is very cheap. A price of HK$2.26 puts it at 0.7x
FY09E P/B, declining to 0.684x in FY10E.
We maintain our Underweight rating on Qingling, given:
1) Its gross margin could continue to be under pressure from rising competition in
China’s truck sector.
2) Poor capital management which is reflected in:
a) Diversified product strategy:
The company is a marginal player in a niche market, with a share of around 2% in

China’s light truck sector.
Instead of focusing on one sector, such as the light truck sector, Qingling Motors has
adopted a diversified product strategy, i.e. producing light trucks, multi-purpose
vehicles, heavy trucks and pick-up trucks at the same time. We believe such a poor
capital management has made it difficult for the company to gain a competitive
advantage for its products.
For example, its heavy truck business, which accounts for 45% of its fixed assets, is
generating a very small investment return, given: i) its high selling price—heavy
trucks, which are based on Isuzu technology, are sold at prices between Rmb350,000
and over Rmb400,000, versus Rmb230,0000 for Sinotruk’s heavy trucks; b) its small
scale—Qingling’s market share in China’s heavy truck market is less than 1%.
b) Despite its strong balance with a net cash per share of Rmb1.69 by end-FY08, the
company is expected to return cash to shareholders, given its diversified product
strategy that entails continued investments in new areas of low investment returns.
3) Low ROE of 3.6% and 4% expected in FY09 and FY10, respectively.
Qingling’s stock is trading at a prospective P/B band of between 0.2x and 0.8x since
January 2002, with an average P/B ratio of 0.5x.
82
(852) 2800-8511 19 December 2009
Figure 83: Qingling Motors’ prospective P/B band

0.9
0.8
0.7 +2 standard dev iation
0.6 +1 standard dev iation
0.5
av erage
0.4
-1 standard dev iation
0.3
-2 standard dev iation
0.2
0.1
0.0
1
8
c-0
c-0
c-0
c-0
c-0
c-0
c-0
c-0
De
De
De
De
De
De
De
De
As shown Figure 83, Qingling is noSure.Now already trading at the high end of its
historical prospective P/B band since January 2002 when the company increased its
shares outstanding by 22% to 2,482 million through the conversion of its CBs and
option exercise by its parent.
Our Jun-10 price target of HK$1.95 is based on 0.6x FY10E P/B, 20% above its
average 0.5x P/B since January 2002.
To put it in a nutshell, we believe, in the short-term, its share price may be boosted
by the abundant liquidity in the current capital market. Some investors may overlook
its problems of poor capital management, low investment return of only 4.1% in
FY10E, and poor liquidity, and decide to focus on is cheap asset-based valuation as
an excuse to drive up its share prices.
However, unless the company can undertake a restructuring to shed its low-return
businesses of heavy trucks and medium trucks to focus on the light truck sector,
and/or return excess cash to shareholders, we continue to see the stock to be in a
valuation trap and refrain from upgrading the stock.
Our key concerns on the stock include : 1) its poor capital management; 2) its
business could be negatively impacted by the expected slowdown in China’s fixed
asset investment growth in FY11; and 3) the expected further erosion in its gross
margins.
We will revisit our view if the company drastically boosts its ROE through measures
such as giving cash back to shareholders and sharply increases its operating margin
through effective cost control.
Risks to our price target are: 1) more intense-than-expected pricing pressure; 2)

higher-than-expected steel cost hike; and 3) the possible failure of its new products to
be accepted by the Chinese market.
83
(852) 2800-8511 19 December 2009
Consumer
Jasmine Bai AC Huabao International Holdings Limited: New business
(852) 2800-8559
jasmine.d.bai@jpmorgan.com prospects
Vineet Sharma, CFA (This note was originally published on 4 December 2009; please see the original
(852) 2800-8523
vineet.k.sharma@jpmorgan.com note for pricing dates)
• 1HFY10 net profit in line with expectations; Revenue was 5% lower;
operating profit 2% higher than expectations. Results did not beat consensus
as in prior periods owing to fewer acquisitions. Management is still very
comfortable with previous guidance to double sales in three years.
• 45% dividend payout is a positive signal. This is a record-high dividend

payout. The previous dividend payout was 30%. In FY09, the payout ratio
increased to 38%, and further to the current 45%.
• New business prospects include: 1) new material for cigarettes;

management expects sales to kick in next year. 2) upstream aromatic
material; Huabao has two bases in Wuxi and Botswana; 3) F&B flavor:
Huabao entered the business in 2007; we estimate EBIT contribution at 3%
in the last six months. New business will be expanded organically and
through acquisition. We expect more acquisitions to come.
• Neutral, Dec-10 target price of HK$9.5. Our forecasts remain unchanged.

We value the stock at 19x March 2011E earnings, which is based on a 20%
discount to the average for China Staples. Risks include continued selling
from management and limited interest in owning a defensive business. As
the company did not beat market estimates as it had in the past, this may
lead to short-term downward pressure on the stock, offering opportunities to
accumulate on declines.
• Potential re-rate catalyst: The market has currently accorded a valuation

discount to Huabao. We believe multiple expansion needs to be driven by:
1) a higher dividend payout; 2) more contribution from F&B flavor
business; 3) future direct acquisitions; and 4) strong results as profits from
new businesses begin to kick in.
84
(852) 2800-8511 19 December 2009
EBITDA EPS
Huabao International is a leading tobacco Sales volume growth assumption
flavor manufacturer in China. As of 2008, it
was a key supplier to nine out of 10 top Impact of a 1% increase 0.58% 0.7%
tobacco brands and has about a 50% market Gross margin assumption
share among Top 10 brands. The company is Impact of a 1% increase 1.08% 1.3%
expected to benefit from consolidation of
Operating expense assumption
China’s tobacco industry and the reduction
of tar in Chinese cigarettes. Huabao also Impact of a 5% increase -1.33% -1.60%
entered the food flavor sector in 2004.
Source: Company and J.P. Morgan

estimate.s
Price target and valuation analysis

We value the stock at 19x March 2011E earnings,
which is based on a 20% discount to the average for
China Staples.
Revenue breakdown, FY09
Key risks: Continued selling from management and

Source: Company data. limited interest in owning a defensive business. Low
visibility of new business at this point.
EPS: J.P. Morgan vs. consensus
J. P. Morgan Consensus
FY10E 0.430 0.428

FY11E 0.524 0.491
Peer group valuation comparison table
Company Ticker Rating Price PT Mkt cap P/E P/B
(HK$) (HK$) (USD MM) FY08 FY09E FY10E FY09E FY10E
Tobacco and tobacco flavors
China Flavors & Fragrances^ 3318 HK NR 1.55 97 22.8 7.6 10.5 0.9 0.9
China Staples Universe
Tingyi 322 HK N 19.98 17.40 14,403 54.9 36.8 30.3 9.9 8.3
China Resources Enterprise 291 HK N 26.3 27.00 8,129 35.1 31.7 24.6 2.4 2.3
Hengan International 1044 HK N 57 43.00 8,968 51.8 33.3 29.5 8.0 7.2
Sector average 41.1 27.4 23.7 5.3 4.7
Source: Bloomberg, J.P. Morgan estimates. Prices as of the close on December 3, 2009. Consensus estimates used for NR stocks.
85
(852) 2800-8511 19 December 2009
1HFY10 net profit in line with expectations

1HFY10 results came in with revenue 5% lower, operating profit 2% higher, and net
profit in line with our expectations. Results did not beat consensus as in previous
times owing to fewer acquisitions. Management is still very comfortable with the
previous guidance to double sales in three years.
Revenue growth was 22%, lower than the full-year guidance of 30% because only a
small acquisition occurred in August. The company expects higher growth in the
second half.
Operating margin improved 190bp owing to economies of scale. Results for tobacco
flavor and food flavor segments are not disclosed separately. Management indicated
at the analyst meeting that tobacco flavor sales grew 19.2%, gross margin was stable.
Food flavor revenue growth was around 40%, gross margin improved.
Table 35: Huabao 1H10 results review

yoy hoh Actural vs.
HK$ 000 1H08 2H08 1H09 2H09 1H10
change change estimate
Revenue 643,551 775,586 892,109 1,046,324 1,088,854 22% 4% -5%
Cost -164,607 -191,382 -220,044 -257,428 -266,587 -7%
Gross profit 478,944 584,204 672,065 788,906 822,267 22% 4% -4%
Gross margin 74.4% 75.3% 75.3% 75.4% 75.5%
other income 6,587 33,961 27,531 12,126 17,756
SG&A -95,942 -117,853 -147,763 -153,040 -145,871
Operating profit 389,589 500,312 551,833 647,992 694,152 26% 7% 2%

Operating margin 60.5% 64.5% 61.9% 61.9% 63.8%
PBT 398,120 505,880 560,226 651,642 700,789 25% 8% 0%

Net profit to shareholders 374,487 487,658 517,256 597,437 610,927 18% 2% 0%
Source: J.P. Morgan estimates, company data.
45% dividend payout is a positive signal

This is a record-high dividend payout. Previously, the company’s payout ratio was
30%. In FY09, the payout increased to 38%, and further to the current 45%.
New business prospects

Management talked about three new business areas. The development strategy is
similar to tobacco flavor: organic growth + acquisition. Management indicated that
margins for new business will be similar to current levels. Capex guidance is for
HK$30MM-HK$40MM per year but no details were given for how much will be
spent for acquisitions. We expect more acquisitions to come for new business
development.
New material for cigarettes. Management estimates the market at Rmb20B. Growth
drivers of the market are: 1) High-end cigarette market is growing faster but high-end
tobacco leaves cannot meet the demand. New material can help to enhance the
quality. 2) Further cuts in tar content will necessitate new materials. Management
expects sales to kick in next year.
F&B and restaurant–related products. Management estimates the market to be

Rmb30B. The company entered the business in 2007 through acquisition. In FY09,
86
(852) 2800-8511 19 December 2009
the EBIT of F&B flavor contributed 2% of total EBIT. We believe this percentage
will increase to around 3%.
Upstream aromatic material. Huabao already has two units in upstream. One is
Wuxi Fuhua and Wuxi jiahua established in 2004/2005. The other F&G (Botswana)
was acquired last week.
Potential re-rate catalyst

The shares are currently trading at 19x March 2010E, 16x March 2011E earnings.
The market has accorded a valuation discount to Huabao. We believe a re-rate needs
to be driven by transparency improvement. The catalyst could include:
1) More dividend payouts
2) Direct transaction in acquisitions
3) Larger portion of EBIT from the F&B flavor business. Among the current
business and new business prospects, F&B flavor has a more diversified client base
and a different distribution system. If Huabao delivers strong results from F&B and
restaurant–related flavor business, it will be evident that the company has a strong
capacity to expand its franchise in the flavor business.
4) Ongoing strong earnings
Neutral, Jun-10 PT HK$ 9.5

We leave our forecasts unchanged. We value the stock at 19x Mar 2011E earnings.
Our target price is based on a 20% discount to the average of the China consumer
staple universe. Risks include continued selling from management and limited
interest in owning a defensive business.
We believe the stock may offer opportunities to accumulate on declines. Huabao’s

earnings did not beat market estimates as they had in the past; this may lead to short-
term downward pressure. Further declines might put forward multiples at such a
large discount to the China Staples universe, presenting opportunities to buy on
declines.
87
(852) 2800-8511 19 December 2009
China Mengniu Dairy Co. Ltd.: More confident about

product mix improvement; more initiatives in the milk
Jasmine Bai A C powder business
(852) 2800-8559
jasmine.d.bai@jpmorgan.com (This note was originally published on 8 December 2009; please see the original
Vineet Sharma, CFA note for pricing dates)
(852) 2800-8523
vineet.k.sharma@jpmorgan.com
• We are more confident about the product mix improvement; positive
changes in the milk powder business: We believe sales of Deluxe brands
have fully recovered. The company is planning new high-end product
launches early next year. We believe trading up by consumers after the
melamine incident and better raw milk quality will help improve the product
mix further. Mengniu has taken many initiatives to manage Mengniu Arla,
the 50:50 JV for the milk powder business. The JV has not performed well
since its inception in 2005. The reason could be that the operating
environment in China’s dairy sector is very different from the developed
market. Given Mengniu’s understanding of the Chinese market and its
strength in distribution, we expect upside potential from the business.
• Rising raw milk prices are not a concern: Mengniu sources 60%-70% of
raw milk through long-term exclusive contracts signed for 30-50 years, and
the volume, quality, and price are reset every year. We do not expect
significant changes in contract prices. Even if the market price of raw milk
increases backed by a global milk powder rally, we believe Mengniu will be
better positioned than competitors due to low-cost pressure.
• Option granting a positive: Mengniu had announced the granting of

89MM share options on November 24, at a strike price of HK$24.4, vesting
in three years. We were concerned about apparent investor worries over less
management incentive and earnings dilution after COFCO-HOPU became
the largest shareholder in Mengniu. After the option granting, we believe
these concerns should ease somewhat.
• We raise our FY10 earning ex-option expense estimate by 9% and Dec-

10 PT to HK$32, implying 30x FY10E headline net profit. On a cash basis,
the implied P/E is 24x FY10E. Key risks to our PT include: 1) another surge
in selling expenses; and 2) unexpected changes in raw milk prices.
88
(852) 2800-8511 19 December 2009
Company description Sensitivity analysis EBIT EPS
Mengniu is a leading dairy producer in Sales volume growth assumption (2010E)

China. Its major products include liquid Impact of a 1% increase 0.69% 1.5%
milk products and ice cream. In 2008, it ASP assumption (2010E)
was ranked No.1 in liquid milk, yogurt Impact of a 1% increase 13.72% 30%
and ice-cream sectors in the Chinese Operating expense assumption as % of sales
dairy industry. (2010E)
Impact of a 1% increase -20.13% -44%
Price target and valuation

analysis
We raised our Dec-10 PT to HK$32 from HK$23, based on
the DCF method. Free cash flow = cash flow from operation -
capex. We assume WACC of 11%, terminal growth rate from
2018 at 2%, and risk-free rate of 4%. The increase in our PT
is due to our earnings estimate revisions.
Revenue breakdown, 2008
Risk-free rate: 4%
Market risk premium: 7%
Beta: 1
Debt/equity: 0%
Cost of debt: 6.00%
Terminal “g”: 2%
Excluding option expenses, we believe our net profit forecast

Source: Company data. is 3% and 6% above Bloomberg consensus for FY09/FY10.
Our price target implies 30x FY10E headline net profit, and
24x cash-based net profit for FY10E. Key risks to our PT
EPS: J.P. Morgan vs. consensus
include: 1) another surge in selling expenses; and 2)
J. P. Morgan
(including unexpected changes in raw milk prices.
new option Consensus
Rmb expense)
FY09E 0.77 0.74
FY10E 0.92 0.89

Peer comparison valuations
Company Ticker Rating Price PT Mkt cap P/E P/B
(HK$) (HK$) (US$ MM) FY08 FY09E FY10E FY09E FY10E
Tingyi 322 HK N 20.1 17.40 14,489 55.2 37.0 30.5 10.0 8.4
Uni-president China 220 HK N 5.57 4.70 2,587 31.5 22.9 20.3 2.9 2.6
Want Want^ 151 HK NR 5.54 9,442 35.7 32.5 24.6 8.8 7.4
China Huiyuan Juice 1886 HK UW 5.79 3.10 1,097 63.8 (34.7) 92.8 1.7 1.7
Sector average 46.5 14.4 42.1 5.8 5.0
Source: Bloomberg, J.P. Morgan estimates. Prices are as of December 7, 2009 close. ^Bloomberg consensus estimates are used.
89
(852) 2800-8511 19 December 2009
Earnings estimate changes

Table 36: Mengniu earnings estimate changes
Rmb in millions
Earnings estimate revisions 2009E 2010E
Previous Current change Previous Current change
Revenue 25,106 25,568 2% 27,239 28,561 5%
Gross margin 25.9% 25.9% 26.1% 26.2%
EBIT margin ex-option expense 7.7% 7.6% 8.1% 8.4%
Reporting net profit 1347 1339 -1% 1614 1600 -1%
Growth 20% 20%
Option expense 290 310 7% 250 460 84%
Net profit ex-option expense 1602 1612 1% 1831 2000 9%
Growth 14% 24%
In our Note, Food For Thought: Why we think dairy sector margins likely to
improve”, published on October 12, 2009, we note that the change in competition
dynamics (more rational pricing strategy and less A&P spending), product mix
improvement, and less capex spending in liquid milk will be major drivers. Our
analysis and discussions with management suggest that the company is more
confident about improving the product mix. Meanwhile, we do not think a raw milk
price increase is a concern as Mengniu sources 60%-70% of raw milk through
contract supply.
For FY09, we leave our earnings estimates largely unchanged. However, due to the
potential for more share option expense, we lower our reported net profit estimate by
1%.
For FY10, we raise our estimates for revenue by 5%, EBIT margin ex-option
expense by 0.1%, net profit ex-option expense by 9%, but lower our reporting net
profit estimate by 1% due to the potential for more option expense.
We note that there is a trade-off between top-line growth and margin. Our top-line
growth estimate is lower, but our EBIT margin estimate is higher than Bloomberg
consensus. If Mengniu extends its distribution to lower-tier cities and rural areas with
low-end products, it could surpass our sales estimates. Its margin could get diluted a
bit, but top line and earnings could have upside from the market expansion.
New products pipeline

The company has focused on product mix improvement this year. The Deluxe brands
have recovered well. After the restriction on OMP in February, Deluxe brands
dropped OMP and kept three other sub-brands . Sales of Deluxe brands have fully
recovered, in our view. The company is planning to launch new products by the end
of this year. We are more confident about the product mix improvement.
In 1H09, Mengniu had about 10% of sales from low-end products, which are plain
milk with tetra packaging, with the retail price at around Rmb2/250ml pack. These
products have gone through price cuts and their gross margin is below 20%. The
company’s high-margin products are mostly in milk beverage and yogurt categories.
Mengniu has increased the share of high-margin products from c0% of sales to 15%
in 1H09. We expect high-margin products, mid-margin products, and low-margin
products to grow 25%/10%/6% in FY10.
90
(852) 2800-8511 19 December 2009
Table 37: Mengniu product mix improvement assumptions

Sales Growth rate
Gross contribution in assumption
Product mix margin 1H09 2010 Products
25% Mostly in milk beverage and yogurt; for example, yogurt
High-end above 28% 15% with red date flavor, farm milk, milk with fruit, etc.
Mid-end 20-28% 75% 10%
Low-end below 20% 10% 6% Plain milk with tetra packaging, little differentiation
Source: Company data, J.P. Morgan.
Postive change in the milk powder business

Mengniu started its milk powder business in 2005 through its 50:50 joint venture
with Arla. The JV runs its production in Inner Mongolia for Mengniu Arla mid-range
powder products. So far, the JV has not worked very well. In 1H09, milk powder
sales were worth Rmb300-Rmb400 million. The capacity as of 1H09 was 1,9000
tons. We estimate the utilization rate was only 30%-40%.
Since mid-09, Mengniu has taken more management initiatives for Menngiu Arla,
which we think is a positive. The operating environment of the dairy sector is very
different from that of developed countries. Numerous international dairy companies
have attempted but failed to penetrate the Chinese dairy market since the late 1990s.
Some of them have retreated entirely from the market. In our view, the slow progress
of Mengniu Arla was another example. Now, given Mengniu’s more management
initiatives, its strength in market development, and improved raw milk quality, we
believe the milk powder business could provide upside potential in two or three
years.
Mengniu’s milk powder business has the Mengniu Arla brand. The selling price is
about Rmb160/can (900g). The selling price is similar to Yili, and c50% lower than
international brands. Its gross margin is more than 40%. We assume Rmb900 million
and Rmb1.4 billion sales, respectively, for FY10 and FY11.
Raw milk price is less volatile than the industry average

The company sources 60%-70% of raw milk through long-term contract supply,
among which 15%-20% comes from big ranches and 40%-50% from centralized
cow-raising centers. The remaining 30%-40% is from milk collection centers, where
price is more volatile. It has a contract with big ranches and centralized cow-raising
centers for 30-50 years for exclusive supply, but the volume, quality and price are
reset every year. According to management, the price for this year is Rmb2.8-2.9/kg,
and the company does not think the price hike will have a big impact on margins.
Table 38: Mengniu raw milk procurement

% of total raw milk procurement
Cattle ranch 15-20%
Centralized cow raising center 45-50%
Milk collection center 30-35%
Source: Company data, J.P. Morgan.
Option granting a positive

More management incentive
China Mengniu announced a total grant of 89.025 million share options to CEO
Yang Wenjun, CFO Yao Tongshan and Executive Director Bai Ying on November
91
(852) 2800-8511 19 December 2009
24. The strike price was HK$24.4, and will be vested in three batches with 20%, 40%
and 40% in three years, respectively.
We believe this is a positive for the company. After COFCO-HOPU became the
largest shareholder in Mengniu, there appeared to be investor concern over less
management incentive and earnings dilution. On July 17, the company had
announced that it would not go ahead with the proposed grant of an aggregate 88.8
million share options. On the next trading day, the share price dropped 2.3%, while
the HSI rose 3.7%. Now, with the grant of options, we believe these concerns should
ease somewhat.
High option expense is partly due to high share price volatility

Mengniu had granted about 85 million share options in 2008 and 89 million in 2009,
about 9% of its current shares. According to the share option scheme, the company
can grant 70 million more share options from now till 2014.
The option granting will book a high option expense in the P&L. The company
estimates an additional option expense of Rmb20 million in 2009 and Rmb210
million/Rms210 million for 2010/2011. The potential high option expense is partly
because the share price volatility was high.
Dec-10 price target of HK$32

