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Asia Machinery-Finding an Ultimate Survivor on the Battlefield

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Asia Machinery-Finding an Ultimate Survivor on the Battlefield Industrials Asia June 2011 This page has been left intentionally blank 1 Industrials Asia June 2011 Peer snapshot Asia construction machinery players: peer comparison Sany Heavy Lonking Zoomlion Doosan Infracore Ticker 600031 CH 3339 HK 1157 HK 042670 KR Currency RMB HKD HKD KRW Share price* 17.00 3.87 17.28 22,000 Market cap* 129,093m 16,564m 102,529m 3,708b Market cap* (USDm) 19,916 2,217 13,166 3,424 Rating Overweight (V) Neutral Neutral (V) Overweight (V) Valuation method PE PE PE PE Target multiple 16.3x 9.5x 13.6x 10.9x Vs 5yr sector average 20% premium 30% discount No discount 20% discount 2011 EPS RMB 1.38 RMB 0.37 RMB 1.13 KRW 2,513 Target price RMB22.5 HKD4.2 HKD18.4 KRW27,000 Potential return 35% 11% 8% 23% Key businesses Product mix – Excavator 18% 16% 2% 63% – Wheel loader - 69% - - – Crane 12% - 34% - – Concrete Machinery 53% - 44% - – Others 17% 14% 19% 37% Region – Domestic 94% 95% 95% 39% – Exports 6% 5% 5% 61% Plants in China Changsha, Huayin Kunshan, Shanghai, Zhengzhou, Longyan – Location Yuanjiang, Changde Yantai, Suzhou Shanghai, Beijing Shanghai Shanghai (Wheel loader) 48,000 (Concrete) 15,060 (Excavator) 29,200 – Capacity (Excavator) 30,000 (Excavator) 8,000 (Crane) 10,100 (Wheel loader) 6,000 (Forklift) 20,000 (Excavator) 3,000 Key Component supplier Cummins, Deutz, In-house, Cummins, – Diesel Engine Cummins, Deutz Cummins, Weichai Weichai Yanma – Valve Rexroth, Kawasaki Kawasaki, Rexroth Partially in-house KYB – Pump Kawasaki Kawasaki, Rexroth Kawasaki, Rexroth In-house – Motor Nabtesco Nabtesco, Rexroth Nabtesco, Rexroth In-house – Cylinder Partially in-house Partially in-house Partially in-house Dongyang Mechatronics Sales Network – Number of dealers 42 main dealers 286 sales outlet 548 (self-owned) outlet 38 main dealers Covering all the Additional 410 third-party – Network strategy by province by province provinces dealers’ outlet Pricing – Excavator (20-25 ton) RMB 880k RMB 840k RMB 800k RMB 800-820k – Wheel loader (5 ton) - RMB 230k - RMB 230k Leasing policy – Leasing sales mix 60% 36% 34% 15% – Financial leasing receivable holder Parent company Listed company Listed company Listed company *Priced as of 15 June 2011 Note: (V) = volatile (please see disclosure appendix) Source: Company data, Bloomberg, HSBC 2 Industrials Asia June 2011 Rationale for valuation and SWOT analysis Sany Heavy Lonking Zoomlion Doosan Infracore Market Positioning by product Segment Outlook _______________________________________Market Positioning _______________________________________ Major player (No. 2 market Major player (No. 4 market Excavator Strong Marginal player Marginal player share of 11.1%) share of 10.2%) Market leader (No. 1 market Major player (No. 2 market Concrete Machinery Strong - - share of 20%) share of 19%) Major player (No. 3 market Major player (No. 2 market Crane Neutral - - share of 8%) share of 24%) Market leader (No. 1 market Wheel Loader Weak - Marginal player Marginal player share of 18%) Valuation summary PE 2011e 12.3 8.8 12.7 8.8 2012e 9.9 7.8 10.6 7.7 EPS growth 2011e 24.5 -6.3 18.0 NM 2012e 24.6 12.3 19.9 14.0 PB 2011e 5.1 2.1 2.5 2.0 2012e 3.8 1.7 2.1 1.6 ROE 2011e 51.5 27.9 21.3 27.0 2012e 45.6 25.4 21.4 23.3 Revenue growth 2011e 46.7 14.5 34.9 13.7 2012e 28.0 14.5 28.2 4.0 Net Margin 2011e 15.4 12.0 14.8 8.6 2012e 15.0 11.7 13.8 9.4 Valuation rationale Target multiple 16.3x 9.5x 13.6x 10.9x Vs 5yr sector average 20% premium 30% discount No discount 20% discount MWell positioned, gaining MHigh dependence on MDiversified product line-up MHigh exposure to share in Chinese wheel loaders Valuation rationale MModerate growth and excavator market excavator market MModerate growth and margin MLow growth and margin MHigh growth high margin margin SWOT analysis MOffering diversified MStrong exposure to MOffering Diversified construction machinery excavator market in construction machinery M products China products Top wheel loader player in China MTop player in truck crane MFirst-mover advantage in MHigher exposure to Strengths M market China and brand concrete machinery and Strong cost control & M recognition excavator segments highest margin among State owned company: top wheel loader makers Majority shareholder is MPotentially to leverage its MFinancial leasing offered Hunan Provincial US market exposure by parentco, not listco People's Government through Bobcat MCannot boost sales MHigh dependency on the MHigh dependence on MRelatively high exposure through financial leasing government policy Wheel loader at 69% to crane segment Weaknesses due to high debt ratio MHigh exposure to fossil MHigher sales portion from MLatecomer in fast-growing MWeaker financial stability fuel price financial leasing excavator market from Bobcat acquisition M Strong candidate to MAfter market parts sales become No. 1 in foreign MAggressive sales MSeeking growth from to derive stable margins dominated excavator