Earnings recovery, initiating with Buy

Deutsche Bank Markets Research Rating Buy Asia China Technology Hardware & Equipment Company Dahua Date 15 November 2016 Initiation of Coverage Earnings recovery, initiating with Buy Reuters Bloomberg Exchange Ticker 002236.SZ 002236 CH SHZ 002236 Forecasts And Ratios Year End Dec 31 2014A 2015A 2016E 2017E 2018E Sales (CNYm) 7,332 10,078 13,332 16,211 19,754 EBIT (CNYm) 960 1,176 1,440 2,120 2,682 EBITDA (CNYm) 1,039 1,268 1,559 2,285 2,907 DB EPS FD(CNY) 0.40 0.48 0.64 0.87 1.09 DB EPS growth (%) -0.1 20.1 33.1 35.8 25.5 Price/BV (x) 4.8 6.5 5.2 4.1 3.3 ROE (%) 24.4 23.5 25.5 27.9 28.0 PER (x) 27.7 29.3 22.3 16.4 13.1 Source: Deutsche Bank estimates, company data Initiating coverage with Buy and target price of CNY17.3 ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Price at 14 Nov 2016 (CNY) 14.22 Price target - 12mth (CNY) 17.30 52-week range (CNY) 16.07 - 11.26 Shenzhen Index 2,205 James Chiu Research Analyst (+886) 2 2192 2848 james.chiu@db.com Price/price relative 81216202411/145/1511/155/16DahuaShenzhen Index (Rebased) Performance (%) 1m 3m 12m Absolute -9.1 -7.4 1.1 Shenzhen Index 3.0 6.8 -4.4 Source: Deutsche Bank Key indicators (FY1) ROE (%) 25.5 Net debt/equity (%) 5.8 Book value/share (CNY) 2.75 Price/book (x) 5.17 Net interest cover (x) – Operating profit margin (%) 10.8 Source: Deutsche Bank We initiate coverage on Dahua, the #2 video surveillance manufacturer in China, with a Buy rating and a target price of CNY17.3, based on 20x 2017E P/E. We expect Dahua’s earnings to re-accelerate after the severe margin erosion during in 2014/15. We expect smart city solutions, IoT applications and overseas expansion to generate strong top-line growth and market share gains while margins stabilize. Dahua currently trades at 17x and we expect the multiple to expand, supported by earnings growth of 31%; Buy. Beneficiary of IoT proliferation The video surveillance industry is expanding rapidly, driven by the rise of IoT, particularly in the areas of traffic monitoring and public safety in smart city implementation. Market research firm, Frost & Sullivan, has estimated the smart city market for products and service revenues to be US$1.5tr in 2020. Fast expansion of its overseas business Dahua has accelerated its overseas business expansion through ODM orders from global security companies (e.g., Honeywell). As the industry consolidates to offset severe price erosion, there are clear incentives for global securities companies to outsource to stay competitive. Combined with Dahua’s own overseas expansion from establishing offices in each continent, management expects the overseas business contribution to expand from 39% in 1H16 to 45% in 2018E. Margin pressure to be alleviated Dahua's margin has been driven lower over the past five years, due to pricing pressures and its strategic transition. However, over the past nine months, there has been clear evidence of stabilization, with improving economies of scale and the increasing contribution of service/operation revenue. We forecast a sustainable level of over 10% for the next two years. Valuation and risks Our target price of CNY17.3 is based on 20x 2017E P/E, supported by 2016-18 earnings CAGR of 31%, average ROE of 27% and solid industry growth. Our target P/E multiple is lower than its historical average P/E multiple of 31x during the past three years. Risks: market share loss, weaker orders and higher labor costs. Distributed on: 15/11/2016 10:51:39 GMT 15 November 2016 Hardware & Equipment Dahua Page 2 Deutsche Bank AG/Hong Kong Model updated:14 November 2016 Running the numbers Asia China Hardware & Equipment Dahua Reuters: 002236.SZ Bloomberg: 002236 CH Buy Price (14 Nov 16) CNY 14.22 Target Price CNY 17.30 52 Week range CNY 11.26 - 16.07 Market Cap (m) CNYm 40,745 USDm 5,979 Company Profile Zhejiang Dahua Technology Co., Ltd. researches, designs and manufactures security and surveillance equipments. It also modular-designs both hardware and software with flexibility for different configurations, various scales of applications and future expansion. Price Performance 812162024Nov 14Feb 15May 15Aug 15Nov 15Feb 16May 16Aug 16DahuaShenzhen Index (Rebased) Margin Trends 10121416182013141516E17E18EEBITDA Margin