Our DCF-based Dec-10 price target of HK$32 implies 30x FY10E headline net
profit. On a cash basis, this implies a P/E of 24x FY10E. Key risks to our price target
include: 1) another surge in selling expenses; and 2) unexpected changes in raw milk
prices.
92
(852) 2800-8511 19 December 2009
Energy
China energy demand—picking up
Brynjar Eirik Bustnes AC
China’s economy has been picking up very strongly in recent months due to the
(852) 2800-8578
brynjar.e.bustnes@jpmorgan.com
stimulus package being put in place in response to the global recession. This has also
impacted energy demand, including petroleum products and natural gas.
YTD apparent demand, ensuing refinery throughput plus net product imports, is up
3.6% and current apparent demand has now crossed the 8-million BOPD mark.
Domestic crude production has been relatively flat in the past few years, while
imports have had to make up for the demand growth. China has also now definitely
crossed the 50%-import dependency mark.
Figure 84: China imports over 50% of crude—Domestic production flat for many years (MM ton)
35
30
25
20
15
10
5
0
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Crude production Crude import
Source: Bloomberg data, J.P. Morgan estimates.
Due to the build-up of new refining capacity in China, the country has been able to
lower the import level of products. China has actually become a net exporter of both
gasoline and diesel in recent months, adding additional pressure on international
refining margins. Most of the product import is fuel oil, followed by LPG and some
naphtha this year.
Figure 85: China imports less products due to refinery capacity build-up in 2009 (MM ton)
35 15%
30 10%
25 5%
20 0%
15 -5%
10 -10%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Refinery T'put Product imports Y/Y Grow th (RHS)
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(852) 2800-8511 19 December 2009
Gasoline demand
Car sales in China have had a very strong sales growth period in recent months due
to stimulus from the government. Stimulus comes in the form of cash refund if an old
car is scrapped for a new one as well as lower sales tax on buying smaller engine
cars. The growth is particularly strong in the passenger vehicle sales segment,
expected to reach almost 50% in 2009 (15% next year). Commercial vehicle sales are
expected to grow around 25% in 2009 (8% next year). Gasoline demand growth has,
however, not really reacted to the strong car sales, and is hovering around the +/-
10% level.
Figure 86: China imports less products due to refinery capacity build-up in 2009 (MM ton)
7.5 30%
6.0 20%
4.5 10%
3.0 0%
1.5 -10%
0.0 -20%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apparent Gasoline Demand Y/Y Grow th (RHS)
Gasoline as a proportion of total oil demand in China has been relatively constant at
20%. It has picked up slightly in recent months due to the lagging demand growth of
diesel. We expect gasoline demand to remain at around 20%.
Figure 87: Gasoline demand grows in line with total products
2.00 9.00
1.75 7.75
1.50 6.50
1.25 5.25
1.00 4.00
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
China gasoline demand (mn BOPD) Ov erall demand (mn BOPD - RHS)
Looking at total car fleet data rather than sales growth, the car fleet in China has
grown around 20% in recent years. This is similar to what we have so far this year.
Compared to gasoline demand growth, the current level of gasoline demand growth
doesn’t appear to be very different from historical levels.
We can, however, come up with a few reasons to explain the possibly slightly lower
gasoline demand relative to car fleet growth so far this year. The best explanation, we
think, is probably that these cars are sold in second- and third-tier cities, which are
94
(852) 2800-8511 19 December 2009
smaller in size (i.e., less need to drive), owners are not as well off (drive less at
higher gasoline prices), some are second or third cars (again driven less), some cities
have limitations on when you can drive (odd/even number plates, which cause people
to buy another car without driving more), and finally more of the cars are smaller
(smaller than 1.6-litre engines), thereby consuming less gas.
Figure 88: Gasoline demand grows half of car fleet (MM vehicles)
50 40%
40 30%
30 20%
20 10%
10 0%
0 -10%
2004
2005
2006
2007
2008
2009
Car grow th (RHS) Gasoline cons grow th (RHS) Cars on road
Source: CEIC, Bloomberg data, J.P. Morgan estimates.
Looking at fuel efficiency in China is not easy considering the lack of data for car-
miles driven. Hence, we look at consumption per car per day. This efficiency
measure (prone to errors) shows that efficiency has doubled in the past five years
from 14 litre/car/day to less than 7 litre/car/day.
Figure 89: Efficiency doubled in China in past five years (MM cars)
50 14.0
40 10.5
30 7.0
20 3.5
10 -
2004
2005
2006
2007
2008
2009
Cars on road Gasoline usage/car(litres/day ), RHS
Source: CEIC, Bloomberg data, J.P. Morgan estimates.
Diesel demand
Demand for diesel in China has not picked up as expected on the back of the strong
economic performance, including industrial production data so far this year. It is
generally believed that diesel demand should be well correlated to IP, both from the
production but more so from the transportation of goods. Infrastructure build-up
should also require diesel and generate demand growth.
95
(852) 2800-8511 19 December 2009
Figure 90: Diesel demand growth still weak, but picking up (MM ton)
15 30%
12 20%
9 10%
6 0%
3 -10%
0 -20%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apparent Diesel Demand Y/Y Grow th (RHS)
As with power earlier this year, diesel did not show demand growth as expected. For
the power side, there were several explanations for this, including lower ramp-up in
the power intensive industry. Power has now, however, caught up with IP figures.
On the diesel side, demand growth has also started to catch up with IP figures,
although it is still looking a bit on the low side. This could be partially due to weak
exports, causing less need for the transportation of goods.
Figure 91: Power has caught up with IP, while diesel demand is still lagging
30%
20%
10%
0%
-10%
-20%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
IP grow th Pow er demand grow th Diesel demand grow th
Other product demand

Gasoline and diesel make up around 60% of total petroleum product demand in
China. The remaining products are fuel oil, naphtha, LPG and other smaller groups.
This “other” group of products has shown the strongest growth in recent months with
10-20% Y/Y demand growth. This is of course off a very low 2008 base as this
group of products also saw the biggest drop last year. Fuel oil is by far the biggest
part of this group, but demand is down around 5% YTD.
It is primarily on the naphtha side that demand has picked up strongly. Naphtha is the
feedstock for most petrochemicals and china has gone from being a net exporter last
year to a net importer this year.
LPG is also seeing a strong rebound in demand, as it became competitive relative to

other fuels due to lower oil prices earlier this year.
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(852) 2800-8511 19 December 2009
Figure 92: Naphtha, LPG and jet kerosene have seen strong demand growth in 2009 (MM ton)
20 30%
15 20%
10 10%
5 0%
0 -10%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apparent Other Products Demand Y/Y Grow th (RHS)
Natural gas and LNG

Natural gas in China still contributes less than 4% of primary energy consumption.
Coal is by far the highest (70%) followed by crude (20%). Nuclear, hydro and other
sources make up the balance.
Until 2006, China has had no means of importing natural gas and relied upon
domestically-produced natural gas. This limited supply also limited demand growth.
Domestic production has over the past few years seen strong growth, and since the
opening of CNOOC’s LNG terminal in 2006, additional natural gas has been made
available. This, strong domestic growth and imported LNG have allowed relatively
stronger demand growth in the natural gas segment in recent years.
Figure 93: Recent LNG import levels at close to 10% of domestic production (BCM)
10 50%
40%
8
30%
6 20%
4 10%
0%
2
-10%
- -20%
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Apr-04
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Natural gas production LNG imports Grow th demand (RHS)
The first LNG terminal received LNG from NWS in Australia on a contract signed
many years ago, with CNOOC Ltd getting a stake in the upstream aspect, on top of
it. The second and third terminals which CNOOC has opened are also taking LNG
from relatively low-priced supply (Tangguh and MLNG Dua), but have also recently
added a contract (from Qatar) at a higher contract price. Incidentally, CNOOC
reportedly had problems marketing these Qatari volumes at prices around US$10-
12/mmBTU.
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(852) 2800-8511 19 December 2009
There are generally little details available on contract pricing for Chinese LNG, but
import data give an indication of where the price levels are. In mid-last year,
CNOOC brought in quite a bit of spot LNG, which caused the average import price
to increase. Due to the recent cold weather in northern China, this is again happening
with PetroChina by leasing capacity from CNOOC and taking in spot.
Figure 94: Contract prices so far appear to be sub-US$4/mmBTU
10 1.4
1.2
8
1.0
6 0.8
4 0.6
0.4
2
0.2
0 0.0
Dec-06
Dec-07
Dec-08
Jun-06
Sep-06
Mar-07
Jun-07
Sep-07
Mar-08
Jun-08
Sep-08
Mar-09
Jun-09
Sep-09
LNG unit price (US$/mmBTU) LNG imports (RHS - BCM)
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(852) 2800-8511 19 December 2009
Financials: Banks
Little clarity on capital raising a short-term overhang, but
Samuel Chen AC overreaction has created a good buying opportunity
(852) 2800-8557
samuel.s.chen@jpmorgan.com Change 1: Largely sufficient internal capital generation, but CBRC asked for
more capital
Cindy Xu
(852) 2800-8502
cindy.p.xu@jpmorgan.com Extracted from the note, “China Banks: Little clarity on capital raising a short-term
overhang, but overreaction created a good buying opportunity," published on 30
Sunil Garg
November 2009. Please see the original note for pricing dates.
(852) 2800-8519
sunil.garg@jpmorgan.com
Higher ROE largely sufficient to support slower loan growth
In our view, theoretically most H-share banks will not see further drop in their capital
Improved internal capital ratios in 2010 or even 2011 in some cases. The abnormally high loan growth rate in
generation should largely be 2009 is very unlikely to repeat due to a much bigger base. We expect 2010 year end
sufficient to fund a slower but
still very strong loan growth in
tier-1 and CAR ratios should be flattish compared with their respective capital ratios
2010, estimated at c18% for as of 2009 year end. This of course depends on ultimate loan growth. However, we
system. believe there will be no major surprise as seen in 2009 and that our loan expectation
of around Rmb7.5trn (18% in the system) reflects the government’s tone of an
“appropriately loose monetary policy".
Table 39: Improved internal capital generation in 2010 would largely be sufficient to fund about 18% loan growth in the system
ICBC CCB BOC BoComm Citic Minsheng Huaxia SPDB SZDB
2010E ROAE 23.3% 24.2% 21.3% 22.7% 20.5% 14.9% 16.7% 22.3% 19.3%
09 final & 10E interim divd payout as of 10E earnings 38.4% 38.8% 35.3% 29.7% 16.4% 12.2% 12.6% 7.5% 15.3%
Tier-1 growth 16.3% 17.5% 15.4% 19.6% 17.5% 13.7% 14.6% 23.5% 18.3%
10E Loan growth 13.3% 16.0% 17.7% 19.4% 21.2% 20.7% 18.0% 19.8% 24.0%
10E RWA growth 15.7% 16.0% 16.9% 17.0% 18.5% 20.9% 20.3% 23.5% 22.8%
Tier-1 ratio 09E 10.2% 9.2% 9.7% 8.0% 9.0% 8.9% 6.6% 6.9% 8.1%
Tier-1 ratio 10E 10.3% 9.3% 9.5% 8.1% 9.0% 8.4% 6.3% 7.0% 7.9%
A slowdown in loan growth should be largely expected

Although the government has reiterated need for continuity in policy stance and to
maintain a relatively accommodative monetary policy and expansionary fiscal policy,
it has also been a consensus that 2009’s loan growth is excessive. A recent State
Council meeting also pointed out challenges including asset bubble arising from
excess liquidity, potential rising inflation and over-capacity. We thus believe loan
growth should slow down to about 18%, or a new Rmb-denominated loan increase of
We think some investors’ around Rmb7-7.5trn in 2010, compared with an expected Rmb9.5trn new Rmb-
expectation of another Rmb9.5T- denominated loans (31.3%) in 2009. This would appropriately reflect the
10T new loan in 2010 (namely government's guideline for a slower and yet still reasonably strong growth. Note that
c25% y/y) is quite unrealistic
an 18% loan growth is still above 14-16% loan growth from 2004-2008, during
which annual new loan increase ranged within Rmb3.2-5trn.
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(852) 2800-8511 19 December 2009
Table 40: Breakdown of annual loan increase by segments: medium & long-term loans may still
be a key loan growth driver in 2010 due to still high financing needs from existing projects.
Rmb bn 2007 2008 1H09 YTD 2009 2009E 2010E
Personal 1,139 794 1,075 2,008 2,458 1,550
Consumer 867 498 666 1,400 1,750 1,100
Personal business 272 296 409 607 707 450
Corporate 2,495 4,137 6,323 6,939 7,042 5,950
ST working capital 1,277 1,190 1,341 1,454 1,392 1,400
Discounted bills (448) 646 1,707 677 600 200
MLTM loans 1,681 2,188 3,169 4,562 4,800 4,200
Others (14) 113 106 246 250 150
Total Rmb inc 3,634 4,931 7,398 8,947 9,500 7,500
Source: PBOC, J.P. Morgan estimates.
CBRC may push for capital raising

Although we believe loan growth will slow down and that banks’ 2010E ROE should
be largely sufficient to fund organic balance sheet growth, possibility of equity
capital raising is rising, given a stronger push from CBRC to ensure “adequate
capital and improve the quality of capital base”. This implicitly means a stronger
focus on tier-1 capital. In addition, in the case of a broad-sector trend, the fear of
lagging behind the race may push banks to consider capital raising earlier than
expected and may raise slightly more than actual needs. After all, in longer-term,
these banks may still need capital for business expansion especially in non-banking
financial services.
Growth capital in medium-term, but definitely not balance sheet repair capital
In our view, CBRC’s push for Although CBRC repeatedly highlighted the importance of credit risk control and
higher capital, by far, does not discourages excess growth, such message is routine warning and it’s CBRC’s
reflect CBRC's fear or concern
on potential ballooning of NPLs
primary task to ensure strong balance sheet strength including asset quality of the
arising from exceptionally high banking system. In fact, one can also see CBRC did mention the importance of
loan growth this year “internal capital generation”, which implicitly refers to its expectation for higher
profitability.
Since 2008 we have been arguing that the high pre-provisioning operating ROA and
relatively low loan to assets ratios means many Chinese banks, especially most H-
share banks can indeed afford a very high credit costs before their equities suffer. As
seen below, even if annual NPL formation rate surged to above 300bps, or in other
words, nearly 13-15% of new corporate loans made in 2009 going bad all suddenly
in a single year of 2010, earnings for some larger banks should still decline by 20%,
and ROE in most cases would be still at mid-teen percentage. Clearly, we believe
there is no need for balance sheet repair.
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(852) 2800-8511 19 December 2009
Table 41: NPL formation rate needed in various 2010E earnings Figure 95: NPL ratios needed in various 2010E earnings growth
growth scenarios. scenarios.
% of 09E down Down Down Down 10.0%
loans Flat 20% 30% 50% 100% 8.0%
BoCom-H 2.2% 3.1% 3.5% 4.2% 5.9% 6.0%
BOC-H 2.6% 3.6% 4.0% 4.7% 6.7% 4.0%
CCB-H 2.3% 3.7% 4.2% 5.2% 7.6% 2.0%
ICBC-H 2.3% 3.9% 4.4% 5.4% 8.0% 0.0%
Citic-H 2.3% 2.9% 3.2% 3.8% 5.3% BoCom-H BOC-H CCB-H ICBC-H Citic-H Huax ia Minsheng SPDB SZDB
Huaxia 1.8% 2.5% 2.7% 3.0% 3.8%
Base Case Flat earning in 2010 2010 fall by 20%
Minsheng 1.2% 1.9% 2.2% 2.8% 4.1%
SPDB 1.4% 2.4% 2.7% 3.3% 4.8% 2010 fall by 50% zero profit in 2010 (breakev en)
SZDB 1.8% 2.0% 2.3% 2.8% 4.1%
We believe there are see some needs for capital in longer-term, especially as
banks expands into other non-banking financial services, such as insurance, and
brokerage. From this perspective, this may still be regarded as growth capital. For
some banks, equity raising is still needed to fund balance sheet and loan growth, thus
may even enhance shareholders’ value. In such case, as we will discuss later, given
timing is some time away, we believe current share price largely are quite not valid
reference points for the pricing of future capital raising.
That said, should equity capital raising happens around 2010 year end or 2011, we
believe such new capital largely will not be used to fund lending, since internal
capital generation is already sufficient to fund an expected 18% system loan growth.
From this perspective, it may not be immediate growth capital indeed.
Change 2: Long time ahead, capital raising plan will reflect shareholders’
interest
Extracted from the note, “China Banks: Little clarity on capital raising a short-term
While there are preliminary and initial talks and discussion among CBRC and bigger
banks, we believe and actual capital raising could be largely a 2010 end or 2011
event at earliest, in most cases. Some banks such as BoComm that have slightly
Noise may persist for long time, lower tier-1 may lead the progress but still could be a 2H2010 event.
and investors may be tired and
would refocus back to • Banks just started considering various options and need time to communicate
fundamentals in three-month
time
with various relevant parties to make preliminary proposal. At this point, CBRC’s
threshold on capital ratios is also quite unclear.
• Once an equity raising plan is decided, it takes a minimum of 5 months or so
from any announcement to actual completion, including 1-2 month for
shareholder approval at minimum typically, and another 2-3 month for regulatory
approval, and time for actual deal completion.
• Importantly, in our view, the whole capital raising issue would be beyond
CBRC’s control. We believe any final plan needs to take consideration of
various interests of the central government that are represented and guarded by
various ministries. Thus it needs a higher level (State Council or politburo) to
balance and decide on final plans. This will take some time.
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(852) 2800-8511 19 December 2009
Investors need political perspective in understanding the complexity

A deep understanding of both political landscape and financial analysis should also
help investors avoid all misperception and confusion some media stories create.
CBRC’s voice may not fully
represent the central
government’s consideration. The We fully understand CBRC is doing the right thing as it pushes for a stronger capital,
central government will probably a better risk-control and stronger profitability, which is its primary goal as a regulator
need to take consideration of ensures the healthiness of the banking system. The complexity, in our view, is that
various other issues, such as the central government may need to take consideration of various interests, which are
stability of domestic equity
market, and also importantly its
guarded by various ministries. Key ministries that need to be involved include:
interests as majority CBRC, CSRC, Huijin (under CIC), Ministry of Finance, and to less extent Social
shareholders. These Security Fund. Smooth communications and coordination are thus critical before any
considerations will also plan can be finalized, in our view.
determine the timing, size and
form of capital raising
As for the banks, in fact, at best can they can only study appropriate proposal that
balances the interests and key consideration of various ministries. Thus, while CBRC
may make its voice on this issue, banks have to respect the interests of CSRC, and
their shareholders such as Huijin, MOF, and SSF.
In conclusion, we believe capital raising is largely not a short-term event. We do

expect noise to persist, but we also believe investors may be tired of future news flow
and still may refocus back to fundamentals. This may particularly be the case when
they see potential strong loan growth in 1Q10, and when the sell-side may further
revise up earnings estimates; we believe this will happen in 3 months time.
Figure 96: Political landscape of key ministries relevant to capital raising issues by state banks
State
State Council
Council
Regulators Shareholders
PBOC
PBOC CBRC
CBRC CSRC
CSRC MOF
MOF
MOF
MOF Hui
Hui Jin
Jin SSF
SSF
• Set monetary policy • Supervise • Approval all capital

– Interest rate operational issues of raising activities. • Set fiscal policies & • Major shareholders of China banks.
– Money supply china banking • Supervise and accounting rules. • Monitor healthy and sustainable growth in banking
• Provide guidance system. monitor the • Currently has stakes in system as major or key shareholders
on loan growth etc • Ensure healthiness efficiency, fairness BoComm and ICBC.
• Control inflation of Chinese banks. and transparency in
rate stock market • Concerned about shareholding dilution from
Protect its existing further capita raising, and cares form of capital
• Wants to see Wants to see CAR • Does not want to interests as raising. Don’t like unnecessary capital raising.
appropriate loan increase and see big new share shareholders in
growth appropriate loan supply which may some banks, and • Huijin may need to apply to State Council for
growth and control hurt stock market. may want more stake new capital to participate in equity raising
Accounting Policy &

Monetary Policy Operational Supervisory Capital Market Approval Shareholders’ Interests
Shareholders’ Interest
Other
Other State-
State-
ICBC
ICBC CCB
CCB BOC
BOC BoComm
BoComm Owned
Owned Banks
Banks
Source: J.P. Morgan research.
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(852) 2800-8511 19 December 2009
Change 3: Size of capital raising depends on various options available

