White goods, golden opportunity-China: Right time, right place and

White goods, golden opportunityChina: Right time, right place and the right people

Disclosures and Disclaimer This report must be read with the disclosures and analystcertifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Consumer Brands & RetailEquities – China

June 2015

By Lina Yan and Erwan Rambourg

The standard fridges and air conditioners of today will soon become smart appliances in the smart homes of tomorrow

It’s a re-rating opportunity – the sector valuation is attractive, the government is pushing industrial innovation, the housing market is perking up and the right management teams are in place

We initiate coverage with Buys on Gree (TP RMB77.2), Qingdao Haier (TP RMB35.9) and Midea (TP RMB46.9)

http://www.research.hsbc.com/

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Consumer Brands & Retail China – Equities June 2015

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Right time, right place and the right people

Zhang Ruimin, the CEO of Haier Group, put it this way. “We used to think: maximise quantity, export

more and manufacture more. This isn’t working. Haier must transform from a traditional manufacturing

enterprise into an internet business.” He said the ultimate aim was for Haier to become a full services

company for the wireless age, where customers place orders for tailor-made appliances, and communicate

directly with their home appliances via smartphone or a controlling device.

Zhang, who turned the company, an almost bankrupt state-owned enterprise, into the world’s second-largest

producer of washing machines, fridges, air conditioners and water heaters, made the comments during an

interview with Reuters published on 13 May 2015. The article also noted that last year Apple announced

that Haier was among the first home appliance makers it was partnering with for its smart home platform.

Zhang’s observations reflect the challenge facing the industry in China – how to turn white goods into smart

goods. Like Haier, the companies we look at in this report are turning their focus to innovation and

connectivity. Gree is the world’s largest air conditioner manufacturer, Qingdao Haier is part of the Haier

Group mentioned above, and Midea is the largest diversified white goods maker in China by revenue.

For some, the smart revolution has already begun. As of the end of 1Q15, Qingdao Haier had four smart

factories and 40 unmanned automatic production lines. Last year, the company sold 1m units of smart

refrigerators, washing machines, air conditioners and water heaters, generating RMB3bn in sales; in

1Q15, the number of smart appliance sales totalled 500,000. Midea started automating its air conditioner

manufacturing process in 2011; since then the number of employees at this unit has fallen from more than

50,000 to 26,000. Both companies have also signed agreements that connect them with international and

domestic online giants (e.g. Apple, smartphone leader Xiaomi and online retailer JD.com).

Investment summary

The days of dull, standardised white goods are numbered. The washing machines, fridges, air conditioners and water heaters of today will soon become the interconnected smart goods in the smart homes of tomorrow. This means wrenching change for many manufacturers in China, but we believe this industry, currently unloved by A-share investors, has great re-rating potential. The government is pushing industrial innovation, the housing market is starting to perk up, production costs are falling, and the price wars should come to an end. The right management teams are in place, too. We initiate coverage of Midea, Gree and Qingdao Haier with Buy ratings.

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Figure 1. Revenue breakdown by segment (2014)

Source: Company reports

As we explain later, we feel it’s the right time to invest in this unloved sector – the three stocks are

trading at a 75% discount to the average A-share trailing PE. The industry is in the right place because of

sector consolidation, the government’s determination to upgrade the country’s industrial base, and the

desire of customers to have the best available products. Lastly, we believe the right managements are in

place to oversee this transformation.

Time to buy

China’s white goods industry is hard to ignore. Around 40% of the world’s washing machines and

refrigerators are made in China, and it’s as high as 70% for air conditioners This report takes an in-depth

look at the industry and analyses the performance and prospects of the leading listed A-share companies

to help overseas investors understand a sector, which remains unloved by domestic A-share investors

despite the 12-month bull market in China. In our view, this lack of interest is largely because mainland

retail investors, the driving force behind the A-share rally, much prefer “new economy” stocks in sectors

supported by government policies that are designed to modernise the country’s industrial base. We argue

that white goods companies will rerate as they have the best of both worlds – they are in the process of

joining the “new economy club” and also have more traditional virtues, such a high level of consolidation

that is missing from many other industries in China. The top five have a market share of 68% and the top

three 54%. We believe consolidation will continue, allowing the leaders to improve market share, margins

and returns, as consumers gravitate to better products, leading brands and smart appliances.

Midea, Gree and Qingdao Haier should all benefit from the consolidation process. Of the three, Qingdao

Haier and Midea are moving the fastest in the areas of smart appliances and the Internet of Things (IoT),

as reflected in their premium valuation over Gree. However, we think Gree can catch up quickly, largely

because of improvements brought about by the reform of state-owned-enterprises (SOEs), a process

which is well underway.

51%

85%

23%

7%

28%

7%

17%

23%1%

7%

3% 1%

20%

2%

5%

7% 11%

1%

0.5% 2%142 140

89

0

50

100

150

Midea Gree QD Haier

RM

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Air conditioners Refrigerators Washing machines Small appliancesMotors Logistics/ ICS Others Other product salesIncome from financial services

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Figure 2. Estimates summary table

(RMBm) 2011 2012 2013 2014 2015e 2016e 2017e 2014-17 CAGR

Revenue Midea 134,128 102,713 121,265 142,311 160,011 181,237 205,112 13.0% Gree 83,517 100,110 120,043 140,005 150,785 167,984 187,636 10.3% Qingdao Haier 73,663 79,857 86,606 88,775 93,669 103,518 115,541 9.2% Reported core net profit Midea 3,473 3,027 3,903 9,477 13,395 15,350 17,890 23.6% Gree 5,109 6,995 8,908 14,145 16,589 19,562 22,979 17.6% Qingdao Haier 2,438 3,177 3,759 4,324 5,770 6,700 7,729 21.4% Reported core net profit y-o-y % Midea -12.8% 28.9% 142.8% 41.3% 14.6% 16.6% Gree 36.9% 27.3% 58.8% 17.3% 17.9% 17.5% Qingdao Haier 30.3% 18.3% 15.0% 33.4% 16.1% 15.4% Net margin Midea 3.2% 4.4% 7.4% 8.4% 8.5% 8.7% 8.9% Gree 6.3% 7.4% 9.1% 10.1% 11.0% 11.6% 12.2% Qingdao Haier 3.7% 4.1% 4.8% 5.6% 6.2% 6.5% 6.7% ROIC Midea 22.3% 17.2% 20.3% 34.9% 39.9% 42.4% 45.0% Gree 23.6% 24.3% 26.1% 30.4% 28.2% 27.9% 27.4% Qingdao Haier 20.3% 18.2% 16.8% 14.0% 14.9% 15.4% 15.6%

Source: Company data, HSBC estimates

We now look at our theme of the “Right time, right place and the right people” in more detail.

1. Right time: white goods makers are A-share laggards

White good companies have been laggards in the A-share market over the last 12 months. Gree, Qingdao

Haier and Midea trade at a 16x trailing PE, a large discount to the A-share average of a 66x PE. They on

average returned 111% vs. 125% for the Shanghai index, 160% for the Shenzhen index, and 180% for the

average of all sectors in the A-share markets. We think the relative underperformance is due to a

preference for new economy stocks, as well as a bias towards small caps over large caps. While this gives

white goods companies defensive qualities, we also believe they have the potential to close the valuation

gap with A-share peers in the second half of 2015, driven by:

Figure 3. Relative share performance to Shanghai A index Figure 4. Relative share performance to Shenzhen A index

Source: CEIC Source: CEIC

-40.0%-20.0%

0.0%20.0%40.0%60.0%80.0%

100.0%120.0%140.0%160.0%

May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15

Qingdao Haier Midea Gree Electric Shanghai SE

-50.0%

0.0%

50.0%

100.0%

150.0%

200.0%

May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15

Qingdao Haier MideaGree Electric Shenzhen SE

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Figure 5. A-share trailing PE by sectors (27 May 2015) Figure 6. A-share 12m performance by sectors (27 May 2015)

Source: Wind, Company data Source: Wind, Company data

A change in attitude among domestic investors as a result of these companies making progress in

the areas of smart appliances and smart factories. The stocks should rerate as they become regarded

as new economy investments related to the internet and the IoT.

Greater interest from foreign investors attracted by sustainable improvements in margins and

ROIC as result of industry consolidation.

The recovery in the property market in 4Q15 should increase investor confidence about earnings

(we are in line with consensus). The government has taken a number of measures to support the

flagging property market this year, including the introduction of looser credit and tax policies. This

has resulted in a pick-up in the number of property transactions and there are signs that prices are

stabilising. With the usual lag of six months between movements in the primary property market and

changes in demand for household appliances, we expect a cyclical recovery in appliance sales from

4Q15. On 4 May 2015, HSBC’s property team issued a report, Eyeing a ‘turbocharged’ recovery, in

which the team upgraded the y-o-y change in ASP forecast in Tier 1,Tier 2 and Tier 3 cities to 10%,

5% and -10% from 0%, 0% and -10%, respectively.

No more price wars: With demand weak and production costs falling, retailers have been competing

on price. So far this year, the blended average manufacturing costs have fallen 10% for refrigerators,

8% for air conditioners, 7% for washing machines, and 8% for heaters. Some investors fear that price

wars, particularly for air conditioners, and poor demand will offset the decline in raw material prices.

We believe this concern is fading and the improved gross profit margin (GPM) will start to filter

through to earnings. Assuming no changes in product prices, we estimate that every 10% drop in bulk

materials will lead to a 5-6ppt improvement in GPM.

2. Right place: policy support, innovation, richer customers

The white goods industry in China is well past the rapid growth stage and is now quite mature and

consolidated. For the industry leaders, the focus is now on quality, efficiency and technology rather than,

33.1

19.2 16.3 13.1

66.0 68.1

23.0

- 50.0 100.0 150.0 200.0 250.0Semiconductors

Softwear and servicesMaterials

Medical equipmentHardware and equipment

MediaCommercial and services

RetailCapital goods

Household personal hygiene productsPharmacy

Telecom servicesConsumer services

Food and household goodsFood, Beverage and Tabacco

Durable goods and servicesDiversified financial

TransportationEnergy

PropertyPublic utilities

Auto and auto partsInsurance

Haier ElectronicsMideaGreeBank

Simple average of sectorsShenzhen Excg Comp IndexShanghai Excg Comp Index

193%

138%

106%

90%180%

160%125%

0% 50% 100% 150% 200% 250% 300% 350% 400%Softwear and services

Diversified financialCapital goods

TransportationRetail

Telecom servicesDurable goods and services

SemiconductorsHardware and equipment

Consumer servicesPublic utilities

PropertyMaterials

Commercial and servicesMedia

Medical equipmentFood and household goods

Auto and auto partsPharmacyInsurance

MideaFood, Beverage and Tabacco

Haier ElectronicsEnergy

Household personal hygiene productsBankGree

Simple average of sectorsShenzhen Excg Comp IndexShanghai Excg Comp Index

https://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=nBEg0ckwJ9&n=458554.PDF

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as Haier Group’s CEO Zhang put it earlier, to “maximise quantity, export more and manufacture more”.

This means the industry is entering a new phase of development.

At the national level, the government this year launched its Made in China 2025 initiative, which is

modelled on Germany’s Industry 4.0 – a reference to the fourth industrial revolution – a programme

launched in 2013. Beijing wants to upgrade the country’s manufacturing sector, led by innovation,

automation and the internet. Reuters described it as part of “a sweeping plan to reinvigorate the country’s

inefficient state-owned enterprises and raise the global competitiveness of domestic industry”. Policy

support is extremely important in China. More details are expected later this year, and they are likely to

include accelerated depreciation schemes and government funding plans. We expect benefits at the

company level as white goods manufacturers raise their game. For example:

The customer is always right: It’s not just the government that wants better, smarter products. So do

customers. As people get richer, the dull old appliances, which were a status symbol years ago,

simply won’t do any more. At the high end of the market, customers want energy efficiency, stylish

design and the very latest technology, rather than the lowest price. The next step is to understand

what individual customers want so products can be customised. For example, appliances, which are

connected to the internet via Wi-Fi and can be controlled remotely from a computer or mobile device,

are already widely available. A step further is smart grid technology: This involves smart appliances

accessing a smart grid power source to optimise energy use. For example, power will only be

supplied to a coffee maker in the morning and the washing machine at night. Eventually,

refrigerators, toasters, dishwashers and washing machines will all be linked to the smart grid network.

Smart grid technology is already widely used in Germany.

Domestic companies are closing the gap: Chinese manufacturers usually lag international peers in

terms of technology, so many consumers are willing to pay a premium for an international brand.

The average selling price (ASP) of foreign brands is much higher than for local products – 67% for

washing machines, 64% for water heaters, 102% for fridges, and 13% for air conditioners. However,

the technology gap is closing. The air conditioner industry is leading the way – note the price

difference is only 13%, and in 2011-14 the ASP of international brands declined 3% and those of

domestic brands rose 9%. Other categories of white goods are starting to catch up, too. This process

will be accelerated by the initiatives, such as Made in China 2025.

Getting smarter: The white goods industry is in the perfect position to benefit from the growth of

smart appliances. Unlike standard appliances, these products allow companies to monitor how

customers use their air conditioners or washing machines. This data gives them a direct link to their

customer base and also enables them to provide value-added services. Gree, Midea and Haier each

have an annual domestic sales volume of around 30m units. This gives them substantial potential

reach in the age of the Internet of Things, given the country has 730m internet users and 302m online

shoppers. Again, this is part of the Made in China 2025 technology upgrade story.

Changing channels: The white goods industry is undergoing major structural shifts. For example,

production, distribution and services are being digitalised. The physical distribution network is going

to be replaced by the omni-channel – the connection between physical retailers and their customers

through different formats. Customer service will depend on smart appliances and apps. Automated

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production is being embraced, as is building online-to-offline (O2O) platforms. In short, the whole

supply chain is going digital and the business model is moving away from wholesaling to being far

more consumer-driven.

Driven by these trends, especially premiumisation, we expect GPM to continue to trend up. Gree’s GPM

should improve to 35.8% in 2017 from 34.4% in 2015 and Midea’s to 28.1% from 27.1% over the same

period. We forecast Qingdao Haier’s GPM to improve 60-100bp on a like-for-like basis, but GPM overall

will remain stable at 30% due to a change in product mix.

3. Right people: management incentives lower execution risks

Midea (through restructuring) and Qingdao Haier (through the introduction of a strategic investor) have

made progress in aligning the interests of the core management team with minority investors, resolving

conflicts of interests with the parent group and incentivising the management team. Unlike Midea and

Qingdao Haier, Gree has yet to introduce a share option scheme, but we believe this may change, either as

a result of SOE reform or the introduction of a strategic investor. We believe that providing the right

incentives to management will lower execution risks and increase investor returns.

Figure 7. Rank of the three white goods makers on different strategies and execution

Rank Number 1 Number 2 Number 3

Export Qingdao Haier Midea Gree Smart appliances Qingdao Haier Midea Gree Online Qingdao Haier Midea Gree Smart factories Qingdao Haier Midea Gree Management incentives Midea Qingdao Haier Gree

Source: HSBC estimates

Ratings

We initiate coverage with Buy ratings on Midea, Gree and Qingdao Haier. They trade at an average 13x

forward PE on 2015e EPS and a 0.8x PEG with ROIC of 15-20%-plus. All have strong earnings visibility,

with dividend payouts of 30-60%-plus. We prefer Gree, followed by Midea and Qingdao Haier. We believe

Gree has the most potential for rerating, given its technology leadership and the potential benefits of SOE

reform. Gree now trades at an 11x PE and a 0.65x PEG, although it has the highest ROIC of the three.

White goods leaders are laggards in the A-share market as large appliance manufacturers are perceived as

old economy stocks. However, we believe the perception will change as they will be at the forefront of

China’s policy of upgrading its industrial base.

Gree, Midea and Qingdao Haier now trade at an 11.6x, 12.1x and 16.3x 2015e PE, respectively, and our

DCF valuation implies a target PE based on 2016e EPS of 11.8x, 12.9x and 16.3x, respectively.

Although the multiples are at the high end of the historical trading ranges, we believe the current PE

valuations are sustainable due to: 1) the valuation discount to A-share peers – their PE valuation discount

to the Shanghai and Shenzhen indexes has widened to 30% and 76%, respectively, from 25% and 70% a

year ago; 2) valuation discount to global peers: despite higher earnings growth, they trade at a 33%

discount to global white goods makers’ average PE of 20x; and 3) cheap PEG: our fair value target prices

imply a 0.8x PEG for Gree, a 0.75x PEG for Midea and a 1x PEG for Qingdao Haier.

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Also, looking forward, we see many catalysts for further re-rating above our target multiples as a result of

favourable government policies (e.g. the Made in China 2025 initiative announced this year), the

improvements in the housing market (it started in 2Q15 and will likely translate into better appliance

demand from 4Q15, with the usual six-month lag), and progress on smart appliances and factories (expect

more products, strategic alliances and innovations to be announced).

It is also useful to look at the valuation of new economy peers. The average trailing PE of software and

services sector is 199x, 123x for medical equipment, and 66x for durable goods and services. To put that

in context, the average trailing PE of the Shanghai index is 23x and 68x for the Shenzhen index.

Midea (000333 CH, Buy, TP RMB46.90)

Strongest growth among peers

We forecast that Midea will deliver a 13% revenue CAGR and a 19.4% profit CAGR in 2014-17e, faster

than the other two companies. This is thanks to a recovery in the growth in market share, a diversified

product portfolio, and profitability gains across segments through economics of scale.

Fast mover to industry 4.0

We believe Midea is the fastest mover in terms of upgrading its technology, as indicated by the strong

contribution from online sales (11% of domestic products sales) and early investments in

production automation.

Best incentivised management team

We believe Midea Group has the best management incentive scheme of the three companies to support

the group’s performance target of above 15% profit growth and above 20% ROE. Management in

aggregate holds more than 9% of Midea Group’s shares through direct equity stakes and share options.

Valuation and risks

Our fair value target price of RMB46.90 is based on DCF. Our DCF assumptions include a 5.5% China

equity risk premium and a 0% terminal growth rate. Midea has a 6% cost of debt and a target 10:90 debt-

to-equity ratio. Its company-specific beta is 1.00 – yielding a 9.0% cost of equity and, therefore, a cost of

capital of 8.6%. Our fair value target price implies a target PE multiple of 14x on 2015e EPS, 12.9x on

2016e EPS and a 0.74x PEG on a 2014-17e profit CAGR of 19.4%.

Catalysts: better-than-expected GPM; pick-up in white goods sales; major developments in

industrial upgrades.

Key downside risks: faster-than-expected rise in selling expenses due to price wars; slower-than-

expected air conditioner sales due to a cool summer.

Gree (000651 CH, Buy, TP RMB77.20)

Higher earnings visibility

We forecast a 10% revenue CAGR and a 17.5% profit CAGR in 2014-17e. Despite the air conditioner

price war that started in 4Q14, we believe Gree has an ample buffer to deliver on earnings. The company

has shifted strategy, moved away from a high GPM and high selling expenses formula. This means it does

not need to make as many provisions for sales rebates as before, which more than offsets the pressure on

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GPM from lower selling prices. Its balance of sales rebates provisions at the end of 2014 was equal to

more than three years of net profits.

Most leveraged to a cyclical rebound in 2H15

More than 90% of Gree’s earnings come from sales of air conditioners. This segment is volatile because it

is closely linked to the state of the property market cycle and a long lead time for pre-orders, which can

create large build-ups in inventories when demand falls. This is why we believe earnings are more

leveraged than for its peers to a property-driven cyclical recovery from 4Q15.

Potential beneficiary of SOE reform

As a state-owned company (SOE), Gree lags the other two in offering management incentives and

delivering on strategies for e-commerce, smart appliances and industrial upgrades. However, this could

change quickly as Beijing pushes ahead with SOE reform.

Valuation and risks


equity risk premium and a 0% terminal growth rate. Gree has a 6% cost of debt and a target 10:90

debt-to-equity ratio. Its company-specific beta is 1.00 – yielding a 9.0% cost of equity and, therefore, a

cost of capital of 8.6%. Our fair value target price implies a target PE multiple of 13.8x on 2015e EPS,

11.8x on 2016e EPS and a 0.79x PEG on a 2014-17e profit CAGR of 17.5%.

Catalysts: end of the price war in the air conditioner market; SOE reform; finding a strategic partner.

Key downside risks: inventory issues to persist; raw material price fluctuations; slower-than-expected

SOE reform.

Qingdao Haier (600690 CH, Buy, TP RMB35.90)

Better positioned to benefit from the consumption upgrade

As discussed in the Chapter “White Goods Industry”, consumption upgrade is a key secular industry

driver. From improvements on technology leadership and product offerings, the trend is for domestic

brands to close the pricing gaps with international brands. We believe Qingdao Haier is better positioned

to benefit from this trend with a strong higher end product portfolio, better technology and brand name.

Asset injections from parent to improve profitability

According to an agreement between Qingdao Haier and Haier Group announced in 2011, Haier Group

promised to resolve non-competition issues and reduce connected transactions with Qingdao Haier by

January 2016 (for more details, see the “Group restructuring” section). We think this will help Qingdao

Haier close the profitability gap with the two peers. As we show in the chapter on comparison analysis,

Qingdao Haier has a lower ROIC due to lower net margins.

Leader in industrial upgrades

Qingdao Haier has pushed ahead with digitalising its production, distribution and services. It has

integrated its logistics and distribution under one platform and opened it up to third parties. In 2014, close

to 20% of its revenue was from third-party services income. Haier was also an early mover in the online

business and investing in smart factories. In 2014, 11% of its domestic sales were online and it has

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opened four smart factories, as at the end of 1Q15. We also believe its strategic investor, KKR, will help

speed up the industrial upgrade process.

Valuation and risks


equity risk premium and a 0% terminal growth rate. Qingdao Haier has a 6% cost of debt and a target

10:90 debt-to-equity ratio. Its company-specific beta is 0.90 – yielding an 8.5% cost of equity and,

therefore, a cost of capital of 8.1%. Our fair value target price implies a target PE multiple of 18.4x on

2015e EPS, 16.3x on 2016e EPS and a 1.17x PEG on a 2014-17 profit CAGR of 15.7%.

Catalysts: better-than-expected GPM; sales recovery in air conditioners; fast growth in the number of

users of its U+ smart appliance systems.

Key downside risks: raw material price fluctuations; faster-than-expected rise in operating costs.

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Investment summary 1

China’s white goods industry 11

Cyclical rebound in 2H15 23

Looking to the future 29

Peer comparison 41

Midea (000333 CH) 51

Gree (000651 CH) 64

Qingdao Haier (600690 CH) 75

Disclosure appendix 98

Disclaimer 100

Contents

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In this chapter, we examine the secular and cyclical drivers of the white goods industry, and we make our

own forecasts for the industry’s growth rates and outlook. We also assess the degree of industry

consolidation and the drivers for further market share gains by the leaders.

White goods: a mature industry

Secular drivers: penetration, urbanisation and replacement cycle

Growth in large domestic appliances like washing machines, fridges, air conditioners and water heaters is

driven by improving lifestyles and better quality products. In China, the urban market is saturated but

rural areas provide opportunities for growth.

According to the China National Bureau of Statistics, as of 2012, every 100 urban households own an

average of 98 washing machines, 99 fridges, 127 air conditioners and 92 water heaters. Outside the cities

the numbers are 67 washing machines, 67 fridges and 25 air conditioners.

Figure 8. Per 100 household urban penetration of appliances Figure 9. Per 100 household rural penetration of appliances

Source: CEIC Source: CEIC

96.8 94.7 96.0 96.9 97.1 98.0

95.0 93.6 95.4 96.6 97.0

99.0

95.1 100.3

106.8

112.1

122.0

127.0

137.8 132.9

135.7 137.4 136.0 136.0

79.5 80.7 83.4 84.8

88.9

92.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

150.0

2007 2008 2009 2010 2011 2012

Uni

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Washing Machine Fridge Air Conditioner TV Water Heater

45.9 49.1

53.1 57.3

62.6 67.2

26.1 30.2

37.1

45.2 61.5

67.3

8.5 9.8 12.2

16.0 22.6

25.4

94.4 99.2

108.9 111.8 115.5 116.9

-

20.0

40.0

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100.0

120.0

2007 2008 2009 2010 2011 2012

Uni

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Washing Machine Fridge Air Conditioner TV

China’s white goods industry

We forecast that combined domestic sales of washing machines,

fridges, air conditioners and water heaters will increase at a

CAGR of around 7% in 2014-17

The industry is quite consolidated, with the top five dominating

the market

We think the companies will further strengthen their grip on

the market

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Urbanisation is another crucial factor. According to the government, the urbanisation rate will be 60% by

2020, up from 54.8% in 2014. This will involve an estimated 100m people migrating to urban areas, an

average of more than 13m per annum. This will drive up demand for white goods appliances as the new

arrivals pursue a lifestyle similar to their urban peers.

The product replacement cycle reflects the desire to upgrade. With rising income, replacing old

appliances with the latest, more energy efficient-products is a natural development. Replacement demand

will account for a large chunk of total demand. For example, we estimate that in 2014 about 49% of

demand for washing machines came from replacement demand; it was 63% for refrigerators and 44.8%

for air conditioners.

Figure 10. The replacement demand as a percentage of total domestic demand, by volume

Source: Industry Online, HSBC estimates

Cyclical drivers

The property market cycle usually leads demand for new home-related appliances by six months.

First, we look at the most recent cycle. China’s government introduced measures to cool the property

market from 3Q10, which lasted until the end of 2012. Once the tightening cycle was over, new

residential home sales grew 17.7% y-o-y by area and 25.2% y-o-y in value in 2013. During this period

growth in appliance sales by the Top 100 retailers (according to the Ministry of Commerce) rose to 13.7%

in 2013 from only 3% in 2012.

Second, we look at the current cycle. The property market cooled again in 2014 as the central bank

tightened liquidity. As a result, new residential home sales declined by 9.4% y-o-y by area and 8.2% y-o-

y in value last year. In line with the property cycle, appliances sales decelerated from 1.9% in 1H14 to a

negative 5% in 2H14, and a negative 6% in 1Q15.

The property market has now entered another loosening cycle. To prevent the economy sliding into a

deflation, in November 2014 the central bank lowered interest rates and started to pump liquidity into the

credit market in November-December 2014. On 30 March 2015, several major new policies were

announced to stimulate the property market. In the current cycle, we expect demand for appliances to

recover in 4Q15, driven by the pick-up in the property market.

55.1%

67.3%

54.4%

44.2%

53.9%

37.3%

49.1%

63.1%

44.8%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

Washer Fridge Air conditioner

2012 2013 2014

13


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In Figure 11-12, we illustrate the correlation between residential property sales and the growth in

appliances sales with a lag of six months. The decline in residential property sales started to slow at the

end of 2014, indicating a pick-up in appliance sales growth from 4Q15.

Figure 11. Appliances volume with a six-month lag vs. residential property volume y-o-y growth

Figure 12. Appliances volume with a six-month lag vs. residential property volume

Source: CEIC, CMM Source: CEIC, CMM

Domestic demand volume forecasts

Based on urbanisation, penetration growth and replacement demand, Figure 13-14 shows our forecasts for

domestic demand for white goods in volume terms. Note that the high penetration rate of air conditioners

in urban areas is the result of households installing more than one unit.

Figure 13. White goods domestic demand, by volume demand drivers

2008a 2009a 2010a 2011a 2012a 2013a 2014a 2015e 2016e 2017e

Per 100 household ownership (units)

Washing machines 71.4 74.2 76.2 79.7 82.5 81.9 85.3 88.2 91.2 94.3 - Urban 94.7 96.0 96.9 97.1 98.0 99 100 100 100 100 - Rural 49.1 53.1 57.3 62.6 67.2 72 77 82 88 94Fridges 61.2 65.7 69.7 79.1 83.1 83.2 86.9 90.8 94.9 96.3 - Urban 93.6 95.4 96.6 97.0 99.0 100 100 100 100 100 - Rural 30.2 37.1 45.2 61.5 67.3 74 81 90 99 100Air conditioners 54.0 58.7 61.7 71.9 75.9 85.6 92.4 99.7 107.5 115.8 - Urban 100.3 106.8 112.1 122.0 127.0 133 140 147 154 162 - Rural 9.8 12.2 16.0 22.6 25.4 28 32 36 40 45Water heaters - Urban 80.7 83.4 84.8 88.9 92.0 95 98 100 100 100Population (in million) 1,328 1,335 1,341 1,347 1,354 1,361 1,368 1,375 1,382 1,388 y-o-y % 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% - Urban 624 645 670 691 712 731 749 767 784 802 - Rural 704 689 671 657 642 630 619 608 597 586 - Urbanisation rate 47.0% 48.3% 49.9% 51.3% 52.6% 53.7% 54.8% 55.8% 56.8% 57.8%y-o-y changes 1.4% 1.6% 1.3% 1.3% 1.2% 1.0% 1.0% 1.0% 1.0%# of households (in thousand) 390,002 396,436 402,469 409,042 414,409 452,298 452,299 452,300 452,301 452,302 - Urban 214,443 223,225 232,563 240,693 248,888 255,633 261,944 268,060 274,231 280,457 - Rural 175,559 173,211 169,906 168,349 165,521 163,086 161,055 159,077 157,043 154,952 # of people per household 3.4 3.4 3.3 3.3 3.3 3.0 3.0 3.0 3.1 3.1 - Urban 2.9 2.9 2.9 2.9 2.86 2.86 2.86 2.86 2.86 2.86 - Rural 4.0 4.0 4.0 3.9 3.88 3.86 3.84 3.82 3.80 3.78

Source: CEIC, Industry Online, HSBC estimates

We forecast that domestic demand volumes will increase at a CAGR of 4.2% for washing machines, 4.0%

for fridges, 6.3% for air conditioners, and 4.1% for water heaters in 2014-17. The key assumptions are

listed in Figure 13.

-40%-30%-20%-10%0%10%20%30%40%50%

-25%-20%-15%-10%

-5%0%5%

10%15%20%25%

Residential Property YoY Gwth Heater YoY Gwth 6 month lag - RHS

Fridge YoY Gwth 6 month lag - RHS AC YoY Gwth 6 month lag - RHS

Washer YoY Gwth 6 month lag - RHS

0

500

1,000

1,500

2,000

2,500

0

20

40

60

80

100

120

140

Residential Property (sqm mn) Heater 6 month lag (Units)-RHS Fridge 6 month lag (Units)-RHS

AC 6 month lag (Units)-RHS Washer 6 month lag (Units)-RHS

14


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As illustrated in Figure 15, the white goods sector grew rapidly in 2009-11 thanks to favourable policy

measures and then went through an adjustment period in 2012-14 as those polices came to an end and the

property market cycle changed.

