Goldman Sachs - China Strategy

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					June 27, 2012

China Strategy

A-Share 2H2012 Strategy: Tough times
near term but medium-term view intact

                                                                                                                                          Equity Research

Earnings risk heightened near term but policy supports                                                          Hanfeng Wang, Ph.D, CFA
medium-term upside                                                                                              +86(10)6627-3318 hanfeng.wang@ghsl.cn
                                                                                                                Beijing Gao Hua Securities Company Limited
While our framework of policy cycle driving the A-share market cycle
(introduced in Ongoing policy tailwind, March 12, 2012) is still well-founded,                                  Helen Zhu
the near-term market may continue to be bumpy as we believe the effect of                                       +852-2978-0048 helen.zhu@gs.com
policy easing has not yet been fully felt and the near-term earnings risks are                                  Goldman Sachs (Asia) L.L.C.
rising, given weak demand has led to high de-stocking pressure and
                                                                                                                Timothy Moe, CFA
weakening profit margins. We cut our top-down earnings forecast for CSI300
                                                                                                                +852-2978-1328 timothy.moe@gs.com
to 3.6%/11.4% 2012E/2013E (vs. 7.4%/16.6% previously) based on lowered                                          Goldman Sachs (Asia) L.L.C.
margin assumption, and lower our year-end index target accordingly from
3,100 to 2,950 (by -5%, target valuation multiple unchanged). Our new index                                     Christopher Eoyang
target still suggests c.15% upside for the rest of the year.                                                    +65-6889-1199 christopher.eoyang@gs.com
                                                                                                                Goldman Sachs (Singapore) Pte

Elevated levels of selling due to shares being unlocked in 2H2012                                               Ben Bei
We expect the amount of shares being unlocked to double in 2H2012 vs.                                           +852-2978-1220 ben.bei@gs.com
                                                                                                                Goldman Sachs (Asia) L.L.C.
1H2012. Specifically for companies on the SME/GEM board of the SSE, the size
will triple vs. 1H2012. Historically, shares being unlocked often lead to elevated                              Chenjie Liu
levels of selling by major shareholders, which would cap market valuation                                       +86(10)6627-3324 chenjie.liu@ghsl.cn
expansion. As such, large caps with already low valuation would face lower                                      Beijing Gao Hua Securities Company Limited
risk vs. what small-mid caps face with higher de-rating risk given their
relatively high valuation and higher portion of shares being unlocked.


Seeking earnings improvement amid overall earnings risk
Our sector earnings analysis suggests a sub-set of sectors should benefit due
to cost savings from weakening upstream material prices and easing financial
conditions, despite the overall earnings risks. We reshuffle our sector
preferences partly based on the conclusions of our earnings analysis. We
upgrade the health care sector to OW from neutral, utilities/construction to
neutral from UW, but downgrade coal to UW from neutral, retailing to neutral
from OW. Overall we like property, non-bank financials, building materials, and
selective consumers (healthcare, home appliance, auto).
 Unlocking of shares will increase substantially in 2H2012
                5000                            Value of unlocked shares_overall (ex. SME&GEM)
                       (Rmb 100 mn)
                4500                            Value of unlocked shares_SME&GEM
                                                    Total average
                4000
                3500
                3000
                2500
                2000
                1500
                1000
                 500
                   0
                   Jan-06     Jan-07   Jan-08    Jan-09   Jan-10   Jan-11   Jan-12   Jan-13   Jan-14   Jan-15


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates



Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, 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. For Reg AC certification and other
important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by
non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S. This report is intended for
distribution to GS institutional clients only.

The Goldman Sachs Group, Inc.                                                                                                           Global Investment Research
June 27, 2012                                                                                                            China




Table of contents

Executive summary: Tough times but will get better                                                                      2 
Revising earnings forecasts/index targets, target valuation multiple unchanged                                          3 
Sector preference revisions: Looking for stable growth amid earnings downside risks                                   13 
Key Issue: Impact of share reductions                                                                                 24 
Disclosure Appendix                                                                                                   33 




Executive summary: Tough times but will get better
                                 In this 2H strategy outlook report, we discuss two topics that are important to 2H2012 A-
                                 share investment views- market/ earnings outlook and the impact of share sale by major
                                 shareholders. Based on our analysis and resulting conclusions, we review our earnings
                                 forecast/index targets and revise our sector preferences:

                                 1)   Market/sector earnings outlook amid easing input cost pressures/financial
                                      conditions: We examine the impact to earnings given the cost savings due to lower
                                      financing costs and broad-based decline in upstream material prices, and how such
                                      impact would differentiate based on the sector;

                                 2)   The impact of share sales by major shareholders. The amount of shares to be
                                      unlocked in the second half of the year will double from the size in 1H2012. From July
                                      2012, we expect to enter the fourth peak period of shares unlocking since 2006,
                                      according to our estimates based on the schedule of shares to be unlocked.

                                 Bumpy near-term path but upside remains in the medium-term: China’s policy
                                 changes are playing out gradually and we feel our framework of policy cycle vs. A-share
                                 market cycle introduced in our 2Q strategy (Ongoing policy tailwind, March 12, 2012) is still
                                 well-founded and supports our medium-term positive view. However, the market continues
                                 to be choppy in the near-term on the back of heightened earnings risk with earnings
                                 season around the corner. Moreover, policy changes implemented so far have not been
                                 absorbed across the overall economy with the developments in EU also adding to near-
                                 term volatility.

                                 Earnings: Destocking pressure leads to lower margin and earnings. We trim our
                                 top-down earnings forecast for CSI300 to 3.6%/11.4% 2012E/2013E from 7.4%/16.6%
                                 respectively, mainly based on lower margin assumptions and we keep the target valuation
                                 multiple unchanged.

                                 We expect steps towards interest rate liberalization announced by PBoC to hurt financial
                                 sector earnings. On the other hand, margin compression is still the major theme for the
                                 non-financial sectors as the upstream sectors’ earnings loss from declining upstream
                                 materials prices could not fully translate into earnings gains by mid-downstream sectors.
                                 This is mainly because mid/downstream sectors are usually fragmented in China and lack
                                 pricing power especially under the present environment of overall weak-demand and low
                                 rate of capacity utilization. Easing financial conditions should be positive but so far its
                                 impact is minimal.

                                 However a sub-set of sectors should benefit amid this environment of softening material
                                 prices and financing cost. Our scorecard analysis indicates that utilities/construction
                                 /airlines/consumer durables should benefit the most while healthcare, media, hotel &
                                 tourism, food & beverage, etc, see the least impact.


Goldman Sachs Global Investment Research                                                                                       2
June 27, 2012                                                                                                               China




                                 Liquidity/valuation and index targets: We lower our index targets purely based on
                                 lowered earnings and we keep our year-end index target P/E unchanged at 11.5x as we
                                 believe ongoing policy changes should continue to support gradual liquidity improvement
                                 and a moderate valuation expansion.

                                 Our new 3m (end-3Q)/6m(year-end)/12m (mid of 2013) are 2,700/2,950/3,050 vs. 2,950
                                 3,100/3,200 previously, respectively, which implies about 15% upside for the rest of the
                                 year and about 22% upside in the next 12 months, consistent with our medium-term
                                 constructive market views.

                                 Sector preferences: We upgrade several sectors with stable/improving earnings outlook
                                 while downgrade others with less favorable earnings prospect amid the current earnings
                                 uncertainties, incorporating the conclusions from our sector earnings analysis. Specifically,
                                 we upgrade the utilities sector to neutral from underweight (UW) while downgrading its
                                 upstream sector, the coal sector to UW from neutral. We upgrade the healthcare sector to
                                 overweight (OW) while we downgrade retail to neutral. We also upgrade the construction
                                 sector to neutral from UW. Overall, we like property, non-banking financials, building
                                 materials, and selective consumer like auto, home appliances, but dislike coal, steel,
                                 chemical and telecom, etc.

                                 Key issue: Impact of share reduction by major shareholders. An important
                                 development in 2H2012 in the A-share market is that from July 2012, the amount of shares
                                 coming out of their lock-up period is significant versus 1H2012. As major shareholders
                                 would be able to sell their shares after the lock-up ends, we consider how major
                                 shareholders have reacted to this in the past and how such reductions in shareholdings by
                                 major shareholders affected stock performance. Historically, major shareholders of
                                 companies on the SME/GEM board (Small- and Medium- Enterprises (SME) and Growth
                                 Enterprise Market (GEM) boards on the Shenzhen Stock Exchange) have reduced their
                                 shares more aggressively than the companies on the main board. Net share reductions
                                 have a negative impact on stock price performance and are also linked to relatively weak
                                 earnings performance.

                                 The increased pressure from shares being unlocked in 2H2012 would cap the room of
                                 potential valuation expansion. We believe the large caps would face less de-rating risk
                                 given the already low valuation (around 10x 12-m forward PE for CSI300 vs. historical
                                 average of 18x+), but substantial valuation expansion should also be less likely. The small-
                                 mid caps would face much higher de-rating risk in 2H2012 given its high valuation (SME
                                 composite index 18x 12-m forward PE based on Wind consensus earnings forecast), and
                                 valuation premium over large caps, as we believe the substantially increased share-
                                 unlocking in 2H2012 should lead to elevated shares reduction by major shareholders of
                                 SME/GEM companies.

                                 We screen a list of small-mid caps with the largest share-unlocking pressure in 2H2012 in
                                 Exhibit 62.




Revising earnings forecasts/index targets, target valuation multiple
unchanged
                                 In this section we examine earnings with a special focus on the impact of cost savings on
                                 overall earnings amid softening input costs and easing financing conditions, and also the
                                 impact on financial earnings from the unexpected step towards interest rate liberalization
                                 announced by PBoC earlier in June.



Goldman Sachs Global Investment Research                                                                                        3
June 27, 2012                                                                                                               China




                                 We revise our earnings forecast and fine-tune our index targets accordingly based on our
                                 latest earnings forecast and our views on market liquidity and valuation.



                                 The impact of cost savings overall and on sector earnings
                                 The prices of many upstream materials have been weak ytd, as indicated by the PPI raw
                                 material price index (Exhibit 1), and financial cost pressure has also been easing since
                                 China started to fine-tune the monetary policy late last year. Below, we analyze how this
                                 environment affects our overall/sector earnings.

                                 Margins still under pressure: Overall margin compression should still be the major
                                 theme despite cost savings from declining upstream material prices and lower financial
                                 cost, as we believe:

                                 1)   Upstream sectors’ earnings (mainly material related sectors) account for a large part of
                                      A-share non-financial earnings (Exhibit 4), and the earnings loss of the upstream
                                      sectors due to the declining material prices have not fully translated into the earnings
                                      gain in the mid/downstream sectors. This is mainly because mid/downstream sectors
                                      in China (often consumer/services related sectors) are fragmented and the competition
                                      within the sectors often leads to price wars, especially given the relatively weak final
                                      demand and declining overall capacity utilization rate. Historically, contraction of
                                      margins for the upstream sectors does not translate into margin expansion for the
                                      mid/downstream sectors (Exhibit 5).

                                 2)   Relative weak demand is a dominating factor, and it has led to declining capacity
                                      utilization rate and rising destocking pressure for the industrial sectors (Exhibit 3). The
                                      capacity utilization index compiled by PBoC (a utilization rate index rather than the
                                      absolute utilization rate) based on a survey of 5,000 industrial enterprises suggests that
                                      the overall utilization rate of the manufacturing sector is still declining (Exhibit 2). We
                                      do not expect a significant margin recovery in the next several quarters unless we see
                                      an immediate and strong economic recovery. Our China economists expect only a
                                      modest recovery in the overall economic activities in 3Q/4Q (GDP yoy forecast
                                      7.9%/8.0%/8.1% for Q2/Q3/Q4 2012), even after taking potential policy changes into
                                      account.

