asia themes: china's long march to soe...

Cross Asset Research11 August 2014

Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by equity research analysts based outside the US who are not registered/qualified as research analysts with FINRA.

FOR ANALYST CERTIFICATION(S) PLEASE SEE PAGE 43.

FOR IMPORTANT FIXED INCOME RESEARCH DISCLOSURES, PLEASE SEE PAGE 43.

FOR IMPORTANT EQUITY RESEARCH DISCLOSURES, PLEASE SEE PAGE 43.

Asia Themes

China’s long march to SOE reforms China appears to be getting back on its SOE (state-owned enterprise) reform agenda, having recently announced a wave of reforms targeting at improving operational and asset efficiency. In this report we look at some of the most affected industries, notably oil & gas, basic materials, banks, telcos and infrastructure. We find that reform progress varies among these, from telcos having seen the most reform progress, to infrastructure with the most opaque reform plans. We believe that while some of these reform plans are a move in the right direction, given still yet limited details, immediate operational and return improvements are likely to be subdued in what could be a long road to efficiency gains.

Economics Research: SOE reforms will be an important driver of growth as China aims to ratchet up corporate efficiency and returns. We look for more reform initiatives at both the central and local level. We expect to see easier entry for private capital into the ‘strategic’ and ‘pillar’ industries, a gradual reduction in state ownership in competitive sectors, and more aligned interests between managements and corporate performance. We note that there is no ‘one size fits all’ reform path, as that will depend on the nature of each SOE and their strategic importance to the state.

Credit Research: The aim of the State-owned Assets Supervision and Administration Commission (SASAC) in the upcoming SOE reforms is two-fold: 1) separation of ownership and regulation; and 2) improving asset returns enabling better asset allocation at a national level. The reform announcements will be initially implemented through a couple of pilot companies. We expect the selected SOEs such as COFCO, BOCOM and the Chinese asset managers to benefit, should the reforms be executed successfully. We recommend buying the COFCO ‘18s.

Equity Research: With supply overcapacity and operational inefficiency dominating some of China’s largest industries, SOE reforms have long been on the agenda for many Chinese companies, thus the question was a matter of timing. With an announcement from the SASAC on 15 July 2014 providing a baseline for what is likely to be a long and nuanced road to SOE reforms, this has also spurred on companies such as Bank of China, PetroChina and Sinopec to announce their own reform plans, aimed at diversifying ownership and asset sales. In the long run, we expect the reforms will be positive for China’s corporate development, if executed effectively; but nuances across industries and companies are likely to present risks in the near term. We examine some of the reforms being undertaken and respective risks and opportunities these may present in the banks, telcos, basic materials, oil & gas and transport industries.

MACRO STRATEGY

ECONOMICS RESEARCH Jian Chang * +852 2903 2654 [email protected]

ASIA CREDIT STRATEGY Krishna Hegde, CFA * +65 6308 2979 [email protected]

EQUITY RESEARCH Asia Ex-Japan Banks May Yan +852 2903 4756 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Oil & Gas Somshankar Sinha +852 2903 2434 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Oil Services & Drilling Clement Chen +852 2903 2498 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Telecom Services Anand Ramachandran, CFA +65 6308 3895 [email protected] Barclays Bank, Singapore

Asia ex-Japan Metals & Mining Ephrem Ravi +852 2903 4892 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Infrastructure & Transport Jon Windham, CFA +852 2903 4672 [email protected] Barclays Bank, Hong Kong *These authors are members of the Fixed Income, Commodities and Currencies Research department and are not equity analysts.

Barclays | Asia Themes

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INVESTMENT SUMMARY

Economics Research As China searches for its next leg of growth, SOE reforms are top of the agenda given the mismatch between size and levels of profitability. Notably, 25% of China’s SOEs are loss making. With a view to improving efficiency, lifting returns, and encouraging innovation, a greater proportion of private ownership appears to be the best way forward. This is likely to foster competition and improve corporate governance and transparency. However, we concede that this is a long road given vested interests of multiple government parties, and a lack of details from SASAC’s pilot plan. We expect reforms to vary according to state, sector and company-specific factors, and thus a nuanced reform process.

FIGURE 1 More than a quarter of SOEs are loss-making

FIGURE 2 SOEs – liability-to-equity ratios on the rise post-GFC

Source: CEIC, Barclays Research Source: CEIC, Barclays Research

Credit Research SASAC’s aim in the upcoming SOE reforms are two-fold: 1) separation of ownership and regulation; and 2) improving asset returns enabling better asset allocation at a national level. The reform announcements will be initially implemented through a couple of pilot companies. We expect the selected SOEs such as COFCO, BOCOM and the Chinese asset managers to benefit, should the reforms be executed successfully. We recommend buying the COFCO ‘18s.

Equity Research China banks: While not listed as reform candidates in the recent government announcements yet, some China banks have proactively announced plans for mixed-ownership reform plans. We believe the fiscal, government SOE reforms may incrementally improve Chinese banks’ NPLs visibility in the medium-to-long term, which may lead to re-rating of China banks. Bank of China (3988 HK; OW; PT HK$4.60) is our top pick in China Banks sector on the back of this theme. BOCOM (3328 HK; EW; PT HK$5.80) and CITIC Bank (998 HK; EW; HK$5.00) may also benefit from upcoming ownership reforms.

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ECONOMICS RESEARCH Jian Chang * +852 2903 2654 [email protected]

ASIA CREDIT STRATEGY

Krishna Hegde, CFA * +65 6308 2979 [email protected]

EQUITY RESEARCH Asia Ex-Japan Banks May Yan +852 2903 4756 [email protected] Barclays Bank, Hong Kong * These authors are members of the Fixed Income, Currencies and Commodities Research department and are not equity research analysts


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China oil & gas: Albeit not specifically listed in the recent SOE pilot program, we believe reform progress will continue in the oil & gas industry, led by Sinopec’s February 2014 announcement of its intention to sell up to 30% of its marketing segment Sinopec Sales (SS). PetroChina has also indicated that it has indentified six platforms for mixed ownership including pipeline divestments, downstream joint ventures and partnerships in tough upstream E&P projects; among these the pipeline divestments are already underway.

China oil services & drilling: The drive for efficiency in the China oil & gas industry bodes well for the oil services sector as private operators such as Anton (3337 HK; OW; PT HK$5.80) and SPT (1251 HK; EW; PT HK$4.90) start to see greater opportunities from clients who are under pressure to reduce costs, thus increasing the market share of oil services companies. However, the reform process is unlikely to be clear cut as market forces come into play, intensifying competition, especially in regular services.

China telecom services: ROIC trends in the sector have been below WACC but the establishment of a national telco tower company and the push towards better handset subsidy and marketing expenses are both in the hopes of “reform” and we believe the continuation of which could lift capital returns. While we are optimistic that progress is being made, we would need to see more in terms of delivery before we argue for a re-rating of stock prices. As such, we remain Equal Weight on both China Unicom and China Telecom.

FIGURE 3 China telecom services – ROIC trends

Source: Company data, Barclays Research

China metals & mining: With heavy overcapacity, we view the basic materials industry as in significant need of reform. We believe that three aspects could make one SOE more likely a reform candidate than another: 1) those with direct SASAC-ownership; 2) those poorer in operating and financial fundamentals; and 3) those with a weak capital position. Some degree of privatisation could likely help as shareholder value is maximized by way of transparency, increased profitability and better returns. However, risks remain that a long drawn out reform process continues to perpetuate asymmetric incentives between managers, the state, and shareholders.

China infrastructure & shipping: We believe the government is more likely to focus on the infrastructure sector than the shipping operators, as the latter is not sufficiently matured for reform as it continues to address operational issues. We instead scan the infrastructure and transport companies and elaborate on those we believe are susceptible to SOE reform plans. We see COSCO Group (parent of China COSCO; 1919 HK; UW; PT HK$3.35) as an unlikely reform candidate in the near term.

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China Mobile China Telecom China Unicom WACC

WACC = 9.8%

Asia ex-Japan Oil & Gas Somshankar Sinha +852 2903 2434 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Oil Services & Drilling Clement Chen +852 2903 2498 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Telecom Services Anand Ramachandran, CFA +65 6308 3895 [email protected] Barclays Bank, Singapore

Asia ex-Japan Metals & Mining Ephrem Ravi +852 2903 4892 [email protected] Barclays Bank, Hong Kong

Asia ex-Japan Infrastructure & Transport Jon Windham, CFA +852 2903 4672 [email protected] Barclays Bank, Hong Kong


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FIGURE 4 CNBM and Chalco screen as the companies most likely to be in the list for “reform” given their balance sheets

FIGURE 5 Profit generation potential of both CNBM and Chalco does not support the net debt positions, in our view

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Note: Data as of 2013. Source: Company data, Barclays Research Note: Data as of 2013. Source: Company data, Barclays Research

FIGURE 6 Barclays Equity Research – featured companies in our coverage universe

Rating (stock/ Price

PriceTarget Potential P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%)

Ticker sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E 2015E 2016E

China Banks

ABC 1288.HK OW / NEU 3.72 4.20 12.9 4.9 4.8 0.9 0.8 N/A N/A 7.0 7.2

Bank of China 3988.HK OW / NEU 3.65 4.60 25.9 4.5 4.4 0.7 0.6 N/A N/A 7.7 7.9

BoComm 3328.HK EW / NEU 5.81 5.80 -0.2 5.3 5.2 0.7 0.6 N/A N/A 5.9 5.9

CCB 0939.HK EW / NEU 5.82 6.50 11.7 4.9 4.8 0.8 0.8 N/A N/A 7.1 7.3

CMB 3968.HK OW / NEU 15.28 17.00 11.3 5.2 5.0 0.9 0.8 N/A N/A 5.2 5.4

China CITIC 0998.HK EW / NEU 5.01 5.00 -0.2 4.2 4.1 0.6 0.6 N/A N/A 7.2 7.3

ICBC 1398.HK OW / NEU 5.16 6.00 16.3 5.1 5.0 0.9 0.8 N/A N/A 6.9 7.0

China Metals & Mining

Angang 0347.HK OW / NEU 5.81 6.50 11.9 10.5 10.6 0.7 0.6 5.2 5.2 4.7 4.7

Chalco 2600.HK UW / NEU 3.53 2.30 -34.8 N/A 24.2 1.0 0.9 16.2 10.6 0.0 0.0

China Coal 1898.HK UW / NEU 4.9 3.70 -24.5 25.5 14.2 0.6 0.6 8.6 6.6 1.2 2.1

CNBM 3323.HK UW / NEU 7.65 6.68 -12.7 4.3 4.0 0.7 0.6 6.9 6.6 3.5 3.7

CR Cement 1313.HK EW / NEU 5.68 5.79 1.9 8.8 8.5 1.2 1.1 6.1 5.5 2.3 2.4

China Shenhua 1088.HK OW / NEU 23.2 27.00 16.4 8.6 8.1 1.1 1.0 5.2 4.7 4.7 5.0

China Oil Services & Drilling

Anton 3337.HK OW / POS 4.23 5.80 37.1 12.7 10.7 2.4 2.1 7.3 6.2 2.4 2.8

SPT Energy Group 1251.HK EW / POS 3.93 4.90 24.7 9.8 7.4 2.0 1.6 5.6 4.4 2.5 3.4

China Oil & Gas

Kunlun Energy 0135.HK UW / POS 13.26 11.40 -14.0 12.9 9.9 1.7 1.5 5.8 4.3 2.1 2.7

PetroChina 0857.HK OW / POS 10.12 11.80 16.6 10.3 9.2 1.1 1.0 5.0 4.5 4.2 4.4

Sinopec 0386.HK EW / POS 7.44 6.80 -8.6 9.3 9.5 1.0 1.0 4.6 4.6 4.6 4.6

China Telecom Services

China Mobile 0941.HK UW / NEU 86 72.00 -16.3 15.3 14.9 1.6 1.5 4.6 4.2 2.8 2.9

China Telecom 0728.HK EW / NEU 4.09 4.20 2.7 14.2 11.9 0.9 0.8 3.6 3.3 2.3 2.5

China Unicom 0762.HK EW / NEU 12.8 13.00 1.6 15.9 12.6 1.0 1.0 3.4 3.0 1.9 2.4

China Infrastructure & Shipping

China COSCO 1919.HK UW / NEU 3.38 3.35 -0.9 N/A N/A 1.3 1.3 25.8 22.1 0.0 0.0

China Merchants 0144.HK OW / NEU 25.6 28.87 12.8 13.7 12.0 1.2 1.1 17.8 18.0 2.0 2.2

CSCL 2866.HK OW / NEU 2.15 2.15 0.0 19.5 14.7 0.8 0.7 9.5 8.1 0.0 0.0

CSD 1138.HK OW / NEU 5.24 6.35 21.2 42.6 26.2 0.7 0.6 15.7 15.3 0.0 0.0

COSCO Pacific 1199.HK OW / NEU 11.5 15.15 31.7 11.1 9.8 0.9 0.8 10.5 9.6 3.6 4.1

Sinotrans Shipping Ltd. 0368.HK OW / NEU 2.16 3.00 38.9 N/A 69.2 0.5 0.5 18.1 13.9 0.2 0.4Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates

http://publicresearch.barcap.com/�


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CONTENTS

INVESTMENT SUMMARY ................................................................................ 2 Economics Research .................................................................................................................................. 2 Credit Research ........................................................................................................................................... 2 Equity Research .......................................................................................................................................... 2

ECONOMICS RESEARCH: WATCH MOVES ON SOE REFORM ............... 6 SOE reforms critical to reinvigorate China’s economy ...................................................................... 6 We look for more reform initiatives at central and local level .......................................................... 7 Chinese SOEs, largely in ‘strategic’ and ‘pillar’ industries ................................................................. 8 New round of SOE reform – incremental, not big bang .................................................................... 9 Key stakeholders that determine the direction and pace ................................................................ 10 Mixed ownership, one basket that can fit many eggs ..................................................................... 11 Waves of central and local SOE reforms across industries ............................................................. 11

CREDIT RESEARCH .......................................................................................... 15 China SOE reform: Incremental not big bang .................................................................................... 15 The Third Plenum decisions being put into action ........................................................................... 16 Central SASAC SOE pilots bode well for long term .......................................................................... 16 Putting these reform measures in context ......................................................................................... 17 What are the credit implications? ......................................................................................................... 18

EQUITY RESEARCH ......................................................................................... 20

CHINA BANKS ................................................................................................... 21 Reforms poised to be next catalysts .................................................................................................... 21 Recently approved fiscal reform could add visibility to banks’ LGFV and property NPL outlook21 SOE reform could be positive but execution will be complicated and results remain to be seen22 Governance reform – helpful for long-term productivity gains ..................................................... 23 Marginally more positive on the MLT NPL outlook ............................................................................ 24

CHINA OIL & GAS ............................................................................................ 25 China’s oil and gas SOEs moving ahead of the pack ........................................................................ 25

CHINA OIL SERVICES & DRILLING ............................................................... 29 China oil services companies – potential reform beneficiaries ...................................................... 29

CHINA TELECOM SERVICES ......................................................................... 31 Seeds of hope – do they sprout or wither away? .............................................................................. 31

CHINA METALS & MINING ............................................................................ 36 “Reform” through the path of least resistance .................................................................................. 36

CHINA INFRASTRUCTURE & SHIPPING ..................................................... 39 Divergence between infrastructure and shipping............................................................................. 39 Possible reform candidates .................................................................................................................... 40


11 August 2014 6

ECONOMICS RESEARCH: WATCH MOVES ON SOE REFORM

SOE reforms critical to reinvigorate China’s economy Reforms of China’s state-owned enterprise (SOEs) sector in the late 1990s underpinned the country’s strong economic performance in the following decade. Most small- and medium-sized firms became privately owned, while many SOEs were corporatised and, some, undergone radical restructuring. The non-state sector now accounts for more than two thirds of GDP. The SOEs’ share of total industrial assets fell from c70% in 1998 to c40% in 2010, while their share of employment dropped from 60% to less than 20%.1

Recent years, however, have seen the ‘advance of the state and retreat of the private sector’. SOEs have gained dominant positions in ‘strategic’ industries, enjoyed administrative monopoly status in many sectors, and expanded aggressively into competitive industries, ‘crowding out’ the development of the private sector. This trend took off after the massive stimulus package over 2008-09 when credit mostly went to the SOEs. The share of SOEs in total assets of non-strategically important sectors rose to 49% in 2011 from 43% in 20012.

