ShowHand in HONGKONG!

Steady flow of retail money from China. Starting from tomorrow (29 Aug
07), mainland retail investors can start to buy Hong Kong-listed stocks. With
personal savings of US$2.2t in China, the size of retail money that may flow
into the Hong Kong is huge. Assuming 2-5% of the money can be channelled
into Hong Kong over the next 12 to 24 months, we are talking about an
amount of as high as US$100b. The impact on the Hong Kong stock market
will be profound and can be summarised as follows:
• Turnover of the market will rise significantly since mainland retail
investors are well-known for their trading-oriented strategy. This is
positive to Hong Kong Exchanges (388; BUY) and brokers that can deal
with those investors.
• Three groups of stocks (which are the likely targets of retail investors)
should perform well over the next 12 months.
o The first group is the China H shares that trade at a significant
discount to their China A-share counterparts. Our recommendations
include Datang Int’l (991), Chalco (260), Jiangxi Copper (358),
Chongqing Iron (1053), Sinopec (386), Jiada Kunji (300), ZTE (763)
and China Life (2628).
o The second group is those companies that will soon issue A shares.
Our recommendations include China Mobile (941), Zijin Mining
(2899), PetroChina (857), China Shenhua (1088), CNOOC (883),
Lenovo (992) and PICC (2328).
o The third group, which is probably less well-known than the first two
groups, is the penny stocks that have low share prices (such as
below HK$3). Chinese investors commonly believe that penny
stocks have high potential for backdoor listing, M&As, asset injections,
earnings surprises and spectacular returns given the high volatility.
Spectacular performance of A-share penny stocks. As the following
tables depict, penny stocks have delivered spectacular returns in the last 12
months even after the severe correction starting from June. In particular, in
the nine months from 22 Aug 06, stocks with share price below Rmb3
delivered a return of 309.7% compared with a return of 170.9% for stocks
with share price above Rmb5. Needless to say, a high return also means high
risk. In the recent correction starting Jun 07, penny stocks dropped
significantly from their recent highs, though they still posted better returns
than the stocks with high prices on a 12-month basis.

China Mobile

1H07 results beat market consensus; net profit up 26% yoy
China Mobile (CMHK) delivered strong interim results. Revenue was up
21.6% yoy to Rmb332.4b. EBITDA increased 14.6% yoy to Rmb89.8b. Net
income increased 25.7% yoy to Rmb37.9b, beating market consensus of 19-
24%. We foresee the company will deliver promising year-end results.
Maintain BUY.
Strong income growth. Total revenue increased 21.6% yoy to Rmb332.4b,
in line with the new subscription growth rate in the past 12 months. In
addition to strong subscription growth, the company believes the strong
revenue growth is supported by an increase in the usage of both voice and
value-added services (VAS). According to CMHK, the 19% voice tariff
reduction actually induced a 20% increase in minutes of usage (MOU). For
VAS, total revenue increased 35.5% yoy due to increases in SMS usage
(+41.0% yoy), together with a significant increase in WAP traffic (+167.1%
yoy) and MMS usage (+77.5% yoy). With all these factors working together,
the company managed to maintain its ARPU at Rmb88 even though the
proportion of free-incoming call package subscribers increased to 60% from
50% in early this year.
Rural subscriber growth will remain strong. Management indicated that
around 50% of new mobile subscribers came from rural region. As the
current rural penetration rate is just around 18%, which is still low compared
with 40% for the country, increasing affordability of mobile services should
ensure the rural market would be an important new subscription contributor in
the future.
EBITDA margin recovered from 51.3% in 2H06 to 53.9% in 1H07. We
foresee room for improvement would be limited as the company might need
to spend even more on sales and marketing in order to maintain its strong net
subscription growth in 2H07.
Higher capex forecast. Management expects full-year capex to have a less
than 10% increase on top of the Rmb99.8b budget, as the company needs to
expand network capacity in order to cater to the increase in usage due to
strong subscription growth and continual increases in MOU. As a result, we
also slightly adjusted our capex forecast to Rmb108b in 2007 and Rmb100b
in 2008. This has a minor impact on our earnings forecasts.
No updates on 3G and A-share listing. According to Chairman Wang, the
company has not received any updates from the government regarding 3G
licensing matters. The company expects the TD-SCDMA network expansion
construction project to be completed by Oct 07, and will embark on trials after
receiving government notification. Regarding the A-share listing, Chairman
Wang reiterates his previous comment, that is, the company does not have a
schedule and it all depends on the government’s rules on red-chips’ return to
the A-share market.
Maintain BUY. Including a special dividend of 8.5 cents to compensate for
the effect on net income due to a change in depreciation policy, the company
has declared an interim dividend of HK$0.922/share. We believe the
company will maintain the 43% general dividend payout ratio in 2H07.
Together with another year-end special dividend, we expect the final dividend
to be HK$1.018/share. We believe the recent share price weakness due to
unstable market conditions and the re-weighting of HSI create a good
opportunity for patient investors to accumulate the stock at a reasonable price.
Reiterate our BUY recommendation with a target price of HK$107.60

Global Equities , hanging on a clift

• Barely holding on. The MSCI World Equity Index (MWI) is holding just above its
major support trend line after pulling back during the global market rout in the past
fortnight. Weekly MACD and RSI indicators have already caved in, which is
worrying as this is usually an early warning sign of further weakness ahead for
global equity markets in the medium term.
• Critical week ahead. Before last Friday’s sell-off in US equity markets, we were
looking forward to a rebound of global equity markets. But we are not certain now.
If the US market continues to head down over the next few days, it could mean
more downside and volatility for global markets.
• 4-year trough cycle not completed yet. In addition, global stock markets have
not completed their 4-year trough cycle. This could happen in 3Q07 if the sharp
pullback over the past fortnight is any indication of the potential correction ahead
for global markets. The last trough was in Oct 02 when 19% was erased from the
MWI in two months.
• Watch S&P500 at 1,450 and 1,488. After hitting a peak of 1,555 in mid-Jul, the
S&P500 turned south rapidly and fell to 1,433 last Friday, a 7.8% decline. There is now very strong resistance at the 1,450 and 1,488 levels.
• Asia cannot shake off global jitters. Asia ex-Japan equity markets finally cracked
last week after holding out valiantly the week before. The MSCI Asia ex-Japan
Index (MAxJ) is currently trying to find some support at its 50-day SMA of 532 pts.
We believe this level may hold for now but is not sustainable in the medium term.
• Major uptrend is over? Based on our preferred wave count, the MAxJ could have
completed its major “Wave 3” bull run (which started in 1Q03) at 579pts in late Jul.
• Expect a protracted correction. The current correction is not expected to be like
the Feb sell-off which was completed in a fortnight. We believe that this correction
will last no less than 2-3 months if the downtrend is “fast and furious” while a
gradual decline could take 3-6 months, if not longer. A 23.6% of Wave 3’s rally
pegs the MAxJ’s retracement level at 480 while a 38.2% retracement points to 420.
These levels represent 17-27% declines from the Jul 07 top.