Merchants' strategy A-share third quarter report in-depth analysis: it is recommended to focus on the sub-industries with relatively high comprehensive scores and improving economic trends.

CMSC released a research report focusing on 60 high-frequency tracking sub-sectors. Using the medium-term economic outlook (standardized processing using medium-term economic indicators that contribute positively to excess returns), performance, profit expectations, chip distribution, valuation levels, trading analysis, cycle stage, track and policy dimensions, quantitative scoring was conducted for each dimension and assigned corresponding weights to obtain the weighted average scores for each industry. It is recommended to pay attention to sub-sectors with comprehensive scores above average and upward economic trends, such as consumer electronics, communication equipment, computer equipment in the information technology sector, as well as automotive parts, engineering machinery, aerospace equipment, wind power equipment in the midstream manufacturing sector, and some consumer pharmaceuticals such as home appliances, beauty care, biologics, decoration and decoration, building materials, securities, insurance, etc. Overall profitability: A-share performance in the third quarter of 24 is still fluctuating at a low level, driven by non-banking sectors, with the decline narrowing. Excluding the real estate and power equipment sectors, overall A-share profitability continued to recover driven by non-banking sectors. If the effects of subsequent policies continue to manifest, the third quarter might be the lowest point for annual profits. Sectors & Indices: Main indices generally declined in terms of revenue, with some net profit growth improving. Key indexes like the SSE 50 and CSI 300 saw improved profitability compared to the mid-year report; the ChiNext Index's profit growth narrowed, and net profit for the Science and Technology start-up index decreased year-on-year. In terms of style, large caps outperformed small caps, and value outperformed growth. The 300 Quality and 500 Quality indexes had relatively higher revenue and profit growth rates. Starting from the financial performance and high-frequency indicators, this article makes judgments on the differentiation of secondary industries' economic outlook and suggests focusing on sectors where the economic outlook continues to improve rapidly: Rapid recovery: Some industries continue to experience rapid improvement in profitability due to supply improvement, stable downstream demand, and synchronized price increases, with profits either turning significantly positive or increasing significantly. This mainly includes the pig industry (feed, livestock industry, agricultural integration), AI hardware (semiconductors, other electronics, communication equipment), non-banking (insurance II, securities II), some other consumer sectors (automotive services, medical beauty, e-commerce, general retail), as well as precious metals, cement, shipping ports, etc. Margin improvement: Mainly concentrated in some resource industries (chemical products, agrochemicals, industrial metals, minor metals), food and beverage (beverages dairy products, snacks, seasoning and fermentation II), finance (large state-owned banks II, joint-stock banks, city commercial banks II, rural commercial banks II, diversified finance), medium-high-end manufacturing (motors II, power grid equipment, general equipment, rail transit equipment II, engineering machinery, automation equipment, computer equipment, professional engineering, communication services), etc. Slowing down: Mainly concentrated in optional consumption/electronics/necessities/energy sectors, such as optional consumption (automobile parts, motorcycles and others, passenger cars, commercial vehicles, white goods, household appliance parts II, sports II), electronics (components, optical electronics, consumer electronics, electronic chemicals II), necessities (planting, fishing, liquor II, non-liquor, textile manufacturing), energy (chemical raw materials, oil and gas extraction II, oilfield services, electricity, gas II), etc. Continued decline: Mainly includes some resource industries such as crude steel, decorative building materials, coke, etc., the household appliance sector including large appliances, small appliances, kitchen and bathroom appliances, clothing and home textiles, the travel-related aviation airports, tourism retailing II, education, the middle manufacturing sector related to photovoltaic equipment, special equipment, military electronics, as well as forestry II, Shenzhen Agricultural Power Group processing, animal health II, biologics II and other sub-sectors. Low-level volatility: Some industries continue to hover at the bottom in terms of profit growth in the third quarter, including the new energy industry chain, which is under pressure from price wars and cost reduction measures, coupled with ongoing oversupply issues, infrastructure and real estate chains, and some media and pharmaceutical industries. Supply side: Inventory cycle: The active restocking efforts have been weak since the end of last year, and the third quarter report shows a slowdown in restocking pace. At the industry level, industries that are actively restocking currently mainly include TMT, cyclical sectors, and some consumer pharmaceutical areas. It is recommended to focus on industries that are actively restocking and have relatively complete inventory clearance, with strong potential for profit improvement in the future, such as TMT, and some sub-sectors in the consumer pharmaceutical area like consumer electronics, communication