Yum Cha 飲茶 · CHINA RAILWAY SECTOR - We expect railway investment to stay firm in the 13th FYP (2016-2020), led by intercity railway and urban transit network development. We

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Yum Cha 飲茶 February 21, 2017

INDICES Closing DoD%

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RMB/USD 6.9 0.2

RESEARCH NOTES

CHINA RAILWAY SECTOR - We expect railway investment to stay firm in the 13th FYP (2016-

2020), led by intercity railway and urban transit network development. We estimate that railway

investment will grow 24.3% in the 13th FYP and that total investment in urban transit networks

will grow 79.8%, reaching >RMB2.2trn. We expect limited growth for railway construction In the

13th FYP due to the high-base effect, but we expect much higher growth for late-cycle railway

investment related to equipment procurement, maintenance and upgrades from 2017 onwards.

We expect rolling stock investment to grow 31.6% and railway maintenance spending to more

than triple, but construction investment to grow only 4.9%. We believe CRC’s focus on opera-

tions should drive an increase in operation spending on equipment. Meanwhile, we expect rail-

way operators to benefit from passenger tariff hikes. Guangshen Railway and CRSC are our top

picks due to their superior earnings growth outlook compared to their peers and construction

companies.

GUANGSHEN RAILWAY [0525.HK; HK$4.88; INITIATE WITH BUY] - We initiate coverage on

Guangshen Railway with a Buy rating and TP of HK$5.81, implying 19.0% upside potential. We

believe further share price upside will come from a railway passenger tariff hike and likely other

railway reform gestures in 2017. We forecast that the Company’s net profit will grow at a CAGR

of 13.3% in 2016-2018, driven by 1) growth recovery in its passenger and freight business, and

2) business expansion related to its services. We didn’t include the earnings impact from a pos-

sible passenger tariff hike. Our earnings sensitivity analysis shows that every 5ppt increase in its

regular train passenger yield growth will boost our earnings forecast for the Company by >10%

in 2017. Therefore, we apply a target multiple of 23.5x 2017E PER for our TP, above its histori-

cal average PER of 17.9x.

CSRC [3969.HK; HK$6.20; INITIATE WITH BUY] - We initiate coverage of CRSC with a Buy

rating and TP of HK$7.74. CRSC is our top pick in the railway equipment sector because of its

high earnings visibility. The Company is involved in both early- and late-cycle railway investment.

Even if new line addition slows down, CRSC can benefit from an increase in demand for its prod-

ucts and services related to railway maintenance and operations. We expect its earnings to grow

at a CAGR of 18.3% in 2016-2018. CRSC had RMB14bn in cash on hand at the end of 1H16,

which was 29% of its market cap. It is likely to have some overseas M&A to enrich its technology

and product offerings for long-term growth. We think the market underappreciates its uniqueness

in the industry value chain and the fact that it is a system integrator, not just an equipment pro-

ducer.

CRRC [1766.HK; HK$7.46; INITIATE WITH HOLD] - We initiate coverage on CRRC with a Hold

rating and a target price of HK$7.72, which implies 3.5% upside potential. We believe its share

price re-rating will still be constrained by slow earnings growth recovery in 2017. With declining

locomotive and MU sales, we expect its earnings growth to be dampened in 2016 and 2017.

While MU maintenance revenue accounts for only ~10% of its total revenue, we expect the

growth recovery from increasing railway operations and maintenance spending to drive slower

earnings growth than for CRSC or CRRC Times Electric. We expect its earnings to remain flat-

tish in 2016 and 2017, with earnings growth recovery only in 2018.

CRRC TIMES ELECTRIC [3898.HK; HK$43.95; INITIATE WITH HOLD] - We initiate coverage

on CRRC Times Electric with a Hold rating and a TP of HK$47.60. We expect its earnings

growth to recover in 2017. We forecast that net profit will grow at a CAGR of 12.1% in 2016-

2018. We expect likely falling MU product business revenue to constrain its earnings growth in

2017. But we believe its urban transit product sales and other new business sales growth will

remain firm, partially offsetting the growth slowdown in its railway business. We expect cost sav-

ings from its acquisition of the IGBT production line only to help it maintain stable margins. We

think its earnings growth recovery in 2017 has largely been factored into the share price. A fur-

ther share price catalyst would be CRC’s incoming MU tenders to bring more clarity to its earn-

ings growth outlook in 2017 and 2018.

