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What’s next after demand bottoming out?—— 2H investment strategy for coal and power sector
Wilson Chen
May. 25th, 2009
www.sw108.com
申万研究 2
Logics
Industrial structure optimizing
Industry Relocation
More Favorable energy industry
structure
More balanced regional energy consumption
Coal
1.Resources in West become more valuable
2.Downstream integration guarantee demand
Power
1.More Exposure in Middle China
2.Less Exposure in East China
Demand bottoming up
Not large rebound
Cost pass-through mechanism
Supply side discipline
Favor Coal for stable spot price
1. Prefer spot exposure
2.Catch the mid-cap valuation gap
Neutral in Power
1. Diversified unit portfolio
2.Catch the mid-cap valuation gap
Long term Short term
Focus on industry structure Supply and demand
www.sw108.com
申万研究 3
1. The implication to energy sector of industry relocation——
A more harmonious relationship between Coal and Power sector
2. Demand bottoming up——
Supply side discipline and cost pass-through mechanism:Long Coal
3. Stock pick——
Gold panning in mid cap and low valuation stock
Contents
www.sw108.com
申万研究 4
1.1 Coal and power——a tug of war
200300400500600700800900
10001100
Mar
-03
Sep
-03
Mar
-04
Sep
-04
Mar
-05
Sep
-05
Mar
-06
Sep
-06
Mar
-07
Sep
-07
Mar
-08
Sep
-08
Mar
-09
Datong Bl ended Shanxi Bl ended
Gross margi n of coal - fi red power sector
- 5. 00%
0. 00%
5. 00%
10. 00%
15. 00%
20. 00%
25. 00%
Gross margi n
Gross margi n of coal sector
0. 00%10. 00%
20. 00%30. 00%
40. 00%
1-Fe
b1-
Apr
1-Ju
n1-
Aug
1-Oc
t1-
Dec
1-Fe
b1-
Apr
1-Ju
n1-
Aug
1-Oc
t1-
Dec
1-Fe
b1-
Apr
1-Ju
n1-
Aug
1-Oc
t1-
Dec
1-Fe
b
Gross margi nSource : Sxcoal, NBS,SWS Research
www.sw108.com
申万研究 5
What happened in the coal contract negotiation?
Power:Loss compensation
Coal:policy cost pass through
Results:10% hike for key contract
Time:Pending the resources tax determine
Source : Sxcoal, Company Reports,SWS Research
2005 2006 2007 2008 2009EAverage QHD Spot Price (5500 kcal) 426 430 486 761 560Shenhua's Seaborne Contract Price (inc. VAT) 359 378 407 468 511Price Gap 19% 14% 19% 63% 10%
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申万研究 6
1.2 Industry Relocation: A better tomorrow?
Demand growth region closer to mines
Upstream and downstream integration
A more harmonious relationship
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申万研究 7
Unbalanced regional energy consumption growth
South
0. 00
1000. 00
2000. 00
3000. 00
4000. 00
5000. 00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
South
East
0. 00
1000. 00
2000. 00
3000. 00
4000. 00
5000. 00
6000. 00
7000. 00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
East
Mi ddl e
0. 00
1000. 00
2000. 00
3000. 00
4000. 00
5000. 00
6000. 00
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Mi ddl e
CAGR=10%
CAGR=13%CAGR=14%
Source : CEIC, SWS Research
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申万研究 8
Unbalanced regional coal production create bottleneckCoal transportati on became very i mportant
0%20%
40%60%
80%
Jan-
06
Mar-
06
May-
06
Jul-
06
Sep-
06
Nov-
06
Jan-
07
Mar-
07
May-
07
Jul-
