CHINESE BROKERS：EARNINGS BOTTOMED;DUE FOR AN OUTPERFORMANCE
We are now positive on the Chinese broker sector and expect outperformancein the next 6-12 months. In line with our expectation at the start of the year,the sector has underperformed the market, on weak market activity. However,we expect this to change, as we see encouraging signs of recovering marketactivity, with a rising margin financing balance along with higher ADT. We seethe sector at its inflection point, as earnings bottomed in 1H17 and are poisedfor 17% growth in 2018E. With the sector trading ~10% below the historicalaverage and an improving earnings outlook, we see attractive risk-reward. Weupgrade Haitong, GFS & Galaxy to Buy, reiterate Top Picks of Huatai & CITICS.
Expect meaningful earnings rebound in 2018E
We believe Chinese brokers’ earnings will bottom out in 2H17E, with a slightrecovery of 1%. We expect to see a much more meaningful rebound in 1H18E,helped by a low base, and we forecast average growth of 17% in 2018E on theback of 20% ADT recovery assumptions. We believe our assumption of 20%ADT growth to Rmb587bn is well supported by rising sentiment, a positivecontribution from MSCI inclusion since June-18 and a likely moderation ofimpact from financial deleveraging. We see encouraging signs of marketrecovery entering 2H17E, with stock ADT +13% hoh, SHCOMP +5% andmargin financing balance +10%. We are positive on the continuedimprovement in net interest income and investment gains, and a moderateddecline in brokerage and IB fees. We forecast an average of 1% earningsrecovery in 2H17E, assuming 5% yoy growth in 2H17E ADT to Rmb537bn and5% yoy growth in margin financing balance to Rmb986bn （vs. Rmb985bncurrently）。 However, we note that, given a relatively high base in 2H16, 2H17Einvestment gains could be a swing factor.
Our assumption of 5% yoy growth in 2H17E stock ADT implies 2017E ADT ofRmb489bn, which is 6% lower than our previous assumption, as we factoredin a poor 1H17. However, we lift our 2017E earnings for most brokers （exceptCSC and EBS） by 0-8%, on the back of better-than-expected net interestincome and investment gains. We lower the forecasts for CSC and EBS by22% and 5%, on weaker IB business and higher cost-to-income ratios.
Valuation and risks
Given the lackluster share price performance, and attractive risk-reward, webelieve the sector is currently undervalued, trading at 1.1x 2017E P/B. We nowhave a positive view on the sector. Among listed brokers, we prefer Huatai-H（Buy） as we see limited further downside on its already-low commission rateand CITICS-H （Buy）， given its market leadership, balanced revenue mix andstrong overseas presence. We believe Huatai and Galaxy are most leveraged toa potential market upturn. We upgrade Haitong-H, GFS-H and Galaxy-H to Buyon attractive valuation. We apply a two-stage Gordon Growth Model （GGM） tovalue the sector. Our fair target multiple is 1.4x PB, implying 18.5x 2017 PE.
Key risks are much stronger/weaker recovery in ADT and A-share markets.Other risks include regulatory change. This report marks the transfer ofcoverage of Chinese brokers to Lexie Zhou.
□ .L.e.x.i.e. .Z.h.o.u./.E.s.t.h.e.r. .C.h.w.e.i .德.意.志.银.行.股.份.有.限.公.司