                                 3)   Historically, the A-share non-financial sector profit margin correlates with the
                                      Corporate Goods Price Index compiled by PBoC (Exhibit 9). For some periods, the two
                                      may diverge but overall their trends look similar. Recent readings of the index suggest
                                      that A-share profit margin is still under pressure.

                                 4)   Impact of lowered financial cost on earnings is positive but only very limited: All
                                      else being equal, our analysis indicates each 25bps borrowing cost savings would
                                      enhance the non-financial earnings by 1.2ppt.

                                      Lower financing costs would generate a dual positive effect on earnings for the non-
                                      financial companies by:

                                      (1) Saving financing expenses directly and,

                                      (2) Boosting the overall demand due to the lower financing costs.

                                      While the latter’s effect on earnings is difficult to quantify and should be minimal given
                                      the small magnitude of the interest rate change, the first effect can be roughly
                                      estimated on a theoretical basis. The financial expense ratio (defined as the financial
                                      expense as % of revenue) for A-share non-financial sectors has been averaging around
                                      1.2% in recent years (Exhibit 7), net profit was around 6%, and average borrowing cost
                                      (defined as the financial expense as % of the borrowings) of the non-financial
                                      companies has been around 4.2% in recent years (Exhibit 8). This was lower than the


Goldman Sachs Global Investment Research                                                                                        4
June 27, 2012                                                                                                                    China




                                      average loan yield of the banking sector, as the listed companies often have better
                                      access to competitive financing terms than the unlisted companies. Based on these
                                      assumptions and all else being equal, we estimate that about every 25bps in
                                      borrowing cost savings would lead to 5.9% savings in financial expenses and could
                                      enhance earnings of the non-financial sectors by around 1.2ppt.

                                 However, sector earnings should differentiate: Low-margin mid-downstream sectors
                                 with relatively more resilient demand growth and tighter supply/demand relationships
                                 should benefit more. We have built a sector scorecard to assess which sectors could
                                 benefit more on a relative basis amid this environment of softening material cost pressure
                                 and easing financial conditions. Note that our scorecard only examines the impact from
                                 cost savings on sector earnings rather than analyze our overall sector preferences (which
                                 are the topic of the next section).

                                 We established the five criteria as below and score each sector by each criterion on a scale
                                 of 0-2, and we also take the industry structure and supply/demand relationship into
                                 consideration. Our scorecard is illustrated in Exhibit 12.

                                 Our scorecard indicates that the utilities, construction, airlines and home appliance
                                 sector should be among those that benefit most from easing material costs and financial
                                 conditions, while consumer/services related sectors should see the least impact, including
                                 healthcare, media, hotel & tourism, food &beverage, etc.

                                 Our criteria are set out below:

                                 1)   Impact from lowered financing cost: Generally the sector would be awarded a high
                                      score if the sector’s financial leverage is high, or the financial expense ratio is high
                                      (Exhibit 12);

                                 2)   Material cost exposures: The sector would be awarded a high score if the ratio of
                                      material-related input costs are high and the materials price decline is significant;

                                 3)   Net profit margin: The sector would be awarded a high score if its margins are low as
                                      the earnings sensitivity to cost changes should be high given slim margins (Exhibit 12);

                                 4)   Demand growth: The sector would be awarded a high score if demand remained
                                      relatively stable despite the unfavorable macro environment, or demand for the sector
                                      is supported by government policies or less affected by the overall macro environment;

                                 5)   Sector structure and demand/supply relationship: The sector would be awarded a high
                                      score if the sector is better-integrated (monopolized), or the supply is relatively tight vs.
                                      demand. We try to assess whether the upstream cost decline could translate into the
                                      earnings gain for the sector by setting this criterion.




Goldman Sachs Global Investment Research                                                                                            5
June 27, 2012                                                                                                                                                                              China




 Exhibit 1: The prices of many upstream materials have                                                     Exhibit 2: The declining capacity utilization rate
 been weak ytd, as suggested by the PPI raw material                                                       (compiled by PBoC, note this is an index and does not
 price index                                                                                               show absolute level of utilization rate)


 20
                                                                                                           48
                                                                                                                           The capacity utilization index (based on survey to 5,000 industrial
        (%)                             PPI:Overall               PPI: Raw Materials
                                                                                                                           enterprises, by PBoC)
                                                                                                           46
 15


                                                                                                           44
 10

                                                                                                           42

  5
                                                                                                           40


  0                                                                                                        38


                                                                                                           36
 -5

                                                                                                           34
-10
                                                                                                           32

-15
                                                                                                           30
   Jan-99         Jan-01       Jan-03            Jan-05      Jan-07         Jan-09          Jan-11
                                                                                                             Jun-92     Jun-95       Jun-98        Jun-01     Jun-04       Jun-07        Jun-10


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                       Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                  Research




 Exhibit 3: The ratio of PMI finished products inventory                                                   Exhibit 4: Upstream sectors’ revenue/earnings (mainly
 index over PMI new order index suggests high inventory                                                    energy & material related sectors) accounts for a large
 levels are not matched by new orders, suggesting high                                                     part of the A-share non-financial revenue/earnings
 destocking pressure


 1.80             %        PMI finished products inventory/new order                                       70%
                                                                                                                          Raw materials related setors as % of A-share overall (ex.
                                                                                                                                                Financials)

 1.60                                                                                                      60%
                                                                                                                           Revenue side            Earnings side
                               2005               2006           2007

                               2008               2009           2010
 1.40                                                                                                      50%
                               2011               2012


 1.20                                                                                                      40%



 1.00                                                                                                      30%



 0.80                                                                                                      20%



 0.60                                                                                                      10%
              1       2    3       4         5           6   7          8    9         10    11      12       Jun-95   Jun-97    Jun-99   Jun-01   Jun-03   Jun-05     Jun-07   Jun-09   Jun-11



Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                       Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                  Research




Goldman Sachs Global Investment Research                                                                                                                                                          6
June 27, 2012                                                                                                                                                                                China




 Exhibit 5: Historically the contraction of margins for                                          Exhibit 6: This is also true for China industrial
 upstream sectors (energy/basic materials) do not                                                enterprises
 translate into margin expansion of the mid/down                                                 (based on the NBS data)
 stream sectors (consumption/service related sectors) in
 the A-share market (based on the data of the listed
 companies)


 16.0%                                                                                          5                                                                                                  70
                                 Net Margin_A-share (ex. Financials)                                                               EBIT margin_China industrial companies
                                                                                                             (%)                                                                             (%)

 14.0%                                                                                          4
                                      Upstream sectors                                                                                                                                             60

                                      Mid-stream+Downstream sectors                             4
 12.0%                                                                                                                                                                                             50

                                                                                                3
 10.0%                                                                                                                                                                                             40

                                                                                                3
  8.0%                                                                                                                                                                                             30
                                                                                                2

  6.0%                                                                                                                                                                                             20
                                                                                                2


  4.0%                                                                                                                                                                                             10
                                                                                                1                                Mid-stream+Downstream industries

                                                                                                                                 Upstream industries (RHS)                                         0
  2.0%                                                                                          1


                                                                                                0                                                                                                  -10
  0.0%
                                                                                                    99-02           01-02        03-02         05-02         07-02        09-02      11-02
     Jun-95       Jun-97    Jun-99    Jun-01    Jun-03    Jun-05    Jun-07    Jun-09   Jun-11


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




 Exhibit 7: The financial expense ratio (defined as the                                          Exhibit 8: The average borrowing cost (defined as the
 financial expense as % of revenue) for A-share non-                                             financial expense as % of the borrowings) of the non-
 financial sectors has been averaging around 1.2% in                                             financial companies has been around 4.2% in recent
 recent years                                                                                    years


                                                                                                    9.5%           Financial Expenses/Financial Liability vs. Rmb lending
                                Financial Expenses/Revenue
                                                                                                                                  rate (weighted average)
 2.7%                                                                                               8.5%                        A-share Overall
                                      A-share Overall (ex. Financials)                                                          A-share Overall (ex. Financials)
                                                                                                                                Rmb lending rate (weighted average)
                                                                                                    7.5%
 2.2%

                                                                                                    6.5%


 1.7%                                                                                               5.5%


                                                                                                    4.5%
 1.2%

                                                                                                    3.5%


 0.7%                                                                                               2.5%
         Jan-95    Jan-97    Jan-99    Jan-01    Jan-03    Jan-05    Jan-07   Jan-09   Jan-11               Jan-95     Jan-97    Jan-99    Jan-01      Jan-03    Jan-05   Jan-07   Jan-09     Jan-11

Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




Goldman Sachs Global Investment Research                                                                                                                                                           7
June 27, 2012                                                                                                                                                                                                                                                                                                                                                                  China




 Exhibit 9: Historically the A-share non-financial sectors’                                                                                                                                                                                                                             Exhibit 10: China macro pre-warning index declined to
 net margin correlates with the Corporate Goods Price                                                                                                                                                                                                                                   the 1998-2001 level (it’s a comprehensive index
 Index compiled by PBoC                                                                                                                                                                                                                                                                 reflecting the overall economic condition compiled by
                                                                                                                                                                                                                                                                                        PBoC based on a number of macro/sector variables)


9.0                                       Corporate Goods Retailing Price Index                                                                                                                                                                                      10.0               155                                                                                      18
                                          Net Margin-non-financials (LHS)                                                                                                                                                                                                                                                                                                (%)
                                                                                                                                                                                                                                                                                                                        China Macro economic prewarning Index
                                                                                                                                                                                                                                                                     8.0                145
8.0
                                                                                                                                                                                                                                                                                                                        China GDP growth rate (RHS)                              16
                                                                                                                                                                                                                                                                                        135
                                                                                                                                                                                                                                                                     6.0
7.0
                                                                                                                                                                                                                                                                                        125
                                                                                                                                                                                                                                                                     4.0                                                                                                         14
6.0                                                                                                                                                                                                                                                                                     115
                                                                                                                                                                                                                                                                     2.0
                                                                                                                                                                                                                                                                                        105                                                                                      12
5.0
                                                                                                                                                                                                                                                                     0.0
                                                                                                                                                                                                                                                                                         95

4.0                                                                                                                                                                                                                                                                                                                                                                              10
                                                                                                                                                                                                                                                                     -2.0                85


3.0                                                                                                                                                                                                                                                                  -4.0                75
                                                                                                                                                                                                                                                                                                                                                                                 8
      Mar-03
               Jul-03


                                 Mar-04
                                           Jul-04


                                                             Mar-05
                                                                      Jul-05


                                                                                        Mar-06
                                                                                                 Jul-06


                                                                                                                   Mar-07
                                                                                                                            Jul-07


                                                                                                                                              Mar-08
                                                                                                                                                       Jul-08


                                                                                                                                                                         Mar-09
                                                                                                                                                                                  Jul-09


                                                                                                                                                                                                    Mar-10
                                                                                                                                                                                                             Jul-10


                                                                                                                                                                                                                                 Mar-11
                                                                                                                                                                                                                                          Jul-11