There is little doubt that the white goods industry is maturing in terms of volume growth. We expect

refrigerators to have relatively slower growth due to high levels of ownership.

Refrigerator sales benefited the most from the “Go Rural” subsidy programme, which ran between

December 2007 and February 2013. Domestic sales volumes grew 50% y-o-y in 2009 and 30% y-o-y in

2010 (according to IOL data). In rural areas 67 of every 100 households owned a fridge in 2012, up from

30 in 2008; in the same year 99% of urban households owned a fridge.

Figure 14. Domestic white goods appliances demand, by volume

('000 units) 2008a 2009a 2010a 2011a 2012a 2013a 2014a 2015e 2016e 2017e

Washing machines - Total domestic consumption 23,800 26,463 33,977 36,360 34,813 37,690 38,528 40,154 41,848 43,613

y-o-y % 11.2% 28.4% 7.0% -4.3% 8.3% 2.2% 4.2% 4.2% 4.2% - New demand 5,292 16,047 19,612 17,719 15,631 21,023 19,620 20,601 21,631 22,712

y-o-y % 203.2% 22.2% -9.7% -11.8% 34.5% -6.7% 5.0% 5.0% 5.0% - Replacement demand 18,508 10,416 14,364 18,641 19,182 16,667 18,909 19,554 20,218 20,901

y-o-y % -43.7% 37.9% 29.8% 2.9% -13.1% 13.5% 3.4% 3.4% 3.4%Replacement demand as % of total 77.8% 39.4% 42.3% 51.3% 55.1% 44.2% 49.1% 48.7% 48.3% 47.9%

Fridges - Total domestic consumption 26,076 39,295 50,965 59,008 55,818 55,893 52,978 55,440 58,033 59,654

y-o-y % 50.7% 29.7% 15.8% -5.4% 0.1% -5.2% 4.6% 4.7% 2.8% - New demand 10,849 22,667 32,877 29,548 18,246 25,781 19,561 20,539 21,566 22,644 y-o-y % 108.9% 45.0% -10.1% -38.3% 41.3% -24.1% 5.0% 5.0% 5.0% - Replacement demand 15,227 16,627 18,088 29,460 37,572 30,112 33,417 34,901 36,467 37,010

y-o-y % 9.2% 8.8% 62.9% 27.5% -19.9% 11.0% 4.4% 4.5% 1.5%Replacement demand as % of total 58.4% 42.3% 35.5% 49.9% 67.3% 53.9% 63.1% 63.0% 62.8% 62.0%

Air conditioners - Total domestic consumption 29,647 37,417 51,503 60,614 57,249 62,352 70,010 74,401 79,072 84,042

y-o-y % 26.2% 37.6% 17.7% -5.6% 8.9% 12.3% 6.3% 6.3% 6.3% - New demand 20,355 27,809 37,400 45,524 26,097 39,119 38,660 40,593 42,622 44,754

y-o-y % 36.6% 34.5% 21.7% -42.7% 49.9% -1.2% 5.0% 5.0% 5.0% - Replacement demand 9,291 9,608 14,103 15,090 31,152 23,233 31,350 33,808 36,450 39,288 y-o-y % 3.4% 46.8% 7.0% 106.4% -25.4% 34.9% 7.8% 7.8% 7.8%

Replacement demand as % of total 31.3% 25.7% 27.4% 24.9% 54.4% 37.3% 44.8% 45.4% 46.1% 46.7%Water heaters - Total domestic consumption 23,900 25,013 27,532 25,865 27,112 28,117 29,151

y-o-y % 4.7% 10.1% -6.1% 4.8% 3.7% 3.7% - Other demand 13,564 18,085 14,871 15,317 15,777 16,250

y-o-y % 33.3% -17.8% 3.0% 3.0% 3.0% - Replacement demand in urban 11,449 9,447 10,994 11,795 12,340 12,901

y-o-y % -17.5% 16.4% 7.3% 4.6% 4.5%Replacement demand as % of total 45.8% 34.3% 42.5% 43.5% 43.9% 44.3%

Source: Consumption data from Industry Online, HSBC estimates

Although sales of air conditioners also benefited from the government subsidies, there is still room for

growth, especially in rural areas. If we assume two air conditioners per household, urban penetration

should reach 200 per every 100 households; this suggests 57% growth from 127 in 2012. In rural areas,

the penetration rate of air conditioners was only 25% in 2012, the lowest in the white goods segment.

For washing machines, the penetration rates in both urban and rural markets are similar to those for

refrigerators (see Figure 13). As washing machines replace manual labour and are a significant

convenience, we believe that as lifestyles improve in rural areas, the penetration rate will increase

significantly from 67% in 2012 in the next three years.

15


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For water heaters, we have less data – an urban penetration rate of 92% in 2012 – but we believe

improving lifestyles will drive growth, especially in rural areas.

Figure 15. CAGR for domestic appliances (domestic demand volume)


The rural growth driver

We believe lower tier cities and rural areas will be the battle ground for white goods manufacturers,

distributors and retailers. The leaders are all focusing on strengthening their distribution networks.

Haier has a sales network of more than 30,000 specialty stores covered by 8,000 Haier Specialty Store

franchisees and over 1,000 Goodaymart Specialty Store franchisees at the county level. Gree has

increased the number of its specialty stores from 15,000 in 2013 to more than 20,000 today. Midea has

15,000 specialty stores at the end of 2014 (10,000 for large appliances, 5,000 for small appliances) and it

is also building out O2O flagship stores through its distributors. The number of Midea flagship stores

grew to 1,900 in 2014 from 300 in 2013 and the target is to reach 4,000 in 2016.

Consumption upgrade drives ASP growth

As the industry matures, upgrades should drive ASP growth as consumers trade up to more sophisticated

products.

Figure 16. Domestic white goods sales ASP

_________ Refrigerator sales __________ ________ Air conditioner sales _________ _______ Washing machine sales ________ 2011 2012 2013 2014 2011 2012 2013 2014 2011 2012 2013 2014

Annual ASP 2,834 2,894 3,057 3,174 3,430 3,589 3,681 3,658 2,003 2,062 2,165 2,258y-o-y growth % 2.1% 5.6% 3.8% 4.6% 2.6% -0.6% 2.9% 5.0% 4.3%

Source: CMM

17.2%

5.2%4.2%

22.5%

-2.6%

4.0%

27.3%

10.6%

6.3%

1.7%

4.1%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

CAGR 2009-2011 CAGR 2012-2014 CAGR 2014-2017

Washer Fridge Air conditioner Water Heater

16


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Refrigerators

Consumers are buying larger fridges. Sales of three-door, multiple-door and other higher end refrigerators

are growing faster than single- and double-door products. Low-end products represented 46% of total

sales in 2014, down from 60% in 2011. In terms of value, the contribution from products with an ASP

above RMB3,000 increased to 65% in 2014 from 51% in 2011.

Figure 17. Domestic fridge volume breakdown by product type Figure 18. Domestic fridge sales value breakdown by ASP (RMB)

Source: CMM Source: CMM

In 2001-14, the ASP of domestic refrigerators went up by 12% to RMB3,174. In our forecast period of

2015-17, we expect the ASP to go up by 2% per annum.

Air conditioners

Energy-efficient products are gaining market share. For example, the sales volume of air conditioners

with variable frequency compressors increased to 57% in 2014 from 48% in 2011. These products have a

higher ASP, so in value terms sales from product with an ASP above RMB3,000 increased to 71% in

2014, up from 63% in 2011. The overall domestic air conditioner sales ASP went up by 6.7% to

RMB3,658 during the same period. In our forecast period of 2015-17, we expect the ASP to go up by 2%

per annum.

Figure 19. Air conditioners, volume breakdown by product Figure 20. Air conditioner sales value breakdown by ASP (RMB)


Washing machines

Roller-type machines (front-loading) are considered faster and more efficient as they consume less water

than top-loading appliances. Market share by volume of roller-type washing machines has increased from

24.7% in 2011 to 32.1% in 2014. They are more expensive and, as a result, the sales value contribution

from products with an ASP above RMB3,000 increased to 49% in 2014 from 37% in 2011.

2.8% 2.4% 1.8% 1.4%

57.2% 53.4% 48.9% 44.6%

30.9% 33.8%35.4%

34.9%

1.9% 2.5% 4.4% 8.3%7.3% 7.9% 9.5% 10.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014

Single Door Double doors Three Multi-Door Bi-fold door

17.0% 17.0% 16.7% 16.1%

32.1% 30.9% 25.7%19.3%

22.1% 20.5%22.1%

24.4%

16.7% 17.1% 22.2%24.2%

12.1% 14.6% 13.4% 16.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014

below RMB2k 2k-3k 3k-5k 5k-9k above 9k

48.1% 52.4% 52.9% 57.3%

51.9% 47.6% 47.1% 42.7%

0%

20%

40%

60%

80%

100%

2011 2012 2013 2014

Frequency conversion Fixed frequency

3.52% 2.02% 0.00% 0.00%

33.90% 31.09% 29.35% 29.31%

23.55% 25.47% 27.12% 26.47%

24.37% 25.29% 26.16% 25.07%

14.65% 16.14% 17.37% 19.15%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014

Below 2k 2k-3k 3k-5k 5k-7k above 7k

17


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Figure 21. Washing machine volume, by product type Figure 22. Washing machine sales, by ASP (RMB)


During the same period, the ASP of domestic refrigerators went up 13% to RMB2,258. In our forecast

period of 2015-17, we expect the ASP to go up by 3% per annum.

Growth outlook In 2014-17, based on our assumptions on ASP and volume growth, we forecast that domestic sales will

increase at a CAGR of 7.3% for washing machines, 6.1% for refrigerators, 8.4% for air conditioners, and

7.2% for water heaters. We also expect more growth from rural areas, due to a lower penetration.

Figure 23. Domestic white goods sales value forecasts

_______ Volume ('000 units) * ________ _____________ ASP (RMB) _____________ ____________ Domestic sales (RMBbn) ___________ 2014 2015e 2016e 2017e 2014 2015e 2016e 2017e 2014 2015e 2016e 2017e CAGR

Washing machines 38,528 40,154 41,848 43,613 2,258 2,326 2,396 2,468 87.0 93.4 100.3 107.6 y-o-y % 2.2% 4.2% 4.2% 4.2% 4.3% 3.0% 3.0% 3.0% 6.6% 7.3% 7.3% 7.3% 7.3%Fridges 52,978 55,440 58,033 59,654 3,174 3,237 3,302 3,368 168.2 179.5 191.6 200.9 y-o-y % -5.2% 4.6% 4.7% 2.8% 3.8% 2.0% 2.0% 2.0% -1.6% 6.7% 6.8% 4.8% 6.1%Air conditioners 70,010 74,401 79,072 84,042 3,658 3,731 3,806 3,882 256.1 277.6 300.9 326.2 y-o-y % 12.3% 6.3% 6.3% 6.3% -0.6% 2.0% 2.0% 2.0% 11.6% 8.4% 8.4% 8.4% 8.4%Water heaters 25,865 27,112 28,117 29,151 1,888 1,944 2,003 2,063 48.8 52.7 56.3 60.1 y-o-y % -6.1% 4.8% 3.7% 3.7% 4.4% 3.0% 3.0% 3.0% -2.0% 8.0% 6.8% 6.8% 7.2%Source: Industry data, HSBC estimates. Note: *Volume is based on sell-in volume

White good industry consolidation – leaders dominate all We use data from China Market Monitor (CMM) to analyse the market concentration of the white goods

industry. Overall, the whole industry is highly consolidated, with the top three having a 47-61% market

share, depending on the product, and the top five having a 65-71% market share.

Figure 24. White goods industry concentration by volume (2014)

Source: CMM

1.2% 1.0% 0.7% 0.7%15.5% 14.3% 11.7% 9.8%

58.7% 58.7%57.6% 57.4%

24.7% 25.9% 29.9% 32.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014

Single Cylinder Double Cylinder Pulsator Roller

24.7% 23.7% 19.9% 19.0%

38.2% 36.5%36.1% 32.3%

21.1% 21.9%23.5%

24.9%

15.9% 17.9% 20.5% 23.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2011 2012 2013 2014

below 1500 1500 - 3000 3000-4500 4500 +

24.8% 23.6%17.2%

26.7%

60.6%51.8%

46.9%55.5%

71.7% 68.0% 64.7%68.8%

0%10%20%30%40%50%60%70%80%

Air Conditioner Fridge Heater WasherTop 1 Top 3 Top 5

18


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Refrigerators

In value terms the market share of the top three fridge manufacturers fell slightly between 2011 and 2014,

from 55.3% to 52.7%; for the top five, it dropped from 72.2% to 71.2%. By volume, the fall was more

apparent – from 54.6% to 51.8% for the top three and from 71.3% to 67.9% for the top five. This reflects

rising competition from smaller companies offering lower priced products, as well as new companies that

entered the market in 2009-11 to take advantage of government subsidies. That said, the industry

consolidation remains at a high level.

Figure 25. Market concentration of refrigerator industry by volume

Figure 26. Market concentration of refrigerator industry by value


The top three by sales value are Haier, Hisense Kelon and Siemens. The leader, Haier, has almost double

the market share of its nearest rival, Hisense Kelon. Figure 27 shows that Haier lost market share over

2011-14; however, this might be due to bias in CMM data. CMM focuses on third-party rather than

manufacturers’ internal channels. During this period Haier shifted more sales to its internal channels (70%

of its total sales in 2014) and this may explain the decline in market share.

Figure 27. Top 5 refrigerator manufactures’ market share by value (2011-14)

Source: CMM

Air conditioners

The market concentration by volume has grown steadily between 2011 and 2014 – the top three have

gone from 69% to 72% and the top five from 57% to 61%. In value terms, the top three have gone from

59% to 65% and the top five from 70% to 75%.

24.1%

51.5%

71.5%

28.1%

54.6%

71.0%

25.2%

52.8%

69.5%

23.6%

51.8%

68.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Top 1 Top 3 Top 5

2011 2012 2013 2014

26.7%

51.4%

70.2%

29.9%

55.3%

72.2%

27.1%

54.3%

72.6%

26.0%

52.7%

71.2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Top 1 Top 3 Top 5

2011 2012 2013 2014

26.7

%

11.0

%

13.3

%

9.9%

8.6%

29.9

%

13.0

%

12.4

%

6.9% 7.7%

27.1

%

14.5

%

12.5

%

7.7%

7.9%

26.0

%

14.1

%

12.6

%

8.8%

7.5%

0%

5%

10%

15%

20%

25%

30%

35%

Haier Hisense Kelon series(Rongsheng)

Siemens Midea series Meiling

2011 2012 2013 2014

19


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Figure 28. Market concentration of air conditioner industry by volume

Figure 29. Market concentration of air conditioner industry by value


The top three are Gree, Midea and Haier, with Gree and Midea having more than a 52% market share

between them. Figure 30 shows that between 2012 and 2014, Gree maintain its lead with a 28% share by

value. Midea rose from 20% in 2012 to 25% in 2014 as a result of restructuring its sales channels. Haier’s

market share is shown to be stable at 13%; however, again, this could be due to bias in CMM data.

Haier’s air conditioner sales rose at an 18% of CAGR in 2011-14, outpacing the industry average.

Figure 30. Top 5 air conditioner manufactures’ market share by value (2011-14)

Source: CMM

Washing machines

The market concentration by value declined in 2011-14 – from 60% to 59% for the top three and from

78% to 74% for the top five. It was a similar story by volume (see table), largely because Haier’s market

share fell (see Figure 33). Over this period Haier’s washing machine sales increased at a CAGR of 7.7%,

in line with the industry growth, so we think CMM’s methodology explains the apparent contradiction.

Figure 31. Market concentration of washing machine industry, by volume

Figure 32. Market concentration of washing machine industry, by value


23.9%

57.4%

69.0%

25.8%

59.1%

70.3%

25.3%

58.9%

69.5%

24.8%

60.6%

71.7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Top 1 Top 3 Top 5

2011 2012 2013 2014

26.1%

59.2%

69.9%

28.8%

61.6%

71.7%

28.3%

62.8%

73.0%

28.0%

64.9%

74.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Top 1 Top 3 Top 5

2011 2012 2013 2014

26.1

%

22.5

%

10.7

%

5.2%

5.0%

28.8

%

19.7

%

13.0

%

4.8%

4.4%

28.3

%

21.6

%

12.9

%

4.5%

4.0%

28.0

%

24.7

%

12.3

%

4.0%

4.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Gree Midea Haier Mitsubishi Electric Oaks

2011 2012 2013 2014

27.0%

60.8%

75.0%

31.2%

59.8%

73.2%

27.9%

56.9%

70.4%

26.7%

55.5%

68.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Top 1 Top 3 Top 5

2011 2012 2013 2014

26.3%

57.9%

78.2%

29.9%

59.3%

77.9%

26.8%

56.7%

74.8%

26.2%

58.5%

73.7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Top 1 Top 3 Top 5

2011 2012 2013 2014

20


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By sales value, the top three are Haier, Midea and Siemens. Haier, the leader, has roughly double the

market share of Siemens, the No 3. Figure 33 shows that between 2012 and 2014, Siemens has

consistently picked up market share and other foreign brands, like Panasonic and Sanyo, have lost share.

Figure 33. Top 5 washing machine manufactures’ market shares by value (2011-14)

Source: CMM

Water heaters

As shown in the tables, the market share of the leading companies is steadily increasing in both volume

and value. With the top three having more than 50% of the market, competition in the water heater

industry remains benign.

Figure 34. Market concentration of water heater industry, by volume

Figure 35. Market concentration of water heater industry, by value


By sales, the top three are AO Smith, a US company, Haier and Midea. The leader, AO Smith, has more

than double the market share of the No 3. Figure 36 shows that between 2012 and 2014, Midea regained

market share through channel restructuring. Although CMM data show Haier losing market share, in

2011-14 its water heater sales rose at a 17% CAGR, outpacing the industry.

26.3

%

20.4

%

11.2

%

11.2

%

9.1%

29.9

%

17.2

%

12.1

%

9.8%

8.8%

26.8

%

16.7

%

13.2

%

8.9% 9.2%

26.2

%

18.4

%

13.8

%

7.9%

7.4%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Haier Midea Siemens Panasonic Sanyo

2011 2012 2013 2014

19.9%

45.9%

63.6%

18.2%

45.3%

63.6%

17.2%

46.9%

64.7%

0%

10%

20%

30%

40%

50%

60%

70%

Top 1 Top 3 Top 5

2012 2013 2014

18.2%

49.9%

64.2%

16.9%

50.3%

65.2%

15.3%

51.1%

65.7%

0%

10%

20%

30%

40%

50%

60%

70%

Top 1 Top 3 Top 5

2012 2013 2014

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Figure 36. Top 5 water heater manufactures’ market share, by value (2011-14)

Source: CMM

Government polices

Since 2008, the government had used various subsidy programmes to boost domestic consumption. As a

result, the white goods industry recorded strong growth in 2009-11. Growth was negative in 2012 after

the subsidies ended, and then recovered in 2013 due to a new subsidy on energy-efficient appliances and

the recovery in the housing market. The energy-efficient subsidy expired in June 2013.

Plan to encourage upgrades

In January 2015, the country’s main planning agency, the National Development and Reform

Commission (NDRC), announced a plan to encourage China’s industry to be more environmentally

friendly and energy efficient. For white goods, this should boost sales of air conditioners, refrigerators,

and washing machines that meet the highest level of energy efficiency, known as level one. Details of this

latest subsidy are not available yet; however, energy grade 1 products account for about 5% of total

appliance sales (including categories like flat screen TVs). We think this “industry leader” programme

will drive further industry consolidation as the energy grade 1 products are dominated by market leaders.

24.1

%

18.2

%

7.6%

7.5%

6.8%

25.0

%

16.9

%

8.5%

7.8%

7.0%

24.9

%

15.3

%

10.8

%

7.4%

7.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

A.O. Smith Haier Midea Wangjiale Wanhe

2012 2013 2014

Figure 37. Government subsidies for the home appliance industry

Exchange old for new subsidy programme

Implementation period -Initial trial period starting 1 June 2009 to 31 May 2010

-Extended to the whole country from June 2010 to expire 31 December 2011 Trial cities/provinces Cities (5x): Beijing, Shanghai, Tianjin, Changsha, Fuzhou; Provinces (4x): Guangdong, Shandong, Zhejiang, Jiangsu Go Rural Implementation period -Initial trial period starting December 2007 to December 2008 in three provinces

-Extended from 3 to 12 provinces from December 2008 for a period of four years -It later was extended to the whole country from February 2009 -Expired in November 2011 for the first three trial provinces; November 2012 for the second batch nine trial provinces; February 2013 for the rest of the country

Trial cities/provinces First batch trial provinces/cities (3x) Shandong, Henan, Sichuan; second batch trial (9x) in Inner Mongolia, Liaoning, Heilongjiang, Anhui, Hubei, Hunan, Guangxi, Chongqing, Shanxi

Energy saving subsidy Implementation period -Started in June 2009 to expired in June 2011

-Adjusted in June 2010 by an increase in the energy saving threshold and reducing the subsidy Phase II Energy saving flat-panel TV and air conditioner subsidy Implementation period -The policy will last from 1 June 2012 to 31 May 2013 to give subsidies on energy saving flat panel TVs and air conditioners

Source: HSBC collected from the NDRC website

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Conclusion

The white goods industry in China has past the fast growth stage and the market is highly consolidated.

Over 2014-17, based on our assumptions on ASPs and volume growth, we forecast that domestic sales

will increase at a CAGR of 7.3% for washing machines, 6.1% for refrigerators, 8.4% for air conditioners

and 7.2% for water heaters.

As the market is so concentrated, we expect the margins and ROIC of the leading manufacturers to

continue to improve. Haier’s net margin should rise from 5.6% in 2014 to 6.7% in 2017e, Midea’s from

10.1% to 12.2%, and Gree’s from 8.4% to 8.9%.

As the industry matures, the focus will increasingly turn from quantity to quality, giving companies with

strong R&D a significant advantage. As profitability becomes a higher priority than scale, margins should

improve through efficiency gains and product upgrades. We expect occasional price wars to strengthen

the leaders’ market share and help clear out channel inventories. At the same time, the industry

consolidation will continue as the dominant companies strengthen their distribution channels in lower tier

cities and rural areas, while benefitting from energy-efficient programmes and ever-more aspirational

consumers seeking the best products.

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In this chapter we look at the outlook for 2015 by assessing cyclical factors, such as air conditioner price

wars, raw material prices and the property cycle.

2015: raw material price benefits outweigh weak demand

Air conditioner price wars

The distribution of air conditioners is different to other types of white goods. Each August, distributors

make pre-payments for the inventory they are ordering, a lead time of about 12 months. In May, they

have a chance to replenish their orders right before the peak season. If market conditions change, the

industry can experience destocking and restocking cycles due to the mismatch between actual sales

and pre-orders.

In 2014, inventories piled up due to a sluggish property market and a cold summer. According to the

“2015 China Air Conditioner Industry White Paper” by CMM, inventory reached more than 40m units by

the end of 2014, equivalent to one year of sales volume at the retail level.

We do not have the data to track the inventory level at a retail level, so we use the inventory-to-sales ratio at

the manufacturers’ factories. This ratio went up to 1.12x in 4Q14 from an average of 0.73x in 9M14 and

0.72x in 2013. With working capital tight because of slower-than-expected retail sales, distributors did not

buy from factories in quantities based on their pre-orders, causing inventories at the factory level to rise too.

To clear stock, Gree started a price war in September 2014 and peers, such as Midea and Haier, followed;

another price war by major air conditioners makers followed in March. According to Ao Wei

Consultancy, the ASP declined by 9% y-o-y during the latest price war. To protect the health of the whole

industry, the government intervened. On 30 April, the NDRC called for a meeting with the major

manufacturer and distributors to ask them to avoid excessive price wars and stabilise prices in the coming

peak sales season.

Cyclical rebound in 2H15

Declining raw material prices are a major tailwind; the benefits for

air conditioner makers will come more in 2H15 after the price war

Competition for refrigerators and washing machines remains

benign; the benefit of lower raw material prices to flow to the

bottom line

We expect industry growth to recover from 4Q15, led by the pick-

up in the property cycle

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So, despite a difficult start to 2015, we expect to see the following:

As the industry margin bottomed out in 1Q15, the downward pressure on the ASP is falling prior to

the peak summer season; the benefit from declining raw material prices will start to flow through.

The usual order replenishment prior to the peak season in May will be limited due to the inventory issue.

Manufacturers’ sell-in volumes will start to improve from 3Q15 from the recovery in housing market

and improving inventories, especially if there is a hot summer.

Market consolidation will increase after the price war.

Figure 38. Air conditioner inventory at manufacturers (’0000 units)

Source: IOL

Raw material prices

The materials most commonly used to make white goods are steel, aluminium, copper and plastics. Price

fluctuations, which are driven by international supply and demand, have a large impact on gross profit

margin (GPM), as retail prices are usually stable. Raw materials account for about 80% of the cost of

goods sold (COGS), and the appliances have a GPM of 25-35%. Assuming there is no change in product

prices, every 10% drop in raw material prices leads to a 5-6ppt improvement in GPM. As Figure 39

shows, YTD the blended average cost for making refrigerators, air conditioners, washing machines and

water heaters has declined by 10%, 8%, 7% and 8%, respectively.

0

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1400

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Inventory at manufacturers (rhs) Inventory to sales ratio

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Figure 39. Raw material composition by products and the price y-o-y % changes

As % of raw

materials

1H13a 2H13a 2013a 1H14a 2H14a 2014a 1H15e 1Q13a 2Q13a 3Q13a 4Q13a 1Q14a 2Q14a 3Q14a 4Q14a 1Q15a 2Q15e

Fridges: 2.1% 3.1% 2.5% -1.0% -2.9% -2.0% -10.5% 3.0% 1.1% 4.8% 1.4% -1.3% -0.7% -1.7% -4.0% -12.1% -7.1% - Copper 15% -4.9% -9.2% -7.1% -10.7% -5.2% -8.0% -12.9% -2.8% -7.1% -8.6% -9.9% -13.7% -7.4% -2.6% -7.8% -14.2% -10.4% - Steel 31% -3.7% 1.1% -1.3% 1.6% -1.9% -0.2% -8.5% -2.1% -5.4% 2.2% 0.1% 0.7% 2.5% -1.0% -2.7% -8.7% -10.2% - Plastics 30% 14.5% 14.8% 14.7% 1.8% -4.4% -1.4% -19.3% 14.9% 14.0% 19.3% 10.6% 3.3% 0.4% -3.0% -5.9% -23.7% -7.7% - Aluminium 5% -7.9% -7.0% -7.5% -9.8% -3.3% -6.5% -1.9% -7.5% -8.4% -7.5% -6.5% -10.3% -9.3% -1.6% -4.9% -2.8% 0.0%Air conditioners: -1.5% -1.9% -1.7% -3.8% -2.4% -3.4% -7.5% -0.7% -2.2% -1.3% -2.5% -4.9% -2.6% -1.3% -3.5% -7.7% -6.8% - Steel 23% -6.3% -4.9% -5.6% -5.4% -3.0% -5.6% -12.7% -5.1% -7.4% -4.7% -5.1% -8.1% -2.5% -1.5% -4.5% -10.2% -17.2%

Cold roll steel 2% -8.6% -2.7% -5.8% -8.1% -9.7% -8.9% -14.9% -8.1% -9.1% -2.2% -3.2% -8.6% -7.5% -8.8% -10.5% -14.6% -17.4%Zinc coat steel 6% -3.4% -7.8% -5.6% -6.9% -0.8% -3.9% -15.4% -1.1% -5.6% -8.8% -6.8% -7.7% -6.2% 0.6% -2.1% -13.7% -20.3%Stainless steel 5% -13.2% -14.0% -13.6% -3.4% 6.5% 1.4% -8.5% -11.6% -14.7% -14.8% -13.1% -14.8% 8.7% 9.3% 3.7% 1.1% -17.9%

Silicon steel 4% -0.8% 2.6% 0.8% -7.5% -9.4% -8.4% -11.9% -2.8% 1.2% 3.6% 1.5% -6.3% -8.8% -8.2% -10.5% -12.0% -14.8%Hot roll steel 3% -10.0% -4.9% -7.6% -8.9% -9.4% -9.2% -17.9% -7.2% -12.8% -3.0% -6.8% -11.6% -6.1% -8.0% -11.0% -16.9% -21.2%

Iron + steel casts 4% -3.7% 1.1% -1.3% 1.6% -1.9% -0.2% -8.5% -2.1% -5.4% 2.2% 0.1% 0.7% 2.5% -1.0% -2.7% -8.7% -10.2% - Copper 20% -4.9% -9.2% -7.1% -10.7% -5.2% -8.0% -12.9% -2.8% -7.1% -8.6% -9.9% -13.7% -7.4% -2.6% -7.8% -14.2% -10.4% - Plastics 10% 14.5% 14.8% 14.7% 1.8% -4.4% -1.4% -19.3% 14.9% 14.0% 19.3% 10.6% 3.3% 0.4% -3.0% -5.9% -23.7% -7.7% - Aluminium 6% -7.9% -7.0% -7.5% -9.8% -3.3% -6.5% -1.9% -7.5% -8.4% -7.5% -6.5% -10.3% -9.3% -1.6% -4.9% -2.8% 0.0%Washing machines: -2.6% -2.0% -2.3% -1.2% -0.1% -2.7% -7.3% -1.9% -3.3% -2.0% -2.0% -3.6% 1.3% 1.3% -1.5% -6.1% -8.0% - Steel 25% -11.2% -9.9% -10.6% -5.1% 0.8% -

10.6%-11.0% -10.0% -12.4% -10.3% -9.5% -12.4% 2.6% 2.9% -1.3% -4.8% -17.9%

Cold roll steel 8% -8.6% -2.7% -5.8% -8.1% -9.7% -8.9% -14.9% -8.1% -9.1% -2.2% -3.2% -8.6% -7.5% -8.8% -10.5% -14.6% -17.4%Zinc coat steel 1% -3.4% -7.8% -5.6% -6.9% -0.8% -3.9% -15.4% -1.1% -5.6% -8.8% -6.8% -7.7% -6.2% 0.6% -2.1% -13.7% -20.3%Stainless steel 15% -13.2% -14.0% -13.6% -3.4% 6.5% 1.4% -8.5% -11.6% -14.7% -14.8% -13.1% -14.8% 8.7% 9.3% 3.7% 1.1% -17.9%

- ABS 10% -3.1% -1.6% -2.4% -4.1% -4.0% -4.1% -18.9% -2.6% -3.8% -0.7% -2.4% -6.8% -1.3% -1.1% -7.0% -19.2% -17.6% - Polypropylene (PP) 11% 4.8% 5.4% 5.1% 4.6% 1.1% 2.8% -24.2% 8.1% 1.4% 5.5% 5.3% 1.8% 7.4% 6.7% -4.4% -27.1% -15.9%Kitchen ware -10.5% -11.6% -11.1% -6.1% 2.2% -2.1% -8.1% -9.0% -11.9% -12.1% -11.2% -13.7% 1.9% 4.8% -0.3% -2.7% -12.9% - Stainless steel 60% -13.2% -14.0% -13.6% -3.4% 6.5% 1.4% -8.5% -11.6% -14.7% -14.8% -13.1% -14.8% 8.7% 9.3% 3.7% 1.1% -17.9% - Copper 20% -4.9% -9.2% -7.1% -10.7% -5.2% -8.0% -12.9% -2.8% -7.1% -8.6% -9.9% -13.7% -7.4% -2.6% -7.8% -14.2% -10.4% - Aluminium 20% -7.9% -7.0% -7.5% -9.8% -3.3% -6.5% -1.9% -7.5% -8.4% -7.5% -6.5% -10.3% -9.3% -1.6% -4.9% -2.8% 0.0%

Source: Thomson Reuters Datastream

Refrigerators

Refrigerators are made up of several basic components: the exterior cabinet body, the door, the inner

cabinet, the insulation inserted between the two, the cooling system, the refrigerant and the fixtures.

