Changjiang Securities:Evolving to meet changing market needs but valuation looks demanding

Private placement approved but issue price lacks appeal vs. market price.

    On 13 May, Changjiang announced that its private placement received approval fromthe securities regulator. It plans to issue up to 787m shares at no less thanRmb10.56/share. If the transaction is completed, the company will raise ~Rmb8.3bn,boosting net assets by 49%. Although the increased capital strength should supportChangjiang's long-term business development, the period of fast growth for capitalintensivebusinesses such as margin lending is over. Coming at a time of weak marketactivity, the added funds will likely deliver only a limited boost to earnings while sharplydiluting EPS. However, we believe the private placement faces significant uncertainty,as the issue price is just ~10% lower than the current market price.

    Evolving to meet changing market needs.

    Since H215, the company has been taking steps to evolve and meet the needs of achanging market. This includes a focus on brokerage and flow-based business, as wellas expanding its presence in investment banking, asset management and innovativesegments. In brokerage, its market share rose 6% in 4M16 compared with end-2015,while its margin lending market share rose 11%. In Q116, investment banking andasset management registered positive YoY revenue growth and results were strongerthan at peers. We like the company's transformation strategy but we are concernedROE may face downward pressure amid subdued trading activity.

    Lowering 2016-18E earnings on weak market activity and fiercer competition.

    We are lowering our 2016-18E EPS 14%/12%/14% to Rmb0.37/0.44/0.49, based onthe following: 1) we are lowering our 2016-18E core sector assumptions (average dailyturnover and average margin lending balance); 2) we are lowering our 2016-18Einvestment yield for the company, given an overall drop in investment yields; 3)Changjiang's aggregate net profit after tax (parent level) was Rmb783m in 5M16; and4) we assume the private placement is successfully completed, raising Rmb8.3bn.

    Valuation: New Rmb10.03 price target; maintain Sell rating.

    We are changing our valuation method to a PB/ROE approach, given industrycharacteristics. Assuming a stable market, we estimate average ROE of 9.7% in thenext 5 years and long-term sustainable ROE of 10.0%. We derive our new Rmb10.03price target by applying 2.20x PB on our 2016E BVPS, implying 22.8x 2017E PE and2.07x 2017E PB. Considering downward pressure on ROE and its higher-than-peervaluation, we maintain our Sell rating.