07
Sep-
07
Nov-
07
Jan-
08
Mar-
08
May-
08
Jul-
08
Sep-
08
Nov-
08
Jan-
09
Rai l way transportati on port i on Seaborne port i on
Coal transportation
Regi onal coal producti on and consumpti on porti on
4% 7%0%
16%
47%
6%
22%
4%
25% 22%
0. 00%10. 00%20. 00%30. 00%40. 00%50. 00%
BTT East South Mi ddl e The ThreeWest
Produti on Consumpti on
Source : CEIC, SWS Research
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申万研究 9
A vision on energy consumption structure
a) By increasing the energy portion in
Central China
b)By increasing the alternative power generation units
Unit decomposition in 2008 Unit decomposition in 2020
Regi onal coal producti on and consumpti on porti on
4% 7%0%
20%
45%
4%
18%
2%
30%25%
0. 00%10. 00%20. 00%30. 00%40. 00%50. 00%
BTT East South Mi ddl e The ThreeWest
Produti on Consumpti on
Source : CEIC, CEC, SWS Research
82%
14%
2%
2%
Coal Hydro Nucl ear Wi nd
68%
20%
5%
7%
Coal Hydro Nucl ear Wi nd
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申万研究 10
More balanced regional energy consumption
Source : CEIC,SWS Research
Regional coal consumption deficit
Major Deficit
Minor Deficit
Minor Surplus
Major Surplus
Major Deficit
Minor Deficit
Minor Surplus
Major Surplus
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申万研究 11
Transportation bottleneck relief
Source : CEIC,SWS Research
Coal railway capacity increase in a larger scale than coal output.
0%
5%
10%
15%
20%
25%
30%
35%
40%
2004 2005 2006 2007 2008 2009E 2010E 2011E
Maj or rai l way upgrade, % hi ke of capaci t y Coal output hi ke%
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申万研究 12
Upstream and downstream integration became realistic
Coal:
Downstream integration:
To ensure the downstream demand
Power:
Upstream integration:
a)To ensure cost stability
b)Newly established mines more valuable
Source : Company Reports, SWS Research
Current
Self sufficient
Outside purchase
2015E
Self sufficient
Outside purchase
Shenhua
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申万研究 13
1.3 P&L of coal and power industries
New markets from Central pick-up;
New mines in West become valuable;
The premium from transportation;
Bargaining power
Bargaining power;
Consumption growth in Central China;
Higher spark spread
Utilization cut in coastal area;Coal
Power
Benefit
Loss
Loss
Benefit
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申万研究 14
Recommended stock in the trend of industry relocation
Coal:We like the companies that
1)More potential in coal mine consolidation in the West
2)Less exposure in coastal area
3)Downstream integration
Recommended stock:
China Shenhua
1)Parent group has coal mines in Ningxia and Xinjiang
2)Least costal area exposure
3)20% revenue from power sector.
Shenhua China Coal YCMCosolidation in west 20 m tons N.A N.ASeaborne exposure 53.00% 78.00% 90.00%Down stream integration 20% revenue N.A N.A
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申万研究 15
Recommended stock in the trend of industry relocation
Power: We like the companies that
More regional exposure in central China
Recommended stock:
China Power Interntional
Largest central exposure.