Meanwhile, the efficiency and profitability of SOEs have been falling. Despite their monopoly status and privileged access to resources and markets, more than 25% of China’s SOEs are loss making (Figure 7). The state sector is much less efficient than the non-state sector, with the former’s return on equity averaging half that of listed companies (Figure 8). The legacy of the massive stimulus was a temporary boost to sales and revenue, followed by inefficient investment, mounting debts, and many ’zombie’ companies (Figure 9).

In our view, SOE reform will be the most critical reform area for China in the coming decade. A vibrant and efficient corporate sector is key to sustaining relatively high growth and enhancing the economy’s potential for innovation and China’s global competitiveness. Successful reforms and resulting institutional and behavioural changes should not only increase profitability, but also improve capital allocation and boost productivity.

FIGURE 7 More than a quarter of SOEs are loss-making

FIGURE 8 Return on equity among SOEs is half that of listed companies

Source: CEIC, Barclays Research Note: * estimated by CSRC, while others by MoF. Source: CEIC, Barclays Research

1 China 2030 : Building a Modern, Harmonious, and Creative Society, World Bank, March 2013 2 Developing Mixed Ownership Structures and Modern Enterprise Systems, Boston Consulting Group& China development Research Foundation,24 March 2014

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Economics Research Jian Chang* +852 2903 2654 [email protected]

*This author is a member of the Fixed Income, Currencies and Commodities Research department and is not an equity research analyst


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We look for more reform initiatives at central and local level We think SOE reform is a major theme for investors to watch, both for the potential benefits and possible risks. Many SOEs are listed companies, or have many listed subsidiaries, although they still tend to behave differently from other listed companies. Many are also big issuers in the onshore and/or offshore bond markets. Hence their reform progress will have important implications for capital markets.

We have been optimistic about progress in the SOE reform3, as we think the government realises the urgency for change. This February and March, Sinopec and the GREE group, two large SOEs owned by central and local governments, respectively, made significant moves to sell up to 30% and 49% of one of their businesses to private capital. Since July, the reform momentum has picked up pace with a wave of initiatives announced (Figure 13).

YTD, the SOE reform initiatives have covered all the monopolistic sectors that the government committed to opening up to private capital at the March NPC meeting, namely finance, oil & gas, electricity, railways, telecom, resource development, and infrastructure. The pilot central SOE reform plan by the SASAC, in contrast, had a focus on reforming the competitive SOEs. The local SOE reform plans, with more executable details, more specific targets and timetables, involve both local monopoly and competitive sectors (Figure 16).

We note that there is no ‘one size fits all’ reform path, as that will depend on the nature of each SOE, their strategic importance to the state, and the ‘missions’ they are expected to undertake, to name a few. Hence, we expect reforms to be both sector- and company-specific. As such, the potential change and impact will vary greatly across industries (ie, monopoly, vs competitive) and enterprises (industry leader or loss-making, single-industry enterprise or conglomerate), involving listed, unlisted and non-SOEs, along the process.

FIGURE 9 SOEs – liability-to-equity ratios on the rise post-GFC

FIGURE 10 Chinese SOE assets by sector, % of total

Source: CEIC, Barclays Research Note: The chart is based on data in the latest available data in 2011. * Public facilities include urban Road, subway & light rail, waste treatment facilities and public information services. Source: WIND, Barclays research

To be sure, the challenges are huge and success is not guaranteed. SOEs have become powerful players in China’s political and economic system, and there are strong vested interests in maintaining the status quo. State interventions through the SOEs to implement macroeconomic and industrial policies or to deliver strategic goals or social responsibilities will continue. Also, the current plan is for the large SOEs to reform from within, in our view, but historical experiences suggest that without a crisis, progress could be slow.

3 see China’s National Party Congress 2014 what we expect from the NPC meeting, 25 February 2014.

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We think the ultimate success or failure of China’s SOE reforms will depend on the leadership’s commitment to the ‘decisive’ role of the market. Despite a lack of consensus at times among key stakeholders (Figure 12), we expect the reform to move ahead 1) easier entry for private firms into the ‘strategic’ and ‘pillar’ industries, 2) a gradual reduction in state ownership in non-strategic sectors, 3) more aligned interests between managements and corporate performance, and 4) better corporate governance with professional boards.

Chinese SOEs, largely in ‘strategic’ and ‘pillar’ industries

More than 50% of their assets are in various monopolistic industries… More than 50% of SOE assets are in the typical monopolistic industries, including urban facilities, transportation, oil & gas, telecom, power and utility (Figure 5). This is followed by the relatively more competitive sectors including property, metals, construction and machinery. Such a structure highlights the urgent need for reform. Most SOEs belong to the so-called ’old economy’, which has been hit hard in the economic slowdown since 2011.

…natural monopoly, administrative monopoly, and market monopoly… It is useful to consider the three types of monopolies relevant for Chinese SOEs. The first is a natural monopoly. As elsewhere, this takes place in the public service sectors, such as power grids, water supply, and oil & gas pipeline networks. The second is an administrative monopoly, which is market power created by regulatory and market-access barriers. For example, restrictions are still widespread on private and/or foreign capital entry into many sectors, particularly in services such as medical care, education and culture, and commercial operation of the natural monopoly industry. The third is market monopoly, which is formed by a few SOEs given their strong market control, such as the three telecom operators.

… reflecting the emphasis on ‘strategic’ and ’pillar’ industries since 2006 The government announced seven ‘strategic’ sectors - defence, power generation and distribution, petroleum and petrochemicals, telecoms, coal, civil aviation, and shipping in December 2006 (Figure 6). These are the sectors that the government considered to be of “critical importance to the national and economic security” and in which the state would keep “sole ownership or absolute controls”. In these sectors, while a few state firms might compete with each other, they are protected from the threat of new entrants, whereas the government aimed to develop the ‘national champions’ to become world class companies.

The government also named a number of ‘basic and pillar’ industries, including machinery equipment, automobiles, information technology, construction, steel, non-ferrous metals, petro-chemicals and hi-tech. For the “backbone firms” in these industries, the policy guidance is that the state would look to “retain relatively strong controls”. And the state should “maintain sufficient influence” in other industries and fields. Unsurprisingly, private firms face a range of entry barriers or other restrictions and disadvantages such as access to financing which prevent them from developing and competing on an level playing field.

FIGURE 11 SASAC identified seven ‘strategic’ industries, nine ‘pillar’ industries and a few others in 2006

Industry Type Industries included Ownership objective No. of SOEs

% central SOE assets

Strategic Power generation and distribution, Oil & gas, telecoms, coal, civil aviation, and shipping

Sole ownership or absolute control

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Machinery, Automobiles, Information technology, Construction, Steel, Non-ferrous metals, chemicals, Survey & design and technology

Relatively strong control

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Other industries

Trading, Medicine, Construction, Materials, Agriculture, Geological exploration

Sufficient influence 50s 8

Note: The documentation (in Chinese) of these classifications can be found at http://www.sasac.gov.cn/n1180/n1566/n258252/n258644/1727614.html and, http://finance.qq.com/a/20061219/000125.htm. Source: SASAC and Barclays Research

http://www.sasac.gov.cn/n1180/n1566/n258252/n258644/1727614.html�

http://finance.qq.com/a/20061219/000125.htm�


11 August 2014 9

New round of SOE reform – incremental, not big bang In the 1990s, China undertook an aggressive clean-up of the SOE sector, launched by the then Premier Zhu Rongji. Zhu formulated the principle of “grasping the big, letting go of the small” in the mid 1990s, setting a clear reform direction. In 1997, the government set a three-year phased goal for the SOEs to turn around their loss-making businesses.

What’s the latest plan? In November 2013, in a monumental meeting, the Third Plenum, the current government approved a reform blueprint for the coming decade. “Actively developing mixed ownership” was agreed as a guiding principle for SOE reform. We list the key reform directions below and our view of how well they’ve been executed so far.

We expect the current SOE reform to be a long March, given changing economic and political environment, stronger resistance and less incentive from the SOEs as many are profit-making and have greater influence and stronger bargaining power than in the 1990s.

Major SOE reform directions approved at the Third Plenum (our comment) • Developing a mixed-ownership economy (strong consensus and meaningful progress)

− To introduce greater competition through diversification of the state's ownership.

− To establish an employee shareholding system.

• Improving modern corporate governance (progress but with strong resistance)

− Clearly define the functions of different SOEs (progress at local government levels).

− Increase state support for SOEs involved in ‘public goods’ provision.

− Reform the state controlled natural monopoly sectors, ie, railway, oil & gas, power, and telecom (strong resistance from SOEs).

1) Separate administrative functions from enterprise management, separate state asset management from government, and promote franchising and supervision.

2) According to different industry characteristics, implement the policy of separating infrastructure from operation, open competitive businesses, and promote market-oriented public resource allocation (such as pricing reforms).

− Remove various forms of administrative monopolies

− A corporate governance structure that is balanced and provides equal protection; a professional management system and market-oriented employment system; and a market-oriented incentive structure and an effective supervision mechanism.

• Encouraging the development of the non-state economy

− Remove implicit regulatory barriers and unreasonable restrictions.

• Enhancing the state asset management system (lack of consensus)

− Establishing state capital operation companies or turning qualified SOEs into state capital investment companies, with a focus on the management of capital.

− Serving the national strategy and investing in areas related to national and economic security; industry focuses are public service provision, strategic industries, environmental protection, technological advancement, and national security.

• Increase SOEs dividend payment to the state and transfer to national pension fund


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Key stakeholders that determine the direction and pace The policy framework involving SOE reform is complicated. Local newspaper reports4 that the government has assigned the leading role to design the various SOE reform tasks to different ministries and departments under the State Council: The MoF for reforming the state asset management system, NDRC for piloting the mixed-ownership economy, and Organisation Department for senior management recruiting. The Central Reform Leading Group, headed by President Xi, will coordinate the reforms.

• The State-owned Assets Supervision and Administration Commission (SASAC) is the manager, investor and supervisor of a total of 113 non-financial central-government-owned SOEs (central SOEs). SASAC was established in 2003 and reports directly to the State Council. By end-2012, the biggest 53 of the 113 SOEs, known as the ‘backbone’ SOEs, represented 84% of total SASAC-administered SOE assets, and 80% of revenues.5

• The Ministry of Finance (MoF) is responsible for overseeing the state-owned financial SOEs. For example, it is the main shareholder of China Everbright group, BOCOM, PICC, China Life, and China Railway corporations among others.

• The Central Organisation Department (COD) is under the Central Committee of the Communist Party of China, and is responsible for the appointment of senior Chinese officials. It appoints the top executives of the 53 ‘backbone’ SOEs, which are subject to review and approval by the Standing Committee of the Politburo. SASAC appoints the rest of the SOEs’ senior executives and undertakes an annual performance evaluation.

• Local SASACs manage the local SOEs. Local SASACs report to the local governments, where the heads are appointed by the central government, often through the Organisation Department. Contributing c70% of total SOE profits in 2013, local SOEs are generally small and concentrated in more competitive markets.

FIGURE 12 Chinese government organisations that influence the SOE reforms

Source: Various Chinese government websites, and Barclays Research

4 http://finance.sina.com.cn/china/20140715/210019712902.shtml 5 China State-Owned Enterprises: On a Bumpy Path Towards Market Reform, Fitch Ratings, June 2014

State Council

National Reform & Development Commission

(NDRC)

State-owned Assets Supervision and Administration

Commission (SASAC)

Non Financial Corporation

Policy Banks The Export & Import of China

China Investment Co.

China Railway Co.China Tobacco Co.

Central HuijingInvestment Ltd.

Financial institutions:Big four banks China Development Bank

113 Central SOEs including China National Cereals, Oils and Foodstuffs Co.(COFCO)China National Pharmaceutical Group Co. (SinoPharma)China National Petroleum Co. (CNPC)China Resource GroupChina Aerospace science and Technology Co.State Grid Corporation of China

Other Financial Institutions

Local Governments

Local SASACs

Local SOEs

Central Committee,Communist Party of China

Central Politburo

& Standing

Committee

Organization Department

National People’ Congress

Ministry of Finance (MoF)

Bank of CommunicationCITIC Group Co.China Everbright GroupPICC GroupChina Life Insurance

100%

100%

100%

100%


11 August 2014 11

Mixed ownership, one basket that can fit many eggs

“Developing mixed ownership” – what does it mean? Since its approval as a guiding principle, developing mixed ownership has been adopted quickly by local governments and SOEs. At this stage, we think it entails two key components:

• more opportunities for non-state capital to take equity stakes in SOEs, and

• more aligned incentives through employees and senior management holding shares.

Practically, greater mixed ownership structures can be achieved through:

• Stock market listings, which will also allow the government to secure its equity value in SOEs, paving the way for the next move of separating ownership from management.

• Diversifying SOEs’ equity ownership by introducing institutional or strategic investors, such as social security funds, insurance companies, and private equity funds.

SASAC’s four-scenarios for state ownership depend on strategic importance In a press briefing in December 2013, SASAC commented on how to determine the level of state ownership, basically a refinement of its stance since 2006 (Figure 6), namely:

• Sole state-ownership will be applied to SOEs involved in state security, and the state capital investment and state capital operation companies that are to be established.

• For SOEs in ‘strategic’ industries, the state will maintain absolute control.

• For SOEs in hi-tech and ‘pillar’ industries, the state will maintain relative control.

• For SOEs in competitive industries, the state can be a minority shareholder or exit.

Waves of central and local SOE reforms across industries

State Council accelerated approval for opening up the monopolistic sectors Since February, a wide range of SOE reform initiatives have been announced. These have covered all the monopolistic sectors that the government committed to opening up to private capital at the March NPC meeting, namely finance, oil & gas, electricity, railways, telecom, resource development, and public utilities. For details, see Figure 13.

SASAC’s pilot reform plan only focuses on competitive sectors On 15 July, SASAC announced a long-awaited plan for SOE reform, which involves a ‘four-area pilot program’ for the central SOEs. Six central SOEs have been picked for the first batch of the pilot program (Figure 14). Two of them, SDIC and COFCO will be “reorganised” to establish state capital investment companies (SCICs). Sinopharm and CNBM were chosen for the mixed-ownership pilot reform. XXCIG, CECEP, Sinopharm and CNBM will pilot a more empowered board of directors system. "Disciplinary inspection teams" will also be sent to some SOEs. In Figure 15, we note the listed subsidiaries of the six central SOEs whose stocks have seen significant movements since the announcements.

10 local governments have revealed local SOEs reform plans At the same time, local SASACs have been active in announcing or drafting local SOE reform plans. Figure 16 lists the proposals of 10 local governments announced over March-July 2014. Depending on the level of economic development, resource endowment, debt concerns, local governments show varying degrees of commitment and preferred directions for local SOE reform, which we discuss in the next section.


11 August 2014 12

FIGURE 13 Major SOE reform initiatives and reform cases

Sector Date Detail

Finance

31-Jul China Everbright group’s (601818.SH) proposed restructuring of its shareholding structure was approved by the State Council. The state-owned enterprise will become a joint-stock company founded by the Ministry of Finance and Central Huijin Ltd.