                                                                                                                                                                                                                                                            Mar-12
                        Nov-03



                                                    Nov-04



                                                                               Nov-05



                                                                                                          Nov-06



                                                                                                                                     Nov-07



                                                                                                                                                                Nov-08



                                                                                                                                                                                           Nov-09



                                                                                                                                                                                                                      Nov-10



                                                                                                                                                                                                                                                   Nov-11



                                                                                                                                                                                                                                                                                         65

                                                                                                                                                                                                                                                                                         55                                                                                      6
                                                                                                                                                                                                                                                                                           Jan-92            Jan-95   Jan-98     Jan-01      Jan-04   Jan-07        Jan-10


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                                                                                                                                                                                                   Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                                                                                                                                                                                              Research




                                                                                                                                          Exhibit 11: A-share (ex. Financials) earnings growth vs. industrial enterprises and SOEs’


                                                                                                                                                                                             (YoY,Ytd,%)                                                                             State Owned & Control Enterprise Earning Growth YTD

                                                                                                                                                                                                    140.0
                                                                                                                                                                                                                                                                                     A-share Ex. Financials Earnings Growth

                                                                                                                                                                                                    120.0                                                                            Industry Enterprise Earning Growth YTD

                                                                                                                                                                                                    100.0

                                                                                                                                                                                                      80.0

                                                                                                                                                                                                      60.0

                                                                                                                                                                                                      40.0

                                                                                                                                                                                                      20.0

                                                                                                                                                                                                             0.0

                                                                                                                                                                                                    -20.0

                                                                                                                                                                                                    -40.0

                                                                                                                                                                                                    -60.0
                                                                                                                                                                                                                               Feb-07




                                                                                                                                                                                                                                                                            Feb-08




                                                                                                                                                                                                                                                                                                    Feb-09




                                                                                                                                                                                                                                                                                                                        Feb-10




                                                                                                                                                                                                                                                                                                                                          Feb-11




                                                                                                                                                                                                                                                                                                                                                           Feb-12




                                                                                                                                     Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




Goldman Sachs Global Investment Research                                                                                                                                                                                                                                                                                                                                             8
June 27, 2012                                                                                                                                               China




Exhibit 12: A-share Sector scorecard: Sector earnings impact from cost savings due to weak upstream material prices
and lowering financing costs


                                                                                                                                  Demand/supply
                                                                                 Material                          Demand
                                                                                                                                   relation, and
                                              Benefits from lowered financial    related                           growth                           Total
      Criteria                                                                              Net profit Margin                    competition/inte
                                                           costs                  cost                           stability/pol                      score
                                                                                                                                  gration within
                                                                                exposures                        icy support
                                                                                                                                    the sector


                                                           Financial                        Net profit
                                              Asset/equ-
      Sectors                                              expense     Score     Score       margin      Score      Score             Score
                                               ity ratio
                                                             ratio                           (2011)

     Utilities                                 346.6%        7.4%        2          2          5.5%        1          1                 2             8
     Construction&Other Industrial Services    467.3%        0.8%        2          2          2.8%        2          1                 1             8
     Airlines                                  379.9%        -0.5%       2          2          6.9%        1          1                 2             8
     Consumer Durables                         261.8%        0.2%        0          2          4.8%        2          2                 1             7
     Non-ferrous metal & Others                226.3%        1.6%        1          1         4.9%         2          1                 1             6
     Steel                                     270.4%        1.3%        1          2          1.2%        2          0                 0             5
     Oil,gas& petrochemical                    192.1%        0.4%        0          2          5.0%        1          1                 1             5
     Construction Materials & Others           242.2%        3.5%        2          1          9.9%        0          1                 1             5
     Shipping&Other transportation             208.4%        1.6%        1          1          2.3%        2          0                 1             5
     Textile&Apparel                           194.6%        1.7%        1          1          7.5%        1          1                 1             5
     Chemical                                  209.1%        1.6%        1          1          5.3%        1          1                 0             4
     Capital Goods                             247.2%        0.7%        0          1          5.6%        1          1                 1             4
     Transportation Infratructure              178.4%        4.3%        2          0         20.0%        0          1                 1             4
     Auto&parts                                228.5%        0.4%        0          1          6.5%        1          2                 0             4
     Property                                  347.8%        2.1%        1          0         15.8%        0          1                 1             3
     Retailing                                 269.8%        0.5%        1          0          3.9%        2          0                 0             3
     IT&equipment/components                   185.3%        0.9%        0          1          6.0%        1          1                 0             3
     Household & Personal Products             162.8%        1.6%        0          1          6.7%        1          0                 0             2
     Telecom                                   217.9%        0.6%        0          0          2.1%        2          0                 0             2
     Coal                                      177.4%        1.0%        0          0         15.4%        0          1                 0             1
     Food&beverage                             190.1%        0.6%        0          1          9.2%        0          0                 0             1
     Hotel &tourism&Others                     220.3%        0.9%        0          0         11.1%        0          0                 0             0
     Media                                     208.3%        0.4%        0          0         12.4%        0          0                 0             0
     Health Care                               168.3%        1.0%        0          0          9.5%        0          0                 0             0


     Note: We rank each sector on a scale from 0-2 on the five criteria set out above, with the higher scores implying greater potential benefits from cost
     savings.

Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




Goldman Sachs Global Investment Research                                                                                                                       9
June 27, 2012                                                                                                                                  China




                                   Exhibit 13: A-share non-financial sectors: Net margin vs. financial leverage (asset/equity
                                   ratio)
                                   Looking for sectors that would benefit more from weak upstream material prices and easing
                                   financial costs (based on 2011A financial data)



                                                                     Leverage level (asset/equity) vs.
                                                                          net margin by sector

                                                    500.0%            Construction&Other Industrial Services

                                                    450.0%

                                                    400.0%
                                                                                   Airlines                  Property
                                                    350.0%                      UtilitiesConstruction Materials & Others
                                                    300.0%                Consumer Durables

                                                                  Steel
                                                    250.0%                          Auto&parts Hotel &tourism&Others

                                                                               Chemical          Media
                                                    200.0%                                                      Transportation Infratructure
                                                                                                             Coal
                                                    150.0%                                 Food&beverage

                                                    100.0%
                                                                                              Textile&Apparel
                                                     50.0%

                                                      0.0%
                                                          0.0%        5.0%            10.0%          15.0%          20.0%         25.0%




                                 Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




                                 Revising our top-down earnings forecast: We review our top-down earnings forecast
                                 for CSI300 index based on our financial team’s estimates on the impact of the recent
                                 interest rate cut/steps for interest rate liberalization on the financial sector’s earnings and
                                 the recent economic/profit data. Specifically we revise our top-down earnings forecast for
                                 CSI300 index from 7.4%/16.6% 2012E/2013E to 3.6%/11.4% respectively mainly based on:

                                 1)   Our 2012E/2013E earnings growth assumptions for the financial sectors are lowered to
                                      12.5%/10.6% from15.5%/16.6% as our financial team believes the earnings of the
                                      banking sector could be down by around 6ppt/12ppt for 2012E/2013E earnings under a
                                      worst case scenario. Banking sector earnings account for more than 90% of the
                                      financial sector earnings and we have assumed half of the impact our financials team
                                      expects to be realized (eventually) under a worse-case;

                                 2)   We also revise our top-down 2012E/2013E growth forecast for the non-financial sectors
                                      to -4.0% /11.6% from 0.5%/16.5% respectively as we fine-tune our margin assumptions
                                      for the non-financial sector to 5.1%/5.3% from 5.3%/5.7% 2012E/2013E respectively.
                                      The realized non-financial net margin in 1Q2012 was 5.3%. So far in 2Q2012, we
                                      continue to see sequential margin compression vs. 1Q as indicated by the weakening
                                      prices of upstream materials.

                                 Our top-down 2012E/2013E earnings growth forecasts for CSI300 are lower than Wind
                                 consensus by 7ppt/5ppt, respectively. While earnings for property, construction, utilities
                                 and consumption related sectors including food & beverage, healthcare, consumer
                                 durables, media, etc, should face less risk than other sectors, earnings downside risk still
                                 remains in major sectors such as coal, oil & petrochemical, steel (Exhibit 17).




Goldman Sachs Global Investment Research                                                                                                         10
June 27, 2012                                                                                                                                                 China




                                        Exhibit 14: Our top-down 2012E/2013 earnings growth forecasts for CSI300 Index



                                                       Top-down       Non-Financial               Non-Financial            Total Earnings
                                                       Estimates      Revenue Growth (%)          Margin (%)               Growth (%)
                                                             2012E               9.4                            5.1              3.6
                                                             2013E               10.6                           5.3             11.4
                                                       Bottom-up
                                                       Estimates

                                                             2012E               10.5                           5.2             10.2
                                                             2013E               11.6                           5.5             16.6

                                       Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates




 Exhibit 15: CSI300 index top-down revenue model                                   Exhibit 16: CSI300 index top-down net margin model
 results                                                                           results


 50                                                                               12%
                        Residual %                                                                   Residual                    Net Margin (Estimated)
                        Revenue Growth (% Actual)
                        Revenue Growth (% Estimated)                              10%                Net Margin (Actual)         Historical average(Actual)
 40                     Historical average(% Actual)


                                                                                   8%
 30

                                                                                   6%

 20
                                                                                   4%


 10                                                                                2%



  0                                                                                0%



                                                                                  -2%
-10




Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS              Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                         Research




Goldman Sachs Global Investment Research                                                                                                                        11
June 27, 2012                                                                                                                                                                       China




                                   Exhibit 17: While earnings for property, construction, utilities and consumption-related
                                   sectors including food & beverage, healthcare, consumer durables, media, etc, should
                                   face less risk than other sectors, earnings downside risk still remains in coal, oil &
                                   petrochemicals, steel.


                                                                  CSI300 Index earnings forecast changes (2012E)_Wind consensus
                                                                                         (1Q2012 to date)
                                                                            Utilities                                                                                      3.2%
                                                                  Food&beverage                                                                                           2.9%
                                           Construction&Other Industrial Services                                                                                       1.8%
                                                                       Auto&parts                                                                           -0.1%
                                                                             Banks                                                                         -0.5%
                                                      Transportation Infratructure                                                                     -0.8%
                                                      IT&equipment/components                                                                        -1.9%
                                                                               Coal                                                                 -2.3%
                                                              Consumer Durables                                                                    -2.5%
                                                                            Overall                                                                -2.6%
                                                                               Steel                                                         -3.6%
                                                          Oil,gas& petrochemical                                                            -4.1%
                                                                             Media                                                         -4.6%
                                                          Overall (ex. Financials)                                                        -4.7%
                                                          Hotel &tourism&Others                                                           -5.0%
                                                  Shipping&Other transportation                                                       -5.3%
                                                                           Property                                                   -5.3%
                                                               Securities& Others                                                    -5.8%
                                                                          Retailing                                                 -6.2%
                                                                          Chemical                                                -7.1%
                                                                         Insurance                                          -8.3%
                                                                       Health Care                                        -9.3%
                                                                    Capital Goods                                     -10.0%
                                                      Non-ferrous metal & Others                                 -12.2%
                                                                            Airlines                  -17.1%
                                                 Construction Materials & Others           -21.0%
                                                                           Telecom         -21.1%
                                                                  Textile&Apparel          -21.8%

                                                                                    -25%            -20%       -15%        -10%               -5%                  0%          5%


                                 Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




                                 Trim year-end index target for CSI300 to 2,950 (potential upside
                                 c.15%) based on lowered earnings forecasts, target valuation
                                 multiple unchanged
                                 We trim our year-end index target for CSI300 index to 2,950 from 3,100 (around 5%) based
                                 on our lowered earnings forecast and we keep our year-end index target P/E unchanged at
                                 11.5x, as we continue to believe that overall market liquidity conditions should gradually
                                 improve in 2H2012 along with the ongoing policy easing, which would support a moderate
                                 valuation expansion.

