Baosteel 9M16 in line with consensus and DBeBaosteel reported its 9M16 results. The company has delivered a top-line ofRMB133.6bn, achieving 78% of full year Bloomberg consensus. Baosteel alsoreported a cost cut of RMB1.1bn. The cost reduction together with improvedmarket condition allowed Baosteel to have an 83% YoY improvement for its9M16 operating profits. The company’s 3Q16 operating profit declined 11%QoQ. Yet, impairment reversal and investment income in 3Q16 enabledBaosteel’s PBT to improve by 9% QoQ. Overall the company’s 9M16 NPATachieved 77% of Bloomberg consensus FY16 estimates and 70% of FY16 DBeNPAT. We deem the results in line with consensus estimates. Baosteel guides FY16 NPAT 600% to 800% YoY growthWith 600% to 800% YoY growth, the company’s 2016 full year NPAT shouldbe ranging from RMB7bn to RMB9bn. That should mean current consensus atRMB7.3bn will potentially move up a bit and also implies Baosteel’s 4Q16 islikely to be QoQ flat. With current spot spreads (proxy for steel millprofitability) off from the 3Q16 average level, Baosteel should have convictionabout its own further cost reductions or strong shipments in 4Q16. Re-iterate Buy on valuationsThough we don’t like the valuation Baosteel paid for the Baosteel-Wugangmerger, the company’s results still demonstrated Baosteel’s own operationsremain best in class in China. While most of its Chinese A share peers aretrading at book value or above, we believe Baosteel trading at 0.8x 2016DBeBVPS remains attractive. As such, we maintain our Buy rating for Baosteel.

Baosteel to take over Wugang via 0.56:1 share swap. On 22 September, Baosteel and Wuhan Iron & Steel (Wugang) announced adetailed plan of their merger. The merger will be completed via a share swap –Baosteel will issue new shares to Wugang’s shareholders to fully absorb thelatter company. Conversion prices have been set based on 90% of the averagemarket prices over the past 20 days – Baosteel at RMB4.60 and Wugang atRMB2.58, which implies a share swap ratio of 0.56:1. After the merger, thetotal number of Baosteel shares will increase from 16,467m to 22,119m. At theparent company level, Baosteel Group will merge with Wugang Group and berenamed Baowu Iron & Steel Group. Trading of the two stocks will continue tobe suspended while the SSE reviews the merger plan. Financially not a great deal. The share swap ratio is ROAE dilutive for Baosteel's shareholders. Baosteel'simplied PBx in the transaction is 0.67x, but Wugang's implied PBx is high at0.96x. However, Baosteel's average ROAE from 2010 to 2014 was 7.9% (weignore 2015 ROAE as it was an extreme year), whereas Wugang's averageROAE in those five years was only 3%. This means that the ROAE of the newcompany (after the merger) will be dragged about 10% lower than Baosteelused to deliver. Meanwhile, the new company's net debt will grow fromRMB54bn to RMB96bn, implying the net gearing for Baosteel growing from47% to c.68%. Without considering any material synergy, the deal doesn’tseem favorable to Baosteel shareholders. Signals to the market mixed. The market might be cheering for the synergy of the merger, including a highermarket share of high-end CRC and GOES, potential cost falls after the merger,and more centralized and efficient procurement and logistics, and so on. However, the transaction might create market concerns about China SASAC'signorance towards minority shareholders' interests because this merger isdilutive to such a good quality asset as Baosteel. This might reduce investors'appetite to invest in China's top SOE assets as there could always beuncertainty about further dilutive mergers. All in all, we like the industryconsolidation and believe in Baosteel management’s capability to create thesynergy. All in all, we like the industry consolidation and believe in Baosteelmanagement’s capability to create the synergy. Provided Baosteel's valuationis still undemanding, we maintain our Buy rating even though we don't like thevaluation of this deal.

