CITIC Pacific (267, $15.64) 12M Target $19.2 BUY

Becky Yuen–becky.yuen@guoco.com (852) 2218 2872

Event: CITIC Pacific's current valuation looks undemanding.

• CITIC Pacific has underperformed HSI index by 7% in past three months. Trading at 0.9x book value, we believe the valuation of CITIC Pacific is undemanding as compared to its historical average of 1.2x PB. A better than expected interim earnings (scheduled in mid-August) may serve as a short-term catalyst to its share price.
• We believe the weak price performance was mainly due to market's concern on the cost increment for the Sino iron ore project and also worries that the new mining tax to be imposed by the Australian government will affect the return of this project.
• Market has already priced in the worst outcome, in our view, while surprise may be on the upside as Australian miners are still debating on whether to exclude magnetite ore from the proposed tax.
• Company's special steel business remained solid in 1H10. Daye Special Steel, CITIC Pacific's Shenzhen-listed subsidiary, has issued a positive profit alert earlier this month stating that its interim net profit is expected to be up by 161% to RMB293mn. Even though we expect profit margin to trend down in 2H10 due to the higher iron ore cost and lower ASP, we remain confident that EBIT of special steel business will achieve a 40% yoy growth in 2010 amid the improvement in product mix.
• In contrast to common steel mills that are struggling to break even at current price level, special still mills are still making profit due to high value-added nature of special steel. With over 50% of special steel demands being derived from automobile and machinery manufacturing sector, special steel price has been relatively stable compared to common steel. While we believe that there may be a slowdown in car sales growth in 2H10, we remain bullish on machinery manufacturing sector due to the continuous urbanization of China. At the same time, demand from petrochemical sector should also be catching up. .
• Even though PRC property market is facing some headwind, we believe earnings from CITIC Pacific’s property business will still have a significant boost in 2010 as the sales of its Lujiazui office tower is likely to be booked this year. According to the company’s earlier guideline, there will be 2mn sqm of development projects to be completed by 2012. Given low land cost of these projects, we believe the company will enjoy a relatively high profit margin even if the property price faces some correction.
• We have cut our NAV estimates to $22.6 to factor in higher capex and potential mining resource tax for the iron ore project. Nonetheless, trading at a 31% discount to the company's 2010 NAV, 0.9x book value and 9.0x 2010 PER, CITIC Pacific's value is undemanding in our view.
• Reiterate BUY but revised our target price to $19.2 due to our adjustment to NAV. The new target price implies a 15% discount to our new NAV estimates. Downside risk will be a further delay in commencement of company's Sino iron ore project, which we expect to be an earnings driver in 2011.