                                 We lower our 3m/12m index target accordingly, and our updated 3m (end-3Q)/ 6m(year-
                                 end)/12m (mid of 2013) are 2,700/2,950/3,050 respectively, which implies about 15%
                                 potential upside for the rest of the year and 22% upside in the next 12 months (Exhibit 18).

                                 We continue to expect the near-term market should be bumpy as we see limited positive
                                 catalysts. The market could strengthen starting around mid-3Q as by then we expect to see:

                                 1)   Some early signs that the cumulative effect of policy loosening is beginning to take
                                      place;

                                 2)   1H2012 earnings/macro data would have been reported and policy makers and the
                                      market should have a clearer picture about how earnings/economy is progressing;




Goldman Sachs Global Investment Research                                                                                                                                              12
June 27, 2012                                                                                                                                              China




                                 3)   Government policy should continue to be supportive and may even strengthen by mid-
                                      3Q to create a stable social/economic environment for the opening of the 18th National
                                      Congress of the CPC;

                                 4)   Clearer message from the development in the Euro-zone than currently .

                                 Risks to our views include: 1) Policy changes are less/slower than we expect; 2) The
                                 pace of economic/earnings recovery are weaker/ later than we expect; 3) The EU issues
                                 evolve into a larger impact than we expect.




                                   Exhibit 18: We lower our 3m/12m index target accordingly, and our updated 3m (end-
                                   3Q)/6m(year-end)/12m (mid of 2013) are 2,700/2,950/3,050 respectively



                                                                                    CSI300 Index Path
                                           3,500.0

                                                                                                                                          3,050 (12-m
                                           3,300.0
                                                                                                                                          target, +22%~)

                                           3,100.0                                                                          2950.0
                                                                                                                      (year-end, +15%~)

                                           2,900.0


                                           2,700.0
                                                                                                                      2,700.0
                                                                                                                 (end-Sep., +5.8%)
                                           2,500.0


                                           2,300.0


                                           2,100.0
                                                Jan-11         Jul-11             Jan-12                Jul-12                Jan-13


                                 Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates




Sector preference revisions: Looking for stable growth amid
earnings downside risks
                                 We revise our sector preferences based on our conclusions from our earnings analysis,
                                 recent market developments and sector valuations. We upgrade several sectors with
                                 improving/stable earnings outlook while downgrading others where we expect further
                                 earnings risks.

                                 Specifically:

                                 1)   We upgrade the healthcare sector to OW from neutral and downgrade the retail sector
                                      to neutral from OW;

                                 2)   We upgrade the utilities sector to neutral and downgrade the its upstream sector, the
                                      coal sector to UW from neutral ;

                                 3)   We also upgrade the construction sector to neutral from UW .




Goldman Sachs Global Investment Research                                                                                                                     13
June 27, 2012                                                                                                                China




                                 Overall we like property, non-bank financials, some select consumer-related
                                 sectors including auto, home appliance and healthcare, but we dislike telecom,
                                 coal, chemical, and steel.

                                 In Exhibit 19-20, we present a summary of our sector ratings. In Exhibit 21, we illustrate
                                 sector performance ytd with our sector ratings highlighted in different colors.



                                 Upgrade the healthcare sector to OW; downgrade retail sector to
                                 neutral from OW
                                 We upgrade the healthcare sector to OW from neutral as:

                                 1)   Policy environment is now becoming incrementally business friendly: In the past two
                                      years, medicine price cuts have been the major theme of the healthcare reform, putting
                                      prolonged pressure on the sector’s margin and earnings growth. However, recently
                                      there have been signs that based on the lessons/experiences of reforms in the past two
                                      years, the policy direction is gradually changing towards supporting sustainable
                                      development of the healthcare sector.

                                 2)   We feel earnings downgrade risks should have been largely priced in and the sector’s
                                      valuation has become more reasonable. Consensus earnings forecast indicates that the
                                      sector should see no growth this year, which would be rare vs. the past decade and
                                      suggests current consensus earnings forecasts are conservative (Exhibit 22). The
                                      valuation of the sector has come down to 20.9x 12-m forward PE, which is the lowest
                                      level in the past two years (Exhibit 24);

                                 3)   Medium-long term sector growth potential intact. Healthcare-related demand should
                                      be supported by increasing income levels and the aging population in China in the
                                      medium-long term (Exhibit 25).

                                 4)   The sector outperformed the market so far in 2Q2012 but ytd its performance is still
                                      largely in line (Exhibit 26). We believe market interest in this sector should gradually
                                      increase amid uncertainties around overall A-share earnings.

                                 Shares unlocking for this sector will increase in 2H2012 (see the next section) and could be
                                 a risk for this sector. However, the unlocking of shares should be mainly from health care
                                 companies from the SME/GEM, thus the impact on CSI300-listed health care companies
                                 should be limited (Exhibit 56).

                                 The retail sector’s performance has been largely in line with the market (Exhibit 27), and we
                                 downgrade the sector to neutral, as we believe:

                                 1)   The sector should continue to see headwinds which include rising rental costs, labor
                                      costs, and the increasing competition from on-line shopping (Exhibit 28).

                                 2)   Some of the major traditional players (like Suning) within this sector are trying to
                                      develop their own on-line shopping business which would cannibalize their traditional
                                      segment and face strong competition from the incumbent on-line shopping
                                      ventures/channels/outlets. It is still uncertain whether this transition would be
                                      successful or not.

                                 3)   Valuation of the sector has come down and is not demanding but a near-term re-
                                      rating is unlikely, in our view, given the problems that the sector is facing (Exhibit 29);

                                 4)   Sub-sector performance could differentiate. Supermarkets should feel less impact from
                                      on-line shopping as their locations are often within walking distance of the
                                      communities, while department stores, home appliances retailers, etc should face
                                      more pressure from the development of on-line shopping.



Goldman Sachs Global Investment Research                                                                                         14
June 27, 2012                                                                                                                 China




                                 Upgrade utilities sector to neutral while downgrading the coal
                                 sector from neutral to underweight
                                 We have been underweight on the utilities sector for a while but turn more positive and
                                 upgrade it to neutral, as:

                                 1)   The sector has benefited from the weakening thermal coal prices and should continue
                                      to benefit if spot coal prices remain weak, especially given that fuel costs usually
                                      account for 68% of the total operation costs of the IPPs (Exhibit 30) and the sector’s
                                      profit margin is at historical low (Exhibit 31);

                                 2)   Electricity tariff rates may be adjusted if the current thermal coal price trend continues
                                      but it would not be imminent, given the utilities sector in China is still a SOE-
                                      dominated sector and vested interests would make the electricity tariff rate adjustment
                                      process long and slow;

                                 3)   Mutual funds’ position in the sector has been light, although it turned higher in the
                                      recent quarters (Exhibit 32);

                                 We are neutral on the sector vs. being more positive (and assigning OW) towards the
                                 utilities sector as the sector has rallied in recent weeks and valuations are already trading
                                 at 98.2% premium over the H-share counter-parts (Exhibit 33).

                                 In the meantime, we further downgrade the coal sector to underweight after we
                                 downgraded it to neutral from OW in our May 18 note (Bumpy near-term path, May 18,
                                 2012) because:

                                 1)   Earnings downgrade risks remain for this sector as the ytd spot coal prices have been
                                      more sluggish than previously expected, and ytd consensus earnings downgrades in
                                      this sector have been mild (Exhibit 35).

                                 2)   Seaborne thermal coal prices are much lower than spot coal prices in China (Exhibit
                                      36), leading to significant import growth ytd (Exhibit 37)and putting further downward
                                      pressure on spot thermal coal prices in China.

                                 The sector has underperformed CSI300 by 5.2 ppt ( Exhibit 38) and we think it should
                                 continue to underperform given the reasons listed above.



                                 Upgrade construction sector to neutral from underweight
                                 We see some positive changes within this sector as below and thus upgrade it to neutral
                                 from UW :

                                 1)   Infrastructure investment growth is gradually stabilizing (Exhibit 40), or could even pick
                                      up in the 2H2012, which would help boost demand for the sector;

                                 2)   The sector should benefit from the relative weak building material prices like steel,
                                      cement prices, etc. as raw material related cost usually accounts for a high portion of
                                      their total operation costs, and the sector’s net profit margin has been thin (Exhibit 39).
                                      As such, earnings would be very sensitive to a change in material costs;

                                 3)   The valuation of the sector is low in terms of P/E valuation (Exhibit 41)

                                 We are neutral on the sector rather than being more positive (and assigning OW) as the
                                 sector has some exposure to residential property construction. We currently see that the
                                 property FAI growth is still coming down rapidly and may continue to remain weak in
                                 2H2012 (Exhibit 40).




Goldman Sachs Global Investment Research                                                                                         15
June 27, 2012                                                                                                            China




                                 We maintain our other sector ratings and we highlight some of the sector calls
                                 below:

                                 Property: Overweight. We maintain overweight on property sector although some near-
                                 term profit-taking is likely given its significant outperformance ytd and the mutual funds’
                                 position in this sector should be crowded. We suggest buying as we expect the sector to
                                 continue to outperform the market after the near-term consolidation in our view, supported
                                 by recovery in the property transaction volume. Broad-based property price increase
                                 should be a risk to the sector as it should lead to re-tightening of the property policies.

                                 Banks: Neutral. The sector valuation has come down to extremely low levels (5.1x 12-m
                                 forward PE vs. historical average of 12.7x since 2004), and the sector performance should
                                 be relatively resilient amid market volatility given its significant underperformance ytd and
                                 already low valuation. However, the current liquidity condition does not support the sector
                                 for consistent outperformance and the recent step towards interest rate liberalization
                                 would hurt the sector’s earnings outlook this year and probably next year.

                                 Non-bank financials: Overweight: Among financials we like insurance and securities
                                 firms. The latter has outperformed the market significantly ytd and some short-term profit
                                 taking could be possible, especially if 1H2012 earnings looks sluggish. But continuous
                                 reform initiatives to broaden the business scope of the securities firms’ med-term
                                 outperformance of the sector should continue to support the sector’s outperformance.

                                 Machinery: Neutral. Sector valuation is not demanding given that the 12-m forward PE
                                 valuation is 13.5x (vs. historical average of 18.2x since 2004) but demand recovery has not
                                 been seen yet.




Goldman Sachs Global Investment Research                                                                                    16
June 27, 2012                                                                                                                                                            China




Exhibit 19: A-share sector allocation I (OW and UW): Overall we like property, non-bank financials, some selective
consumer-related sectors including auto, home appliance and healthcare, and we dislike telecom, coal, chemical, and
steel


                                                      PE(x)   PB(x)

                       Index
                                Previous      New
 Sectors              Weighting                       2012E 2012E                                                    Remarks
                                 rating      rating
                        (%)

                                                                      Sector valuation is not demanding in our view. Investment yields are not likely to be worse than last
                                                                      year's, and with the yield on bank wealth management products declining, the premium growth should
 Insurance               4.3        OW        OW      18.0     2.2
                                                                      show a turnaround in the coming several quarters. We believe policy environment is becoming
                                                                      supportive.