equipment, computer equipment, engineering machinery, semiconductors, automotive parts, livestock industry, beverages and dairy products. Capacity cycle: Since 2023 Q3, the year-on-year growth rate of projects under construction by A-share non-financial listed companies has been trending downward, with Q3 non-financial capital expenditure growth already at a low of 4.8% in the past ten years, with limited scope and time for further decline expected. With the gradual manifestation of policy effects next year, corporate profits are expected to return to an upward trajectory, and this round of capacity contraction is expected to reach a turning point. At the industry level, most industries have seen a continuous decline or slowdown in capital expenditure growth since the middle of last year, with only the information technology sector still expanding. Industries with capital expenditure growth rates below the 30th percentile for two consecutive periods and showing signs of recovery mainly include semiconductors, components, batteries, aerospace equipment, kitchen and bathroom appliances, cement, feed, etc., and are expected to be the first to end the capacity contraction period. Combined with the continuous downward trend in the inventory-sales ratio and below the same period last year, it is recommended to focus on precious metals and chemical products in the resource sector, general/rail/transit/automation equipment in the machinery sector, and breeding and food processing in the agricultural and animal husbandry food and beverage field to seize the opportunity for capacity clearance. Demand side: Profit growth and gross profit margin: Looking at the trend of net profit growth and gross profit margin, areas where profitability is improving include industrial metals, precious metals, and chemical products in the resources sector; feed, livestock industry, white goods, seasoning and fermentation, textile manufacturing, e-commerce, medical beauty in the consumer services sector; automotive parts, shipping ports, aviation airports, engineering machinery in the midstream manufacturing sector; computer equipment, communication equipment, semiconductors, optical electronics in the TMT sector; and securities, insurance, environmental management in other areas. Contract liabilities: In the major industries, the year-on-year growth rate of financial and real estate contract liabilities in the third quarter expanded, the year-on-year growth rate of medical healthcare contract liabilities turned positive, and the year-on-year decreases in contract liabilities in resource, consumer services, and public utilities were all larger than in the second quarter.Narrowing. In the first-tier industries, the contract liabilities of automobiles, non-ferrous metals, pharmaceuticals, biotechnology, national defense and military industry, machinery, utilities, and non-banking sector have increased at a higher rate, and compared to the second quarter, they are expected to increase and thicken future profits.Cash Flow: Free cash flow ratio: The higher the return rate of free cash flow, the more free cash is available for acquisitions, reinvestments, debt repayments, or for increasing shareholder returns through buybacks and dividends after meeting sustainable development needs in the industry. Looking at major industries, the ratio of free cash flow (TTM) to total market value is as follows: resources > consumer services > healthcare > TMT > midstream manufacturing > utilities. Industries with higher free cash flow return rates are mainly concentrated in the upstream and downstream industries such as resources and consumer services, while the midstream manufacturing industry is constrained by capital expenditure and operating costs, leading to relatively lower free cash flow return rates. Areas expected to benefit from debt restructuring to improve cash flow: construction (larger proportion of government-owned construction companies), environmental protection (water treatment, solid waste management, etc.), and computer (government IT services) with more downstream government clients, a high proportion of accounts receivable and recent improvements, or significantly benefiting from increased debt restructuring efforts resulting in subsequent cash flow and profit increases. Three-tier recommendations based on financial indicators: 1) Industries expected to continue to prosper include high-end manufacturing sectors such as semiconductors, computer equipment, communication equipment, automotive parts, and automation equipment under the influence of industrial trends and cyclical recovery; securities and insurance benefiting from the revival of the capital market and their own fundamental improvements; e-commerce, general retail, breeding industry, home appliances, etc., benefiting from the recovery of consumer spending trends. 2) Industries expected to reverse their difficulties can be seen in sectors with low capital expenditure growth rates and continuous decline in inventory turnover, such as precious metals and chemicals in the resources sector, general/rail/transit/automation equipment in the machinery sector, and farming and food processing in the agriculture and food and beverage sectors. In addition, the inflection point of computer equipment is emerging, pending further confirmation; 3) Cash cow industries, including parts of the energy and consumer sectors with higher free cash flow ratios, and industries expected to benefit from debt restructuring leading to cash flow and profit improvements such as construction, environmental protection, and computer industries. Risk warning: policy changes, macroeconomic fluctuations.