1H16 results in line with DBe, beat market consensus. Baosteel reported 1H16 results after market close on 30 August. Its revenuewas RMB78bn, down 3% YoY and 6% HoH, achieving 39% of FY16 DBe and46% of Bloomberg consensus. 1H16 NPAT arrived at RMB3.5bn, cf. RMB3.2bnin 1H15 and RMB2.2bn net loss in 2H15. Baosteel 1H16 results were in linewith DBe but beat market consensus, achieving 43% FY16DBe and 68%Bloomberg consensus. The stock trading remains suspended for theconsolidation/restructure with Wuhan Steel. Unit GP improved as expected. Baosteel sold 11.85mt steel products in 1H16, up 11% YoY. Average unit grossprofit of major products improved c.RMB472/t HoH, in line with market HRCconcurrent spread trajectory. 3Q16 QTD HRC spread is similar to that in 1H16. As such, we expect Baogang to maintain its 1H16 profitability in 3Q16. Inaddition, Baogang’s Zhanjiang furnace started production on 15 July, whichshould further boost production volume in 2H16 and FY17 as expected. Increasing interest expense, unlikely to decline in 2H16. Interest expense in 1H16 increased by to RMB1.4bn, up 90% YoY, almost 40%of its NPAT in 1H16. The increasing interest expense was attributable to 1)Converted US$ dominated debt to RMB dominated debt, which resulted inRMB270m interest expense, 2) Expensed financing expense of Zhanjiangproject, previously capitalized, of RMB150m and 3) Financed with new debt ofRMB20bn, which required interest expense of RMB200m in 1H16. Theseinterests seem to be the recurring expense, unlikely to drop in 2H16. We expect healthy sales volume growth, Buy reiterated. Trading of Baosteel has been suspended since 27 June, owing to theconsolidation/restructure with Wuhan Steel. As the Zhanjiang base ramp-upprogressed, Baosteel is the only company under our coverage for which weexpect healthy sales volume growth in 2017/2018. Buy reiterated.

1H16 NPAT up 141% YoY, in line with expectation Guoxuan High-Tech announced 1H16 results on 22 August. Its 1H16 revenuewas RMB2,399mn, up 169% YoY and 29% HoH, achieving 44% FY16 DBe and40% of Bloomberg consensus. Guoxuan grew its 1H16 NPAT to RMB534mn,up 141% YoY and 47% HoH, representing 50% of FY16 DBe and 45% ofmarket consensus. We remain optimistic about company’s performance in2H16, with the expectation that China government’s modified EV subsidypolicy may be settled in 2H16. Buy reiterated. Gross margin of battery business remained resilient in 1H16 Guoxuan’s topline grew 169% YoH to RMB2,399mn, driven by China EV sales– up 127% YoY to 170k units. Revenue from battery increased 45% HoH and161% YoY to RMB1,989mn. Gross margin of battery remained as high as 50%in 1H16. We believe its gross margin will be maintained in 3Q due to rawmaterial price drop recently and battery ASP may remain resilient in 3Q. Positive operating cashflow Guoxuan managed to generate positive operating cashflow in 1H16 atRMB112mn. And the company remain in net cash, though its ratio deterioratedfrom 48.2% as of 2H15 to 12.9% as of 1H16. Cash decreased due to significantcash outflow for CAPEX to expand capacities. 3Q preliminary results in line, Buy reiterated We expect company’s operation may remain stable in 3Q as it was in 2Q, andmay improve in 4Q16 when subsidy policy may be settled down in 2H16. Management guided 9M16 NPAT to c.RMB697mn-797mn, up 110%-140%YoY, representing 67%-75% FY16 DBe. Buy reiterated. Key risks: unexpectedchanges in subsidy policies and EV demand; and quicker-than-expected ASPdrop or slower-than-expected cost cut.

Ganfeng 1H16results beat consensus but miss our estimates Ganfeng Lithium announced 1H16results after market close on 21August.1H16revenue was RMB1,343m, up 147% YoY and 66% HoH, achieving 52%of FY16DBe and 44% of Bloomberg consensus. Ganfeng recorded NPAT ofRMB278m, representing 34% of FY16DBe and 58% of Bloomberg consensus,a miss on DBe but beating consensus. Excluding a non-recurring loss ofRMB47m resulting from Mbell’s (Ganfeng's subsidiary) fire accidents, NPAT ofGanfeng should achieve c. 40% FY16DBe. Higher–than-expected COGS Lithium products revenue reached RMB1,189m, in line with our expectations.However, COGS of lithium products were higher than our expectations.Without enough raw materials (spodumene concentrates) secured in 1H16, webelieve Ganfeng had to purchase raw materials at a higher cost. Gross profit ofGanfeng’s lithium only reached c.38%, much lower than Tianqi’s 77% duringthe same period. Lithium carbonate prices should stabilize in 4Q16 Battery-grade lithium carbonate prices have peaked out from RMB148k/t inApril, dropping to RMB118k/t (VAT excluded) as of 19August. Without theChinese government’s modified EV subsidy policy settled, demand growth ofdownstream EV batteries was less impressive. With the expectation that theChinese government will announce the modified subsidy policy in 2H16, webelieve lithium carbonate prices may stabilize in 4Q16. Raw material supply should be secured since 4Q16 With the ramp-up of the Mt Marion project (Ganfeng owns 43% of thisupstream asset) since 4Q16and the project likely eventually supplyingc.42ktpa LCE of spodumene concentrates by year-end 2017, Ganfeng shouldmaterially improve its profitability and earnings. As such, we expect thatGanfeng will be able to further grow its bottom line.