                                                                      Current valuation for the sector is not demanding and already factors in weakness in the property
 Property                4.9        OW        OW      10.3     1.7    sector. Also, fine-tuning in property tightening policies is ongoing. The sales volume recovery has been
                                                                      better than expected and might continue to exceed relatively low expectations.


                                                                      Valuation is not demanding and the sector is the long-term beneficiary of China's deepening financial
 Securities& Others      5.6        OW        OW      29.7     2.1    reforms, which we expect to be high on the agenda. Policies on product innovation could become
                                                                      more supportive, in our view.


                                                                      Valuation of the sector is not demanding and already factors in the near-term earnings risks, in our
 Construction
                         1.7        OW        OW      10.6     1.6    view. Demand is gradually recovering and product prices have largely stabilized. Potential policy easing
 Materials & Others
                                                                      should provide further support to demand.


                                                                      Sales numbers are gradually improving. Fierce competition may erode sector margins but valuation is
 Auto&parts              2.0        OW        OW      10.7     1.7
                                                                      still attractive. Policies are becoming more friendly than in the past year.


                                                                      Valuation is still within a reasonable range and correlation between demand for consumer durables and
 Consumer Durables       2.3        OW        OW      11.0     1.9    property sales is less than expected; rural penetration improvement/consumption upgrade underpins
                                                                      demand sustainability. Risk to the sector includes greater-than-expected slowdown in broad sales.


                                                                      Brand names continue to enjoy secular uptrend in China, and valuation is within a reasonable range.
 Textile&Apparel         0.4        OW        OW       9.8     1.4
                                                                      Stable export growth is another earnings driver.



                                                                      Earnings risks have largely been priced in; sector valuation not demanding. We view the sector as a
 Health Care             4.6       Neutral    OW      24.0     3.5
                                                                      long-term beneficiary of China's growing income and aging population.


                                                                      Sector valuation not demanding but coal demand growth and spot coal prices ytd have been
                                                                      disappointing. The price gap between seaborne thermal coal prices and spot coal prices in China
 Coal                    6.7       Neutral    UW      11.0     2.0
                                                                      should lead to increase in coal import, putting further pressure on domestic spot thermal coal prices.
                                                                      Supply for coke coal should be tighter than thermal coal, trading at premium over thermal coal.


                                                                      Demand is weakening and earnings risk arises; valuation not attractive given the highly cyclical feature;
 Chemical                2.4        UW        UW      16.2     2.6
                                                                      prefer resource-based names.



                                                                      Valuation is reasonable but sliding demand/competition remains an industry concern; difficult to
 Steel                   2.3        UW        UW      12.8     0.9
                                                                      improve margins.


                                                                      China Unicom is trying to gain market share and should hold an advantage over the other two players,
 Telecom                 1.0        UW        UW      30.1     1.2    but earnings growth could be sacrificed. Valuation has turned lower but is not yet attractive. Less
                                                                      bearish on telecom equipment companies.

 OW Sectors                         23.6      25.7
 Neutral Sectors                    65.5      62.0
 UW Sectors                         11.0      12.4


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates




Goldman Sachs Global Investment Research                                                                                                                                       17
June 27, 2012                                                                                                                                                               China




Exhibit 20: A-share sector allocation II (sectors with Neutral rating)


                                                       PE(x)   PB(x)

                         Index
                                  Previous    New
 Sectors                Weighting                      2012E 2012E                                                     Remarks
                                   rating    rating
                          (%)

                                                                       Valuation is not demanding but the sector is facing increasing pressure from the rapid development of
 Retailing                 2.6      OW       Neutral   15.9     2.7    online shopping in China. Sub-sector performance may vary amid the changing competitive landscape.
                                                                       We like some leading names in niche markets, such as fresh food retailing.


                                                                       Earnings have been strong so far, and valuation is not demanding. But the sector is still among the
 Food&beverage             7.5     Neutral   Neutral   18.3     5.2
                                                                       most crowded due to its outperformance in 2H2011; bottom-up stock selections is important.



 Non-ferrous metal &                                                   Although valuations have come down, it is high compared with other cyclical sectors. Demand growth
                           8.1     Neutral   Neutral   25.0     2.9
 Others                                                                may disappoint as the persistent property tightening in China has led to weaker FAI growth.



                                                                       Traffic volume growth should be stable and declining oil prices could be a positive catalyst, but
 Airlines                  1.0     Neutral   Neutral   11.7     1.4
                                                                       valuations appear justified in our view.



 Transportation
                           0.8     Neutral   Neutral   12.6     1.3    Earnings growth is stable and low; valuation is reasonably low, but there is a lack of sector catalysts.
 Infrastructure


 Hotel , Tourism &                                                     Valuation is relatively high compared with growth; brand names continue to enjoy secular uptrend in
                           0.7     Neutral   Neutral   17.2     2.8
 Others                                                                China.


                                                                       Low growth and high valuation; sector continues to benefit from the government’s supportive policy on
 Media                     0.4     Neutral   Neutral   29.2     2.4    the cultural industry. Bottom-up stock selection is important as companies within this sector tend to
                                                                       have varying fundamentals.

                                                                       Worries over asset quality amid slower growth and the impact of the LGFVs remain, although we
                                                                       believe risks of massive write-off should under control by the Chinese government. Valuation is lower
 Banks                    17.7     Neutral   Neutral    5.5     1.1
                                                                       than historical trough levels, which is supportive, and the earnings outlook is stable in our view. Small
                                                                       and mid-sized banks are likely to have higher beta than large banks.


 Oil, gas &                                                            Unattractive growth profile and earnings risks should remain but the sector has underperformed the
                           2.2     Neutral   Neutral   10.5     1.4
 petrochemical                                                         market for a while and valuation is not demanding.


                                                                       The sector fundamentals do not seem to have stabilized yet. Rising labor cost generates demand for
 Capital Goods            11.5     Neutral   Neutral   15.3     2.2    capital goods as a substitute for labor, which is a mid- to long-term trend in China. Further slowdown in
                                                                       FAI growth/property FAI remains a concern.


 IT &                                                                  Subsectors with different fundamentals, but overall the earnings downgrade risk remains, and
 equipment/componen        2.4     Neutral   Neutral   19.3     3.3    valuation is not supportive. There are signs of sector fundamental bottoming out. Some of the names
 ts                                                                    benefit from strong growth in consumer electronics/touch screen mobile phone etc.


 Shipping & Other                                                      Still neutral as we see unsteady global growth, and China's demand has been weak so far. The industry
                           1.8     Neutral   Neutral   16.5     1.2
 transportation                                                        over-capacity remains an overhang.



                                                                       Earnings outlook has improved due to the weakening thermal coal prices. Valuation is not attractive
 Utilities                 2.2      UW       Neutral   15.6     1.8
                                                                       and earnings growth sustainability of the sector depends on tariff policy.


                                                                       Valuation is not demanding and easing input cost pressure should improve near-term earnings outlook
 Construction & Other
                           3.1      UW       Neutral    8.9     1.3    as the industry margin is generally low. We may turn more bullish if we see a sustainable trend in
 Industrial Services                                                   margin improvement and recovery in infrastructure/property FAI growth.

 OW Sectors                         23.6      25.7
 Neutral Sectors                    65.5      62.0
 UW Sectors                         11.0      12.4


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates.




Goldman Sachs Global Investment Research                                                                                                                                           18
June 27, 2012                                                                                                                                                                                                                             China




 Exhibit 21: Sector performance ytd with our sector                                                                                         Exhibit 22: Consensus earnings forecasts for the
 ratings highlighted in different colors (new sector                                                                                        healthcare sector have already been conservative
 ratings)


                                       CSI300 Return by sector (2012YTD)
                                                                                                                    %                                                      Earnings growth for Health Care
                       OW sector                 Neutral sector                                        UW sectore                           140%
                    Securities& Others                                                                                   37.3
                                                                                                                                            120%                                                                                   Wind
                               Property                                                                        26.6
                                                                                                                                                                                                                                   consensus
           Non-ferrous metal & Others                                                                       22.9
                                                                                                                                                                                                                                   forecast
                   Consumer Durables                                                               15.7                                     100%
                       Food&beverage                                                               14.8
               Hotel &tourism&Others                                                             13.2
                                                                                                                                             80%
                             Insurance                                                           13.2
Construction&Other Industrial Services                                                          11.9
                                                                                                                                             60%
                                Utilities                                                   10.0
                           Health Care                                                     9.4
                           Auto&parts                                                      9.3                                               40%
                              SHSZ300                                                      8.8
                              Retailing                                                   7.5                                                20%
                        Capital Goods                                                 6.7
           Transportation Infratructure                                               6.3
                                                                                                                                              0%
      Construction Materials & Others                                                5.2
                      Textile&Apparel                                               4.4
                                                                                                                                             -20%
                                 Media                                              3.5
                                   Coal                                         2.6
                              Chemical                                         1.9                                                           -40%
           IT&equipment/components                                            0.8
                                Airlines                                      0.0                                                            -60%
                                 Banks                                        0.0                                                                     2002     2003     2004   2005     2006   2007     2008   2009     2010   2011 2012E 2013E
       Shipping&Other transportation                               -0.1
                                   Steel                           -0.6
               Oil,gas& petrochemical                          -3.4
                              Telecom         -22.7

                                            -30       -20    -10          0           10               20      30        40      50


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                                                        Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                                                   Research




 Exhibit 23: The healthcare sector consensus earnings                                                                                       Exhibit 24: The valuation of the healthcare sector has
 forecast is stabilizing (based on Wind consensus                                                                                           come down to 20.9x 12-m forward PE
 forecast)


                     Health Care sector earnings forecast (Wind consensus)                                                                      70
                                                                                                                                                             (X)
    33                                                                                                                                                                                 Health Care                Average
                                     2009                   2010                      2011                          2012
              (Rmb bn)                                                                                                                          60


    28
                                                                                                                                                50



    23                                                                                                                                          40



                                                                                                                                                30
    18


                                                                                                                    Earnings forecast is        20
                                                                                                                    becoming stable
    13                                                                                                                                                                                                                            20.9X
                                                                                                                                                10

     8
     Jan-09         Jul-09         Jan-10             Jul-10              Jan-11                   Jul-11               Jan-12                      0
                                                                                                                                                    Jan-04     Jan-05    Jan-06       Jan-07   Jan-08    Jan-09       Jan-10   Jan-11   Jan-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                                                        Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                                                   Research




Goldman Sachs Global Investment Research                                                                                                                                                                                                         19
June 27, 2012                                                                                                                                                                                              China




 Exhibit 25: The healthcare related demand is supported                                                     Exhibit 26: The healthcare sector outperformed the
 by the increasing aging population in China in the                                                         market so far in 2Q2012 but ytd its performance is still
 medium-long term                                                                                           largely in line with the market


 500                                                                                                 35%   117
            (Mn)                                                                                                                            Health Care sector index

 450                                                                                         440
                                                                                                31% 30%    112                              Health Care sector relative performance (vs. CSI300 Index)
                                                                                      413
                                                                               400        29%
 400                                                                   386         28%
                                                                                                           107
                                                                             26%
                                                               342                                   25%
 350
                                                                     23%                                   102
 300                                                   285
                                                             20%                                     20%
                                               248                                                          97
 250                                                 17%
                                       221                                                                           (June 30, 2011=100)
                                             16%
                                                                                                     15%    92
 200                       178
                                 13%
                   142                                                                                      87
 150   127               11%                                                                         10%
             10%
 100                                                                                                        82
                                                                                                     5%
  50
                                                                                                            77

