China brokers have gained 11% on average since last week on macro positives. Recovering market activity, implementation of announced capital market reform policies and still undemanding valuation could catalyze further re-rating. We suggest to add leaders as policies will skew towards them. Maintain OUTPERFORM on sector and reiterate BUY on CITICS.
- Multi macro positives improved market sentiment. Market optimism resumed following the strike of Phase One China-US trade deal, the recovering macro data and the CEWC. Risk appetite returned, evidenced by rebounding A-share ADT, velocity and margin balance (Fig. 1-4), and investors are refocusing on the undervalued broker sector. Besides, Northbound recorded net inflows for 24 straight sessions, and MTD monthly net inflows marked the 3rd highest (excl. indices reviews months) ever. The 1st & 2nd high was in Jan & Feb 2019, when A-share market started to bottom out.
- Looking forward to policy implementation ahead. We see many capital market reform policies announced in 2H19 will finalize/implement in coming months, which could hold up market sentiment. We noticed that the policies (Fig. 6) are highlighted by a thorough reform of the equity financing market (from IPO, follow-on offerings to M&A across ChiNext to NEEQ), where leaders in investment banking will be major beneficiaries. The introduction of registration-based IPO system to ChiNext is most attractive, and we expect the reform plan to reveal within 1H20E. A near-term catalyst could be the launch of CSI 300 Index option on 23 Dec, which can potentially boost trading activity and help hedge brokers’ prop-trading.
- Why stick to our top pick CITICS (6030 HK) even it was one of the best performers in recently? 1) CITICS is best positioned to benefit from equity financing market reform (No.1 by underwriting amount in 11M19; 3rd by no. of STAR Market IPO) and institutionalization (~50% brokerage deposit from institutional clients); 2) Regulators made it clearer that they would foster stronger and larger leaders, and we believe more new businesses will be introduced through pilot programs. CITICS owns the most pilot qualifications (Fig. 7), enabling it to enjoy the market consolidation; 3) We think the market has noticed the alpha out of the beta nature of brokers, as the valuation premium of leaders over other peers is expanding (Fig. 12). CITICS now trades at 1.08x 1yr forward P/B, 10% below its historical avg. (1.2x). We are reviewing our earnings forecast and TP for the sector and stocks.
- Key downside risks: 1) a plunge of A-share ADT; 2) reacceleration of trade dispute, and 3) slower-than-expected implementation of capital market reform.