New production line of 20kt lithium hydroxide announced. Ganfeng announced its intent to build a new production line of lithiumhydroxide in Xinyu City with total annual capacity of 20kt lithium hydroxideincluding 15ktpa battery grade and 5ktpa industry grade. The project isexpected to require CAPEX of RMB30.28mn and is slated to be finished in 18months. Lithium battery factory with 219mn AH (c.0.8Gwh). Ganfeng has also decided to invest RMB228mn to expand the capacity ofMbell from the current 74.88mn AH, by 219mnAH in Dongguan City. Theconstruction period should be about one year. Ganfeng estimated that thisnew lithium battery production will help to improve the top/bottom lines byc.RMB560mn /RMB60mn, respectively. Positive impact on Ganfeng. We maintain our positive view on Ganfeng. Its Mt. Marion project in Australiashould start to operate and ramp up in 4Q16 and early 1Q17, in line with ourprevious expectation. We also believe Ganfeng’s leading industry experience inprocessing can help to quickly ramp up its new 20ktpa lithium hydroxideproduction line.

M&A announced, real impact remains to be seen. On June 26th, Baosteel and Wuhan steel announced a potential mergertransaction, promoted by the Chinese government; the trading of their stockswill be suspended beginning June 27th, 2016. While the details of the potentialmerger transaction have yet to be disclosed, we believe it will likely happen atthe parent company level rather than listed company level. Any potentialsynergy and industry impact (regarding both companies) remains to be seen.Considering Boasteel’s valuation, quality products, and management, wereiterate Buy.

Stock split effective on Jun 24th Ganfeng's 10 to 10 share split has been effective since Jun 24, 2016. Thus,without any earnings adjustment and valuation adjustment, our TP haschanged to RMB39/share based on the new outstanding shares.

Most leveraged major player to EV lithium battery; initiating with Buy. Guoxuan is the fourth-largest EV lithium battery player in China, in terms ofsales in 2015. It is also the most leveraged major player on the stock market tothe EV lithium battery business, which is set to contribute 90% of its revenueand 94% of its gross profit in 2016. We believe Guoxuan’s aggressive capacityexpansion and competitive advantages should help it to grow market sharesignificantly and make it a major beneficiary of the Chinese government’starget to put 5mn EV units on the road by end-2020. We initiate with a Buy. Quick growth rate of EV sales. China EV sales rose to 331k units last year, up 340% YoY, driven by bothimprovements in demand and government stimulus. The Chinese governmentplans to put 5m units on the road by the end of 2020. We expect China EVsales to grow 27%/57%/36% in the next three years, generating 19/30/39 Gwhlithium battery demand in our forecast years. We believe EV sales will likelyrally in 2H16 after the renewal of subsidy policies in June. EV lithium battery focus with aggressive expansion. Guoxuan High-Tech has been focused on producing EV lithium batteries sinceits establishment and this segment is set to contribute 90% of its revenue and94% of its gross profit in 2016. This makes it the most leveraged stock to EVlithium batteries in the market. The company has a very aggressive expansionplan and total capacity should expand from c.0.16Gwh in 2011 to c. 8.9Gwh in2018, with a CAGR of 78%. Though the group’s operating margin will likely fallfrom a high level of 27% in 2015 to 20% in 2020, driven by lower ASP, strongvolume growth should push the bottom line higher in the next three years. The strong will likely become stronger. We expect Guoxuan to catch up with industry peers and gain more marketshare due to its stronger competitiveness, stemming from 1) first-moveradvantage, as it is already listed as one of the 25 quality producers approvedby MIIT; 2) strong client relationships with key producers in EV markets; and 3)its proven capability of R&D to improve energy density and sufficient fundingto support capacity expansion. Additional material can be found in our FITTreports “Welcome to the Lithium-ion Age”, published on 8 May 2016, and“Charging the car of tomorrow”, published on 2 June 2016. Initiating coverage with Buy; target price set at 26x 2017E P/E; risks. Our target price of RMB40.4 is based on 26x 2017E EPS and implies 29%upside potential. We believe our multiple is justified, given an earnings CAGRof 46% and high ROEs of above 30% over the next three years. Key risks:unexpected changes in the govt’s subsidy policy and EV demand (see pp3,4-5).