28-Jul Bank of Communications (3328.HK), China’s fifth largest bank, confirmed that it is studying plans to deepen its mixed-ownership structure. This implies that the state-controlled bank, partly owned by HSBC Holdings(18.7%), could sell more stakes to private and foreign investors. Its largest shareholder is the MoF, which has a 26.5% stake.

25-Jul

The CBRC approved plans to establish three private banks in Shenzhen, Wenzhou and Tianjin. 1) Tencent, Inc. (700.HK), Shenzhen Baiyeyuan Investment Co. and Shenzhen Liye Group are the three main co-founders of Webank. 2) Chint Group and Huafon Group(002064.SZ) are the co-founders of the proposed bank in Wenzhou, which will target local small and micro companies, individuals and rural area businesses. 3) The Huabei and Maigou (Tianjin) groups will co-found a bank in Tianjin, which will mainly engage in corporate banking services.

10-Jul The State Council emphasised a need to promote the commercial insurance business.

Oil & gas

01-Jul

Sinopec (00386.HK) announced a proposal to open at least 30% of its distribution business to private capital. The total assets of the restructured distribution subsidiary amount to CNY341.8bn. Management also said that it would give priority to industry investors (such as E-commerce, logistics), domestic investors and investors favouring the public interest (such as social security funds).

24-Jun

CNPC announced a new board with five of the eight directors coming from outside the organisation. The five include the Chairman of Singapore Airline Ltd and ex-president of Bank of China in Malaysia. This is the first time that more than half of the seats on CNPC’s board have been occupied by external directors.

(CNPC's listed arm PetroChina(601857.SH) started its mixed ownership reform in 2010 when it sold its LNG terminals to Kunlun Energy (0135.HK). The company also announced a plan to reduce its stake in a subsidiary consolidating the eastern part of the West to East Pipeline operation in May 2014.)

Electricity 26-Jul

NDRC held a conference on SOE reform with key stakeholders in the energy & power industry. Participants generally agreed to introduce private capital and more market-oriented systems. However, the incentives to carry out the reform are still in lack among the key players.

28-May State Grid Corporation of China will introduce private capital to the electric vehicle charging pilot program.

Railways

25-Jul The first privately operated railway in Xinjiang completed its track construction. This project was invested by Xinjiang Guanghui Co. Ltd. (600256.SH) and Huatong Equity Investment Ltd.

03-Apr The State Council confirmed the establishment of a CNY200-300bn railway development fund and approved the introduction of private capital into the sector.

Telecoms 24-Jul

China Communication Facility and Service Company (‘the tower company‘") was established on 18 July 2014. It was formed by the ‘Big 3‘ telecom operators: China Mobile (941.HK), China Unicom (600050.SH) and China Telecom (728.HK), which have stakes of 40%, 30.1% and 29.9% respectively. The shareholders also announced an intention to introduce private capital for 30-50% of the company and it would seek to go public at some point.

Resources 18-Jul China Beijing International Mining Exchange (CBMX) completed its shareholding restructuring with investment from private equity Chuanguhui Group. CBMX will also launch an exploration rights market after the restructuring.

Infrastructure 23-Apr

The State Council announced that China will allow private capital to invest in some sectors dominated by public investment and state-owned enterprises. The government will select a first batch of 80 infrastructure projects from industries such as railways, ports and other transportation infrastructure, new-generation information infrastructure and the petrochemicals industry.

25-Mar The NDRC starts to draft legislation to facilitate private equity entering infrastructure projects under the PPP model.

Conglomerates 26-Mar

Citic Group, with businesses ranging from banking to oil exploration, announced a plan to list in Hong Kong through an asset injection into its already listed Hong Kong unit, Citic Pacific Ltd (0267.hk). In doing so, Citic Group will become one of the few Chinese SOEs, and the first state-owned conglomerate, to have all of its main assets listed in Hong Kong. This will give global investors another way to access the Chinese economy.

Source: Various news reports and Barclays Research


11 August 2014 13

FIGURE 14 Details of SASAC central SOE pilot reforms

Four pilot reform areas Details SOEs involved

Establishing state capital investment companies

• To improve the management and operational efficiency of state-owned assets • The companies will in principle focus on investment and projects, rather than capital operations

SDIC, COFCO

Mixed ownership reform • Introduce non-state equity into shareholding structures • To improve governance structure and promote a market-oriented recruiting system (ie,

professional managements and modern compensation schemes) • Encourage employee ownership plans

CNBM, Sinopharma

Board of director system • Clarify the function of SASAC and boards of directors • Boards will be more active in selecting senior management, making performance assessments,

and structuring compensation schemes

CNBM, Sinopharma, CECEP, XXCIG

Discipline inspection • Intensified supervision of SOEs' key managements, and improving anti-corruption mechanisms within enterprises

Two or three SOEs at a national level

Source: SASAC and Barclays Research

FIGURE 15 Listed subsidiaries of the six pilot central SOEs

Source: Company website and filing, Barclays Research

Group name Listing Company-H share Stock code Listing Company- A share Stock code

State Development & Investment Corporation (SDIC)

Hus lien international (Holding) Co. Ltd. 969.HK China National Complete Plant Import and Export Co., Ltd. 000151.SZ

SDIC Xinji Energy Company Limited 601918.SH

SDIC Power Holdings Co., Ltd. 600886.SH

SDIC Zhonglu Fruit Juice Co., Ltd. 600962.SH

Sinotex Investment and Development Co., Ltd. 600061.SH

China National Cereals, Oils and Foodstuffs Corporation (COFCO)

CPMC Holdings Ltd. 906.HK COFCO Tunhe Co., Ltd. 600737.SH

COFCO Land Holdings Ltd. 207.HK COFCO Biochemical (Anhui) Co., Ltd. 000930.SZ

China Agri-Industries Holdings Ltd. 606.HK COFCO Property (Group) Co., Ltd. 000031.SZ

China Foods Ltd. 506.HK

China Mengniu Dairy Co. Ltd. 2319.HK

Yashili International Holdings Ltd 1230.HK

China Modern Dairy Holdings Ltd. 1117.HK

China National Building Material Group Corporation (CNBM)

China National Building Material Co. Ltd. 3323.HK Beijing New Building Materials Public Limited Company 00786.SZ

Luoyang Glass Co. Ltd. 1108.HK China Fiberglass Co., Ltd. 600176.SH

Luoyang Glass Co., Ltd.(Dual-listed) 600876.SH

Anhui Fangxing Science and Technology Co., Ltd. 600552.SH

Ruitai Materials Technology Co., Ltd. 002066.SZ

China National Pharmaceutical Group Corporation (SinoPharma)

China Traditional Chinese Medline Co. Ltd. 570.HK China National Medicines Corporation Ltd. 600511.SH

Sino Pharma Group Co. Ltd. 1099.HK China National Accord Medicines Corporation Ltd. 000028.SZ

Beijing Tiantan Biological Products Co. Ltd. 600161.SH

Shanghai Modern Pharmaceutical Co., Ltd. 600420.SH

China Energy Conservation and Environmental Protection Group (CECEP)

CECEP COSTIN New Material Group Ltd. 2228.HK Yantai Valiant Fine Chemicals Co., Ltd. 002643.SZ

Billion Industrial Holdings Ltd. 2299.HK Xi'an Qiyuan Mechanical and Electrical Equipment Co., Ltd. 300141.SZ

China Ground Source Energy Industry Group Ltd. 8128.HK

Xinxing Cathy International Group (XXCIG)

Xinxing Ductile Iron Pipes Co., Ltd. 000778.SZ

Jihua Group Co. Ltd. 601718.SH


11 August 2014 14

FIGURE 16 Local government SOE reform plans

Date Province Details

05-Aug Beijing

Beijing targets to improve the state asset securitization ratio to 50% by 2020 , and divided SOEs into three categories: 1) Public services(ie, public transportation, water supply), aims for a state-owned capital concentration level of 80%. 2) Special functions (ie, government financing vehicles), aims for a state-owned capital concentration level of 60%. 3) Competitive sectors, including strategic support and general competitive.

09-Jul Guangdong

The draft reform plan will be subject to revisions. The timetable, roadmap and major measures regarding reforms are expected to be announced shortly. In February, Guangdong announced 54 SOE projects in 13 industries to be open for private capital investment. Guangdong had outlined its reform targets by 2020 in an earlier announcement, as follows: - To achieve mixed ownership in more than 80% of its SOEs by 2020 - Raise the asset securitisation ratio of provincial SOEs to 60% from 20%, and push for the full listing of their major

businesses.

09-Jul Jiangsu Jiangsu released its SOE reform plan, which included more than 20 proposals. However, the proposals appear cautious and lack detail. The plan only mentioned speeding up the development of mixed ownership and allowing equity compensation for employees.

08-Jul Sichuan

Sichuan will promote mixed ownership reform in three areas: - Establish a system for SOE shares to be traded. - Provide support for SWUEE to become the main regional equity market in China. - Position SWUEE as the main platform for mixed-ownership related transactions. Sichuan plans to concentrate 80% of its state assets in key areas (such as public facilities and strategic new industries) by 2020, and set no limit on private investment in terms of sectors or industries. The government will also encourage SOEs to introduce private equity into restructuring exercises and seek listings when appropriate.

07-Jul Shanghai

Shanghai has announced a timetable for SOE reform – it envisages 3-5 years to complete the reforms related to modern corporate structure and mixed ownership. It outlined three major paths to promote mixed ownership and stock listings: - Formation of joint-stock companies under a corporate structure. - Market-oriented consolidation and restructuring. - Grant equity incentive compensation to employees.

01-Jul Chongqing

Chongqing opened its first batch of SOE projects with a total investment value of CNY265bn for cooperation with private enterprises. Batches of similar projects will be released over 2014-17. The first batch includes 110 projects from 25 SOEs, divided into five categories: - Raising capital through share placements to introduce strategic investors. - Asset and equity transactions through publicly listed entities on the South West Unit Equity Exchange (SWUEE) - Technology transfer in the energy sector. - Joint ventures with private capital, involving projects in real estate, shale gas, new energy, healthcare sectors. - Projects under the BOT (build, operate, transfer) and EPC (engineering, procurement, construction) models.

30-Jun Hubei

The reform plan of Hubei province has been finalised and will be officially announced soon. The plan is reported to place more emphasis on mixed ownership reform. The plan is also intended to widen the diversity of investors in SOEs, and reduce risks around local government debt by improving the operation of funding platforms. The government pledged to setup a modern corporate structure for all wholly state-owned enterprises, and to promote mixed ownership for all those operating in competitive industries.

30-Jun Shandong Shandong issued opinions regarding SOE reform, including introducing professional executives, promoting mixed ownership and establishing state capital investment companies. The opinions also confirmed an increase in the profit contribution from SOEs and an expansion of the social insurance fund using state-owned capital.

25-Mar Xinjiang

Xinjiang released a provincial level plan and targets to have 10 SOEs listed by 2020. The plan includes: - To increase the level of securitization of state-owned assets. - To promote mixed ownership, and encourage participation of private capital in the oil & gas, coal mining and

infrastructure sectors. - To introduce modern corporate structures and board of directors.

18-Mar Guizhou

Guizhou released a three-year plan, aiming to finalize its reforms by 2016. The theme is to carry out mixed ownership reform and develop modern corporate structures in SOEs. All of the 28 provincial SOEs will undertake mixed-ownership reform in three years, with no lower limit on the state-owned holding specified. It has been confirmed that this ownership reform will be open to all kinds of social capital.

Source: Various news reports and Barclays Research


11 August 2014 15

CREDIT RESEARCH

China SOE reform: Incremental not big bang • We view SASAC’s Central SOE reform announcement on 15 July as a significant step

at a central level following the announcements made at the Third Plenum in November 2013. The reform announcements span a number of areas – in each case, they will be initially implemented through a couple of pilot companies.

• In recent months, a number of provinces have announced their own reform proposals local SOEs. In the financial sector, reform moves are also taking place –we view announcements by Bank of Communications and China Everbright as indications of more to come.

• The SASAC’s announcement indicates an incremental strategy with pilot programs being used to feel out the challenges and fine-tune the blueprint before a larger scale execution. The focus is on adjusting ownership and managerial/institutional reforms.

• The transformation of China National Cereals, Oils and Foodstuffs Corporation (COFCO) into a state-owned investment company increases its strategic importance. While it is unclear what assets (and liabilities) will be moved into the entity through the process of reform, on the basis that the corporation will be significantly larger we think it would deserve a lower risk premium. We recommend buying the COFCO 18s and expect 20bp of compression vs. CNOOC over a 6-12 month period.

• The SOEs involved in the mixed-ownership reform pilot, Sinopharm and China National Building Materials Group, do not have any bonds outstanding. However, we would not be surprised to see some offshore bond issuance to diversify their funding sources.

• The oil & gas majors are not included in any of the SASAC pilot programs. We do not view their exclusion as a headwind for valuations and believe their strategic nature remains intact. In any case, there have already been reform moves by the oil & gas SOEs: PetroChina and Sinopec have announced asset/stake divestments. We think any improvements in efficiency/performance/corporate governance across the broader SOE sector would support further spread compression for the Chinese oil & gas majors as global investors become more comfortable with these groups. A crossover bid (from US/European investment grade investors) for this segment was a key theme in Asian credit in Q2 2014. We recommend the SINOPE ‘23s and SINOPC ‘23s given the proposed partial divestments.

• While the other industrial SOEs are not part of SASAC’s reform pilots, we think the drivers of their spreads will remain the broader macro story/sentiment around China. Regulatory changes with regard to cross-border guarantees are a key development that is likely to affect the amount and format of bond issuance.

• In financials, Bank of Communications’ (BOCOM) announcement was viewed positively by equity markets. BOCOM trades in line with other large Chinese banks after adjusting for the issuance structure. Progress on SOE reform should drive spread compression in the Chinese asset management companies like China Cinda, China Orient Asset Management and China Huarong Asset Management.

• The reverse acquisition of Citic Group by Citic Pacific is an example of pilot reform being undertaken without being labelled as such. We view this route (HK entity being used to list significantly larger China onshore assets of parents) as another area that could have positive implications for credit.

ASIA CREDIT STRATEGY

Krishna Hegde, CFA * +65 6308 2979 [email protected] *This author is a member of the Fixed Income, Currencies and Commodities Research department and is not an equity research analyst


11 August 2014 16

The Third Plenum decisions being put into action In November 2013, the 18th Communist Party of China (CPC) Central Committee meeting (Third Plenum) approved a reform blueprint for the coming decade (for details see China: The Third Plenum - Mind the priorities, 18 November 2013 – by Jian Chang). The recent announcements of SOE reform need to be seen in the context of this blueprint. While there is a long list of proposals approved at the Third Plenum (with regard to changes in the management of state assets), a few are being put into action through the recent announcements, namely:

• promoting market-oriented reform in SOEs;

• clarifying functions of the different SOEs;

• separating government functions from enterprise management;

• improving corporate governance;

• setting up professional manager system;

• establishing several state asset operation companies; and

• encouraging qualified SOEs to transform into state asset investment companies.

Central SASAC SOE pilots bode well for long term After careful selection, in the spirit of the announcements made at the Third Plenum in November 2013, six central SOEs have been picked for the first batch of SASAC’s pilot program announced on 15 July 2014. The ‘four-area pilot plan’ focuses on developing a state capital investment company (SCIC), mixed ownership structures, as well as reforms to enhance incentive structures and improve corporate governance. The benefits of most of these measures will only be seen over the long term.