DATA RELEASES DUE THIS WEEK

Feb 22 China January Property Prices

Feb 22 Conference Board China January

Leading Economic Index

Source: Bloomberg

2

RESEARCH NOTES

GAMING SECTOR - We joined an investor tour organized by Dynam Japan (6889.HK) last week and met with a member

of the Liberty Democratic Party (LDP) and Japanese National Diet. We understand that the Integrated Resorts (IR) bill

enacted in December 2016 only provides a policy framework and that it will take about a year to formulate detailed laws

for implementation. At the Company level, Dynam Japan does not rule out the possibility of getting involved in developing

casino facilities in the future, but it will take some time for careful consideration, as the investment amount could be over

500bn yen (HK$34bn) for a casino project.

SNIPPETS

CHINA AIRCRAFT LEASING [1848.HK; HK$9.39; NOT RATED] - The Company released a positive profit alert for 2016

results. It expects net profit to grow not less than 60% year on year. This implies net profit last year should be more than

HK$608m, in line with market expectations. It is trading at 10.4x 2016 PER. One of its major peers, BOC Aviation

(2588.HK), is trading at 8.3x 2016E PER, based on consensus.

CGN POWER [1816.HK; HK$2.42; NOT RATED] - The Company announced that the expected commercial operation of

Taishan Unit 1 and Taishan Unit 2 has been adjusted from the original 1H17 and 2H17 to 2H17 and 1H18, respectively.

This is quite disappointing, in our view, as this is the second delay of this project since the Company’s IPO in 2014.

Taishan Unit 1 and Unit 2 have a total capacity of 3500MW, equivalent to 20% of its existing capacity in 1H16. As its

share price has risen by about 14% year to date because of favourable policy news flow, the project delay, although not

totally unexpected, may still trigger profit taking. The Company is trading 13.1x 2016E PER.

CENTRAL CHINA SECURITIES [1375.HK; HK$4.31; NOT RATED] - The Company announced a share buyback for

10% of its H-shares (125m shares). The buyback price will be capped at not more than 5% above the average closing

price of the last five trading days. We believe the reason for the buyback is quite straightforward, as its A-share price is

trading at a 197% premium over the H-shares.

1

Sector Report

February 21, 2017

Kelly Zou—Analyst

(852) 3698-6319

[email protected]

Wong Chi Man—Head of Research

(852) 3698-6317

[email protected]

Railway investment focus shifting to late-cycle operations;

Guangshen Railway and CRSC top picks Investment focus shifting to late-cycle operations. We expect railway investment to

stay firm in the 13th FYP (2016-2020), led by intercity railway and urban transit network

development. We estimate that railway investment will grow 24.3% in the 13th FYP and

that total investment in urban transit networks will grow 79.8%, reaching >RMB2.2trn. We

expect limited growth for railway construction In the 13th FYP due to the high-base effect,

but we expect much higher growth for late-cycle railway investment related to equipment

procurement, maintenance and upgrades from 2017 onwards. We expect rolling stock

investment to grow 31.6% and railway maintenance spending to more than triple, but

construction investment to grow only 4.9%.

Accelerating railway reform to help resolve funding issues. The central government is

promoting public-private partnership (PPP) projects to sustain infrastructure FAI growth.

Total investment in all PPP projects the NDRC released by the end of 2016 reached

RMB13.5trn, 6.9x the investment value of the first batch of PPP projects announced in

May 2015. Progress, however, is far from satisfactory, considering only 32% of the PPP

projects had properly started by the end of 2016. We believe CRC has to accelerate

railway business reforms to improve railway profitability; otherwise, private investors won’t

participate in these railway projects. Key measures include raising passenger tariffs,

increasing HSR density, expanding freight business and developing land resources.