Extracted from the note, “China Banks: Little clarity on capital raising a short-term
At this point, there is little clarity on the capital requirement threshold CBRC are
comfortable with. While CBRC denies the Reuter’s report that it may ask bigger
banks to raise capital ratio to 13% and says there is no change to current 10% CAR
requirement, in various speeches by senior officials from CBRC, clearly CBRC
would like to see higher capital ratios, and particularly tier-1 ratios too. Moreover,
CBRC also does not make clear what tier-1 capital ratios bigger banks need to
achieve. We believe CBRC also need time to communicate with other relevant
ministries on this issue.
Possible short-fall to total regulatory capital is not equal to size of equity raising
While generally referred as "capital raising", what market really fears is indeed
equity raising. Given unclear threshold and possible objection from CSRC and
government shareholders, it’s too early to determine the size of equity raising indeed.
This is particularly the case given that larger banks indeed do have strong buffer to
issue tier-2 debts.
Below we illustrate the calculation on shortfall in regulatory capital (tier-1 and tier-2)
in various total CAR requirements.
• As seen, if CBRC really raises the total CAR requirement to 13%, the banks
under our coverage may need to raise around Rmb370B through equity or tier-2
debts.
• If this CAR requirement reduces by 1% to 12%, size of shortfall would
substantially decline to around Rmb160bn. The shortfall in some bigger banks
mainly in CCB and BOC would be substantially lower.
Even if total CAR is raised to • As we can also see, in fact, the shortfall in regulatory capital even in the case of
13%, there is still ample room to
13% can be covered through tier-2 debt issuance. We believe most H-share banks
issue tier-2 debts. In particular,
we believe the regulators should (except BoComm) still have room to issue sub-debt, and other tier-2 debts
allow more issuance of (hybrid capital debt and convertibles, which largely have never been issued).
convertibles, which is non-
existent • Even though sub-debt is more costly and demand may be much less now due to
restriction of cross-holding, we believe banks can still improve CAR through
convertibles and hybrid capital debt (though hybrid capital debt is also more
costly).
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(852) 2800-8511 19 December 2009
Table 42: Calculation of regulator capital shortfall to various total CAR thresholds
Rmb bn ICBC CCB BOC BoComm Citic Minsheng Huaxia SPDB SZDB Total
10E RWA 6,953 6,044 6,118 2,326 1,351 1,275 528 1,225 450 27,840
memo: 10E RWA growth 15.7% 16.0% 16.9% 17.0% 18.5% 20.9% 20.3% 23.5% 22.8% 17.4%
Deductions 48 16 66 2 0 1 0 1 1 147
Tier-1 capital 09E 644 486 530 159 103 94 29 70 30 2,263

Add: 2010E earnings 170 138 117 41 23 15 5 18 7 558
Minus: 2009 final &10E interim dividend 65 53 41 12 4 2 1 1 1 183
Others (chg in minority interest/revl. reserve) - 1 6 2 (1) (0) (0) (0) (0) 7
Tier-1 capital 10E 749 571 612 190 121 107 33 86 36 2,645
Tier-2 Capital 202 140 166 87 21 26 19 33 16 759

among which: General Provision 123 70 78 24 8 13 8 18 6 367
Revaluation reserves/others 4 11 14 0 0 2 0 -4 1 28
Others 0 0 0 10 0 0 0 0 0 10
Existing sub-debt 75 60 74 53 12 2 6 19 8 339
Existing hybrid capital debt 0 0 0 0 0 9 4 0 2 15
10E CAR if no more tier-2 debt issuance 13.0% 11.5% 11.6% 11.8% 10.5% 10.3% 9.8% 9.6% 11.3%
New regulatory capital needed for 13% CAR 1 91 83 27 34 34 17 42 8 363

Subdebt buffer (max 25% of tier-1) 112 83 79 - 18 25 2 3 1 328

Other tier-2 debt buffer (max 25% of tier-1) 187 143 153 48 30 18 4 21 7 647
New capital needed after all tier-2 buffer 0 0 0 0 0 0 10 17 0 28
As discussed, however, clearly CBRC is focusing more on equity capital. The table
below highlights the size of potential equity raising in three scenarios. In our view,
however, investors may look at second and third scenario. In the third scenario, a
10% tier-1 ratio is more than enough to boost total CAR to above 13%. Investors
should not forget Chinese banks have a good amount of general provision on their
balance sheet.
Table 43: Equity shortfall in various scenarios

2010E ICBC CCB BOC BoComm Citic Minsheng Huaxia SPDB SZDB Total
10E tier-1 before deduction 10.2% 9.2% 9.7% 8.0% 9.0% 8.9% 6.6% 6.9% 8.1%
10E General provisions/other reserves as % of RWA 1.8% 1.3% 1.5% 1.5% 0.6% 1.1% 1.6% 1.2% 1.4% 1.5%
Tier-1 needed at 13%CAR if tier-2 at 25% of tier-1 8.9% 9.3% 9.2% 9.2% 9.9% 9.5% 9.1% 9.5% 9.3% 9.2%
Scenario 1: equity shortfall to 13%CAR & tier-2 max at 25% of tier-1 - 12 3 26 13 15 15 31 7 138
Scenario 2: equity shortfall to 12% CAR & no more tier-2 debt issue - 37 22 4 21 21 11 29 3 91
Scenario 3: Equity shortfall to 10% tier-1 ratio - 44 5 42 14 21 19 37 9 219
Although quite unlikely in our view, should CBRC also allow full utilization of tier-2
buffer, Chinese banks can increase their total CAR quite significantly by
approximately 3.5ppt on weighted average, boosting total CAR to about 15% on
weighted average. This is particularly the case for the few largest banks. As seen in
the figure 3 below, this would also probably make the sector’s total CAR as high as
some other very well capitalized banking sectors in the region which are also among
the highest globally.
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(852) 2800-8511 19 December 2009
Table 44: Theoretical maximum total CAR reachable through tier-2 debt issuance
ICBC CCB BOC BoComm Citic Minsheng Huaxia SPDB SZDB
10E Tier-1 Ratio 10.3% 9.3% 9.5% 8.1% 9.0% 8.4% 6.3% 7.0% 7.9%
10E General provisions/other reserves 1.8% 1.3% 1.5% 1.5% 0.6% 1.1% 1.6% 1.2% 1.4%
Existing tier-2 debts as % if 10E RWA 1.1% 1.0% 1.2% 2.3% 0.9% 0.9% 1.9% 1.5% 2.1%
10E CAR without more tier-2 debt issue 13.0% 11.5% 11.6% 11.8% 10.5% 10.3% 9.8% 9.6% 11.3%
Additional max tier-2 buffer 4.3% 3.7% 3.8% 1.8% 3.6% 3.3% 1.2% 2.0% 1.9%
Theoretical max 10E CAR reachable 17.3% 15.2% 15.4% 13.6% 14.1% 13.7% 11.0% 11.6% 13.1%
Banks may have various options

In our view, it’s also premature to be cautious as investors also do not know the form
of capital raising. This could be tier-2 debt and equity raising, a cut in dividend or a
We believe a combination of tier-
combination. Even if there is equity raising, it may not straight secondary offering
2, and rights issue in both A and and indeed could be rights issue, which in our view, is an ideal solution.
H shares are ideal solutions
• As we discussed earlier, indeed there are theoretically enough buffer for many
banks, especially the largest few state-controlled banks and Citic Bank to issue
tier-2 debts. While sub-debt issuance to other banks is strongly discouraged by
CBRC and could be difficult going forward , a small placement of such debt to
insurance companies and other market fixed-income investors is still possible,
though at higher yield. In addition, importantly, hybrid capital debt, and
convertibles can also be considered.
• Dividend payout ratio does not need to be maintained. The expected strong
earnings growth in 2010 may support a possible small cut in dividend payout,
which should be acceptable to investors. Remember the state-controlled banks’
dividend policy is “steady dividend growth policy" rather than a fixed payout
policy. With over 30% earnings growth expected in 2010, payout ratio could be
slightly cut but still within the targeted payout ratio range indicated during their
IPOs.
• In some cases, RWA has room to be lowered. For example, Bank of China
indicated it may be able to reduce its RWA through some change to legal terms
of its off-balance sheet exposures and assign more precise risk weighting to some
Investors have appeared to be off-balance sheet items than that is used in their conservative and rough
focusing on BOC’s potential
approach. Thus even in the case of equity raising, size may not be as big as some
capital raising, which is probably
overdone. In our view, BOC market investors or media like Reuters speculated.
indeed has room to cut RWA and
• Even in the case of equity raising, it may not all through straight secondary
so the size of any potential
equity raising may also not be as offering as market has feared. In our view, rights issue is not only likely but also
big the best solution to protect all stakeholders' interests, including various ministries
and thus the central government, as well as market investors.
Rights Issue is the best solution to reconcile the interests

of various stakeholders
In our view, rights issue is the best solution because:
• It helps boost banks' tier-1 and total Capital ratios that CBRC is looking for.
• Given participation of government majority shareholders, the majority of funds of
new capital would come from the government, thus reducing the needs from
market. This substantially alleviated the pressure of new share supply and thus
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(852) 2800-8511 19 December 2009
may be a positive surprise to the market which has worried about new papers.
This option thus could also be acceptable to CSRC.
• In rights issue, importantly, all shareholders including the government majority
shareholders such as Huijin, SSF, and MOF are not diluted, and importantly,
given this is not balance sheet repair capital, it may not change or at least will
minimize the impact on the upside to EXISTING shareholders or investors. Note
in the case of rights issue, although fair value per share will be lower, given
rights issue typically are priced at a big discount to market price, it also lowers
the existing shareholders’ holding costs. (see below a detailed analysis)
• Similar to government majority shareholders, minority shareholders and market
investors' interests are also protected: 1) There is no dilution to their percentage
stake. 2) The pressure on market will also be much lower given that government
participation means much less need for money from the market. 3) There is also
largely no material change to upside in medium-term, after adjusting their current
holding costs and number of shares held.
Rights issue: Hypothetical scenario analysis for BoComm
We illustrate below in detail why in the case of a hypothetical rights issue scenario,
medium/longer-term investors’ interest are largely protected, despite some short-term
impact which has been more than reflected through the share price decline.
Given already lower tier-1 ratios and relatively high tier-2 in total capital, we believe
BoComm does not have much room to boost capital through tier-2 debt issuance.
Assuming no change in dividend policy, and assuming our expected loan growth of
19% (Rmb360bn), we estimate it needs around Rmb30bn to get total CAR to
assumed target of 13%. This implies a tier-1 of 9.4% from otherwise 8.1% estimated
for 2010 year end. Such money would be split between A-share and H-shares.
Table 45: Hypothetical rights issue scenarios for Bank B.

Net No of new % of Offer Offering ROAE BPS EPS Tier-1
Disc. To Price Price P/B Offer Size (US$bn) Offering PE CAR
Proceeds shares current Size P/PPoP (%) (RMB) (RMB) ratio
curt. share Rmb A- H-
HKD RMB 10E 11E US$ bn （Bn） Total 10E 11E 10E 11E 10E 10E 11E 10E 11E 10E 10E
price cap bn shares shares
(49%) 4.5 3.97 0.99 0.76 4.30 7.56 15.4% 30.0 4.39 2.32 2.07 5.0 4.2 3.1 2.5 21.2 4.00 5.20 0.79 0.94 9.4% 13.0%
(43%) 5.0 4.41 1.09 0.84 4.30 6.81 13.9% 30.0 4.39 2.32 2.07 5.6 4.6 3.4 2.7 21.2 4.05 5.27 0.79 0.95 9.4% 13.0%
(38%) 5.5 4.85 1.18 0.91 4.30 6.19 12.6% 30.0 4.39 2.32 2.07 6.1 5.1 3.7 3.0 21.2 4.10 5.32 0.80 0.96 9.4% 13.0%
(32%) 6.0 5.29 1.28 0.98 4.30 5.67 11.6% 30.0 4.39 2.32 2.07 6.6 5.5 4.0 3.3 21.2 4.13 5.37 0.80 0.97 9.4% 13.0%
(26%) 6.5 5.73 1.37 1.06 4.30 5.24 10.7% 30.0 4.39 2.32 2.07 7.1 5.9 4.3 3.5 21.2 4.17 5.42 0.80 0.98 9.4% 13.0%
(21%) 7.0 6.17 1.47 1.13 4.30 4.86 9.9% 30.0 4.39 2.32 2.07 7.6 6.3 4.7 3.8 21.2 4.20 5.46 0.81 0.98 9.4% 13.0%
(15%) 7.5 6.61 1.57 1.20 4.30 4.54 9.3% 30.0 4.39 2.32 2.07 8.2 6.7 5.0 4.0 21.2 4.22 5.49 0.81 0.99 9.4% 13.0%
(9%) 8.0 7.05 1.66 1.28 4.30 4.26 8.7% 30.0 4.39 2.32 2.07 8.7 7.1 5.3 4.3 21.2 4.24 5.52 0.81 0.99 9.4% 13.0%
(4%) 8.5 7.49 1.76 1.35 4.30 4.00 8.2% 30.0 4.39 2.32 2.07 9.2 7.5 5.6 4.5 21.2 4.26 5.54 0.81 1.00 9.4% 13.0%
2% 9.0 7.93 1.85 1.42 4.30 3.78 7.7% 30.0 4.39 2.32 2.07 9.7 7.9 5.9 4.8 21.2 4.28 5.57 0.82 1.00 9.4% 13.0%
Assuming a Rmb30B rights issue, and assuming a worst-case scenario, this is largely
also not growth capital, then its fair multiple would decline given a lower ROE. We
estimate this would decline from our current fair terminal PB value of 2.47x to 2.17x,
as sustainable ROE would decline to 17.4% from 19.6% due to lower leverage. As a
result, its fair value per share would decline depending on rights offering price.
However, if there is no such capital raising, for existing investors who already held
BoComm as of Monday last week (when news [source: Reuters] started to circulate),
then the upside as of that date to our Dec-10 fair value would be nearly 33%.
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(852) 2800-8511 19 December 2009
As subsequent days’ share price declines, if an investor got in the stock at Friday’s
close price, after adjusting for hypothetical rights issue, an existing investor indeed
would have slightly more total return than he/she would have by Monday, taking into
account of lower holding costs and more total number of shares after rights issue.
In fact, the investors would have the same upside by Thursday close (HK$9.18) if a
rights issue is confirmed, as compared with his/her potential return as of last
Monday’s close HK$9.8 and no capital raising is planned.
Table 46: Comparison of upside for shareholders, prior to announcement and current level
Fair Return for
Offering % of current Sustainable terminal Holding total
size Price New shares SO ROE PB Fair value cost % upside holding
Rmb bn HK$ bn % HK$ HK$ HK$
Prior to news - - - 0% 19.6% 2.47x $13.0 9.8 32.7% 3.20
Rights issue 30 4.5 7.56 15.4% 17.4% 2.17x $11.3 8.2 36.7% 3.49
Rights issue 30 6.0 5.67 11.6% 17.4% 2.17x $11.6 8.5 36.6% 3.48
Rights issue 30 7.0 4.86 9.9% 17.4% 2.17x $11.8 8.6 36.5% 3.47
If there is ordinary secondary offering, downside already priced in

If there is no rights issue, we believe downside has already been priced in. As we
discuss, given the capital raising is probably 12 months away at minimum in most
cases for H-shares banks, and that these banks are still growing their balance sheet
and profits steadily, one cannot use the current price as reference.
In the above BoComm’s case, assuming they raise Rmb30B at around current price
(1.85x 10E PB, and 8x 2011E PE), then without additional growth, fair value per
share would be still HK$12. The decline from Tuesday to end of Thursday largely
already reflected such change in fair value.
Information
China Minsheng Banking H-share offering
On November 18, 2009, China Minsheng Banking Corp (600016 CH/1988 HK)
raised US$3.86 billion in its Hong Kong initial public offering, priced at HK$9.08
per share. We believe Minsheng is a volume growth opportunity, but in line with
medium-sized peers. While it was one of the fastest growing banks in China, growth
has stabilized since 2006. We expect its volume growth to be in line with key
medium-sized banks peers, though still above state banks.
Investment case and risks: Key positives: (1) Commercial culture and tradition for
changes—“Business units reform” is ahead of other banks and shall improve revenue
generation and credit pricing; (2) rapid growth in retail banking and strong cross-
selling to its SME customers; and (3) benign credit quality trend and centralized
credit risk management/loan management. Key challenges: (1) a high cost base that
is unlikely to improve materially in next 2 years; and (2) need to keep strong deposit
growth.
Key comparable should be Citic and SPDB, not other H-share banks. Minsheng is
very different to most H-share banks in terms of size, branch network, funding
franchise, retail penetration and more importantly underlying profitability. Even
compared with Citic and SPDB, to which Minsheng is similar in above aspects,
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(852) 2800-8511 19 December 2009
Minsheng is slightly inferior due to lack of parent support, less retail penetration than
Citic and less favorable funding mix and less favorable operating/credit cost profile
than SPDB.
We derived our DDM-based Dec-10 PT of Rmb9.4, which implies a P/BV of 2.0x

and P/E of 14.5x (FY10E). Our PT suggests a sustainable RoE of 15.6%, cost of
equity of 11.4%, and a long-term growth rate of 6.5%. Key risks to our PT are
unexpected major headwinds in the domestic economy and failure to keep up deposit
growth.
Stock recommendations
We believe China Citic Bank is one of the banks with the strongest earnings and
ROE momentums in the sector with a 30% upside potential. We initiated coverage
with an Overweight rating and our Dec-10 PT of HK$8.60 and added it to our Asia
Analysts’ Focus List. Our price target is based on DDM. We use a fair P/BV-based
multiple of 2.15x, with a normalized ROE of 16.6%, assuming a risk-free rate of
5.3%, cost of equity of 11.2%, and a terminal growth rate of 6.5%. Key risks to PT
are unexpected significant equity capital raising and a substantial slowdown in
deposit growth. We believe the earnings leverage potential in Citic-H is not fully
discounted. Although the shares have nearly tripled YTD, we believe more re-rating
lies ahead, given a >500bp gain in ROE in FY10E—the highest ROE uplift in the
sector based on our forecasts. Our FY10/FY11 EPS estimates are 25%/28% above
consensus, and we peg FY09-FY11E EPS CAGR at 38%. The stock is one of our top
2 picks for 1H10.
Investment positives: 1) NIMs are relatively more leveraged than many peers to
rising interest rates. 2) Underlying profitability has improved significantly and is
now in line with some state-controlled banks and higher than most medium-sized
banks. 3) Rapid growth in retail banking, with particular success in wealth
management and credit cards. 4) Strong support from the parent’s integrated
financial services platform, which has led to more cross-selling and a larger client
base. 5) Potential stake increase by BBVA should support confidence in Citic’s
earning prospects.
Major weakness and challenges: 1) Lower exposure to mortgages, and medium- and
loan-term project loans. The portion of collateralized loans has traditionally been
lower. 2) Deposit franchise is still mainly based on corporate accounts—needs to be
diversified. 3) Since 1H09, credit card delinquency has picked up notably. While the
amount of NPLs remains small relative to total loans, further delinquencies in the
card portfolio could postpone an overall recovery in credit costs.
Our Dec-10 PT of HK$8.6 implies 30% upside: We believe Citic-H should trade at a
slightly lower P/BV than most H-share banks (except for BOC-H). However, our
Dec-10 PT still suggests 30% upside from the current level. Our DDM-based Dec-10
PT of HK$8.6 implies 2.4x FY10E P/BV and 12.7x FY10E P/E.
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(852) 2800-8511 19 December 2009
Michael Chan AC
Financials: Insurance
(852) 2800-8592
michael.cf.chan@jpmorgan.com China Insurance Sector: Premium growth, VNB and
Joseph Leung investment returns have room for positive surprise in 2010
(852) 2800-8517 (This note was originally published on November 16, 2009; please see the original
joseph.mj.leung@jpmorgan.com
note for pricing dates)
Sunil Garg
(852) 2800-8518 • Accumulate at “three lows”: The China insurok.ance sector is currently
sunil.garg@jpmorgan.com operating in a “three-low” environment – low premium growth, low equity
J.P. Morgan Securities (Asia Pacific) Limited investment, and low interest rates, which caused the underperformance relative to
banks YTD. We expect investment yields and premium growth to largely bottom
out in 2009. Our positive bias remains on life insurance in 2010, with China Life
as our top pick.
• Key catalysts in 2010: We expect life premium growth, particularly for China
Life, to return to c15% in 2010, driven by an increase in individual agents and as
a result of the premium restructuring campaign this year. This should drive VNB
growth by 24%-27% in 2010. In the next 12-18 months, the LT investment
assumption could be revised up to 6.0% (from 5.0%-5.5% now) if the investment
scope is broadened to real estate and other sectors. A 10% increase in investment
assumption would increase EV by 8.1% for China Life and 12.2% for Ping An,
by our estimates.
• Valuations premium likely to persist: Chinese insurers are never cheap, in our
view, and they will remain “not cheap” given their smaller market representation
(7% of financial assets only versus 17% in developed markets) and faster
premium growth (than loan growth). Insurers in Asia ex-Japan have consistently
traded at a higher P/Es and P/BVs than banks. We believe there is still upside to
the current 2.5x EV for Chinese life insurers.
• We raise our price targets: We increase our Dec-10 PT for China Life
Insurance to HK$45.0 (from HK$35.1), for Ping An Insurance to HK$81 (from
HK$64), and for PICC Property & Casualty to HK$4.6 (from HK$3.9) by rolling
over our revised EV and VNB forecasts. We also revise our 2010 EPS forecasts –
up by 11.0% for China Life and 0.5% for Ping An, but down by 4.6% for PICC.
• Key risks to our PTs: China Life: lower-than-expected premium growth and
major regulatory changes. Ping An: slower-than-expected premium growth, and
execution risk in integrating SZDB. PICC: stronger-than-expected underwriting
income and premium growth.
Table 47: China insurance sector's valuation summary
Price Dec-2010 P/EV P/AV Implied new biz P/E P/BV
Reuters Rating 16-Nov-09 Price target FY09E FY10E FY09E FY10E FY09E FY10E FY09E FY10E FY09E FY10E
HK$ HK$ x x x x x x x x x x
China Life 2628.HK OW 39.10 45.0 3.2 2.6 1.2 1.0 36.6 25.4 31.0 26.4 4.4 3.7
Ping An 2318.HK N 73.60 81.0 3.0 2.5 1.1 0.9 26.9 19.2 45.2 33.9 4.6 3.9
PICC 2328.HK UW 6.03 4.6 NA NA NA NA NA NA 278.8 50.8 2.4 2.0
Source: Bloomberg, Company reports and J.P. Morgan estimates.
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(852) 2800-8511 19 December 2009
Raising our price targets