Initiating coverage on Ganfeng with Buy Ganfeng Lithium is one of the largest lithium compound processors in China,with a total capacity of c.30ktpa LCE in 2016E. Ganfeng is directly benefitingfrom higher ASPs of lithium compounds, driven by booming EV sales and leadacidbattery replacement. Through purchasing shares in Process MineralsInternational, Ganfeng will become the largest shareholder (43.1%) of the MtMarion project, which will solve the problems of an uncertain raw materialsupply in the long term. With a target price of RMB78, we initiate coverage onGanfeng Lithium with a Buy rating Tripled demand in the next decade In our Lithium 101 report “Welcome to the Lithium-Ion Age”, we forecast thatglobal lithium demand will triple over the next 10 years, driven by electricalvehicles, energy storage and traditional markets. By 2025, global batteryconsumption will exceed 535GWh. This has a major impact on lithium. Turningto the supply side, the response from primary producers has not been fastenough to match demand. Recent price hikes, however, have encouragedowners to develop new assets to enter the market, but even with this increase,we believe that the market will not start to rebalance until mid-2017. Price of lithium compounds expected to remain high We believe that, after a 40% YoY hike in 2015, the price of lithium carbonatewill experience a further 143% YoY increase in 2016 and remain high atRMB120,000/t, (excl. VAT) and RMB100,000/t in 2017. As a lithium miningproducer and compound processor, Ganfeng will benefit from both owning theraw material and the processing technology as demand rises to absorb its newcapacity and spodumene concentrates from Mt. Marion. Raw material supply shortage in the short term, no big concern in the long run Ganfeng has significantly expanded its processing capacity but wasconstrained due to a shortage of raw material supply. However, through anexclusive sales agreement with RIM, Ganfeng will remove this bottleneckbeginning in 3Q16. As Ganfeng becomes the largest shareholder in Mt. Marion,we believe that Ganfeng is likely to secure raw material supply from Mt.Marion in the long term to satisfy its capacity expansion plan. Valuation and risks With resilient lithium prices and strong shipment growth in the coming years,we forecast that Ganfeng’s 2016/2017E NPAT will grow 655% YoY and 41%YoY, respectively. Our TP was derived from a DCF model, with a WACC of8.6%., cost of equity of 10.1%, risk-free rate of 3.9%, market risk premium of5.6% and beta of 1.11. Using a terminal growth rate of 3% in line with industrygrowth, Our TP of RMB78 implies 17% upside potential and 2016/17E P/Es of36x/25x. Major risks: a slower-than-expected ramp-up of the Mt. Marionproject.

1Q results in line with DBe but beat consensus Baosteel announced its 1Q16 results after market close on April 27. Baosteelrecorded revenue of RMB35bn, achieving 18% of the DBe and 20% of marketconsensus. Its bottom line arrived at RMB15.3bn, achieving 19% of DBe and39% of market consensus. Its results were in line with DBe but beat marketconsensus. We believe 1Q16 results should be positive to the share price. BuyRe-iterated. Profitability and volume both improved In 1Q16, China HRC price increased by 16% QoQ, while Baosteel’s ASPimproved by RMB423/t, up 12% QoQ. Company’s profitability significantlyimproved. Average unit gross profit of major products increased from negativeRMB964/t in 4Q15 to positive RMB538/t in 1Q16. Baosteel sold 5.62mmt steelproducts, up 7% YoY, which is the best 1Q sales volume number in the pastfour years. After switching its U.S dollar dominated debt to RMB dominateddebt, net financing cost significantly increased to RMB528mn, mainly fromincreasing interest payment and decreasing interest income. We believe thereis an RMB190mn inventory revaluation gain due to improved steel in 1Q. Healthy cash flow from operation and declining CAPEX Cash flow from operation significantly improved to RMB7bn in 1Q16 fromRMB5.8bn in 4Q16, while its CAPEX significantly cut to RMB3bn 1Q16, from5.7bn in 4Q15. In addition, its net gearing ratio was kept at healthy level as35% as of 1Q16 quarter end, after increasing mid-term bank note of c.RMB5bnand short term financing bond of c. RMB10bn. Company’s AR and inventoryincreased to 44 days and 69 days in 1Q16, from 37 days and 56 days in 4Q15respectively. However, its AP days also climbed to 75 days in 1Q16 from 60days in 4Q15, accordingly. Quality volume growth in 2016 expected, Buy reiterated We remain a cautious view on China steel industry and believe currentrestocking cycle will peak out in June, highlighted in the report “When will thiscyclical recovery peak out” published on April 15, 2016. However, Baosteelremains to be our top pick because of its expected quality volume growth fromZhangjiang project ramp up in 2016. Current Baosteel is trading at 0.82x BVPS,with 31% upside potential to our TP of RMB7.9. We reiterate Buy on Baosteel.