Based on our estimates and assuming the components represent up to 80% of COGS, the raw material

costs for a refrigerator break down like this – 31% steel, 30% plastics, 15% copper and 5% aluminium.

Figure 40. Refrigerator: % of raw materials


Steel, 31%

Copper, 15%

Plastics, 30%

Aluminum, 5%

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Air conditioners

According to our estimates, the breakdown for a typical air conditioner is about 23% steel (cold roll steel,

zinc coat steel, stainless steel, silicon steel, hot roll steel and iron or steel casts), 20% copper, 10% plastic

and 6% aluminium.

Figure 41. Air conditioner: % of raw materials


Washing machines

Washing machines include 25% steel, 11% polypropylene (PP) and 10% Acrylonitrile butadiene styrene

(ABS), two types of plastics.

Figure 42. Washing machines: % of raw materials


Sensitivity of GPM to raw material prices

In 2014, raw materials accounted for 78% of total COGS for Midea, 74% for Gree, and 63% for Qingdao

Haier. Overall GPM in 2014 was 25.5% for Midea, 36.6% for Gree, and 27.5% for Qingdao Haier.

It’s clear that movements in raw material prices have a large impact on margins when the ASP is stable.

Based on our estimates, assuming there are no changes in product prices, for every 10% drop in bulk

materials, gross profit margin should improve by 5-6ppt.

Steel, 23%

Copper, 20%

Plastics, 10%

Aluminum, 6%

Steel, 25%

Acry lonitrile butadiene sty rene (ABS), 10%

Poly propylene (PP), 11%

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Figure 43. Raw material price y-o-y growth %

Source: Thomson Reuters Datastream

Property cycle

As discussed earlier, the property market cycle usually leads the demand for new home-related appliances

by six months, the average time between buying a property and moving in. Residential floor space sold in

December 2014 was down only 3% y-o-y, a pick-up from the declines of 20% and 15% in July 2014 and

August 2014, respectively. In March 2015, the decline in volume narrowed to only 1%.

In the same month the government issued the most powerful loosening measures of the last seven years,

called “3.30 new policies”. According to Barron’s.com, up to 27 April 2015, housing transaction volumes

in April went up by 26% y-o-y; in first and second tier cities volumes rose 61% and 17% y-o-y,

respectively, and the ASP was up 5%.

In Figure 43-48, we illustrate the correlation between the residential property sales and the sales of

refrigerators, air conditioners and washing machines, with a six-month lag. While the recovery in the

housing market started at the end of 2014, we believe growth in demand for home appliances will resume

in 4Q15.

Figure 44a. Refrigerator volumes with a six-month lag vs. residential property volume y-o-y growth

Figure 44b. Refrigerator volumes with a six-month lag vs. residential property volume


-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

1-Apr-13 1-Jul-13 1-Oct-13 1-Jan-14 1-Apr-14 1-Jul-14 1-Oct-14 1-Jan-15 1-Apr-15

Aluminium Copper Steel ABS

-30%

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0%

10%

20%

30%

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Residential Property YoY Gwth Fridge YoY Gwth 6 month lag - RHS

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Figure 45. Air conditioner volumes with a six-month lag vs. residential property volume y-o-y growth

Figure 46. Air conditioner volumes with a six-month lag vs. residential property volume


Figure 47. Washing machine volumes with a six-month lag vs. residential property volume y-o-y growth

Figure 48. Washing machine volumes with a six-month lag vs. residential property volume


Outlook for 2015

Air conditioners

We see 1Q15 as the bottom as price wars depress the ASP and margins but clear inventories. As we enter

the peak summer season, we believe the promotions will start to disappear and the benefits from declining

raw material prices will filter through to the bottom line. The recovery in the property market from

beginning of the year should also help sales from 4Q15. We expect earnings momentum to improve

materially in 2H15 from 1H15.

Refrigerators and washing machines

Competition remains benign. The benefit from lower raw material process can flow to the bottom line or

help boost sales through increasing investments in distribution channels.

Water heaters

The sluggish property market hurt water heater sales, so we expect a recovery from 4Q15. Growth will

likely be driven by product upgrades and new product launches.

-40%

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In this chapter, we review the new trends that are shaping the future landscape of the white goods industry.

China’s white goods makers are developing their brands overseas to boost growth. Domestically, they are

developing smart appliances, growing online channels, and investing in smart factories. Exports

As the domestic market becomes more mature, exports are becoming an important part of the strategy by

white goods makers in China to globalise their brands. China is already the largest manufacturer and

exporter of electronic appliances. We estimate that China accounts for more than 40% of global capacity

for colour TVs, washing machines and refrigerators, and at least 70% when it comes to air conditioners.

IOL data show that in 2014 31% of the fridges made in China were exported, as were 33% of washing

machines and 40% of air conditioners. Last year exports accounted for 38% of Midea’s sales, 12% of

Qingdao Haier’s sales and 11% of Gree’s sales.

Figure 49. The breakdown of total sales volume (2014) Figure 50. The y-o-y % growth of white goods export volume

Source: IOL Source: IOL

While exports are obviously important, the companies use different strategies. To export your own brand,

you need an overseas sales network or good partnerships in foreign markets. This is more difficult than

the production-driven original equipment manufacturer (OEM) model. In general, the large companies in

33%40%

31%

67%60%

69%

0%

20%

40%

60%

80%

100%

Washers Air conditioners Refridgerator

Export Domestic

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

2006 2007 2008 2009 2010 2011 2012 2013 2014Fridges export Yoy% Air conditioners export Yoy% Washers export Yoy%

Looking to the future

New trends and company strategies, including exports, smart

appliances, online, smart factories and incentives

Qingdao Haier leads in smart appliances, followed by Midea; Gree

has ground to make up

Automation the potential game-changer

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China are switching from OEM to exporting their own brands and the original design model (ODM). In

Figure 51, we compare the export strategies of Midea, Qingdao Haier and Gree.

Figure 51. Comparison of white goods makers’ export strategies

Company Strategies Details % of export under its own brands/ODM

Qingdao Haier

Own brand/ODM only

First stage: focus on its own brand only and developed markets, like Europe, the US and Japan in export

Second stage: target to acquire second tier international brands to expand market share

Haier does not do OEM exports and its Haier brand is the number one brand globally for washing machines with a 14.4% share by volume

It started to develop its high end products’ global share under its own Casarte brand, and acquired brands, like Sanyo and Fisher & Paykel;

Globally, Haier has 21 industry parks, 24 manufacturing factories, 10 R&D centres and 19 overseas trading companies.

100%

Midea Try to increase the share of own brand/ODM

First stage: export mainly under OEM to grow its share in the export market

Second stage: invest in international brands and form strategic alliances overseas

Third stage: target to export under its own brand or ODM under its own control

Global production: in 2007, Midea started its first overseas production base in Vietnam

Global sales & distribution: 1) 2008: Midea and Carrier set up a JV to develop overseas markets; 2) 2010: acquired a 32.5% stake in Carrier's business in Egypt and Morocco; 3) 2011: acquired 50% stake in Carrier's businesses in Latin American countries of Brazil, Argentina and Chile; 4) 2012: Midea set up a JV in India with Carrier and holds a 60% stake

Tie-up with Bosch in the European market: on 31 March 2015, Midea signed a JV contract with Bosch to manufacture VRF central air conditioning systems in Hefei and export these to Europe

More than 60% of export sales under its own Midea brand or ODM in 2014 (38% under Midea own brands; 22% under ODM)

Gree Try to increase the share of own brand/ODM

First stage: export under OEM model to gain market share and focus on emerging markets

Second stage: export more under ODM and its own brand and focus on developed markets

Global production: Gree started its first overseas production in Brazil in 2001

Global sales & distribution: Gree set up its US sales office in 2012

In 2014, Gree has a 20% market share by volume in the air conditioner export market, based on IOL data

50% in 2014, up from 30% in 2012 of export volume is under its own brands (exports under its own brands to 100 countries and regions globally)

Source: Company disclosures, HSBC

Conclusion

Qingdao Hair and Midea have the highest proportion of export sales either through their own brand or the

ODM model. This gives the companies better control over their sales overseas, disregarding fluctuations

in exchanges rates, economic cycles overseas and tariff changes.

Smart appliances

White good makers in China are developing smart appliances and smart systems to connect directly with

consumers and complete the digitalisation process that links research, production and sales. Smart

appliances will be the main driver of the replacement cycle of appliances by stimulating upgrade demand.

Definitions differ, but smart appliances generally refer to products that use computer systems and

communications technology to make functions faster, cheaper, more energy efficient and more convenient.

Appliances that are connected to the internet via Wi-Fi and can be controlled remotely from a computer

or mobile device are already widely available in many markets. A step further is smart grid technology:

This involves smart appliances accessing a smart grid power source to optimise energy use. For example,

power will only be supplied to a coffee maker in the morning and the washing machine at night.

Eventually, we believe refrigerators, toasters, dishwashers and washing machines will all be linked to the

smart grid network. Smart grid technology is already widely used in Germany.

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We think white goods leaders have natural advantages when it comes to developing new ecosystems for

smart appliances, part of the Internet of Things (IoT). For example, they can choose whether to develop

their own smart platforms or work with major online companies. Gree, Midea and Haier all have an

annual domestic sales volume of around 30m units. This gives them a significant head start in terms of

customer reach, especially for smart appliances.

Figure 52. Annual domestic sales volume (m, 2014)

Gree Midea Haier

Air conditioners 30.3 16.8 6.8 Refrigerators 8.0 15.1 Washing machines 4.7 12.9 Total 30.3 29.4 34.9


c

Strategies in China

We review the smart appliances strategies of Qingdao Haier, Midea and Gree, as well as those of pure

internet companies like Xiaomi and JD.com.

Qingdao Haier

In 2014, Qingdao Haier started commercial sales of internet/smart appliances. It sold 1m units of smart

refrigerators, washing, air conditioners and water heaters, generating RMB3bn of sales under its U-home

smart appliance system. In 1Q15 alone the company sold half a million smart appliances.

Qingdao Haier has a two-pronged approach. One is developing its own smart products – at the end of last

year the company had 25 categories. The other is to attract more suppliers and users to form its own smart

ecosystem – it has the most open smart appliance platforms that are available to third-party brands and

industry partners via its 7 Smart Life Ecosystem, part of the company’s U+ Platform.

The plan is to open the U+ Platform to more appliance brands, product categories and services providers

to provide consumers with a “safe, convenient, comfortable and pleasing” lifestyle anytime and anywhere.

The goal is total connectivity between devices through communications, internet, TV broadcasting, and

power grid networks at a family, community and global level. The elements that make up this connected

world include U+Smart family, U+Cloud, U+Big data, U+APP and U+Cloud.

We believe Qingdao Haier is leading the way in China in the area of open smart systems. By the end of

last year it had attracted nearly 100 partners and, significantly, Qingdao Haier was among the first home

appliance makers globally to partner with Apple’s smart home platform.

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Figure 53. Qingdao Haier’s smart appliances, modules and partners

Key modules Strategic partners

Smart Air Ecosystem Use air conditioners, air boxes, air rubic cubes, mini-air conditioners, purifiers as the hardware terminals and “Haier Good Air” “Air Box” and ”Air Steward” APPs as the user terminals to provide users with value-added services to improve air quality

Apple: Joined Apple’s HomeKit smart appliance platform in March2015

Smart Food Ecosystem Use smart refrigerators as the hardware terminals and “Haier Fridge” “Weizhidao Gourmet” and “U-Cellar+” APPs as the user terminals to provide users with value-added services to improve food quality

Device connectivity: GE, Honeywell, Panasonic, Emerson, Samsung, Toshiba

Smart refrigerator products include Smart Window series, Smart Control Four-door series, and Casarte Smart series

Smart Wash Ecosystem Based on its database on clothes, water quality, detergent and customer washing habits, through smart washing machines to build an open platform for perfect washing solutions. Smart washing machines provide automatic cloth detection, automatic washing programme selection, and automatic release of detergents

Data connectivity: Benlaishenghuo Net, COFCO, HNA Group, Yihaodian, BAIDU, Sino Ocean Land, Meishi Tianxia, Baixianji, ROHM, 3M,Excegroup, Wanda Group

The platform is open to apparel brands, detergent brandsSmart Safety Ecosystem It aims to provide users with functions, such as personal safety

(emergency alarm, fall alarm, missing alarm, abnormal sleep alarm, abnormal health alarm, hijack alarm) and family safety (fire, water, electricity and gas alarm) and community safety and monitoring

Cross-field supplier connectivity: P&G, Unilever, DCT, Greenland, Yuexiu Property, Neusoft, Mitsubishi, State Grid, CRC, Greentown, Evergrande, Fosun Group, FreescaleQualcomm, Baosteel, Intel Peer connectivity: Bohe, Beita, Chunyu, Yuzhiyi, Judong Kangye

Smart Health Ecosystem Use U+ Health Cloud to provide functions sports, diet, health,environment, chronic disease management functions

Smart Entertainment Ecosystem

Co-operate with Alibaba on smart TV Content connectivity: Xiami Music, Bosheng, Orvibo, Iqiyi, Alibaba, Realtek, Optoma, Huawei, Tianqian kalaok Smart Water Ecosystem Integrate water heaters, fans, water purifiers, water heaters based

on “Haier Smart Washer”, “Haier Heat Control” “Smart Heater” APPs to realise real-time data interaction and automatic monitoring of water heaters


Midea

Midea has a different approach to smart appliances than Qingdao Haier. Rather than starting with

developing an open system, Midea has chosen to develop individual smart appliances. The idea is that, at

a later stage, it can either develop an integrated smart home system or connect its smart appliances to

other platforms or networks. In March 2014, Midea published its M-Smart report, highlighting 25

categories of smart appliances. The aim is to have more than 50% of air conditioner sales classified as

“smart” by 2018.

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Figure 54. Midea’s smart appliances, modules and partners

Key modules Strategic partner

Air smart housekeeper

Midea's air conditioners, air purifiers, humidifiers and dehumidifiers to provide “one-stop” air quality solutions on air temperature, humidity, cleanness, etc.

Xiaomi: In December 2014, Midea offered 55m new shares at RMB23.01 to Xiaomi. Xiaomi will have a 1.288% stake in Midea and it has also signed a strategic agreement to co-operate in the smart home value chain and e-commerce

Smart air conditioners have functions like voice control, sleep mode, remote control, electricity usage management, and information alerts

Nutrient smart housekeeper

It provides integrated control of all kitchen appliances through its cloud platform using Wi-Fi and IGRS protocols

Apple: On 18 March 2015, Midea joined Apple’s HomeKit smart home platform Smart small appliances with functions like auto detection, auto alerts;

smart microwaves with auto cooking based on QR code scanning, remote control, smart menu downloads

Water smart house keeper

Smart washing machines with functions to auto detect load and decide the volume of detergent

Alibaba: On 3 April 2015, Midea signed an agreement with Alibaba to co-operate in marketing, system connectivity, smart appliances, supply chain warehousing, product customisation

Safety smart house keeper

Smart range tops with auto gas leakage alerts, auto switch-off, kid lock, timed cooking, firewall

SIIX: On 3 April 2015, Midea signed a JV agreement with SIIX EMS to jointly develop smart switch controls

Other partners: JD, Huawei, Qualcomm, Neusoft, TI, Broadcom, Marvell, LeTV. SRRC, CHEARI, HKUST


Midea’s smart appliance products and strategic partners are shown in Figure 54. Midea’s plan is to

provide integrated smart home solutions that cover air quality, nutrient, water quality and safety. The

strategy is to: 1) start by developing individual smart appliance products; and 2) through remote control,

big data and sensor technology, produce appliances that are intelligent, healthy and energy efficient under

three matrixes – One Housekeeper, One Community and One Centre. One Housekeeper released 25

categories of smart appliances in 2014; One Community has built up a 10m consumer strong Media

Consumer Society and will improve marketing through social media; One Centre upgrade all smart

appliances through M-BOX.

At a later stage, Midea will start to build its own ecosystem and integrated solutions based on its cloud

platform, APP development and Wi-Fi modules. In 2015, it plans to increase the number of smart product

categories to 30 and develop B2B business under Smart Hotels.

Gree

Gree has a distinctive strategy, probably because it focuses on a single product: air conditioners. Gree

focuses on developing a smart power management solution that allows a family to transmit surplus

electricity generated by Gree photovoltaic air conditioners to the city grid. The device also allows

customers to monitor energy use to choose the most economical option. Gree’s smart strategies are based

on one control platform, a smart power management centre and big data.

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Figure 55. Gree’s smart appliances, modules

Smart power system Based on multi-line photovoltaics air conditioner system, a family can have its own electricity supply and can also transmit surplus electricity to the city grid. The device also allows each family to monitor the energy generation/usage status anytime to choose the most economical power usage solutions

Smart air conditioners Use air conditioners as the central hubs/power source to connect to other appliancesSmart phones Gree will launch its own smart phones in 2015 as the user terminals for using its smart appliancesOther smart devices Water heaters, water purifiers, smart remote control terminals


Pure internet companies: Xiaomi and JD.com

We also examine the smart appliance strategies of pure internet companies. Domestic smartphone giant

Xiaomi and online retailer JD.com (JD US, Not Rated) are the two most active in developing the Internet

of Things/appliances through their own smart ecosystems.

Xiaomi

A pure internet-based smart phone manufacture in China under the brand “Xiaomi”: as Xiaomi does not

manufacture appliances, its general principal is to create an open smart ecosystem to attract more users,

suppliers, services and third-party technologies, and to co-operate with other manufacturers to develop the

hardware. Xiaomi’s strategies are:

To use the Xiaomi smartphone as a control centre to connect with Xiaomi Cloud, the MIUI system

and app through Xiaomi’s low-cost smart module.

To connect its smart phone users with the smart appliance users to interact with them on multiple

hardware interfaces.

Figure 56. Xiaomi smart modules

Key modules Strategic partner

Universal Smart Module Based on Wi-Fi/Communication Protocol with Xiaomi Cloud, upgrade traditional devices to smart appliances

Midea: offered 55m common shares at RMB23.01 per share to Xiaomi. Xiaomi will have own 1.29% of the common shares of Midea after the transaction. The two parties also formed a strategic cooperation alliance to develop smart home systems and e-commerce

Xiaomi Smart Home App

Connect devices so that every family member can control all appliances. Also, connect devices with e-commerce and apps so that the customer can place orders easily. Deeply integrated with the MIUI system so the users can connect/control every device with just one click

Universal Smart Hardware Cloud Provide network and cloud services to manufacturers to enable them to store, calculate, and access their user data

Source: Company announcements

JD.com

In March 2015, JD.com announced it was developing a Smart Home Combo Kit with Broadlink. In the

same month it also established a JV with IFLY TECK (002230 CH, Not Rated) to cooperate on smart

home business and speech recognition. It wants to build a network of appliances that can control devices

automatically and conveniently. The company develops its own smart chips so appliances can be

upgraded to smart devices. The smart chips are based on Wi-Fi chip technology, mobile connection and

virtual networking.

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Figure 57. JD.com smart modules

Key modules Strategic Partner

Smart Home Combo Kit Kitchen, bedroom, dining appliances

JD Smart Cloud system partners include: Changdi, TCL, Joyoung, Tupo, Povos, Haier, Lightmates, A.O.Smith, Pcpop, Fotile, Dooya, Hisense, Kelon, Gongniu, Dr.Drinks, Sense-U, Chigo, Mfresh, Phillps, Galanz, Supor, Qinyuan, Lifesense, Yuyue

JD App All the products can be controlled through the JD app; connects 300 kinds of devices and will reach 1,000 soon

Source: Company announcements

E-commerce strategies

The shift from offline to online is accelerating. Qingdao Haier, Gree, and Midea are adapting their

business models to the new dynamics in consumer behaviour by flattening the organisational structure,

digitalising their channels and investing in smart factories.

Figure 58. Y-o-Y Value Growth Figure 59. Y-o-Y Volume Growth

Source: MIIT Source: MIIT

In 2014, online consumer electronics (CE) sales grew 51% y-o-y to RMB201bn. The contribution to

online CE sales from large appliances grew to 30% of the total in 2H14, up from 26% in 1H13. Online

sales of large appliances, small appliances and mobile handsets grew 72%, 78% and 40% y-o-y,

respectively, in 2014. By category, online sales of water heaters, washing machines, refrigerators, air

conditioners and flat panel TVs grew 170%, 170%, 75%, 67% and 64%, respectively, last year.

By value, online consumer electronics purchases now represent 13% of total sales. The online volume

penetration of flat panel TVs, washing machines, refrigerators, air conditioners and water heaters reached

21%, 14%, 13%, 11% and 10%, respectively, in 2H14.

64% 67% 75%

170% 170%

80%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Flat panelTV

Air con Fridge Washer Waterheater

Air puriferYoy % 2014/2013

67% 70% 74%85%

166%

78%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

Flat panelTV

Air con Fridge Washer Waterheater

AirpurifierYoy % 2014/2013

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Online scale

We compare the three companies in terms of online scale, categories and strategies. In Figure 63, we

compare the online contribution to their respective domestic large and small appliances sales by adjusting

the retail online Gross Merchandise Volume (GMV) to ex-factory revenue. This shows that in 2014

online accounted for 11% of Qingdao Haier and Midea’s sales but only 1% of Gree’s sales.

In Figure 62, we compare the three’s market shares by category. Qinghao Haier and Midea had roughly

the same market share of 10% for online large appliance sales. Qingdao Haier and Midea’s market share

in small appliances, including water heaters, was 5% and 13%, respectively.

The market concentration for large appliances is much lower online than offline. The top three’s market

share is above 50%, but they only have 21% of online large appliance sales. As online will continue to

outpace offline, we believe they need to ramp up their online channels.

Online strategies

White goods makers adopt different online strategies. The common theme is to evolve their

production/distribution to a consumer-driven model (Consumer-to-Business) from the existing wholesale-

driven model (Business-to-Business) by flattening the organisational structure, digitalising their channels

and investing in smart factories.

Midea Group

In 2008, Midea opened its flagship Tmall store. By 2014, the company achieved online retail GMV of

RMB10bn, up from only RMB716m in 2009. It also set up its own e-commerce company in 1H14.

Midea’s online strategies include:

Figure 60. Breakdown of online CE sales by value (1H13) Figure 61. Breakdown of online CE sales by value (2H14)

Source: MIIT Source: MIIT

Figure 62. Online sales by categories (2014)

Qingdao Haier Midea Gree Market

Retail GMV (RMBm) Large appliances 5,540 6,000 1,000 59,100 Small appliances 1,562 4,000 - 31,000 Total 7,102 10,000 1,000 201,100 Market share by value (%) Total 3 Large appliances 9.4% 10.2% 1.7% 21.2% Small appliances 5.0% 12.9% 0.0% 17.9% Total 3.5% 5.0% 0.5% 9.0%

Source: MIIT, Company data, HSBC estimates

- Big appliances

26%

- Small appliances

17%

- Mobile handsets

57%

- Big appliances

30%

- Small appliances

12%

- Mobile handsets

58%

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E-commerce and logistics platforms: Midea’s online sales are managed and fulfilled by its distributors.

In the future it wants to aggregate all online sales, product and inventory information under its own e-

commerce company, and use one online platform to sell to other online channels. It also wants to further

internalise last-mile logistics to its own logistics platform, Annto. Starting from the end of June 2015, it

plans to use Annto to fulfil all large appliance orders on Tmall by the end of the year.

Digitalisation: It aims to link its customer, products, and suppliers in one system, and to be able to

manage the whole goods flow, finance flow and information flow real-time on one mobile device.

Connecting with customer: It wants to establish direct connections with retail customers by starting

its own vertical website: www.midea.com and online-to-offline (O2O) flagship stores. The O2O

stores are positioned as one-stop customer service centres by integrating retailing, after services and

member services. Midea had 1,900 flagship stores at end-2014 and plans to increase this to 3,000-

4,000 by 2016.

Qingdao Haier

Qingdao Haier was an early mover to the online channel. It started e-commerce in 2012 through its own

e-commerce company and it also provides consumers with customised appliances under the “Leader”

brand online. In 2014, its online sales reached 8% of the total revenue and 11% of domestic appliance

sales after growing 150% y-o-y. This includes sales from its vertical e-commerce website: ehaier.com and

sales from JD.com, Tmall, Egou under Suning and Gome.

Haier has already integrated its internal distribution and logistics sources under one platform that is open to

third parties. As of 2014, third-party integrated channel services (ICS) accounts for 19% of Qingdao Haier’s

total revenue. Meanwhile, Haier wants to transform its distribution network into an O2O service platform.

Gree

Air conditioners require specialised installation and after-sales services, so online penetration is the

lowest among large appliances, at only 11%. Gree was slower than the other two to move online. In 2014,

Gree joined Tmall’s “11.11” promotion for the first time and recorded RMB140m sales. Later, it

announced an O2O cooperation with Alibaba to connect its 20,000 speciality stores to Alibaba’s online

Figure 63. White goods markers’ online scale


http://www.midea.com/

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platform. In March 2015, Gree formally launched its own e-commerce website: mall.gree.com. However,

in 2014, only 1% of Gree’s domestic appliance sales were made online and the company is still at an

early stage in terms of digitalising its products and online services.

Industry 4.0

The government this year launched its Made in China 2025 initiative, which is modelled on Germany’s

Industry 4.0 – a reference to the fourth industrial revolution – a programme launched in 2013. Beijing

wants to upgrade the country’s manufacturing sector, led by innovation, automation and the internet. We

now compare the three white goods makers’ investments in smart factories, which are essential for order

customisation and virtual control of the production process.

Qingdao Haier

As of the end of 1Q15, Haier had four smart factories and 40 unmanned automatic production lines. Its

first smart factory was built in Shenyang in 2014 for manufacturing refrigerators. This factory supports

the customisation of 500 SKUs on nine production platforms. The three other smart factories started

operations in 1Q15 – one for front-loading washing machines in Foshan, one for air conditioners in

Zhengzhou, and another for electric water heaters in Huangdao district, Qingdao.

Midea

Midea started automating its air conditioner manufacturing process in 2011. As a result, the number of

employees at its air conditioning unit has fallen from more than 50,000 in 2011 to 26,000 in 2014. Midea

has four unmanned automatic production lines. The next step is virtual control and monitoring of all air

conditioner production and trials are underway at its factories in Nanshan and Wuhan.

Gree

We have not found any detailed information; however, chairman, Mrs. Dong Mingzhu, has said that

automation and smart appliances are high priorities, according to the AGM on 1 June 2014.

Management incentives

We now compare the three companies’ management incentive schemes.

Midea Group

We believe Midea Group has the best management incentive scheme of the three companies. Through its

group listing in September 2013, Midea achieved:

The alignment of core management team’s interests with the listed company: Before the group’s

listing, the core management team received compensation from both the listed company and the

unlisted group. After the listing, the team holds shares in the listed company, aligning the team’s

interests with minority shareholders.

Highest management equity holding ratio: In April 2012, Midea Holding (the largest and controlling

shareholder) transferred its 3% stake in Midea Group at RMB44.56 per share to Ningbo Meicheng

(宁波美晟). Meicheng is a partnership company held by 47 leading members of the management

team. Together with other management equity holding plans, as of May 2015 the management team

in aggregate holds a 6.5% equity stake in Midea.

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A share option plan: In February 2014, Midea’s AGM approved its first “management share option

plan”. As of the end of 2014, the plan covers a total of 626 employees and the unvested option shares

totalled 90,66m, about 2.4% of the total shares. The second option plan was announced in Mar 2015.

At the AGM in April 2015, Midea also announced that it was starting a “partnership asset management

plan” covering 31 of the company’s core management team. It will use the employees’ own funds and

borrowed money to purchase Midea Group’s shares from the secondary market. The size of the plan has

since been raised to RMB230m from RMB115m. The shares purchased are subject to a 12-month lock-up

period and will be granted to individual participants if they can meet annual performance targets. The

shares will be unlocked over a three-year period, starting from 2018.

The group’s 2015 general performance target is annual profit growth of more than 15% and ROE above

20%. Excluding the new partnership asset management plan, the management team in aggregate holds

more than 9% of Midea Group’s shares through direct equity stakes and share options, the highest level

among the three companies.

Qingdao Haier

From 2009, Qingdao Haier has issued four share options plans, gradually increasing the number of staff

covered. The fourth plan came after KKR became a strategic investor, covering 454 employees,

representing close to 1.8% of the company’s shares outstanding. The performance target is to deliver a

15% profit CAGR in 2014-16. However, Qingdao Haier’s management does not directly own many

Haier shares. As of end of 2014, the top 17 managers held in aggregate 9,576,600 shares, about 0.31% of

total shares outstanding.