FIGURE 17 Details of SASAC central SOE pilot reforms

Four pilot reform areas Details SOEs involved

Establishing state capital investment companies

• To improve the management and operational efficiency of state-owned assets

• The companies will in principle focus on investment and projects, rather than capital operations

SDIC,COFCO

Mixed ownership reform • Introduce non-state equity into shareholding structures • To improve governance structure and promote a market-oriented recruiting

system (ie, professional managements and modern compensation schemes)

• Encourage employee ownership plans

CNBM, Sinopharma

Board of director system • Clarify the function of SASAC and boards of directors • Boards will be more active in selecting senior management, making

performance assessments, and structuring compensation schemes

CNBM, Sinopharma, CECEP, XXCIG

Discipline inspection • Intensified supervision of SOEs' key managements, and improving anti-corruption mechanisms within enterprises

Two or three SOEs at a national level

Source: Barclays Research

https://live.barcap.com/go/publications/content?contentPubID=FC1985706�



11 August 2014 17

For the state-owned asset investment company reform, two targets are expected to be achieved:

• A separation of the ownership of SOEs from the supervisory responsibility. Currently, SASAC is both the key shareholder of SOEs as well as the supervisor. Completion of the pilot program in this area would allow SASAC to focus on strengthening its supervision of state-owned assets.

• Improved efficiency and higher returns. To explore how asset investment companies can serve the national strategy effectively, by adjusting and optimising their investment focus and raising operational efficiencies and the return on state assets.

The rationale for choosing these four specific pilot reforms is to guide SOE reforms across all levels at a later stage. The proposals for mixed-ownership, board of director changes as well as ‘discipline’ inspections are unlikely to have an immediate impact on offshore SOE bonds. We think mixed-ownership is likely to ultimately raise productivity and efficiency, thereby boosting returns from SOEs, which have lagged the private sector in recent years.

Corporate governance overall is also likely to improve through a clarification of the roles and functions of SASAC, which currently acts as both a supervisor and the board of directors. The boards of the four central SOEs in the pilot scheme will be able to select senior management, conduct performance reviews and decide compensation schemes, albeit under SASAC's guidance.

Putting these reform measures in context Monopoly sectors are not included in the SASAC announcement. The objective seems to be to develop ‘champions’ within sectors, using the investment company to facilitate better strategy. Of the remaining reforms, we think the mixed-ownership pilot will be important to monitor since a radical version could have implications for credit-worthiness and implied support for the companies. The reform measures covering boards of directors and discipline inspections will not rank as significant for markets, in our view.

We view the reforms announced by SASAC on 15 July as just one aspect of the broader SOE reform agenda. For example, we view the measures being undertaken at Sinopec (stake sale of retail assets) as well as the acquisition of Citic Group by Citic Pacific (see CITIC Pacific - Potentially transformational acquisition, 26 March 2014) are examples of SOE reforms that are as significant as the SASAC announcement.

Beyond the SASAC announcement (which deals with non-financial SOEs), we have also seen changes being announced/indicated in the financial sector.

• After the market close on 28 July 2014, Bank of Communications announced that it was studying feasibility plans to deepen its mixed-ownership structure and improve corporate governance. The bank also noted that its current shareholding structure already represented the basic characteristics of a mixed-ownership economy by having state-owned, private and foreign capital (MOF/HSBC/Social Security Fund/Others: 26%/19%/14%/41% as of end-2013) - which alludes to one objective of the SOE reforms at a central and provincial level. (For details, see report by equity analyst May Yan, Bank of Communications Co., Ltd: BOCOM announced it would deepen mixed-ownership and corporate governance reform; positive for stock sentiment, 28 July 2014.)

• China Everbright announced on 1 August that its shareholder structure would be transformed from a wholly-state-owned enterprise to a joint stock limited company between the MoF and Central Huijin. What this means for the listed entity are unclear at this stage. However, we believe this restructuring opens the door for private sector participation in some of the group’s wholly-owned assets (similar to the Citic Group/Citic Pacific transaction).






11 August 2014 18

What are the credit implications? For China macro: Even as Chinese SOEs have grown in scale, shareholder returns have been sub-par. Raising the efficiency of Chinese SOEs will be pivotal to sustaining growth of China’s economy amid its rebalancing away from investment-led growth. The SOE reforms, if successful, coupled with the higher payouts intended to improve returns to the government, which will remain the largest SOE shareholder, should boost productivity levels in the economy, and thereby, its potential growth rate. We view the SOE reforms as one of the many areas where reform is needed (ie, fiscal, LGFV changes, shadow banking and financial sector) to ultimately improve the credit profile of the sovereign and reduce the sovereign risk premium.

For individual Chinese SOE credits: The performance of the bonds of Chinese SOEs between September 2013 and the end of July (capturing the period of the Third Plenum and various reform announcements) appears largely driven by the sentiment improvement around the China complex – which has helped both industrial SOEs and financials. Figure 18 shows that spread compression has been largely a function of the size of the initial spread, with two key exceptions:

• Short-dated tight spread SOEs (ie, oil & gas companies) have found a floor of sorts. We attribute this to the availability of substitutes (Chinese bank CDs/short-dated private placements) that provide comparable spreads, and preventing further compression.

• Sector headwinds for Chinese SOE property companies, especially in Q1, took the upper hand over the broader compression theme for SOEs. Differentiation within the property sector has been significant.

FIGURE 18 OAS change of China SOEs – Sep 2013 to July 2014 vs. spread in Sep 2013

Source: Barclays Research

COFCO: The reform process is a positive for the companies explicitly identified to be part of the pilot programs. Among the six companies referenced in the SASAC announcement, only COFCO (China National Cereals, Oils and Foodstuffs Corp) has USD bonds outstanding. The COFCO USD bonds are guaranteed by the offshore holding company, COFCO HK, with a letter of support from COFCO Corp. At end-2013, COFCO HK accounted for about 54% of COFCO Corp’s assets and revenue. According to the announcement, COFCO will be reorganised to establish a “state-owned asset investment company” on a trial basis. Essentially, COFCO Corp will hold the ownership rights of some SOEs on behalf of SASAC.

BCHINA 20

ICBCAS 20

ICBCAS 21

BOCOM 23COSL 22

CHIRES 22

BEIENT 41

SINOCH 20

SINOCH 40BEIENT 22

SZIHL 17

CHINAM 22

CHRAIL 23

CHCONS 18

RLCONS 23 BRTFOD 18

LONGYU 16

MEIPOW 18

CATIC 18

CRHZCH 16CHIOLI 20CHIOLI 17

CHIOLI 22

CHIOLI 42

YUEXIU 18

YUEXIU 23

YXREIT 18

POLYRE 18

y = -0.5545x + 79.31R² = 0.3857

-120

-80

-40

0

40

80

120

200 220 240 260 280 300 320 340 360 380 400

Spread chg, bp

OAS, bp (Sep 13)

China Financials/SBLCs Core SOEs

Non-core SOEs China Property

Linear (Non-core SOEs)


11 August 2014 19

While the actual assets (and liabilities) to be transferred into COFCO Corp are unclear, we think the fact that COFCO was selected as one of the pilot state-owned asset investment companies reinforces its strategic nature. As the reforms progress and assets are added, we would expect COFCO’s credit profile to improve – even if only because it will have a larger scale. COFCO bonds trade 20-30bp wide of CNOOC bonds. Although CNOOC has better standalone credit metrics at this point, as investors recognise the increased strategic importance of COFCO Corp, we would expect the spread differential between the bonds of the two companies to compress.

Across the COFCO HK curve, we believe the ’18s have most room to compress. Over time, we would also not rule out the potential for further bond issuance, which could emerge at the COFCO Corp level, with direct cross-border guarantees from the onshore parent given the government-directed initiatives to invest in international agricultural businesses. YTD, COFCO Corp has been actively involved in M&A with its acquisition of a 51% stake in Noble Agri and a 51% stake in Nidera.

Other Chinese SOEs:

Strategic industries at a central and state level: State support to remain high. We think valuations will be more a function of technicals than fundamentals. Rating agencies will continue to give a strong uplift versus standalone ratings, given the nature of these businesses. Differentiation on the basis of standalone credit profiles is likely to be limited. Given the experience of the past year – ie, asset injections in the case of Citic Pacific – we think it will remain important to look at the strength of the parent when assessing bonds.

We think the SINOPE ‘23s and SINOPC ‘23s are attractive as the proposed partial divestment of its downstream marketing segment (retail distribution such as gas stations) should improve its financial metrics and liquidity position. Government policies are broadly in favour of the Chinese oil and gas sector, as evidenced by the shift towards a more market-based pricing mechanism (closer link between the refined oil product prices and crude oil prices) and government backing for long-term gas and oil supply deals.

Competitive industries: We are very watchful of a potential weakening of linkages between the state (either at a central level or province/municipal level) and SOEs as a result of the mixed-ownership reforms. In our view, most of the bond issuers are not at a risk of this link becoming weaker. We recommend:

• SBSG 3.75% ‘18s (issued by Bao-Trans Enterprises, with keepwell support from the onshore Baoshan Iron & Steel Co Ltd). Central government support for the Baosteel Group, which holds a c79.7% stake in Baoshan Iron & Steel Co Ltd, remains strong and the government’s policy to reduce the domestic steel production capacity would be positive for Baosteel.

• Chinese gas distribution utilities – BEIENT and CHIRES bonds. The gas distribution SOEs (Beijing Enterprises Holdings and China Resources Gas) continue to benefit from strong government support, as regulatory policies are biased toward promoting clean energy (natural gas, solar, hydro, wind).

Financials: In financials, Bank of Communications’ (BOCOM) announcement was viewed positively by equity markets. BOCOM trades in line with other large Chinese banks after adjusting for the issuance structure and we don’t expect the announcements to affect its credit spreads.

Progress on SOE reform should drive spread compression in the Chinese asset management companies like China Cinda, China Orient Asset Management and China Huarong Asset Management. We think mixed ownership reform will result in improved disclosure and increased transparency.


11 August 2014 20

Equity Research EQUITY RESEARCH


11 August 2014 21

CHINA BANKS

Reforms poised to be next catalysts The following is excerpt from our recently published report China Banks: Reforms poised to be next catalysts, 31 July 2014.

BOCOM announced on 28 July 2014 that the bank is proactively studying a mixed-ownership reform plan. The State-Owned Assets Supervision and Administration Commission (SASAC) also unveiled a reform plan for six large state-owned enterprises (SOEs) on 15 July 2014. In addition, the Political Bureau of the CPC Central Committee has also approved a plan for comprehensive fiscal reform recently. These reform plans, if successfully implemented, could improve the visibility of Chinese banks’ NPLs in the medium to long term (MLT), which could in turn help Chinese bank shares to break out of their range-trading pattern, in our view.

Among the large H-share China banks, we believe BOC (rated OW, our top pick) could be potentially a beneficiary from fiscal reform, mainly due to its high exposure to SOE lendings and the aggressive loan extension to LGFVs during the 2009 China government’s stimulus measures. In addition, among the mid-size H-share banks, BOCOM (EW) and CITIC Bank (EW) could be beneficiaries of management stock incentive plans.

In the near term, a China banks share price rally has materialized. We believe the above reform news along with some other positive catalysts will continue to support China banks in the next few months. These catalysts include: 1) decent 1H14 earnings to be reported in the second half August; 2) Shanghai-Hong Kong Stock Connect Program likely to be launched in October; and 3) Fourth Plenary Meeting for the Communist Party in which the party will announce the “success of anti-corruption” and refocus on reforms and economic work.

Recently approved fiscal reform could add visibility to banks’ LGFV and property NPL outlook Local governments’ (LG) debt issues and their heavy financial reliance on land sales have been the key sources of many economic and social problems in China. According to the National Audit Office’s (NAO) announcement on 30 December 2013, total local government debt stood at RMB 17.9tn as of end-1H13 (growing from RMB10.7tn at end-2010). There have been increasing concerns about the sustainability of local governments’ high leverage levels, their debt repayment ability amid a slowing economy as well as the elevated property price in China. We believe fiscal reform is crucial to address these problems and the associated financial risks.

Large scale of fiscal reform The People’s Daily reported on 6 July 2014 that Finance Minister Lou Jiwei set a clear timetable to build a modern fiscal system that will help optimize resource allocation, unify market standards, and boost social justice. A matter being discussed is whether to allow LGs to issue bonds directly, where approvals by the central government and local legislature are required. In addition, according to PBOC chief economist Ma Jun (China Chief Economist Forum, 17 July 2014), preparation of balance sheets of most provincial governments has largely been completed by authorities, which will be used to evaluate debt risks and solvency of LGs. We believe fiscal reform initiatives should strengthen LGs’ balance sheets and diversify their revenue streams, if implemented.

EQUITY RESEARCH Asia ex-Japan Banks Industry view: NEUTRAL May Yan

+852 2903 4756 [email protected] Barclays Bank, Hong Kong Chen Wang +852 2903 3994 [email protected] Barclays Bank, Hong Kong Mimi Kong +852 2903 4671 [email protected] Barclays Bank, Hong Kong

Direct bond issuance by local government is being discussed; Preparation of local governments’ balance sheets has been mostly done





11 August 2014 22

FIGURE 19 External factors that could affect the key performance drivers of China’s banking sector

Note: ↑stands for positive and ↓ for negative impact. Source: Barclays Research

Change of performance evaluation of local governments Local GDP growth rates have been the key performance indicator by which the central government evaluates LG officials, which drives LGs’ irrational pursuit of their local economic growth, regardless of the resultant negative impact. The China Daily reported on 10 December 2013 that the Communist Party of China Central Committee had issued a document promising to shift away from GDP-based assessment of LGs and sets out more evaluation criteria related to resources, the environment, scientific innovation, employment, income, health and social insurance. In our view, the new evaluation system will reduce LGs’ incentive to launch heavy investment projects, therefore help lower their financing needs and lead to “greener” GDP growth, if well implemented.

Positive for banks’ LGFV and property loan quality We believe fiscal and tax reforms are crucial for addressing LG debt, property prices and financial risks. In our view, the announced fiscal reforms should be able to: 1) strengthen LGs’ balance sheets and diversify their revenue streams; 2) rebalance the relationship between the central government and LGs; and 3) help lower the risk of property prices falling too quickly and sharply. If fiscal reform initiatives are well implemented, concerns over LGFV debt repayment and property NPLs should be partly mitigated, in our view.

SOE reform could be positive but execution will be complicated and results remain to be seen

BOCOM is proactively studying mixed-ownership reform plan BOCOM announced after market close on 28 July 2014 that the bank is proactively studying the feasibility of plans to deepen mixed-ownership reform and improve corporate governance at the bank, which is in line with Chinese government’s announcement made at the 3rd Plenary Session of the 18th CPC Central Committee last November. Although BOCOM provided no further details, we believe that the key reform areas, among others, could be giving senior management and employee stock ownership incentives as well as further broadening the ownership structure of the bank. We expect that senior management and employees, with increasing shareholdings allowed, could have more incentive to perform in the future.

Soft landing?

Hard landing?

Fiscal reform

Land reform

SOE reform

Interest rate deregulation

More regulation on shadow banking

activities

Capital regulations development

(pref. shares, IRB)

LT NPLs ↑ ST↓, LT↑ ↑ ↑

-LGFV ↑

-Property ↑ ↑

-Overcapacity ↑

-Shadow banking ↑ ↑

LT sustainable NIM ↑ ↓

-Funding cost ↓

-Loan yield ↑ ↑

-Asset yield ↑ ↓

Capital level ↓ ↑

Structural Reforms Financial Sector RegulationsEconomic Trajectory

More evaluation criteria related to have been added to evaluation of local governments’ achievements

Click here to see our recently published report “BOCOM announced it would deepen mixed-ownership and corporate governance reform; positive for stock sentiment” on 28 July 2014

https://live.barcap.com/go/publications/content?contentPubID=2056523�


11 August 2014 23

Four key strategies in the just announced SOE reform pilot programme The SASAC announced on 15 July 2014 that six SOEs had been chosen for pilot reforms in ownership, management and supervision, and four key reform strategies were identified:

• Setting up state-owned asset investment companies;

• Mixed-ownership reform;

• Setting up a new board of directors system at SOEs; and

• Sending “disciplinary inspection teams” to SOEs

Improvement remains to be seen These moves, in our view, signal the start of SOE ownership reform. We believe SOE reform, if well implemented, should be positive for China’s economic rebalancing, banks’ asset quality, and state-owned banks’ performance. Theoretically, management will likely have more incentive to perform and we expect that shareholdings by senior management could have a bigger impact on smaller SOEs than on the larger ones.

