Asia Pacific Equity Research 13 August 2018
China Power Equipment Bigger, Greener & More Reliable: Key Picks within China's Power equipment sector (Ex A-shares)
We initiate coverage of the power equipment sector with a preference for China Transmission & Distribution (T&D) equipment suppliers over generation Infrastructure & Industrial equipment suppliers. We see growth in grid investments accelerate to 14-15% AC Patrick Xu, CFA growth p.a. in 2019-20 from -1% in 2017 driven by China’s need of a bigger, (852) 2800 8577 greener and reliable power grid, while generation investments could decline. [email protected] Bloomberg JPMA PXU
Equity Ratings and Price Targets Mkt Cap Price Rating Price Target Company Ticker ($ mn) CCY Price Cur Prev Cur Prev Shanghai Electric Group Company Limited - H 2727 HK 4,839.68 HKD 2.58 N — 2.50 — Dongfang Electric Corporation Limited - H 1072 HK 1,874.19 HKD 4.76 N — 4.80 — Source: Company data, Bloomberg, J.P. Morgan estimates. n/c = no change. All prices as of 13 Aug 18. See page 45 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan 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.
www.jpmorganmarkets.com Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Shanghai Electric Group Company Limited - H Neutral Elevator is the largest earnings contributor 2727.HK,2727 HK We initiate coverage of Shanghai Electric-H with a Neutral rating and DCF-derived Price: HK$2.58 Jun-19 PT of HK$2.50, implying 3% downside potential. We also initiate coverage Price Target: HK$2.50 of Shanghai Electric-A with an Underweight rating and DCF-derived Aug-19 PT of RMB2.20, implying 58% downside potential. The company is an industrial China conglomerate engaged in the manufacturing of elevators, power equipment and Infrastructure & Industrial electromechanical components. Patrick Xu, CFA AC (852) 2800 8577 Company background: The company was incorporated in 1985 in Shanghai [email protected] consolidating then Shanghai Motor Factory, Shanghai Steam Turbine Factory, Bloomberg JPMA PXU
Shanghai Electric Group Company Limited - H (Reuters: 2727.HK, Bloomberg: 2727 HK) Company Data Rmb in mn, year-end Dec FY16A FY17A FY18E FY19E FY20E Shares O/S (mn) 14,725 Revenue (Rmb mn) 79,078 79,544 81,533 82,449 84,862 Market Cap (Rmb mn) 33,135 Net Profit (Rmb mn) 2,060 2,660 2,627 2,590 2,656 Market Cap ($ mn) 4,840 EPS (Rmb) 0.15 0.18 0.18 0.18 0.18 Price (HK$) 2.58 DPS (Rmb) 0.00 0.09 0.08 0.08 0.09 Date Of Price 13-Aug-18 Revenue growth (%) 1.4% 0.6% 2.5% 1.1% 2.9% Free Float(%) - EPS growth (%) (8.7%) 23.0% (1.2%) (1.4%) 2.6% 3M - Avg daily vol (mn) 10.96 ROCE 6.7% 7.2% 6.3% 6.1% 6.0% 3M - Avg daily val (HK$ mn) 30.70 ROE 5.0% 5.3% 4.7% 4.5% 4.5% 3M - Avg daily val ($ mn) 3.9 P/E (x) 15.3 12.5 12.6 12.8 12.5 HSCEI 1,0943.08 P/BV (x) 0.7 0.6 0.6 0.6 0.6 Exchange Rate 7.85 Dividend Yield 0.0% 4.0% 3.8% 3.7% 3.8% Fiscal Year End Dec Source: Company data, Bloomberg, J.P. Morgan estimates. Price Target End Date 30-Jun-19
2 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Key catalysts for the stock price: Upside risks to our view: Downside risks to our view: 1. Further industry consolidation through M&As; 1. Stronger-than-expected demand for 1. Weaker-than-expected demand for power 2. Relaxation of purchasing restrictions on power generators; generators; property; 2. Stronger-than-expected demand for 2. Weaker-than-expected demand for elevators; 3. Trade frictions that discourage imports of elevators; 3. Lower-than-expected earnings from JVs offering automation products. 3. Higher-than-expected earnings from JVs automation products. offering automation products.