Figure 64. Midea option plans

First Second

Announcement date 1/13/2014 3/31/2015 Option issue date 2/25/2014 5/28/2015No of participants 626 733No of shares (m) 91 84As % of total shares 2.2% 2.0%Options exercise price (RMB) 20.00 30.54 Vesting periods 2015 (33.3%), 2016 (33.3%), 2017 (33.3%) 2016 (33.3%), 2017 (33.3%), 2018 (33.3%) Vesting conditions on performance 2015: 2014 core profit growth >15% (actual

142.8%), ROE > 20% (actual 26.61%) 2016: 2015 core profit growth >15%, ROE > 20% 2017: 2016 core profit growth >15%, ROE > 20%

2016: 2015 core profit growth >15% , ROE > 20% 2017: 2016 core profit growth >15%, ROE > 20% 2018: 2017 core profit growth >15%, ROE > 20%


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Figure 65. Qingdao Haier option plans

First Second Third Fourth

Announcement date 5/1/2009 9/1/2010 5/1/2012 4/12/2014 Option issue date 10/28/2009 2/9/2011 6/27/2012 2/26/2015No of participants 49 68 200 454 No of shares (m) 35 22 26 54 (47.6m options, 6.9m

restricted shares) As % of total shares 2.6% 1.6% 1.0% 1.8% Options exercise price (RMB) 5.24 10.11 10.36 16.63 Restricted share price (RMB) NA NA NA 7.73 Vesting periods 2010 (10%), 2011 (20%), 2012

(30%), 2013 (40%) 2012 (30%), 2013 (30%), 2014 (40%)

2013 (50%), 2014 (50%) 2016 (40%), 2017 (60%)

Vesting conditions on performance

2010: 2009 core profit growth >18% (actual 35%), ROE > 10% (actual 14.0%)









2016: 2015 core profit growth >15%, ROE > 20%

2017: 2016 core profit growth >15%, ROE > 20%


Gree

Gree do not have a share option plan in place. As of the end of 2014, the top five managers held in

aggregate 28.3m shares, about 0.94% of the total shares outstanding.

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ROIC

In Figure 66, we compare the return on invested capital (ROIC) and ROIC drivers of the three white good

manufactures. Gree has the highest in terms of return on equity, assets and invested capital, as it has the

highest net margin and asset turnover. In 2012-14, both Gree and Midea increased their ROIC due to

improving net margin. ROIC for Qingdao Haier’s declined to 14% in 2014 from 18% in 2012 as its asset

turnover fell. Its invested capital rose as gross debt borrowings and share capital increased.

In our calculation, we use the average of balance sheet items and our calculation for invested capital

includes all interest-paying liabilities, total equity of the company and net deferred tax liabilities. In the

table, we also compare the ROIC drivers, including GPM and cash flow.

Gree had the highest GPM (36.6%) last year. However, if selling & marketing expenses are subtracted

from the GPM, the three companies have similar mid-teen contribution margins. The reason for this is

different business model for sales & distribution (details in the company sections). For example, Gree has

a higher GPM with higher ex-factory prices, but it also gives higher sales rebates to distributors listed

under selling and marketing expenses. Midea has a similar distribution model. Qingdao’s ex-factory

prices are already net of sales rebates and the selling and marketing expenses are lower as the company

sells directly to its sales offices. All three companies have strong operating cash flows.

Peer comparison

We compare the three companies on returns, cash flows, scale,

growth rates, margins and segment contribution

Gree has highest returns on invested capital and Qingdao Haier

has the best operating cash flow cycle

Through restructuring, Midea has delivered the largest

improvement in margins and growth rates since 2012

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Figure 66. ROIC comparison table

_______________ Gree _________ ______________ Midea ____________ ___________ Qingdao Haier __________ 2012a 2013a 2014a 2012a 2013a 2014a 2012a 2013a

(restated)2014a

Net margin 7.4% 9.1% 10.1% 3.2% 4.4% 7.4% 4.1% 4.8% 5.6%Core net profit margin incl. hedging loss/gain 7.2% 8.8% 9.6% 3.4% 4.5% 6.5% 4.0% 4.3% 4.9%Asset turnover 1.04 1.00 0.97 1.14 1.31 1.31 1.79 1.56 1.30Average TA to Equity 4.19 3.83 3.60 2.85 2.56 2.56 3.32 3.12 2.77ROE 32.1% 34.5% 35.1% 10.3% 14.7% 24.8% 24.2% 23.5% 20.3%ROA 7.7% 9.0% 9.8% 3.6% 5.8% 9.7% 7.3% 7.5% 7.3%ROIC 18.4% 22.5% 29.3% 11.7% 14.0% 20.1% 18.2% 16.8% 14.0%Dividend payout ratio (% of reported net profit) 41% 42% 64% NA 63% 40% 31% 30% 30%Total assets (RMBm) 107,567 133,702 156,231 87,737 96,946 120,292 49,688 61,093 75,006 Total liabilities (RMBm) 79,987 98,235 111,099 54,571 57,865 74,561 34,262 41,062 45,886 Total revenue (RMBm) 100,110 120,043 140,005 102,713 121,265 142,311 79,857 86,606 88,775 y-o-y % 19.9% 19.9% 16.6% -23.4% 18.1% 17.4% 8.4%(10.8%*) 8.5% (11%*) 2.5% (4.9%*)Reported core net profit incl. hedging (RMBm) 7,213 10,613 13,492 3,518 5,406 9,208 3,177 3,759 4,324 y-o-y % 40.1% 47.1% 27.1% 1.3% 53.7% 70.3% 30.3% 18.3% 15%A. GPM 26.6% 32.6% 36.6% 22.6% 23.3% 25.5% 25.2% 25.3% 27.5%B. Selling & marketing expense ratio (%) 14.6% 18.8% 20.6% 9.1% 10.3% 10.4% 12.1% 11.9% 13.0%C. Administration expense ratio (%) 4.1% 4.2% 3.4% 5.8% 5.6% 5.3% 6.5% 6.3% 6.8%Contribution margin (A-B) (%) 12.0% 13.9% 16.0% 13.4% 13.0% 15.1% 13.2% 13.4% 14.5%D. OPM (%) 8.1% 9.4% 12.1% 7.8% 7.6% 9.8% 6.3% 6.7% 7.4%Working capital Inventory turnover days 85.9 59.6 35.7 61.3 59.8 51.9 43.4 39.0 42.9 Raw material 30.4 29.9 18.3 13.5 14.3 10.8 23.6 15.2 14.2Trade + bills receivable days 130.4 146.4 13.8.5 79.1 66.5 67.9 69.5 84.5 89.3Trade + bills + deferred payable Days 235.7 216.4 166.3 131.3 113.3 127.0 144.1 166.0 180.6Working Capital Days (WC *365 / COGs) 28.5 61.8 89.8 32.2 33.3 16.2 (7.8) (13.9) (14.4)Sales rebates provision as % of net profit 194% 265% 330% 103.2% 138.1% 127.9% NA NA NAOP cash inflow / revenue ratio 18.4% 10.8% 13.5% 7.9% 8.3% 17.4% 6.9% 7.5% 7.9%OP cash inflow / OP ratio 226.3% 115.1% 112.2% 101.6% 109.5% 176.9% 110.5% 111.5% 106.5%

Source: Company data. HSBC estimates (note *: the growth is revenue growth by excluding the impact of parts and non-main business sales)

Working capital

In 2014, Qingdao had the best working capital cycle – it was negative. The difference in working capital

cycles is again due to the difference in sales and distribution models. As 70% of Qingdao Haier’s

products are sold through internal channels, it means its working capital turnover includes the negative

working capital cycle at the retail channel. In comparison, the working capital cycle of Gree and Midea

only reflects that at the manufacturing end.

Figure 67. Working capital cycle comparison

____________ Midea _____________ ______________ Gree _______________ ___________ QD Haier ____________ 2012 2013 2014 2012 2013 2014 2012 2013 2014

Inventory turnover days 61.3 59.8 51.9 85.9 59.6 35.7 43.4 39 42.9 Raw material 13.5 14.3 10.8 30.4 29.9 18.3 23.6 15.2 14.2Trade + bills receivable Days 79.1 66.5 67.9 130.4 146.4 138.5 69.5 84.5 89.3 Trade + bills + deferred rev payable Days 131.3 113.3 127.0 235.7 216.4 166.3 144.1 166.0 180.6 Working capital cycle 9.0 13.0 (7.3) (19.4) (10.4) 8.0 (31.3) (42.5) (48.3)Working Capital Days 32.2 33.3 6.2 28.5 61.8 89.8 (7.8) (13.9) (14.4)

Source: Company data (Working Capital Days = Working Capital*365/ COGs)

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Revenue scale

In Figure 68-69, we compare the sales scale of the three companies at the listed company level. At Qingdao

Haier’s parent company there are about RMB15bn in appliances-related sales, which are planned to be injected

into the listed company by January 2016, according to an announcement on 18 January 2011. This part of

business is not included in our comparison.

Figure 68. Main business sales scale (2011-14) Figure 69. Total revenue scale (2011-14)

Source: Company reports Source: Company reports

Net profit scale comparison

In Figure 70, we compare the three companies’ net profit and y-o-y growth rates in core profits, taking

into account of hedging losses/gains.

Figure 70. Core net profit & growth

Source: Company Reports(use net profit incl. hedging loss / gain for Midea and Gree)

132.

1

96.1

112.

4

131.

1

76.8

91.2

108.

1

122.

7

73.0

79.2

85.7

88.2

0

20

40

60

80

100

120

140

2011 2012 2013 2014

Midea Gree QD Haier

134.

1

102.

7

121.

3

142.

3

83.5

100.

1

120.

0

140.

0

73.7

79.9

86.6

88.8

0

20

40

60

80

100

120

140

160

2011 2012 2013 2014

Midea Gree QD Haier

3.5 5.

4 9.2

7.2 10

.6

13.5

3.2

3.8

4.3

1.3%

53.7%70.3%

40.1%

47.1% 27.1%30.3%

18.3%15.0%

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

0

5

10

15

20

25

30

2012 2013 2014

RM

B b

n

Midea Gree QD Haier Midea YoY % (RHS) Gree YoY % (RHS) QD Haier YoY % (RHS)

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Growth

In Figure 71, we compare the revenue growth in 2011-14. Qingdao Haier’s revenue growth was the

smoothest thanks to its diversified product portfolio and its direct control of distribution channels, which

reduced the volatility from inventory cycles.

Figure 71. Sales y-o-y % growth

Source: Company reports (* the 2014 revenue growth for Qingdao Haier has been adjusted based on a reduction in connected transactions between the parent and the listco)

Midea’s sales dropped sharply in 2012 due to overexpansion and an inventory build-up in 2009-11. After

it scaled back growth started to recover and in 2014, revenue from its main business was RMB131bn,

close to that of RMB132bn in 2011.

Gree’s sales have outperformed the other two thanks to market share gains in air conditioner sales. It was

able to gain share by maximising the leveraging of its distributors’ working capital under the “higher

GPM, higher selling expenses” model. Sales by product

Figure 72. Revenue breakdown by segments (2014)


21.6%

-23.4%

18.1%

17.4%

37.3%

19.9% 19.9%

16.6%

28.2%

11.3% 11.0% * 6.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

2011 2012 2013 2014

Midea Gree QD Haier

51%

85%

23%

7%

28%

7%

17%

23%1%

7%

3% 1%

20%

2%

5%

7% 11%

1%

0.5% 2%142 140

89

0

50

100

150

Midea Gree QD Haier

RM

B b

n

Air conditioners Refrigerators Washing machines Small appliancesMotors Logistics/ ICS Others Other product salesIncome from financial services

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In 2014, Midea’s net revenue was RMB142.3bn, similar to that of Gree (RMB140bn). Qingdao Haier

revenue totalled RMB88.8bn in the same period (Qingdao Group will inject all appliance-related business

into Qingdao Haier by January 2016, according to an announcement made in January 2011).

Qingdao Haier has the most diversified revenue stream. Integrated Channel Services (ICS), that provide

distribution and logistics services to third parties, accounted for 19.6% of revenue in 2014. Apart from ICS,

equipment parts accounted for another 4.9%. These sales were mostly connected transactions with its

parent company, and the number has fallen from 9% in 2012 in line with a commitment made by the parent

in 2011. Qingdao Haier also has the most diversified portfolio of large appliances, with air conditioners,

washing machines and refrigerator accounting for 23%, 17% and 28% of its revenue in 2014, respectively;

small appliances, including kitchen appliances and water heaters accounted for about 7%.

Air conditioner sales account for 85% of Gree’s total revenue, with the balance coming from small

appliances and industry products under the TOSOT brand.

Midea has the most diversified product portfolio. Large and small appliances accounted for 65% and 23%

of revenue, respectively, with the rest coming from motor and other product sales. For large appliances,

air conditioners, washing machines and refrigerator sales accounted for 51%, 7%, and 7% of

revenue, respectively.

Figure 75. 2014 sales value of refrigerators of the companies Figure 76. 2014 sales value of washing machine of the companies

Source: Company data Source: Company data

10

25

0

5

10

15

20

25

30

Midea Gree QD Haier

RM

B bn

Refrigerators

10

15

0

2

4

6

8

10

12

14

16

18

Midea Gree QD Haier

RM

B bn

Washing machines

Figure 73. 2014 sales value of air conditioners Figure 74. 2014 sales value of small appliances


72.7

118.7

20.0

0

20

40

60

80

100

120

140

Midea Gree QD Haier

RM

B bn

Air conditioners

32.7

1.8

6.4

0

5

10

15

20

25

30

35

Midea Gree QD HaierR

MB

bnSmall appliances

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Sales by region

Midea has the highest revenue from international markets (38%), while export sales accounted for 11.3%

and 12.1% of Gree’s sales and Qingdao Haier’s sales, respectively.

Figure 77. Sales breakdown of main business by regions (2014)

Source: Company Reports

Margins

In Figure 78-85, we compare the gross margins, contribution margins, operating expense ratios, operating

margin and net margins.

GPM

As explained earlier, Gree’s higher GPM is linked to its high selling and marketing costs. A better

comparison is the contribution margin, which is GPM minus the selling expense ratio.

Figure 78. Gross margin Figure 79. Contribution Margin (GPM-Selling expense to Revenue ratio)

Source: Company Reports Source: Company Reports

62.0%

88.7% 87.9%

38.0%

11.3% 12.1%

0%

20%

40%

60%

80%

100%

120%

Midea Gree QD Haier

Domestic International

26.6%

32.6%

36.6%

22.6% 23.3%25.5%

25.2%

25.3%27.5%

10%

15%

20%

25%

30%

35%

40%

2012 2013 2014

Gree Midea Qingdao Haier

12.0%

13.9%

16.0%

13.4%

13.0%

15.1%

13.2%

13.4%

14.5%

10%

11%

12%

13%

14%

15%

16%

17%

2012 2013 2014


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SGA cost ratio

Midea has the lowest SGA cost ratio for both selling expenses and admin cost ratios. We think this

corresponds to its lower GPM. When we compare contribution margin – GPM minus selling expenses –

Midea and Qingdao Haier are quite similar.

Figure 80. Selling expense to sales ratio Figure 81. Admin expense to sales ratio


OPM

Qingdao Haier’s EBIT margin is the lowest due to a slightly lower contribution margin and also the

contribution from ICS. ICS accounted for 20% of its sales in 2014, but we estimate it generated a net

margin of less than 2%. This implies an 8.7% OP margin, excluding ICS, making it closer to the OPM

generated by Midea.

Figure 82. SGA / revenue Figure 83. Operating margin


Net margins In addition to reported net profit, we use three other measures of net profit. One is HSBC’s net profit

forecasts, which assess the core profit growth of by stripping out all non-operational gains/losses (our

definition of non-core is similar to those used for Hong Kong-listed stocks). A second is reported core

profit, which is the company’s own measure of its core profit, and it usually includes some financial

gains/losses that considered non-core under HSBC’s net profit forecasts. The last is adjusted core profit,

14.6%

18.8%20.6%

9.1%10.3% 10.4%

12.1%11.9% 13.0%

0%

5%

10%

15%

20%

25%

2012 2013 2014


4.1% 4.2%3.4%

5.8% 5.6%5.3%

6.5% 6.3%6.8%

0%

2%

4%

6%

8%

2012 2013 2014


18.7%

23.0%24.1%

14.9%15.8% 15.6%

18.6%

18.2%19.8%

10%12%14%16%18%20%22%24%26%

2012 2013 2014


8.1%9.4%

12.1%

7.8%7.6%

9.8%

6.3% 6.7%

7.4%7.1%

7.9%8.7%

2%

4%

6%

8%

10%

12%

14%

2012 2013 2014Gree MideaQingdao Haier Qingdao Haier excluding ICS

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including hedging gain/loss by adding back hedging mark-to-market gains/losses to reported profit, as

investors look at hedging as the normal recurring part of business.

Below, we compare the reported core net margin and core net margin, including hedging impact. Similar

to OPM, Gree generated the highest net margin and Qingdao Haier the lowest (but it has the lowest

margin volatility). Using core net margin, including hedging, Gree and Midea exhibit smoother net

margin trends than if the reported core profit measure is used.

Figure 84. Core net margin Figure 85. Core net margin, including hedging gain/loss net margin

Source: Company Reports Source: Company Reports

Product comparison We compare the revenue scale, growth rates and GPM of the three companies product by product.

Air conditioners

Air conditioners account for 98%, 58% and 30% of Gree’s, Midea’s and Qingdao Haier’s product sales,

respectively. Gree’s air conditioner sales are roughly six times that of Qingdao Haier and 1.6x that of

Midea. In terms of growth rates, air conditioner sales for Gree, Midea and Qingdao Haier grew 12.5%,

16.9% and 11.6%, respectively, in 2014. GPM for Gree, Midea and Qingdao was 39.8%, 27% and 30.4%,

respectively, in 2014. As discussed earlier, this is mostly due to differences in distribution models.

Figure 86. Air conditioner sales and sales growth Figure 87. Air conditioner GPM

Source: Company Data Source: Company Data

7.0% 7.4%

10.1%

2.9% 3.2%

6.7%

4.0% 4.3%4.9%

0%

2%

4%

6%

8%

10%

12%

2012 2013 2014


7.2%

8.8%9.6%

3.4%4.5%

6.5%

0%

2%

4%

6%

8%

10%

12%

2012 2013 2014

Gree Midea

51

62

73 89

105

119

15

18

20

-26.1%

20.8% 16.9%18.9%

18.7%12.5%

22.0% 21.4%

11.6%

-150%

100%

0

250

2012 2013 2014

RM

B b

n

Midea GreeQD Haier Midea YoY % (RHS)Gree YoY % (RHS) QD Haier YoY % (RHS)

24.4% 24.5%27.0%

27.5%

34.5%39.8%

27.3%28.5% 30.4%

0%

15%

30%

45%

2012 2013 2014Midea Gree QD Haier

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Washing machines

Washing machines account for 23% and 8% of Qingdao Haier’s and Midea’s product sales, respectively.

Qingdao Haier revenue in this segment was 53% larger than Midea in 2014. Sales growth for Qingdao

Haier was stable in 2012-14, in line with the industry. Midea’s washing machine sales grew strongly

during the same period, due to a low base and a recovery growth from channel re-stocking.

Qingdao Haier’s washing machine GPM in 2014 was 33.2%, higher than 28.5% for Midea, thanks to a

better product mix and fewer promotions.

Figure 88. Washing machine sales and sales growth Figure 89. Washing machine GPM


Refrigerators

Fridges accounted for 37% and 7.8% of Qingdao Haier’s and Midea’s product sales, respectively. Qingdao

Haier’s refrigerator sales were roughly 2.5x larger than Midea’s in 2014. Hurt by the sagging property

market, refrigerator sales at Qingdao Haier declined 2.6% y-o-y in 2014. Midea recorded 19.6% growth

thanks to a low base and recovery growth from channel re-stocking. Qingdao Haier’s refrigerator GPM in

2014 was 32.1%, higher than Midea’s 24.1%, thanks to a better product mix and fewer promotions.

Figure 90. Refrigerator sales and sales growth Figure 91. Refrigerator GPM


6.2 8.1 10.0 13.3 14.3 15.3

-44.0%

29.6% 23.8%

8.7%8.1% 6.5%

-100%

-50%

0%

50%

0

50

100

2012 2013 2014

RM

B b

n

Midea QD HaierMidea YoY % (RHS) QD Haier YoY % (RHS)

24.2%26.6% 28.5%

29.5%

32.9%33.2%

0%

15%

30%

45%

2012 2013 2014Midea QD Haier

6.0 8.1 9.7

25.2 25.3 24.7 -49.6%

36.6%19.6%

0.5%0.6% -2.6%

-100%

-50%

0%

50%

0

50

100

2012 2013 2014

RM

B b

n

Midea QD HaierMidea YoY % (RHS) QD Haier YoY % (RHS)

17.2% 19.1%24.1%

30.7%30.0% 32.1%

0%

15%

30%

45%

2012 2013 2014Midea QD Haier

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Small appliances

Midea’s small appliance sales were 16x times that of Gree and 5.5x that of Qingdao Haier. Small appliances

account for 26%, 9.7% and 1.5% of Midea’s, Qingdao Haier’s and Gree’s product sales, respectively, in

2014. Again, thanks to channel restructuring, Midea outperformed Qingdao Haier and Gree in 2014 by

growing its small appliances sales by 17.5% y-o-y. Qingdao Haier and Gree recorded 6.8% and 10.4%

growth, respectively, in 2014. Small appliances GPM of Qingdao Haier was the highest at 42.3% in 2014.

Figure 92. Small appliance sales and sales growth Figure 93. Small appliance GPM


Conclusion

We draw the following conclusions:

The industry generates strong cash flow with operating cash flows consistently exceeding

operating profits.

Gree has the highest returns (ROE, ROA and ROIC) as it has the highest net margin and

asset turnover.

While Gree has the highest GPM, the three companies’ contribution margins are quite similar, due to

differences in the booking of sales rebates and distribution strategies.

Gree and Midea have strong profit buffers in the form of a “sales rebates provision”, about 1-3 times

their one-year profits.

Distributing directly through its own sales offices, Qingdao Haier has the smoothest growth profile

and best working capital cycles.

As a result of restructuring, Midea has delivered the most improvement in margins and growth rates

since 2012.

Qingdao Haier’s OPM adjusted for the lower margin ICS business is quite similar to Midea; still,

Gree has the highest OPM.

Qingdao Haier has the most diversified product portfolio for large appliances; Midea has the highest

contribution from small appliances.

26

28 33

1 2 2 6 6 6

-20.8%8.1%

17.5%12.5%

11.4%10.4%

10.8%-2.4%

6.8%

-250%0

50

2012 2013 2014

RM

B b

n

Midea GreeQD Haier Midea YoY % (RHS)Gree YoY % (RHS) QD Haier YoY % (RHS)

23.6% 24.2% 24.7%

22.6%19.9%

23.3%

39.7% 41.5% 42.3%

0%

15%

30%

45%

2012 2013 2014Midea Gree QD Haier

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Company description Midea was established in 1982 in Shunde, Guangdong, as an electric fan manufacturer. The group’s sales

reached RMB142bn in 2014, with large appliances accounting for 65% of total sales and small appliances

accounting for 23% of total sales. Its businesses now encompass the manufacturing of air conditioners,

refrigerators, washing machines, as well as small household appliances, motors and logistics. The brands

owned by Midea include “Midea”, “Little Swan”, “Welling” and “Hualing”. Its sales network has 100%

coverage in tier-1 and -2 cities and above 95% coverage in tier-3 and -4 cities through its 70,000

distributors (4,600 first tier distributors and sub-distributors) with 15,000 specialty stores and 45,000

points of sales (POS) at the county and township level. Out of the revenue generated by its main business,

38% are exports and more than 60% of exports are under its own brand or ODM. It has six international

production bases in Vietnam, Russia, Egypt, Brazil, Argentina and India.

Figure 94. Midea brand portfolio

Source: Company data

Midea (000333 CH)

We forecast Midea to deliver a 13% CAGR in revenue and a

19.4% CAGR in profit in 2014-17

Midea has the best-incentivised management team among peers,

delivering above-peer-average growth from market share gains

Initiate with a Buy rating and a DCF-based fair value target price

of RMB46.9

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Corporate structure

Midea Group is managed under 12 business units: nine for appliances manufacturing, two for parts

manufacturing and one for logistics.

Before it was listed, the group was managed under a three-tier system: the group level, under which were

five business groups (cooling group, household electronics group, motor equipment group, logistics group

and international business group), under which were 12 business units.

After its listing, the group streamlined its organisational structure, removing the middle layer, with the

group level now directly managing the 12 business units. This reorganisation means senior management

is now more incentivised to help drive the whole group’s profits and returns, whereas under the old

structure they were incentivised to drive the profits and returns of their respective business group.

Now, at the group level, the group functions are only limited to strategic planning, administration, human

resources, and finance and auditing. All production-related functions are managed at the business unit level.

Figure 95. Midea corporate structure

Source: Company data, HSBC

Group restructuring

On 12 November 1993, Midea Electronics was listed on the Shenzhen Stock Exchange under the stock

code 000527 CH. Its ultimate controlling shareholder, Midea Holding, a private company owned by

founder Mr. He Xiangjian and his family, held a 42.94% stake in Midea Electronics through Midea

Group after the listing.

Large appliances

Midea Group

Home air conditioner

Central air conditioner

Fridge

Washing m

achine

Compressor

Household appliances

Kitchen appliances

Washing appliances

Environmental appliances

Water heater

Electric motor

Logistics

Small appliances Electric motor

Logistics

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In 2000, management completed a management buyout (MBO) of Midea Electronics from a collectively

ownership enterprise.

In March 2006, Midea Electronics implemented a non-tradable share reform, making all its shares

tradable.

From November 2011 to March 2012, Ding Hui Investment and four other strategic investors

accumulated a 21.15% stake in Midea Group, the holding company of Midea Electronics. This 21.15%

stake was equivalent to a 12.5% stake in Midea Group after the IPO. The consideration was RMB11.1bn,

equivalent to RMB52.5 per share in listed Midea Group. These investors were subject to a one-year lock-

up after the listing of Midea Group.

On 18 September 2013, Midea Group completed its listing under the stock code 000333 CH, with Midea

Electronics simultaneously being delisted. After the corporate restructuring, Midea Group still owned two

listed subsidiaries, Little Swan (000418 CH) for washing machine manufacturing and Welling (382 HK)

for motor manufacturing. Following the listing, the business exposure of Midea Group’s parent company,

Midea Holding, was limited to property development, financial investments, commodity trading and other

non-core assets.

Shareholding structure Figure 96. Midea Group current shareholders structure

Source: Company report

Prior to the listing of Midea Group, the interests of the core management team, comprising seven

members, were not aligned with those of the minority shareholders of the listed Midea Electronics. At the

time, the core management team had a 16% equity interest in the then-unlisted Midea Group (which

owned various white goods businesses with potential conflicts of interest with the listed Midea

Electronics), and were being remunerated both by Midea Group and Midea Electronics.

After the listing of Midea Group, an incentive share plan was implemented for core management staff of

the group and its major subsidiaries in 2012, which more closely aligned management’s interests with

those of the minority shareholders. Under the arrangement, parent Midea Holding transferred a 3%

interest in Midea Group to the incentive share plan (named Ningbo Meicheng Equity Investment

Partnership). A total of 47 members of core management participate in this incentive share plan.

In December 2014, Midea Group issued 55m new shares to Xiaomi Technology. After the issuance, the

controlling shareholder Midea Holding, various strategic private equity investors, Xiaomi, management

and public investors now hold 36.24%, 12.38%, 1.29%, 6.50% and 43.59%, respectively.

Midea Group

Public investorsXiaomiManagement

teamControlling shareholder

Strategic investors

36.24% 12.38% 1.29% 6.50% 43.59%

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Sales and distribution

Decentralised sales and marketing

Midea Group’s sales and marketing functions have been decentralised to individual business units (BU).

Each BU is not only responsible for product research and production, and also an integrated platform for

research, production and sales.

Midea Group’s sales network is managed by its distributors and supervised by each BU’s marketing

function. The group headquarters decide the sales budget, and the each BU has autonomy in managing its

own P&L and deciding its own sales and marketing plan. Under this decentralised system, headquarters

no longer provide a sales guarantee to each BU.

Distributorship

Air conditioner sales are managed by the group’s distributors through 40 sales offices (since 2013), and

Midea Group sells directly to the sales offices. The sales channel for air conditioners, refrigerators and

washing machines are managed independently, and each POS can decide on their own inventory.

Its sales networks are managed under regional distributorships. Regional distributors are classified as

first-tier distributors, and there are 4,600 of them. There are 52 sales companies in total in the air

conditioner business. The ownership structure of these sales companies was quite diversified. Now,

Midea encourages one to two largest distributors to buy out the minority stakes from other shareholders to

concentrate the ownership structure in the sales companies.

Inventories are sold to first-tier distributors on a cash basis. Under regional distributors, there are sub-

distributors to cover all sales channels, including national key accounts (KA), specialty stores, traditional

channel and online channel.

Midea Group headquarters takes responsibility for advertising and designing promotional strategies. Its

regional distributors will be responsible for selecting sales channels, POS promotion and sales subsidies,

logistics and warehousing services.

Figure 97. Midea domestic sales breakdown by channels


Specialty stores40%

National KA

20%

Traditional channel

20%

Online10%

Others10%

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The group’s sales network covers 15,000 specialty stores (10,000 for large appliances and 5,000 for small

appliances) and 45,000 point of sales (POS) at county and township and total 85,000 national wide

(30,000 for large appliances and 55,000 for small appliances) through its 70,000 distributors 4,600 first

tier distributors and sub-distributors).

Midea Group began launching O2O flagship stores in 2013 and had a total of 1,900 such stores as at the

end of 2014. The group is targeting to open up to 2,500 flagship stores in 2015 and 3,000-4,000 in 2016.

The group is also targets to open 100 experience centres for air conditioners.

Overseas, Midea Group has built a total of 3,800 POS as at end-2014, up 46% from the previous year.

Details discussion of Midea’s export strategies are provided under Chapter “comparison of strategies”.

Investment thesis

Stronger growth among peers

We forecast Midea to deliver a 13% CAGR in revenue and a 19.4% CAGR in profit in2014-17, faster

than the other two peers. The fast growth is thanks to:

Recovery growth in market shares

After its overexpansion in 2009-11, Midea’s sales fell 23% y-o-y in 2012. Through channel

restructuring, Midea was able to regain market share in 2013-14, but revenue generated from its core

products range in 2014 (RMB131bn) was still marginally what it generated in 2011 (RMB132bn).

We expect the recovery in market share to continue over our forecast period.

A diversified product portfolio

Midea has the most diversified product portfolio in its peer group and still has room to further gain

market shares in various product categories, in our view. Large appliances and small appliances

accounted for 65% and 23% of its revenue, respectively, with the rest derived from motors and other

product sales. In the large appliance segment, the three key products are air conditioners, washing

machines and refrigerators, which accounted for 51%, 7%, and 7% of its revenue in 2014,

respectively. In terms of sales revenue, Midea is ranked second for air conditioners, washing

machines and water heaters, and fourth in refrigerators.