For the banking sector, we expect the government to remain the majority shareholder of the large state-owned banks, instead of the banks’ management and employees, as the banks’ crucial and irreplaceable position in the financial system and China’s economic structure.

However, the efficiency improvements at SOEs remain to be seen, in our view, as we see many hurdles at the execution level.

Governance reform – helpful for long-term productivity gains In June 2014, the State Council released Guidelines on Promoting Fair Market Competition and Safeguarding Normal Market Order (the Guidelines). The focus of the Guidelines, in our view, is to relax market access and reduce excessive government intervention.

Equal market access The State Council will formulate a negative list, explicitly laying out industries and areas in which investment is restricted and/or forbidden. For all industries not mentioned on the list, equal access should be granted to all market players, e.g. private sector investors. We believe that the availability of equal market access could facilitate the involvement of private capital into more areas of the economy.

Cutting the red-tape Excessive government intervention, including redundant administrative approval requirements, severely affects the efficiency of the economy, especially for smaller businesses that have limited financial and human resources. The Guidelines require all existing unnecessary administrative procedures that are non-compliant with laws and rules to be removed. This is in line with current government’s target to deepen administrative system reform and change government functions. We expect that the reduction of red-tape could effectively lower the time and financial costs for enterprises and correspondingly improve their operating efficiency.

Potential to improve long-term economic growth rate We believe these Guidelines, if successfully followed, could attract more investment from the private sector, which could in turn release productivity and accelerate innovation as the private sector is believed to be typically more efficient and creative than the public sector. In the long term, it could facilitate economic transformation to a sustainable model of higher growth.

SOE reforms likely have bigger impact on smaller SOEs

Private sector investors to be treated equally in non-restricted industries

Further reduction of government intervention and administrative approval to improve efficiency

Investment from private sector to facilitate transformation to a sustainable growth model


11 August 2014 24

Marginally more positive on the MLT NPL outlook We are now turning marginally more positive on China bank shares in the medium to long term as we believe fiscal reform, SOE reform and governance reform discussed above could potentially reduce risks of local government over-leverage and property market bubbles as well as improve China’s long-term economic structure and prospects. Although the execution of reforms is tricky and will take a long time, we expect better visibility eventually on NPL overhangs, such as debt from LGFVs and property sector NPLs, and believe proper execution of the reforms is the key for any sector re-rating in the long term.

Among the large H-share China banks, we believe BOC (rated OW, our top pick) could be potentially a beneficiary from fiscal reform, mainly due to its high exposure to SOE lendings and the aggressive loan extension to LGFVs during the 2009 China government’s stimulus measures. In addition, among the mid-size H-share banks, BOCOM (EW) and CITIC Bank (EW) could be beneficiaries of management stock incentive plans.

FIGURE 20 Featured stocks in our coverage

Rating PricePrice

Target Potential P/E (x) P/BV (x) Div. Yield (%)

Ticker (stock/ sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E

ICBC 1398.HK OW / NEU 5.16 6.00 16.3 5.1 5.0 0.9 0.8 6.9 7.0

CCB 0939.HK EW / NEU 5.82 6.50 11.7 4.9 4.8 0.8 0.8 7.1 7.3

ABC 1288.HK OW / NEU 3.72 4.20 12.9 4.9 4.8 0.9 0.8 7.0 7.2

BOC 3988.HK OW / NEU 3.65 4.60 25.9 4.5 4.4 0.7 0.6 7.7 7.9

BOCOM 3328.HK EW / NEU 5.81 5.80 -0.2 5.3 5.2 0.7 0.6 5.9 5.9

CMB 3968.HK OW / NEU 15.28 17.00 11.3 5.2 5.0 0.9 0.8 5.2 5.4

CITIC Bank 0998.HK EW / NEU 5.01 5.00 -0.2 4.2 4.1 0.6 0.6 7.2 7.3Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates



11 August 2014 25

CHINA OIL & GAS

China’s oil and gas SOEs moving ahead of the pack While China’s oil and gas SOEs were not named in the first batch of pilot program for the SOE reform, they have already moved ahead of SOE peers in terms of reform. PetroChina and Sinopec have each introduced their own plans, more akin to mixed ownership, which include JVs and partnerships in different segments of their businesses.

Mixed ownership reform is the key for oil and gas SOEs The pilot SOE reform plan released by SASAC on 15 July 2014 covered four key areas: 1) state asset investment, 2) mixed ownership, 3) evaluation of key management performances, and 4) inspection by the Central Disciplinary Committee. For China’s oil and gas SOEs, we see the key area for reform as mixed ownership for an industry that usually operates as an oligopoly.


Rating Price Price

Target Potential P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%)

Ticker (stock/sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E 2015E 2016E

PetroChina 0857.HK OW / POS 10.12 11.80 16.6 10.3 9.2 1.1 1.0 5.0 4.5 4.2 4.4

Sinopec 0386.HK EW / POS 7.44 6.80 -8.6 9.3 9.5 1.0 1.0 4.6 4.6 4.6 4.6Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates

PetroChina – six platforms of reform PetroChina set out six platforms for mixed ownership reform, as introduced by company Chairman Zhou Jiping during the annual National People’s Congress (NPC) in March 2014. While we view the plan as well-rounded, reform in upstream was only limited to developing risky and unconventional resources.

FIGURE 22 PetroChina has introduced six platforms for SOE reform

PetroChina Chairman Zhou Jiping introduced the six platforms for SOE reform at the company during the March 2014 National People’s Congress

Six platforms of reform Comments

Unused reserves Established Yan’an Oil Co., a partnership with Yanchang Oil to resolve areas where mining rights overlap; established Golden Gobi Co. to explore oil sands in Xinjiang; established Hongshan Co., a partnership with local Xinjiang government

Unconventional oil and gas Including CBM (coal bed methane), shale gas, and tight gas resources which are more challenging and risky

Pipeline West-East Pipeline, Russia-China Pipeline and new pipelines to be constructed

Overseas business To expand cooperation with international and domestic private partners

Finance CNPC’s finance arm which is engaged in financing, insurance, etc

Refining and chemical To introduce more partnerships with local governments and local companies, as well as international oil companies


EQUITY RESEARCH Asia ex-Japan Oil & Gas Industry view: POSITIVE Somshankar Sinha +852 2903 2434 [email protected] Barclays Bank, Hong Kong Ying Lou +852 2903 4673 [email protected] Barclays Bank, Hong Kong



11 August 2014 26

Divestment of pipeline assets to unlock value and reduce capex Among these areas, PetroChina has moved most rapidly on divesting pipeline assets. Before the Third Plenum set out plans to introduce mixed ownership in SOEs, PetroChina had already begun divesting natural gas assets to unlock value and reduce capital expenditure, starting with the sale of LNG terminals to Hong Kong-listed subsidiary Kunlun Energy.

FIGURE 23 PetroChina has looked to unlock value from asset disposals and spinning off assets into joint ventures

Date Project Value

(RMB bn) Comments

May-10 Jiangsu LNG 0.5 Kunlun acquired PetroChina's 55% stake at 1.1x book value and similar to appraisal value

Aug-10 Dalian LNG 2.0 Kunlun acquired PetroChina's 75% stake at 1.0x book value and 0.9x appraisal value

Dec-10 60% stake in Beijing Pipeline

18.9 Kunlun bought PetroChina's 60% stake in the Beijing-Shaanxi project for RMB19bn. Acquisition was at 2.8x original book value and at 1.0x appraisal value.

Dec-12 Third West East pipeline 62.5 Hived off to a joint venture with three partners including Baosteel to construct the RMB116bn project. Initial equity contributions at par value. PetroChina holds 52% in the JV

Jun-13 Parts of WE-I and WE-2 60.0 Spun off western sections of WEP-1/2 into a JV with Guolian and Taikang which paid RMB60bn to take up a 50% stake. PetroChina booked a RMB25bn pre-tax gain on the transaction

Source: Company data, Kunlun, Baosteel, and Barclays Research

In 2012, PetroChina sold a 48% stake in the then yet-to-be-built West-East 3 (WEP-3) pipeline to domestic strategic and financial investors. In June 2013 it further transferred the western sections of WEP-1/2 into a JV where Guolian Fund and Taikang Asset paid RMB60bn for a 50% stake in these projects that had a NAV of just RMB20bn, according to PetroChina. A pre-tax gain of RMB25bn was recorded by PetroChina on the transfer.

In May 2014, PetroChina announced its intention to divest the entire stake in the eastern portions of the first and second West to East pipelines (WEP-1/2). While the transaction value will depend on the outcome of the public auction, we believe that the assets could sell at a premium, particularly if the precedent 2013 JV transaction is any guide.

FIGURE 24 PetroChina cut capex 10% in 2013, guides a 7% cut in 2014

FIGURE 25 We expect PetroChina to generate positive FCF in 2014E

Source: Company data, Barclays Research estimates Source: Company data, Barclays Research estimates

The asset divestments have helped PetroChina reign in its capital expenditure and should further improve the company’s return profile. The company cut capex by 10% in 2013 and has guided a 7% cut of capex in 2014, for example.

(2)

3

24

(10)(7)

(15)

(10)

(5)

0

5

10

15

20

25

30

10 11 12 13 14E

PetroChina Capex (% y/y)

0

100

200

300

400

06 07 08 09 10 11 12 13 14E 15E

Capex+Acq Dividends CFO-Interest

PetroChina Cash Flow (RMB bn)


11 August 2014 27

Sinopec – selling 30% of its marketing segment Sinopec announced in February 2014 that it plans to sell up to 30% of its marketing segment, Sinopec Sales (SS). The company expressed its intent of selling the stake to key strategic investors, but with the company focused on selling the asset at a rich premium to NAV this could preclude meaningful participation from strategic investors, leaving domestic financial investors to anchor the deal. Assuming a 15x 2015E P/E, similar to global valuation averages of fuel and convenience store companies, the sale of 30% of the marketing segment could raise an estimated cUS$20bn. However, for Sinopec, while we believe the potential sale would be a positive, the overall impact is likely to be limited.

FIGURE 26 Sinopec Sales (SS) – fair value and valuation scenarios

In our 12-month price target for Sinopec of HK$6.80, we value the marketing segment at an implied 10.8x 2015E P/E. However, we believe Sinopec would be keen to sell up to a minority 30% stake at a premium. At 15x 2015E P/E, for example, we estimate it could raise RMB120bn (cUS$20bn) for a 30% stake. It is unclear if the market would be willing to re-rate the entire business to this potential divestment value without any change in business outlook. Even if this were to happen, we still only see 10% potential upside from current levels.

Base case

Divestment case Barclays Research comments

Financials (RMB bn)

2015E EBITDA 50 50 7% higher than 2013 reported EBITDA

2015E EBIT 38 38 2013 EBIT was RMB35bn

2015E net profit 27 27 Reported net income of RMB25bn in 2013

2015E cash profit 39 39 Adding back depreciation and amortization

Valuations

Ascribed 2015 P/E (x) 10.8 15.0 Assuming that 15x 2015E P/E is a fair multiple for SS…

Equity value (RMB bn) 291 405 … SS equity value could be worth RMB405bn

2014E net debt (0) (0) Sinopec has transferred minimal external net debt to SS

2014E minority interest 7 7

EV (RMB bn) 297 412 Divestment case EV is 40% higher than our base case

Implied multiples for Sinopec Sales

EV/NAV (x) 1.26 1.75 We carry the business at 1.3x EV/net assets in our PT

EV/Fixed Assets (x) 1.07 1.48 At a higher value, it could be worth 1.5x assets

EV/EBITDA (x) 6.0 8.3 The higher value could also imply a greater than 8x EV/EBITDA

P/E (x) 10.8 15.0 Our Sinopec PT values marketing at 10.8x 2015E P/E

P/CE (x) 7.4 10.4

FCF yield (%) 5.3 3.8 New investors would need to find 3.5-4.0% FCF yield reasonable if they are to buy a stake at 15x P/E

Sinopec Corp valuation

Valuation (HK$/sh) 6.8 8.1 If the value is pegged at a higher P/E of 15x, our Sinopec Corp fair value estimate would be 19% higher, all else equal…

Potential upside (%) (9) 9 …implying upside from current price levels

Note: Priced as of 7 August 2014. Source: Company information, Barclays Research estimates


11 August 2014 28

FIGURE 27 Sinopec – outline of selection criteria and procedures for the proposed SS divestment

While a recent June 2014 announcement by Sinopec lacked details of potential bidders… …the company did identify seven selection criteria and detailed procedures for the sale process.

Key items Details Barclays Research comments

Mode • Divestment will be via a capital increase of SS

• The transaction will be a negotiated deal and not by way of a public offering

• Sinopec is structuring the divestment as a primary issuance of shares by SS

• The cash raised can then be transferred back to Sinopec in a tax efficient manner by SS repaying some of the current liabilities owed by SS to Sinopec

Investor selection criteria

• Offer price and their respective proposed investment amount

• Sinopec is keen to divest a minority stake at a premium citing unparalleled infrastructure

• Complementary strengths with Sinopec and potential to become a business partner

• Sinopec is keen to increase the scale and profitability of its non-fuel business.

• Sinopec cites convenience retailing, car services, telematics, O2O, financial services and advertising as opportunities

• Place of registration, whether a domestic Chinese investor or foreign bidder

• We believe that Sinopec may be more amenable to domestic investors

• Whether it will enhance general public interest in China

• Sinopec is also keen that SOE reform and mixed ownership are socially and politically acceptable, in our view

• Potential investor’s industry standing, brand image and reputation, and financial strength

• We expect Sinopec to prefer credible investors that will enhance the standing of SS

• Intended holding period of the equity investor

• We expect Sinopec to prefer investors with a longer holding period

• No significant conflict with the principal business of Sinopec Group

• Sinopec appears to be dissuading direct competitors, for example global energy majors, from participating in the transaction

Procedure Investor selection and identification: • Bidders will submit a letter of intent• Sinopec to identify potential

investors based on criteria • Potential investors will be provided

with Information Memorandum and other materials

• Potential investors required to submit a non-binding offer and binding offer

• Sinopec to select and identify the interested investors after evaluation by independent committee

Negotiation and completion: • Conditional transaction documents

exchanged with interested investors• All parties complete internal

approval procedures and relevant external approval procedures

• Completion shall occur once all condition precedents are satisfied

• The divestment will be a negotiated transaction with multiples parties

• Sinopec has said before that it intends to conclude the transaction in 2H14

Source: Company statement (30 June 2014), Barclays Research


11 August 2014 29

CHINA OIL SERVICES & DRILLING

China oil services companies – potential reform beneficiaries We believe that the independent Chinese Oilfield Services (OFS) group 6 could be beneficiaries of ongoing reform of the Chinese SOEs in the oil & gas industry. Indeed, the potential increase in private capital and participation of independent players, as well as higher accountability faced by key management, could all lead to the development of a more market-based and meritocratic industry. We believe the industry has been plagued by inefficient capital allocation and also a certain amount of complacency within the in-house OFS companies of the Chinese oil majors, and thus a greater focus on capital discipline and improvements in efficiency could lead to more market share opportunities for the independent oil services companies in the medium-term.