Table 48: Raising our price targets for Chinese insurers
Price target (HK$) Methodology
New Old Chg.
China Life 45.0 35.1 28.2% Based on appraisal valuation using a 27x new business multiple.
Ping An 81.0 64.0 26.6% Based on SOTP with a 10% holding company discount, valuing life
insurance on appraisal value using 28x new biz multiple, P/BV
valuation for banking (2.0x) and P&C (1.5x), and P/E (8x) for other
businesses.
PICC 4.6 3.92 17.6% Based on DCF of free cash flow.
Key risks to our PTs: China Life: Lower-than-expected premium growth and major
regulatory changes. Ping An: slower-than-expected premium growth, and execution
risk in integrating SZDB. PICC: stronger-than-expected underwriting income and
premium growth.
Major revisions to EPS and actuarial estimates

Table 49: Revisions to earnings and actuarial estimates
Rmb
China Life Ping An PICC
2009E 2010E 2009E 2010E 2009E 2010E
EPS (New) 1.11 1.28 1.43 1.88 0.02 0.10
EPS (Old) 1.00 1.16 1.40 1.87 (0.02) 0.11
Revision, % 10.6% 11.0% 2.2% 0.5% nm -4.6%
ROE, % (New) 15.6 15.2 11.3 12.4 0.91 4.30

ROE, % (Old) 14.1 13.8 11.1 12.4 -1.12 4.51
Revision, % 10.9% 10.1% 2.1% 0.3% nm -4.6%
DPS (New) 0.33 0.38 0.29 0.47 0.00 0.06

DPS (Old) 0.30 0.35 0.28 0.47 0.00 0.06
Revision, % 10.6% 11.0% 2.2% 0.5% nm 0.0%
Value of new business (New) 0.64 0.81 1.59 1.97 na na

Value of new business (Old) 0.58 0.69 1.50 1.76 na na
Revision, % 10.2% 17.2% 6.2% 12.1% na na
Embedded value (New) 10.80 13.18 21.85 25.80 na na

Embedded value (Old) 10.44 12.50 21.76 25.55 na na
Revision, % 3.4% 5.5% 0.4% 1.0% na na
Stock picks - China Life still our top pick

China Life (2628.HK, Overweight)
China Life remains our top pick in the sector. Our Overweight rating is predicated on
the following: 1) the premium restructuring campaign this year by focusing on sales
of long-term regular premium risk products (five-year and 10-year in particular)
should result in strong growth in embedded value and value of new business (>30%)
with expansion in new business margins; 2) the premium growth trend is expected to
return to positive growth in 2010 with the restructuring completed and an increase in
life insurance sales driving new business growth. China Life should have the least
impact on premium growth under the new accounting standard for premium
recognition; and 3) the group's investment strategy is conservative but is also swift to
respond to market opportunities. The increase in equity investment in 1H09 to 13.3%
was a positive surprise to the market.
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(852) 2800-8511 19 December 2009
Ping An Insurance (2318.HK, Neutral)

We maintain our Neutral rating on Ping An. Our rationale is based on the following:
1) the top-line premium momentum is likely to weaken after an exceptionally strong
2009; 2) the insurance-led financial model is untested in China and by increasing
banking exposure through the acquisition of Shenzhen Development Bank (SZDB)
may result in a reduction in overall valuation for the group as banks tend to trade at
lower multiples than insurance companies in China; and 3) the risk of a potential
equity raising exercise is still on the horizon.
PICC (2328.HK, Underweight)

Although top-line premium growth is likely to remain robust in 2010 driven by car
sales in China, we continue to worry about underwriting profitability and volatility in
the annual earnings. Fundamentally, it is hard to get excited about PICC with its low
ROE and a tendency to surprise in underwriting results. The competition in the P&C
market remains intense with premium rates falling for most non-motor insurance
lines. One of the main positives of PICC is its potential restructuring angle as its
parent seeks an A-share listing.
Table 50: Positive and negative drivers of the Chinese insurers

Positive Negative
China Life 1) Top line premium growth back to positive growth in 2010. 1) Relatively high valuations.
2) Double-digit growth in EV, NBV plus expansion in new biz margin. 2) Perceive as state-owned management style.
3) Increase of life agents to one million over next three years. 3) Potential market share erosion by banks in the medium-term.
4) Conservative yet opportunistic investment strategy. 4) Increasing competition in Tier-2 cities and rural area.
5) Potential strategic investment in domestic banks.
Ping An 1) Starting to be more active in Tier-2 and rural markets. 1) Top line premium growth is likely to weaken in 2010.
2) Positive earnings momentum in 2010. 2) Compression in new business margins due to competitive rates.
3) Acquisition of SZDB will boost banking exposure. 3) Potential share placements.
4) Early mover advantage in real estate investments. 4) Execution risk in SZDB acquisition.
5) A diversified financial model. 5) Re-classification of insurance premium.
PICC 1) Improved capital position after the Rmb5 billion sub-debt issue. 1) Potential competition from alternative distribution channels.
2) Continued regulation on solvency should restrain excessive competition. 2) The stake owned by AIG remains an overhang.
3) Strong car sales will continue to drive premium growth. 3) Volatile earnings track record and poor underwriting results.
4) Potential restructuring of parent and group companies. 4) Lowest ROE but highest valuation in the region.
Valuation summary
Table 51: Chinese insurance sector valuations
China Life Ping An PICC
2009E 2010E 2011E 2009E 2010E 2011E 2009E 2010E 2011E
P/EV (x) 3.2 2.6 2.1 3.0 2.5 2.1 n.a. n.a. n.a.
P/E (x) 31.0 26.4 23.3 45.2 33.9 26.4 278.3 50.8 16.2
P/B (x) 4.4 3.7 3.2 4.6 3.9 3.3 2.4 2.0 1.8
Implied new business multiple (x) 36.6 25.4 18.1 26.9 19.2 13.4 n.a. n.a. n.a.
ROE (%) 15.6 15.2 14.7 11.3 12.4 13.5 -1.1 4.5 11.9
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Table 52: Key operating trends for China Life and Ping An
2008 2009E 2010E 2011E
Value of 1-year sales, Y/Y %
China Life 15.6% 30.2% 26.7% 18.8%
Ping An (Life) 18.8% 36.6% 23.9% 22.3%
Embedded value, Y/Y %

China Life -4.9% 27.2% 22.0% 19.8%
Ping An (Life) -5.1% 41.8% 23.1% 21.3%
Shareholders' funds, Y/Y %

China Life -12.1% 21.9% 17.0% 13.7%
Ping An -25.8% 23.4% 17.0% 15.1%
New business margin (on FYP), %

China Life 43.0% 50.1% 49.4% 49.6%
Ping An 19.6% 16.4% 15.9% 15.1%
New business margin (on APE), %

China Life 21.5% 26.7% 28.5% 29.4%
Ping An 38.2% 35.3% 33.1% 31.8%
Source: Company reports and J.P. Morgan estimates.
Underperformance relative to banks

Chinese insurers have underperformed the Chinese banks YTD. We believe one of
the key factors for the underperformance relates to the weak headline premium
growth versus loan growth in 2009. China Life has underperformed Ping An YTD,
again for the reason of slower premium growth. We expect performance of the
insurance sector to improve with premium growth returning to double-digit growth in
2010.
Table 53: Sector performance: China insurance vs. China banks

% YTD 1M 3M 6M 12M
Insurance 73.6% 9.2% 18.7% 38.5% 95.0%
Banks 86.1% 9.8% 26.3% 49.1% 93.1%
Difference -12.5% -0.6% -7.5% -10.6% 1.9%
China Life – H 66.0% 8.8% 19.2% 39.4% 84.0%
Ping An - H 95.7% 10.3% 18.9% 38.5% 115.9%
Difference -29.7% -1.5% 0.3% 0.9% -31.9%
HSI 59.5% 4.9% 12.9% 30.8% 64.7%
MSCI China 48.2% 1.9% 11.9% 30.9% 75.2%
Source: Bloomberg and J.P. Morgan. Note: China banks include ICBC, BOC, CCB, BOCOM, CMB and Chinese insurers include China
Life, Ping An and PICC.
Figure 97: China: Insurance premium growth vs. Loan growth

%, Y/Y
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
2006 2007 2008 2009E 2010E
Loan growth Premium growth
Source: CIRC, Company reports and J.P. Morgan estimates.
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Global insurance sector valuations

Table 54: Global peer valuations
16-Nov-09 Price Bloomberg Mkt cap P/EV (x) P/E (x) P/BV (x) Yield (%) ROE (%)
(LC) Code Rating US$m FY09e FY09e FY10e FY09e FY10e FY09e FY10e FY09e FY10e
Australia QBE 22.51 QBE AU N 21,513 n.a. 10.1 10.0 2.0 1.9 5.9 6.2 21.3 19.8
Suncorp 8.99 SUN AU OW 10,660 n.a. 13.2 9.4 0.7 0.7 1.4 1.4 7.0 8.1
IAG 4.07 IAG AU UW 7,894 n.a. 13.8 12.5 1.7 1.7 5.5 5.5 11.7 12.7
AMP 6.41 AMP AU N 12,252 1.7 14.6 13.1 5.1 4.9 6.2 6.4 33.6 35.6
AXA Asia Pac 5.99 AXA AU 11,552 1.9 19.8 22.0 2.8 2.7 3.8 4.2 19.2 19.2
Taiwan Cathay FHC 61.50 2882 TT N 18,503 2.8 75.4 22.7 3.0 2.7 0.9 3.1 4.6 12.3
Shinkong FHC 14.40 2888 TT UW 3,278 3.4 203.7 71.4 1.4 1.4 0.6 1.1 0.7 2.0
Fubon FHC 38.80 2881 TT OW 9,741 2.3 14.7 11.6 1.7 1.6 4.1 5.2 13.0 14.0
China China Life 39.10 2628 HK OW 134,720 3.2 31.0 26.4 4.4 3.7 1.0 1.1 15.6 15.2
Ping An 73.60 2318 HK N 67,781 3.0 45.2 33.9 4.6 3.9 0.4 0.7 11.3 12.4
PICC 6.03 2328 HK UW 8,669 n.a. 278.3 50.8 2.4 2.0 0.0 0.8 0.9 4.3
CIIH 27.20 966 HK NR. 5,974 3.6 41.6 33.3 6.2 5.1 0.2 0.4 16.0 16.3
CPIC 26.88 601601 CH NR. 30,317 3.0 38.2 34.2 3.9 3.0 0.9 1.0 8.4 8.3
Korea Samsung F&M 219,000 000810 KS OW 8,983 1.4 14.4 13.2 1.8 1.6 n.a. n.a. 13.0 12.8
Dongbu Insurance 33,450 005830 KS OW 2,050 n.a. 7.1 6.5 1.3 1.1 1.2 1.3 20.5 18.2
Korean Re 10,100 003690 KS OW 997 n.a. 5.8 5.6 1.0 0.9 3.2 3.5 15.2 17.8
Hyundai M&F 19,500 001450 KS N 1,509 n.a. 6.6 n.a. 1.2 n.a. 2.1 n.a. 18.9 n.a.
LIG Insurance 22,800 002550 KS OW 1,184 n.a. 6.0 n.a. 1.1 n.a. 2.4 n.a. 19.5 n.a.
Meritz Insurance 7,460 000060 KS OW 800 n.a. 7.6 6.3 1.3 1.2 3.4 4.0 17.3 18.7
U.K. Aviva 409 AV/ LN OW 18,632 0.7 8.8 8.1 2.6 2.5 8.1 8.1 9.2 13.6
Prudential 617 PRU LN OW 26,005 1.1 11.0 9.3 3.2 3.0 0.0 3.1 15.1 12.6
Legal & General 86 LGEN LN UW 8,395 0.7 10.4 8.3 1.1 1.1 8.6 8.6 2.3 7.1
Royal & SunAlliance 122 RSA LN OW 6,836 1.1 9.0 8.7 1.1 1.1 6.5 6.7 12.4 12.2
Europe Allianz 85.10 ALV GR OW 57,873 1.8 12.0 8.2 1.2 1.1 4.1 4.7 9.5 14.1
AXA 16.46 CS FP N 55,728 0.9 9.1 10.4 0.9 0.9 0.0 2.4 10.9 8.3
GENERALI 18.25 G IM NR 42,337 1.0 15.1 11.0 2.2 2.2 2.2 3.3 11.0 14.2
Canada Manulife 20.07 MFC CN NR 31,067 0.7 23.7 9.5 1.2 1.1 3.8 2.6 5.4 12.4
Source: Bloomberg, Company reports and J.P. Morgan estimates. Bloomberg consensus estimates for non-rated companies.
Key catalysts for Chinese insurers in 2010

Apart from the performance in the A-share market and the interest rate trends in
China that are key to the insurance sector next year, we expect there will be at least
three major sector-specific catalysts that should drive the insurance sector next year.
Premium growth should rebound in 2010

After a very strong year driven by bancassurance sales in 2008, premium growth in
China in 2009 has been largely consolidating, with premium growing by 4.0%
January-September this year due to business restructuring. Among the major
insurers, China Life is more negatively affected this year as the company turns its
focus to growing policies with a duration of five and 10 years.
We expect life premium growth to pick up in 2010 in China due to the following:
• The business shift from a single-premium and bancassurance-centric

strategy to a long-term regular premium business (five years and 10 years)
is likely to be largely complete in 2009. This should remove the drag on
premium growth.
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• Renewal business should naturally pick up following the increase in regular

premium business in 2009.
• Increase in individual agents by the main insurance companies including

China Life and Ping An. China Life is targeting to increase its life insurance
salesforce to one million in the next three years.
Table 55: Premium growth trends for China Life and Ping An
Year-on-year, %
2008 2009E 2010E 2011E
Based on PRC GAAP:
Total premium growth

China Life 51.2% -3.1% 15.7% 14.7%
Ping An (Life) 29.1% 33.0% 23.4% 21.1%
Regular premium growth - FYP

China Life 21.5% 13.7% 20.5% 16.2%
Ping An (Life) 30.2% 45.5% 33.6% 27.2%
Single premium growth - FYP

China Life 101.4% -21.5% 11.2% 10.2%
Ping An (Life) 52.8% 66.0% 23.5% 29.2%
Total FYP growth

China Life 75.0% -13.4% 14.0% 12.2%
Ping An (Life) 42.1% 57.0% 27.6% 28.3%
Based on HK GAAP or IFRS:
Total premium growth

China Life 20.9% 16.0% 20.8% 18.4%
Ping An (Life) 18.3% 17.7% 12.5% 12.1%
Regular premium growth - FYP

China Life 24.3% 12.4% 29.2% 18.9%
Ping An (Life) 26.1% 28.6% 23.0% 25.0%
Single premium growth - FYP

China Life 7.9% 1.8% 17.8% 7.5%
Ping An (Life) 33.1% 15.3% 4.8% -7.3%
Total FYP growth

China Life 23.1% 11.7% 28.5% 18.2%
Ping An (Life) 28.3% 24.2% 17.4% 16.1%
China Life is likely better than Ping An in terms of premium trends

China Life should see a recovery in premium growth in 2010 after contracting in
2009 due to the business campaign to restructure the business mix. Ping An is likely
to see a moderation in its premium growth in 2010 after an outstanding year in 2009.
From a trading standpoint, the momentum in premium growth is likely to be more
positive for China Life than for Ping An.
China Life has higher agent productivity

Both China Life and Ping An are aiming to increase their life insurance salesforce
over the next several years, particularly China Life, which aims to increase its
salesforce from approximately 740,000 at present to about one million over the next
three years. Compared to Ping An, China Life has been relatively slow in adding new
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individual agents. The total number of individual agents in China Life has only
increased by approximately 15% since 2005, while that of Ping An Life has risen by
almost 100% during the same period. This also explained traditionally faster
premium growth at Ping An.
Figure 98: Total number of individual life agents Figure 99: Number of agents as a percentage of total pool
No. of agents % of total
1H09 393,576 740,000 70%
355,852 60%
2008 716,000 15% 15%
50%
315,000 17%
1H08 676,000 16%
40% 16% 17%
301,801 30%
2007 638,000
48% 47%
205,437 20% 36%
2006 650,000 32% 35% 31%
10%
200,193
2005 640,000
0%
2005 2006 2007 1H08 2008 1H09
0 500,000 1,000,000 1,500,000 2,000,000 2,500,000
Life industry China Life Ping An Life China Life Ping An Life
Source: CEIC and company reports. Source: Company reports and J.P. Morgan.
Based on first-year premiums (FYP), China Life appears to have higher productivity
per agent than Ping An. This is also true if we take the total premium income per
agent.
Figure 100: Agent productivity (based on FYP) Figure 101: Agent productivity (based on total premium income)
Rmb Rmb
450,000 600,000
400,000
500,000
350,000
300,000 400,000
250,000
300,000
200,000
150,000 200,000
100,000
100,000
50,000
0 0
2005 2006 2007 1H08 2008 1H09 2005 2006 2007 1H08 2008 1H09
China Life Ping An Life China Life Ping An Life
Source: Company reports and J.P. Morgan estimates. Source: Company reports and J.P. Morgan estimates.
Investment in the real estate sector

Further broadening of investment channels should be a positive catalyst for the sector
because it would improve the long-term investment returns of the insurers. The
recent change to expand the investment in corporate bonds including issues by H-
shares and red-chips to 40% from 30% of total assets is long-term positive as yields
are above 4.5% at five-year or above. The next in the pipeline that may be relaxed by
the CIRC includes property investments and further relaxation in overseas
investments. In Asia, real estate investments by insurers are common. In countries
like Australia, Korea, and Taiwan, the insurance companies have approximately 5%-
10% of their total assets invested in the real estate sector. We expect if Chinese
insurers were to invest in properties and broaden their investment in infrastructure,
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the long-term investment assumption has the potential to increase to 6.0% from
4.5%-5.0%, at present. This would have a notable positive impact to their embedded
value (see next section for more details).
Figure 102: Real estate investment in Asia Figure 103: Potential investment in real estate by Chinese insurers
% of total investments Rmb in billions
4,000
12%
3,342
3,500
10%
3,000
8% 2,400
2,500
6% 2,000
4% 1,500 5% of total assets,
2% 1,000 7% of total inv estment
0% 500 167
0
FY04 FY05 FY06 FY07 FY08 FY09
Total assets in sector, FY08 Total inv estment in sector, FY09E Real estate as % of total assets
Taiw an Korea Australia
Source: Company reports. Source: CIRC and J.P. Morgan estimates.
Potential changes to long-term investment assumptions

Our long-term investment assumption for the Chinese life insurers is averaging about
5.0% at present. Based on final results for FY08, the life insurance companies
reduced their investment assumption to take into account the fall in China interest
rates and bond yields. Despite the downward revisions, both China Life and Ping An
continue to forecast an upward sloping trend in investment returns for the next
several years. Since there are still new asset classes to be opened for investment and
the fact that interest rates should have largely bottomed in China, the investment
assumption trend may increase next year.
Figure 104: China Life's investment assumption Figure 105: Ping An Life's investment assumption
% %
6.5 6.5
6.0 6.0
5.5 5.5
5.0 5.0
4.5 4.5
4.0 4.0
3.5 3.5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2008 assumption 2007 2006 2005 2004 2008 assumption 2007 2006 2005 2004
Source: Company reports. Source: Company reports.
We expect in the long run the investment return can improve further from the current
levels assumed when more asset classes are added to the investment portfolio. We
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estimate that the long-term sustainable investment returns can reach approximately
6% for Chinese insurers from 5.0%-5.5% at present.
Table 56: Long-term investment assumption for Chinese insurers

ROI % of total Attributable
assumption investment returns
Equity 11.50% 15% 1.7%
Bonds 4.5% 58% 2.6%
Bank deposits 3.0% 10% 0.3%
Infrastructure 10.0% 8% 0.8%
Property 8.0% 5% 0.4%
Others 6.0% 4% 0.2%
LT investment assumption 100% 6.1%
EV sensitivity to investments
Insurance companies’ embedded value (EV) is sensitive to changes in investment
assumption. We estimate that a 10% increase in investment assumption would
translate into an 8.1% increase in EV for China Life and 12.2% increase for Ping An.
Based on our estimated potential long-term investment assumption of 6%, if the
property sector is included and an increase in infrastructure investment, the
investment returns would be roughly 20% higher than the investment yield assumed
at present. This would result in significant enhancement to the embedded value
estimates (Table 57).
Table 57: China Life: EV sensitivity to investment

Rmb in millions
LT investment yield Net worth VIF EV Chg. in EV
Investment returns
Base case 5.1% 153,759 113,561 267,320 0.0%
+10% 5.6% 153,759 135,146 288,905 8.1%
+15% 5.8% 153,759 145,939 299,698 12.1%
+20% 6.1% 153,759 156,731 310,490 16.1%
+25% 6.4% 153,759 167,524 321,283 20.2%
+30% 6.6% 153,759 178,316 332,075 24.2%
+35% 6.9% 153,759 189,109 342,868 28.3%
+40% 7.1% 153,759 199,901 353,660 32.3%
Table 58: Ping An: EV sensitivity to investment