Cent ral uni t por t i on
0. 0%
20. 0%
40. 0%
60. 0%
80. 0%
100. 0%
CPI CRP Huaneng Datang Huadi an
Cent ral
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申万研究 16
1. The implication to energy sector of industry shift——
A more harmonious relationship between Coal and Power sector
2. Thriver: Benefited from demand bottoming up——
Supply side discipline and cost pass-through mechanism:Long Coal
3. Stock pick——
Gold panning in mid cap and low valuation stock
Contents
www.sw108.com
申万研究 17
2.1 Demand bottoming up: worst is gone
Source : Sxcoal,SWS Research
PMI index rebound above 50 Daily input and output of QHD port indicated demand rebound
10
20
30
40
50
60
70
80
2005年7月
2005年9月
2005年11月
2006年1月
2006年3月
2006年5月
2006年7月
2006年9月
2006年11月
2007年1月
2007年3月
2007年5月
2007年7月
2007年9月
2007年11月
2008年1月
2008年3月
2008年5月
2008年7月
2008年9月
2008年11月
PMI index PMI Steel Index
300350400
450500550600650700
Aug
-08
Sep
-08
Oct
-08
Nov
-08
Dec
-08
Jan-
09
Feb
-09
Mar
-09
Average daily input (k tons)
Average daily output (k tons)
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申万研究 18
L-shaped or V-shaped? A deja-vu of 2000
Coal and Power downstream demand still weak in 2009E
Source : CEIC,SWS Research
Coal Demand (2.4% )
Non-ferrous Metals(8% )Ferrous Metals(1.2% )
Coal-fired Generation (1.8% )49%
Chemicals(3% ) Cements(9% )
18% 5% 7%12% 9% 8%6%
Generation (3.6% )
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申万研究 19
2.2 Supply side discipline:Coal
Source : Sxcoal,SWS Research
0
200
400
600
800
1000
2007
-01
2007
-04
2007
-07
2007
-10
2008
-02
2008
-05
2008
-08
2008
-11
2009
-02
-100%
-50%
0%
50%
100%
150%
Monthly output MoM grow th
050
100150200250300
2007
-01
2007
-04
2007
-07
2007
-10
2008
-02
2008
-05
2008
-08
2008
-11
2009
-02
-200%-100%0%100%200%300%400%500%
Small rural mines MoM grow th
2006 2007 2008E 2009E 2010E 2011EState-owned Key 1119 1240 1407 1505 1611 1724YOY growth 10.81% 13.47% 7.00% 7.00% 7.00%Utilization rate 96.00% 102.60% 102.48% 101.92% 100.89% 107.95%State-owned Local 320 324 396 416 428 441
YOY growth 1.25% 22.22% 5.00% 3.00% 3.00%Utilization rate 109.74% 99.36% 109.39% 106.13% 100.55% 103.57%
Township 892 959 888 799 879 967YOY growth 7.51% -7.40% -10.00% 10.00% 10.00%Utilization rate 106.76% 107.51% 92.60% 80.49% 87.05% 95.75%
Total 2331 2523 2691 2720 2918 3132YOY growth 8.24% 6.66% 1.60% 7.27% 7.32%Utilization rate 99.61% 103.14% 99.19% 95.06% 96.23% 103.27%
We turned down the utilization rate of Township Mines
What has changed from 1999 to 2009?
1.Government’s attitude to coal industry.
2.Industry concentration ratio largely increase
3.Stronger balance sheet and cash flow.
Monthly clean coal output in Shanxi Monthly clean coal output in township mines
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申万研究 20
2.2 Supply side discipline:IPPs
Source : CEC,Company reports, SWS Research
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
19
851
986
19
871
988
19
891
990
19
911
992
19
931
994
19
951
996
19
971
998
19
992
000
20
012
002
20
032
004
20
052
006
20
072
008
E2
009
E2
010
E
4000
4200
4400
4600
4800
5000
5200
5400
5600
Utilization hours Generation growthCapacity growth
42%
27%
31%
Big five Local large companies Rest
Why IPPs continue the aggressive capex?
1.To gain larger market share
2.Political incentive
3.Easy financing access
Capex plan still aggressive for major IPPs
While demand is bottoming out in 2009,utilization rate is not Market share of electric power industry
0
10
20
30
40
50
60
Huaneng Datang Huadi an CRP
2008 2009E 2010E
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申万研究 21
Coal sector: policy cost and material cost past through;
Pricing mechanism is more flexible.
2.3 Cost pass through mechanism:limited space for spot coal price decline
Power sector: inefficient in the marketization of on-grid tariff
Sell side tariff hike will be a good entry point.