CRC highly likely to lift railway passenger tariffs in 2017. In Dec 2016, the NDRC

published a document titled “Tentative Measures for the Supervision and Examination of

Transport Cost Pricing for Normal Passenger Trains” for public consultation, signalling

railway passenger tariff reform is likely to happen in 2017. Railway passenger tariff base-

rate hikes have been suspended since 1995, making rail tariffs well below those of airlines

and highways. We expect CRC to raise passenger tariffs for regular train service in 2017

after it finishes the cost examination required by the NDRC. This should help railways

improve margins and resolve funding issues.

Order of preference: Guangshen Railway (GSR), CRSC, CRRC Times Electric,

CRRC. We believe CRC’s focus on operations should drive an increase in operation

spending on equipment. Meanwhile, we expect railway operators to benefit from

passenger tariff hikes. Guangshen Railway and CRSC are our top picks due to their

superior earnings growth outlook compared to their peers and construction companies.

China railway sector

Source: Bloomberg, CGIS Research estimates

Note: pricing based on Feb 20, 2017

Sources: Bloomberg, CGIS Research estimates

Ticker Mkt cap Up/Down PEG

US$ m % 2015 2016E 2017E 2015 2016E 2017E 2017E

Guangshen Railway 525 HK 5,355 4.88 5.81 Buy 19.1% 28.6 22.7 19.8 61.8% 25.8% 14.9% 1.3

CRSC 3969 HK 7,025 6.20 7.74 Buy 24.8% 17.0 16.0 13.5 11.4% 6.4% 17.7% 0.8

CRRC 1766 HK 40,886 7.46 7.72 Hold 3.5% 15.3 14.9 15.4 5.9% 2.2% -3.1% -5.0

CRRC Times Electric 3898 HK 6,657 43.95 47.60 Hold 8.3% 15.5 15.4 13.9 23.5% 0.7% 10.9% 1.3

Ticker

2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

Guangshen Railway 525 HK 1.1 1.1 1.1 10.2 8.8 8.1 1.5% 1.8% 2.1% 4.0% 4.9% 5.5%

CRSC 3969 HK 2.6 2.2 2.0 9.6 7.7 6.3 0.4% 1.0% 1.2% 15.1% 14.0% 14.5%

CRRC 1766 HK 1.9 1.7 1.5 7.4 6.7 5.9 1.8% 1.8% 1.8% 12.2% 11.5% 9.9%

CRRC Times Electric 3898 HK 3.4 2.9 2.5 11.9 10.6 9.2 0.9% 0.9% 1.0% 22.0% 18.7% 17.7%

P/Bk EV/EBITDA Dividend yield ROE

Price

(lc) PT (lc) Rec

PER EPS growth

Company Ticker RatingPrice

(HK$)

PT

(HK$)+/-upside

GSR 525 HK Buy 4.88 5.81 19.0%

CRSC 3969 HK Buy 6.20 7.74 24.8%

CRRC 1766 HK Hold 7.46 7.72 3.5%

CRRC Times Electric 3898 HK Hold 43.95 47.6 8.3%

2

Guangshen Railway [525.HK]

BUY

Close: HK$4.88 (Feb 20, 2017)

Target Price: HK$5.81 (+19.0%)

Price Performance

Market Cap US$5,354m

Shares Outstanding 1,431m

Auditor PWC

Free Float 100.0%

52W range HK$3.15-5.17

3M average daily T/O US$23m

Major Shareholding Guangzhou Railway

(Group) Company

(37.1%)

Sources: Company data, Bloomberg

Kelly Zou—Analyst

(852) 3698-6319

[email protected]

Wong Chi Man, CFA—Head of Research

(852) 3698-6317

[email protected]

Source: Company data, CGIS Research estimates

China Railway Sector We initiate coverage on Guangshen Railway with a Buy rating and TP of HK$5.81, implying 19.0% upside potential. We believe further share price upside will come from a railway passenger tariff hike and likely other railway reform gestures in 2017. We forecast that the Company’s net profit will grow at a CAGR of 13.3% in 2016-2018, driven by 1) growth recovery in its passenger and freight business, and 2) business expansion related to its services. We didn’t include the earnings impact from a possi-ble passenger tariff hike. Our earnings sensitivity analysis shows that every 5ppt in-crease in its regular train passenger yield growth will boost our earnings forecast for the Company by >10% in 2017. Therefore, we apply a target multiple of 23.5x 2017E PER for our TP, above its historical average PER of 17.9x.