Rmb in millions
LT investment yield Net worth VIF EV Chg. in EV
Investment returns
Base case 5.0% 36,744 52,055 88,799 0.0%
+10% 5.5% 36,744 62,862 99,606 12.2%
+15% 5.8% 36,744 68,266 105,010 18.3%
+20% 6.0% 36,744 73,669 110,413 24.3%
+25% 6.3% 36,744 79,073 115,817 30.4%
+30% 6.5% 36,744 84,476 121,220 36.5%
+35% 6.8% 36,744 89,880 126,624 42.6%
+40% 7.0% 36,744 95,283 132,027 48.7%
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China insurers are currently at “three lows”

The insurance sector in China is currently operating at three lows – low interest rates,
low equity exposure, and low premium growth. This has resulted in low investment
yields and low top-line growth in the sector, and helped to explain the
underperformance this year relative to the Chinese banks which have at least strong
loan volumes to support share price performance. We believe the insurance sector is
currently at a watershed and the “three lows” will only improve from here.
Low premium growth

The first low is the low premium growth in 2009, which only increased by 4.0%
from January to September this year. This is largely the result of premium
optimization campaign initiated by the major insurance companies this year and is
unlikely to be repeated in 2010, in our view. The top-line premium growth in 2010 is
likely to be stronger than 2009 with the rebasing from single and short-term policies
to long-term regular business completed.
Table 59: Premium growth in China

Jan-Sep 2009 FY08
Market share Premium growth, y/y Market share Premium growth, y/y
China Life 38.0% -4.6% 40.3% 50.3%
Ping An Life 16.5% 33.5% 13.8% 27.8%
Taikang Life 7.6% -1.8% 7.9% 68.7%
CPIC Life 8.1% -6.9% 9.0% 30.4%
New China Life 7.9% 10.2% 7.6% 70.8%
Taiping Life 2.6% 5.7% 2.6% 19.4%
Others 19.3% 8.0% 18.9% 61.6%
Total 100.0% 4.0% 100.0% 48.3%
Local 95.1% 3.8% 95.1% 53.2%
Foreign JV 4.9% 8.9% 4.9% -8.8%
Source: CEIC and J.P. Morgan estimates.
Low interest rates

The second low is the low interest rate environment, which has had an adverse effect
on the investment returns of the insurers this year. Except for 2003, the interest rates
and bond yields in 2009 are likely to be the lowest in a decade. An increase in
interest rates should improve investment returns incrementally through higher bond
yields and negotiable deposit rates. Our house view is that interest rates in China will
start to rise in the middle of 2010.
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Figure 106: Recurring investment yield Figure 107: Total investment yield
% %
6.0% 15.0%
5.0%
10.0%
4.0%
3.0%
5.0%
2.0%
1.0% 0.0%
0.0% 2002 2003 2004 2005 2006 2007 2008 2009E
2001 2002 2003 2004 2005 2006 2007 2008 2009e -5.0%
China Life Ping An PICC China Life Ping An PICC
Low equity exposure

The third low is the low equity exposure. At the end of June 2009, the three major
insurers had a total equity investment of 7.0%-13.3%. This is considered low relative
to the peak of 25% in 2007. The low equity investment and volatile A-share market
have resulted in lower dividend income and capital gains this year. By comparison,
the equity investments by Chinese insurance companies have appeared to converge
with other Asia markets.
Figure 108: Equity investments by Chinese insurers Figure 109: China insurers used to have the lowest equity investments
% of total investments % of total investments
30.0% 40%
35%
25.0%
30%
20.0%
25%
15.0% 20%
15%
10.0%
10%
5.0%
5%
0.0% 0%
2002 2003 2004 2005 2006 2007 2008 2009E 2002 2003 2004 2005 2006 2007 2008 2009E
China Life Ping An PICC China Australia Taiwan Korea
Source: Company reports and J.P. Morgan estimates. Source: Company reports and J.P. Morgan estimates. Note: Australia is based on total
shareholders' funds only. The ratio on a like-with-like basis would be a lot lower.
Premium valuations for superior growth?

Chinese insurers have consistently traded at higher valuations than rest of Asia and
the developed markets (Figure 110). We think the higher valuations of the Chinese
insurers are likely reflecting the following:
• Higher growth market due to low penetration and increasing wealth
accumulation in China.
• Scarcity value as there is a lack of life insurance companies listed in Asia.
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• Chinese insurers are high-beta and tend to be played as a proxy to the A-

share market.
Figure 110: P/BV multiples: China vs. Asia vs. Developed markets
x
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2004 2005 2006 2007 2008
China Asia ex -China US/UK/JP
Source: FactSet and J.P. Morgan.
Chinese insurers are not cheap, but they could get very
expensive
One of the common concerns about the insurance sector is that it is not a cheap
sector, by almost all valuation yardsticks. Insurers are trading at higher P/E and P/BV
multiples than banks which are presumably more transparent and easier to
understand. In terms of P/EV, Chinese insurers are the most expensive ones in Asia
and when compared to insurers in the developed markets. In fact, the valuations of
the Chinese insurers are only reaching the levels achieved at the beginning of 2007,
and still far off from the peak. Although the conditions are somewhat different right
now than they were in 2007, the sector has underperformed the market and the
banking sector this year.
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Figure 111: P/EV Figure 112: Implied new business multiple

x x
7 90.0
80.0
6
70.0
5 60.0
50.0
4
40.0
3
30.0
2 20.0
10.0
1
0.0
0 -10.0
Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09
China Life Ping An China Life Ping An
Valuation versus other insurers

Chinese insurance companies have the highest valuations in Asia on all yardsticks.
This has been the case since their listing several years ago. We expect these premium
valuations of the Chinese insurance companies will continue due to the companies’
superior growth profile. On a top-line basis, by focusing on premium growth,
Chinese insurers have been growing faster than other insurers in the region during
the past several years. The scarcity value also counts as there are limited fast-
growing life companies in the region that are listed. The big traditional listed life
companies such as Manulife and Prudential are mainly international insurance
companies that do not offer a pure localized story like that of the Chinese insurers or
the Korean non-life companies, in our view.
Figure 113: P/BV multiples: China vs. Asia vs. developed markets Figure 114: Premium growth in key Asian markets
x %, y/y
10.0 50.0%
39.1%
8.0 40.0%
6.0 30.0% 24.7%
4.0 20.0% 14.1% 14.5%
2.0 10.0%
0.0 0.0%
2004 2005 2006 2007 2008 2005 2006 2007 2008
China Asia ex -China US/UK/JP China Korea Taiw an
Source: FactSet. Source: CEIC and J.P. Morgan.
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Insurance valuations versus banks

Insurance stocks are normally less transparent than banking stocks given the long-
term business nature of insurance underwriting. Apart from the fact that insurers are
less understandable to the general market than banks, they are also not
straightforward for investors to value because simple earnings and book value are not
very relevant for young life insurance companies that are growing a lot of new
premium income. In China, insurance stocks are trading at higher P/E and P/BV
multiples than banks, which are generating higher ROE.
In Korea, listed insurance stocks are mainly non-life companies and therefore P/E
and P/BV multiples are more relevant to compare with the banking stocks. In Korea,
insurance companies have higher ROE and trade at slightly higher P/BV multiple
than banking stocks.
In Taiwan, insurance companies are mainly in financial holdings structure which

includes banking and other financial services. There is limited room to compare
valuations between banks and insurers in Taiwan, in our opinion.
Figure 115: P/BV multiples: Insurers vs. Banks; Asia vs. Developed market
x
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2004 2005 2006 2007 2008
Asia Pac Banks Asia Pac Insurance
Dev eloped market Banks Dev eloped market Insurance
Source: FactSet and J.P. Morgan.
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Figure 116: P/E multiples: China banks vs. insurance Figure 117: P/BV multiples: China banks vs. insurance
x x
120.0 CH banks CH ins 12.0 CH banks CH ins
100.0 10.0
80.0 8.0
60.0 6.0
40.0 4.0
20.0 2.0
0.0 0.0
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Source: Bloomberg, company reports, and J.P. Morgan estimates. Source: Bloomberg, company reports, and J.P. Morgan estimates.
Figure 118: P/E multiples: Korea banks vs. insurance Figure 119: P/BV multiples: Korea banks vs. insurance
x x
20.0 KR banks KR ins 3.5 KR banks KR ins
18.0
16.0 3.0
14.0 2.5
12.0
2.0
10.0
8.0 1.5
6.0 1.0
4.0
2.0 0.5
0.0 0.0
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Figure 120: P/E multiples: Taiwan banks vs. insurance Figure 121: P/BV multiples: Taiwan banks vs. insurance
x x
900.0 TW banks TW ins 3.5 TW banks TW ins
800.0
3.0
700.0
600.0 2.5
500.0 2.0
400.0 1.5
300.0
200.0 1.0
100.0 0.5
0.0 0.0
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
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Insurance looks attractive from a top-down perspective

Upside to the size of the insurance sector in Asia
China insurance sector remains relatively insignificant to the banking sector in
China, both in terms of market cap and total assets. In fact, this inequality is common
across other markets, but the skew is more acute in the emerging markets. We
believe this is largely created by the fact that the bulk of the financial base in most of
these markets is still predominantly bank deposits. With insurance only accounting
for approximately 7% of total financial base in China by our estimates (Figure 123),
we see significant upside to the size of the insurance sector.
Figure 122: Market cap of financial sector (ex-property) Figure 123: Total assets of financial sector (ex-property)
% of total % of total
100% 87% 100% 93% 91%

77%
80% 80% 71%
65%
60% 60%
40% 40%
22% 22%
14% 17%
20% 7% 20% 11%
6% 7% 4% 4%
0% 0%
0% 0%
Banks Insurance Others Banks Insurance Others
China Asia Pac US/UK/Japan China Asia Pac US/UK/Japan
Source: FactSet and J.P. Morgan. Source: FactSet and J.P. Morgan.
China penetration is low by Asian standards

This is not a new argument to favor the China insurance sector, but it is still a
powerful one, in our view. The penetration rate (premium-to-GDP) and insurance
density (premium per capita) remain generally low in China, and this is in sharp
contrast to the more developed markets in Asia. Assuming a narrowing of the gap
between China and the rest of Asia is likely to generate premium growth for a
sustained period of time in the future. We estimate that premium income in China
could double to Rmb1.5 trillion if the penetration rate were to increase from the
current 2.5% to 5.0%. At 5% penetration rate, the insurance density (premium per
capita) would be approximately Rmb1,000 (US$160). This is still well below the
figures in some of the more developed markets in Asia back in 1999.
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Figure 124: Penetration rate (Life premium-to-GDP) Figure 125: Life insurance density (Premium per capita)
% US$
14 12.8 13.3 6,000
12
10.3 9.9 5,000
10 8.9 8.4 8.0
7.6 4,000
8
3,000
6 4.8
4.2 4.1 4.0 3.6
4 2,000
2.2
1.0 1.4
2 1,000
0
0
USA Japan UK PRC Korea India Taiwan Hong Kong
USA Japan UK PRC Korea India Taiwan Hong Kong
1999 2008 1999 2008
Source: Swiss Re. Source: Swiss Re.
Investment returns have upside potential

Despite the gradual broadening of investment channels in China since 2003, the
investment scope for insurance companies is still relatively narrow with regulatory
limitations imposed on almost all major asset classes including equities and bonds.
There are still segments in which Chinese insurance companies are prohibited from
investing, including the property sector (though some insurance companies actually
hold property assets through their trust companies) and derivatives. Major overseas
investments on top of the approved QDII quota normally require government or
regulatory approvals. In our view, the investment returns of the Chinese insurers are
artificially capped and heavily dependent on the performance of the A-share market,
though on the liabilities side regulations have also capped the guarantee returns on
insurance policies at 2.5%. We expect there is still upside to the investment returns
on the Chinese insurers in the long run.
Table 60: Investment limitations of Chinese insurers

Corporate bonds Prior to June 03: Only allowed to invest 10% in corporate bonds issued by four
types of state-owned enterprises.
Post June 03: Relax from 10% to 20%, and allow to invest in bonds rated AA or
above.
2005: Further relax to 30% of total assets.
2009: Further relax to 40% of total assets.
Equity investment funds Investment in equity investment funds may not exceed 15% of total assets.
Direct equities Direct A-shares investment (up to 5% of total assets) has been permitted since
2004. Further relaxed to 10% since 2006.
Overseas Chinese stocks Jun 2005: Invest up to 10% of total foreign investment quota permitted by SAFE.
Also allow to invest through QDII and RMB conversion.
Infrastructure Allow indirect investment in selective infrastructure projects since March 2006.
Non-publicly traded entities Allow to invest in non-publicly traded commercial banks since Sep 2006. Likely to
extend to other sectors including resources, telecom and energy.
Others including property Investment in commercial property sector may open up.
Source: CIRC.
125
(852) 2800-8511 19 December 2009
Figure 126: Investment yields by country in Asia

%
15.0%
10.0%
5.0%
0.0%
2002 2003 2004 2005 2006 2007 2008 2009E
-5.0%
-10.0%
China Australia Taiw an Korea
-15.0%
Source: Company reports and J.P. Morgan estimates. Note: investment yield for Australia represents investment returns on
shareholders’ funds only.
Potential risk factors

Do not compete head on with the banks on short-term
business
Table 61: Banks versus insurance
Business characteristics Insurers Banks
Main products Risk, savings and investment Loans and fees products
Product life Medium- to long-term Short-term
Investment horizon Long-term Medium-term
Investment scope Equities, bonds, deposits Debt securities
Source of funds Insurance premiums Customer deposits
Business margins Built-in at policy inception Driven by funding costs
Distribution capability Individual sales agents Branches
Business cross-over Not proven Bank-led FI
Future growth Pension market, health Wealth management
Key investment focus Embedded value; VNB Earnings; BV; ROE
Risks Lapse, surrenders NPLs
Insurance companies should not compete head on with the banks, in our view. Banks
are conducting largely short-term businesses (with the exception of mortgage loans
and some medium-term financing). Customer deposits are ‘sticky’ and tend to stay
with the banks for a long period of time. In contrast, insurance business is more long
term, especially in the life business, where policies can last for a few decades. In our
view, Chinese insurers have focused too much on short-term business (single and
three-year regular premiums) in the past, and in doing so have competed head on
with the banks, which have a natural competitive advantage on customer deposits. In
China, short-term insurance policies are mainly distributed through the
bancassurance channel and it involves insurers paying high commissions to their
banking partners. We believe insurers are better off using their strengths by selling
long-term regular premium policies through the individual agents because this is the
business the banks find it hard to compete with without a dedicated insurance sales
force.
126
(852) 2800-8511 19 December 2009
Hong Kong experience in insurance market

The threat from banks distributing and manufacturing insurance products is captured
in the market share changes in Hong Kong. The traditional insurance companies
were once the dominant players in Hong Kong before 2000. This shape of the
insurance market in Hong Kong has changed since the Asian currency crisis in 1998
when bigger local banks started to sell insurance products to generate higher non-
interest income.
Table 62: Market share of new life business in Hong Kong
1Q 2009 2001 +/-
Banks:
BOC Group Life 8.1% 5.4% 2.7%
HSBC Life 17.3% 5.1% 12.2%
Hang Seng Insurance 11.6% 5.1% 6.5%
Other banks 2.8% 1.1% 1.7%
Traditional insurers:
AIA 4.3% 11.4% -7.1%
Manulife 4.3% 5.7% -1.4%
AXA China 4.4% 4.5% -0.1%
Other insurers 47.2% 61.7% -14.5%
Source: OCI.
An insurance-led financial group in China is a new concept
Ping An is adopting what it calls a “three-pillar” strategy to develop insurance,
banking, and asset management in order to build an integrated financial services
provider in China. Given that insurance is already quite well established (second-
largest in market share in China) relative to the other two businesses, the group is
still predominantly an insurance-led financial institution, in our view. Although Ping
An plans to enhance its banking platform by acquiring a 30% stake in Shenzhen
Development Bank, it is too early to judge whether such an insurance-led banking
model will work in China. Based on our understanding, there are not many leading
insurance-led financial institutions in the world (e.g., AIG in the past), and some
European banks are actually disposing of their insurance subsidiaries following the
recent financial crisis in order to preserve capital.
Capital is adequate but not excessive
Chinese insurance companies do not strike us as having excessive capital, with the
exception of China Life. Both Ping An Life and PICC have a solvency margin that is
slightly above the minimum requirement. Both companies have resorted to raising
subordinated debt to increase their capital ratios, but the setback of this is that the
closer to the expiry date of these debts the less it will be counted as capital in the
solvency calculation. Fund raising through equity issuance is another possibility but
given the relatively high volatility and low-return of the listed insurance companies
in China, the dilution effect is likely to deter potential investors. We believe the
insurers should work harder to deliver a more stable return to shareholders, but this
may imply a reduction in equity exposure and much improved risk management.
Table 63: Solvency above statutory requirement
Actual solvency Excess solvency
Margin, 1H09 above min.
% (Rmb mm)
China Life 324% 99,744
Ping An Life 221% 24,572
PICC* 118% 2,408
Ping An P&C 161% 2,386
Source: Company reports. Note: PICC solvency margin has improved to 157% after the recent issuance of Rmb5 billion sub-debt.
127
(852) 2800-8511 19 December 2009
Healthcare
Leon Chik AC We prefer pharmaceuticals and distribution now and
(852) 2800-8590
leon.hk.chik@jpmorgan.com
suggest waiting for medical equipment and consumables
We believe that investments in the healthcare sector will continue to be strong even
after the current round of stimulus-related spending because healthcare is one of the
few industries in China with no excess capacity, very little demand for resources, and
can employ a large number of skilled workers. Therefore, we believe that the
investment in new healthcare facilities to continue to be strong even after other
stimulus-related spending in infrastructure (rail, roads, subways, etc) starts to fade
away as the government focus less on stimulus and more on containing inflation and
asset prices. We also see government policies fostering more private investments,
consolidation in the industry, and the promotion of enterprises that can become
global leaders.
Investing in more healthcare infrastructure

We expect healthcare spending to grow at a much faster rate of GDP as China lifts its
healthcare spending as a percentage of GDP from the current 5% to a level closer to
the international level of c. 10%. Recently, the stimulus package, which resulted in a
doubling of spending in railways, has also resulted in a surge in fixed asset
investment in the healthcare arena (more hospitals, clinics and equipment). And, we
believe that would result in a rise in demand for equipment in 2010 followed by a
rise in demand for drugs and medical consumables in 2011.
Figure 127: China’s healthcare-related fixed asset investment Figure 128: China—Government expenditure in healthcare
80% 80%
60% 60%
Pct Chg Y/Y
40% 40%
20% 20%
0%
0%
Mar-08
Jul-08
Sep-08
Jan-09
Mar-09
Jul-09
Sep-09
May-08
Nov-08
May-09
07
07
08
08
09
09
7
8
7
9
v-0
v-0
-0
-0
-0
b-
g-
b-
g-
b-
g-
ay
ay
ay
Fe
Au
Fe
Au
Fe
Au
No
No
M
Medical FAI (Y/Y Chg) Gov ernment healthcare ex penditures (% Y/Y)
Source: Bloomberg. (CNGE7 Index).