Direct sell
Transparent transmission and distribution tariff
systemMarket-based tariff setting mechanism
Selling tariff hike
Coal cost linkage mechanism
2005 2006 2007 2008 2009E 1Q09Average QHD Spot Price (5500 kcal) 426 430 486 761 560 550
Start
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申万研究 22
What is changing the expectation and expectation spread
00.51
1.52
2.53
Oct-0
6
Dec-0
6
Feb-0
7
Apr-0
7
Jun-
07
Aug-0
7
Oct-0
7
Dec-0
7
Feb-0
8
Apr-0
8
Jun-
08
Aug-0
8
Oct-0
8
Dec-0
8
Feb-0
9
Apr-0
9
Power composite HSCEI
0. 00%50. 00%
100. 00%150. 00%200. 00%250. 00%300. 00%350. 00%400. 00%
Oct -
06
Dec-
06
Feb-
07
Apr-
07
J un-
07
Aug-
07
Oct -
07
Dec-
07
Feb-
08
Apr-
08
J un-
08
Aug-
08
Oct -
08
Dec-
08
Feb-
09
Apr-
09
Coal composite HSCEI
Demand grow;Policy cost transfer Demand slip
down;downstream weak;price decline
expectation
Demand bottoming up;price rebound
Demand grow;Coal cost linkage mechanism
Coal price surge
Expectation of coal price decline; tariff hike Expectation of coal price
rebound; marketization pricing mechanism
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申万研究 23
1. The implication to energy sector of industry shift——
A more harmonious relationship between Coal and Power sector
2. Thriver: Benefited from demand bottoming up——
Supply side discipline and cost pass-through mechanism:Long Coal
3. Stock pick——
Gold panning in mid cap and low valuation stock
Contents
www.sw108.com
申万研究 24
PE and PB ratio spread between mid and large cap historical high
3.1 Large discount on mid-cap stock unjustified
00.20.40.60.811.21.4
2005年1月7日
2005年4月7日
2005年7月7日
2005年10月7日
2006年1月7日
2006年4月7日
2006年7月7日
2006年10月7日
2007年1月7日
2007年4月7日
2007年7月7日
2007年10月7日
2008年1月7日
2008年4月7日
2008年7月7日
2008年10月7日
2009年1月7日
PBR of mid cap IPP PBR of large cap IPP
051015202530
2003年1月3日
2003年7月3日
2004年1月3日
2004年7月3日
2005年1月3日
2005年7月3日
2006年1月3日
2006年7月3日
2007年1月3日
2007年7月3日
2008年1月3日
2008年7月3日
2009年1月3日
PER of mid cap Coal PER of large cap coal
50% discount in PB ratio for mid-cap IPP35% discount in PE ratio for mid-cap Coal
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申万研究 25
Current stock price assume a 30% ASP decline
While although YCM has largest spot exposure in the industry, coal price risk is not that large:
(1) Location advantages: Shandong is one of the biggest coal consumption and import provinces. Short transportation distance.
(2) Stable key client relationship
Potential Catalysts:Continuously share repurchase:RMB9.7 bn cash at hand
3.1.1 YCM: spot exposure factor exaggerated
Source : WIND,SWS Research
50% relative PE discount unjustified
Shandong East South North Export
00. 20. 40. 60. 8
11. 21. 41. 6
2003
13
年月
日20
034
3年
月日
2003
73
年月
日20
0310
3年
月日
2004
13
年月
日20
044
3年
月日
2004
73
年月
日20
0410
3年
月日
2005
13
年月
日20
054
3年
月日
2005
73
年月
日20
0510
3年
月日
2006
13
年月
日20
064
3年
月日
2006
73
年月
日20
0610
3年
月日
2007
13
年月
日20
074
3年
月日
2007
73
年月
日20
0710
3年
月日
2008
13
年月
日20
084
3年
月日
2008
73
年月
日20
0810
3年
月日
2009
13
年月
日
Rel at i ve PE Average
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申万研究 26
3.1.2 CPI: Benefits from capacity diversification not fully recognized
Source : WIND,SWS Research
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Huaneng Datang Huadi an CRP CPI
Uni t f uel cost hi ke i n 2008
2009F
Coal - fi red Hydro
Tabl e 1: Pot ent i al Asset I nj ect i on: Wul i ng Power
Commenced operation Capacity Location Wuqiangxi Hydro 1996 240*5 Hunan
Lingjintan 2000 270 Hunan
Hongshui Hydro 2003 25*5 Hunan
Wanmipo Hydro 2004 80*3 Hunan
Sanbanxi Hydro 2004 250*4 Guizhou
Jinweizhou 2002 21*3 Hunan
Majitang 1983 18.5*3 Hunan
Guazhi 2007 50*3 Guizhou
Dongping 2007 72*3 Hunan
Source: Sinohydro, SYWG Research
Assuming the acquisition to generate 8% ROI, financing cost at 5%, the EPS enhancement will be 4 cents, or 20% of FY09E.