Investment Highlights

Traffic diversion from HSR lines no longer a business overhang: We believe the traffic diversion to its passenger business from HSR lines has largely stabi-lized. The Company introduced new train services to offset the traffic decline from competition with HSRs with its parent company’s support. We expect passenger traffic growth to resume for its three train services from 2017 onwards, and we forecast that its passenger volume will grow modestly by 1% p.a. in 2017 and 2018. With the introduction of new services, the Company can improve its pas-senger yield, which we expect to grow >4% p.a. in 2017-2018.

Transportation service business expansion a new earnings growth driver: GSR’s services revenue to HSR lines grew at a CAGR of >30% in 2010-2015. Revenue from those services represented 19% of its total revenue in 2015 vs. only 7% in 2010. We expect its services revenue to grow at a CAGR of 10.9% in 2016-2018, driven by fast passenger traffic growth of HSR lines in Guangdong province. Based on the comprehensive service framework agreement GSR signed with CRC, the annual cap of its revenue from the services it provides to CRC will grow at a CAGR of >15% in 2016-2018.

Near-term share price catalyst to come from a passenger tariff hike: We think a rise in the passenger tariff is already on the government’s agenda. Pas-senger tariff rate hikes have been suspended since 1995, so railway tariffs are lower than those of airlines and highways. We didn’t include the earnings impact from a passenger tariff hike in our earnings forecast. Our earnings sensitivity analysis shows that every 5ppt increase in its regular train passenger yield growth will boost our earnings forecast for the Company by >10% in 2017.

Buy with a target price of HK$5.81: Our TP is based on a target multiple of 23.5x 2017E PER. Historically, the Company has traded at an average forward PER of 17.9x. Currently the stock trades at 19.8x 2017E PER. We expect further share price upside to come from accelerated railway business reform.

INITIATE COVERAGE: Share price upside on potential passenger tariff hike

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 15,801 14,801 15,725 17,371 18,647 19,965

Recurring net profit (RMB m) 1,274 662 1,071 1,347 1,547 1,729

Net margin (%) 8.1 4.5 6.8 7.8 8.3 8.7

Recurring EPS (RMB) 0.18 0.09 0.15 0.19 0.22 0.24

% change -3.4 -48.0% 61.8% 25.8% 14.9% 11.8%

PER(x) 24.0 46.2 28.6 22.7 19.8 17.7

PBR(x) 1.1 1.1 1.1 1.1 1.1 1.1

EV/EBITDA(x) 9.2 12.3 10.2 8.7 8.1 7.6

3

CRSC [3969.HK]

BUY

Close: HK$6.20 (Feb 20, 2017)


Price Performance



Auditor Ernst & Young

Free Float 64.0%

52W range HK$3.79-6.55


Major Shareholding CRSC Corporation

(75.1%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage of CRSC with a Buy rating and TP of HK$7.74. CRSC is our top pick in the railway equipment sector because of its high earnings visibility. The Company is involved in both early- and late-cycle railway investment. Even if new line addition slows down, CRSC can benefit from an increase in demand for its prod-ucts and services related to railway maintenance and operations. We expect its earnings to grow at a CAGR of 18.3% in 2016-2018. CRSC had RMB14bn in cash on hand at the end of 1H16, which was 29% of its market cap. It is likely to have some overseas M&A to enrich its technology and product offerings for long-term growth. We think the market underappreciates its uniqueness in the industry value chain and the fact that it is a system integrator, not just an equipment producer.