   0                                                                                                 0%
       2000    2005        2010     2015       2020    2025    2030    2035    2040    2045   2050          72
                                                                                                              Jun-11            Aug-11            Oct-11            Dec-11        Feb-12          Apr-12
                                Aged 60+              As % of total population (RHS)


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                        Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                   Research




 Exhibit 27: The retail sector’s performance has been                                                       Exhibit 28: On-line shopping sales grew more rapidly
 largely in line with the market ytd                                                                        than the traditional retailers’ sales


115                                                                                                                                        On-line shopping sales
                               Retailing sector index
                                                                                                                                           On-line shopping sales growth (RHS, %)
110
                               Retailing sector relative performance (vs. CSI300 Index)                                                    Total retail sales of social consumer goods growth (RHS, %)
                                                                                                            3000                                                                                            140%
105                                                                                                                    (Rmb bn)               128.8%
                                                                                                                                                                                                            120%
                                                                                                            2500
100                                                                                                                                 112.9%
                                                                                                                                                       105.2%
                                                                                                                                                                                                            100%
 95                                                                                                         2000

       (June 30, 2011=100)                                                                                                                                                                                  80%
 90                                                                                                                                                             75.3%
                                                                                                            1500                                                        67.8%
 85                                                                                                                                                                                                         60%
                                                                                                                                                                                53.1%
                                                                                                            1000
 80                                                                                                                                                                                                         40%
                                                                                                                                                                                        32.5%   28.3%
                                                                                                                                              28.7%                                                      26.8%
 75                                                                                                          500                                               18.3%
                                                                                                                                                       15.5%
                                                                                                                                    16.8%                               17.1%                               20%

 70
                                                                                                                 0                                                                                          0%
 65                                                                                                                   2006     2007        2008   2009     2010     2011 2012E 2013E 2014E 2015E
   Jun-11            Aug-11              Oct-11            Dec-11          Feb-12         Apr-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                        Source: I-Research, Wind, Gao Hua Securities Research, Goldman Sachs Global
Research                                                                                                   ECS Research




Goldman Sachs Global Investment Research                                                                                                                                                                         20
June 27, 2012                                                                                                                                                                China




                                             Exhibit 29: Valuation of the retailing sector has come down and should not be
                                             demanding (12m-forward PE 14.4x vs. historical average of 23x)


                                                                    60
                                                                                                          Retailing               Average
                                                                               (X)


                                                                    50



                                                                    40



                                                                    30



                                                                    20



                                                                    10                                                                           14.4X


                                                                     0
                                                                     Jan-04   Jan-05   Jan-06    Jan-07     Jan-08      Jan-09   Jan-10     Jan-11   Jan-12



                                           Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




 Exhibit 30: Fuel costs on average have accounted for                                     Exhibit 31: The utilities sector’s profit margin is close to
 68% of the total operation cost of the IPPs                                              historical low


                                                                                            25%
 73%
                  Fuel cost as % of total operating cost (IPPs)   Average                                                                   Net Margin_Utilities
                                                                                                                                            Historically average
 72%
                                                                                            20%

 71%

                                                                                            15%
 70%


 69%
                                                                                            10%


 68%
                                                                                                5%
 67%


 66%                                                                                            0%


 65%
           2007             2008           2009            2010      2011                   -5%
                                                                                               Mar-02                 Mar-04        Mar-06            Mar-08       Mar-10   Mar-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                      Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                 Research




Goldman Sachs Global Investment Research                                                                                                                                         21
June 27, 2012                                                                                                                                                                                               China




 Exhibit 32: Fund position of the Utilities sector has been                                                Exhibit 33: Dual-listed names’ A-H premium in Utilities
 light (for A-share equity-focused mutual funds)                                                           sector: A-share utilities names are far more expensive.


                          Production and supply of power, gas and water (the mutual
4.0                                                                                               2,500    350%
                          fund position)
         (%)                                                                            (Index)                                                     Utility sector A-H premium
                          Production and supply of power, gas and water sector index
                          (RHS)
3.5                                                                                                        300%                                      Average A/H Premium
                                                                                                  2,000
                                                                                                                                                     Total-cap weighted A/H premium
3.0
                                                                                                           250%


2.5
                                                                                                  1,500
                                                                                                           200%

2.0

                                                                                                           150%
                                                                                                  1,000
1.5

                                                                                                           100%
1.0
                                                                                                   500
                                                                                                            50%
0.5



0.0                                                                                                0         0%
   Mar-06        Mar-07          Mar-08         Mar-09         Mar-10          Mar-11         Mar-12          Jan-07               Jan-08        Jan-09            Jan-10          Jan-11           Jan-12



Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                       Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                  Research




 Exhibit 34: The ytd spot coal prices has been more                                                        Exhibit 35: But ytd the consensus earnings downgrade
 sluggish than previously expected                                                                         in the coal sector has been moderate


                                                                                                                                    Coal sector earnings forecast (Wind consensus)
 1200                                           Datong quality mix(5800kcal/kg)
               Rmb/t                                                                                        118
                                                Shanxi quality mix(5500kcal/kg)                                                              2009           2010            2011            2012
 1100                                                                                                                   (Rmb bn)

 1000                                           Shanxi mix(5000kcal/kg)
                                                                                                            108
      900 
                                                                                                                                                                                     Earnings forecast is
      800                                                                                                    98                                                                      becoming stable

      700 
                                                                                                             88
      600 
      500 
                                                                                                             78
      400 
      300                                                                                                    68
      200 
      100                                                                                                    58
                                                                                                               Jan-09        Jul-09         Jan-10      Jul-10       Jan-11        Jul-11      Jan-12
         02‐09 07‐09 12‐09 05‐10 10‐10 03‐11 08‐11 01‐12 06‐12


Source: SXCoal-Port coal price, Gao Hua Securities Research, Goldman Sachs                                Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Global ECS Research                                                                                       Research




Goldman Sachs Global Investment Research                                                                                                                                                                      22
June 27, 2012                                                                                                                                                                      China




 Exhibit 36: Seaborne thermal coal prices are much lower                                 Exhibit 37: …leading the significant import growth ytd
 than spot coal prices in China...


                                        Price differences(Rhs)
 1300                                                                            350       2400                                                                                    600 
            Rmb/t                                                      Rmb/t
                                        Domestic thermal CIF                                       10ths tons            Monthly coal import           Monthly metallurgical
 1200                                                                            300                                                                   coal import
                                        Australia thermal CIF                              2100 
                                                                                                                                                                                   500 
                                                                                 250 
 1100                                                                                      1800 
                                                                                 200                                                                                               400 
 1000                                                                                      1500 
                                                                                 150 
  900                                                                                      1200                                                                                    300 
                                                                                 100 
  800                                                                                       900 
                                                                                 50                                                                                                200 
  700                                                                                       600 
                                                                                 0 
                                                                                                                                                                                   100 
  600                                                                            ‐50        300 

  500                                                            ‐100                         0                                                                                    ‐
     03‐10 06‐10 09‐10 12‐10 03‐11 06‐11 09‐11 12‐11 03‐12 06‐12                               04‐06        04‐07           04‐08        04‐09      04‐10       04‐11      04‐12



Source: SXCoal-Port coal price, Gao Hua Securities Research, Goldman Sachs              Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Global ECS Research                                                                     Research




 Exhibit 38: The coal sector has underperformed CSI300                                   Exhibit 39: The construction sector’s net profit margin
 in 2Q2012                                                                               has been thin


104                                                                                        4.5%
         (Oct 1 2011=100)
                                        Coal sector Index                                                                           Net Margin_Construction

                                                                                           4.0%                                     Historically average
 99                                     Coal sector vs. CSI300 Index

                                                                                           3.5%
 94

                                                                                           3.0%

 89
                                                                                           2.5%


 84
                                                                                           2.0%



 79                                                                                        1.5%



 74                                                                                        1.0%
                                                                                              Mar-02            Mar-04          Mar-06           Mar-08         Mar-10         Mar-12
   Oct-11    Nov-11   Dec-11   Jan-12    Feb-12   Mar-12    Apr-12   May-12    Jun-12


Source: SXCoal-Port coal price, Gao Hua Securities Research, Goldman Sachs              Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Global ECS Research                                                                     Research




Goldman Sachs Global Investment Research                                                                                                                                                23
June 27, 2012                                                                                                                                              China




 Exhibit 40: Infrastructure investment growth gradually                        Exhibit 41: Valuation(12-m forward PE) of the
 stabilizes                                                                    construction sector is low


 70                         Total FAI YTD YoY                                                                     Construction&Other Industrial Services
                                                                                  25
        (%)
                            Property Investment YTD YoY                                     (X)                   Average
 60                                                                               23
                            Infrastructure investment YTD YoY
                                                                                  21
 50
                                                                                  19
 40
                                                                                  17

 30                                                                               15

 20                                                                               13

                                                                                  11
 10
                                                                                   9
  0
                                                                                   7
                                                                                                                                                 7.9X
 -10                                                                               5
    Feb-04         Feb-06           Feb-08            Feb-10         Feb-12         08-10         09-04   09-10     10-04   10-10    11-04   11-10      12-04


Source: SXCoal-Port coal price, Gao Hua Securities Research, Goldman Sachs    Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Global ECS Research                                                           Research




Key Issue: Impact of share reductions
                                      An important development in 2H2012 in A-shares is that starting from July 2012, the
                                      amount of shares coming out of their lock up period is significant compared with 1H2012
                                      (Exhibit 42). As major shareholders would be able to sell their shares after the unlocking,
                                      we consider how major shareholders have reacted to shares unlocking in the past and how
                                      such reductions in shareholdings by major shareholders have affected stock performance.

                                      In this section, we examine reductions in shareholdings by major shareholders and market
                                      implication.

                                      Shares unlocking in 2H2012 will be double the size in 1H2012, and size of shares
                                      unlocking from the SME & GEM board should triple (Exhibit 42).

                                      1)     Substantial increase in shares unlocking. The total amount of share unlocking in
                                             2H2012 should reach RMB1,029bn (4.3% of total market cap, or 5.6% of the floatable
                                             market cap), among which RMB395bn is from companies listed on the SME & GEM
                                             board (around 10% of the market cap of the SME/GEM companies), and the rest is from
                                             those on the main board (3% of the market cap of main board companies). This would
                                             be the fourth peak period of the shares being unlocked since 2006, although the
                                             average monthly amount of share-unlocking would be less than that over the previous
                                             peak periods. (Exhibit 43).

                                      2)     The first wave in shares being unlocked will come in July/August (monthly average of
                                             RMB150bn) and the next bigger one in November/December (monthly average of
                                             RMB240bn).

                                      3)     Sectorwise, consumer staples/healthcare and industrials should see the highest
                                             portion of shares being unlocked in 2H2012 (Exhibit 56).

                                      Reduction in shareholdings vs. shares being unlocked. We cannot predict when and
                                      how the shares unlocked would be sold by shareholders. Our analysis of historical trends

Goldman Sachs Global Investment Research                                                                                                                        24
June 27, 2012                                                                                                            China




                                 shows that there has been a reduction in shareholdings when a substantial amount of
                                 shares were unlocked and available to be sold (Exhibit 44). This suggests that an increase
                                 in the amount of shares unlocked could lead to the increase of shares reductions by major
                                 shareholders. On average, the volume of net reduction in shareholdings as % of the shares
                                 unlocked in the same month was around 5% in the past 12 months, and the ratio was 13%
                                 for companies from SME/GEM board (Exhibit 45).