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申万研究 27
3.1.3 IPPs: Be cautious on coal price rebound
Earnings Change in 1% coal price hike
0%
-5%
-10%
-15%-20%
-25%
-30%
Huaneng Datang Huadian CRP CPI
Earnings Change
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申万研究 28
3.1.4 Valuation Matrix for Coal Sector Demand bottoming up is mostly digested by investors.
Next main theme should be spot price rebound caused by strict supply side discipline.
Shenhua: long term value eminent.Capital injection and industry consolidation should be the catalyst.
China Coal: Fair value play because the market not fully recognized downside risk of export business.
Source : Datastream SWS Research
Valuation Matrix
Source : Datastream SWS Research
A-H premium
Company names PremiumChina Shenhua 32.43%China Coal Energy 62.54%YCM 98.89%
Company names Country Ticker Closing price 08PE 09PE 10PE 08PB 09PB 10PBPeabody US BTU.US 28.94 8. 97 13. 31 10. 79 2. 41 1. 78 1. 47Arch coal US AIS.US 16.12 6. 68 37. 40 10. 13 1. 29 1. 02 0. 88BHP Australia BHP.AX 33.34 8. 37 18. 72 22. 65 2. 86 2. 52 2. 15Rio tinto Australia RIO.AX 61.88 5. 31 17. 79 15. 87 1. 63 1. 42 1. 24
Company names Ticker Rating Closing price Target price 08PE 09PE 10PE 08PB 09PB 10PBChina Shenhua 1088.HK Outperform 23.20 24.50 15. 32 13. 87 11. 94 2. 74 2. 33 2. 05China Coal Energy 0836.HK Neutral 8.28 8.50 14. 09 13. 08 10. 94 1. 63 1. 44 1. 33YCM 1171.HK Outperform 8.71 10.00 5. 84 8. 76 7. 87 1. 43 1. 22 1. 06
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申万研究 29
3.1.5 Valuation Matrix for Power Sector
Demand bottoming up but utilization rate not yet.
Should be cautious on the coal price rebound.
Sector recovery is definite but all priced in.
A-H premium
Source : Datastream SWS Research
Company names Ticker Rating Closing price Target price 08PE 09PE 10PE 08PB 09PB 10PBCPI 2380.HK Outperform 1.86 2.20 -9.79 8.86 8.09 0.85 0.76 0.69Huadian 1071.HK Outperform 1.93 2.50 -4.02 7.21 5.35 0.90 0.81 0.73Huaneng 902.HK Outperform 4.95 5.50 -13.27 11.84 9.52 1.43 1.31 1.18CRP 836.HK Neutral 15.92 16.00 38.83 15.61 12.74 2.74 2.41 2.12Datang 991.HK Neutral 3.72 3.50 54.87 13.60 8.13 1.50 1.37 1.06
Company names PremiumHuaneng 76.01%Datang 132.08%Huadian 192.75%
Valuation Matrix
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申万研究 30
The views expressed in this report accurately reflect the personal views of the analyst. The analyst declares that neither he/she nor his/her associate serves as an officer of nor has any financial interests in relation to the listed corporation reviewed by the analyst. None of the listed corporations reviewed or any third party has provided or agreed to provide any compensation or other benefits in connection with this report to any of the analyst, the Company or the group company(ies). A group company(ies) of the Company confirm that they, whether individually or as a group (i) are not involved in any market making activities for any of the listed corporation reviewed; or (ii) do not have any individual employed by or associated with any group company(ies) of the Company serving as an officer of any of the listed corporation reviewed; or (iii) do not have any financial interest in relation to the listed corporation reviewed or (iv) do not, presently or within the last 12 months, have any investment banking relationship with the listed corporation reviewed.