Source: Bloomberg (CNFAHC Index).
In the meantime, the focus on capital spending, combined with credit tightening, has
ironically resulted in more subdued expenditure in healthcare by the government as
well as public hospitals. We believe this has contributed to a lull in spending in 2H09
which we believe to be temporary (see the falling Y/Y growth in overall government
expenditure in healthcare in the right-hand side figure above). Typically, credit
availability improves in the first half of the year and we expect demand from new
hospitals should start in 2H10. If this is the case, then the slowdown in 2H09 should
result in pent-up demand for 2010.
128
(852) 2800-8511 19 December 2009
Next major sector but timing is everything

We believe that macroeconomic conditions are right for healthcare to become a
major sector in both the economy and the stock market. In China, healthcare
expenditure is just less than 5% of GDP compared with over 10% for most
developed nations. Healthcare in aggregate is one of the largest sectors in the US
economy and the aggregate market capitalization is approximately 12-15% of the
entire stock market. In comparison, there are no healthcare stocks in China with over
US$10 billion market capitalization and the percentage of market capitalization is
well under 2%, by our estimates. We believe that the sheer size of the population and
the propensity of Chinese to take care of their elders should lead to ample
opportunities in the next 10-15 years.
In the next three-six months, we believe the best opportunity would be in the
pharmaceutical distribution sector and traditional Chinese medicines as well as low-
cost western medicines. These sectors can participate in the long-term secular growth
of the healthcare industry in China but not suffer the risk of falling demand for
bigger ticket items such as medical equipment and medical consumables that may see
demand being temporarily delayed from 2009 until 2010, due to the government’s
huge commitments to construct hospitals and other infrastructure projects in 2009.
Longer term, we suggest that investors look towards the increase in demand that the
new hospitals should bring over the next two years. We expect the pent-up demand
for healthcare products (equipment and consumables) to resume once the stimulus-
related spending slows down, perhaps in late 2010 or early 2011.
Company highlights: Our top pick in this sector is Sinopharm (1099HK, OW) due
to its simple growth story, comprising strong pharmaceutical sales growth in China
and market share gains by the largest operator. We also see good value in China
Shineway (2877HK, OW), China’s leading maker of traditional Chinese medicines
(TCM) that is doubling its sales force over two years to sell its products to the rural
population. Shandong Weigao (8199HK, OW) is one of China’s leading medical
consumables makers, which is growing slower than normal due to hospitals cutting
back on purchases due to a lack of credit, but we see this as a buying opportunity
before sales pick up again in 2010E. We have a Neutral rating on Mindray (MR US)
because more than half of its sales are in overseas markets which have contracted in
2009, and we prefer to wait for more evidence of an export recovery.
129
(852) 2800-8511 19 December 2009
Real estate
AC
Raymond Ngai, CFA
(852) 2800-8527 We expect near-term stable policy for the property sector
raymond.ch.ngai@jpmorgan.com
Monetary policy likely to remain accommodative
Lucia Kw ong, CFA After the CPC meeting, investors are relieved that the central government intends to
(852) 2800-8526
maintain its pro growth policy stance; hence, the accommodative monetary policy is
lucia.yk.kwong@jpmorgan.com
unlikely to be reverted soon. Homebuyers expect some of the incentives provided at
Sunny Tam, CFA local government level to expire by end of this year, but property prices should
(852) 2800-8524 remain firm in FY10. Hence, the secondary markets in Beijing and Shanghai were
sunny.wy.tam@jpmorgan.com
buoyant in the past few weeks.
Ryan Li Urbanization likely to pick up speed in small- to medium-sized cities/counties

(852) 2800-8529 At the Annual Economic Summit, facilitating agricultural population to migrate into
ryan.lh.li@jpmorgan.com
cities was identified as one of the key initiatives to boost domestic consumption; it
was mentioned that the residency restriction at small- to medium-sezed
cities/counties would be relaxed to facilitate their migration. No details on
when/where/how it would be implemented is announced yet, but we believe relaxing
residency restrictions will encourage more people to move into the cities, given that
discrimination between residents/non-residents is still one of the major concerns
when making migration decisions. We believe the new policies should benefit
developers with more exposure to third/fourth-tier cities/lower-end housing.
We expect stable policy in the near term but more risk in the medium term
We expect relatively accommodative policies to stay in the near term, although in the
medium term, we believe the risk may emerge from the implementation of property
tax on high-end residential. Shenzhen was cited to be one of the first pilot cities to try
implementing property tax, and the key risk lies in the fact that the tax rate of
property tax might be high so as to deter speculative demand and hoarding of
properties. We would probably get more details around the next National People’s
Congress (NPC) meeting in around March/April next year.
130
(852) 2800-8511 19 December 2009
Information
Primary sales fell only 5% M/M in November, a traditionally slow season
Property sales volumes in the eight major cities we track were down around 5/% in
November, after strong sales in October during the Golden Week holidays and also
trade fairs held in the same month. We believe this was not bad at all, given that
November is a traditionally slow season.
We expect nationwide sales volume to slow 8% Y/Y in 2010. We believe strong

sales in 2009 were driven by pent-up demand in 2009 and investment demand; we do
not expect this to be sustained in 2010. Actually sales volume in first-tier cities may
drop 10%-20% next year, on an even higher base of comparison.
Table 64: Monthly sales

Million sqm
Beijing Shanghai Hangzhou Guangzhou Shenzhen Chongqing Chengdu Tianjin
Jan-08 0.91 1.53 0.20 0.35 0.27 1.13 0.57 0.43
Feb-08 0.39 0.72 0.09 0.23 0.06 0.53 0.32 0.21
Mar-08 0.66 1.84 0.16 0.38 0.19 0.79 0.63 0.53
Apr-08 0.65 1.41 0.20 0.40 0.33 0.89 0.69 0.47
May-08 0.91 1.72 0.30 0.39 0.38 1.25 0.52 0.51
Jun-08 1.00 1.41 0.19 0.67 0.30 0.73 0.41 0.49
Jul-08 0.71 1.19 0.18 0.61 0.26 1.05 0.37 0.40
Aug-08 0.41 1.01 0.13 0.61 0.28 0.57 0.44 0.32
Sep-08 0.74 0.99 0.17 0.51 0.34 0.87 0.46 0.33
Oct-08 0.79 0.86 0.13 0.36 0.34 1.23 0.41 0.43
Nov-08 0.81 1.03 0.17 0.54 0.36 1.01 0.46 0.49
Dec-08 0.81 1.56 0.19 0.49 0.71 1.10 0.55 0.42
Jan-09 0.73 0.81 0.13 0.46 0.52 0.70 0.54 0.29
Feb-09 0.92 1.22 0.17 0.47 0.36 1.41 0.85 0.57
Mar-09 1.69 2.31 0.40 0.64 0.69 1.83 0.92 1.24
Apr-09 2.12 2.57 0.69 0.83 0.79 2.26 1.02 1.08
May-09 1.98 2.69 1.08 0.67 0.76 1.78 1.15 1.28
Jun-09 2.00 2.66 1.36 0.72 0.66 1.68 0.67 1.16
Jul-09 2.06 2.68 0.61 1.26 0.55 1.75 0.96 1.34
Aug-09 1.69 2.40 0.84 1.26 0.39 1.73 0.92 1.42
Sep-09 1.67 2.04 0.65 0.91 0.33 2.05 0.96 1.22
Oct-09 1.63 2.44 0.61 0.55 0.50 2.97 1.05 1.09
Nov-09 (e) 1.89 2.19 0.56 0.61 0.47 1.91 1.45 1.24
M/M %Chg 16% -11% -4% 11% -6% -36% 36% 14%
Y/Y % Chg 132% 112% 231% 13% 31% 89% 217% 4%
YTD Y/Y% Chg 130% 77% 234% 76% 100% 103% 100% 53%
Source: Centaline, City real estate trading centres, J.P. Morgan estimates.
131
(852) 2800-8511 19 December 2009
Table 65: Selected major Chinese cities—Average daily sales

M/M
No. of M/M % M/M % M/M M/M % M/M M/M % % M/M
units BJ chg SZ chg SH % chg CQ chg CD % chg TJ chg HZ chg GZ % chg
Jan-08 222 -33% 74 0% 510 -3% 406 -11% 264 -12% 166 -49% 166 -49% na
Feb-08 118 -47% 28 -62% 256 -50% 196 -52% 104 -60% 99 -40% 99 -40% na
Mar-08 218 78% 102 265% 546 113% 289 47% 256 130% 200 102% 63 -36% na
Apr-08 197 -9% 90 -11% 460 -16% 354 23% 260 2% 152 -24% 72 13% na
May-08 241 22% 175 94% 555 21% 435 23% 242 -7% 152 0% 96 34% na
Jun-08 308 28% 98 -44% 465 -16% 301 -31% 173 -28% 166 9% 75 -22% na
Jul-08 200 -35% 81 -17% 346 -26% 304 1% 165 -5% 123 -25% 61 -19% na
Aug-08 158 -21% 96 19% 340 -2% 298 -2% 180 10% 98 -21% 49 -19% na
Sep-08 369 133% 112 17% 290 -15% 323 8% 186 3% 106 9% 48 -2% na
Oct-08 331 -10% 121 8% 246 -15% 356 10% 204 10% 124 17% 47 -3% na
Nov-08 431 30% 191 57% 388 58% 444 25% 236 16% 146 18% 60 29% na
Dec-08 435 1% 255 34% 451 16% 419 -6% 268 14% 126 -13% 74 23% na
Jan-09 246 -43% 149 -42% 267 -41% 340 -19% 236 -12% 93 -27% 46 -38% 195
Feb-09 310 26% 194 30% 420 57% 650 91% 419 78% 207 124% 64 39% 282 45%
Mar-09 461 49% 277 43% 716 70% 731 12% 423 1% 380 84% 152 139% 353 25%
Apr-09 639 38% 245 -12% 744 4% 894 22% 460 9% 352 -7% 198 30% 357 1%
May-09 558 -13% 282 15% 793 7% 789 -12% 455 -1% 390 11% 355 80% 449 26%
Jun-09 580 4% 234 -17% 889 12% 635 -20% 279 -39% 361 -7% 427 20% 358 -20%
Jul-09 539 -6% 191 -18% 783 -12% 724 6% 359 27% 407 13% 307 -28% 166 -54%
Aug-09 485 -10% 132 -31% 696 -11% 661 -9% 341 -5% 467 15% 238 -23% 226 36%
Sep-09 481 -1% 95 -28% 632 -9% 643 -3% 340 0% 383 -18% 298 26% 226 0%
Source: Beijing Online Trading Centre, Shanghai Online Trading Centre, Shenzhen Land Resources and Housing Management Bureau, Chengdu Housing Management Bureau, Chongqing Land
Resources and Housing Management Bureau, Tianjin Land Resources and Housing Management Bureau, Focus.cn
BJ: Beijing, SZ: Shenzhen, SH: Shanghai, CQ: Chongqing, CD: Chengdu, TJ: Tianjin, HZ: Hangzhou, GZ: Guangzhou.
Table 66: Supply outlook

GFA available for Avg monthly take-up Months of supply based Take-up in Months of supply based
sale# in 10M09 on 9M09 avg sales Oct-09 on latest month’s take-up
MM sqm MM sqm Sales/mthly take-up MM sqm Sales/mthly take-up
Guangzhou 4.5 0.88 5 1.10 4
Shenzhen 3.8 0.58 7 0.50 8
Beijing 13.8 1.65 8 1.63 8
Shanghai 5.2 2.20 2 2.44 2
Hangzhou* 1.7 0.59 3 0.61 3
Chongqing 10.8 1.85 6 2.97 4
Chengdu^ 5.5 0.90 6 1.05 5
Source: City real estate trading center websites, J.P. Morgan estimates. #Defined as units with presale permits but not sold and unsold stocks. *Includes six major districts; excludes Yuhang and
Xiaoshan. ^Includes six main districts only; districts such as Shuangliu, Pi'xian, Wenjiang, Xindu, etc. are excluded.
132
(852) 2800-8511 19 December 2009
Table 67: Chinese developers’ 2009 YTD contracted sales

2009 2009 09 ASP Contract Contract Contract Contract Cumu FY09
Contract sales sales sales sales sales sales lative sales Pct
sales YTD Avg YTD Jul 09 Aug 09 Sept 09 Oct 09 Y/Y target Achieved
figure until Rmb MM Rmb psm Rmb MM Rmb MM Rmb MM Rmb MM chg Rmb MM %
Beijing Capital Land End-Oct 9,990 11,616 1,430 1,247 1,400 920 295% 10,000 100%
Sino-Ocean Land End-Oct 11,000 NA 700 1,300 >1,100 NA NA 11,000 100%
China Vanke End-Oct 52,690 9,226 5,110 4,820 5,460 6,540 35% 60,000 88%
China Overseas Land End-Oct 36,839 8,452 3,603 3,091 3,894 3,660 87% 40,000 92%
CR Land End-Oct 20,060 10,421 2,270 2,520 >700 NA NA 18,000 111%
Guangzhou R&F End-Nov 22,621 10,092 1,545 2,063 2,035 2,194 61% 23,000 90%
Greentown End-Oct 41,000 14,420 4,400 5,800 5,200 3,864 204% 45,000 91%
Hopson End-Aug 9,000 10,449 NA NA NA NA NA 11,437 79%
KWG End-Oct 6,000 NA 700 570 700 900 NA 5,000 120%
Shanghai Forte End-Sept 6,468 8,972 712 708 901 NA NA 6,500 100%
Shui On Land End-Jul 3,065 NA 720 NA NA NA NA 3,300 93%
Yanlord End-Sept 10,000 NA 2,240 NA NA NA NA 9,600 104%
Agile End-Oct 13,700 6,438 1,100 1,700 1,100 2,000 NA 15,900 86%
Source: Company data, J.P. Morgan estimates.
Non-consensus calls
Gaining market share is key for 2010
While we expect an overall slowdown in sales in 2010, and a possible softening in
prices, we believe some developers can still achieve sales growth via more new
project launches in more cities and capturing larger market share. Most developers
have locked in 50%-70% of their FY10 earnings through pre-sales already; in our
view, the winners will be those who are able to achieve good sales in 2010 and
secure strong growth for 2011. We believe mid-caps will offer more upside than
large caps, as they should be able to deliver higher growth on a lower base.
Key stock picks for 2010

We prefer stocks with higher exposure to commercial properties, which we believe
should be less vulnerable to policy risks, and stocks that we believe could deliver
strong earnings growth in 2010/2011. Our top picks are:
Franshion Property (817.HK, OW): A state-owned enterprise with a unique exposure

to commercial properties—there could be potential asset injections from the parent
company, Sinochem. Our Dec-10 PT of HK$3.3 implies a P/E of 28x and a P/BV of
1.8x on FY11E, considering strong earnings growth in FY12E. Our PT is based on a
20% discount to NAV, the same target discount we assign to SOL. In comparison,
for CRL, we assign a 12% target premium to NAV. We take into account
Franshion’s high-quality portfolio in prime locations and NAV growth potential from
injections. Key risks to our PT include further weakening of leasing demand and
rental rates in Shanghai.
Glorious Property (845.HK, OW): An undervalued mid-cap stock with a low-cost

prime land bank—we expect net profit growth of 95% in 2010 and a further 21%
growth in 2011. Our Dec-10 PT of HK$5.0 is based on 12x FY10E P/E, 9.9x FY11E
P/E, and 2.2x FY10E P/BV. Our target FY10E/11E P/E is at the mid-range of 11x-
14x, which we apply to mid-cap regional homebuilders, despite its strong cash
position. We take into account the relatively low-profile brand name of the company
but its relatively good land bank quality, and believe the stock should trade closer to
the average valuation of its nearest peers, which are at 12x-13x FY10E P/E and c. a
30% discount to NAV. Key risks to our PT are policy risks, price risks in Shanghai,
133
(852) 2800-8511 19 December 2009
and heavy weight of Shanghai Bay assumptions in our EPS forecasts and NAV
estimate.
Guangzhou R&F (2777.HK, OW): Strong management and good execution

capability. By applying a 12x FY10 P/E, we derive our Jun-10 PT of HK$17.5. We
believe R&F can maintain earnings growth at a minimum of low teens beyond FY10
and hence we use a PEG of 1.0x to derive our target P/E of 12x. Our PT represents
an undemanding 3.0x P/BV. Key risks to our price target are a potential economic
recession, a widespread nationwide housing prices correction, the progress of
contract sales, its high financial leverage, and the outcome of A-share listing.
134
(852) 2800-8511 19 December 2009
Figure 129: China property—Sector P/E ratio (all stocks under Figure 130: China property—Sector P/E ratio (ex-NWCL and Vanke)
coverage) 56
52
50 48
44
45 40 +2 Std dev
40 +2 Std dev 36
32
35
28 +1 Std dev
30 +1 Std dev 24
20
25
Average = 18.7X 16
20 12
15 8
-1 Std dev 4 -1 Std dev
10 0
5 -4 -2 Std dev
-2 Std dev -8
0
Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09
Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09
A
Figure 131: China property—Sector NAV prm/disc Figure 132: China property— Sector NAV prm/disc (ex- Vanke)
100% 60%
80% 40%
60%
+2 Std dev 20%
40% +2 Std dev
20% 0%
+1 Std dev
0% -20% +1 Std dev
-20%
-40%
-40%
Long Term Avg: -5% -60%
-60%
-80% -80% Long Term Avg: -25%
May -103Std Mar 04 Jan 05 Nov 05 Sep 06 Jul 07 May 08 Mar 09 -100%
May 03 Mar 04 Jan 05 Nov 05 Sep 06 Jul 07 May 08 Mar 09
Figure 133: China property—Sector P/B ratio (all stocks under Figure 134: China property—Sector P/B ratio (ex-NWCL and Vanke)
coverage) 5.0
5.0 4.5
4.5 4.0 +2 Stdev
4.0 3.5
+2 Stdev
3.5 3.0 +1 Stdev
3.0 2.5
+1 Stdev
2.5 2.0
Mean
2.0 1.5
1.5 1.0 -1 Stdev

-1 Stdev
1.0 0.5
-2 Stdev
0.5 -2 Stdev 0.0
03 04 05 06 07 08 09
0.0
03 04 05 06 07 08 09
135
(852) 2800-8511 19 December 2009
Transportation
Corrine Png A C Summary
(65) 6882-1514
corrine.ht.png@jpmorgan.com The transport sector is highly leveraged to a global recovery. We have forecast a
moderate 7% and 8% rebound in passenger and shipping volumes in 2010,
J.P. Morgan Securities (Asia Pacific) Limited respectively. However, upside surprises are possible as passenger and cargo demand
have historically grown at 1.7x and 2.0x real GDP growth, respectively, and J.P.
Morgan Economics team forecasts a 7.2% real GDP growth for Asia ex-Japan in
2010. We are more bullish on the airline and land transport sectors’ earnings
recovery than shipping, as the former does not face structural overcapacity once
demand normalizes. We believe the slew of deliveries will delay the shipping
sector’s return to sustainable profitability to 2H10 at the earliest. However, as this is
already widely known, a smaller supply-demand gap (especially for dry bulk) could
drive an earlier re-rating. Rebounding fuel prices are less of a concern when demand
recovers as surcharges help to offset this impact—the transport sector’s record-high
profits in 2007 testify to this. Most transport stocks are beneficiaries of a weaker US
dollar, given their large US$ capex and debt. This downturn will likely drive
consolidation, but cross-border M&A is more difficult due to regulatory restrictions
and political sensitivity.
How much of the recovery has been priced in?
Transport stocks are early cyclicals and have started to price in part of the recovery.
Most are near their historical average valuations, partly because huge losses have
significantly eroded their book values. Although the stocks could trade range-bound
in the near term or correct when they announce weak 2H/4Q results, we see any
weakness as a good opportunity to accumulate airlines and select shipping and land
transport companies as they have historically provided large absolute and relative
returns in a cyclical upturn.
Recommendations
We prefer airlines to shipping in the Chinese transport sector and our top pick is Air
China, which we expect to outperform more than the domestically-focused China
Southern and the restructuring China Eastern. We remain cautious on the shipping
sector but are incrementally more positive in 2010 than we were in early 2009 and
our top pick is China Shipping Container Lines, given its backend-loaded vessel
deliveries and capex.
136
(852) 2800-8511 19 December 2009
Figure 135: Asian airlines passenger demand-supply projection

25.0 Passenger
25.0 Passenger traffic
traffic RPK
RPK growth
growth (%
(% )) Passenger
Passenger capacity
capacity ASK
ASK growth
growth (%
(% ))
20.0
20.0
15.0
15.0
10.0
10.0
5.0
5.0
0.0
0.0
-5.0
-5.0
-10.0
-10.0
-15.0
-15.0
2200 EE
2200 EE
2200 EE
EE
9911
9922
9933
9944
9955
9966
9977
9988
9999
0022
0033
0044
0055
0066
0077
0088
0000
0011
0099
1100
1111
1122
1199
1199
1199
2200
2200
2200
1199
1199
1199
1199
1199
1199
2200
2200
2200
2200
2200
2200
2200
Source: AAPA, IATA, company reports, CEIC, J.P. Morgan estimates.
Figure 136: Dry bulk shipping demand—Supply projection

15% D
Dem
emand
andgrowth
growth Supply
Supply growth
growth 14.4%
15% 13.3% 14.4%
13.3%
13%
13%
10% 8.0%
8.0%
10% 7.7% 9.0%
9.0%
7.7% 10.5%
8% 10.5% 6.0%
6.0%
8% 6.9%
5% 6.9% 7.5%
5% 7.2% 2.7% 7.5% 5.7%
7.2% 2.7% 5.7%
3%
3%
0%
0%
-3%
-3%
-5%
-5%
2007 2008 2009E 2010E 2011E 2012E
2007 2008 2009E 2010E 2011E 2012E
Source: Clarksons, CEIC database, J.P. Morgan estimates.
Figure 137: Container shipping demand-supply projection

15% Demand growth Supply growth
13% 11.0% 10.3% 9.9%
10% 8.2% 8.3%
8% 10.2% 4.5% 6.2%
5% 6.3%
3% 5.4% 3.5%
0%
-3%
-5%
-8%
-10% -11.0%
-13%
-15%
2007E 2008E 2009E 2010E 2011E 2012E
Source: Clarksons, Containerisation International, J.P. Morgan estimates.
137
(852) 2800-8511 19 December 2009
Telecom
Jimmy Cheong AC
(852) 2800 8566
jimmy.j.cheong@jpmorgan.com
We remain cautious on the Chinese telecom sector going
into 2010
Michelle Wei
(852) 2800-8562 We do not have an Overweight rating on the sector. Our top pick on a relative
michelle.z.wei@jpmorgan.com basis is China Mobile and our top stock to avoid is China Unicom.
J.P. Morgan Securities (Asia Pacific)
Limited • Capex leading itself to overcapacity: We believe all three operators will spend
high capex budgets in 2009. China’s telecom sector will spend its highest annual
capex on record this year of close to Rmb400 billion. This could be the highest
annual capex spend on record, representing a rise of 72% in 2009 from 2007
levels and 33% from 2008 levels. This compares with 2002- 2007, when the
capex CAGR was only 1.6%. Operators have aggressive network expansion and
3G rollout plans for 2009. We believe there could be a plethora of capacity
coming on board in 2010.
• Previous capex bubbles saw underperformance: Previous capex humps have
led to several years of industry overcapacity. Being SOEs, we feel the three
telecom operators are being asked by the government to do their part in
stimulating the domestic economy via infrastructure spend on telecom equipment.
It also reflects more fundamentally the worsening competitive position for the
industry over the next 1-2 years, as all new capex could turn into empty capacity,
in our view. Fundamentals will likely be steered by this capex issue which keeps
us cautious. This impact has just started to hit financials.
• Industry restructuring leading to more credible competition: In the past
several years CM has been enjoying a very comfortable competitive environment
whereby it captured most of the industry’s new subscribers, revenues and
profitability. Industry restructuring changed all that. There are now two credible
competitors to challenge CM’s dominance. Both CT and CU have intentions to
significantly lift their mobile market share. We think price competition could
accelerate.
• 3G earnings risk: 3G rollouts and associated high sales and marketing costs are
likely to depress margins and profitability, affecting earnings over the next
several quarters. As we conclude that the 3G service plan take-up is likely to
remain lackluster due to high pricing, stocks riding on the success of 3G
subscriptions (i.e. China Unicom) have the highest risk to disappoint, in our view.
China Mobile Ltd: Analyst Day takeaways: TD progressing well, lots of

fancy apps and 4G is closer than you think
(Extracted from the note, “China Mobile Ltd: Analyst Day takeaways: TD
progressing well, lots of fancy apps and 4G is closer than you think”, published on
20 November 2009; please see the original note for pricing dates)
• Shenzhen Analyst Day: CM’s Analyst Day showcased what they believe to
be the next major area of growth. With penetration at 55%, continued tariff
pressures, declining elasticity and lower ARPU from new rural customers,
CM admitted that it will be challenging to maintain growth. However,
management is confident future growth will come from 3G-4G value-added
138
(852) 2800-8511 19 December 2009
services and applications such as Mobile TV, Mobile Wallet, Mobile

eReaders, and increased data usage through greater smartphone penetration.
• TD improving with 4G just around the corner: Management stated that