Key financial metrics FY17A FY18E FY19E FY20E Valuation and price target basis Revenues (LC) 79,544 81,533 82,449 84,862 The stock trades 13x FY19E P/E vs Chinese peers' average of 18x. Our TP Revenue growth (%) 1% 3% 1% 3% is derived from DCF valuation and implies 13x FY19E P/E. EBITDA (LC) 8,139 8,964 9,069 9,271 EBITDA margin (%) 10% 11% 11% 11% Tax rate (%) 9% 14% 14% 14% Net profit (LC) 2,660 2,627 2,590 2,656 EPS (LC) 0.19 0.18 0.18 0.18 EPS growth (%) 22% -6% -1% 3% P/E chart DPS (LC) 0.09 0.08 0.08 0.09 BVPS (LC) 3.77 3.86 3.95 4.05 Operating cash flow (LC mn) (7,525) 1,986 2,795 2,225 Free cash flow (LC mn) (11,852) (990) 196 (269) Interest cover (X) 16.0 13.6 12.8 12.3 Net margin (%) 3.3% 3.2% 3.1% 3.1% Sales/assets (X) 0.42 0.40 0.40 0.40 Debt/equity (%) 28% 27% 28% 27% Net debt/equity (%) -53% -49% -24% -21% ROE (%) 5.3% 4.7% 4.5% 4.5% Key model assumptions FY17A FY18E FY19E FY20E Revenue growth (%) 0.6% 2.5% 1.1% 2.9% Gross profit margin (%) 22.8% 24.0% 23.9% 23.7%
Source: Bloomberg, Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates.
Sensitivity analysis EBITDA EPS JPMe vs. consensus, change in estimates Sensitivity to FY18E FY19E FY18E FY19E EPS FY18E FY19E 1ppt chg in revenue growth -3% -6% -4% -10% 1ppt chg in GPM -3% -6% -4% -10% JPMe 0.18 0.18 % chg N/A N/A Consensus 0.17 0.17 Source: Bloomberg, Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates. Comparative metrics CMP Mkt Cap P/E PEG P/BV YTD LC $Mn FY18E FY19E FY18E FY19E FY18E FY19E Stock perf. Shanghai 2.6 10,152 12.6 12.8 23.0 3.8 0.0 0.0 -19.9 Electric-H Nari 16 10,468 18.6 16.2 1.3 2.0 3.1 2.8 -14.4 Technology Hongfa 21.4 2,330 18.6 16.2 1.3 2.0 3.1 2.8 -27.4 Technology Dongfang 4.8 3,148 17.1 17.4 6.9 0.8 0.6 0.5 -24.6 Electric-H TBEA 6.9 3,718 13.2 11.1 0.5 0.8 0.8 0.8 -30.8 General 192.6 57,055 17.3 15.5 13.3 12.2 4.4 3.8 -5.3 Electric Siemens 111 107,909 16.4 14.6 13.5 10.9 1.9 1.8 -4.7 Source: Bloomberg, Company and J.P. Morgan estimates. Prices are as of 10/08/2018.
3 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Corporate history and major shareholders The company was incorporated in 2004 with its main operating assets injected by the majority shareholder - Shanghai Electric (Group) Corporation. Shanghai Electric (Group) Corporation in turn was incorporated in 1985 consolidating Shanghai Motor Factory, Shanghai Steam Turbine Factory, Shanghai Boiler Factory, Shanghai Power Station Auxiliary Machinery Factory and etc. The company made the IPO in HK in 2005 and was listed in Shanghai through an RTO in 2008.
Figure 1: Company key events The majority shareholder of the company, Shanghai Listed in Hong Kong Completed Electric Group, was Stock Exchange in Fangcheng nuclear incorporated in 1985 2005 power plant in 2015
Shanghai Electric Listed in Shanghai was incorporated in Stock Exchange 2004 with its main through an RTO in operating assets 2008 injected by Shanghai Electric Group
Source: Company data.