Improving profitability

With better economies of scale by each segment, we believe Midea has room to further improve

profitability across categories.

Fast mover in the era of Industry 4.0

Industry 4.0 is the collective term for technologies, such as the Internet of Things and Internet of

Services, which aim to create a highly interconnected data environment for production, distribution and

services. We believe Midea is becoming a fast mover in the Industry 4.0 space, as indicated by its

relatively high proportion of online sales (11% of domestic product sales) and early investment in

production automation.

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Currently, Midea’s online sales are managed and fulfilled by its distributors. Going forward, we believe it

can use its own e-commerce company to aggregate all online sales, product and inventory information

under one online platform.

Also, by internalising last-mile logistics (the company has developed its own logistics platform called

Annto) from the end of June 2015, we think it will be able to expedite its progress to digitalise the

distribution process, creating a direct link between its manufacturing facilities and consumers.

In terms of revamping production, Midea started automating air conditioner manufacturing in 2011 and

now has four unmanned production lines, including one line in Shunde, Guangdong. Management intends

to implement full virtual control and digitalisation of the company’s air conditioner production.

Best incentivised management team

In our view, Midea has the best management incentive scheme among the three home appliance makers

we initiate coverage on in this report in terms of both depth and breadth, supporting the group’s

performance target of more than 15% profit growth and above 20%.ROE

Approved at the AGM in April 2015, Midea has launched a “partnership asset management plan”. The

scheme covers 31 of the company’s core management and will use these employees’ own funds and

borrowed money to purchase Midea Group’s shares from public shareholders. This plan further aligns

management’s interests with those of minority shareholders.

Excluding the new “partnership asset management plan”, management in aggregate holds a 9% interest in

Midea Group’s shares through direct equity stakes and share options; this is the highest level among the

three home appliance makers we initiate coverage on in this report and its option plan covers total 626

employees.

Earnings estimates

Our earnings estimates are largely derived from our estimates of revenue, gross margins, selling and

administrative operating costs, and net finance income. In the normal course of business, Midea hedges

its exposure to foreign currency and raw material price fluctuations through futures and forward contracts.

We do not attempt to model the marked-to-market gains and losses from these hedging activities, but we

note they can have a meaningful impact the company’s reported earnings.

Revenue

We forecast Midea to deliver 12.4% y-o-y revenue growth in 2015 and a 13% CAGR in revenue in 2014-

17. We expect the growth in air conditioner sales – at 11.7% in 2015 – will be an important driver. Air

conditioners are the group’s key product category, accounting for 51.1% of total revenue and 58% of

product sales revenue in 2014.

For its main products, we forecast revenue using bottom-up approach based on our estimates of volume

market share and ASP. We forecast air conditioner revenue in 2015 to grow by 11.7% y-o-y, while

refrigerator and washing machine revenue grows by 15.8% and 16.9%, respectively. Our key assumptions

are outlined in Figure 98.

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Figure 98: Midea Large Appliances forecast (RMBm, ‘000 UNITS)

2014a 2015e 2016e 2017e CAGR (2014-17e)

Air conditioner forecasts Sales from Air Conditioners 72,705 81,201 92,278 104,900 13.0%

y-o-y % 16.9% 11.7% 13.6% 13.7% Total Volume ('000 unit) 29,027 31,784 34,730 37,963 9.4%

y-o-y % 8.1% 9.5% 9.3% 9.3% Total ASP 2,505 2,555 2,657 2,763 3.3%

y-o-y % 8.1% 2.0% 4.0% 4.0% Domestic Air conditioner - Sales volume ('000 unit): IOL 70,010 74,401 79,072 84,042 6.3%

y-o-y % 12.3% 6.3% 6.3% 6.3% - Midea market share (%): IOL 24.0% 24.3% 24.5% 24.7% Export Air conditioner - Sales volume ('000 unit): IOL 46,786 51,464 56,611 62,272 10.0%

y-o-y % -4.1% 10.0% 10.0% 10.0% - Midea market share (%): IOL 26.1% 26.6% 27.1% 27.6% Washing machine forecasts Sales from Washing Machine 9,974 11,664 13,418 15,415 15.6%


y-o-y % 15.7% 10.3% 8.5% 8.4% Total ASP 976 1,035 1,097 1,163 6.0%

y-o-y % 7.0% 6.0% 6.0% 6.0% Domestic Washing machine - Sales volume ('000 unit): IOL 38,528 40,154 41,848 43,613 4.2%

y-o-y % 2.2% 4.2% 4.2% 4.2% - Midea market share (%): IOL 20.7% 21.4% 22.0% 22.6% Export Washing machine - Sales volume ('000 unit): IOL 19,370 20,338 21,355 22,423 5.0%

y-o-y % 6.2% 5.0% 5.0% 5.0% - Midea market share (%): IOL 11.6% 13.1% 14.1% 15.1% 9.2% Refrigerator forecasts Sales from Refrigerators 9,724 11,260 12,708 14,008 12.9%


y-o-y % 6.6% 10.3% 8.5% 7.0% Total ASP 1,382 1,452 1,510 1,555 4.0%

y-o-y % 12.1% 5.0% 4.0% 3.0% Domestic Refrigerator - Sales volume ('000 unit): IOL 52,981 55,440 58,033 59,654 4.0%

y-o-y % -5.2% 4.6% 4.7% 2.8% - Midea market share (%): IOL 8.8% 9.5% 10.0% 10.5% Export Refrigerator - Sales volume ('000 unit): IOL 23,307 24,473 25,696 26,981 5.0%

y-o-y % 11.0% 5.0% 5.0% 5.0% - Midea market share (%): IOL 10.2% 10.2% 10.2% 10.2%

Source: Company data, IOL, HSBC estimates

For small appliances, which accounted for 23% of revenue in 2014, we estimate revenue to grow 10% in

2015 and at a 10% CAGR in 2014-17.

We forecast the overall revenue of the group to grow by 12.4% in 2015 and at a 13% CAGR in 2014-17.

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Figure 99. Midea revenue breakdown Figure 100. Midea gross profit breakdown

Source: Company data, HSBC estimates Source: Company data, HSBC estimates

Gross profit margin

The cyclical drivers of the group’s gross profit margin (GPM) are:

Fluctuations in raw materials costs: raw materials accounted for 78% of COGS in 2014

Price wars: would lower selling prices and, therefore, GPM

Currency fluctuations: RMB appreciation leads to a cut in FOB export prices and lower export GPM

The structural drivers for GPM are:

ASP and product mix: a greater sales contribution from high-end/new products lifts GPM

Cost optimisation: automation, factory utilisation rates, manufacturing cost optimisation will

gradually improve GPM

Regional mix: the share of exports in total sales; more exports leads to a lower blended GPM.

Exports accounted for 38% of its core business sales in 2014, and we expect the ratio to be stable

However, as Midea adopts a wholesale model by selling through its distributors, it is more relevant to

look at the contribution margin (which is GPM minus selling and marketing expenses), taking into

account wholesale prices changes and promotion subsidies paid to distributors. We summarise the key

assumptions used in our GPM forecasts in Figure 101.

We forecast GPM in 2015 to expand by 160bp to 27.1%, driven mainly by a decline in raw material

prices. As we estimated earlier in the chapter “2015: better 2H over 1H”, for every 10% change in the

cost of raw materials for air conditioners, refrigerators and washing machines, the GPM would on average

expand by 5-6 ppt. For the year to date, the blended average cost of manufacturing refrigerators, air

conditioners, washing machines and heaters has declined by 10%, 8%, 7% and 8%, respectively.

Our forecast of 2015 GPM expansion due to a decline in raw materials costs is derived mainly from the

air conditioner segment. For the refrigerators and washing machines, we expect Midea to pass on most of

the cost savings it makes from lower raw material costs to its channels in order to gain market shares.

However, we expect the contribution margin to expand by only 130bp to 16.4% in 2015 from 15.1% in

2014, due to significant price competition in air conditioners in 1Q15. We expect marketing and selling

51.1%

50.7%

50.9%

51.1%

6.8%

7.0%

7.0%

6.8%

7.0%

7.3%

7.4%

7.5%

23.0%

22.5%

21.8%

21.2%

2.8%

2.5%

2.3%

2.1%

1.4%

1.5%

1.5%

1.5%

7.5%

8.0%

8.4%

8.9%

0.5%

0.5%

0.6%

0.7%

0 70 140 210

2014

2015

2016

2017

Air conditioners RefrigeratorsWashing machines Small appliancesMotors LogisticsOther product sales Income from financial services

54.1%

55.2%

55.6%

56.1%

6.5%

6.7%

6.7%

6.5%

7.8%

8.1%

8.2%

8.4%

22.3%

21.0%

20.1%

19.3%

1.8%

1.5%

1.4%

1.3%

0.7%

0.7%

0.7%

0.7%

6.2%

6.2%

6.5%

6.8%

0.7%

0.7%

0.8%

0.9%

0 20 40 60

2014

2015

2016

2017

Air conditioners RefrigeratorsWashing machines Small appliancesMotors LogisticsOther product sales Income from financial services

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expenses to increase by 15.5% y-o-y in 2015 versus 19.5% growth in gross profit and 12.4% growth in

revenue over the same period. As the industry’s inventory levels and price promotions normalise in 2H15,

we expect more of the benefit from lower raw materials prices to filter through to the contribution margin.

Selling, general and administrative

We forecast total SGA to rise by 15.3% y-o-y in 2015 and at a 14.7% CAGR in 2014-17. We expect the

SGA cost to sales ratio to increase to 16.0% in 2015 from 15.6% in 2014.

Figure 102. Expense ratios vs. contribution margin


Operating profit

Based on the above revenue, GPM and SGA forecasts, we expect EBIT to grow at an 18.4% CAGR over

2014-17e on a 13% growth CAGR in revenue. In 2015, as we forecast growth in gross profit to outpace

that of SGA, we estimate EBIT to grow by 25.9% y-o-y driven by 12.4% revenue growth and EBIT

margin expansion of 120bp to 11%.

9.8%11.0% 10.4% 10.6% 10.8% 10.8%

4.3%

6.4%5.3% 5.4% 5.5% 5.6%

13.4% 13.0%

15.1%16.4% 16.6% 17.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2012 2013 2014 2015e 2016e 2017e

Selling & distribution expenses to sales ratio Admin expenses to sales ratio Contributional Margin

Figure 101. Gross profit margin

1H14a 2H14a 2014a 2015e 2016e 2017e

Overall GPM 26.0% 24.9% 25.5% 27.1% 27.4% 27.7% Air conditioners 26.8% 27.1% 27.0% 29.5% 30.0% 30.5% Refrigerators 26.9% 21.1% 24.1% 25.6% 26.1% 26.6% Washing machines 29.4% 27.8% 28.5% 30.0% 30.5% 31.0% Small appliances 26.3% 22.9% 24.7% 25.2% 25.2% 25.2% Motors 14.8% 17.9% 16.2% 16.2% 16.2% 16.2% Logistics 9.0% 16.0% 12.7% 12.7% 12.7% 12.7% Other product sales 20.0% 22.0% 21.0% 21.0% 21.0% 21.0% Income from financial services 49.0% 19.4% 36.8% 36.8% 36.8% 36.8%Contribution Margin 16.1% 13.9% 15.1% 16.4% 16.6% 17.0%


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Figure 103. Operating Profit


Net finance income

As discussed later in the cash flow analysis, Midea generates strong cash flows from its operations. Its net cash,

including that from investment products, amounted to RMB29,511m as at end-2014. We forecast net interest

income to come to RMB522m, RMB677m and RMB931m in 2015, 2016, and 2017, respectively. Figure 104. Net finance income (RMBm)

2013a 2014a 2015e 2016e 2017e

Interest Income 802 348 727 865 1,119 Cash Balance 19,466 36,366 43,265 55,969 66,400 Interest Income Rate 4.1% 1.0% 1.7% 1.5% 1.7% Interest Cost -651 -184 -206 -188 -189 Gross Debt Balance 11,354 6,855 3,762 3,776 0 Interest Cost Rate 5.7% 2.7% 5.5% 5.0% NA Net Interest Income 151 165 522 677 931


Net profit

Factoring in our estimates of the company’s dividend payout ratio for minority shareholders and effective

tax rate, we forecast net profit to grow by 27.5% y-o-y in 2015 to RMB13,395m from RMB10,502m in

2014. We expect the net profit to increase at a CAGR of 19.4% in 2014-17 versus a 13% CAGR in

revenue over the same period. We are now in line with consensus on 2015 net profit forecast (3.6%

above).

However, there are three ways in which we can gauge Midea’s profit growth. The first is based on the

standard approach used by HSBC to assess the core profit of Hong Kong-listed stocks, stripping out all

non-operational gains and losses. The second is reported core profit, which is the company’s own

measure of core profit, and usually includes some financial gains and losses (but excluding any marked-

to-market gains and losses from hedging activities) that would be considered non-core by HSBC. The

third is reported core earnings plus marked-to-market gains and losses from hedging activities; some

investors believe hedging activities should be considered part of the company’s recurring earnings.

Our net profit forecasts do not include that for non-core and non-recurring items.

7,9669,186

14,012

17,640

20,108

23,265

7.8% 7.6%

9.8%

11.0% 11.1%11.3%

0%

2%

4%

6%

8%

10%

12%

0

5,000

10,000

15,000

20,000

25,000

2012 2013 2014 2015e 2016e 2017e

RM

Bm

EBIT EBIT Margin

15.3%

52.5%

14.0%15.7%

25.9%

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Figure 105. HSBC estimates vs. Consensus

RMBm ______________ 2015e _____________ ______________ 2016e _____________ ______________ 2017e ____________ HSBC estimates Consensus % diff HSBC estimates Consensus % diff HSBC estimates Consensus % diff

Total revenue 160,011 162,930 -1.8% 181,237 186,593 -2.9% 205,112 207,659 -1.2% Operating profit 17,640 17,247 2.3% 20,108 20,620 -2.5% 23,265 23,518 -1.1% Profit 13,395 12,935 3.6% 15,350 15,384 -0.2% 17,890 18,183 -1.6%

Source: Thomson Reuters Datastream, HSBC estimates

Cash flows

We conduct our cash flow forecasts based on working capital forecasts, capex forecasts, and dividend

payout.

Our working capital forecasts assumptions are listed in Figure 106. Midea reported 16 working capital

days in 2014 and we forecast this to steadily increase to 34 days by 2017 by assuming stable inventory

days but slower working capital cycles. Figure 106: Working capital

2013a 2014a 2015e 2016e 2017e

Inventory Turnover Days 59.8 51.9 54.1 54.1 54.1 Raw material 14.3 10.8 10.8 10.8 10.8

Trade + Bills Receivable Days 66.5 67.9 66.9 66.9 66.9 Trade + Bills+ Deferred rev Payable Days 113.3 127.0 121.8 118.2 113.3 Working Capital Days (Working Capital*365/ COGs) 33.3 16.2 24.4 28.5 33.9


We forecast RMB4bn of capex annually from 2015 to 2017. In 2015, the company guided total capex of

RMB3,600m, with: 1) only RMB800m investments allocated to expanding capacity in small appliances;

2) RMB1,200m for developing global R&D centres and upgrading existing R&D facilities; and 3)

RMB1,600m to upgrade the company’s information and software infrastructure.

In terms of dividend payout, Midea has a dividend policy of paying out more than one third of its

earnings. Midea paid out a 63.4% dividend in 2103 and 40.1% in 2014. We forecast the dividend payout

ratio to remain stable at 40% going forward.

Per forecast in Figure 107, we estimate its net cash position, including investments in wealth management

products, will increase to RMB66.4bn by end-2017 from RMB29.5bn by end-2014.

Figure 107. Cash flows (RMBm)

2013a 2014a 2015e 2016e 2017e

Net cash from operating activities 10,054 24,789 19,369 22,851 25,389 Net cash from investing activities -467 -28,862 -4,000 -4,000 -4,000 - capex -2,115 -2,678 -4,000 -4,000 -4,000 Net cash from financing activities -5,364 -7,410 -8,470 -6,148 -10,958 Net increase in cash 4,223 -11,484 6,900 12,703 10,431 Cash at beginning of year 14,499 19,003 9,772 16,671 29,375 Cash at end of year 19,003 9,772 16,671 29,375 39,806 (Net Debt) / Net Cash 7,649 2,917 12,909 25,598 39,806 (Net Debt)/ Net Cash including wealth management products 8,113 29,511 39,503 52,192 66,400 as % of equity 21% 65% 73% 83% 90%


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Figure 108. Midea earnings estimate summary

(RMBm) Year ended 31 December 2010a 2011a 2012 2013a 2014a 2015e 2016e 2017e

Sales 110,272 134,128 102,713 121,265 142,311 160,011 181,237 205,112Product sales 110,262 134,046 102,598 120,975 141,668 159,176 180,151 203,700Income from financial 10 82 115 290 643 836 1,086 1,412

Gross profit 20,038 25,697 23,202 28,242 36,235 43,307 49,671 56,918Total operating expenses -13,812 -16,829 -15,316 -19,166 -22,232 -25,641 -29,487 -33,518

Selling & distribution expenses -9,635 -11,630 -9,390 -12,432 -14,734 -17,018 -19,570 -22,114Admin expenses -4,177 -5,198 -5,926 -6,733 -7,498 -8,623 -9,916 -11,404

EBIT 8,423 8,815 7,966 9,186 14,012 17,640 20,108 23,265Net finance income -430 -948 -614 151 165 522 677 931PBT 7,930 8,230 7,710 10,012 13,991 17,980 20,604 24,014Net income 3,746 3,473 3,259 5,317 10,502 13,395 15,350 17,890HSBC Net income (loss) 3,455 2,609 2,709 3,927 10,273 13,395 15,350 17,890Reported Core Profit 3,746 3,473 3,027 3,903 9,477 Reported Core Profit incl. hedging impact 3,746 3,473 3,518 5,406 9,208 Margins Overall GPM 18.2% 19.2% 22.6% 23.3% 25.5% 27.1% 27.4% 27.7%Contribution Margin 9.4% 10.5% 13.4% 13.0% 15.1% 16.4% 16.6% 17.0%SGA / Revenue ratio -12.5% -12.5% -14.9% -15.8% -15.6% -16.0% -16.3% -16.3%

S&D 8.7% 8.7% 9.1% 10.3% 10.4% 10.6% 10.8% 10.8%Admin 3.8% 3.9% 5.8% 5.6% 5.3% 5.4% 5.5% 5.6%

OPM 7.6% 6.6% 7.8% 7.6% 9.8% 11.0% 11.1% 11.3%EBITDA margin 7.6% 6.6% 10.5% 10.1% 12.2% 13.2% 13.2% 13.3%Reported Net margin 3.4% 2.6% 3.2% 4.4% 7.4% 8.4% 8.5% 8.7%HSBC Net margin 3.1% 1.9% 2.6% 3.2% 7.2% 8.4% 8.5% 8.7%Reported Core Margin 3.4% 2.6% 2.9% 3.2% 6.7% Reported Core incl. hedging impact Margin 3.4% 2.6% 3.4% 4.5% 6.5% y-o-y % Revenue 21.6% -23.4% 18.1% 17.4% 12.4% 13.3% 13.2%GP 28.2% -9.7% 21.7% 28.3% 19.5% 14.7% 14.6%Contribution GP Selling & distribution expenses 20.7% -19.3% 32.4% 18.5% 15.5% 15.0% 13.0%Admin expenses 24.5% 14.0% 13.6% 11.4% 15.0% 15.0% 15.0%OP 4.7% -9.6% 15.3% 52.5% 25.9% 14.0% 15.7%Reported Net profit -7.3% -6.2% 63.1% 97.5% 27.5% 14.6% 16.6%HSBC Net Income -24.5% 3.8% 45.0% 161.6% 30.4% 14.6% 16.6%Reported Core Profit 28.9% 142.8% Reported Core Profit incl. hedging impact 53.7% 70.3%


1Q15 results

Revenue grew 10.5% y-o-y in 1Q15, outperforming peers. Reported net profit grew by 31.6% y-o-y to

RMB3,342m in 1Q15, while reported core profit grew by 4.5% y-o-y and reported core profit, including

gains and losses from hedging activities, was up 42.2% y-o-y. In 1Q15, air conditioners, refrigerators and

washing machines showed robust growth of 10%, 37% and 27%, respectively. Domestic air conditioner

sales and commercial air conditioners delivered strong growth of 18% and 23%. This strong growth in

large appliances was driven by a recovery in the growth of its distribution channel and growing consumer

awareness of the Midea brand.

GPM reached record higher thanks to an improved product mix and declining raw material costs.

The overall GPM expanded by 1.5ppt y-o-y to a record-high 26.9% in 1Q15, while the GPM for air

conditioners expanded by 3.4ppt y-o-y. The GPM expansion was thanks to declining raw materials and a

better product mix.

EBIT declined on high selling expenses, but provisions provide an ample buffer for profits. Midea’s

EBT declined by 2.2% as its selling expenses grew by 44.5% in 1Q15 and contribution margin was flat y-

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o-y. It increased spending on channel subsidies amid the ongoing price war in the air conditioner market

and raised provisions on sales rebates. Its end-1Q15 balance of other current liabilities, the majority of

which are sales rebate provisions, grew by 12% vs the end of 2104 and 58% y-o-y. Sales rebate

provisions at the end of December was 1.3 times as much as 2014 profit, providing an ample buffer to

protect profit growth should the company decide write back the provisions.

Valuation and risks

Our DCF approach combines our earnings model and EBITDA estimates with our assumptions on

depreciation, working capital, taxes and debt levels. We explicitly estimate minority interest EBITDA and

then strip this out of consolidated operating earnings. We model cash flows and EBITDA explicitly up to

2017, after which we build in semi-explicit cash flow estimates running off a sales growth assumption

and a profitability metric through to 2025. After this stage, we move to a terminal valuation phase. Our

DCF assumptions include a 5.5% China equity risk premium and a 0% terminal growth rate. Midea has a

6% cost of debt and a target 10:90 debt-to-equity ratio. Its company-specific beta is 1.00, yielding a 9.0%

cost of equity and hence a cost of capital of 8.6%.

We have assumed maintenance capex of RMB800m along with a 0.5% EBIT margin decline each year

for the semi explicit forecast period.

Based on these assumptions, our DCF-based fair value target price is RMB46.9, implying 22% upside against

the 2 June closing price. We initiate coverage of this stock with a Buy rating.

Our fair value target price implies PE multiples of 14x on 2015e EPS and 12.1x on 2016e EPS, and a 0.8x

PEG on our estimated 2014-17e profit CAGR of 19.4%.

Catalysts: better-than-expected GPM; pick-up in white goods sales; major developments in industrial

upgrades.

Key downside risks: faster-than-expected rise in selling expenses due to price wars; slower-than-

expected air conditioner sales due to a cool summer.

Figure 109. Midea PE Band Chart Figure 110. Midea PB Band Chart vs. ROE

Source: Thomson Reuters Datastream, HSBC Estimates Source: Thomson Reuters Datastream, HSBC Estimates

4.0x

6.0x

8.0x

10.0x

12.0x

05

1015202530354045

Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15Price 4.0x 6.0x8.0x 10.0x 12.0x

2.0x2.5x

3.0x

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1.5x

0%

10%

20%

30%

40%

0

10

20

30

40

50

Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15Price ROE (RHS)

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Company description

Gree Electric Appliances was founded in 1989 and is based in Zhuhai, Guangdong. The company was

formerly known as Haili Air-conditioning Engineering Co., Ltd. of Zhuhai and changed its name to Gree

Electric Appliances, Inc. of Zhuhai in 1994. In 2014, the group’s sales reached RMB140bn with air

conditioner, small appliances, other industrial and financial business accounting for 85%, 1% and 14% of

total sales, respectively. The brands owned by Gree include “Gree”, “TOSOT” and “Kinghome”. It has a

national network of more than 30,000 POS for air conditioners through 27 distributors’ sales offices.

Under its main business, 11% are exports to the international market but only 30% of export volume is

under its own brands.

90% of Gree’s air conditioner sales are from residential air conditioners, including wall-mounted, floor

standing, window, and portable air conditioners. The remaining 10% are commercial air conditioners.

Industrial products include valves, pumps, compressors, fan motors, packaging and other general-purpose

equipment, electric motors, equipment for power transmission and distribution, control equipment, electric

wires and cables, optical cables and electrical equipment, capacitors, varnished wires and moulds.

Gree (000651 CH)

We forecast Gree to deliver a 10% CAGR in revenue and a 17.5%

CAGR in net profit is 2014-17e

Most leveraged to a cyclical rebound in 2H15; potential beneficiary

of SOE reform


of RMB77.2

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Shareholding structure

In 1991, Gree was restructured into Zhuhai Gree Electronics Holding Limited. In 1996, Gree listed on the

Shenzhen Stock Exchange under stock code 000651 CH.

In March 2006, Gree completed non-tradable share reform and all of its shares became tradable.

Gree’s controlling shareholder is Gree Group, which held a 19.16% stake in Gree as at end-2014.

In 2007, a total of 80m shares, or about 10% of the total shares outstanding, were transferred to Hebei

Jinghai from Gree Group. The shareholders of Hebei Jinghai are its top 10 distributors, accounting for

more than 65% of its domestic sales. As at end-2014, these key distributors held a 9.09% stake in Gree.

Management only had a 0.94% direct share investment in Gree as at end-2014.

Figure 111. Gree shareholder structure


Potential SOE reform

Zhuhai SASAC, Gree’s ultimate controlling parent, is implementing corporate restructuring in line with SOE

reform. Gree Group, the direct parent of the listed Gree company, is an integral part of Zhuhai SASAC’s

restructuring.

According to an announcement by the listed Gree on 18 February 2014, in the first stage of restructuring, Gree

Group will transfer its 51.94% stake in Gree Property at zero consideration to a platform company set up for

SOE reform by Zhuhai SASAC. After the asset injection, the shareholding structure, Zhuhai SASAC will own

the SOE platform company, which will own Gree Property, whereas Zhuhai SASAC previously directly

owned Gree Property. The SOE platform company will be injected with other assets owned by Zhuhai SASAC,

including a 100% stake in Zhuhai Gree Hong Kong and Macau Bridge Project Management Company.

In the second phase of restructuring, once the asset transfer is completed, a strategic investor will be

sought for Gree Group through the disposal of the 49% stake in Gree Group owned by Zhuhai SASAC.

After the restructuring, Gree Group’s only major asset will be its 18.22% stake in the listed Gree

company.

Zhuhai SASAC

Gree Group

Gree Property Limited

Zhuhai Gree Property Limited

Gree (000651.SZ)

100%

51.94%

0.94%

100%

18.22%

Key distributors

9.09%

Management

0.94%

Pubic

70.81%19.16%

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While there has yet to be any major progress on SOE reform at Gree Group, we believe the planned

restructuring will happen and that it will directly benefit the listed Gree in terms of improving

management incentives, potentially triggering a rerating in the stock.

These benefits are already becoming visible. At its 2014 annual general meeting (AGM) on 1 June 2015,

Gree elected a new board of directors. The new board has nine members and three of them are

independent directors. Mr. Ye Zhixiong occupies one board seat nominated by Zhuhai SASAC. He has

strong connections to Gree, as he previously worked as the chairman and party head at Gree Group from

May 2004 to August 2006. We believe he could help strengthen collaboration between Gree Group and

Zhuhai SASAC to drive SOE reform.


Gree’s sales and distribution have evolved through four distinct phases of development.

In the first phase, during 1995-97, Gree divided its distribution network by region and each region only

had one first-tier of distributors. Gree directly managed its first-tier distributors, while its first-tier

distributors helped manage sub-distributors. In this phase, Gree helped its first-tier distributors to grow in

scale and profits.

In the second phase, during 1998-99, Gree started to introduce more than one first-tier distributor to each

region in order to reduce the bargaining power of distributors. In this phase, it also tried to increase

control over distributors by using bar codes to control the inventory by regions and cooperating with

distributors to maintain stable retail prices by regions. Under stage two, it effectively eliminated the risks

of having only one distributor in one region.

In the third phase, during 2000-12, after Gree had successfully developed its national network coverage

by incubating large tier-one distributors, the company found the distribution model lacked support for

small sub-distributors and did not have a direct link to the end retail POS. Thus, in the third three phase,

Gree allowed its major distributors to set up one regional sales office in each region. Under this regional

sales office management structure, the major distributors have to collaborate on sales and marketing

activities, rather than implement sales and marketing independently for the benefit of their own bottom

line. Gree can also provide direct support to sub-distributors through regional sales offices. The model

enhanced Gree’s control on its distribution channel and improved efficiency.

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Figure 112. Gree distributorship (1995-2012)


In the fourth phase since 2013, Gree started to centralize and further tighten its control on distributors

through the establishment of the sales company Shengshi Hengxi. Under this model, Gree used a ‘higher

GPM, higher cost model’ to control distributors’ profits and maximize its leverage on distributors’

working capital. As a result, Gree’s GPM expanded from 26.6% in 2012 to 36.6% in 2014, while its

selling and distribution expenses grew at a 41% CAGR on the back of an 18% sales CAGR during the

same period. Although Gree was already the market leader in air conditioners, it was able to outpace

market growth by leveraging its distributors’ working capital. During the same period (2012-14), its net

profit grew at a 38% CAGR and net margin improved to 10% in 2014 from 7.4% in 2012.

Investment thesis

Higher earnings visibility

We forecast Gree to deliver a 10% CAGR in revenue and 17.5% CAGR in net profit over 2014-17e. As

the No 1 air conditioner maker with a 28% market share, Gree has strong control over its profitability.

Despite the air conditioner price war since 4Q14, Gree has a large profit buffer that should enable it to

continue to deliver earnings growth. Its leverage on distributors’ working capital reached the maximum

level in 2H14, as channel inventory amounted to 40m units for the whole industry. To help its distributors

destock, it reversed its ‘high GPM, high selling expenses’ distribution strategies, so that it no longer

needs to take as much sales rebate provisions under selling expenses as before, more than offsetting the

GPM pressure from lower selling prices. Its balance of sales rebate provisions at the end of 2014 were

equal to more than three years of net profits.

Most leveraged to a cyclical rebound in 2H15

More than 90% of Gree’s earnings are from air conditioner sales. The air conditioner cycle is linked to the

property cycle and can be very volatile due to the destocking inventory cycle created by the mismatching

One Tier 1 per region

Tier 2 distributor a

Tier 2 distributor b

…. …

Tier 2 distributor n…

Gree(1995-1997)

Tier 1 distributor

Multiple Tier 1 per region


Tier 2 distributor b

…. ….

