China Financial Leasing Industry

Equity Research | Non-Bank Financial May 3, 2016

This page is a summary of a report originally written in Chinese. Please contact us for more information of the original report. The Chinese version shall prevail in the event of any discrepancy between the two versions.

Positive (initiation)

Financial leasing industry in an up cycle

Wang Wen SFC CE No. BGL298 wangwen@gfgroup.com.hk +86 755 8826 1286 Felix Luo SFC CE No. AQF573 felixluo@gfgroup.com.hk +852 3719 1048 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

The financial leasing industry in China has grown rapidly over the past decade.

However, the penetration rate of financial leasing is relatively low in China compared with

developed countries. We believe opportunities for future industry development will come

from improved regulation on government support, strong demand for financial leasing

driven by industrial upgrade under the 13th FYP, and China’s strategy to step up exports

of products and technology.

Industry overview Licenses for companies in the financial leasing business can be

categorized into the CBRC-administered “Financial Leasing” license (capitalized to

distinguish from “financial leasing” in the general sense, same hereinafter), and the

MOFCOM-administered “Foreign-Funded Leasing” and “Domestic-Funded Leasing”

licenses. Among these three, the Foreign-Funded Leasing license is the easiest to obtain

and is held by the large number of companies, while companies with the “Financial

Leasing” license tend to have greater capital strength. The business model of the industry

is highly homogeneous regardless of the different types of firms, with sale-leaseback the

mainstream model. The core ROE of financial leasing companies mainly hinges upon

their interest spread, asset quality and financial leverage.

Three types of companies in comparison Financial Leasing companies demonstrate

certain advantages in terms of the interest rates on their liabilities and their financial

leverage as a result of the different regulatory requirements for the three types of

companies. Based on historical data, the ROE of all three types of companies are quite

similar mainly as Financial Leasing companies have the lowest ROA among the three,

which is an indicator of changes in companies’ net interest spread. Financial Leasing

companies tend to have interest spreads that are lower than Foreign and Domestic-

Funded Leasing companies, though the gap is narrowing. The reason why Financial

Leasing companies have failed to turn the advantageous interest rates on their liabilities

into higher interest spreads lies in the difference in their customer base compared with

companies operating with the other two licenses. Separately, Financial Leasing

companies have much better asset quality, although leading companies with the other

two types of licenses have also shown strong control over asset quality. We believe further

interest rate downside is limited in 2016 and that overall liquidity will remain loose. As

such, the competition among financial leasing companies should focus on the asset front.

Key risks include 1) macroeconomic risks such as multiple interest rate cuts implemented

in a row and a surge in non-performing assets at leasing companies as a result of

deterioration in the domestic economy, 2) weaker-than-expected policy support for the

financial leasing market, and 3) disappointing effects of companies’ operational strategies.

Sector share price performance

Source: Bloomberg Note: Data based on Apr 27 closing price

1M chg % 3M chg % YTD chg %

Far East Horizon 2.7 6.6 -14.3

Universal Medical -3.2 9.7 -2.0

China Aircraft 10.4 43.4 6.6

May 3, 2016

2

Sector report

Figure 1: Number of financial leasing companies in China Figure 2: Financial leasing business volume in China

Sources: Wind, GF Securities (HK)

Figure 3: Three types of licenses for financial leasing companies

Sources: Public information, GF Securities (HK)

80 109 142 170 233 369 643

1,106

2,202

4,508

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

No. of financial leasing co.

Registered capital (Rmb 100m, RHS)

200%

546%

139%

89%

33%67%

35% 52% 39%0%

100%

200%

300%

400%

500%

600%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

2006 2008 2010 2012 2014

Year-end contract balance (Rmb 100m) YoY

Financial Leasing Domestic-Funded Foreign-Funded

Nature Non-bank financial Non-financial institution Non-financial institution

Registered capital Rmb100m Rmb170m Rmb10m

License

acquisitionVery difficult On trial basis Easy

Leverage

ceiling

Capital adequacy not lower than 8%;

theoretical ceiling 12.5xRisk assets not exceeding 10x of net assets Risk assets not exceeding 10x of net assets

Unique financing

channelsInterbank lending NA Access to cross-border financing

Regulator CBRC MOFCOM MOFCOM

Regulation of leased

underlyings

Large No. of restrictions on underlyings

"Window guidance"

Clear ownership of underlyings

Underlyings in existence and able to

generate income rights

Clear ownership of underlyings

Underlyings in existence and able to

generate income rights

Regulatory

documents

Administrative Rules for Financial Leasing

Companies issued by CBRC

Administrative Rules for Supervision of

Financial Leasing Companies

Notice on Issues about Engaging in the

Financial Leasing Business

Administrative Rules for Foreign Parties

Investing in Leasing Industry

Notice on Strengthening and Improving the

Approval & Management of Foreign-Invested

Financial Leasing Companies

Far East Horizon (3360 HK)

Equity Research | Non-Bank Financial May 3, 2016

This page is a summary of a report originally written in Chinese. Please contact us for more information of the original report. The Chinese version shall prevail in the event of any discrepancy between the two versions.