The company is an SOE, with Shanghai Electric (Group) Corporation as the direct controlling shareholder (61%) and Shanghai SASAC as the ultimate controlling shareholder (64%) as of end FY17.
Figure 2: Shareholding structure, Shanghai Electric
SASAC
100% 100%
Shanghai Electric Shenergy Group Co (Group) Corporation Ltd
59% 100% 3%
Shanghai Electric Sarasin & Partners Group HK Co Ltd LLP
2% 1%
Shanghai Electric Group Co Ltd (2727 HK)
Source: Company data.
4 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Management profile Three of the four non-independent board directors spent most of their careers with various entities owned by Shanghai SASAC. None of the board directors held shares of the company or options to such shares as of end FY17. There's no equity incentive for the management.
Table 1: Management profile, Shanghai Electric
Worth of Remuneration Name Age Title Profile shares (USD) (USD) Mr. Zheng Jianhua is currently Chairman of the Board and Chief Executive Officer Chairman and Chief of the Company and performs duties on behalf of the president. He is also the Zheng Jianhua 57 Executive Officer chairman of Shanghai Electric (Group) Corporation. - 118,493 Mr. Zhu Kelin is currently the vice chairman of the Company and a non-executive Director of the Board. Mr. Zhu graduated from Western Sydney University with a Zhu Kelin 55 Vice Chairman master degree in business administration. - - Mr. Chen Ganjin Is currently a vice president of the Company. Mr. Chen obtained a bachelor degree in Engineering, a master degree in business administration from China Europe International Business School and a master's degree in professional Chen Ganjin 49 Vice President accounting from The Chinese University of Hong Kong. - 100,665 Mr. Hu Kang joined the Company in April 2013 and is currently the chief financial officer of the Company, the chairman of the supervisory committee of Shanghai Chief Financial Mechanical and Electrical Industry Co., Ltd., and the chairman of Shanghai Electric Hu Kang 54 Officer Group Finance Co., Ltd. - 112,653 Ms. Li Jing joined the Company in March 2004 and is currently the chief information officer and head of the information management department of the Company. She Chief Information obtained a bachelor's degree in computer engineering and a master's degree in Li Jing 50 Officer accounting. 1,235 132,633 Ms. Tong Liping joined the Company in March 2004 and currently serves as the Tong Liping 46 Chief Legal Officer chief legal officer, head of the legal affairs department and solicitor of the Company. - 115,727 Secretary to the Ms. Fu Rong joined the Company in June 2005 and is currently the secretary to the Fu Rong 47 Board Board, secretariat director of the Board of the Company. - 106,045 Mr. Li Chung Kwong Andrew is currently the company secretary and head of the Li Chung Kwong investor relations department of the Company. He is a fellow member of The Hong Andrew 58 Company Secretary Kong Institute of Certified Public Accountants. - 169,057 Source: Company data, Bloomberg, priced as of 31/12/2017
Main businesses The company’s businesses are grouped under four segments. Industrial Equipment and High Efficiency & Clean Energy Equipment are the two main segments and accounted for 71% of the gross profit in FY17.
5 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 3: Gross profit mix by products 60%
50%
40%
30%
20%
10%
0% 2014 2015 2016 2017 2018E 2019E 2020E Industrial equipment High efficiency & clear energy equipment Mordern service business New energy & environmental protection
Source: Company data, J.P. Morgan estimates.
Industrial equipment The segment is mainly engaged in 1) the manufacturing and servicing of elevators, 2) the design and manufacturing of industrial components, 3) the design, manufacturing and commissioning of automation components & systems, and 4) the manufacturing of electric motors.
Figure 4: Industrial equipment, Shanghai Electric Passenger elevators Elevators (products & services) Moving sidewalks t
n AC & DC motors e
m Electric motors p i
u Power generators q e
l a i
r Transportation t
s monitoring system u
d Automation (components & systems) n I 3D printing equipment
Robot Assembly Cell Industrial components Seawater Desalination
Source: Company data.