TD-SCDMA development is progressing well with key KPIs such as call
drop out rates, call connection rates, and 3G/2G handover success rates
reaching acceptable standards as seen with other 3G technologies. TD
terminal selection is also getting larger. In addition, CM will try to make the
transition to 4G via TD-LTE as soon as possible. It forecasts TD-LTE data
cards to be available in mid-2010 and TD-LTE smartphones to be ready by
end-2011. A trial TD-LTE network will be on show at the 2010 Shanghai
World Expo.
• Good strategy with solid track record: We are generally impressed with
CM’s clear vision and strategy. We do not dispute CM’s strong track record
in developing VAS services. CM grew VAS (data & non-voice) revenues as
a percentage of ARPU from almost zero in 2000 to 28% today. It aspires to
emulate Japanese operators who have a VAS contribution of more than 40%
of ARPU. However, we think new products and services are more of a
medium- to long-term story rather than something that is going to contribute
materially to earnings over the next two years. We hold this view because
smartphone–type terminals need to enable these services such as Mobile TV,
Mobile Gaming, etc. are still expensive (+ US$500) and it will take some
time for prices to decline for it to be appealing to the mass market.
• CM is our top pick in the space but we remain cautious on the sector: We
rate CM Neutral with a Dec 10 DCF-based PT of HK$75. Our price target is
based upon a 10 year DCF model. We assume a WACC of 11.4% derived
from a cost of equity of 10.5%, cost of debt of 5%, equity risk premium
assumption of 6.5%, and a risk-free rate of 4% with 5% target gearing. Our
price target is a one-year forward price target. Key risks to our price target
are excessive mobile competition and asymmetric policies. CM is still our
preferred pick in the space for its strong cash-generating ability. We think
CM’s valuation appears reasonable given its expected financial performance
and its growth outlook. However, we are cautious on the sector as we are
concerned about the aggressiveness of China Unicom and China Telecom.
Industry news
(Extracted from the note, “China Telco Monthly: Oct-09 MIIT industry data
highlights: Slight revenue drop, capex still high and the mobile net adds momentum
continues”, published on 27 November 2009; please see the original note for pricing
dates)
MIIT and NDRC mandate local fixed-line tariff cap:

MIIT and NDRC jointly issued revised regulations on local fixed-line call tariffs on
November 24. Effective immediately, basic monthly fee and local call rates for fixed-
line local telephone services (including PHS services) will change from the current
government-mandated prices to a price cap system. Operators must provide
customers with at least one pricing plan in which the fee structure and accounting
units are equivalent to the current standard tariffs, and this plan should not exceed
current standards (set in 2001). At the same time, operators can create their own
plans in accordance with market condition and customer needs. The notice also
stipulates a price cap management scheme for long-term leased line fees. Our view is
that these changes will not have a material impact on the market.
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Operators offer more aggressive subsidy plans

China Telecom’s Beijing branch has brought into effect more aggressive subsidy
plans. The new plans apply to customers who deposit an upfront fee, which will be
rebated over a 24-month period, and also promise a monthly minimum spend. CT
Beijing will be giving away free e-Surfing handsets the value of which could equal
up to 70% of the total required minimum spending for a 24-month contract, much
higher than the previous 30%. Meanwhile, CM is also stepping up sales and
marketing efforts nationwide. CM’s Shanghai branch recently jointly kicked off a
mobile phone trade-in program with Suning Appliance chain store, China's second
largest home appliance retailer. This program offers customers an e-coupon worth
10% of the new 3G handsets selling price which could be used for their future
purchase. CM’s Guangdong branch and Suning Appliance also took joint initiatives
to lower 3G handset prices by 10-20% starting on the second weekend of November.
On top of the price cuts, CM will continue to offer subsidies of Rmb500-1,800 to
customers. The two companies are targeting at selling 2G and 3G handsets at similar
price levels. Meanwhile in Beijing, China Mobile has been offering recharge bonus
to Gotone, M-Zone and Easyown customers and the promotion will last until the end
of November. Gotone customers can get recharge bonus worth 50% of the amount
they credit their account with if they promise a minimum monthly spend for 12
months and Easyown customers are also offered recharge bonus equaling 20% of
their top up credits. Meanwhile, China Mobile will give away free airtime in
November to TD-SCDMA customers who use TD services in October.
CM invests Rmb40mn in wireless-fixed phone joint project

China Mobile commenced a joint development initiative with vendors for TD-
SCDMA office wireless-fixed phone project on November 24. Investment will be
around Rmb40 million which will come from the parent company’s TD-SCDMA
R&D development fund. The so-called fixed wireless phone uses the TD network
and could switch between 2G and 3G networks. The phone is also installed with
China Mobile's value-added services and can access the internet with a speed of 2.8
Mbps, and surf on the internet via PC. CT has also recently launched its new 3G
fixed-wireless service called “e-Surfing Biztalk”.
iPhone initial sales disappointing

China Unicom announced on 3 November 2009 that around 5,000 iPhones have been
sold since the handset hit shops on October 30, 2009. China Unicom CEO Chang
Xiaobing said in a recent interview with Bloomberg that the sales numbers were
acceptable but could have been better. He disclosed China Unicom will start more
aggressive iPhone marketing campaigns starting November 16 and is focused on
subscriber growth with a target of 1million new 3G customers each month. We are
concerned with CU’s competitive positioning and the divergence between CU’s
reputation as a discount mobile carrier with inferior network coverage and its 3G
ambitions to turn itself into a high-end operator. Heavily relying on the success of the
iPhone is a strategy which may disappoint, in our view.
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Update on subscriber data
Year-to-date monthly subscriber data are summarized below

Table 68: Year-to-date monthly subscriber data
Units in thousands Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09
China Mobile GSM 443,309 450,179 457,250 463,920 470,671 477,164 482,987 488,105 493,124 497,677 502,936 508,370 513,466
China Unicom GSM 131,945 132,941 133,365 134,204 135,844 137,692 138,833 139,515 140,377 141,057 141,864 142,799 143,600
China Telecom CDMA 28,400 27,970 27,910 28,930 30,630 32,840 34,710 36,910 39,280 41,730 43,810 46,780 49,920
Total wireless subs 603,654 611,090 618,525 627,054 637,145 647,696 656,530 664,530 672,781 680,464 688,610 697,949 706,986
China Telecom fixed 211,880 210,370 208,350 207,380 205,830 204,000 202,100 200,750 199,360 197,690 196,170 194,390 192,930
China Netcom fixed 106,537 105,017 100,146 109,445 108,944 109,167 108,996 108,707 108,452 108,121 107,639 107,131 106,184
Total fixed subs 318,417 315,387 308,496 316,825 314,774 313,167 311,096 309,457 307,812 305,811 303,809 301,521 299,114
China Telecom broadband 42,880 43,570 44,270 45,030 45,900 46,770 47,490 48,240 49,050 49,870 50,560 51,450 52,150
China Netcom broadband 25,204 25,438 25,416 31,052 31,687 32,614 33,154 33,933 34,913 35,727 36,598 37,467 38,006
Total broadband subs 68,084 69,008 69,686 76,082 77,587 79,384 80,644 82,173 83,963 85,597 87,158 88,917 90,156
Source: Company. Note: All subscribers in thousands.
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Utilities and infrastructure

AC
Edmond Lee, CFA
(852) 2800-8575 What is changing?
edmond.ch.lee@jpmorgan.com
Change 1: China water: Expect positive earnings surprises from Guangdong
Boris Kan Investment
(852) 2800-8573
boris.cw.kan@jpmorgan.com
Extracted from the note, “Guangdong Investment Limited: Our low risk, reasonable
return pick in the space,” published on 6 December 2009. Please see the original
Karen Li note for pricing dates.
(852) 2800-8589
karen.yy.li@jpmorgan.com
We are positive on GDI’s 2H09 results because of the following three catalysts:
Ajay Mirchandani
(65) 6882-2419 1) Potential positive surprises from China water sales
ajay.mirchandani@jpmorgan.com
As reported by the press (including sohu.com), Southern China (including
Guangdong) suffered a severe drought in early Nov 2009. In fact, our findings
(Figure 139) suggest that, in addition to Nov 09, rainfall in Jul-Oct 09 were also
lower than in 2008 and the long-term historical average. Hence, we believe demand
for GDI’s water supplies will be higher in 2H09 given that users will have less water
supplies from other alternative sources (e.g. local reservoirs, etc). More importantly,
we have confirmed with management that the dry weather has not affected GDI’s
own water supplies, and its water business operations remain as usual.
In addition, continued economic recovery in Guangdong (Figure 138) should also

provide strong support on demand for GDI’s water supplies in 2H09, particularly for
industrial users which account for Dongguan’s >40% of water demand.
Figure 138: Guangdong GDP : Signs of economic recovery Figure 139: Guangdong: Monthly avg. rainfall differential (in mm) *
15% 1,200 100
Guangdong’s rainfall in Jul-Oct09 was much
1,000 80 drier than historical avg., while Jul-Oct08 had
13%
60 higher rainfall. We believe Nov09 will also
800
11% 40 record low rainfall figures
600 20 -30 +25 -140
9% -30
400 0
7% -20
200
-40
5% - -60 2008 2009
1Q072Q073Q074Q081Q082Q083Q084Q081Q092Q093Q09 -80
Real GDP grow th % (LHS) Nominal GDP (RHS in Rmb B) Jul Aug Sep Oct
Source: CEIC * Avg. monthly rainfall differential represents the difference between (1) average rainfall in a given
month in Guangdong vs. (2) the long term historical average rainfall in Guangdong in that month.
I.e. a negative value represents a dry month while a positive value indicates a wet month.
** Figures shown in the chart represent the rainfall difference between 2008 vs. 2009
Source: China Weather Observatory Bureau
Our calculations suggest that every 10% increase in China water sales will lead to a
potential 3-4% 2009E EPS upside. While that might not sound like a lot, we believe
it will surprise investors given that the stock has only delivered ~11% core earnings
growth over the past 2-3 years.
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(852) 2800-8511 19 December 2009
Table 69: Sensitivity analysis on increased China water sales

Impact on 2009E pre-
tax profits
China water sale vol 20% > base case + 6.8%
China water sales - base case 0%
China water sale vol 5% < base case - 1.7%
China water sale vol 10% < base case - 3.4%
GDI’s losing position in 1H09 China water sale vol 15% < base case - 5.1%
was mainly driven by a China water sale vol 20% < base case - 6.8%
HK$75MM impairment provision Source: J.P. Morgan estimates.
in Yue Jiang Power Plant.
2) Continued recovery in the power business
With the continued recovery in power demand (Figure 140) and without further
impairment provisions expected, we believe profitability of GDI’s power business to
improve in 2H09 from 1H09 levels (vs. HK$43MM losses in 1H09, of which
HK$75MM being impairment provision). This is consistent with our findings in
other listed IPPs.
Figure 140: Power production in Guangdong Province Table 70: GDI’s power business profit & loss position (in HK$ MM)
1H07 2H07 1H08 2H08 1H09
Y/Y Pow er dmd grow th % (LHS) 30.0 Segmental profit / losses 94 (383) (101) (180) (33)
10% during the period
Pow er produced (RHS in Bln Kw h)
25.0 Attributable profits (losses) 12 16 (32) (3) (10)
0%
from associates / JCE
-10% Total profits (losses) after 106 (367) (133) (183) (43)
20.0 impairment losses
-20% Of which: Impairment losses - (469) (55) (134) (75)
15.0 recorded
-30% Total profits (losses) 106 102 (78) (49) 32
incurred before impairment
-40% 10.0
losses
Jan- Feb- Mar- Apr- May - Jun- Jul- Aug- Sep- Oct- Source: Company
09 09 09 09 09 09 09 09 09 09
Source: CEIC (Note: We use the power production in Guangdong as opposed to power
consumption in Guangdong because ALL of GDI’s power plants are located in the Guangdong
Province. Hence, power supplied from other areas (e.g. 3 Gorges) are not as relevant
3) Potential property revaluation gain

Thanks to the continued improvement in the property market, we expect GDI’s
property assets to enjoy further revaluation gain in 2H09, in particular the Teem
plaza. A quick review of the company’s income statements from 1H07 to 1H09
indicated that GDI’s investment properties have recorded an aggregate net
revaluation loss of HK$216MM.
While it might be too simplistic to draw the conclusion that GDI’s investment
property assets are recorded at a lower valuation level in Jun 2009 than in Dec 2006
(due to constant changes in its property asset portfolio from period to period), it is
conceivable that there is room for further upward revision on property values in
2H09. Our calculations suggest that every HK$100MM property revaluation gain
might lead to a potential ~5% 2009E EPS boost.
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(852) 2800-8511 19 December 2009
Figure 141: Power production in Guangdong Province Table 71: Sensitivity analysis on increased China power business
Impact on 2009E pre-
100% Total net loss position of 600 tax profits
80% HK$216MM from 1H07 400 HK$400MM revaluation gain in 2H09 19.6%
60% to 1H09 (RHS) 200 HK$300MM revaluation gain in 2H09 14.7%
40% HK$200MM revaluation gain in 2H09 9.8%
-
20% HK$100MM revaluation gain in 2H09 4.9%
(200) Base case (no revaluation gain in 2H09) 0%
0%
-20% (400) Source: J.P. Morgan estimates
-40% (600)
-60% (800)
1H07 2H07 1H08 2H08 1H09
Property rev al gain (loss) (RHS in HK$MM)
As a % of core profits (LHS in %)
Source: Company data
Asset injections unlikely in near term, but gearing falling fast: Our recent
discussions with management lead us to believe that any potential asset injections
will not be likely over the next 3-6 months. But with its strong FCF position, we
expect GDI’s gearing to fall to <15% by 2010YE from 33% in 1H09A.
Impact: Low risk, reasonable return pick: While investors might remain
disappointed over the continued delay in potential asset injections, we reiterate OW
due to (1) its expected strong 2H09E earnings (including the expected non-core
property revaluation gain) and (2) undemanding valuation at 11x 2010E PER, 3%
dividend yield & ~11% 2009-11E EPS CAGR. GDI is one of the cheapest stocks in
our China utility / infrastructure space (other than Huaneng / Harbin / Huadian /
CCCC) while having one of the lowest risk profile & highest earnings visibility, in
our view. The stock might appeal to investors who are concerned about (1) potential
macro tightening, (2) margin squeeze & (3) demanding valuation in other sectors.

Our Dec-10 price target of HK$5.2 is based upon sum-of-the-parts valuation which can be broken down as follows:
NAV Breakdown Val. Method. Total value Per sh NAV %

HK water DCF 18,413 2.99 58%
China water DCF 8,046 1.31 25%
Power DCF 819 0.13 3%
Toll roads DCF 626 0.10 2%
Hotel 8x 2010E EV/EBITDA 912 0.15 3%
Departments stores 14x 2010E EV/EBITDA 969 0.16 3%
New projects N/A - - 0%
Property NAV -mark-to-market 2,148 0.35 7%
Total 31,934 5.2 100%
Risk to our PT includes lower water sales in China.
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(852) 2800-8511 19 December 2009
Information
Information 1: China wind—Expect strong 2H09 results
Extracted from the note, “China High Speed Transmission: Riding the wave;
reiterate OW,” published on 11 November 2009. Please see the original note for
pricing dates.
Our recent discussions with CHSTE’s management indicated that operations in 2H09
remained strong. We believe this implies that the company’s core businesses are in
line to deliver the full-year target in FY2009, in particular the wind gearbox business
(6,000MW, vs. 2,055MW in 1H09).
Strong YTD addition in new installed wind capacity, potentially surpassing US
The potentially strong performance of CHSTE is consistent with our understanding
in the wind sector. In Jan-Sep’09, China’s total new installed wind capacity reached
4.1GW (vs. 4.7GW for FY2008). And according to china5e.com, China is expected
to double its wind capacity from ~13GW in 2008YE to 26GW in 2009YE.
Considering that new wind capacity addition in the US will be <9GW this year,
China might rank #1 in new wind capacity addition in 2009 (vs. #2 in 2008).
Table 72: Global wind annual new installed capacity addition & o/s installed wind capacity
2008 Installed
2008 Annual capacity Y/Y capacity, EOY Y/Y
Country add'n (MW) % Country (MW) %
It is expected that China 1 USA 8,358 137% USA 25,170 50%
(13GW) will surpass the 2 China 6,300 278% Germany 23,903 7%
USA (<9GW) to be #1 3 India 1,800 4% Spain 16,754 11%
country in new installed 4 Germany 1,665 -68% China 12,210 102%
wind capacity in 2009E 5 Spain 1,609 -53% India 9,645 21%
6 Italy 1,010 67% Italy 3,736 37%
7 France 950 119% France 3,404 39%
8 UK 836 96% UK 3,241 36%
9 Portugal 712 84% Denmark 3,180 2%
10 Denmark 77 -91% Portugal 2,862 33%
ROW 3,739 117% ROW 16,686 28%
Total 27,056 35% Total 120,791 0%
Source: GWEA
Government raising 2020 renewable targets a LT positive

In addition, the Chinese Government has also raised its 2020 targets where (1)
renewable capacity will account for 17% of total installed capacity by 2020, and (2)
2020 wind capacity target has now raised to 150GW from 100GW. This is
significant as the Government was lagging behind to revise up wind capacity targets
in the past. The fact that the Government has now gone ahead of the market shows
their commitment in developing the sector.
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(852) 2800-8511 19 December 2009
Figure 142: China’s renewable target (excluding hydro, in MW) Figure 143: Upward revision on 2020 wind target by the Government
2,000 2% 160 10%
140 w ind capacity (LHS MW)
1,500
2020E: Total renewable target 1% 8%
= 290GW, vs. 18GW in 2008A 9% 5% 120 As a % of total cap. (RHS %)
100 6%
~0%
1,000 80
1% ~0% 4%
83% 60
500 1% 40
98% 2%
20
- 0 0%
2008A 2020E 2008A 2020E target 2020E target 2020E target
Coal+hydro Wind Nuclear Solar Biomass (2005) (2008) (now )
Source: NDRC Source: NDRC
Other companies in the sector also had strong 3Q09 results

CHSTE’s expected strong performance in 2H09 is also is consistent with the strong
3Q2009 results by other players in by other companies in the sector such as
Goldwind and Dongfang Electric.
Figure 144: Wind turbine sales revenue for GW & DF (in Rmb MM) Figure 145: Wind turbine gross profit for GW & DF (in Rmb MM)
8,000 8000
+198% GW DF 25% GW DF
7,000 7000
6,000 6000
+168% 16%
5,000 5000
4,000 +178% 4000 27%
3,000 3000 26%
13%
2,000 +320% 2000 19% 23%
1,000 1000 6%
0 0
1-3Q09 1-3Q08 3Q09 3Q08 1-3Q09 1-3Q08 3Q09 3Q08
Source: Company. % Figures represent Y/Y % growth. Source: Company. % Figures represent % gross margin.
We believe the strong 3Q09 performance by Dongfang and Goldwind also helped
alleviate market concerns about CHSTE and the sector on (1) margin pressure due to
over-capacity in downstream wind turbine producers, (2) bottleneck created by grid
connection.
Concern #1: Margin pressure from downstream turbine producers

CHSTE’s gross margin on wind
There was originally a concern that CHSTE might suffer margin pressure as
gearbox sales in 1H09: 31.0% vs.
29.9% in 1H08
downstream wind turbine producers might transfer ASP (and hence margin) pressure
of their own to upstream component suppliers in light of increased competition in the
We expect 2H09 margin to hold up
wind turbine market. While this still holds true, the concern has largely been
on 1H09 levels
alleviated as (1) 3Q09 gross margin for wind turbine producers have actually
improved, (2) CHSTE can create cost savings through increased internal production
after the acquisition of the acquisition of Jiangsu Hongsheng in 2008.
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(852) 2800-8511 19 December 2009
Table 73: Recent price cuts by Goldwind on key component suppliers Figure 146: Capacity ramp-up by major Chinese WTG producers (MW)
Remarks
Supplier 1 14,000 Windey
Date of company 12,000 JPM 2010E new wind capacity Baoding
announcement 18 Sep 2009 addition in China
Name of supplier Zhuzhou CSR Electric Corp 10,000 Xiangtan
Key component supplies 1.5 Permanent magnet direct drive power 8,000
generator stator SHE
Original contract amounts Contract 1: Rmb 240MM 6,000
Huay i
Contract 2: Rmb 960MM 4,000 ~45% 2008-
Revised contract amounts Contract 1: Rmb 198MM (18% cut) 10E CAGR DFE
Contract 2: Rmb 878MM (9% cut) 2,000
GW
Supplier 2 -
Date of company Sinov el
announcement 9 Sep 2009 2008E
2008A 2010E
China National Building Materials Blades
Source: CWEA, China Electricity Newspaper, JPM estimates
Name of supplier Corp
Note: The above analysis exclude capacity for foreign players (e.g. Suzlon / GE / Vestas),
Key component supplies Wind turbine blades implying that overcapacity situation might be more severe than expected.
Original contract amount Rmb 630MM
Revised contract amount Rmb 595MM (6% cut)
Source: Company reports
Over-capacity in downstream wind turbines, not upstream gearboxes so far