Tier 2 distributor n….

Gree(1998-1999)


Regional Sales Offices

Big distributor a

Big distributor b

Small distributor a

Smalldistributor b

Small distributor n

Big distributor n

Gree(2000-2012)

Regional Sales OfficesTier 1 distributor b

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of demand and supply, and pre-orders with one year’s lead time. Therefore, we believe Gree offers the

highest earnings leverage among peers to the property driven cyclical recovery from 4Q15.

Potential beneficiary of SOE reform

Gree lags the other two major Chinese white goods makers in terms of effective management incentive

plans and execution of strategies relating to e-commerce, smart appliances and Industry 4.0. However,

this could soon change through SOE reform. We have seen from the cases of Qingdao Haier and Midea

how a strategic partner or group restructuring can help improve management incentives, align

management and minority shareholders’ interests and result in strategic investments. As a result, we

believe Gree has the potential to improve through SOE reform.

Earnings estimates

Our earnings forecasts are largely derived from our estimates of revenue, gross margins, selling and

administrative (operating) costs, and net finance income. In the normal course of business, Gree hedges

its exposure to foreign currency and raw material price fluctuations through futures and forward contracts.

We do not attempt to model the marked-to-market gains and losses from these hedging activities, but note

they can have a meaningful impact the company’s reported earnings.

Revenue

Gree’s main products are air conditioners, accounting for 84.8% of total revenue and 86.2% of product sales

revenue in 2014. We forecast Gree to deliver a 10.3% revenue CAGR in 2014-17e and 7.7% y-o-y revenue

growth in 2015e. We estimate the revenue growth in air conditioners would be 5.3% in 2015e.

We forecast the revenue from air conditioners based on our estimates of volume market and ASP. We

forecast air conditioner revenue to grow by 5.3% y-o-y in 2015e.

Figure 113: Gree air conditioner forecasts (RMBm)

2014a 2015e 2016e 2017e CAGR (2014-17e)

Air conditioner forecasts Sales from Air Conditioners 118,719 125,035 136,394 148,804 7.8%


y-o-y % 2.1% 9.3% 6.5% 6.5% Total ASP 3,005 2,896 2,968 3,040 0.4%

y-o-y % 10.3% -3.6% 2.5% 2.4% Domestic air conditioner - Sales volume ('000 unit): IOL 30,288 33,676 36,185 38,880 8.7%

y-o-y % 10.4% 11.2% 7.5% 7.4% - Gree market share (%): IOL 43.3% 45.3% 45.8% 46.3% Export air conditioner - Sales volume ('000 unit): IOL 9,216 9,492 9,777 10,071 3.0%

y-o-y % -18.2% 3.0% 3.0% 3.0% - Gree market share (%): IOL 19.7% 19.7% 19.7% 19.7%


Industry products accounted 1.6% of Gree’s revenue in 2014. We estimate industry product revenues to

grow by 25% in 2015e and 25% CAGR over 2014-17e.

Small appliances accounted 1.3% of Gree’s revenue in 2014. We estimate small appliances revenue to

grow by 10% in 2015e and 10% CAGR over 2014-17e.

We forecast the total revenue of the group to grow by 7.7% in 2015e and at a 10.3% CAGR in 2014-17e.

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Figure 114. Gree revenue breakdown Figure 115. Gree gross profit breakdown


Gross profit margin

The cyclical drivers for GPM are:


Price wars: would lower the selling prices and thus GPM

Currency fluctuations: RMB appreciation could lower FOB export prices and thus export GPM


ASP and product mix: a greater sales contribution from high-end / new products increases GPM



Regional mix: the share of exports in total sales; more exports lead to a lower blended GPM. Exports

were 11% of core business sales in 2014, and we expect the ratio to remain stable.

We forecast Gree’s overall GPM to shrink by 220bp to 34.4% in 2015e, mainly due to the decline in the GPM

of air conditioners by 2ppt y-o-y to 37.8% due to the price war in air conditioners that began in 4Q14.

Stripping out marketing and selling expenses, we expect the contribution margin to expand by 46bp to

16.4% in 2015e from 16.0% in 2014. As discussed earlier, Gree started to reverse its ‘high GPM, high

selling expenses’ strategies in 4Q14 and we expect it to lead to a 6.5% y-o-y decline in marketing and

selling expenses in 2015e, which should protect the company’s profit growth and relieve the working

capital pressure on its distributors. We expect gross profit to grow 1.1% in 2015e.

84.8%

82.9%

81.2%

79.3%

1.3%

1.3%

1.3%

1.3%

1.6%

1.9%

2.1%

2.3%

10.7%

12.4%

14.0%

15.6%

1.6%

1.5%

1.5%

1.5%

0 50 100 150 200

2014

2015e

2016e

2017e

Air conditioners Small appliancesIndustrial products Other product salesIncome from financial services

92.1%

91.2%

90.9%

90.3%

0.8%

0.9%

0.8%

0.8%

0.7%

0.8%

0.9%

1.0%

3.4%

4.2%

4.5%

5.0%

3.0%

2.9%

2.8%

2.8%

0 20 40 60 80

2014

2015e

2016e

2017e

Air conditioners Small appliancesIndustrial products Other product salesIncome from financial services

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1H14a 2H14a 2014a 2015e 2016e 2017e

Overall GPM 33.8% 38.6% 36.6% 34.4% 35.5% 35.8% Air conditioners 35.6% 42.9% 39.8% 37.8% 39.8% 40.8% Small appliances 25.9% 20.0% 23.3% 23.3% 23.3% 23.3% Industrial products 14.2% 15.6% 15.2% 15.2% 15.2% 15.2% Others products 14.6% 9.6% 11.5% 11.5% 11.5% 11.5% Financial Services 68.3% 68.7% 68.5% 68.5% 68.5% 68.5%Contribution margin 17.0% 15.2% 16.0% 16.4% 16.7% 17.0%


Selling, general and administrative expenses

Total SGA was equal to 24.1% of the company’s net revenue in 2014. We expect marketing and selling

expenses to decrease by 6.5% in 2015e and admin expenses to increase by 3%, along with 1.1% growth

in gross profit and 7.7% growth in revenue. We forecast total SGA to decline by 5.1% y-o-y in 2015e and

increase at a 6.6% CAGR in 2014-17e.

We expect the SGA cost to sales ratio to go down to 21.2% in 2015e from 24.1% in 2014, mainly due to

the decline in marketing and selling expenses.

Figure 117. Expense ratios vs contribution margin


Operating profit

Based on the above revenue, GPM and SGA forecasts, we expect a 14.4% CAGR in EBIT over 2014-

17e. We expect EBIT to increase by 9.9% to RMB18,549m in 2015e, with a 20bp increase in EBIT

margin to 12.3%, and sales growing 7.7% y-o-y to RMB150.8bn.

14.6%

18.8%20.6%

17.9% 18.8% 18.8%

4.1% 4.2% 3.4% 3.3% 3.1% 2.9%

12.0%13.9%

16.0% 16.4% 16.7% 17.0%

0%

5%

10%

15%

20%

25%

2012 2013 2014 2015e 2016e 2017e

Selling & Distribution expense to Sales ratio Admin Expense to Sales ratio Contribution Margin

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Figure 118. Operating profit


Net finance income

As discussed later in the cash flow analysis, Gree generates strong cash flows from its operations. Its net

cash amounted to RMB46,540m as at end-2014. We forecast net interest income at RMB1,083m,

RMB1,403m and RMB1,941m in 2015e, 2016e and 2017e, respectively.

Figure 119. Net finance income (RMBm)

2013a 2014a 2015e 2016e 2017e

Interest Income 835 1,250 1,364 1,754 2,362 Cash Balance 38,542 54,546 70,164 94,470 122,782 Interest Income Rate 2.2% 2.3% 1.9% 1.9% 1.9% Interest Cost -227 -228 -280 -351 -421 Gross Debt Balance 5,616 8,006 9,477 11,377 13,445 Interest Cost Rate 4.0% 2.9% 3.0% 3.1% 3.1% Net Interest Income 608 1,021 1,083 1,403 1,941


Net profit and net profit margin

Factoring in the dividend payout ratio for minority shareholders and effective tax rate, we forecast net

profit to grow 17.2% y-o-y to RMB16,589m in 2015e from RMB14,155m in 2014 and at a CAGR of

17.5% over the 2014-17e period on the 10.3% CAGR that we forecast in revenue. Our 2015 net profit

forecast is more or less in line with consensus (0.2% higher).

The company’s net margin in 2014 was 10.1%. With the expected increase in net profit in 2015, the net

margin could expand by 90bp to 11.0% in the same year.

However, there are three ways in which we can gauge Gree’s profit growth. The first is based on the

standard approach used by HSBC to assess the core profit of Hong Kong listed stocks, stripping out all

non-operational gains and losses. The second is reported core profit, which is the company’s own

measure of core profit, and usually includes some financial gains and losses (but excluding any mark-to-

market gains and losses from hedging activities) that would be considered non-core by HSBC. The third

is reported core earnings plus mark-to-market gains and losses from hedging activities; some investors

believe hedging activities should be considered part of the company’s recurring earnings.

Our net profit forecasts do not include non-core and non-recurring items.

8,13611,271

16,88418,549

21,74825,255

8.1%9.4%

12.1% 12.3%12.9% 13.5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2012 2013 2014 2015e 2016e 2017e

RM

Bm

EBIT EBIT margin

38.5%

49.8%9.9%

17.2%16.1%

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Figure 120. HSBC estimates vs. consensus

RMBm ________________ 2015e ________________ _______________ 2016e _______________ _____________ 2017e ______________ HSBC estimates Consensus % diff HSBC estimates Consensus % diff HSBC estimates Consensus % diff

Total revenue 150,785 157,065 -4.0% 167,984 176,286 -4.7% 187,636 198,651 -6%Operating profit 18,549 19,031 -2.5% 21,748 22,068 -1.4% 25,255 25,337 0%Profit 16,589 16,553 0.2% 19,562 19,247 1.6% 22,979 22,065 4%


Cash flows

We derive our cash flow forecasts based on working capital forecasts, capex forecasts, and dividend payout.

Gree had 89.8 working capital days in 2014, which steadily increase to 116 days by 2017e, assuming

stable inventory days but slower working capital cycles.

Figure 121. Working capital

2013a 2014a 2015e 2016e 2017e

Inventory Turnover Days 59.6 35.7 46.1 46.1 46.1 Raw material 29.9 18.3 28.0 28.0 28.0

Trade + Bills Receivable Days 146.4 138.5 146.9 146.9 146.9 Trade + Bills+ Deferred rev Payable Days 216.4 166.3 163.3 161.3 159.1 Working Capital Days(Working Capital*365/ COGs) 61.8 89.8 106.7 112.8 115.9


We forecast capex at RMB1.5bn annually in 2015-17e.

Gree’s dividend payout was 41.5% in 2013 and 63.7% in 2014. We forecast the dividend payout ratio at

50% going forward.

We estimate its net cash position products will increase to RMB123bn by the end of 2017e from

RMB54.5bn as at the end of 2014.

We estimate net cash to increase to RMB60.7bn by the end of 2015e from RMB46.5bn at the end of

2014, after annual capex of RMB1.5bn.


2013a 2014a 2015e 2016e 2017e

Net cash from operating activities 12,970 18,939 23,941 33,687 39,234 Net cash from investing activities -2,186 -2,862 -1,500 -1,500 -1,500 Capex -2,461 -1,777 -1,500 -1,500 -1,500 Net cash from financing activities -2,424 -1,864 -6,823 -7,881 -9,421 Net increase in cash 8,360 14,213 15,618 24,306 28,312 Cash at beginning of year 21,370 29,259 54,546 70,164 94,470 Cash at end of year 38,542 54,546 70,164 94,470 122,782 (Net Debt) /Net Cash 32,926 46,540 60,687 83,093 109,337 As % of Equity 93% 103% 114% 131% 146%


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Figure 123. Gree earnings estimate summary

(RMBm) Year ended 31 December 2010a 2011a 2012a 2013a 2014a 2015e 2016e 2017e

Sales 60,807 83,517 100,110 120,043 140,005 150,785 167,984 187,636 Gross profit 13,333 15,367 26,676 39,165 51,273 51,826 59,712 67,194 Total operating expenses -10,388 -10,834 -18,682 -27,599 -33,708 -31,987 -36,855 -40,818

Selling & distribution expenses -8,410 -8,050 -14,626 -22,509 -28,890 -27024 -31644 -35346 Admin expenses -1,978 -2,783 -4,056 -5,090 -4,818 -4963 -5211 -5471

EBIT 4,650 5,856 8,136 11,271 16,884 18,549 21,748 25,255 Net Interest Income 333 294 511 608 1,021 1,083 1,403 1,941 PBT 5,056 6,329 8,763 12,892 16,752 19,633 23,152 27,196 Net income (loss) 4,276 5,237 7,380 10,871 14,155 16,589 19,562 22,979 HSBC Net income (loss) 4,203 5,059 7,264 9,857 15,154 16,589 19,562 22,979 Reported Core income (loss) 4,027 5,109 6,995 8,908 14,145 16,589 19,562 22,979 Margins Overall GPM 21.9% 18.4% 26.6% 32.6% 36.6% 34.4% 35.5% 35.8% SGA / Revenue ratio -17.1% -13.0% -18.7% -23.0% -24.1% -21.2% -21.9% -21.8%

S&D 13.8% 9.6% 14.6% 18.8% 20.6% 17.9% 18.8% 18.8% Admin 3.3% 3.3% 4.1% 4.2% 3.4% 3.3% 3.1% 2.9%

OPM 7.6% 7.0% 8.1% 9.4% 12.1% 12.3% 12.9% 13.5% PBT margin 8.3% 7.6% 8.8% 10.7% 12.0% 13.0% 13.8% 14.5% Reported Net margin 7.0% 6.3% 7.4% 9.1% 10.1% 11.0% 11.6% 12.2% HSBC Net Margin 6.9% 6.1% 7.3% 8.2% 10.8% 11.0% 11.6% 12.2% Reported Core Margin 6.6% 6.1% 7.0% 7.4% 10.1% 11.0% 11.6% 12.2% y-o-y % Revenue 42.6% 37.3% 19.9% 19.9% 16.6% 7.7% 11.4% 11.7% GP 25.0% 15.3% 73.6% 46.8% 30.9% 1.1% 15.2% 12.5% Selling & distribution expenses 45.1% -4.3% 81.7% 53.9% 28.3% -6.5% 17.1% 11.7% Admin expenses 26.3% 40.7% 45.7% 25.5% -5.3% 3.0% 5.0% 5.0% OP 43.5% 25.9% 38.9% 38.5% 49.8% 9.9% 17.2% 16.1% PBT 49.6% 25.2% 38.5% 47.1% 29.9% 17.2% 17.9% 17.5% Reported Net profit 46.8% 22.5% 40.9% 47.3% 30.2% 17.2% 17.9% 17.5% HSBC Net Income 45.6% 20.4% 43.6% 35.7% 53.7% 9.5% 17.9% 17.5% Reported Core Profit 46.1% 26.9% 36.9% 27.3% 58.8% 17.3% 17.9% 17.5%


1Q15 results: Inventory destocking lowers GPM, but provisions provide ample buffer for profits

Gree reported 1Q15 results. Its product revenue declined by 0.7% y-o-y to RMB24,504m (the last time

Gree recorded a sales decline was in 1H09, when its revenue dropped by 20%). EBIT dropped by 8% y-o-

y due to a 3.9% drop in contribution margin and increase in administration cost ratio. Its net profit grew

23% y-o-y to RMB2,775m in the quarter, reported core profit declined by 10% y-o-y and reported core

profit including hedging losses and gains grew 33% y-o-y.

GPM, and selling and distribution costs both declined. As discussed earlier, Gree adopted a ‘high GPM,

high selling costs’ model to control its channels and maximise leverage on distributors’ working capital.

Due to the slowdown in the property market and a cool summer in 2014, the air conditioner channel

inventory reached a peak of 40m units in 4Q14, equivalent to one-year of domestic sales volume,

according to CMM. To help distributors de-stock, Gree began cutting ex-factory prices aggressively in

4Q14. The results are reversing the ‘high GPM, high selling costs’ model, and lower selling and

distribution costs relating to sales rebates provisions. Consequently, in 1Q15, its GPM dropped by 2.5ppt

to 33% while its selling costs declined by 9.8% y-o-y. Its contribution margin declined by 3.9% y-o-y,

less than the 6.7% decline in gross profit.

Leading indicator, deferred revenue, grew q-o-q. Deferred revenue is a good leading indicator of

revenue growth. As the distributors’ working capital is tied up in the channel inventory, the deferred

revenue balance is set to decline or see slower growth. As at the end of 2014, its deferred revenue balance

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fell by 46% y-o-y. As at the end of 1Q15, the balance grew 35% q-o-q and declined 25% y-o-y, indicating

there was an improvement in the turnover in the channel.

Ample buffer for profits. Gree makes provisions on sales rebates, which act as a buffer for profits. As at

the end of 1Q15, its other current liabilities, the majority of which are sales rebate provisions, grew 51%

y-o-y and 4% q-o-q to RMB50,520. The balance is about 3.6x as large as Gree’s 2014 profit, which we

think provides an ample buffer to protect profit growth should the company decide to write back the

provisions.

Valuation and risks






DCF assumptions include a 5.5% China equity risk premium and a 0% terminal growth rate. Gree has a

6% cost of debt and a target 10:90 debt-to-equity ratio. Its company-specific beta is 1.00, yielding a 9.0%

cost of equity and hence a cost of capital of 8.6%.


for the semi-explicit forecast period.

Based on these assumptions, our DCF-based fair value target price is RMB77.2, which implies 20%

upside against the 2 June closing price. As a result, we initiate coverage of the stock with a Buy rating.

Our fair value target price implies PE multiples of 13.8x on 2015e EPS and 11.6x on 2016e EPS and a

0.79x PEG on our forecast of a 17.5% CAGR in profit for 2014-17e.

Catalysts: an end to the price war in the air conditioner market; SOE reform; finding a strategic partner.

Downside risks: inventory issues persist; raw material price fluctuations; slower-than-expected progress

on SOE reform.

Figure 124. Gree PE band chart Figure 125. Gree PB band chart vs ROE

Source: Thomson Reuters Datastream, HSBC estimates Source: Thomson Reuters Datastream, HSBC estimates

4.5x

6.0x7.5x

9.0x

10.5x

0

10

20

30

40

50

60

70

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Price 4.5x 6.0x7.5x 9.0x 10.5x

2.0x

2.5x

3.0x

3.5x

1.5x

0%

10%

20%

30%

40%

50%

60%

0

10

20

30

40

50

60

70

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15Price ROE (RHS)

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Company description

Thirty years ago, Haier was a small refrigerator maker that had gone with seemingly stagnant growth

prospects in Qingdao, a coastal city best known for Tsingtao beer. The Haier Group is now a respected

global brand and the world’s largest manufacturer of white goods that sells products in more than 100

countries. In 2012, Boston Consulting Group ranked the company the eighth most innovative firm in the

world.

Much of the success has been put down to Haier Group’s Chairman Zhang Ruimin who helped to turn the

company around in 1984 and has been there ever since. His latest innovation was to split the workforce

into 2,000 self-managed teams that perform a range of different roles and encourage employees to come

up with ideas for new products or services.

The Haier Group has two listed companies – Qingdao Haier (600690 CH), on which we initiate coverage

here with a Buy rating, and Haier Electronics (1169 HK, HKD23.15, Buy). The Haier Group and other

shareholders acting in concert hold a combined 40.9% stake in Qingdao Haier. Haier Group holds a 59.6%

interest in Haier Electronics through Qingdao Haier (46.5%) and Haier Investment and Development

(13.1%). Haier Electronics is fully consolidated into Qingdao Haier.

In 2014, Qingdao Haier’s revenue reached RMB88,775m, and sales from large appliances, small

appliances and integrated channel services (ICS) accounted for 68%, 7% and 20% of its revenue,

respectively. Out of its main businesses, 12% of sales are from exports to international markets, all under

its Haier brand or ODM.

Globally, Haier has 21 industry parks, 24 manufacturing factories, 10 R&D centres and 19 overseas

trading companies.

Qingdao Haier (600690 CH)

We forecast Qingdao Haier to deliver a 9% CAGR in revenue and

a 15.7% CAGR in profit in 2014-17

Better positioned to benefit from upgrade demand; asset injection

and the reduction of connected transactions with the parent to close

the profitability gap with peers; leader in Industry 4.0 development


of RMB35.9

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Figure 126. Qingdao Haier brand portfolio


Shareholder structure

Qingdao Haier was listed in November 1993 as a manufacturer of refrigerators under stock code 600690

CH. It started air conditioner manufacturing from 2001 by taking a controlling stake in Qingdao Haier Air

Conditioner Limited from its parent.

In May 2006, Qingdao Haier completed the non-tradable share reform and all its shares became tradable.

In 2010, it became the controlling shareholder of Haier Electronics (1169 HK) and thereby added

washing machines, water heater and integrated channel services (ICS) to its main businesses.

In 2011, it acquired modelling, special steel and other businesses from Haier Group by buying stakes in

10 companies.

On 30 September 2013, Qingdao Haier announced that KKR was coming on board as its strategic

investor through the issuance of new shares at RMB11.29 per share to the private equity company for

total proceeds of RMB3.4bn. After the new share issuance, KKR holds 9.95% in Qingdao Haier.

The controlling shareholder of Qingdao Haier is Haier Group, which in total holds a 40.91% stake

through its direct holding and holdings under Haier International and Qingdao Haier Investments, who are

shareholders acting in concert.

Haier Group is a collectively owned enterprise owned by management and staff, but the ownership titles

have yet to be confirmed for individual stakeholders. The core management team only has a 0.31% direct

stake in Qingdao Haier. The market has been concerned that management is not incentivised enough by

equity compensation. A future reform at the group level will likely change the situation.

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Figure 127. Qingdao Haier shareholder structure


Investment thesis

Better positioned to benefit from the consumption upgrade

As discussed in the “White goods industry” chapter, the trend of consumers ‘trading up’ in terms of their

purchasing behaviour in China is a key secular industry driver. From improving on technology leadership

and product offering, the trend is for domestic brands to close the pricing gap with international brands.

The upgrade of domestic brands has been well-proven in the air conditioner industry. The average selling

price (ASP) gap between domestic brands and international brands was only 13%, the narrowest among

white goods categories. Moreover, in 2011-2014, the ASP of international brands declined by 3% and that

for domestic brand grew 9%.

We believe Qingdao Haier is better positioned to benefit from this trend with a higher end product

portfolio, more advanced technology and a stronger brand name.

Haier’s strong positioning in high-end white good products is demonstrated by its premium ASP vs.

domestic peers, especially for refrigerators.

Figure 128. Retail ASP of washing machines Figure 129. Retail ASP of refrigerators


Qingdao Haier (600690.SH)

Haier Group

Qingdao Haier Group Asset

Management Committee

Haier International

Qingdao Haier Investments

Qingdao Haier Venture Capital Investment Consulting

20.66% 2.64%

98.6%1.4%51.94%

17.61%

KKR

9.95%

Core management

0.31%

Public

48.83%

40.91%

2,694 2,776 2,863 3,045

1,621 1,685 1,757 1,824

1,952 1,975 2,079

2,205

1,843 1,958 2,047 2,143

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2011 2012 2013 2014

RM

B

International brands Domestic brands Haier LittleSwan

4,554 4,686 4,908 5,283

2,389 2,452 2,561 2,617

3,135 3,077 3,282

3,503

2,209 2,276 2,389 2,571

-

1,000

2,000

3,000

4,000

5,000

6,000

2011 2012 2013 2014

RM

B

International brands Domestic brands Haier Midea

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In terms of refrigerators, international brands’ ASP was at a 102% premium to domestic brands in 2014.

The gap was widened from that of 91% in 2011, as international brands’ ASP in 2014 grew 16% over that

in 2011, and growth in ASP of domestic brands was only 9.6% during the same period. In contrast,

Haier’s ASP premium to domestic brands widened to 34% from 31% in 2011, and it was able to grow its

ASP by 11.8% in 2011-14.

In terms of washing machines, international brands’ ASP was at a 67% premium to domestic brands in

2014, similar to that in 2011. Haier’s ASP attained a 21% premium to domestic ASP and a 3% premium

to Midea’s premium washing machine brand, Little Swan.

For water heaters, international brands’ ASP was at a 64% premium to domestic brands in 2014. Haier had a

10% premium to domestic brands’ ASP, while the Midea brand was at a 9% discount to domestic brands’ ASP.

For air conditioners, international brands’ ASP was at only a 13% premium to domestic brands in 2014.

In 2011-14, international brands’ ASP declined by 3% and that for domestic brands grew 9%. Gree, Haier,

and Midea brands are all at a premium to domestic brands’ ASP at 15%, 5% and 5%, respectively.

Asset injections from the parent to improve profitability

According to the agreement between Qingdao Haier and Haier Group, announced on 7 January 2011,

Haier Group promised to resolve the non-competition issue and reduce connected transactions with

Qingdao Haier by January 2016 (for details, see section “Group restructuring”).

By doing so, we believe Qingdao Haier can close its profitability gap with peers. As we analysed under the

section “Comparison analysis”, Qingdao Haier has a lower ROIC than Midea and Gree due to lower margins.

In 2014, Qingdao Haier acquired Haier Group’s R&D assets in China, and the minority interests of four

companies, including that of Qingdao Haier Air Conditioner Electronics. In 2011-13, Qingdao Haier

acquired from its parent the upstream white goods assets (modelling, special steel and new materials) and

overseas white goods assets.

In 2015, Haier’s parent plans to inject its overseas white goods assets, TV manufacturing and home

furnishing business, a 41% stake in Mitsubishi Qingdao Haier Air Conditioner JV and a stake in Carrier

Qingdao Haier Freeze Box JV into Qingdao Haier. (The announcement of the injection of overseas white

goods assets was made on 25 May 2015.)

Figure 130. Retail ASP of air conditioners Figure 131. Retail ASP of water heaters


42034281 4215

4060

32943470

3593 3598

3742

3975 3964

4126

3323

3592

39463785

3552 3488

3749 3780

3000

3500

4000

4500

5000

2011 2012 2013 2014

RM

B

International brands Domestic brands Gree Midea Haier

2,391 2,518

1,487 1,531

1,297 1,391

1,682 1,684

-

500

1,000

1,500

2,000

2,500

3,000

2013 2014

RM

B

International brands Domestic brands Midea Haier

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We estimate the net revenue accretion to Qingdao Haier will be about RMB10bn and the after tax profit

accretion will be around RMB350-400m.

Leader in moving to Industry 4.0

We believe Qingdao Haier is the sector leader in moving to Industry 4.0 through the digitalisation of its

production, distribution and services and has successfully integrated its research, product, logistics and

distribution platforms. We also believe strategic investor KKR will help quicken Haier’s steps to Industry

4.0. Its early-mover advantages are shown by:

Diversified services income:

ICS, which provide distribution and logistics services to third parties, accounted for 19.6% of

Qingdao Haier revenue in 2014. The company has successfully integrated the distribution, services

and logistics networks under one ICS platform and opened it up to third parties.

Digitalisation of sales:

In 2014, its online sales reached 8% of total revenue and 11% of domestic appliance sales after

growing 150% y-o-y.

Smart factories:

As at the end of 1Q15, the company built four smart factories and 40 unmanned automatic production

lines. Its first smart factory was built in Shenyang in 2014 for the manufacturing of refrigerators. This

factory supports customisation of 500 SKUs on nine platforms.

Smart appliances:

In 1Q15, Haier sold 500,000 units of smart refrigerators, washing machines, air conditioners and

water heaters, a 400% growth in volume y-o-y.

Group restructuring

Qingdao Haier was listed on the Shanghai Stock Exchange in 1993. In 2000, Haier Group conducted a

back-listing of Haier Electronics by injecting assets into a listed vehicle called CCT Telecom. In 2010,

Haier Group transferred the majority of its holding in Haier Electronics (1169 HK) to Qingdao Haier, and

the group positioned Qingdao Haier as its listing flagship for white goods and Haier Electronics as its

listing flagship for integrated channel services.

On 7 January 2011, Qingdao Haier and Haier Group reached and published an “agreement to resolve the

non-competition issue and reduce connected transactions between the parent and Qingdao Haier” and

planned to complete the followings by January 2016:

The group will inject all overseas white goods assets into Qingdao Haier, including the group’s

investments in the JVs with Mitsubishi Heavy and Carrier.

The group will inject all modelling, special steel and new materials assets into Qingdao Haier.

The group will inject the overseas trading business into Qingdao Haier.

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Connected procurement transactions between the group and Qingdao Haier will be reduced to below 30%.

Group will inject TV, home furnishing and other related assets into Qingdao Haier.

Strategic investor KKR

On 30 September 2013, Qingdao Haier announced KKR would become its strategic investor via the issuance

of new shares at RMB11.29 per share to the private equity company for total proceeds of RMB3.4bn. After the

new share issuance, KKR holds 9.95% in Qingdao Haier with a lock-up of three years.

According to Haier’s announcements, KKR and Qingdao Haier are going to cooperate in the following

areas:

Strategic positioning of the group, smart appliances, overseas business development, and mergers and

acquisitions

Helping Haier to improve its incentive scheme and performance evaluation mechanism

Optimising the group’s capital structure

Further improving the operational efficiency of the group

As we showed in the chapter “New trends and new strategies”, Qingdao Haier is behind Midea in terms

of management shareholding, option plans and direct compensation. If KKR is able to help improve

management incentives, we believe more value can be unlocked for shareholders.


In terms of domestic sales, Qingdao Haier sells directly to third-party channels or its own sales offices

under Haier Electronics’ ICS. Its own sales network is managed under the ICS under Haier Electronics.

Haier Electronics’ ICS covers the specialty store channel and part of online sales, altogether accounting

for close to 70% of Qingdao Haier’s total sales. Third-party channels include national consumer

electronics chains, supermarket chains and other regional chain stores, covering close to 30% of its sales.

Qingdao Haier’s own sales & distribution network now has nine freight forward centres, 90 distribution

centres, 2m square meters of warehouses and storage areas, 7,600 country-level specialty stores, 26,000

township-level specialty stores, 190,000 village contact stations, and a logistics network that

includes17,000 service stations, which cover all 2,800 counties in China.

Under its own ICS, inventories are sold directly to its own sales offices, and its sales offices directly cover the

specialty stores. Sales offices offer an average credit term of 22 days to its franchisees. As Haier has a just-in-

time production model, it only carries about 19 days’ inventory in between its factories and the specialty stores.