Early- and late-cycle railway investment to drive railway business growth. We expect CRSC’s railway business revenue (63.5% of its total revenue in 2017E) to grow 15% p.a. in 2016-2018. CRSC provides control systems prod-ucts and services for both early- and late-cycle railway investment. Even if early-cycle railway construction investment slows down, the Company can sustain revenue growth with its product and service offerings for late-cycle HSR opera-tions. We estimate over 50% of its revenue is recurring revenue from rail control systems upgrades and replacements, which usually happen 8-10 years after its products are put into operation.

Urban transit business to outgrow its railway business. We expect CRSC’s urban transit product and service (19.5% of its total revenue in 2017E) to grow faster than its railway business. We expect its urban transit business revenue to grow 30% per annum in 2016-2018. Apart from new line addition, China is pro-moting control system connectivity among different urban transit rail lines. We expect domestic companies like CRSC to gain market share from foreign com-panies, like Siemens and Alstom.

Overseas expansion and other business diversification to drive long-term growth. We forecast that its overseas business revenue will grow at a CAGR of >17% in 2016-2018, driven by 1) railways’ “Go Overseas” strategy, and 2) CRSC’s penetration into other emerging markets with its experiences in railway “speed-up” projects. We forecast that its other business revenue will grow by 10-20% p.a. in 2016-2018, with growth from its sales expansion in areas like smart city and ultra high-speed wireless LAN technology.

BUY with a TP of HK$7.74: Our TP is based on a target multiple of 17x 2017E PER, vs. its historical average of 13.3x PER. Currently, the stock trades at 13.5x 2017E PER. We think market underappreciates its uniqueness in the in-dustry value chain and the fact that it is a system integrator, not just an equip-ment producer.

INITIATE COVERAGE: Preferred rail-equipment stock with high earnings growth

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 13,065 17,329 23,952 29,187 34,136 40,002

Recurring net profit (RMB m) 1,260 2,033 2,496 3,026 3,563 4,232

Net margin (%) 9.6% 11.7% 10.4% 10.4% 10.4% 10.6%


% change 1.8% 49.2% 11.4% 6.4% 17.7% 18.8%

PER(x) 28.2 18.9 17.0 15.9 13.5 11.4

PBR(x) 3.8 3.3 2.6 2.2 2.0 2.6

EV/EBITDA(x) 22.2 12.1 9.6 7.7 6.3 6.1

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CRRC [1766.HK]

Hold

Close: HK$7.46 (Feb 20, 2017)


Price Performance



Auditor Deloitte

Free Float 94.0%

52W range HK$6.45-8.35


Major Shareholding CRCCG (54.2%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage on CRRC with a Hold rating and a target price of HK$7.72, which

implies 3.5% upside potential. We believe its share price re-rating will still be constrained

by slow earnings growth recovery in 2017. With declining locomotive and MU sales, we

expect its earnings growth to be dampened in 2016 and 2017. While MU maintenance

revenue accounts for only ~10% of its total revenue, we expect the growth recovery from

increasing railway operations and maintenance spending to drive slower earnings growth

than for CRSC or CRRC Times Electric. We expect its earnings to remain flattish in 2016

and 2017, with earnings growth recovery only in 2018.


Core business recovery to dampen in 2017. With slow locomotive and MU sales

recovery, we expect earnings growth to be dampened in 2016 and 2017. We forecast

that its revenue will remain largely flat YoY in 2016 and 2017. Since MU maintenance

revenue accounts for ~10% of CRRC’s total revenue, we don’t expect rising mainte-

nance revenue to fully offset falling newly built MU product revenue in 2017. New line

addition, increasing HSR train density and rising maintenance demand will drive busi-

ness growth recovery from 2018 on. We expect its revenue to grow 11.3% YoY in

2018.

Urban transit business and new business growth to continue. We expect its

urban transit business revenue to grow by 20% p.a. in 2016-2018. As at the end of

9M16, the order backlog for its urban transit vehicle business stood at RMB106.9bn,

equivalent to 4.4x of its urban transit business revenue in 2015. CRRC has expanded

its business into the new energy and environmental protection equipment industries.

We forecast that its new business revenue will grow by 10-15% p.a. in 2016-2018.