                                 Net reduction in shareholdings. We found several trends between those periods where
                                 shares were purchased and sold by major shareholders.

                                 1)   Share purchasing by major shareholders often turns more active after prolonged
                                      market decline (Exhibit 46), as we saw in 2005-2006/late 2008-early 2009 periods.
                                      However, the continuing decline in the A-share market since late 2009 has only led to a
                                      moderate increase in share purchasing by major shareholders in A-share market;

                                 2)   Share selling by major shareholders often turns more active after a prolonged market
                                      rally but the volume should be higher and less volatile than the share purchasing
                                      (Exhibit 47).

                                 3)   Therefore, for most of the time since early 2007, major shareholders in the A-share
                                      market have been reducing their shareholdings on a net basis. The volume of net
                                      reduction in shareholding largely moves inversely with the market (Exhibit 48).
                                      Cumulative amount of net reductions have reached RMB381bn since 2006, or 2.3% of
                                      the cumulative amount of shares unlocked during the period. Note that this is a
                                      somewhat incomplete estimate as it does not include the shares reductions by non-
                                      major shareholders (usually shareholdings less than 5% of a company). The average
                                      monthly net shares reduction was around RMB6.3bn in the past two years(Exhibit 49)

                                 4)   Reduction in shareholdings by shareholder: The bulk of net reductions was from
                                      corporate shareholders, which accounts for 82% of the total net reduction in
                                      shareholdings. The net-reductions by company management and non-management
                                      individuals accounts for the remaining 11% and 7% respectively.

                                 5)   Major shareholders of the SME/GEM companies are more willing to sell.
                                      SME/GEM net-shares reduction has accounted for around 60% of the total net
                                      reduction in shareholdings in recent months, and was around 45% on average in the
                                      past two years, although total market cap of SME/GEM companies was only around
                                      15% of the total A-share market cap (Exhibit 50), which supports conclusions that the
                                      major shareholders, especially company management of the companies in SME/GEM
                                      board are more likely to sell their shares once unlocked.

                                 6)   Net share reductions by company managements of the SME/GEM companies account
                                      for much higher proportion (36.8%) than the company managements of those on the
                                      main board (Exhibit 51), as the SME/GEM companies are private-sector companies and
                                      the company managements are usually the major owners of the companies.

                                 Share purchasing/selling by major shareholders vs. stock price performance on
                                 SME&GEM board: Share purchasing by major shareholders is positive for stock prices.
                                 Our analysis indicates that a stock gains 3% on average in 30 days if the major
                                 shareholders purchase a certain amount of shares of the stock (Exhibit 53). On the contrary,
                                 share selling by major shareholders is negative for stock prices, as in Exhibit 52.

                                 Net-share reductions by major shareholders vs. earnings growth/valuation: On
                                 average the 2010/2011 earnings CAGR of the 50 companies with the least net-share
                                 reduction by major shareholders was 10ppt higher than the 50 companies with largest net
                                 reduction in shareholdings (Exhibit 55). The average P/E valuation for the 50 companies
                                 with the least net reduction in shareholdings by major shareholders was 37.6x while it was
                                 60.7x for the 50 companies with the most net reduction in shareholdings, which suggests



Goldman Sachs Global Investment Research                                                                                   25
June 27, 2012                                                                                                              China




                                 that major shareholders are more likely to sell their shares after unlocking if the company’s
                                 growth outlook is not favorable, or the company’s valuation is high.

                                 Reduction in shareholdings by major shareholders to cap the room of A-share
                                 market valuation expansion. We believe the increase of unlocked shares in 2H2012
                                 would cap substantial market valuation expansion. Our year-end CSI300 index target P/E
                                 11.5x represents about 10% valuation normalization from current PE 10.4x.The target P/E is
                                 already substantially lower than the average P/E since 2004 as we have taken the impact
                                 from increased shares supply into consideration.

                                 While there is a risk that valuation expansion could be less than we expect due to the
                                 increase of unlocked shares in 2H2012, we believe that, with China’s policy easing
                                 continuing and improving liquidity improving, such a risk should be relatively low.

                                 Bigger risk of small-mid cap de-rating. While the large caps should face less valuation
                                 risks upon the increased shares unlocking in 2H2012 given the already low valuation, we
                                 believe the small-mid caps should face much larger de-rating risks.

                                 1)   The SME composite index is now trading at 17.9x. 12-m forward P/E, which represents
                                      a 108% valuation premium over the large caps (CSI100 index) (Exhibit 60);

                                 2)   Our analysis suggests that major shareholders of the small-mid caps are more likely to
                                      sell their shares after shares being unlocked, especially if the company’s valuation of is
                                      high;

                                 3)   The amount of shares unlocking in the small-mid caps are much higher in terms of the
                                      ratio of the shares unlocked (10% of the market cap of the SME/GEM companies vs.
                                      4.3% for the broad market) and their valuation premium over large caps would narrow.

                                 We thus expect valuation premium of the small-mid caps to gradually narrow to a more
                                 normal level. Our previous analysis (3 questions on small caps’ valuation premium, April 18
                                 2012) indicates that only 60ppt of small-mid caps’ valuation premium could be justified by
                                 earnings growth fundamentals, which suggest the small-mid caps’ valuation should face
                                 around 10%-15% de-rating risk if the valuation premium of the small-mid caps normalize to
                                 a level which earnings growth could support.

                                 In Exhibit 62, we screen a list of the small-mid caps that should have the largest ratio of
                                 share unlocking in 2H2012.




Goldman Sachs Global Investment Research                                                                                       26
June 27, 2012                                                                                                                                                                           China




 Exhibit 42: Amount of shares being unlocked should                                              Exhibit 43: The market should come into the fourth peak
 increase substantially in 2H2012 for SME&GEM board                                              period of the shares unlocking since 2006 starting from
 and overall (ex. SME&GEM) vs. in 1H2012                                                         July 2012


       700                                                                                       5000                    Value of unlocked shares_overall (ex. SME&GEM)
                                          Value of unlocked shares                                      (Rmb 100 mn)
                 (Rmb bn)                                                 634.3
                                                                                                 4500                    Value of unlocked shares_SME&GEM
       600                               SME &GEM board
                                                                                                                                   Total average
                                         Overall (ex SME&GEM)                                    4000

       500                                                                                       3500

                                                                394.7                            3000
       400                           378.2

                                                                                                 2500
       300
                                                                                                 2000


       200                                                                                       1500

                         110.2                                                                   1000
       100
                                                                                                  500

         0                                                                                          0
                                1H2012                               2H2012                         Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




 Exhibit 44: Positive correlation: Net reduction in                                              Exhibit 45: …the relationship is more significant for
 shareholdings vs. shares being unlocked (overall)                                               SME&GEM board


                Share net reduction (Overall) vs. value of unlocking                                         Share net reduction (SME&GEM) vs. value of unlocking
                                 shares (Overall)                                                                              shares (SME&GEM)
                Unlocking market                                                                 100        Unlocking market
             2,500                                                                                          caps (Rmb bn)
                caps (Rmb bn)
                                                                                                  90

             2,000                                                                                80

                                                                                                  70

             1,500                                                                                60
                                                      y = 35.36x + 30.321
                                                                                                  50                                                              y = 8.5643x + 6.1986
                                                          R² = 0.1872
             1,000                                                                                                                                                     R² = 0.3911
                                                                                                  40

                                                                                                  30
              500
                                                                         Share reduction          20
                                                                         (Rmb bn)
                                                                                                  10                                                                      Share reduction
                                                                                                                                                                          (Rmb bn)
                 0
  -5                 0              5            10             15            20           25      0
                                                                                                        0         1            2           3       4       5         6           7          8

              -500



Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




Goldman Sachs Global Investment Research                                                                                                                                                    27
June 27, 2012                                                                                                                                                                            China




 Exhibit 46: Share purchasing by major shareholders                                              Exhibit 47: Share selling by major shareholders often
 often turns more active after prolonged market decline                                          turns more active after a prolonged market rally


0.25%                   Share buying as % of A-share floated market cap                 7,000   0.25%                      Share reduction as % of A-share floated market cap             7,000

                        SHCOMP Index (RHS)                                                                                 SHCOMP Index (RHS)

                                                                                        6,000                                                                                             6,000
0.20%                                                                                           0.20%



                                                                                        5,000                                                                                             5,000

0.15%                                                                                           0.15%


                                                                                        4,000                                                                                             4,000


0.10%                                                                                           0.10%

                                                                                        3,000                                                                                             3,000



0.05%                                                                                           0.05%
                                                                                        2,000                                                                                             2,000




0.00%                                                                                   1,000   0.00%                                                                                     1,000
     Jan-05    Jan-06     Jan-07    Jan-08     Jan-09     Jan-10     Jan-11    Jan-12                Jan-05       Jan-06      Jan-07    Jan-08    Jan-09    Jan-10    Jan-11    Jan-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




 Exhibit 48: The volume of net shares reduction by major                                         Exhibit 49: The average monthly net shares reduction
 shareholders largely moves inversely with the market                                            was around RMB6.3bn in the past two years


 0.30%                   Net Reduction as % of A-share floated market cap               6,000     5                                                                                       6,000
                                                                                                          (Rmb bn)            Net Reduction           SHCOMP Index (RHS)
                         SHCOMP Index (RHS)
 0.25%                                                                                  5,500                                                                                             5,500

 0.20%                                                                                            0
                                                                                        5,000                                                                                             5,000

 0.15%
                                                                                        4,500                                                                                             4,500
                                                                                                 -5
 0.10%
                                                                                        4,000                                                                                             4,000
 0.05%
                                                                                        3,500   -10                                                                                       3,500
 0.00%
                                                                                        3,000                                                                                             3,000
-0.05%
                                                                                                -15
                                                                                        2,500                                                                                             2,500
-0.10%

                                                                                        2,000                                                                                             2,000
-0.15%                                                                                          -20

-0.20%                                                                                  1,500                                                                                             1,500


-0.25%                                                                                  1,000   -25                                                                                       1,000
      Jan-05   Jan-06     Jan-07     Jan-08     Jan-09     Jan-10     Jan-11   Jan-12                 Jan-05    Jan-06      Jan-07     Jan-08    Jan-09     Jan-10    Jan-11    Jan-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




Goldman Sachs Global Investment Research                                                                                                                                                   28
June 27, 2012                                                                                                                                                                                   China




 Exhibit 50: Major shareholders of the SME/GEM                                                           Exhibit 51: Net share reductions by managements of the
 companies have been more inclined to sell historically                                                  SME/GEM companies account for much higher
                                                                                                         proportion (36.8%) than the managements of the main
                                                                                                         board companies (10.9%)


                                 Net Reduction (Overall)                                                                      Major share-holders' shares net reduction (SME&GEM
                                 Net Reduction (SME&GEM)                                                                                     board, since Jan 2005)
12        (Rmb bn)                                                                               100%
                                 Net Reduction (SME&GEM) as % of overall (RHS)
                                                                                                 90%
10                                                                                                                                                    14.3%
                                                                                                 80%

 8                                                                                               70%
                                                                                                                                                                           Non-management
                                                                                                                 36.8%                                                     individuals
                                                                                                 60%
 6
                                                                                                                                                                           Corporate
                                                                                                 50%

 4                                                                                                                                                                         Company management
                                                                                                 40%


 2                                                                                               30%

                                                                                                                                                           48.9%
                                                                                                 20%
 0
                                                                                                 10%

