Logistics:Sector in vogue,but be selective

Deutsche Bank Markets Research Asia China Transportation Logistics Industry Logistics Date 19 November 2015 Initiation of Coverage Sector in vogue, but be selective Three selection criteria and two stock picks ________________________________________________________________________________________________________________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) 124/04/2015. Sky Hong, CFA Research Analyst (+852) 2203 6131 sky.hong@db.com Key Changes Company Target Price Rating0152.HK – to 15.10(HKD) NR to Buy0598.HK NA to 6.30(HKD) NR to BuySource: Deutsche Bank Top picks Sinotrans (0598.HK),HKD4.32 BuySource: Deutsche Bank Companies Featured Shenzhen International (0152.HK),HKD12.80 Buy 2014A 2015E 2016EP/E (x) 7.58.78.5EV/EBITDA (x) 4.15.45.1Price/book (x) 1.11.11.0Sinotrans (0598.HK),HKD4.32 Buy 2014A 2015E 2016EP/E (x) 13.711.210.3EV/EBITDA (x) 8.35.85.1Price/book (x) 1.31.11.0Source: Deutsche Bank Although it is a sector very much in vogue, investing in Chinese logistics is not without risks. We suggest investors 1) follow the trade flow, 2) go asset light, and 3) choose industry leaders. Using these three criteria, we pick two stocks. Sinotrans is our top pick. Apart from its stronger exposure to intra-Asia and domestic markets, the company looks well positioned to benefit from industry consolidation and group restructuring. We also like Shenzhen International. Its logistics business looks set to grow strongly, while Qianhai land and the government repurchase of toll roads offer further upside potential. Logistics demand is ultimately subject to trade flows Our regression analysis shows the R2 between US merchandise trade and 3PL revenue is as high as 95%. This suggests trade flows are the ultimate driver of logistics demand. While inter-regional trade outpaced intra-regional trade pre- Global Financial Crisis (GFC), stronger intra-Asia growth and strength in e-commerce in China should lead to outperformance of intra-Asia and domestic trade. We expect China’s logistics sector to expand at a 10% CAGR in 2015-17E. Trade flows have also driven the evolution of the logistics value chain. The advantages of asset-light models We use fixed assets as a % of total assets to separate asset-light and asset-heavy models. Our screen of global logistics players suggests 50% is a good ratio to divide the two groups. Our analysis suggests that while asset-heavy generally enjoyed higher margins than asset-light pre-GFC, the situation reversed post-GFC as asset-heavy players’ pricing power deteriorated. Along with more efficient asset turnover, the asset-light group was able to more than offset its lower leverage by delivering better ROEs post-GFC. The share prices of the asset-light group also outperformed asset-heavy post-GFC. After it adopted an asset-light model, DSV’s share price has increased 20x since 2000. SOE players look well positioned for industry consolidation China’s logistics industry is highly fragmented, with the top 50 players holding only a 10% market share. The revenue of Sinotrans, the largest 3PL player in China, is only one quarter that of DHL. With sector consolidation set to accelerate, we expect major SOE players, leveraging on their strong financial positions, integrated services, and extensive network, to become consolidators and eventually to evolve into integrators. Meanwhile, these SOE logistics listcos are also likely to benefit from ongoing SOE group restructuring in China. Sinotrans is our top pick; we also like Shenzhen International; risks Apart from having stronger exposure to intra-Asia and domestic markets, we think Sinotrans is likely to become the sole logistics platform if a merger between China Merchants and Sinotrans Group goes ahead. Its asset turnover is more efficient than that of its domestic peers’ and, together with potential for further levering up, this should let it capture better ROEs ahead. Our SOTP-based TP of HK$6.3 implies a 2016E P/E of 17x, a discount to global peers at 20x. We also like Shenzhen International and initiate coverage with a Buy and an SOTP-based TP of HK$15.1. In addition to robust growth in its logistics segment, its Qianhai land, if fully converted, may be worth HK$15/share on our estimat