Undertakings of the AnalystWilson ChenI am conferred the Professional Quality of Securities Investment Consulting Industry by the Securities Association of China or have equivalent professional competence. I issue this report independently and objectively with due diligence. This report distinctly and accurately reflects my research opinions. I have never been, am not, and will not be compensated directly or indirectly in any form for the specific recommendations or opinions herein. Information Disclosure with respect to the CompanyThe Company fulfills its duty of disclosure within its sphere of knowledge. The clients may contact [email protected] for the relevant disclosure materials.
Introduction of Share Investment RatingSecurity Investment Rating :When measuring the difference between the markup of the security and that of the market’s benchmark within six months after the release of this report, we define the terms as follows: Buy : with a markup more than 20% better than that of the market ;Outperform : With a markup 5% to 20% better than that of the market ;Neutral : with a markup less than 5% better or worse than that of the market ;Underperform : with a markup more than 5% worse than that of the market.Industry Investment Rating:When measuring the difference between the markup of the industry index and that of the market’s benchmark within six months after the release of the report, we define the terms as follows: Overweight : Industry performs better than that of the whole market ;Neutral : Industry performs about the same as that of the whole market ;Underweight : Industry performs worse than that of the whole market.
We would like to remind you that different security research institutions adopt different rating terminologies and rating standards. We adopt the relative rating method to recommend the relative weightings of investment. The clients’ decisions to buy or sell securities shall be based on their actual situation, such as their portfolio structures and other necessary factors. The clients shall read through the whole report so as to obtain the complete opinions and information and shall not rely solely on the investment ratings to reach a conclusion. The Company employs its own industry classification system. The industry classification are available at our sales personnel if you are interested.CSI300 is the benchmark employed in this report for A-share listed firms and FXI/SWS Triple-C Index is the benchmark employed in this report for HK-listed firms.
Disclaimer
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申万研究 31
This report is to be used solely by the clients of Shenyin & Wanguo Securities Research Institute Co, Ltd. (hereinafter referred to as the “Company”). The Company will not deem any other person as its client notwithstanding his receipt of this report.This report is based on published information which the Company believes to be reliable, however, the authenticity, accuracy or completeness of such information is not warranted by the Company. The materials, tools, opinions and speculations contained herein are for the clients’ reference only, and are not to be regarded or deemed as an invitation for the sale or purchase of any security or other investment instruments. The clients understand that the text message reminder and telephone recommendation are no more than a brief communication of the research opinions, which are subject to the complete report released on the Company’s website (http://www.sw108.com). The clients may ask for follow-up explanations if they so wish.The materials, opinions and estimates contained herein only reflect the judgment of the Company on the day this report is released. The prices, values and investment returns of the securities or investment instruments referred to herein may fluctuate. At different periods, the Company may release reports which are inconsistent with the materials, opinions and estimates contained herein. The clients shall consider the Company’s possible conflict of interests which may affect the objectivity of this report, and shall not base their investment decisions solely on this report. The investment and services referred to herein may not be suitable for certain clients and shall not constitute personal advice for individual clients. The Company does not ensure that this report fully takes into consideration of the particular investment objectives, financial situations or needs of individual clients. The Company strongly suggests the clients to consider themselves whether the opinions or suggestions herein are suitable for the clients’ particular situations; and to consult an independent investment consultant if necessary.Under no circumstances shall the information contained herein or the opinions expressed herein forms an investment recommendation to anyone. Under no circumstances shall the Company be held responsible for any loss caused by the use of any contents herein by anyone.Independent investment consultant should be consulted before any investment decision is rendered based on this report or at any request of explanation for this report where the receiver of this report is not a client of the Company.
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Shanghai SWS Research & Consulting Co., Ltd.
Wilson Chen
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