Another issue worth highlighting is that while the downstream wind turbine market
is suffering over-capacity problems currently, that is not the case in the upstream
wind gearbox market. As seen from the figure below, CHSTE, Chongqing Gearbox
Co. (and China No.2 Heavy Machinery Co., not included here) are the only 3
gearbox producers in China that are capable of producing >1MW wind gearboxes
(vs, 10-15 players in the wind turbine market), whereas Hangzhou Advance Gearbox
Group has yet to develop technology in >1MW gearboxes so far.
Figure 147: Major global wind gearbox producers
Source: Hansen
Concern #2: Grid connections being the bottleneck

Another key concern by the market is that grid connections might become a
bottleneck in the overall development of the wind sector. While the concern is valid,
we believe the situation is not as significant as the market expects given that (1)
Goldwind & Dongfang still delivered >150% Y/Y growth in wind turbine revenue in
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1-3Q2009 despite the bottleneck situation and (2) the NDRC has already identified
this as one of the major problems in the development of the sector and hence more
remedies will likely be remedies from Grid Companies going forward.
In addition, upstream component suppliers like CHSTE will likely have less direct
impact on the issue than downstream players such as wind turbine producers / wind
farm operators, as the former do not need to deal with Grid Companies directly.
Table 74: Key problems on grid connections to wind farms in China

Key issues Remarks
High-voltage lines 20-30% of newly installed wind turbines not being able to connect to the grid in 2008,
especially for wind projects which require high-voltage 500kV / 750kV lines
Grid network system 55% wind capacity in 7 provinces requires connections to 220kV grid network system
Capex by Gridco Significant capex burden by the two grid companies under the stimulus package
Other reasons Lack of planning on routes of power dispatch and destinations (e.g. 2 100MW wind
farms in Inner Mongolia West & Inn. Mon East).
Lack of co-ordination between wind farm & grid on building transmission network.
e.g. a 460MW in Jiuchuan (Gansu) can only dispatch 65% of power.
Lack of co-ordination between peak / base load power (coal vs. hydro vs. wind). e.g.
Inner Mongolia in winter time, Jilin / Jiajiu in Gansu
Source: Company reports
Impact: Top pick in power equipment sector

We stay positive on CHSTE thanks to its (1) geared exposure to the wind sector, (2)
more attractive valuation with higher EPS growth (>40% 2008-11E core EPS CAGR
vs. 12%/ 20% for Shanghai/Dongfang), (3) less exposure to the grid connection
bottleneck (upstream) than downstream wind turbine producers and wind farm
operations. Key near-term catalysts are impending listing of other wind companies &
new wind capacity additions.

Our Dec-10 price target of HK$21.5 is based on DCF assuming a 11.9% WACC and
a 2% terminal growth. Risks to our PT include lower-than-expected wind installed
capacity in China.
Information 2: China city gas—New gas pricing policy still under review
Extracted from the note, “China City Gas Distributors: Maintaining our bullish
stance,” published on 06 November 2009. Please see the original note for pricing
dates.
Our latest understanding of the impending gas pricing policy is that it is still under
review by various involved parties. As reported by Bloomberg on 2 Nov 2009,
management of the ENN Group (Xinao’s parent) “received a proposal of the price
reform from the government about two months ago. The Chinese government was
seeking feedback on potential changes to the (gas) pricing”. China City Gas
Association (26 Oct 2009) also reported that the oil majors have received gas pricing
proposals from the Government authorities for feedback. We maintain our view that
the policy will likely be in place by 1H10, given that more gas will be imported into
China next year (e.g. Turkmenistan).
Potential magnitude of gas price hike

In addition to timing of the policy, the magnitude of the increase is another key area
of focus. However, views from various industry players are inconclusive so far on
this issue. ENN Group management, for instance, expected that wholesale gas prices
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might increase by 20-30% (Bloomberg 2 Nov 2009). An official from Petrochina

(China City Gas Association 26 Oct 2009) expected natural gas prices to be based on
a standardized (across the country), blended & weighted-average principle between
(1) domestic and (2) imported gas.
Table 75: Potential key terms of proposed gas pricing policies as quoted by industry participants
Pricing methodology JPM Comments
ENN Upstream gas prices to Hard to tell which “base” gas price they are referring to.
Group increase by 20-30% and retail But if we use Xinao’s 1H2009 average gas purchase price of Rmb
(Xinao’s prices may rise about 10 %, 1.72 / m3, gas price might increase to Rmb 2.06-Rmb 2.23 / m3 under
parent) accordingly. the new policy.
Still, it is lower than the >Rmb 3/m3 for Turkmenistan / Qater LNG.
Future gas prices might be We already have similar mechanism under the current regulatory
linked to products including regime, except that the annual increase is capped at 8%.
coal and crude oil
Downstream natural gas Similar in nature to the automatic pass through mechanism
prices will more closely
reflect upstream price
movements
Petro- Standardized (across the If a standardized price is used, there will be no problem in dealing
china country), blended & weighted- with the amount of gas price increment for each gas source (e.g.
average principle between (1) WE1, WE2, etc).
domestic and (2) imported gas. As a reference, China’s total natural gas consumption in 2008 was
80.7B m3, of which 4.4B m3 (5%) were from imports.
Under this method, natural gas price will only be able to rise gradually
given that the imported portion will likely remain small over the next 3-
5 years. We believe there will be certain "one-off" increment (say Rmb
0.4 / m3 hike) first before such method is adopted.
One potential issue to deal with will be how to align end-user tariffs
amongst different cities if input gas prices were adjusted to a
standardized price.
Source: Bloomberg, China City Gas Association
Automatic pass-through mechanism still holds the key

It is difficult to pinpoint the potential winners and losers among different city gas
distributors on potential gas price changes until we actually see the finalized version.
One thing that looks more certain is that any gas price increases will likely
accompany an automatic pass through mechanism to protect gas sales margins for
city gas distributors. And any gas price increase will not likely erode natural gas’s
competitiveness against other alternative fuels.
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Figure 148: Fuel cost competitiveness in Shanghai for residential Figure 149: Fuel cost competitiveness in Beijing for residential users
users (in Rmb / GJ)
(in Rmb / GJ)
140 +128% 127 %
180 +140%
120 +83%
+ 54%
160 +70%
140 + 67% 100
120 80 +20%
100 +32% 0%
0% 60
80
60 40
40 Nat Gas Nat Gas Nat Gas Nat Gas LPG Electricity
Nat Gas Nat Gas Nat Gas LPG Electricity (Current) (CTG) * (SJ3) * (int'l price) (Current) (Current)
(Current) (SEP) * (int'l price) (Current) (Current) **
**
Source: NDRC. China Gas Association.
Source: NDRC. China Gas Association. Note: % figures represents % premium on natural gas at current price levels.
Note: % figures represents % premium on natural gas at current price levels. * Assume 100% pass-thru on end-user tariffs when gas costs increase from current level to CTG
* Assume 100% pass-thru on end-user tariffs when gas costs increase from WE1 level to SEP. and SJ3 respectively.
** Same principle as *, except that gas cost increase from WE1 level to int'l level ** Same principle as *, except that gas cost increase from WE1 level to int'l level
(US$12/mmbtu) (US$12/mmbtu)
Impact: Still positive on the gas sector

We remain positive on the China city gas sector in light of the recent developments.
The new gas pricing policy will likely enhance the future growth of the sector and
should justify the current valuation premium of gas utilities (15-20x 2010E P/E) over
IPPs (10-15x) as we see in their counterparts in other regions (e.g. HK and Korea).
Xinao is our top pick in view of its attractive valuation (13x 2011E P/E) and the
likelihood it will benefit more from the new policy. We also like BJE as we expect
(1) positive surprises on 2009 gas sales thanks to the recent cold weather, and (2)
potential water asset injections into BJE Water (371 HK, NR) after 4-5 months. A
key NT catalyst is developments on the new gas policy.
Valuation methodology and risks to our price targets

Ratings JPM PT PT date Valuation methodology Risks to our price target
(HK$)
Xinao (2688 HK) OW 22.2 Dec-10 Based on DCF with a 10.1% WACC and a 2% terminal Lower than expected gas sales
growth rate.
BJ Enterprises (392 OW 56.1 Dec-10 SOTP Lower than expected gas sales
HK)
Towngas China (1083 N 3.64 Dec-10 Based on DCF with a 10.3% WACC and a 2% terminal Lower than expected gas sales
HK) growth rate.
China Gas (384 HK) N 3.5 Dec-10 Based on DCF with a 9.8% WACC and a 2% terminal Lower than expected gas sales
growth rate.
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Appendix I:
Following text used by permission from Professor Robert D. Fiala of Concordia
University, Nebraska, USA--as excerpted from www.orientalarchitecture.com
The Bund (Waitan) is one of the most recognizable architectural symbols of
Shanghai. "Bund" derives from an Anglo-Indian word for an embankment along a
muddy waterfront and that is what it was in the beginning when the first British
company opened an office there in 1846. Located on the west bank of a bend
(running north and south at this point) in the Huangpu River and just south of Suzhou
Creek, the Bund became the site of some of the earliest foreign settlements after
Shanghai was opened as one of five "Treaty Ports" in the Treaty of Nanjing that
ended the Opium War in 1842. Because of its proximity to the Yangtze (Changjiang)
River--the path into central China, Shanghai grew rapidly as the economic center of
foreign interests.
Jardine Matheson & Company bought its first land here in 1848 and the river front
soon became vital to the interests of the entire foreign settlement. In the latter 19th
early 20th century the Bund became the financial and political center of the
international community and (indeed of much of China). It was China’s Wall Street,
as Shanghai's financial market became the third largest in the world (behind London
and New York). Nearby were located a number of important consulates, including
the British, American, Russian and Japanese.
The twenty-four major structures, of uneven height along approximately 1.5

kilometers of Zhongshan Lu and the Huangpu River, have changed little externally
since the 1930s. All were constructed in western-inspired styles—classical, Gothic,
renaissance, eclectic and modern—a reported seventeen styles of architecture. The
Bund has been called a 'museum of international architecture’, and indeed it was and
still is. But it was also much more. Here were located the banks, hotels, exclusive
clubs, press organizations and headquarters of international concerns.
After the establishment of the People's Republic of China in 1949 the old tenants
were gone. They had already been impacted by the wartime crises. Many of the
structures were subdivided into government offices, department stores or storage
areas, furnishings were sold off or destroyed, and architectural features covered. The
Bund, one might say, was moribund.
Much of this now is changing with the revitalization of Shanghai, strongly

encouraged by a visit of Deng Xiaoping in 1992. The next year the plans for the
Bund were finalized and the renewal of Shanghai began in earnest. Although many
of the state-protected historic buildings of the Bund remain vacant, or perhaps
underutilized as government offices as of this writing (April 2002), there are strong
indications that this might change—even though the old tenants have outgrown their
old quarters and will not return since many are now in more spacious and
comfortable quarters on the east side of the river in Pudong. But their old buildings
are newly appreciated, with even brass plates outlining their previous use, and efforts
are being made to bring elements of the international community back to where it
started in the Bund, as well as on the Pudong side.
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The area does have a new vitality. Zhongshan Dong Lu has been widened to ten
lanes to accommodate the increased Shanghai motor traffic, and the promenade along
the banks of the Huangpu has also been elevated and enhanced as a place to view the
ever-changing skyline of Pudong across the water. It actually is part of a new dike to
protect the city. One only need look at a few images of this area taken in 1980 that
are on this site to gain an appreciation of this new vitality. A decade ago there was
little in Pudong besides warehouses, shipping facilities and small shops. Now it is the
most extensive construction site in the world. Both sides of the Huangpu River
reflect important aspects of Shanghai's heritage—its past, present and future.
Text by Professor Robert D. Fiala of Concordia University, Nebraska USA.
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Companies Recommended in This Report (all prices in this report as of market close on 18 December 2009, unless
otherwise indicated)
Air China (0753.HK/HK$5.44/Overweight), Alibaba.com Limited (1688.HK/HK$16.32/Neutral), Anhui Conch Cement
Company Limited - H (0914.HK/HK$47.25/Overweight), Baidu.com (BIDU/$415.84 [17-December-2009]/Overweight),
Bank of China - H (3988.HK/HK$4.03/Overweight), Bank of Communications Co (3328.HK/HK$8.73/Overweight),
Beijing Enterprises Holdings Limited (0392.HK/HK$51.85/Overweight), Brilliance China Automotive
(1114.HK/HK$2.29/Overweight), China Citic Bank - H Share (0998.HK/HK$6.18/Overweight), China Coal Energy
(1898.HK/HK$13.40/Overweight), China Construction Bank (0939.HK/HK$6.36/Overweight), China Cosco Holdings, Ltd.
(1919.HK/HK$9.23/Neutral), China Dongxiang Group Co Ltd. (3818.HK/HK$5.28/Neutral), China Gas Holdings Limited
(0384.HK/HK$3.68/Neutral), China High Speed Transmission (0658.HK/HK$18.32/Overweight), China Life Insurance Co.
Ltd (2628.HK/HK$37.80/Overweight), China Mengniu Dairy Co. Ltd. (2319.HK/HK$27.45/Overweight), China Merchants
Bank - H (3968.HK/HK$19.56/Neutral), China Minsheng Banking (600016.SS/Rmb7.50/Neutral), China Mobile Ltd
(0941.HK/HK$71.30/Neutral), China Mobile Ltd (CHL/$45.55 [17-December-2009]/Neutral), China Overseas Land &
Investment (0688.HK/HK$16.32/), China Resources Power Holdings (0836.HK/HK$14.68/Neutral), China Shenhua Energy
(1088.HK/HK$37.15/Neutral), China Shineway Pharmaceutical Group Limited (2877.HK/HK$14.74/Overweight), China
Shipping Container Lines (2866.HK/HK$2.65/Overweight), China Southern Airlines (1055.HK/HK$2.47/Neutral), China
Telecom Corporation Ltd (0728.HK/HK$3.16/Neutral), China Telecom Corporation Ltd (CHA/$41.20 [17-December-
2009]/Neutral), China Unicom (0762.HK/HK$9.86/Underweight), China Unicom (CHU/$12.74 [17-December-
2009]/Underweight), China Yurun Food Group (1068.HK/HK$20.05/Overweight), CNOOC (0883.HK/HK$11.84/Neutral),
DongFeng Motor Co., Ltd. (0489.HK/HK$10.62/Overweight), Franshion Properties (China) Ltd.
(0817.HK/HK$2.67/Overweight), Glorious Property (0845.HK/HK$3.50/Overweight), Great Wall Motor Company Limited
(2333.HK/HK$8.46/Neutral), Greentown China Holdings (3900.HK/HK$12.06/Neutral), Guangdong Investment Limited
(0270.HK/HK$4.25/Overweight), Guangzhou R&F Properties (2777.HK/HK$13.40/Overweight), Hengan International
Group Ltd (1044.HK/HK$55.05/Neutral), Huabao International Holdings Limited (0336.HK/HK$7.87/Neutral), Industrial
and Commercial Bank of China - H (1398.HK/HK$6.20/Overweight), Li Ning Co Ltd (2331.HK/HK$25.50/Neutral),
Maanshan Iron and Steel - H (0323.HK/HK$5.66/Overweight), Mindray Medical (MR/$33.89 [17-December-
2009]/Neutral), Netease (NTES/$37.51 [17-December-2009]/Overweight), PetroChina (0857.HK/HK$9.19/Underweight),
PICC Property & Casualty Co. Ltd (2328.HK/HK$6.84/Underweight), Ping An Insurance (2318.HK/HK$66.50/Neutral),
Qingling Motors Co (1122.HK/HK$1.89/Underweight), Shandong Weigao Group Medical Polymer Co. Ltd.
(8199.HK/HK$25.40/Overweight), Shanghai Pudong Development Bank (600000.SS/Rmb20.73/Overweight), Shenzhen
Development Bank (000001.SZ/Rmb23.93/Overweight), Sina Corp (SINA/$44.86 [17-December-2009]/Neutral), Sinopec
Corp - H (0386.HK/HK$6.66/Overweight), Sinopharm (1099.HK/HK$26.95/Overweight), Sinotruk
(3808.HK/HK$9.36/Neutral), Sohu.Com (SOHU/$53.97 [17-December-2009]/Overweight), Towngas China Company
Limited (1083.HK/HK$2.99/Neutral), Tsingtao Brewery (0168.HK/HK$39.15/Underweight), Weichai Power
(2338.HK/HK$60.35/Neutral), Xinao Gas (2688.HK/HK$18.62/Overweight), Yanzhou Coal Mining - H
(1171.HK/HK$16.12/Neutral), ZTE Corp (0763.HK/HK$43.65/Neutral)
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responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with
respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report
accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research
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CNOOC, Glorious Property, Industrial and Commercial Bank of China - H, PICC Property & Casualty Co. Ltd, Ping An Insurance,
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JPMSI has received compensation in the past 12 months for products or services other than investment banking from Air China,
Bank of China - H, Bank of Communications Co, China Citic Bank - H Share, China Construction Bank, China Life Insurance Co.
Ltd, China Merchants Bank - H, China Minsheng Banking, CNOOC, Franshion Properties (China) Ltd., Glorious Property,
Greentown China Holdings, Industrial and Commercial Bank of China - H, PICC Property & Casualty Co. Ltd, Shanghai Pudong
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(600808.SS), Maanshan Iron and Steel - H (0323.HK), Minth Group (0425.HK), Qingling Motors Co (1122.HK), Sinotruk
(3808.HK), Weichai Power (2338.HK), Yanzhou Coal Mining - A (600188.SS), Yanzhou Coal Mining - H (1171.HK),
Zijin Mining Group Co Ltd (2899.HK)
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J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2009

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Asia Pacific Equity Research

China Insights & Strategy

Qian Wang Macroeconomic views

Figure 1: China—Real IP growth

Source: CEIC, J.P. Morgan Economics.

Overall tone on macro policy still growth-friendly

expenditure to focus on education, social security, economic housing, agriculture,

We believe such adjustments in monetary conditions are already taking place. As we

Policy focus on domestic consumption

Figure 2: China—GDP and household income

Source: CEIC and J.P. Morgan Economics.

Broad-based export recovery

Overall, China’s November trade figures continued to show steady sequential

• In further details, exports in the important category of mechanical and

• A breakdown by destinations shows a broad-based improvement in demand.

Figure 3: China—Merchandise trade

Source: CEIC, J.P. Morgan Economics.

Figure 4: China—Exports of steel products and low-end consumer goods

Source: CEIC, J.P. Morgan Economics.

Figure 5: China—Exports of mechanical and electrical products

Source: CEIC, J.P. Morgan Economics.

Figure 6: China—Exports by region

Source: CEIC, J.P. Morgan Economics.

New loan creation is stabilizing

household loans increased in November, to reach Rmb237.7 billion (compared with

Figure 7: China—Money supply and loan growth

Source: CEIC, J.P. Morgan Economics.

Figure 8: China—New loan creation

Source: CEIC, J.P. Morgan Economics.

CPI inflation turns positive

Figure 9: China—Headline CPI, food prices and non-food CPI

Source: CEIC, J.P. Morgan Economics.

PMI indicates solid momentum in industrial activity

• Among forward-looking components, new orders edged down marginally

• The inventory component rose modestly to 45.4 in November in the NBS

• With regard to labor market conditions, the employment component of the

Figure 10: China—Manufacturing PMIs

Source: CEIC, J.P. Morgan Economics.

Figure 11: China—PMI export orders and merchandise exports

Source: CEIC, J.P. Morgan Economics.

Figure 12: China—Manufacturing PMIs’ input prices

Source: CEIC, J.P. Morgan Economics.

Figure 13: Comparison of nominal effective exchange rates

Source: CEIC, J.P. Morgan Economics.

Figure 14: China—Exports and real effective exchange rate

Source: CEIC, J.P. Morgan Economics.

Cyclical case for Rmb’s movement

Figure 15: China—contribution to headline GDP growth

Source: CEIC, J.P. Morgan Economics.

Figure 16: US retail sales and China’s exports to the US

Source: CEIC, J.P. Morgan Economics.

Current account adjustment

Figure 17: China and US current account balances

Source: CEIC, J.P. Morgan Economics.

Capital inflows back in the limelight

Source: CEIC, J.P. Morgan Economics.

Figure 19: Relative index performance

1. The government’s recent reiteration of its “proactive fiscal policy” and

2. An upward earnings estimate revision momentum for the MSCI China

3. A marked sequential improvement in liquidity from December 2009 to

4. The expectation that Rmb will resume appreciation in FY10, given an

Key investment themes and sector views

should be least affected by a potential tightening kicking in as of 2Q10 and a