Margin expansion due to post-merger cost savings. We expect its gross profit

margin to expand from 19.6% in 2015 to 20.3% in 2016. Even with changes in prod-

uct mix, we expect its gross profit margin to largely stabilize at around 20% in 2017-

2018. We also expect cost savings in SG&A. After factoring in other losses, we ex-

pect its operating profit margin to stabilize at 7.4-7.5% in 2016-2018.

HOLD with a TP of HK$7.72. We set our TP at HK$7.72 and give CRRC a Hold

rating. Our TP is based on a target multiple of 16x 2017E PER and suggests 3.5%

upside potential. Historically, the stock has traded at an average PER of 18.6x. Given

the subdued EPS growth in 2017, we believe a lower target PER multiple is appropri-

ate.

INITIATE COVERAGE: Earnings to remain subdued in 2017

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 96,525 218,451 237,785 242,311 249,659 277,982


Net margin (%) 4.3% 5.0% 5.0% 5.0% 4.9% 5.0%


% change 0.2% na 5.9% 2.2% -3.1% 12.3%

PER(x) 22.0 16.1 15.2 14.9 15.4 13.7

PBR(x) 2.5 1.0 1.9 1.7 1.5 1.4

EV/EBITDA(x) 11.0 4.2 7.4 6.7 6.3 5.5

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CRRC Times Electric [3898.HK]

Hold

Close: HK$43.95 (Feb 20, 2017)


Price Performance


Shares Outstanding 547m

Auditor Ernst & Young

Free Float 100.0%

52W range HK$36.50-49.50


Major Shareholding CRRC ZELRI (50.2%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage on CRRC Times Electric with a Hold rating and a TP of HK$47.60.

We expect its earnings growth to recover in 2017. We forecast that net profit will grow at a

CAGR of 12.1% in 2016-2018. We expect likely falling MU product business revenue to

constrain its earnings growth in 2017. But we believe its urban transit product sales and

other new business sales growth will remain firm, partially offsetting the growth slowdown

in its railway business. We expect cost savings from its acquisition of the IGBT production

line only to help it maintain stable margins. We think its earnings growth recovery in 2017

has largely been factored into the share price. A further share price catalyst would be

CRC’s incoming MU tenders to bring more clarity to its earnings growth outlook in 2017

and 2018.

Investment Highl ights

Late-cycle spending on railway operations to drive its railway business growth

recovery: We expect a gradual recovery in demand for the locomotive and MU prod-

uct segment resulting from the 13th FYP. New HSR line additions are expected to drive

only modest demand growth for MUs. But increases in HSR speed and the CRC focus

on shifting railway operations should drive operation and maintenance demand for its

products. The expansion of the railway freight business also supports demand growth

for its locomotive products. We expect urban transit product revenue growth to remain

firm in 2016-2018. Overall, we expect its core train-borne electrical systems (>70% of

its total revenue) to grow at a CAGR of 10.5% in 2016-2018.

IGBT and deep-sea marine engineering product business to drive long-term

growth: We forecast that the Company’s electric parts and components business

revenue will grow at a CAGR of 15.0% in 2016-2018. It has applied its IGBT modules

to its urban transit vehicle products. As its urban transit vehicle equipment sales

growth should remain strong in 2016-2018, we expect this to drive IGBT production to

achieve economies of scale and generate profit. We expect its marine engineering

product segment revenue to grow at a CAGR of 7.5% in 2016-2018. The Company

plans to build a plant for this business in Mainland China. Given the lack of major do-

mestic competitors in the deep-sea marine equipment sector and SMD’s (Soil Ma-

chine Dynamics Ltd) leading market share, it should be able to gradually develop its

sales in the domestic market in the long term.

HOLD with a TP of HK$47.60: Our TP is based on a target multiple of 15.0x 2017E

PER, which suggests 8.3% upside potential. The stock has historically traded at an

average PER of 18.7x. With slower EPS growth, we believe a lower PER multiple is

appropriate. A further share price catalyst would be CRC’s incoming MU tenders to

bring more clarity to its earnings growth outlook in 2017 and 2018.