We expect the segment’s gross profit growth to be primarily driven by automation products such as CNC control systems, servo drive device and smart controller. We
6 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
project 10-12% growth p.a. in the revenue from elevator services in FY18-20E driven by the installed base of elevators in China while we’re more cautious on elevator product sales because we expect little growth in property completion.
Table 2: Gross profit forecast of Industrial Equipment, Shanghai Electric
2015 2016 2017 2018E 2019E 2020E Revenue breakdown Industrial equipment 23,945 32,415 33,570 35,790 37,544 39,517 Elevators - products 13,524 13,552 13,324 13,756 13,483 13,126 Elevators - services 4,088 4,500 5,200 5,832 6,462 7,092 Electric motors 2,196 2,013 2,046 2,046 2,046 2,046 Automation 1,781 1,442 2,416 3,141 4,083 5,308 Components 546 7,785 8,637 9,069 9,522 9,998 Others 1,810 3,123 1,947 1,947 1,947 1,947
Revenue y/y Industrial equipment -8% 35% 4% 7% 5% 5% Elevators - products -2% 0% -2% 3% -2% -3% Elevators - services 17% 10% 16% 12% 11% 10% Electric motors -17% -8% 2% 0% 0% 0% Automation 10% -19% 68% 30% 30% 30% Components -34% 1326% 11% 5% 5% 5% Others -50% 73% -38% 0% 0% 0%
Gross margin breakdown Industrial equipment 21% 22% 20% 20% 20% 20% Elevators 21% 21% 21% 21% 21% 21% Electric motors 21% 23% 20% 20% 20% 20% Automation 21% 23% 20% 20% 20% 20% Components 21% 23% 20% 20% 20% 20% Others 19% 20% 12% 12% 12% 12% Source: Company reports and J.P. Morgan estimates.
We’re bullish on the automation sector in China driven by strong support from the government, rising labor costs and increasing need for customization. Our meetings with companies and experts in the industry in mid-May on the back of J.P. Morgan China Summit reaffirmed our bullish view on automation spend in China (China Industrial Ecosystem: China Summit & Industrial Tour Takeaways: Shifts & new transformations of China's old economy, Karen Li and the team, 16 May, 2018). Our forecast of 30% revenue growth p.a. in FY18-20E is in line with our revenue forecast of the key players in the industry such as Inovance (300124 CH, OW).
7 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 5: China industrial robots sales – 2016 vs 2020E Units sold 120,000 2016-20E CAGR 39% 2016-20E CAGR 14% 100,000
80,000
60,000
40,000
20,000
- Domestic Foreign 2016 2020E
Source: IFR, China’s robotics industry development plan and J.P. Morgan estimates.
We expect flattish revenue from elevator product sales in FY18-20E because we think continued market share gain will probably be negated by declining ASP. We project the segment’s gross margin to remain at 21% in FY18-20E as declining manufacturing margin is offset by increased contribution from the higher-margin service business.
8 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 3: Elevator forecast, SHE
Unit 2015 2016 2017 2018E 2019E 2020E Revenue breakdown RMB mn Elevators - products 13,524 13,552 13,324 13,756 13,483 13,126 Elevators - services 4,088 4,500 5,200 5,832 6,462 7,092 Revenue y/y Elevators - products -2% 0% -2% 3% -2% -3% Elevators - services 17% 10% 16% 12% 11% 10% Gross margin breakdown Elevators 21% 21% 21% 21% 21% 21% Sales volumes Elevators Units 61,898 69,079 75,600 86,878 94,789 102,718 ASP RMB Elevators 218,488 196,181 176,243 158,332 142,240 127,785 y/y -7% -10% -10% -10% -10% -10%
Property completion 10,000 sqm 100,039 106,128 101,486 106,560 106,560 106,560
Elevator production Units 760,000 776,000 746,433 780,703 781,560 782,426 Elevator imports Units 1,739 2,097 2,567 2,695 2,695 2,695 Elevator exports Units 74,101 76,380 77,974 78,822 79,678 80,544 Elevator demand Units 687,638 701,717 671,026 704,577 704,577 704,577 Elevator installed base Units 4,259,600 4,936,900 5,582,509 6,260,669 6,937,830 7,613,990 Replacement Units 26,538 24,417 25,417 26,417 27,417 28,417 Demand / property finished Units/mn sqm 687 661 661 661 661 661 Market share Elevator 8% 9% 10% 11% 12% 13%
Service revenue per elevator installed RMB 960 912 931 931 931 931 Source: Wind, Company reports and J.P. Morgan estimates.