Scope for market share gains The Chinese OFS industry has historically been dominated by in-house companies of China's National Oil Companies (NOCs). With independent OFS companies only accounting for c5-10% of the current market, we see scope for greater market share gains if the industry shifts to a greater focus on returns and efficiency. This may tilt the balance in favour of companies with: 1) access and willingness to adopt new technology, 2) key strategic alliances with international OFS companies, and 3) profit-driven and more efficiently-run independent OFS companies.



Price Target

Potential P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%)

Ticker sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E 2015E 2016E

Anton Oilfield Services 3337.HK OW / POS 4.23 5.80 37.1 12.7 10.7 2.4 2.1 7.3 6.2 2.4 2.8

SPT Energy Group 1251.HK EW / POS 3.93 4.90 24.7 9.8 7.4 2.0 1.6 5.6 4.4 2.5 3.4Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates

FIGURE 29 Independent OFS companies in China have little market share currently

Independent Chinese OFS companies have been growing domestic market share steadily since 2009. We see scope for further gains with an opening-up of the market through reforms.


6 Chinese Oilfield Services (OFS) group includes: Anton Oilfield Services, SPT Energy, Petroking, Hilong Holdings, Honghua Group.

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

2009A 2010A 2011A 2012A 2013A

SPT Energy Anton Oilfield Services

Domestic revenue as a % of China capex

EQUITY RESEARCH Asia ex-Japan Oil Services & Drilling Industry view: POSITIVE Clement Chen +852 2903 2498 [email protected] Barclays Bank, Hong Kong



11 August 2014 30

Reform process could be slow and painful though While we believe the opening-up of the market is likely to result in market share gains for the independent OFS companies, it could be a long drawn process that will have to see significant industry consolidation. We expect this change to be gradual and potentially ‘painful’ for the industry. Indeed, if the large number (more than 1,000) of privately owned small-scale OFS/drilling companies currently in the market experience industry consolidation, many of these smaller players – particularly those without key product differentiation or unique service offerings – could start being phased out of the market, paving the way for more integrated, higher-value add companies to gain market share.

Opening of the sector has had its pros and cons so far The opening up of the Chinese OFS sector has led to more opportunities for independent OFS companies as certain oilfields start to adopt more merit-based and/or commercially driven tendering policies to award contracts. This has resulted in contract wins directly from Chinese oil majors for Anton Oilfield Services in the Ordos basin where it has historically only been able to win contracts through partnerships with the in-house OFS subsidiaries of Chinese oil majors or via jobs outsourced through these partners. However, this gradual ‘opening-up’ of the sector has invariably led to greater competition and as a result, is likely to put pricing pressure on some oilfield services – particularly regular services (such as pressure pumping) where there is little differentiation between providers.


11 August 2014 31

CHINA TELECOM SERVICES

Seeds of hope – do they sprout or wither away? The speedy establishment of the national tower-co and then the reported “encouragement” by the government to the operators to control their subsidy and marketing expenses are both recent initiatives that introduce “reform” hopes. Continuation of these trends and initiatives could materially lift depressed returns on capital and consequently be a powerful positive catalyst, but we need to see more by way of execution for a sustained rerating of the stocks. We hope this is the case as we maintain our glass half full view. We are EW on China Unicom (CU) and China Telecom (CT) and UW on China Mobile (CM).


Rating PricePrice

Target Potential P/E (x) EV/EBITDA (x) Div. Yield (%)

Ticker (stock/ sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E

China Mobile 0941.HK UW / NEU 86 72.00 -16.3 15.3 14.9 4.6 4.2 2.8 2.9

China Telecom 0728.HK EW / NEU 4.09 4.20 2.7 14.2 11.9 3.6 3.3 2.3 2.5

China Unicom 0762.HK EW / NEU 12.8 13.00 1.6 15.9 12.6 3.4 3.0 1.9 2.4Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates

Return on capital – a depressing historical trend, and hence, the importance of “reform” hopes Consider Figure 31 below – CM’s ROIC has been on a material decline since industry restructuring in 2008 – CT and CU have never generated returns in excess of WACC since listing.

FIGURE 31 China telecom services – ROIC trends


It is not that these trends are not recognized by the market, and hence, the depressed valuation cases for the three stocks, as outlined in Figures 32 and 33 below. Needless to say, there is material room for higher efficiencies and, hence, improvement in return levels.

0%

5%

10%

15%

20%

25%

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

China Mobile China Telecom China Unicom WACC

WACC = 9.8%

EQUITY RESEARCH Asia ex-Japan Telecom Services Industry view: NEUTRAL Anand Ramachandran, CFA +65 6308 3895 [email protected] Barclays Bank, Singapore



11 August 2014 32

FIGURE 32 China telecom services – historical EV/EBITDA trends (x)

FIGURE 33 China telecom services – historical P/B trends (x)

Source: Company data, Barclays Research Source: Company data, Barclays Research

The government (as a major shareholder in the three companies and the policymaker) has a critical hand to play – recent trends do seem to indicate a renewed focus on returns, which then becomes a crucial focus point for the stocks. Whether it be the setting up of a national tower-co or news reports of SASAC ordering cuts to selling and marketing expenses, there seems to be an intent to get the operators to focus on improving their returns on capital employed, and this then has become a crucial watch factor given the low base and substantial room for improvement. We hope more tangible and quantifiable signs emerge to drive a sustained re-rating for the sector on three fronts:

• Lower capex as a result of the tower-co now taking up incremental tower builds.

• Better margin expectations on better cost controls, especially if SASAC’s rumoured encouragement to the operators to cut selling and marketing expenses is implemented.

• Better returns to shareholders, starting with dividends, where CM has been a perennial underachiever. With net cash at 26% of market cap (as of December 2013) – we see the 43% dividend payout policy as inexplicable – it could easily be double that number.

FIGURE 34 China telecom service – balance sheet abstracts

Note: Priced as at market close on 7 August 2014. Source: Barclays Research estimates

2.0

3.0

4.0

5.0

6.0

7.0

Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

CM CT CU

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

CM CT CU

2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E

DPS (Rmb) 1.93 1.92 1.98 0.07 0.08 0.08 0.15 0.19 0.24

Net debt /(cash) -361,926 -341,440 -365,286 99,855 95,014 82,385 123,364 104,418 80,584

Payout ratio (%) 43% 43% 43% 35% 33% 30% 30% 30% 30%

Dividend yield (%) 2.8% 2.8% 2.9% 2.3% 2.3% 2.5% 1.5% 1.9% 2.4%

FCF yield (%) -1.6% 0.4% 3.7% 0.0% 0.3% 0.4% 0.2% 1.5% 1.8%

Net debt to equity (%) net cash net cash net cash 34.6% 31.5% 26.0% 54.3% 43.8% 31.8%

Net debt to EBITDA (x) net cash net cash net cash 1.0 0.9 0.8 1.3 1.0 0.8

China UnicomChina Mobile China Telecom


11 August 2014 33

Tower-co incorporated, now down to execution On 11 July 2014, the three operators announced the establishment of a national tower company (China Communication Facility Services Corp.). The tower-co’s business scope includes construction, maintenance and operation of telecommunication towers; ancillary facilities including base station control rooms; power suppliers; air conditioning; and interior distribution as well as providing outsourcing services for base station equipment maintenance. The tower-co is jointly held by CM, CU and CT, whose shareholdings are 40%, 30.1%, and 29.9%; respectively, with a registered capital base of RMB10bn.

Based on a media interview with the tower-co’s CEO, Liu Aili (c114, 21 July 2014), we note that the tower-co is likely to take a “three-step” process as we previously expected. First, the tower-co is to be responsible of building new assets; second, the existing tower assets from the operators will be injected into the tower-co; and last, the tower-co will look to attract private capital after the existing tower assets injection. It aims to go public eventually, according to the interview.

We believe the establishment of a tower-co as positive to the whole sector, given: 1) infrastructure sharing could reduce the overall capex burdens and boost cash flow profiles – this should benefit all three operators; and 2) if one takes a longer-term view of this tower-co eventually being listed and consequently the value of the tower assets being crystallised for the three telcos (who holds stakes in the tower-co) and this could drive potential value upside. Furthermore, we expect CT and CU to benefit more vs. CM as both operators could potentially tap into CM’s tower resources after all excising tower assets are injected, and thus, they could expand coverage and network quality to narrow the gap with CM.

Nonetheless, given the lack of details and specifics on how and when the tower-co will start operating, we await for the management teams of all three telcos to shed more light during the upcoming 2Q14/1H14 results. We outline our sensitivity analysis in Figure 35 below.

FIGURE 35 China Telecom Services – sensitivity analysis on our estimates if the national tower-co were to be established

Source: Barclays Research estimates

2015E 2016E 2015E 2016E 2015E 2016E

Our current estimates

EBITDA (Rmb mn) 224,051 241,748 101,155 104,469 99,412 105,699

Net income (Rmb mn) 90,814 93,605 18,608 22,094 15,342 19,332

FCF (Rmb mn) 6,036 51,370 14,539 21,783 22,872 27,713

DCF valuation as at 2014YE (HK$) 82.8 4.7 17.4

50bps decrease in EBITDA margin & 20% savings in capex in 2015-2016 (10% capex savings longer term)

EBITDA (Rmb mn) 220,500 237,866 99,405 102,651 97,820 104,044

% impact -1.6% -1.6% -1.7% -1.7% -1.6% -1.6%

Net income (Rmb mn) 87,549 92,819 17,295 21,952 14,147 19,190

% impact -3.6% -0.8% -7.1% -0.6% -7.8% -0.7%

FCF (Rmb mn) 43,261 82,967 30,104 35,371 36,335 40,433

% impact 616.7% 61.5% 107.1% 62.4% 58.9% 45.9%

DCF valuation as at 2014YE (HK$) 89.5 5.4 19.6

% impact 8.1% 14.4% 13.1%

China Mobile China Telecom China Unicom


11 August 2014 34

We assume that: 1) the tower-co to start building new assets from 2015 onwards, which would drive capex reductions and, thus, increase our free cash flow estimates (20% capex savings for 2015E-16E, and 10% capex savings longer term incorporated in our sensitivity analysis); 2) a new cost item on tower rental expense, but somewhat balanced out by lower network maintenance costs (we incorporate 50bps EBITDA margin decease in our sensitivity analysis); and 3) lower our depreciation charges going forward, resulting from the lower capex.

Our sensitivity analysis shows that there could be an increase in DCF fair value given reductions in capex spent and that there could be minimal impact on net income in 2016E as potential savings from depreciation kick in.

A cut in selling and marketing expenses? Recent news reports (including Sina, 10 July, and China News, 10 July) indicated that SASAC had ordered and three operators “voluntarily” have committed to reducing selling-related expenses for three consecutive years from 2014. Furthermore, other news reports (Xinhuanet, 9 July) said that all three operators look to reduce handset subsidies as well.

Although we believe there is limited scope to materially lower selling and marketing costs in the short term, as we expect CT and CU to lift their subscriber acquisition momentum after the recent issuance of 4G/FDD-LTE trial licenses (on 27 June 2014) in 16 cities and, thus, a slight pick-up in the competitive dynamics into 2H, we think the news signals a stance that operators would not compete irrationally, especially given that the VAT implementation from 1 June will likely materially hit operators’ short-term profitability and, thus, limit their financial headroom. Meanwhile, we expect the VAT implementation will trigger a change in operators’ cost structures as they look for ways to maximise the input VAT credit they can claim and use that to offset the tax burden from the top line.

FIGURE 36 China telecom services – EBITDA margin trends (%, off service revenue, inc. VAT impact)

Source: Company data, Barclays Research estimates

25%

30%

35%

40%

45%

50%

2011 2012 2013 2014E 2015E 2016E

China Mobile China Telecom China Unicom


11 August 2014 35

FIGURE 37 China telecom services – selling and marketing expenses

Source: Company data, Barclays Research estimates

2013 2014E 2015E 2016E

Selling and marketing expenses other than handset subsidies (exc. VAT impact)CM (selling expenses) 91.8 104.8 118.1 132.5

CU (selling & marketing expenses) 43.0 40.9 42.1 43.3

CT (SG&A exc. G&A) 39.2 46.4 50.3 55.4Total 174.0 192.1 210.5 231.2

% y/y 17.6% 10.4% 9.6% 9.8%Handset subsidies

CM 26.3 37.0 42.4 49.2

CU 7.8 6.2 7.0 8.0

CT 22.8 30.1 32.1 34.4Total 56.9 73.4 81.5 91.6

% y/y 10.4% 28.9% 11.1% 12.4%


11 August 2014 36

CHINA METALS & MINING

“Reform” through the path of least resistance Reforms will most likely happen, but the timing, magnitude and consequences are highly uncertain. Hence, we do not factor reforms into our base case approaches in the valuations of our equities. The ones that appear most in need of reform are arguably the ones with the most stretched balance sheets and weakest financial performance. Hence, the companies likely to be target for reforms consist disproportionately of stocks we currently rate Underweight.

Reform is a natural path in the evolution of most corporate entities in China Most of the basic materials companies (especially the processing oriented ones, such as steel, aluminium and coal companies) globally have been state-owned entities at some stage of their existence. Over time, they have been privatized with the governments slowly reducing their grip on shareholding, corporate governance, strategy setting, operations, and funding – leaving them as more private entities than state owned. We see a similar path for many of the Chinese entities.

China’s brand of state capitalism makes reforms more step-functions than is the case for other privately owned and controlled corporations “Reforms” are clearly not a one-way street. In many cases – especially in the intermediate steps towards improvement – there are significant pitfalls as well. Almost any change could be construed and labelled as a “reform”. It may initially end up being just higher bonuses and compensation for managers of Chinese SOEs without adequate oversight and performance management mechanisms for the long-term profitability potential of these companies. However, assuming that reforms do not get used as a rent-seeking ploy from vested interests in some of the companies, which in most cases we believe they will not, we apply a few screens to see which companies are most likely to be on the reform list.

Premise 1: Start from the Top:

Central SASAC-owned SOEs are more likely to be in the earlier phases of SOE reform than provincial government-owned ones While no one has a monopoly over the “reform” agenda, it is most likely that the Central SASAC-owned SOEs in China are more likely to be in the first wave of companies to be experimented with. This indicates Shenhua, China Coal Energy, CNBM, Chalco, CR Cement and Angang are the most likely early reform candidates in metals and mining.

Premise 2: Bad needs more improvement than good

The worse off the position is, the more urgent the burning platform for “reform” “Hybrid ownership” is another slogan for companies pushing ahead with reforms. The worse it gets for a company, the more urgent the need for reform. CNBM is already on the first list of six companies announced for reform by the government. Moreover, Chalco screens as a reform candidates in our analysis.

Premise 3: Look to the future

Companies making (or with potential to make) substantial investments in new technologies/processes in future (or heavy balance sheets as a result of such investments in recent times) would require independent boards to supervise and incentivize management Another leg of reform would be to get independent boards, enabling better monitoring and incentivized management teams. In this aspect, nearly every central government-owned SOE could have the opportunity for improvement.

EQUITY RESEARCH Asia ex-Japan Metals & Mining Industry view: NEUTRAL Ephrem Ravi +852 2903 4892 [email protected] Barclays Bank, Hong Kong


11 August 2014 37

FIGURE 38 CNBM and Chalco screen as the companies most likely to be in the list for “reform” given their balance sheets

FIGURE 39 Profit generation potential of both CNBM and Chalco does not support the net debt positions, in our view

0%

50%

100%

150%

200%

250%

300%

350%


China Coal

Energy


Net debt/equity (%)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0%

50%

100%

150%

200%

250%

300%

350%


China Coal

Energy


Net debt/equity (%) Net margin


FIGURE 40 Shenhua and CR cement have the highest net margins …

FIGURE 41 … and highest interest cover – consequently, they appear less likely to be in the list for the reform candidates in terms of hybrid ownership in the first phase

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

China Shenhua

CR Cement

CNBM China Coal

Energy

Angang Chalco

Net margin (%)

-2

0

2

4

6

8

10

12

14

16

18

China Shenhua

CR Cement

China Coal

Energy

CNBM Angang Chalco

Interest cover (x)


FIGURE 42 Proportion of independent non-executive directors in Chinese central SOEs in our coverage is uniformly >50% ...