ZKSH 1Q16 results in line with expectation. Zhong Ke San Huan announced 1Q16 results after market close on April 26th. Company’s revenue in 1Q16 was RMB790mn, down 2% YoY, achieving 20%DBe and 20% Bloomberg consensus, respectively. Its bottom line arrived atRMB63mn, up 2% YoY, achieving 20% DBe and 19% Bloomberg consensus,respectively. We maintain our positive view on China EV and global EV sales,which is likely to increase demand in volume and support the magnet prices. Stable gross profit margin and big net cash on hand. The price of PrNd oxide remained stable in 1Q16, while magnet price declinedheavily in March. However, ZKSH managed to maintain GPM stable. Its GPMimproved by 1.8ppt YoY and is still 0.6ppt higher than average GPM in lastyear. In addition, company’s cash flow from operation was as large asRMB200mn and accumulated cash on hand has arrived at RMB1,892mn as of1Q16 quarter end. ZKSH’s net cash ratio further climbed to 38.9% as of 1Q16quarter end from 35% in FY2015 year end. Positive view on EV outlook globally in 2016, Buy maintained. We retain our optimistic view on EV sales in China as well as globally. China ison its way to accumulate 5mn units on the road by year 2020 and the preorderof Tesla model 3 also demonstrates a very positive outlook on EV salesgoing forward in the world. Considering ZKSH’s quality products and marketshare in the high-end magnet products for EV, we believe it can benefit fromboth volume and price going forward. Buy maintained.

FY2015 results in line with expectation. Baosteel announced its FY15 results on PRC GAAP after market close on Mar30. Baosteel recorded revenue of RMB164bn in FY2015, achieving 100%FY15DBe and 100% Bloomberg consensus. Baosteel’s NPAT attributable toshareholders was RMB1,013mn, achieving 105% FY15DBe and 105%Bloomberg consensus, in line with expectation. As the company has alreadyannounced profit alert on Jan.20th, 2016, we believe these results should benon-event to share price. Deteriorated profitability, significant non-recurring cost. Baosteel’s profitability was deteriorated in FY2015. Company’s average unitgross profit of major products fell from RMB540/t in FY2014 to RMB399/t inFY2015 (ASP declined by RMB943/t and unit cost declined by RMB802/t.) Nonrecurringcost including net financing cost (loss from foreign exchange) andimpairment loss on inventory was significant in FY2015. However, as Baosteelalready cut the US dollar debt in 2015 and current steel price is running at verylow level, we would not expect huge cost in these two items again in FY2016. Strong balance sheet and healthy cash flow from operation. Baosteel maintains a strong balance sheet and healthy cash flow fromoperation Baosteel successfully cut net gearing ratio from 32.1% as of 2014year end to 30.6% as of 2015 year end. Its AR days and inventory days weresteadily at 40 days and 61 days, respectively while its AP days increased to 61days in FY2015. Cash flow from operation kept at positive RMB21bn in FY2015Positive guidance on FY2016. With increasing steel sales volume to 27.11mt, Baosteel guidance its FY2016revenue at RMB160bn and operating cost at RMB149bn, implying a recurringPBT of c.RMB10bn, better than DBe of RMB8bn. Baosteel will invest CAPEX ofRMB14bn in FY2016, including RMB6.3bn for Zhanjiang project. We believethat with the ramp-up of Zhanjiang project, company’s profitability willgradually improve. Quality company with quality volume growth, Buy maintained. We remain a cautious view on China steel industry as we have not seen anysignificant improvements in supply/demand balance yet. However, as Baosteelhas been consistently outperforming its peers in term of profitability, andBaosteel is the only company under our coverage that we believe can benefitfrom quality volume growth in the coming two years. Buy reiterated.