There were close to 700 elevator manufacturers in China as of end 2017. The company’s market share rose to 10% in FY17 from 8% in FY15 by volumes in China. We expect the company to continue gain market share with strong clients recognition.
19% of the respondents to a survey conducted by China Real Estate Association in March 2018 voted Mitsubishi as their first choice brand of elevators, ranking number one among the main competitors for the eighth consecutive year.
9 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 6: Market share by volume in China, Shanghai Mitsubishi Table 4: First choice of elevator brand, China 14% Rank Brand % as first choice 13%
12% 1 Mitsubishi 19% 11% 10% 2 Hitachi 18% 9% 8% 3 Kone 14% 7% 6% 4 ThyssenKrupp 11% 2014 2015 2016 2017 2018E 2019E 2020E
Source: Wind, Company reports and J.P. Morgan estimates. 5 Otis 9% Source: Shanghai Elevator Trade Association.
We expect the competition to heat up as demand growth stalls and ThyssenKrupp (TKA GY, N) adds 50,000-unit capacity in Shanghai. The new plant is slated to commence production after Aug 2018. The 50,000-unit capacity represents 7% of the total production in China in 2017 which outpaces our projection of 5% demand growth in 2018. Therefore, we think the manufacturing gross margin of elevators will remain under pressure in 2018-20.
The company doesn’t break down the elevator gross margin by manufacturing and services. However, the fact that the overall elevator gross margin remained flattish in FY15-17 despite increased contribution of the higher-margin services revenue implies that the manufacturing gross margin probably declined over the same period. We expect increased contribution of services revenue in FY18-20E to offset the impact from the declining manufacturing margin and keep the overall gross margin stable.
Figure 7: Elevator, SHE 40% 35% 30% 25% 20% 15% 10% 5% 0% 2014 2015 2016 2017 2018E 2019E 2020E Gross margin - elevator manufacturing & services Services % total elevator sales
Source: Company reports and J.P. Morgan estimates.
New energy and environmental protection equipment The segment is mainly engaged in 1) the design and manufacturing of wind turbines, 2) EPC of environment protection projects and sales of related equipment, and 3) the manufacturing of nuclear island equipment.
10 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 8: New energy & environmental protection equipment, Shanghai Electric
n o i Water treatment t c e t Environmental protection o r equipment p
l a
t Sludge treatment n t e n m e n m o
r Wind turbines p i i v u n q e e
&
Steam generator y g r
e Nuclear island equipment n e
w
e Pressurizer (PRZ) N
Source: Company data.
We expect the segment’s gross profit growth to be primarily driven by the sales of wind turbines in FY18-20E, because we forecast China’s total wind power investment to rebound 6% in FY18E and 15% in FY19E.
11 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 5: Gross profit forecast of New Energy & Environmental Protection, Shanghai Electric
2015 2016 2017 2018E 2019E 2020E Revenue breakdown New energy & environmental protection 12,092 13,392 11,018 12,825 15,054 17,756 Wind turbines 7,625 8,664 6,557 7,560 9,472 11,510 Nuclear island equipment 1,865 2,090 1,032 1,342 1,085 1,085 Environmental protection equipment 2,182 2,217 3,087 3,581 4,154 4,818 Others 420 421 342 342 342 342
Revenue y/y New energy & environmental protection 24% 11% -18% 16% 17% 18% Wind turbines 45% 14% -24% 15% 25% 22% Nuclear island equipment 3% 12% -51% 30% -19% 0% Environmental protection equipment 8% 2% 39% 16% 16% 16% Others -37% 0% -19% 0% 0% 0%
Gross margin breakdown New energy & environmental protection 10% 14% 15% 15% 14% 14% Wind turbines 5% 14% 12% 12% 12% 12% Nuclear island equipment 27% 10% 35% 35% 35% 35% Environmental protection equipment 15% 23% 15% 15% 15% 15% Others 0% 4% 7% 8% 9% 10% Source: Company reports and J.P. Morgan estimates.