promotion of excavators excavators Potentially to boost sales Opportunities market MPotential disposal of MOverseas expansion volume via financial MOverseas expansion by financial leasing business through CIFA leasing building plants in ma to improve cash flows M markets Recovery of US market MForeign brands entering MIndustry competition and into matured wheel MMore competitive crane MHigh gearing ratio slowdown = potential loader market market preventing capacity pressure on strong M Margin and balance sheet M expansion + R&D Threats capacity expansion at risk due to high Overseas business recovery is slow (i.e MStrong competition from MLow brand recognition in financial leasing = Europe especially Italy) local brands in China overseas market negative operating cash MMacro tightening in China MMacro tightening in China MMacro tightening in China flow MMacro tightening in China Source: Company data, Bloomberg, HSBC 3 Industrials Asia June 2011 Investment summary Machinery companies have enjoyed a cyclical sector boom over the past few years in China, but growth has yet to slow before the mature stage of the industry life cycle Aggressive industry-wide capacity expansion will likely outpace demand and weigh on overall profitability We initiate with an Overweight (V) on Sany Heavy and Doosan Infracore, Neutral on Lonking, and Neutral (V) on Zoomlion Cyclically off the downhill Many machinery companies have benefited from the construction machinery sector’s strong growth during the past few years in China. Property, mining and infrastructure FAI played a key role in driving industry demand. While China focuses on moving towards a consumption-driven economy over the long term, we continue to believe FAI will be the key to achieve its target GDP. Nevertheless, we believe that the construction machinery industry in China has reached the end of its growth stage, assuming it follows a four-stage industry life cycle. During the growth stage, several leaders in the industry have surfaced and become more stable, and market share gains can now be envisaged. As the industry benefits from strong FAI, the industry is still growing faster than the rest of economy, but we expect growth to slow before the market matures. The recent spate of government-driven FAI has created opportunities for the Chinese machinery sector to develop rapidly. The boom in property and infrastructure has rewarded many firms with high profit margins and this, in turn, has encouraged existing players as well as new entrants to invest their profits in further expansion. However, the strong growth cannot be sustained indefinitely. Fast-expanding capacity the biggest concern Our biggest concern for sector is its fast-expanding production capacity. In 2010 and 2011, all producers benefited from the demand recovery, as the leading machinery companies had not increased their production capacity during the financial crisis in 2008-2009. Most Chinese construction machinery companies began aggressively expanding their excavator capacity and distribution networks from 2010, resulting in overcapacity from 2012. We think this aggressive capacity expansion could lower the overall profitability of the industry; higher competition will increasingly affect sales promotion, product prices, and margins. For example, we expect total excavator capacity to reach 412k units by 2012 (versus 197k units in 2010), 77% higher than industry demand, at 233k units. Therefore, we urge investors to be more 4 Industrials Asia June 2011 selective and identify an ultimate survivor in this battlefield. Aggressive capacity expansion is likely to bring this industry from its growth stage to maturity. From a long-term perspective, even though we expect further growth in the construction machinery sector, driven by increased FAI, we believe that what is now a pure growth industry will become cyclical depending on macro policies and industry capacity. We believe China’s relatively low urbanization will drive construction machinery demand further, as its ratio remains below 50% versus that of developed countries at above 80%. Despite the government’s push to make the Chinese economy more consumer-driven, this is a long-term change, and China’s per capital FAI is still lower than that of developed countries globally. We believe the industry will continue to see further growth; however, it is uncertain whether machinery companies can continue to enjoy higher margins without this translating into higher stock prices and stock multiples. The peak of the cycle could come either in 2011 or 2012 in terms of earnings, growth rates and share prices. Therefore, we see more room for upside selectively for companies making market share gains as opposed to companies growing below industry average. To decide where we are in the current cycle, we should look at macroeconomic indicators as well as industry-wide capacity expansion plans, utilisation rates, and industrial conditions (PMI). All these indicators were at their bottoms in 2009 and have seen a strong recovery in 2010 and y-t-d 2011.
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