Tianqi -- major beneficiary of lithium boom; initiating coverage with a Buy Tianqi Lithium is the third-largest lithium producer globally, supplying a criticalraw material for Electric Vehicle (EV) batteries. Demand trends are clear,especially in China where EV sales will rise 34% over the next three years. Supply is constrained and highly concentrated, with 86% controlled by fourproducers, supporting a very strong price outlook until 2018. With high quality,low cost reserves and well-timed processing capacity additions, earnings areset to surge eight-fold this year, taking RoE to 48.5%. We initiate coveragewith a Buy and a TP of RMB149.9, implying 38% upside potential. High lithium price supported by demand and industry structure The average lithium price rose 44% last year and will gain a further 126% toRMB120,000/t in 2016, a level that will likely be maintained until at least 2018. Strong EV sales in China, a slow ramp-up of new supply and a concentratedindustry structure are the key supporting factors. The EV battery industry is atthe start of a rapid growth phase and generates a demand for lithium with aCAGR of 7~8% in the coming years. For Tianqi and other leading producers,we project an outlook very similar to the iron ore boom last decade. Global No. 3 lithium supplier with meaningful shipment increase Tianqi controls close to 18% of global lithium capacity. In 2015, throughTalison (51%-owned), we estimate that Tianqi shipped c.34kt LCE (equityadjusted volume, vs. global production of 190kt LCE estimated). As well asowning the world-class Greenbushes mine, which has one of the largest andhighest grade spodumene reserves in the world, Tianqi recently acquired alithium carbonate processing plant in Zhangjiagang, which doubled itsprocessing capacity. With further ramp-up of Greenbushes’ spodumeneconcentrate shipments and Zhangjiagang’s processing plant, we believeTianqi’s shipments for spodumene concentrates and lithium compounds willincrease 30%/20% and 93%/7% in 2016/2017 respectively. DCF-based TP suggests 38% upside; initiating coverage with a Buy With a resilient lithium price and strong shipment growth, we forecastearnings to rise eight-fold this year and a further 14% in 2017, generating anRoE of 48.5%. We derive our target price from a DCF model, with a WACC of8.5%. We adopt 10.8% as the cost of equity to reflect a risk-free rate of 3.9%, amarket risk premium of 5.6% and a beta of 1.24. Using a terminal growth rateof 3%, we set our target price at RMB149.9, implying 38% upside potentialfrom current levels. Major risks: slower-than-expected demand pick-up fromEV.

Buy the leading Chinese magnets producer with high growth. Zhong Ke San Huan is a leading global NdFeB magnets producer with 16ktNdFeB magnets capacity at end-2014 (ranked No.1 globally). High-end NdFeBaccounts for 13kt of this, equivalent to ~30% of total high-end NdFeB magnetscapacity in China. Given its leading technology, improving sales mix towardshigher-margin auto motors and emerging demand from hybrid/electricvehicles, we expect San Huan’s net margin to increase to ~10% in 2017 from~7% in 2015 leading to a two-year EPS CAGR of ~37%. We initiate coverageon with a Buy and a target price of RMB17.0, implying 43% upside potential. A leading player in NdFeB magnets with improving revenue mix. Zhong Ke San Huan, with its 16kt NdFeB magnets capacity and high-endtechnology, leads in magnet supply in, for example, electric power steering(EPS) motor, voice coil motors (VCM) and electronic motors. We also likemanagement’s increasing focus on auto motors with higher margins (~30%GM vs. others ranging from ~15-25% in 2014). We expect supply of magnetsto auto motors to account for ~63% of total sales in 2017 from ~48% in 2014,and gross margin to improve to ~26% in 2017 from 24% in 2014. Robust hybrid/electric vehicle growth supports mid-to-long-term earnings. We expect hybrid/electric vehicles to be the major driver of magnet demand inthe coming years with a ~30% CAGR from 2014-18. Therefore, we are positiveon the company’s entry into hybrid/electric vehicles and expect HEV/EV-relatedsales to enjoy robust growth from a low base of hundreds of tonnes in 2014. Zhong Ke San Huan’s recent JV with Hitachi Metal focusing on magnets inHEV/EV will further improve its technology and cement its leading position. Initiating with Buy; risks: weaker magnets demand and intense competition. We use DCF to derive our target price of RMB17.0 (WACC: 8.8%, tgr: 2%). Ourtarget price translates into ~50x/34x 2016/17E EPS (net cash PE at ~46x/31x2016/17E EPS). The stock currently trades at ~35x/24x 2016/17E EPS (net cashPE at 31x/23x 2016/17E EPS), lower than its domestic peers’ c.39x 2016E EPS. Considering its leading position in the magnets industry and robust growth inthe magnets market, we are initiating Zhong Ke San Huan with a Buy rating. Risks: weaker magnet demand and intense competition.