By adding about 25 days’ inventory at the factory, Qingdao Haier has only 43 total inventory days in its supply

chain. It pays for the intersegment transaction to ICS at about 1.25% of goods value.

When Qingdao Haier sells into third-party national KA, like Gome and Suning, the company usually

gives them a credit term of two months.

In terms of export sales, Qingdao Haier has its own overseas sales and distribution network, and it pays

for connected transactions based on 1.5% of FOB prices.

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Earnings estimates

We derive our 2015-17e earnings by forecasting the revenue, gross margins, selling and administrative

operating costs, and net finance income respectively.

Revenue

Qingdao Haier has diversified revenue from white goods manufacturing to ICS. ICS accounted for 20%

of its revenue in 2014, and 75% of revenue was from white goods manufacturing. Qingdao Haier’s main

products are refrigerators, accounting for 28% of total revenue and 37% of white goods revenue in 2014.

Air conditioners, washing machines and small appliance accounted for 30%, 23% and 10% of its 2014

white goods revenue, respectively.

We forecast Qingdao Haier to deliver a 9.2% revenue CAGR in 2014-17 and 5.5% y-o-y revenue growth in

2015. We estimate the growth for white goods and ICS would be 8.7% and 9.2%, respectively, in 2015.

However, we expect equipment parts sales to decline by 45% y-o-y in 2015 as Qingdao Haier continues to

lower the connected transaction with its parent on parts procurement that started from 2H14. Equipment parts

sales accounted for 5% of its revenue in 2014 and we expect that to decline to 2% in 2015.

For white goods manufacturing, we forecast revenue using a bottom-up approach based on volume

market share and ASP growth. Refrigerator revenue in 2015 is forecasted to grow by 4.6% y-o-y, while

air conditioner and washing machine revenue should grow 12.6% and 4.9%, respectively. Our key

assumptions are summarised in Figure 133.

Figure 132. Qingdao Haier domestic sales breakdown by channels


KA 20%

Specialty stores65%

Online8%

Supermarkets7%

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Figure 133. Qingdao Haier white goods appliance forecasts (RMBm)

2014a 2015e 2016e 2017e CAGR (2014-17e)

Refrigerator forecasts Sales from Refrigerators 24,668 26,595 28,403 29,834 6.5%

y-o-y % -2.6% 7.8% 6.8% 5.0% Total volume ('000 unit) 16,513 17,285 18,098 18,636 4.1%

y-o-y % -1.5% 4.7% 4.7% 3.0% Total ASP (RMB) 1,494 1,539 1,569 1,601 2.3%

y-o-y % -1.1% 3.0% 2.0% 2.0% Domestic Refrigerators - Sales volume ('000 unit): IOL 52,981 55,440 58,033 59,654 4.0%

y-o-y % -5.2% 4.6% 4.7% 2.8% - Haier market share (%): IOL 28.6% 28.6% 28.6% 28.6% Export Refrigerators - Sales volume ('000 unit): IOL 23,307 24,473 25,696 26,981 5.0%

y-o-y % 11.0% 5.0% 5.0% 5.0% - Haier market share (%): IOL 5.9% 5.9% 5.9% 5.9% Air Conditioner forecasts Sales from Air Conditioners 20,012 22,529 25,321 28,416 12.4%

y-o-y % 11.6% 12.6% 12.4% 12.2% Total volume ('000 unit) 9,392 10,366 11,423 12,568 10.2%

y-o-y % 10.5% 10.4% 10.2% 10.0% Total ASP (RMB) 2,131 2,173 2,217 2,261 2.0%

y-o-y % 1.0% 2.0% 2.0% 2.0% Domestic Air Conditioners - Sales volume ('000 unit): IOL 70,010 74,401 79,072 84,042 6.3%

y-o-y % 12.3% 6.3% 6.3% 6.3% - Haier market share (%): IOL 9.8% 10.3% 10.8% 11.3% Export Air Conditioners - Sales volume ('000 unit): IOL 46,786 48,189 49,635 51,124 3.0%

y-o-y % -4.1% 3.0% 3.0% 3.0% - Haier market share (%): IOL 5.5% 5.7% 5.9% 6.1% Washing Machine forecasts Sales from Washing Machines 15,273 16,020 16,803 17,624 4.9%


y-o-y % 6.0% 4.9% 4.9% 4.9% Total ASP (RMB) 1,041 1,041 1,041 1,041 0.0%

y-o-y % 0.4% 0.0% 0.0% 0.0% Domestic Washing Machines - Sales volume ('000 unit): IOL 38,528 40,154 41,848 43,613 4.2%

y-o-y % 2.2% 4.2% 4.2% 4.2% - Haier market share (%): IOL 33.5% 33.8% 34.1% 34.4% Export Washing Machines - Sales volume ('000 unit): IOL 19,370 19,951 20,549 21,166 3.0%

y-o-y % 6.2% 3.0% 3.0% 3.0% - Haier market share (%): IOL 9.2% 9.2% 9.2% 9.2% Water Heater forecasts Sales from Water Heaters 4,534 4,876 5,228 5,603 7.3%


y-o-y % -11.5% 5.4% 4.6% 4.6% Total ASP (RMB) 1,020 1,040 1,066 1,093 2.3%

y-o-y % 17.7% 2.0% 2.5% 2.5% - Sales volume ('000 unit): IOL 25,865 27,112 28,117 29,151 4.1%

y-o-y % -6.1% 4.8% 3.7% 3.7% - Haier market share (%): IOL 17.2% 17.3% 17.4% 17.6%


Small appliances, including water heaters accounted for 7.2% of 2014 revenue, and non-heater appliances

accounted for only 2% of revenue. About 70% of the other appliances are kitchen wares, and we expect

other appliances to grow by 12.5%, 13% and 13.5% in 2015, 2016 and 2017, respectively.

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ICS, which accounted for 19.5% of total revenue in 2014, provides distribution and logistics services to

third parties. In 2014, about two-thirds of the ICS revenue was from the third-party (3P) ICS under Haier

Electronics, and the rest 3P ICS revenue was from assets or business owned by Qingdao Haier only. Since

2011, Qingdao Haier has gradually injected ICS assets into Haier Electronics, so we expect non-Haier

Electronics ICS revenue to decline by 15% per annum in our forecast period as the asset injection

continues. We expect 3P ICS from Haier Electronics to grow by 21%, 33% and 35% in 2015, 2016 and

2017, respectively (consistent with our estimates for Haier Electronics), as we expect its distribution

revenue to grow at an 11% CAGR in 2014-2017 and logistics revenue to grow at an 82% CAGR. Based

on the above assumptions, overall ICS revenue is expected to grow by 9.2% in 2015 and by 20.1% and

26.1% in 2016 and 2017.

The company’s equipment parts sales have has been declining since 2H11 as Qingdao Haier tries to

internalise its parts procurement by reducing connected transactions with its parent. Although the decline

in revenue has a minimal impact on the bottom line, the process should be completed in 2015 as it targets

to reduce connected transactions with the parent to below 30%. We expect equipment sales to further

decline by 45% in 2015 and then remain stable in 2016 and 2017.

Altogether, we estimate the total revenue of the company will rise to RMB93.7bn in 2015, up 5.5% y-o-y,

and growing at a 9.2% CAGR in 2014-17.

Figure 134. Qingdao Haier revenue breakdown Figure 135. Qingdao Haier gross profit breakdown


Gross profit margin

The cyclical drivers for GPM are:


Price wars: these could lower selling prices and, therefore, GPM

Currency fluctuations: RMB appreciation leads to a cut in FOB export prices and lower export GPM


ASP and product mix: a greater sales contribution from high-end/new products lift GPM



27.8%

28.4%

27.4%

25.8%

22.5%

24.1%

24.5%

24.6%

17.2%

17.1%

16.2%

15.3%

7.3%

7.5%

7.4%

7.2%

19.6%

20.3%

22.1%

25%

0 20 40 60 80 100 120 140

2014

2015

2016

2017

Refridgerator Air conditionerWashing machine Water heater + small applianceICS Equipment partsNon-main business

32.4%

31.4%

30.8%

29.6%

24.9%

26.4%

27.2%

28.0%

20.7%

19.8%

19.1%

18.4%

11.1%

10.9%

10.9%

10.9%

5.0%

6.8%

7.8%

9.4%

0 5 10 15 20 25 30 35 40

2014

2015

2016

2017

Refridgerator Air conditionerWashing machine Water heater + small applianceICS Equipment partsNon-main business

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Regional mix: the share of exports in total sales; more exports leads to a lower blended GPM.

Exports represented 12% of its core business sales in 2014

As discussed earlier, Qingdao Haier has a direct sales model in which it sells directly to its own sales

office, and its revenue is net of sales rebates to distributors/franchisees, so its GPM is good reflection off

the above factors. In contract, for Midea and Gree we should look at contribution margin, which is GPM

minus selling and marketing expenses by considering changes in the whole sales prices and promotion

subsidies paid to the distributor altogether. In Figure 136, we listed our keep assumptions for GPM.

We forecast the GPM of Qingdao Haier to expand by 237bp to 29.9% in 2015, mainly driven by declines

in raw material costs. As we estimated earlier in the chapter “2015: better 2H over 1H”, for every 10%

movement in the raw materials for air conditioners, refrigerators and washing machines, the GPM will on

average expand by 5-6 ppt. For the year to date, the blended average costs for making refrigerators, air

conditioners, washing machines and heaters have declined by 10%, 8%, 7% and 8%, respectively.

We expect equipment parts GPM to go up to 49.5% in 2015 as a result of a reduction in revenue under

connected transactions with the parent.

The gross profit of the company is expected to increase by 14.6% in FY15 to RMB27,993m from

RMB24,430m in 2014.

Looking at the contribution margin, we foresee most of the benefit of the GPM expansion to filter through

to the bottom line. We expect the contribution margin to expand by 190bp to 16.3% in 2015.


2013a 2014a 2015e 2016e 2017e

Gross Profit (RMBm) 21,945 24,430 27,993 30,864 34,009y-o-y Growth 11.32% 14.58% 10.26% 10.19%

Overall GPM 25.3% 27.5% 30.1% 30.0% 29.6%Refrigerators 30.0% 32.1% 33.1% 33.5% 33.8%

Air conditioners 28.5% 30.4% 32.9% 33.2% 33.5%Washing machines 32.9% 33.2% 34.7% 35.2% 35.5%

Water heaters + small appliances 41.5% 42.3% 43.3% 43.8% 44.3%Integrated channel services 4.8% 7.0% 10.0% 10.5% 11.0%

Equipment parts 14.6% 24.5% 49.5% 49.5% 49.5%


Selling general and administrative

We forecast total SGA to grow 9.3% y-o-y in 2015 and at an 8.4% CAGR in 2014-17. We estimate

selling and distribution expenses to grow 11.0% y-o-y in 2015, with 14.6% growth in gross profit and

5.5% growth in revenue, and administrative expenses to grow by 6% y-o-y.

We expect the SGA cost-to-sales ratio to increase to 20.5% in 2015 from 19.8% in 2014.

From 2010 to 1H14, Qingdao Haier’s selling and distribution cost ratio has gradually declined, benefiting from

the lower cost enjoyed from its internal distribution channel. In June 2010, Haier lowered the sales margin

granted to its own sales companies to 1.75% from 2.25%, and it was further lowered to 1.25% in April 2011. In

terms of export, it pays its internal sales companies 1.5% on FOB prices.

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In 2015, we expect the selling and distribution expenses ratio to go up because of: 1) the reduction in

revenue related to equipment parts; and 2) higher expenses on price wars on air conditioners, especially in

1H15. We expect the ratio to come down after 2015.

Figure 137. Expense ratios vs. contribution margin


Operating profit

Based on revenue, GPM and SGA forecasts, we expect EBIT to grow at a 19.5% 2014-17 CAGR. We

expect FY15 EBIT to increase by 29.1% to RMB8,491m with 166bp of expansion in the EBIT margin to

9.1% driven mostly by declining raw material costs.

Figure 138. Operating profit


Net finance income

As discussed later in cash flow analysis, Qingdao Haier generates negative working capital inflows from

its operations with a negative working capital cycle. We forecast net interest income of RMB559,

RMB656 and RMB746 in 2015, 2016, and 2017, respectively.

12.1% 11.9%13.0%

13.7% 13.5% 13.2%

6.5% 6.3% 6.8% 6.8% 6.5% 6.2%

13.2% 13.4%14.5%

16.2% 16.3% 16.2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

2012 2013 2014 2015e 2016e 2017e

Selling and Distribution Expense to Sales ratio Admin Expense to Sales Expense ratio Contribution Margin

4,9945,841

6,577

8,4919,786

11,218

6.3%6.7%

7.4%

9.1% 9.5% 9.7%

0%

2%

4%

6%

8%

10%

12%

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2012 2013 2014 2015e 2016e 2017e

RM

Bm

EBIT EBIT Margin (RHS)

16.8%12.6%

29.1%15.3%

14.6%

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Figure 139. Net finance income (RMBm)

2013a 2014a 2015e 2016e 2017e

Interest income 285 540 559 656 746 Cash Balance 20,641 28,644 28,531 32,413 37,348 Interest Income Rate 1.4% 1.9% 2.0% 2.0% 2.0% Interest Cost -105 -129 -129 -147 -167 Gross Debt Balance 1,891 2,809 3,199 3,651 4,173 Interest Cost Rate 5.6% 4.6% 4.0% 4.0% 4.0% Net Interest Income 179 411 430 510 578


Net profit

Factoring in the dividend payout ratio for minority shareholders and the effective tax rate, we forecast net

profit to grow 16.5% y-o-y in 2015 to RMB5,770m from RMB4,992m in 2014. We expect net profit to

grow at a CAGR of 15.7% in 2014-17 with revenue rising at a 9.2% CAGR. We are more or less in line

with consensus on our 2015 net profit forecast (0.4% below).

However, there are two ways in which we can gauge its profit growth. The first is based on the standard

approach used by HSBC to assess the core profit of Hong Kong-listed stocks, stripping out all non-

operational gains and losses. The second is reported core profit, which is the company’s own measure of

core profit, and usually includes some financial gains and losses that would be considered non-core by

HSBC.

Our net profit forecasts do not include that for non-core and non-recurring items. Figure 140. HSBC estimates vs. Consensus

RMBm ______________ 2015e ________________ ________________ 2016e _________________ _____________ 2017e ______________ HSBC estimates Consensus % diff HSBC estimates Consensus % diff HSBC estimates Consensus % diff

Total revenue 93,669 97,256 -3.7% 103,518 104,043 -0.5% 115,541 112,393 3%Operating profit 8,491 8,269 2.7% 9,786 9,665 1.2% 11,218 10,504 7%Profit 5,770 5,794 -0.4% 6,700 6,708 -0.1% 7,729 7,827 -1%


Cash flows

We conduct our cash flow forecasts based on working capital forecasts, capex forecasts, and dividend

payout.

Our working capital forecasts assumptions are listed in Figure 141. Qingdao Haier has negative working

capital days of 14 days in 2014, which steadily shortened to 6 days in 2015 by assuming the price war in

the air conditioner market will prolong the working capital cycle.

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Figure 141: Working Capital

2013a 2014a 2015e 2016e 2017e

Inventory Turnover Days 39.0 42.9 42.9 42.9 42.9 Raw materials 15.2 14.2 14.2 14.2 14.2

Trade + Bills Receivable Days 84.5 89.3 89.8 90.3 90.8 Trade + Bills+ Deferred rev Payable Days 166.0 180.6 182.8 185.2 187.5 Working Capital Days (Working Capital*365/ COGs) -13.9 -14.4 -6.4 -7.2 -8.5


We forecast RMB4bn capex in 2015 and RMB2.5bn annually in 2016 and 2017. Of the RMB4bn capex

we expect in 2015, we assume: 1) RMB2bn of investments in smart factories; 2) RMB1.2bn on Sinopec

marketing; and 3) the rest on investments in logistics and acquisitions.

Our capex forecasts do not consider acquisitions from its parent.

Qingdao Haier has a dividend policy of paying out more than 20% earnings. It consistently paid out 30%

each year in 2012-14. We forecast the dividend payout ratio to remain stable at 30% going forward.

As per our forecasts in Figure 142, we estimate its net cash position to increase to RMB33.1bn by the end

of 2017 from RMB25.8bn at the end of 2014.


2013a 2014a 2015e 2016e 2017e

Net cash from operating activities 6,511 7,007 5,230 7,941 9,233 Net cash from investing activities -1,382 -3,251 -4,000 -2,500 -2,500 - Capex -1,757 -2,005 -4,000 -2,500 -2,500 Net cash from financing activities -925 4,359 -1,343 -1,559 -1,799 Net increase in cash 4,205 8,115 -113 3,882 4,935 Cash at beginning of year 16,243 20,421 28,644 28,531 32,413 Cash at end of year 20,421 28,539 28,531 32,413 37,348 (Net Debt)/ Net Cash 18,751 25,835 25,332 28,762 33,175 as % of equity 94% 89% 76% 76% 77%


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Figure 142. Qingdao Haier earnings estimate summary

(RMBm) Year ended 31 December 2010a 2011a 2012a 2013a-restated

2014a 2015e 2016e 2017e

Sales 60,588 73,663 79,857 86,606 88,775 93,669 103,518 115,541Gross profit 14,168 17,399 20,153 21,945 24,430 27,993 30,864 34,009Total operating expenses -11,232 -13,153 -14,818 -15,786 -17,573 -19,206 -20,744 -22,409 - Selling & distribution expenses -7,815 -9,099 -9,629 -10,307 -11,578 -12,852 -14,008 -15,269 - Admin expenses -3,417 -4,053 -5,189 -5,479 -5,995 -6,354 -6,736 -7,140EBIT 3,446 4,169 4,994 5,841 6,577 8,491 9,786 11,218Net interest income 74 118 122 179 411 430 510 578PBT 3,707 4,414 5,428 6,724 8,047 9,207 10,582 12,083Net income (loss) 2,029 2,690 3,269 4,174 4,992 5,770 6,700 7,729HSBC Net income (loss) 1,823 2,542 2,922 3,433 3,870 5,420 6,350 7,379Reported Core Profit 1,643 2,438 3,177 3,759 4,324 5,770 6,700 7,729Margins Overall GPM 23.4% 23.6% 25.2% 25.3% 27.5% 29.9% 29.8% 29.4%Contribution Margin 10.5% 11.3% 13.2% 13.4% 14.5% 16.2% 16.3% 16.2%SGA / Revenue ratio 18.5% 17.9% 18.6% 18.2% 19.8% 20.5% 20.0% 19.4%

S&D 12.9% 12.4% 12.1% 11.9% 13.0% 13.7% 13.5% 13.2%Admin 5.6% 5.5% 6.5% 6.3% 6.8% 6.8% 6.5% 6.2%

OPM 5.7% 5.7% 6.3% 6.7% 7.4% 9.1% 9.5% 9.7%PBT margin 6.1% 6.0% 6.8% 7.8% 9.1% 9.8% 10.2% 10.5%Net margin 3.3% 3.7% 4.1% 4.8% 5.6% 6.2% 6.5% 6.7%HSBC Net Margin 3.0% 3.5% 3.7% 4.0% 4.4% 5.8% 6.1% 6.4%Reported Core Margin 2.7% 3.3% 4.0% 4.3% 4.9% 6.2% 6.5% 6.7%y-o-y % Revenue 83.7% 21.6% 8.4% NA 2.5% 5.5% 10.5% 11.6%GP 62.5% 22.8% 15.8% NA 11.3% 14.6% 10.3% 10.2%Selling & distribution expenses 56.8% 16.4% 5.8% NA 12.3% 11.0% 9.0% 9.0%Admin expenses 61.5% 18.6% 28.0% NA 9.4% 6.0% 6.0% 6.0%OP 119.3% 21.0% 19.8% NA 12.6% 29.1% 15.3% 14.6%PBT 113.0% 19.1% 23.0% NA 19.7% 14.4% 14.9% 14.2%Reported Net profit 76.5% 32.6% 21.5% NA 19.6% 15.6% 16.1% 15.4%HSBC Net Income 79.3% 39.4% 15.0% NA 12.7% 40.1% 17.2% 16.2%Reported Core Profit 53.9% 48.4% 30.3% NA 15.0% 33.4% 16.1% 15.4%


1Q15 results

1Q15 sales growth recovered from 4Q14. Qingdao Haier recorded a 2.3% y-o-y decline in revenue,

representing an improvement from the 8.3% decline in 4Q14. On an adjusted basis, its 1Q15 revenue

grew above 2%. From the company disclosures of Haier Electronics, we note that washing machine and

heater sales grew 6.6% y-o-y in 1Q15, up from the 1% growth seen in 4Q14, and ICS growth picked up to

1.8% from the 4.3% decline seen in 4Q14. Its net profit grew 12.9% y-o-y and reported core net profit

grew 15.3%.

GPM expansion drove growth in EBIT. Thanks to a better product mix and declining raw material

costs, its GPM expanded by 2.9ppt to 27.7%, leading to a 9% gross in operating profit on flat revenue. Its

EBIT grew 12% y-o-y, thanks to effective cost control.

Smart appliances recorded fast growth. In 1Q15, Qingdao Haier sold 500,000 units of smart

appliances, including refrigerators, washing machines, air conditioners and water heaters. The volume

grew 400% y-o-y. Haier continues to make progress on the development of its U+ Smart System. The

company has enabled connectivity among devices through the U+ system; the next step is to facilitate

interaction between consumers and devices.

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Valuation and risks






DCF assumptions include a 5.5% China equity risk premium and a 0% terminal growth rate. Qingdao

Haier has a 6% cost of debt and a target 10:90 debt-to-equity ratio. Its company-specific beta is 0.90,

yielding 8.5% cost of equity and, therefore, a cost of capital of 8.1%.


for the semi-explicit forecast period.

Based on these assumptions, our DCF-based fair value target price is RMB35.9, implying 18% upside

against the 2 June closing price. We initiate coverage of the stock with a Buy rating.

Our fair value target price implies PE multiples of 18.4x on 2015e EPS and 16.3x on 2016e EPS, and a

1.2x PEG on our forecast of a 15.7% CAGR in profit for 2014-17e.

Catalysts: better-than-expected GPM; sales recovery in air conditioners; fast growth in the number of

users of its U+ smart appliance systems.

Key downside risks: raw material price fluctuations; faster-than-expected rise in operating costs.

Figure 144. Qingdao Haier PE Band Chart Figure 145. Qingdao Haier PB Band Chart vs. ROE

Source: Thomson Reuters Datastream, HSBC estimates Source: Thomson Reuters Datastream, HSBC estimates

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Financials & valuation: Gree Electric Appliances Buy Financial statements

Year to 12/2014a 12/2015e 12/2016e 12/2017e

Profit & loss summary (RMBm)

Revenue 140,005 150,785 167,984 187,636EBITDA 18,241 20,029 23,364 27,014Depreciation & amortisation -1,357 -1,480 -1,616 -1,759Operating profit/EBIT 16,884 18,549 21,748 25,255Net interest 1,021 1,083 1,403 1,941PBT 16,752 19,633 23,152 27,196HSBC PBT 17,751 19,633 23,152 27,196Taxation -2,499 -2,929 -3,454 -4,058Net profit 14,155 16,589 19,562 22,979HSBC net profit 15,154 16,589 19,562 22,979

Cash flow summary (RMBm)

Cash flow from operations 20,931 23,942 33,687 39,234Capex -1,777 -1,500 -1,500 -1,500Cash flow from investment -2,862 -1,500 -1,500 -1,500Dividends -9,024 -8,294 -9,781 -11,490Change in net debt -14,859 -14,040 -22,406 -26,244FCF equity 3,713 8,802 15,276 18,604

Balance sheet summary (RMBm)

Intangible fixed assets 4,630 4,549 4,468 4,387Tangible fixed assets 16,702 16,803 16,768 16,590Current assets 120,143 147,222 179,628 217,388Cash & others 54,546 70,164 94,470 122,782Total assets 156,231 183,330 215,620 253,121Operating liabilities 104,788 122,015 142,624 166,567Gross debt 5,838 7,416 9,316 11,384Net debt -48,708 -62,748 -85,154 -111,399Shareholders’ funds 44,153 52,447 62,228 73,718Invested capital -17,859 -23,605 -36,230 -50,984

Ratio, growth and per share analysis

Year to 12/2014a 12/2015e 12/2016e 12/2017e

Y-o-y % change

Revenue 16.6 7.7 11.4 11.7EBITDA 45.9 9.8 16.7 15.6Operating profit 49.8 9.9 17.2 16.1PBT 29.9 17.2 17.9 17.5HSBC EPS 53.7 9.5 17.9 17.5

Ratios (%)

Revenue/IC (x) -10.6 -7.3 -5.6 -4.3ROIC -109.7 -76.5 -62.1 -49.4ROE 38.5 34.3 34.1 33.8ROA 10.0 10.0 10.0 10.0EBITDA margin 13.0 13.3 13.9 14.4Operating profit margin 12.1 12.3 12.9 13.5EBITDA/net interest (x) - - - -Net debt/equity -107.9 -117.4 -134.7 -149.1Net debt/EBITDA (x) -2.7 -3.1 -3.6 -4.1CF from operations/net debt - - - -

Per share data (RMB)

EPS Rep (fully diluted) 4.71 5.52 6.50 7.64HSBC EPS (fully diluted) 5.04 5.52 6.50 7.64DPS 3.00 2.76 3.25 3.82Book value 14.68 17.44 20.69 24.51

Key forecast drivers

Year to 12/2014a 12/2015e 12/2016e 12/2017e

Air conditioners Growth Rate 0.13 0.05 0.09 0.09Small appliances growth rate 0.10 0.10 0.10 0.10Overall GPM 0.37 0.34 0.36 0.36SGA growth rate 0.22 -0.05 0.15 0.11

Valuation data

Year to 12/2014a 12/2015e 12/2016e 12/2017e

EV/sales 1.0 0.8 0.6 0.4EV/EBITDA 7.3 6.0 4.2 2.6EV/IC PE* 12.4 11.3 9.6 8.2P/Book value 4.3 3.6 3.0 2.6FCF yield (%) 2.0 4.8 8.4 10.2Dividend yield (%) 4.8 4.4 5.2 6.1

Note: * = Based on HSBC EPS (fully diluted)

Issuer information

Share price (RMB)62.53 Target price (RMB)77.20 2

3.5

Reuters (Equity) 000651.SZ Bloomberg (Equity) 000651 CHMarket cap (USDm) 30,330 Market cap (RMBm) 188,082Free float (%) 100 Enterprise value (RMBm) 119,778Country China Sector Household DurablesAnalyst Lina Yan Contact +852 2822 4344

Price relative

Source: HSBC Note: price at close of 04 Jun 2015

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Financials & valuation: Qingdao Haier Co Ltd Buy Financial statements

Year to 12/2014a 12/2015e 12/2016e 12/2017e


Revenue 88,775 93,669 103,518 115,541EBITDA 7,360 9,343 10,735 12,266Depreciation & amortisation -783 -853 -949 -1,048Operating profit/EBIT 6,577 8,491 9,786 11,218Net interest 411 430 510 578PBT 8,047 9,207 10,582 12,083HSBC PBT 6,925 8,857 10,232 11,733Taxation -1,354 -1,522 -1,718 -1,925Net profit 4,992 5,770 6,700 7,729HSBC net profit 3,870 5,420 6,350 7,379


Cash flow from operations 7,007 5,230 7,941 9,233Capex -2,005 -4,000 -2,500 -2,500Cash flow from investment -3,251 -4,000 -2,500 -2,500Dividends -1,591 -1,733 -2,012 -2,321Change in net debt -7,084 502 -3,429 -4,413FCF equity 4,739 2,858 7,319 8,876


Intangible fixed assets 75 75 75 75Tangible fixed assets 8,087 11,312 12,940 14,470Current assets 59,475 61,815 69,385 78,875Cash & others 28,644 28,531 32,413 37,348Total assets 75,006 80,494 89,615 100,557Operating liabilities 42,930 43,990 47,970 52,982Gross debt 2,809 3,199 3,651 4,173Net debt -25,835 -25,332 -28,762 -33,175Shareholders’ funds 21,461 25,499 30,188 35,596Invested capital -3,863 754 2,091 3,164


Year to 12/2014a 12/2015e 12/2016e 12/2017e

Y-o-y % change


Ratios (%)

Revenue/IC (x) -24.8 -60.3 72.8 44.0ROIC -154.6 -460.1 580.8 361.4ROE 21.5 23.1 22.8 22.4ROA 10.0 10.0 10.6 10.8EBITDA margin 8.3 10.0 10.4 10.6Operating profit margin 7.4 9.1 9.5 9.7EBITDA/net interest (x) - - - -Net debt/equity -89.9 -77.3 -76.8 -77.4Net debt/EBITDA (x) -3.5 -2.7 -2.7 -2.7CF from operations/net debt - - - -




Year to 12/2014a 12/2015e 12/2016e 12/2017e

Refrigerator Growth Rate -0.03 0.08 0.07 0.05Air conditioner Growth Rate 0.12 0.13 0.12 0.12Washing machine Growth Rate 0.06 0.05 0.05 0.05Small Appliances Growth Rate 0.14 0.13 0.13 0.14Overall GPM 0.28 0.30 0.30 0.30SGA Growth 0.11 0.09 0.08 0.08

Valuation data

Year to 12/2014a 12/2015e 12/2016e 12/2017e

EV/sales 0.8 0.8 0.7 0.5EV/EBITDA 9.5 7.6 6.3 5.1EV/IC - 93.7 32.2 19.9PE* 24.8 17.7 15.1 13.0P/Book value 4.5 3.8 3.2 2.7FCF yield (%) 4.9 3.0 7.6 9.2Dividend yield (%) 1.7 1.8 2.1 2.4


Issuer information


3.9

Reuters (Equity) 600690.SS Bloomberg (Equity) 600690 CHMarket cap (USDm) 15,488 Market cap (RMBm) 96,044Free float (%) 100 Enterprise value (RMBm) 70,699Country China Sector Household DurablesAnalyst Lina Yan Contact +852 2822 4344

Price relative


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Financials & valuation: Midea Group Co Ltd Buy Financial statements

Year to 12/2014a 12/2015e 12/2016e 12/2017e


Revenue 142,311 160,011 181,237 205,112EBITDA 17,333 21,176 23,855 27,218Depreciation & amortisation -3,320 -3,536 -3,747 -3,953Operating profit/EBIT 14,012 17,640 20,108 23,265Net interest 165 522 677 931PBT 13,991 17,980 20,604 24,014HSBC PBT 13,991 17,980 20,604 24,014Taxation -2,344 -2,967 -3,400 -3,962Net profit 10,502 13,395 15,350 17,890HSBC net profit 10,273 13,395 15,350 17,890