Accumulate (initiation)

Target price: HK$6.80

Leading financial leasing company in China; initiate at Accumulate with TP of HK$6.80

Wang Wen SFC CE No. BGL298 wangwen@gfgroup.com.hk +86 755 8826 1286 Felix Luo SFC CE No. AQF573 felixluo@gfgroup.com.hk +852 3719 1048 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Leading financial leasing company in China The company ranks among top financial leasing companies in China in terms of both asset volume and earnings. Its assets are allocated mainly across nine industries, i.e. healthcare, education, construction, transportation, packaging, industrial equipment, textile, electronics and public utilities. The company has demonstrated a steady operational track record, with its total assets increasing from Rmb7.2bn in 2007 to Rmb139.3bn in 2015 (CAGR 45%), and its revenue growing from Rmb700m to Rmb11.8bn during the same period (CAGR 43%). Leasing business outlook improving Leasing business profitability is typically dependent on three key factors, namely net interest spread (NIS), leverage ratio and asset quality. Following the rapid NIS contraction in 2015, there is little room for Far East Horizon to see further NIS declines, as further interest rate downside is limited and as the company has become less sensitive to interest rate changes after previous adjustments in its assets allocation. Following its latest private placement, the company’s leverage ratio stood at 6.07x at end-2015, much lower than its historical high of 7.57x and the regulatory ceiling of 10x. In addition, a low-interest bond market should also help the company raise its ROE by adding leverage. The company’s asset quality is healthy with its end-2015 NPL ratio of 0.97% lower than that of banks, demonstrating sound risk control. Clear blueprint for healthcare and high-end education development, though profit contribution yet to be seen The company has acquired nine hospitals so far, covering orthopedics, oncology, obstetrics & gynecology, and nephrosis, with more than 3,000 beds by the end of 2015. The company will continue to invest in the healthcare industry in 2016, with the number of beds targeted to reach 6,000-7,000. We estimate that an additional Rmb60m-70m in net profit from these hospitals will be consolidated into the company’s financial statements this year, which should give a limited boost to its overall earnings. Securitization to enhance asset utilization efficiency The company transferred assets worth a total of Rmb15.4bn off its balance sheet in 2015 through asset securitization, and has indicated that assets worth more than Rmb15bn will be securitized this year. Initiate at Accumulate with TP of HK$6.80 We expect the company’s revenue and net profit to grow at a CAGR of 16% over the next three years given its steady asset expansion, moderating NIS decline in 2016, effective asset quality control, and well-defined strategy for industry development. In the absence of any significant macroeconomic risks, the company should see the operating environment for its financial leasing business improve in 2016; it should continue to obtain low-cost financing relying on the abundance of liquidity in the market and the substantial room for it to further add leverage, so that it can break away from the difficulties created by plunging NIS in 2015. The company has built a well-structured presence in the healthcare industry, and would see its share price boosted if the operational results of its hospitals are confirmed. We initiate coverage with an Accumulate rating and target price of HK$6.80 based on a three-year average P/B of 1.1x, representing 9.0x 2016E P/E. Key risks include 1) macroeconomic risks such as multiple interest rate cuts implemented in a row, a surge in non-performing assets at leasing companies as a result of deterioration in the domestic economy, and a rise in debt financing interest rates caused by defaults, 2) weaker-than-expected policy support for the financial leasing market, and 3) disappointing effects of companies’ operational strategies.

Stock valuation

Sources: Company data, GF Securities (HK)

Revenue

(Rmb m)

Net profit

(Rmb m)

EPS

(Rmb)

EPS YoY P/E BPS

(Rmb)

P/B ROE

2014 10,061 2,342 0.71 25% 8.7 5.30 1.2 15.2%

2015 11,796 2,580 0.65 -8% 9.5 5.81 1.1 13.3%

2016E 13,628 2,979 0.75 15% 8.2 6.33 1.0 12.9%

2017E 16,015 3,493 0.88 17% 7.0 6.92 0.9 13.7%

2018E 18,226 4,049 1.03 16% 6.0 7.60 0.8 14.4%

Stock performance

Source: Bloomberg

Key data

Source: Bloomberg

-60%

-40%

-20%

0%

20%

40%

4/28/2011 4/28/2013 4/28/2015

Far East Horizon Heng Sang Index

Apr 27 closing (HK$) 6.18

Shares in issue (m) 3,950

Major shareholders Sinochem Grp (23.29%)

Market cap (HK$ bn) 24.4

3M avg. vol. (m) 2.48

52W high/low (HK$) 7.29/5.32

May 3, 2016

4

Company report

Figure 4: Key assumptions and earnings forecasts

Sources: Wind, GF Securities (HK)

Rmb m 2011 2012 2013 2014 2015 2016E 2017E 2018E

Total assets 47,100 60,569 86,513 110,726 139,313 164,389 180,828 198,911

YoY 86% 29% 43% 28% 26% 18% 10% 10%

Interest-bearing assets 41,568 57,587 80,746 100,829 121,970 139,355 152,780 168,191

YoY 68% 39% 40% 25% 21% 14% 10% 10%

NIM (restated) 4.4% 4.3% 3.9% 3.3% 2.6% 2.4% 2.4% 2.4%

NIS (restated) 2.3% 2.1% 2.2% 1.8% 1.0% 0.9% 1.0% 1.0%

Financial leasing & factoring (interest income) 3,063 4,334 5,170 6,458 6,849 7,709 8,837 9,790

Consultancy (fee income) 1,100 1,526 2,245 2,709 3,851 4,621 5,545 6,377

YoY 37% 39% 47% 21% 42% 20% 20% 15%

Revenue from industrial operation 686 797 574 1010 1207 1436 1795 2244

YoY 163% 16% -28% 76% 19% 19% 25% 25%

Business tax & surcharges -2.70% -2.60% -1.50% -1.10% -0.90% -1.00% -1.00% -1.00%

Revenue 4,716 6,486 7,868 10,061 11,796 13,628 16,015 18,226

Gross profit margin 53% 55% 63% 59% 60% 59% 59% 59%

Net profit margin 24% 23% 24% 23% 22% 22% 22% 22%

ROA 3.2% 2.8% 2.6% 2.4% 2.1% 2.0% 2.0% 2.1%

ROE 16.9% 13.7% 14.2% 15.2% 13.3% 12.9% 13.7% 14.4%

May 3, 2016

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Company report

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

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Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.

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