FIGURE 43 ….and shows no significant correlation with profitability

0%5%

10%15%20%25%30%35%40%45%50%

China Coal

Energy

Angang CR Cement

CNBM China Shenhua

Chalco

% INED

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0%5%

10%15%20%25%30%35%40%45%50%

China Coal

Energy

Angang CR Cement

CNBM China Shenhua

Chalco

% INED Net margin



11 August 2014 38

FIGURE 44 Featured stocks under our coverage


Price Target Potential P/E (x) P/BV (x)

Net gearing (%)

SASAC ownership (%)

Ticker sector) HK$ (HK$) -/+ (%) 2014E 2015E 2014E 2015E 2014E 2014E

China Shenhua 1088.HK OW / NEU 23.2 27.00 16.4 8.6 8.6 1.2 1.1 14% 73%

China Coal Energy 1898.HK UW / NEU 4.9 3.70 -24.5 29.6 25.5 0.6 0.6 80% 58%

Angang 0347.HK OW / NEU 5.81 6.50 11.9 16.5 10.5 0.7 0.7 41% 68%

Chalco 2600.HK UW / NEU 3.53 2.30 -34.8 N/A N/A 1.0 1.0 270% 39%

CR Cement 1313.HK EW / NEU 5.68 5.79 1.9 9.1 8.8 1.3 1.2 64% 73%

CNBM 3323.HK UW / NEU 7.65 6.68 -12.7 4.5 4.3 0.8 0.7 367% 44%Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates



11 August 2014 39

CHINA INFRASTRUCTURE & SHIPPING

Divergence between infrastructure and shipping Although China’s state-owned enterprises in the shipping space were not selected in the first batch of the pilot program for the SOE reforms, we highlight that a logistics SOE was included. We believe this is a continuation of a trend in which the government has focused reform efforts on the infrastructure sector and less on shipping.

Greater willingness to carry out reforms on logistics/infrastructure sector CMST Development (600787 CH; not rated), an SOE that provides warehousing, storage and logistics services, was selected as one of the SOEs for mixed ownership reform on 14 July 2014. Its shares have been suspended since 28 July as the company is undergoing a private placement to raise funds for expansion into a comprehensive national logistics provider.

On 24 April 2014, the central government introduced the first batch of 80 infrastructure projects for private investment after the 23 April 2014 meeting of the State Council, which decided that China will allow private capital to invest in some monopolised sectors that were previously dominated by public investment and state-owned enterprises. The 80 pilot projects relate to the following areas: railways, ports and other transportation infrastructure.

• See China: First batch 80 infrastructure projects open for private investment, Jian Chang, 24 April 2014 (link)

Reform less likely for shipping in the near term However, we see the carrying out of mixed ownership reform on shipping to be less likely in the near term as we believe the domestic shipping industry is not sufficiently mature for reform. In a depressed freight rate environment whereby losses appeared to have become the norm, we expect the shipping industry has more pressing problems to address, namely to stop losses from continuing.

FIGURE 45 Chinese coastal freight rates and Baltic Dry Index

Wallowing in depressed freight rates First priority is to improve profitability in a highly competitive domestic shipping market

400

600

800

1000

1200

1400

1600

600800

1,0001,2001,4001,6001,8002,0002,2002,4002,600

BDI (LHS)

China domestic coal freight (RHS)

Source: Bloomberg, Barclays Research

In our view, against the backdrop of low freight rate, the primary interests of COSCO and China Shipping Group, the two dominant shipping SOEs, are to protect their profitability and market shares by barring more stakeholders and players from entering the domestic shipping market.

EQUITY RESEARCH Asia ex-Japan Infrastructure & Transport Industry view: NEUTRAL Jon Windham, CFA +852 2903 4672 [email protected] Barclays Bank, Hong Kong

Losses suffered by shipping industry as the undercurrent



11 August 2014 40

Possible reform candidates We examined a few infrastructure and transport SOEs that we see as potential candidates for reform and different permutations of how these reforms could occur.

Sinotrans & CSC Group Listed companies under group that may be impacted: Sinotrans Shipping (368 HK; EW) and Sinotrans Limited (598 HK; not rated).

Reforms for the Sinotrans & CSC Group have already been happening since its 25 March 2014 announcement of a series of intra-group transactions. The group mandate is to streamline assets and make Sinotrans Shipping the group’s shipping platform and Sinotrans Limited its logistics platform. In that regard, Sinotrans Logistics completed the sale of its container shipping and dry bulk vessels to Sinotrans Ship on 31 July 2014. We see the potential for more group logistics operations to be moved into Sinotrans Logistics. Meanwhile, on 24 July 2014, Sinotrans Limited raised HK$1.68bn through a private placement that was described by the company as being needed “to fund the Group’s business development”, which we believe was intentionally vague and which could allow it to capture intra-group acquisitions of logistics assets.

China State Shipbuilding Group Listed companies under group that may be impacted: CSSC (600150 CH; not rated), Guangzhou Shipyard (317 HK; not rated).

Guangzhou Shipyard is undergoing asset restructuring because CSSC, its majority shareholder, plans to inject its South China shipbuilding assets into the company. Assets proposed for injection by CSSC include core military assets. Separately, Guangzhou Shipyard also intends to acquire shipbuilding assets from third parties. Shares of Guangzhou Shipyard have been suspended since 8 April 2014.

COSCO Group Listed companies under group that may be affected: China COSCO (1919 HK; UW), COSCO Pacific (1199 HK; OW) and COSCO International (517 HK; not rated).

In our view, the COSCO Group is an unlikely reform candidate. As the company’s performance has been lacklustre in the recent years, COSCO does not fit the bill for SOE reform in the near term but could be “made an example of” at some point in the future. However, we do see the potential for asset shuffles that have been ongoing, although not necessarily part of the SOE reform. We identify the following assets currently owned by the COSCO Group that may be injected into one of the listed companies.

• COSCO Logistics – the group currently wholly owns COSCO Logistics, which was purchased from China COSCO on 26 April 2013 as the listco attempted to avert delisting.

• Container manufacturing – the group currently owns a 21.8% stake in CIMC (2039 HK; not rated), which it purchased from COSCO Pacific on 13 June 2013.

• Ports – the group owns a 51%-stake in Port of Long Beach, US (annual capacity 2.6mn teu) and a few joint venture terminals in Naples and Rotterdam.

• Shipbuilding – a few COSCO shipyards in China.


11 August 2014 41

China Merchants Group Listed companies under group which may be impacted: China Merchants (144 HK; OW).

In our view, China Merchants Logistics, the group’s logistics segment, would most likely be injected into China Merchants Holdings for the following reasons. First, the facilities of China Merchants Logistics are adjacent to China Merchants’ Shenzhen ports so it would be sensible to integrate them, in our view. Second, China Merchants’ already has experience in operating cold chain and bonded logistics, which bears much resemblance with logistics. Third, the logistics assets fall under the umbrella of “infrastructure” rather than “transport” and would more likely be supported.

China Shipping Group Listed companies under the China Shipping Group include China Shipping Development (1138 HK; OW) and China Shipping Container Lines (2866 HK; OW). In our view, COSCO Group is unlikely to be a reform candidate.

FIGURE 46 Featured stocks under our coverage

Rating PricePrice

Target Potential P/E (x) P/BV (x) Div. Yield (%)

Ticker (stock/sector) HK$ (HK$) -/+ (%) 2015E 2016E 2015E 2016E 2015E 2016E

China COSCO 1919.HK UW / NEU 3.38 3.35 -0.9 N/A N/A 1.3 1.3 0.0 0.0

China Merchants 0144.HK OW / NEU 25.6 28.87 12.8 13.7 12.0 1.2 1.1 2.0 2.2

COSCO Pacific 1199.HK OW / NEU 11.5 15.15 31.7 11.1 9.8 0.9 0.8 3.6 4.1

CSCL 2866.HK OW / NEU 2.15 2.15 0.0 19.5 14.7 0.8 0.7 0.0 0.0

CSD 1138.HK OW / NEU 5.24 6.35 21.2 42.6 26.2 0.7 0.6 0.0 0.0

Sinotrans Shipping Ltd. 0368.HK OW / NEU 2.16 3.00 38.9 N/A 69.2 0.5 0.5 0.2 0.4Notes: 1) Prices as of close on 7 August 2014. 2) Ratings: OW = Overweight; EW = Equal Weight; UW = Underweight. Industry views: Pos: Positive; Neu: Neutral; Neg: Negative. 3) For full disclosures on each covered company, including details of our company-specific valuation methodology and risks, please refer to http://publicresearch.barcap.com. Source: Company data, Bloomberg, Barclays Research estimates



11 August 2014 42

FIGURE 47 China marine ownership web (as of end June 2014)


SASAC

China Merchants GroupCOSCO GroupChina Shipping

Group

China COSCO

1919HK

COSCO Pacific

1199HK

CIMC2039 HK

China Shipbuilding

China Merchants

144HK

SIPG600018 CH

China State Shipbuilding

CSCL 2866 HK

Sinotrans & CSC Holdings

China Shipbuilding601989 CH

YZJYZJ SP

Jiangnan600072 CH

Private

Guangzhou Shipyard CIMC Enric

3899 HK

CM Energy Shipping

601872 CH

Rongsheng1011 HK

SITC1308 HK

COSCO CorpCOS SP

COSCO Intl517 HK

Sinotrans Shipping368 HK

Sinotrans Ltd598 HK

CSD1138 HK

Haisheng600896 CH

China CSSC600150 CH

China CSSC600150 CH

Shipping

Ports & logistics

Shipyards & equipment

Primary business

*Bubble size based on total market cap

52% 23% 26%

41%

24%

54%

70% 43%

63%

53%

46% 46%

28%

58% 68% 55%

40%

61%

35%


11 August 2014

ANALYST(S) CERTIFICATION(S):

In relation to our respective sections we, May Yan, Jon Windham, CFA, Anand Ramachandran, CFA, Clement Chen, Somshankar Sinha, EphremRavi, Jian Chang and Krishna Hegde, CFA, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.

FICC: IMPORTANT DISCLOSURES CONTINUED

Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 14th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072.

Barclays Capital Inc. and/or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result,investors should be aware that Barclays may have a conflict of interest that could affect the objectivity of this report. Barclays Capital Inc. and/or one of its affiliates regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). Barclays trading desks may have either a long and / or short position in such securities, other financial instruments and / or derivatives, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, Barclays fixed income research analysts regularly interactwith its trading desk personnel regarding current market conditions and prices. Barclays fixed income research analysts receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability ofthe investment banking department), the profitability and revenues of the Fixed Income, Currencies and Commodities Division and the potential interest of the firm’s investing clients in research with respect to the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays produces various types of research including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research may differ from recommendations contained in other types of research, whether as a result of differing time horizons, methodologies, or otherwise. Unless otherwise indicated, Barclays trade ideas areprovided as of the date of this report and are subject to change without notice due to changes in prices. In order to access Barclays Statement regarding Research Dissemination Policies and Procedures, please refer tohttps://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html. In order to access Barclays Research Conflict Management Policy Statement, please refer to: http://group.barclays.com/corporates-and-institutions/research/research-policy.

EQUITY: IMPORTANT DISCLOSURES CONTINUED

Barclays Research is a part of the Corporate and Investment Banking division of Barclays Bank PLC and its affiliates (collectively and each individually, "Barclays"). For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Research Compliance, 745 Seventh Avenue, 14th Floor, New York, NY 10019 or refer to http://publicresearch.barclays.com or call 212-526-1072.

The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by investment banking activities.

Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA. These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’s account.

Analysts regularly conduct site visits to view the material operations of covered companies, but Barclays policy prohibits them from acceptingpayment or reimbursement by any covered company of their travel expenses for such visits.

In order to access Barclays Statement regarding Research Dissemination Policies and Procedures, please refer to https://live.barcap.com/publiccp/RSR/nyfipubs/disclaimer/disclaimer-research-dissemination.html. In order to access Barclays Research Conflict Management Policy Statement, please refer to: http://group.barclays.com/corporates-and-institutions/research/research-policy.

The Corporate and Investment Banking division of Barclays produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differfrom recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Materially Mentioned Stocks (Ticker, Date, Price)

Aluminum Corporation of China Ltd. (2600.HK, 07-Aug-2014, HKD 3.53), Underweight/Neutral, D/J/L

Anton Oilfield Services (3337.HK, 07-Aug-2014, HKD 4.23), Overweight/Positive, J

Bank of China Limited (3988.HK, 07-Aug-2014, HKD 3.65), Overweight/Neutral, D/J/K/L/M/N

Bank of Communications Co., Ltd. (3328.HK, 07-Aug-2014, HKD 5.81), Equal Weight/Neutral, D/J/K/L/M/N

China CITIC Bank Corporation (0998.HK, 07-Aug-2014, HKD 5.01), Equal Weight/Neutral, D/J/K/L/M/N

China Coal Energy Co., Ltd. (1898.HK, 07-Aug-2014, HKD 4.90), Underweight/Neutral, J

China Construction Bank Corp. (0939.HK, 07-Aug-2014, HKD 5.82), Equal Weight/Neutral, A/D/J/K/L/M/N


11 August 2014


China COSCO Holdings Co., Ltd. (1919.HK, 07-Aug-2014, HKD 3.38), Underweight/Neutral, J/K/N

China Merchants Bank Co., Ltd. (3968.HK, 07-Aug-2014, HKD 15.28), Overweight/Neutral, D/J/K/L/M/N

China Merchants Holdings (0144.HK, 07-Aug-2014, HKD 25.60), Overweight/Neutral, J/K/M/N

China Mobile (0941.HK, 07-Aug-2014, HKD 86.00), Underweight/Neutral, J

China National Building Material Co., Ltd. (3323.HK, 07-Aug-2014, HKD 7.65), Underweight/Neutral, J

China Resources Cement Holdings Ltd. (1313.HK, 07-Aug-2014, HKD 5.68), Equal Weight/Neutral, J

China Shenhua Energy Co., Ltd. (1088.HK, 07-Aug-2014, HKD 23.20), Overweight/Neutral, D/J/K/L/M/N

China Shipping Container Lines Co., Ltd. (2866.HK, 07-Aug-2014, HKD 2.15), Overweight/Neutral, J

China Shipping Development Co., Ltd. (1138.HK, 07-Aug-2014, HKD 5.24), Overweight/Neutral, J

China Telecom (0728.HK, 07-Aug-2014, HKD 4.09), Equal Weight/Neutral, C/D/J/K/L/M/O

China Unicom (0762.HK, 07-Aug-2014, HKD 12.80), Equal Weight/Neutral, J

COSCO Pacific Limited (1199.HK, 07-Aug-2014, HKD 11.50), Overweight/Neutral, J/K/N

Industrial & Commercial Bank of China Ltd. (1398.HK, 07-Aug-2014, HKD 5.16), Overweight/Neutral, D/J/K/L/M/N

Kunlun Energy (0135.HK, 07-Aug-2014, HKD 13.26), Underweight/Positive, D/J/K/L/M/N

PetroChina (0857.HK, 07-Aug-2014, HKD 10.12), Overweight/Positive, C/D/J/K/L/M/N/O

Sinopec (0386.HK, 07-Aug-2014, HKD 7.44), Equal Weight/Positive, C/D/J/K/L/M/O

Sinotrans Shipping Ltd. (0368.HK, 07-Aug-2014, HKD 2.16), Overweight/Neutral, J

SPT Energy Group (1251.HK, 07-Aug-2014, HKD 3.93), Equal Weight/Positive, J

Disclosure Legend:

A: Barclays Bank PLC and/or an affiliate has been lead manager or co-lead manager of a publicly disclosed offer of securities of the issuer in theprevious 12 months.