Cash flow from operations 24,789 19,369 22,851 25,389Capex -2,678 -4,000 -4,000 -4,000Cash flow from investment -28,862 -4,000 -4,000 -4,000Dividends -4,216 -5,377 -6,162 -7,181Change in net debt 4,733 -9,992 -12,690 -14,207FCF equity 24,932 17,169 20,887 23,732


Intangible fixed assets 7,122 6,161 5,200 4,239Tangible fixed assets 20,184 21,609 22,823 23,832Current assets 86,427 98,364 117,133 134,370Cash & others 9,772 16,671 29,375 39,806Total assets 120,292 132,694 151,716 169,000Operating liabilities 67,586 75,062 84,883 95,234Gross debt 6,855 3,762 3,776 0Net debt -2,917 -12,909 -25,598 -39,806Shareholders’ funds 39,470 47,489 56,677 67,385Invested capital 42,876 40,902 37,400 33,902


Year to 12/2014a 12/2015e 12/2016e 12/2017e

Y-o-y % change


Ratios (%)

Revenue/IC (x) 3.7 3.8 4.6 5.8ROIC 32.6 37.1 44.9 56.7ROE 28.4 30.8 29.5 28.8ROA 10.9 12.0 12.2 12.6EBITDA margin 12.2 13.2 13.2 13.3Operating profit margin 9.8 11.0 11.1 11.3EBITDA/net interest (x) - - - -Net debt/equity -6.4 -24.0 -40.7 -54.0Net debt/EBITDA (x) -0.2 -0.6 -1.1 -1.5CF from operations/net debt - - - -




Year to 12/2014a 12/2015e 12/2016e 12/2017e

Air conditioners growth rate 0.17 0.12 0.14 0.14Refrigerators growth rate 0.20 0.16 0.13 0.10Washing machines growth rate 0.24 0.17 0.15 0.15Small appliances growth rate 0.17 0.10 0.10 0.10Overall GPM 0.25 0.27 0.27 0.28SGA Growth Rate 0.16 0.15 0.15 0.14

Valuation data

Year to 12/2014a 12/2015e 12/2016e 12/2017e

EV/sales 1.1 0.9 0.7 0.6EV/EBITDA 8.9 6.8 5.5 4.3EV/IC 3.6 3.5 3.5 3.5PE* 15.6 12.0 10.4 9.0P/Book value 4.1 3.4 2.8 2.4FCF yield (%) 15.8 10.9 13.3 15.1Dividend yield (%) 2.6 3.4 3.8 4.5


Issuer information


3.3

Reuters (Equity) 000333.SZ Bloomberg (Equity) 000333 CHMarket cap (USDm) 25,854 Market cap (RMBm) 160,327Free float (%) 100 Enterprise value (RMBm) 144,639Country China Sector Household DurablesAnalyst Lina Yan Contact +852 2822 4344

Price relative


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cGree Electric DCF valuation (RMBm)

NPV of cash flows 171,670 Net cash (debt) 60,687

Equity value 232,357 Number of shares (m) 3,008 Value per share (RMB) 77.2 Explicit Explicit Explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Terminal Free cash flow calculation 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Sales 150,785 167,984 187,636 197,017 206,868 217,212 228,072 234,914 241,962 249,221 256,697 Sales growth 8% 11% 12% 5% 5% 5% 5% 3% 3% 3% 3% EBIT 18,549 21,748 25,255 23,642 23,790 24,979 26,228 21,142 21,777 22,430 23,103 EBIT margin 12.3% 12.9% 13.5% 12.0% 11.5% 11.5% 11.5% 9.0% 9.0% 9.0% 9.0% NOPAT 13,912 16,311 18,941 17,732 17,842 18,735 19,671 15,857 16,332 16,822 17,327 Depreciation 1,398 1,535 1,678 1,718 1,758 1,798 1,838 1,868 1,898 1,928 1,958 Gross cash flow 15,310 17,846 20,619 19,450 19,600 20,532 21,509 17,725 18,230 18,750 19,285 Less minority interest EBITDA 105 122 141 133 134 141 148 122 125 129 132 Increase in working capital -7,881 -4,537 -4,794 -2,345 -2,463 -2,586 -2,715 -1,711 -1,762 -1,815 -1,869 Chg in WC as a % of inc sales -73.1% -26.4% -24.4% -25.0% -25.0% -25.0% -25.0% -25.0% -25.0% -25.0% -25.0% Maintenance Capex 1,000 1,000 1,000 800 800 800 800 600 600 600 600 Free cash flow 6,324 12,186 14,684 16,171 16,203 17,006 17,846 15,293 15,743 16,207 16,684 178,633 Year 1 2 3 4 5 6 7 8 9 10 11 11 WACC 8.60% PV of cash flow 5,824 10,332 11,465 11,625 10,726 10,366 10,017 7,904 7,493 7,102 6,732 72,083 NPV of cash flows 171,670 Number of shares (m) 3,008 Long-term growth rate 0% WACC calculation Cost of equity 9.0% Cost of debt 6.0% Tax rate 25.0% Target equity ratio 90% Target debt ratio 10% Risk free rate (Rf) 3.5% Equity risk premium 5.5% Specific beta 1.00 WACC 8.6%


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cQingdao Haier DCF valuation (RMBm)


Equity value 109,452 Number of shares (m) 3,046 Value per share (RMB) 35.9 Explicit Explicit Explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Terminal Free cash flow calculation 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Sales 93,669 103,518 115,541 122,474 129,822 137,611 145,868 153,161 160,819 168,860 177,303 Sales growth 6% 11% 12% 6% 6% 6% 6% 5% 5% 5% 5% EBIT 8,491 9,786 11,218 11,023 11,684 12,385 13,128 12,253 12,866 13,509 14,184 EBIT margin 9.1% 9.5% 9.7% 9.0% 9.0% 9.0% 9.0% 8.0% 8.0% 8.0% 8.0% NOPAT 6,368 7,339 8,414 8,267 8,763 9,289 9,846 9,190 9,649 10,132 10,638 Depreciation 775 872 970 1,015 1,060 1,105 1,150 1,195 1,240 1,285 1,330 Gross cash flow 7,143 8,211 9,384 9,282 9,823 10,394 10,996 10,385 10,890 11,417 11,969 Less minority interest EBITDA 1,864 2,087 2,324 2,299 2,433 2,574 2,723 2,572 2,697 2,828 2,964 Increase in working capital -1,393 291 457 173 184 195 206 182 191 201 211 Chg in WC as a % of inc sales -28.5% 3.0% 3.8% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% Maintenance Capex 1,500 1,500 1,500 900 900 900 900 900 900 900 900 Free cash flow 2,386 4,916 6,017 6,257 6,674 7,115 7,579 7,095 7,484 7,890 8,315 94,968 Year 1 2 3 4 5 6 7 8 9 10 11 11 WACC 8.10% PV of cash flow 2,207 4,207 4,763 4,582 4,521 4,459 4,394 3,805 3,713 3,621 3,530 40,318 NPV of cash flows 84,120 Number of shares (m) 3,046 Long-term growth rate 0% WACC calculation Cost of equity 8.45% Cost of debt 6.0% Tax rate 25.0% Target equity ratio 90% Target debt ratio 10% Risk free rate (Rf) 3.5% Equity risk premium 5.5% Specific beta 0.90 WACC 8.1%


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cMidea DCF valuation (RMBm)


Equity value 197,734 Number of shares (m) 4,216 Value per share (RMB) 46.9 Explicit Explicit Explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Semi-explicit Terminal Free cash flow calculation 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Sales 160,011 181,237 205,112 219,470 234,833 251,271 268,860 282,303 296,418 311,239 326,801 Sales growth 12% 13% 13% 7% 7% 7% 7% 5% 5% 5% 5% EBIT 17,640 20,108 23,265 21,947 23,483 25,127 26,886 22,584 23,713 24,899 26,144 EBIT margin 11.0% 11.1% 11.3% 10.0% 10.0% 10.0% 10.0% 8.0% 8.0% 8.0% 8.0% NOPAT 13,230 15,081 17,449 16,460 17,612 18,845 20,164 16,938 17,785 18,674 19,608 Depreciation 2,575 2,786 2,992 3,032 3,072 3,112 3,152 3,182 3,212 3,242 3,272 Gross cash flow 15,805 17,867 20,441 19,492 20,684 21,957 23,316 20,120 20,997 21,916 22,880 Less minority interest EBITDA 1,704 1,926 2,203 2,101 2,229 2,367 2,513 2,169 2,263 2,362 2,466 Increase in working capital -2,190 -2,178 -2,433 -1,436 -1,536 -1,644 -1,759 -1,344 -1,412 -1,482 -1,556 Chg in WC as a % of inc sales -12.4% -10.3% -10.2% -10.0% -10.0% -10.0% -10.0% -10.0% -10.0% -10.0% -10.0% Maintenance Capex 1,000 1,000 1,000 800 800 800 800 600 600 600 600 Free cash flow 10,911 12,763 14,805 15,155 16,119 17,147 18,244 16,007 16,722 17,472 18,258 195,486 Year 1 2 3 4 5 6 7 8 9 10 11 11 WACC 8.60% PV of cash flow 10,047 10,821 11,559 10,896 10,670 10,452 10,240 8,273 7,958 7,657 7,367 78,884 NPV of cash flows 184,825 Number of shares (m) 4,216 Long-term growth rate 0% WACC calculation Cost of equity 9.0% Cost of debt 6.0% Tax rate 25.0% Target equity ratio 90% Target debt ratio 10% Risk free rate (Rf) 3.5% Equity risk premium 5.5% Specific beta 1.00 WACC 8.6%


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cWhite Goods Comp Table

CY Mkt-Cap Price Rev CAGR EPS CAGR ______ PE (x) ______ _____ PB (x) ______ ___ P/Sales (x) _____ __ EPS Growth ____ ______ ROE _______ Company BLM code End USD m Ccy 2-Jun (2014-16e) (2014-16e) CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e

Domestic Peers Gree Electric (TP: RMB77.2, Rating: Buy) 000651 CH Dec 31,565 RMB 64.2 9.5% 17.6% 13.6 11.6 9.9 4.4 3.7 3.1 1.4 1.3 1.2 30% 17% 18% 38% 34% 34% Midea (TP: RMB46.9, Rating: Buy) 000333 CH Dec 26,116 RMB 38.4 12.9% 20.9% 15.4 12.1 10.6 4.1 3.4 2.9 1.1 1.0 0.9 -21% 28% 15% 28% 31% 29% Qingdao Haier (TP: RMB35.9, Rating: Buy) 600690 CH Dec 15,130 RMB 30.9 8.0% 15.9% 18.9 16.3 14.1 4.4 3.7 3.1 1.1 1.0 0.9 7% 16% 16% 22% 23% 23% Hangzhou Robam App. 002508 CH Dec 3,326 RMB 42.4 31.6% 35.4% 36.5 26.8 19.9 8.2 6.3 5.0 5.7 4.4 3.3 44% 36% 35% 26% 26% 27% Zhejiang Supor 002032 CH Dec 3,065 RMB 30.0 15.4% 16.4% 27.6 23.5 20.3 5.0 4.3 3.7 2.0 1.7 1.5 17% 17% 15% 20% 19% 19% Zhejiang Dun'An Artificial Env. 002011 CH Dec 2,835 RMB 20.8 14.2% 61.2% 138.7 42.8 53.4 5.0 4.8 4.4 2.7 2.4 2.0 -40% 224% -20% 4% 5% 8% Guangdong Elecpro Elec. Appliance Hldg. 002260 CH Dec 2,487 RMB 58.1 70.5% 114.6% 468.2 403.2 101.7 43.8 43.2 38.0 22.3 15.0 7.7 NA 16% 297% 0% 16% 36% Hisense Kelon Elect.Hdg. 000921 CH Dec 2,483 RMB 14.1 12.9% 40.8% 28.2 15.0 14.2 5.5 4.3 3.8 0.6 0.5 0.5 -46% 88% 5% 22% 19% 17% Zhejiang Kangsheng 002418 CH Jan 2,380 RMB 38.9 -66.6% -64.1% 223.3 147.7 1,728.4 7.8 7.1 85.3 8.0 6.1 71.7 NA 51% -91% 3% 4% 0% Joyoung 002242 CH Dec 2,285 RMB 18.4 12.7% 11.4% 26.3 24.0 21.2 4.6 3.9 3.5 2.4 2.1 1.9 13% 10% 13% 18% 17% 17% Wuxi Little Swan 000418 CH Dec 2,242 RMB 24.0 15.1% 18.1% 21.8 18.6 15.6 3.4 2.9 2.4 1.3 1.1 1.0 69% 17% 19% 17% 16% 17% Jiangsu Changfa Refrig. 002413 CH Dec 2,214 RMB 62.2 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Guangdong Chant Gp. 002616 CH Dec 2,092 RMB 37.0 NA 104.9% 174.6 93.7 41.6 NA 7.4 6.5 NA 7.3 4.5 NA 86% 125% 6% 7% 17% Zhejiang Meida Industrial 002677 CH Dec 1,916 RMB 59.3 14.5% 16.6% 85.9 73.0 63.2 12.0 19.9 9.0 25.3 22.4 19.3 NA 18% 16% 15% 14% 14% Guangdong Xinbao Elect. App.Hdg. 002705 CH Dec 1,819 RMB 25.5 NA NA 52.0 43.2 NA 5.2 4.7 NA 2.0 1.8 NA -7% 20% NA 0% 12% 0% Guangdong Vanward New Electric 002543 CH Dec 1,710 RMB 24.1 18.5% 25.1% 39.6 29.9 25.3 4.1 3.5 3.0 2.7 2.2 1.9 8% 32% 18% 10% 12% 12% Zhenjiang Dongfang Elec. Heating Tech. 300217 CH Dec 1,554 RMB 24.3 42.5% 60.0% 93.6 53.2 36.5 8.3 7.3 6.4 9.4 6.6 4.6 14% 76% 46% 9% 12% 13% Changshu Tianyin Electromechanical 300342 CH Dec 1,507 RMB 46.6 28.0% 36.3% 106.0 70.5 57.0 11.8 8.8 9.6 22.8 16.4 13.9 -13% 50% 24% 12% 15% 17% Aucma 600336 CH Dec 1,493 RMB 13.6 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Vatti 002035 CH Dec 1,319 RMB 22.8 18.2% 25.8% 29.2 23.6 18.4 5.6 4.7 3.7 1.9 1.6 1.4 21% 24% 28% 21% 20% 20% Shai.Highly (Gp.) 600619 CH Dec 1,315 RMB 16.1 NA NA NA 42.4 NA NA 3.3 NA NA 0.8 NA NA NA NA 0% 8% 0% Guangdong Macro 000533 CH Dec 1,222 RMB 11.0 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Hefei Meiling 000521 CH Dec 1,144 RMB 10.2 9.3% 22.1% 26.4 21.7 17.7 2.3 2.1 1.9 0.7 0.6 0.6 8% 22% 22% 9% 9% 10% Huayi Compr 000404 CH Dec 1,111 RMB 12.3 14.4% 22.8% 36.7 29.5 24.3 3.3 3.1 2.8 1.0 0.8 0.8 12% 24% 21% 11% 10% 12% Zhejiang Aishida Elec. 002403 CH Dec 1,065 RMB 27.5 NA NA NA 66.2 49.6 NA 3.7 3.5 NA 2.6 2.2 NA NA 33% 0% 6% 7% Sichuan Yimikang Env. Tech 300249 CH Dec 995 RMB 35.0 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Jiangsu Chunlan Refrigg. Equ.Stk. 600854 CH Dec 984 RMB 11.7 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Guangdong Homa App. 002668 CH Dec 967 RMB 36.2 NA 24.9% 29.4 24.8 18.9 NA 3.4 2.9 NA 1.0 0.9 4% 19% 32% 0% 15% 16% Ningbo Snlt.Elect.Appc. 002473 CH Jan 853 RMB 33.0 -65.7% -63.5% 36.4 23.4 273.1 4.1 3.3 38.7 1.5 1.1 12.7 NA 56% -91% 10% 14% 1% Guangdong Huasheng Elect.App. 002670 CH Dec 604 RMB 18.7 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Average 11% 27% 78.6 55.7 119.8 7.6 6.8 11.1 5.8 4.2 7.1 7% 43% 27% 10% 12% 12%

Source: Thomson Reuters Datastream, I/B/E/S consensus estimates, HSBC estimates for covered companies. Ranked by market cap (USD). calendarised to December.

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cWhite Goods Comp Table

CY Mkt-Cap Price Rev CAGR EPS CAGR ______ P/E (x) ______ _____ P/B (x) ______ ____ P/Sales (x) ____ ___ EPS Growth ____ ______ ROE _______ Company BLM code End USD m Ccy 2-Jun (2014-16e) (2014-16e) CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e CY14a CY15e CY16e

HK Peers Haier Electronics (TP: HKD26.5, Rating: Buy) 1169 HK Dec 8,466 HKD 23.1 12.2% 17.2% 21.3 18.3 15.5 4.3 3.5 2.8 0.6 0.6 0.5 14% 17% 17% 25% 22% 21% Skyworth Digital 751 HK Mar 2,827 HKD 7.7 11.0% 4.9% 12.4 11.9 11.3 1.8 1.6 1.5 0.5 0.5 0.4 24% 4% 6% 16% 14% 14% Hisense Kelon Elect. 921 HK Dec 2,483 HKD 7.4 NA NA NA 10.6 8.7 NA 1.4 1.0 NA 0.4 0.4 NA NA 22% 0% 27% 25% TCL MLTM.Tech. 1070 HK Dec 1,159 HKD 6.7 8.1% 43.2% 37.6 22.9 18.4 2.0 1.8 1.7 0.3 0.2 0.2 NA 65% 25% 5% 8% 9% Haier Healthwise 348 HK Jan 757 HKD 1.0 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Welling Holding 382 HK Dec 694 HKD 1.9 NA NA NA 4.7 NA NA NA NA NA 0.4 NA NA NA NA 0% 22% 0% Aupu Group Holding 477 HK Dec 308 HKD 2.3 NA NA NA NA NA NA NA NA NA NA NA NA NA NA 0% 0% 0% Chigo Holding 449 HK Dec 254 HKD 0.2 NA NA NA 6.5 NA NA 0.5 NA NA 0.2 NA NA NA NA 0% 8% 0% Average 10% 22% 23.8 12.5 13.5 2.7 1.8 1.8 0.5 0.4 0.4 19% 28% 17% 6% 13% 9% International Peers General Electric GE US Dec 274,871 USD 27.3 -5.5% -2.8% 16.5 21.2 17.5 2.1 2.4 2.5 1.8 2.2 2.1 1% -22% 21% 13% 9% 12% Samsung Electronics 005930 KS Dec 170,944 KRW 1,303,000 3.5% 7.8% 8.3 7.6 7.1 1.2 1.0 0.9 0.9 0.9 0.9 -22% 9% 7% 15% 14% 14% Panasonic 6752 JP Mar 35,533 JPY 1,806.5 2.5% 18.5% 24.4 20.6 17.4 2.4 2.1 1.9 0.6 0.6 0.5 NA 18% 19% 10% 11% 12% Hitachi 6501 JP Mar 32,803 JPY 846.4 2.6% 17.0% 15.0 12.4 10.9 1.4 1.3 1.2 0.4 0.4 0.4 12% 20% 14% 10% 10% 11% Whirlpool WHR US Dec 14,703 USD 187.0 7.2% 15.8% 16.4 15.1 12.2 3.0 2.8 2.4 0.7 0.7 0.6 14% 9% 23% 0% 17% 18% Bosch (TP: INR22,700, Rating: Hold) BOS IN Mar 11,515 INR 22,744.1 14.1% 30.3% 58.3 46.1 34.4 10.1 8.6 7.1 6.5 6.1 5.0 36% 26% 34% 19% 20% 23% Electrolux ELUXB SS Dec 9,397 SEK 258.6 7.4% 20.3% 22.9 22.5 15.8 4.5 3.9 3.4 0.7 0.6 0.6 15% 2% 42% 22% 18% 23% LG Electronics (TP: KRW64,000, Rating: Hold) 066570 KS Dec 8,150 KRW 55,400 3.5% 54.8% 25.0 12.8 10.4 0.9 0.8 0.7 0.2 0.1 0.1 126% 95% 23% 3% 6% 7% Average 4% 20% 23.3 19.8 15.7 3.2 2.9 2.5 1.5 1.4 1.3 26% 20% 23% 12% 13% 15%

Source: Thomson Reuters Datastream, I/B/E/S consensus estimates, HSBC estimates for covered companies. Ranked by market cap (USD). Calendarised to December

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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Lina Yan and Erwan Rambourg

Important disclosures

Equities: Stock ratings and basis for financial analysis HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.

From 23rd March 2015 HSBC has assigned ratings on the following basis: The target price is based on the analyst’s assessment of the stock’s actual current value, although we expect it to take six to 12 months for the market price to reflect this. When the target price is more than 20% above the current share price, the stock will be classified as a Buy; when it is between 5% and 20% above the current share price, the stock may be classified as a Buy or a Hold; when it is between 5% below and 5% above the current share price, the stock will be classified as a Hold; when it is between 5% and 20% below the current share price, the stock may be classified as a Hold or a Reduce; and when it is more than 20% below the current share price, the stock will be classified as a Reduce.

Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation or resumption of coverage, change in target price or estimates).

Upside/Downside is the percentage difference between the target price and the share price.

Prior to this date, HSBC’s rating structure was applied on the following basis: For each stock we set a required rate of return calculated from the cost of equity for that stock’s domestic or, as appropriate, regional market established by our strategy team. The target price for a stock represented the value the analyst expected the stock to reach over our performance horizon. The performance horizon was 12 months. For a stock to be classified as Overweight, the potential return, which equals the percentage difference between the current share price and the target price, including the forecast dividend yield when indicated, had to exceed the required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock was expected to underperform its required return by at least 5 percentage points over the succeeding 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands were classified as Neutral.

*A stock was classified as volatile if its historical volatility had exceeded 40%, if the stock had been listed for less than 12 months (unless it was in an industry or sector where volatility is low) or if the analyst expected significant volatility. However, stocks which we did not consider volatile may in fact also have behaved in such a way. Historical volatility was defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility had to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Rating distribution for long-term investment opportunities

As of 05 June 2015, the distribution of all ratings published is as follows:

Buy 39% (29% of these provided with Investment Banking Services) Hold 43% (29% of these provided with Investment Banking Services) Sell 18% (20% of these provided with Investment Banking Services)

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For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current rating models: under our previous model, Overweight = Buy, Neutral = Hold and Underweight = Sell; under our current model Buy = Buy, Hold = Hold and Reduce = Sell. For rating definitions under both models, please see “Stock ratings and basis for financial analysis” above.

HSBC & Analyst disclosures Disclosure checklist

Company Ticker Recent price Price Date Disclosure

GREE ELECTRIC APPLIANCES 000651.SZ 62.53 04-Jun-2015 4, 5, 6, 7MIDEA GROUP CO LTD 000333.SZ 38.03 04-Jun-2015 2, 6, 7

Source: HSBC

1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next

3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this

company. 4 As of 30 April 2015 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 30 April 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of

and/or paid compensation to HSBC in respect of investment banking services. 6 As of 30 April 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of

and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 30 April 2015, this company was a client of HSBC or had during the preceding 12 month period been a client of

and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as

detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this

company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in

securities in respect of this company HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments (including derivatives) of companies covered in HSBC Research on a principal or agency basis.

Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.

Whether, or in what time frame, an update of this analysis will be published is not determined in advance.

For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.

Additional disclosures 1 This report is dated as at 05 June 2015. 2 All market data included in this report are dated as at close 01 June 2015, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its

Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.

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Disclaimer * Legal entities as at 30 May 2014 ‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking Corporation Limited, Hong Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Bank Canada, Toronto; HSBC Bank, Paris Branch; HSBC France; ‘DE’ HSBC Trinkaus & Burkhardt AG, Düsseldorf; 000 HSBC Bank (RR), Moscow; ‘IN’ HSBC Securities and Capital Markets (India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities Egypt SAE, Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv; ‘US’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler AS, Istanbul; HSBC México, SA, Institución de Banca Múltiple, Grupo Financiero HSBC; HSBC Bank Brasil SA – Banco Múltiplo; HSBC Bank Australia Limited; HSBC Bank Argentina SA; HSBC Saudi Arabia Limited; The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR; The Hongkong and Shanghai Banking Corporation Limited, Bangkok Branch

Issuer of report The Hongkong and Shanghai Banking Corporation Limited Level 19, 1 Queen’s Road Central Hong Kong SAR Telephone: +852 2843 9111 Fax: +852 2596 0200 Website: www.research.hsbc.com

This document has been issued by The Hongkong and Shanghai Banking Corporation Limited (“HSBC”) in the conduct of its Hong Kong regulated business for the information of its institutional and professional investor (as defined by Securities and Future Ordinance (Chapter 571)) customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited is regulated by the Hong Kong Monetary Authority. All enquires by recipients in Hong Kong must be directed to your HSBC contact in Hong Kong. If it is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of the Research Division of HSBC only and are subject to change without notice. HSBC and its affiliates and/or their officers, directors and employees may have positions in any securities mentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). HSBC and its affiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those companies. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc in the UK. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the general information of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (“SFA”) and accredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. This publication is not a prospectus as defined in the SFA. It may not be further distributed in whole or in part for any purpose. The Hongkong and Shanghai Banking Corporation Limited Singapore Branch is regulated by the Monetary Authority of Singapore. Recipients in Singapore should contact a "Hongkong and Shanghai Banking Corporation Limited, Singapore Branch" representative in respect of any matters arising from, or in connection with this report. In Australia, this publication has been distributed by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). Where distributed to retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch incorporated in Hong Kong SAR. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. It may not be further distributed in whole or in part for any purpose. In Korea, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch ("HBAP SLS") for the general information of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets Act (“FSCMA”). This publication is not a prospectus as defined in the FSCMA. It may not be further distributed in whole or in part for any purpose. HBAP SLS is regulated by the Financial ServicesCommission and the Financial Supervisory Service of Korea. In Canada, this document has been distributed by HSBC Bank Canada and/or its affiliates. Where this document contains market updates/overviews, or similar materials (collectively deemed “Commentary” in Canada although other affiliate jurisdictions may term “Commentary” as either “macro-research” or “research”), the Commentary is not an offer to sell, or a solicitation of an offer to sell or subscribe for, any financial product or instrument (including, without limitation, any currencies, securities, commodities or other financial instruments). © Copyright 2015, The Hongkong and Shanghai Banking Corporation Limited, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of The Hongkong and Shanghai Banking Corporation Limited. MICA (P) 157/06/2014, MICA (P) 136/02/2015 and MICA (P) 041/01/2015

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Europe

Consumer Brands & Retail Antoine Belge Head of Consumer Brands and Retail Equity Research +33 1 56 52 43 47 [email protected]

Anne-Laure Jamain Analyst +44 207 991 6587 [email protected]

David McCarthy Head of Consumer Retail, Europe +44 207 992 1326 [email protected]

Andrew Porteous Analyst +44 20 7992 4647 [email protected]

Paul Rossington Analyst +44 20 7991 6734 [email protected]

Jérôme Samuel Analyst +33 1 56 52 44 23 [email protected]

Emmanuelle Vigneron Analyst +33 1 56 52 43 19 [email protected]

Graham Jones Analyst +44 20 7992 5347 [email protected]

Damian McNeela Analyst +44 20 7992 4223 [email protected]

CEEMEA

Consumer Brands & Retail Bulent Yurdagul Analyst +90 212 3764612 [email protected]

Jeanine Womersley Analyst +27 21 6741082 [email protected]

Ankur P Agarwal Analyst +966 11 299 2103 [email protected]

Yazeed Al Turki Analyst +966 11 299 2260 [email protected]

Specialist Sales

David Harrington +44 20 7991 5389 [email protected]

Asia

Consumer Brands & Retail Erwan Rambourg Head of Consumer Brands and Retail Equity Research +852 2996 6572 [email protected]

Christopher Leung Analyst +852 2996 6531 [email protected]

Lina Yan Analyst +852 2822 4344 [email protected]

Catherine Chao Analyst +852 2996 6570 [email protected]

Charlene Liu +852 2822 4398 [email protected]

Karen Choi Analyst +822 3706 8781 [email protected]

Jena Han Analyst +822 3706 8772 [email protected]

Permada (Mada) Darmono Analyst +65 6658 0613 [email protected]

Amit Sachdeva Analyst +91 22 2268 1240 [email protected]

Chloe Wu Analyst + 8862 6631 2866 [email protected]

North & Latin America

Consumer & Retail Richard Cathcart Analyst +55 11 2169 4429 [email protected]

Ana C Hernandez Associate +52 55 5721 2745 [email protected]

Food & Beverage Carlos Laboy Global Head of Beverages Research +1 212 525 6972 [email protected]

James Watson, CFA Analyst +1 212 525 4905 [email protected]

Catherine Foster Analyst +55 11 3847 9348 [email protected]

Henry Nasser Analyst +55 11 2169 4424 [email protected]

Agricultural Products Alexandre Falcao Analyst +55 11 3371 8203 [email protected]

Ravi Jain Analyst +1 212 525 3442 [email protected]

Gustavo Gregori Analyst +55 11 3847 9881 [email protected]

Global Consumer Brands & Retail Research Team

mailto:[email protected]











Issuer of report: The Hongkong and Shanghai Banking Corporation Limited

Lina Yan* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2822 4344 [email protected]

Lina Yan joined HSBC in May 2010 as a Hong Kong and China consumer analyst. Prior to this, she worked for six years as a buy-side analyst, spending three years covering the consumer and property sectors at a Hong Kong-based institutional fund house specialising in China equities and another three years as an investment analyst in Canada. Lina holds an MSc in finance from the University of British Columbia.

Erwan Rambourg* Analyst The Hongkong and Shanghai Banking Corporation Limited +852 2996 6572 [email protected]

Erwan Rambourg is Global Co-Head of Consumer & Retail Research and a top-ranked analyst covering the luxury and sporting goods sectors. Erwan joined HSBC in 2005 after working for eight years as a marketing manager in the luxury goods industry, notably for Richemont and LVMH. He is regularly featured in the Wall Street Journal and the Financial Times, and appears on CNBC and Bloomberg. He is the author of The Bling Dynasty - Why the Reign of Chinese Luxury Shoppers Has Only Just Begun, a book published by Wiley in September 2014.

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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