 -2                                                                                              0%
      Jan-11   Mar-11     May-11     Jul-11    Sep-11    Nov-11     Jan-12    Mar-12    May-12


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                     Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                Research




 Exhibit 52: Share selling is usually negative for stock                                                 Exhibit 53: Share purchasing by major shareholders is
 prices (estimates based on the data of shares being                                                     positive for stock prices (estimates based on the data of
 unlocked)                                                                                               shares being unlocked)


 100.5                                                                                                   104.0
                         Stocks relative performance (SME&GEM board) before/after reduction                                           Stocks performance before/after buying (SME&GEM board)

          (Reduction day=100)                                                                                      (Buying day=100)
 100.0
                                                                                                         103.0


  99.5
                                                                                                         102.0

  99.0

                                                                                                         101.0
  98.5


                                                                                                         100.0
  98.0



  97.5                                                                                                    99.0



  97.0
                                                                                                          98.0




Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                     Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                Research




Goldman Sachs Global Investment Research                                                                                                                                                          29
June 27, 2012                                                                                                                                                                                      China




 Exhibit 54: Major shareholders are more likely to sell                                          Exhibit 55: Major shareholders are more likely to sell
 their shares after unlocking, if the company’s valuation                                        their shares after unlocking, if the company’s growth
 is high                                                                                         outlook is less favorable


               The average P/E (since 2010) valuation for the 50 companies with                                   The earnings CAGR (since 2010) for the 50 companies with the least
 70                 the least net-share reduction/ most net-share purchase                      35%                         net-share reduction/ most net-share purchase
         (x)                                                                                               (%)
                                                                      60.7                                                   30.6%
 60                                                                                             30%



 50                                                                                             25%


                                                                                                                                                                                19.8%
 40                       37.6                                                                  20%



 30                                                                                             15%



 20                                                                                             10%



 10                                                                                              5%



  0                                                                                              0%
         Net Buying shares as % of total(Top 50)   Net Reduction shares as % of total(Top 50)              Net Buying shares as % of total(Top 50)        Net Reduction shares as % of total(Top 50)


Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




 Exhibit 56: Shares being unlocked in the healthcare                                             Exhibit 57: Shares being unlocked for CSI300 companies
 sector should mainly be from healthcare companieson                                             are much less than those for SME/GEM companies
 the SME/GME board


                                                                                                2,500                     Value of unlocked shares in CSI300 index                                     12%
               Value of unlocked shares as % of total market caps
                                                                                                           (Rmb
                          (2H2012, Health Care sector)                                                                    Value of unlocked shares in CSI300 index as % of total market
                                                                                                                          caps (RHS)
 16.0%
                                                                                                                                                                                                       10%
                            14.4%                                                               2,000
 14.0%

                                                                                                                                                                                                       8%
 12.0%
                                                                                                1,500
 10.0%
                                                                                                                                                                                                       6%
  8.0%
                                                                                                1,000
  6.0%                                                                                                                                                                                                 4%


  4.0%
                                                                                                  500
                                                                                                                                                                                                       2%
  2.0%
                                                                      0.1%
  0.0%
                                                                                                      0                                                                                                0%
                     SME &GEM boards                              CSI300 Index
                                                                                                       Jan-06    Jan-07   Jan-08   Jan-09   Jan-10   Jan-11   Jan-12   Jan-13    Jan-14   Jan-15




Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                             Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                        Research




Goldman Sachs Global Investment Research                                                                                                                                                               30
June 27, 2012                                                                                                                                                                                                                                                                                                               China




 Exhibit 58: Historically, net reduction in shareholdings                                                                                                                                                              Exhibit 59: Shares being unlocked in 2H2012 would be
 were more by major shareholders of companies with                                                                                                                                                                     mainly from companies with relatively high valuation
 relatively high valuation (SME&GEM board)                                                                                                                                                                             (SME&GEM board)


 14       (Rmb bn)
                                 Shares net reduction by PE groups (SME&GEM board)                                                                                                                                                      Value of shares unlocked in 2H2012 by PE groups
                                                                                                                                                                                                                                                        (SME&GEM board)
                                                                                                                                                                                                                        (Rmb bn)
 12                                        0-10x                                10x-20x
                                           20x-30x                              30x-40x                                                                                                                                                               24.9      1.0
                                                                                                                                                                                                                                                                                  51.7
                                           40x-50x                              50x+
 10


  8                                                                                                                                                                                                                                                                                                                       >50x
                                                                                                                                                                                                                                102.1                                                         50.2
                                                                                                                                                                                                                                                                                                                          40x-50x
  6                                                                                                                                                                                                                                                                                                                       30x-40x
                                                                                                                                                                                                                                                                                                                          20x-30x
  4                                                                                                                                                                                                                                                                                                                       10x-20x
                                                                                                                                                                                                                                                                                                                          <10x
  2


  0
               Jun-07


                                  Dec-07


                                                     Jun-08


                                                                       Dec-08


                                                                                          Jun-09


                                                                                                             Dec-09


                                                                                                                               Jun-10


                                                                                                                                                 Dec-10


                                                                                                                                                                     Jun-11


                                                                                                                                                                                        Dec-11


                                                                                                                                                                                                          Jun-12
                        Sep-07




                                                              Sep-08




                                                                                                   Sep-09




                                                                                                                                        Sep-10




                                                                                                                                                                              Sep-11
      Mar-07




                                            Mar-08




                                                                                 Mar-09




                                                                                                                      Mar-10




                                                                                                                                                          Mar-11




                                                                                                                                                                                                 Mar-12


                                                                                                                                                                                                                                                                          150.4




Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS                                                                                                                                                  Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS
Research                                                                                                                                                                                                             Research




                                                                                                            Exhibit 60: The small-mid caps in A-share are still trading at a very high valuation
                                                                                                            premium over large caps


                                                                                                                                                                                                                        SME Composite 12-m fPE / CSI100 12-m fPE (RHS)                                              4.0
                                                                                                                                        47                (X)
                                                                                                                                                                                                                                                                                                        (X)
                                                                                                                                                                                                                        SME Composite fPE

                                                                                                                                                                                                                        CSI100 fPE                                                                                  3.5
                                                                                                                                        42


                                                                                                                                                                                                                                                                                                                    3.0
                                                                                                                                        37



                                                                                                                                                                                                                                                                                                                    2.5
                                                                                                                                        32



                                                                                                                                        27                                                                                                                                                                          2.0




                                                                                                                                        22                                                                                                                                                                          1.5



                                                                                                                                        17                                                                                                                                                                          1.0

                                                                                                                                                                                                                                                                                                     17.9X

                                                                                                                                        12                                                                                                                                                                          0.5



                                                                                                                                         7                                                                                                                                                                          0.0
                                                                                                                                          2006-05                  2006-11             2007-05            2007-11   2008-05   2008-11     2009-05   2009-11   2010-05   2010-11     2011-05   2011-11         2012-05




                                                                                                     Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research




Goldman Sachs Global Investment Research                                                                                                                                                                                                                                                                                         31
June 27, 2012                                                                                                                                                          China




                                   Exhibit 61: Sectorwise, consumer staple/healthcare and industrials should see the
                                   highest portion of shares being unlocked in 2H2012 (SME & GEM board)


                                                            Value of unlocked shares as % of total market caps (SME &GEM
                                                                                   boards, 2H2012)
                                                                 Consumer Staple                                                                  21.0%


                                                                       Health Care                                              14.4%


                                                                        Industrials                                 9.8%


                                                            Overall (ex. Financials)                               9.7%


                                                                            Overall                                9.6%


                                                           Consumer Discretionary                                8.6%


                                                       Telecommunication Services                         6.9%


                                                                         Financials                     6.4%


                                                           Information Technology                       6.1%


                                                                    Basic Materials                    5.6%


                                                                            Energy              3.5%


                                                                           Utilities     1.3%


                                                                                  0.0%          5.0%           10.0%          15.0%       20.0%           25.0%


                                 Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates




                                   Exhibit 62: A list of the small-mid caps that have the largest ratios of shares unlocking
                                   scheduled in 2H2012


                                                                                                                              Unlocking
                                                                                                                 Unlocking                        Performance
                                    Ticker     Name                                A-share sector                             shares as % of                      2012E PE
                                                                                                                 day                              (2012YTD, %)
                                                                                                                              total (%)

                                    002287.SZ Cheezheng Tibetan Medicine           Health Care                    2012-8-28           89.9%               8.8%      36.4
                                    002292.SZ Guangdong Alpha                      Consumer Durables             2012-9-10            75.0%           -11.2%        50.1
                                    300023.SZ Bode Energy Equipment                Capital Goods                 2012-10-30           75.0%            6.3%         NM*
                                    002311.SZ Guangdong Haid Group                 Food&beverage                 2012-11-27           75.0%           25.0%         27.3
                                    002313.SZ SUNSEA Telecommunications IT                                        2012-12-3           75.0%           17.9%         22.6
                                    002317.SZ Guangdong Zhongsheng                 Household Products            2012-12-11           75.0%               1.9%      22.0
                                    002294.SZ Shenzhen Salubris                    Health Care                    2012-9-10           74.9%           32.5%         22.5
                                    002303.SZ Shenzhen MYS                         Construction Materials 2012-11-5                   74.8%           -7.0%         18.9
                                    002327.SZ Shenzhen Fuanna Bedding              Textile&Apparel               2012-12-31           74.8%           13.4%         26.6
                                    300002.SZ Beijing Ultrapower Software          IT                            2012-10-30           72.8%            2.6%         16.5
                                    002305.SZ Wuhan Langold Real Estate            Property                       2012-11-6           72.2%           19.7%         NM*
                                    300015.SZ Aier Eye Hospital Group              Health Care                   2012-10-30           71.5%           -19.2%        36.3
                                    002315.SZ Focus Technology                     IT                            2012-12-10           71.5%           -12.4%        22.0
                                    002293.SZ Luolai Home Textile                  Textile&Apparel                2012-9-10           71.2%               2.7%      22.5
                                    002275.SZ Guilin Sanjin Pharmaceutical Health Care                            2012-7-10           71.0%           11.8%         21.8
                                    300032.SZ Jinlong Machinery & Electronic Capital Goods                       2012-12-25           70.1%           38.1%         42.6
                                    300011.SZ Beijing Dinghan Technology           Capital Goods                 2012-10-30           70.1%           -0.9%         23.4
                                    002308.SZ Vtron Technologies                   IT                            2012-11-27           69.8%           -0.7%         19.0
                                    300012.SZ Centre Testing International         Construction                  2012-10-30           69.4%           25.5%         32.5
                                    002285.SZ Shenzhen Worldunion                  Property                       2012-8-28           68.4%           40.1%         19.3
                                    Note: * means no WIND consensus PE estimates


                                 Source: Wind, Gao Hua Securities Research, Goldman Sachs Global ECS Research estimates




Goldman Sachs Global Investment Research                                                                                                                                     32
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Disclosure Appendix


Reg AC
We, Hanfeng Wang, Ph.D, CFA, Helen Zhu, Timothy Moe, CFA, Christopher Eoyang, Ben Bei and Chenjie Liu, hereby certify that all of the views
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Goldman Sachs Global Investment Research                                                                                                                   33
June 27, 2012                                                                                                                                       China




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Goldman Sachs Global Investment Research                                                                                                               34
June 27, 2012                                                                                                                                          China




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Goldman Sachs Global Investment Research                                                                                                                  35
June 27, 2012                                                                                                                    China




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Goldman Sachs Global Investment Research                                                                                           36

				
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Description: Tough times near term but medium-term view intact