B: An employee of Barclays Bank PLC and/or an affiliate is a director of this issuer.

C: Barclays Bank PLC and/or an affiliate is a market-maker and/or liquidity provider in equity securities issued by this issuer or one of its affiliates.

D: Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from this issuer in the past 12 months.

E: Barclays Bank PLC and/or an affiliate expects to receive or intends to seek compensation for investment banking services from this issuer within the next 3 months.

F: Barclays Bank PLC and/or an affiliate beneficially owned 1% or more of a class of equity securities of the issuer as of the end of the month priorto the research report's issuance.

G: One of the analysts on the coverage team (or a member of his or her household) owns shares of the common stock of this issuer.

H: This issuer beneficially owns 5% or more of any class of common equity securities of Barclays Bank PLC.

I: Barclays Bank PLC and/or an affiliate has a significant financial interest in the securities of this issuer.

J: Barclays Bank PLC and/or an affiliate trades regularly in the securities of this issuer.

K: Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from this issuer within the past 12 months.

L: This issuer is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

M: This issuer is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLCand/or an affiliate.

N: This issuer is, or during the past 12 months has been, a non-investment banking client (non-securities related services) of Barclays Bank PLC and/or an affiliate.

O: Barclays Capital Inc., through Barclays Market Makers, is a Designated Market Maker in this issuer's stock, which is listed on the New York Stock Exchange. At any given time, its associated Designated Market Maker may have "long" or "short" inventory position in the stock; and its associated Designated Market Maker may be on the opposite side of orders executed on the floor of the New York Stock Exchange in the stock.

P: A partner, director or officer of Barclays Capital Canada Inc. has, during the preceding 12 months, provided services to the subject company for remuneration, other than normal course investment advisory or trade execution services.

Q: The Corporate and Investment Banking division of Barclays Bank PLC, is a Corporate Broker to this issuer.

R: Barclays Capital Canada Inc. and/or an affiliate has received compensation for investment banking services from this issuer in the past 12 months.

S: Barclays Capital Canada Inc. is a market-maker in an equity or equity related security issued by this issuer.

Risk Disclosure(s)


11 August 2014


Master limited partnerships (MLPs) are pass-through entities structured as publicly listed partnerships. For tax purposes, distributions to MLP unitholders may be treated as a return of principal. Investors should consult their own tax advisors before investing in MLP units.

Guide to the Barclays Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as Overweight, Equal Weight or Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry (the "industry coverage universe").

In addition to the stock rating, we provide industry views which rate the outlook for the industry coverage universe as Positive, Neutral or Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

Overweight - The stock is expected to outperform the unweighted expected total return of the industry coverage universe over a 12-month investment horizon.

Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the industry coverage universe over a 12-month investment horizon.

Underweight - The stock is expected to underperform the unweighted expected total return of the industry coverage universe over a 12-month investment horizon.

Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable or tocomply with applicable regulations and/or firm policies in certain circumstances including where the Corporate and Investment Banking Division of Barclays is acting in an advisory capacity in a merger or strategic transaction involving the company.

Industry View

Positive - industry coverage universe fundamentals/valuations are improving.

Neutral - industry coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

Negative - industry coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "industry coverage universe":

Asia ex-Japan Banks

Agricultural Bank of China Limited (1288.HK) Axis Bank (AXBK.NS) Bank Central Asia (BBCA.JK)

Bank Mandiri (BMRI.JK) Bank Negara Indonesia (BBNI.JK) Bank of Baroda (BOB.NS)

Bank of China (Hong Kong) Ltd. (2388.HK) Bank of China Limited (3988.HK) Bank of Communications Co., Ltd. (3328.HK)

Bank of East Asia Ltd. (0023.HK) Bank of India (BOI.NS) Bank Rakyat Indonesia (BBRI.JK)

Bank Tabungan Negara (BBTN.JK) BS Financial Group (138930.KS) China CITIC Bank Corporation (0998.HK)

China Construction Bank Corp. (0939.HK) China Merchants Bank Co., Ltd. (3968.HK) China Minsheng Banking Corp., Ltd. (1988.HK)

Chongqing Rural Commercial Bank (3618.HK) CTBC Financial Holding (2891.TW) Dah Sing Banking Group Ltd. (2356.HK)

Dah Sing Financial Holdings Ltd. (0440.HK) DBS Group Holdings, Ltd. (DBSM.SI) DGB Financial Group (139130.KS)

E.Sun Financial Holding (2884.TW) Federal Bank (FED.NS) First Financial Holding (2892.TW)

Hana Financial Group (086790.KS) Hang Seng Bank Ltd. (0011.HK) HDFC Bank (HDBK.NS)

HSBC Holdings PLC (0005.HK) ICICI Bank (ICBK.NS) Indusind Bank (INBK.NS)

Industrial & Commercial Bank of China Ltd. (1398.HK)

Industrial Bank of Korea (024110.KS) ING Vysya Bank (VYSA.NS)

KB Financial Group (105560.KS) Kotak Mahindra Bank Ltd. (KTKM.NS) Mega Financial Holding (2886.TW)

OCBC Group (OCBC.SI) Punjab National Bank (PNBK.NS) Shinhan Financial Group (055550.KS)

SinoPac Financial Holdings (2890.TW) Standard Chartered PLC (2888.HK) State Bank of India (SBI.NS)

UOB Group (UOBH.SI) Woori Finance Holdings (053000.KS) Yes Bank (YESB.NS)

Asia ex-Japan Infrastructure & Transport

Adani Ports and SEZ Ltd. (APSE.NS) Air China (0753.HK) AirAsia Bhd (AIRA.KL)

AirAsia X Bhd (AIRX.KL) Airports of Thailand PCL (AOT.BK) Asia Aviation PCL (AAV.BK)

Beijing Capital International Airport (0694.HK) Cathay Pacific Airways (0293.HK) China COSCO Holdings Co., Ltd. (1919.HK)

China Eastern Airlines (0670.HK) China Merchants Holdings (0144.HK) China Rongsheng Heavy Ind. (1101.HK)

China Shipping Container Lines Co., Ltd. (2866.HK) China Shipping Development Co., Ltd. (1138.HK)

China Southern Airlines (1055.HK)

ComfortDelGro (CMDG.SI) COSCO Pacific Limited (1199.HK) Essar Ports Ltd. (ESRS.NS)

Evergreen Marine Corp Ltd. (2603.TW) GMR Infrastructure Ltd. (GMRI.NS) Gujarat Pipavav Port Ltd. (GPPL.NS)


11 August 2014


GVK Power & Infrastructure Ltd. (GVKP.NS) Hutchison Port Holdings Trust (HPHT.SI) IL&FS Transportation Networks Ltd. (ILFT.NS)

International Container Terminal Services Inc. (ICT.PS)

IRB Infrastructure Developers Ltd. (IRBI.NS) Jaiprakash Associates Ltd. (JAIA.NS)

Jiangsu Expressway Co., Ltd. (0177.HK) Kerry Logistics Network Ltd. (0636.HK) Malaysia Airports Holdings Bhd (MAHB.KL)

Neptune Orient Lines Ltd. (NEPS.SI) Orient Overseas (International) Ltd. (0316.HK)

Pacific Basin Shipping Ltd. (2343.HK)

Reliance Infrastructure Ltd. (RLIN.NS) Singamas Container Holdings Ltd. (0716.HK) Singapore Airlines (SIAL.SI)

Sinotrans Shipping Ltd. (0368.HK) Wan Hai Lines (2615.TW) Westports Holdings Bhd (WPHB.KL)

Yang Ming Marine Transport (2609.TW) Yangzijiang Shipbuilding (Holdings) Ltd. (YAZG.SI)

Zhejiang Expressway Co., Ltd. (0576.HK)

Asia ex-Japan Metals & Mining

ACC Limited (ACC.NS) Adaro Energy Tbk PT. (ADRO.JK) Aluminum Corporation of China Ltd. (2600.HK)

Ambuja Cements (ABUJ.NS) Angang Steel Co., Ltd. (0347.HK) Anhui Conch Cement Co., Ltd. (0914.HK)

Banpu PCL (BANPU.BK) BHP Billiton Ltd. (BHP.AX) Bumi Resources Tbk PT. (BUMI.JK)

China Coal Energy Co., Ltd. (1898.HK) China Hongqiao Group Ltd. (1378.HK) China National Building Material Co., Ltd. (3323.HK)

China Resources Cement Holdings Ltd. (1313.HK) China Shanshui Cement Group Ltd. (0691.HK)

China Shenhua Energy Co., Ltd. (1088.HK)

China Steel Corp. (2002.TW) Coal India (COAL.NS) CST Mining Group Ltd. (0985.HK)

Fortescue Metals Group Ltd. (FMG.AX) Harum Energy Tbk PT. (HRUM.JK) Hindalco Industries Ltd. (HALC.NS)

Hindustan Zinc Ltd. (HZNC.NS) Hyundai Steel Co. (004020.KS) Indo Tambangraya Megah Tbk PT. (ITMG.JK)

IRC Ltd. (1029.HK) Jiangxi Copper Co., Ltd. (0358.HK) Jindal Steel & Power (JNSP.NS)

JSW Steel (JSTL.NS) Korea Zinc Co., Ltd. (010130.KS) Maanshan Iron & Steel Co., Ltd. (0323.HK)

MMG Limited. (1208.HK) National Aluminium Co., Ltd. (NALU.NS) NMDC Ltd. (NMDC.NS)

POSCO (005490.KS) Sesa Sterlite Ltd. (SESA.NS) Shree Cement (SHCM.NS)

Steel Authority of India (SAIL.NS) Tata Steel (TISC.NS) TB Bukit Asam Tbk PT. (PTBA.JK)

UC Rusal (0486.HK) Yanzhou Coal Mining Co., Ltd. (1171.HK)

Asia ex-Japan Oil & Gas

Bharat Petroleum Corp., Ltd. (BPCL.NS) Cairn India (CAIL.NS) China Resources Gas (1193.HK)

China Steel Chemical (1723.TW) CNOOC (0883.HK) ENN Energy (2688.HK)

Formosa Chemicals (1326.TW) Formosa Petrochemical (6505.TW) Formosa Plastics (1301.TW)

Gail India (GAIL.NS) Hindustan Petroleum Corp., Ltd. (HPCL.NS) Indian Oil Corp., Ltd. (IOC.NS)

Kumho Petrochemical (011780.KS) Kunlun Energy (0135.HK) LG Chem (051910.KS)

Lotte Chemical (011170.KS) Nan Ya Plastics (1303.TW) Oil & Natural Gas Corp., Ltd. (ONGC.NS)

Oil India (OILI.NS) PetroChina (0857.HK) PETRONAS Chemicals (PCGB.KL)

Petronet LNG (PLNG.NS) Reliance Industries (RELI.NS) S-Oil (010950.KS)

Sinopec (0386.HK) SK Innovation (096770.KS) TSRC Corp. (2103.TW)

Asia ex-Japan Oil Services & Drilling

Anton Oilfield Services (3337.HK) China Oilfield Services (COSL) (2883.HK) EZRA Holdings (EZRA.SI)

Hilong Holding, Ltd. (1623.HK) Honghua Group (0196.HK) Keppel Corp. (KPLM.SI)

Sembcorp Marine (SCMN.SI) SPT Energy Group (1251.HK) UMW Oil & Gas Corp. (UMOG.KL)

Asia ex-Japan Telecom Services

Advanced Info Service (ADVANC.BK) Axiata Group (AXIA.KL) Bharti Airtel Ltd. (BRTI.NS)

Bharti Infratel Ltd. (BHRI.NS) China Mobile (0941.HK) China Telecom (0728.HK)

China Unicom (0762.HK) Chunghwa Telecom (2412.TW) DiGi.Com (DSOM.KL)

Far EasTone (4904.TW) HKT Trust and HKT Limited (6823.HK) Hutchison Telecom HK (0215.HK)

Idea Cellular Ltd. (IDEA.NS) KT Corp. (030200.KS) LG Uplus Corp. (032640.KS)

M1 (MONE.SI) Maxis (MXSC.KL) PCCW Limited (0008.HK)

PT Indosat (ISAT.JK) PT Telkom (TLKM.JK) PT XL Axiata (EXCL.JK)


11 August 2014


Reliance Communications Ltd. (RLCM.NS) Singapore Telecom (STEL.SI) SK Telecom (017670.KS)

SmarTone Telecommunications Holdings Ltd. (0315.HK)

StarHub Limited (STAR.SI) Taiwan Mobile (3045.TW)

Telekom Malaysia (TLMM.KL) Total Access Communication (DTAC.BK)

Distribution of Ratings:

Barclays Equity Research has 2578 companies under coverage.

45% have been assigned an Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 55% of companies with this rating are investment banking clients of the Firm.

39% have been assigned an Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 46% of companies with this rating are investment banking clients of the Firm.

14% have been assigned an Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 42% of companies with this rating are investment banking clients of the Firm.

Guide to the Barclays Research Price Target:

Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock will trade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's pricetarget over the same 12-month period.

Barclays offices involved in the production of equity research:

London

Barclays Bank PLC (Barclays, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Securities Japan Limited (BSJL, Tokyo)

São Paulo

Banco Barclays S.A. (BBSA, São Paulo)

Hong Kong

Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong)

Toronto

Barclays Capital Canada Inc. (BCCI, Toronto)

Johannesburg

Absa Bank Limited (Absa, Johannesburg)

Mexico City

Barclays Bank Mexico, S.A. (BBMX, Mexico City)

Taiwan

Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan)

Seoul

Barclays Capital Securities Limited (BCSL, Seoul)

Mumbai

Barclays Securities (India) Private Limited (BSIPL, Mumbai)

Singapore

Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)


8 August 2014 48

DISCLAIMER:

This publication has been prepared by the Corporate and Investment Banking division of Barclays Bank PLC and/or one or more of its affiliates (collectivelyand each individually, "Barclays"). It has been issued by one or more Barclays legal entities within its Corporate and Investment Banking division as providedbelow. It is provided to our clients for information purposes only, and Barclays makes no express or implied warranties, and expressly disclaims all warrantiesof merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays will not treat unauthorizedrecipients of this report as its clients. Prices shown are indicative and Barclays is not offering to buy or sell or soliciting offers to buy or sell any financialinstrument.

Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays, nor any affiliate, nor any of their respective officers,directors, partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss ofanticipated savings or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication orits contents.

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The views in this publication are those of the author(s) and are subject to change, and Barclays has no obligation to update its opinions or the information inthis publication. The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were preparedindependently of any other interests, including those of Barclays and/or its affiliates. This publication does not constitute personal investment advice or takeinto account the individual financial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for allinvestors. Barclays recommends that investors independently evaluate each issuer, security or instrument discussed herein and consult any independentadvisors they believe necessary. The value of and income from any investment may fluctuate from day to day as a result of changes in relevant economicmarkets (including changes in market liquidity). The information herein is not intended to predict actual results, which may differ substantially from thosereflected. Past performance is not necessarily indicative of future results.

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All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF011292738 (BSE) | Corporate Identification Number: U67120MH2006PTC161063 | Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | ShivsagarEstate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other research reports are distributed in India by Barclays Bank PLC, India Branch.

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8 August 2014 49

Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Related financial products orservices are only available to Professional Clients, as defined by the Dubai Financial Services Authority.

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