INITIATE COVERAGE: Growth to recover in 2017 but reflected in share price

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 8,856 12,676 14,145 15,380 16,603 18,775


Net margin (%) 16.6% 18.9% 20.9% 19.4% 19.9% 19.9%


% change 18.1% 52.9% 23.5% 0.7% 10.9% 13.3%

PER(x) 29.2 19.1 15.5 15.4 13.9 12.2

PBR(x) 5.1 4.2 3.4 2.9 2.5 2.1

EV/EBITDA(x) 23.4 14.7 11.9 10.6 9.2 7.8

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1

COMPANY NEWS

Analyst: Livy Lyu (Tel: (852) 3698 6393); [email protected];

Wong Chi Man, CFA (Tel: (852) 3698 6317); [email protected]

GAMING SECTOR – UPDATE ON JAPAN’S INTEGRATED RESORTS BILL

Summary. We joined an investor tour organized by Dynam Japan (6889.HK) last week and met with a member of the Liberty Demo-

cratic Party (LDP) and Japanese National Diet. We understand that the Integrated Resorts (IR) bill enacted in December 2016 only

provides a policy framework and that it will take about a year to formulate detailed laws for implementation. At the Company level,

Dynam Japan does not rule out the possibility of getting involved in developing casino facilities in the future, but it will take some time

for careful consideration, as the investment amount could be over 500bn yen (HK$34bn) for a casino project.

Still one year to go to enact the implementation bill. After enactment on December 15, 2016, the IR bill requires the Japanese

government to enact the “Implementation bill”, which incorporates regulatory requirements and concrete provisions to deal with gam-

bling addiction within one year. According to Tsukasa Akimoto, a member of the LDP and Japanese National Diet, the implementation

bill should be enforced by end-2017, and will probably be passed during special sessions of the Diet around October. So far, the po-

tential social effects and precaution measures for addiction and violence are still under discussion by the IR project team members of

the LDP.

Two kinds of partnerships may be considered for Japanese casino operators: 1) forming JVs with foreign players with experi-

ence in operating casinos; and 2) franchising models, such as Tokyo Disneyland, i.e. foreign partners collect royalties without getting

involved in daily operations. The local prefecture government may first choose among the operators and sites before screening and

licensing from the central government. The main purpose of the IR bill is to attract more inbound tourists. They do not rule out a high-

er entrance fee for local Japanese residents to prevent any negative social impact, such as gambling addiction.

Potential changes in the regulations related to the Pachinko industry remains unclear. Most Pachinko players are seniors and

farmers. The Company believes pachinko, a local time-killing game in Japan, is different from the potential casino gambling industry

in terms of its gaming characteristics. The Company has been focusing on lower-spending pachinko machines (1 yen/ball) in the last

few years and will continue to get rid of high-volatility machines in the next couple of years. The regulation of pachinko machine vola-

tility is still in a grey area, but this should become clearer after enactment of the implementation bill.

Visit to Dynam’s Yamaguchi resort land site. We visited the Company’s staff training center in Yamaguchi and a pachinko hall in

Ishioka last week. According to management, they are still considering how to build the training center into a resort with hotel and

convention facilities. The training center is well-located by the Japan Sea, with 58 lodging rooms available for 274 guests and two

indoor natural hot spring pools. The Company does not rule out the possibility of casino facilities development in the future. But it will

take some time for careful consideration, as the investment amount could be over 500bn yen for a casino project.

Valuation. If we assume Dynam will pay a DPS of 12 yen for this financial year, the Company is offering 6.4% dividend yield. We

believe the share price may remain range-bound in the near term, as there are limited growth prospects for the existing business, and

we may not see much progress with the implementation bill before Q3 this year.

February 21, 2017

2

Figure 1: Pachinko machines in Dynam Training Center, Yamaguchi

Source: CGIS Research

Figure 2: Accommodation in Dynam Training Center, Yamaguchi


Figure 3: Undeveloped land site in Yamaguchi Figure 4: Pachinko hall in Ishioka, Ibaragi

Source: CGIS Research Source: CGIS Research

3

Figure 5: Pachinko players are mainly seniors


Figure 6: Third-party gift buyer booth by the Ishioka Pachinko hall


4

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BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :

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