High efficiency and clean energy equipment The segment is mainly engaged in the manufacturing of coal-fired power generation equipment, gas turbines and Power Transmission & Distribution (PTD) equipment. The company is largest supplier of coal-fired power generators in China.
12 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 9: High efficiency & clean energy, Shanghai Electric
Coal - Fired power
Fired power generation
n a
t Gas turbines - Fired power e l n c e
& m
PTD Equipment (Power p y i transmission & distribution) c u n q e i e
c Desulfurization, denigration i y f g f & dust removal r e
e h n g e i H
Non- PTD Equipment Solar Energy
Overall smart grid
Source: Company data.
We expect the segment’s revenue to decline 5-10% p.a. in FY18-20E mainly due to declining investments in thermal power generation, though we think the revenue from PTD should grow over the same period.
We think the gross margin of thermal power equipment will likely remain stable at 16% in FY18-20E because the market in China has consolidated to an oligopoly among Dongfang Electric (1072 HK, N/600875 CH, UW), Harbin Electric (1133 HK, NC) and the company.
13 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 6: Forecast of High Efficiency & Clean Energy Equipment, SHE
Unit 2015 2016 2017 2018E 2019E 2020E Revenue breakdown RMB mn High efficiency & clean energy equipment 28,697 28,104 26,174 24,783 22,303 20,367 Thermal power equipment 20,879 20,760 18,627 16,721 13,117 9,760 PTD equipment 7,818 7,344 7,547 8,062 9,186 10,607 Revenue y/y High efficiency & clean energy equipment 0% -2% -7% -5% -10% -9% Thermal power equipment 0% -1% -10% -10% -22% -26% PTD equipment 0% -6% 3% 7% 14% 15% Gross margin breakdown High efficiency & clean energy equipment 17% 17% 15% 15% 14% 13% Thermal power equipment 17% 17% 16% 16% 16% 16% PTD equipment 17% 16% 12% 11% 10% 9%
Thermal power investment RMB bn 116 112 74 64 48 35 State Grid & South Grid investments RMB bn 519 574 567 606 690 797 Market share Thermal power equipment 18% 19% 25% 26% 27% 28% PTD equipment 1.3% 1.1% 1.3% 1.3% 1.3% 1.3% Source: Wind, Company reports and J.P. Morgan estimates.
Modern services The segment is mainly engaged in power plant engineering and services, integrated transmission & distribution engineering, financial services and others, which derived from the manufacturing businesses of the company.
Figure 10: Modern services, Shanghai Electric
Power plant engineering (projects & services)
Power engineering
Power transmission & distribution s
e (projects) c i v r e S
n r
e Insurance brokers d o M
Financial services Financial consulting & leasing
International trade
Source: Company data.
14 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
We forecast the engineering & services revenues as a percentage to the power equipment revenues of the company and expect 10-16% revenue growth p.a. in FY18-20E driven by equipment sales in the High Efficiency and New Energy segments. We project financial services revenue as a percentage to the company’s cash balance which yielded 3.8-5.7% a year in FY15-17.
Table 7: Modern Services forecast, SHE
2015 2016 2017 2018E 2019E 2020E Revenue breakdown Modern service business 17,824 17,842 13,664 14,971 13,251 12,839 Power plant engineering 7,657 8,530 6,469 7,587 6,953 6,947 Power plant services 1,900 2,300 1,988 2,332 2,137 2,135 Integrated T&D engineering 2,513 1,691 1,755 2,058 1,886 1,885 Financial services 1,696 1,543 1,962 1,682 1,473 1,471 Others 4,058 3,778 1,490 1,311 802 402 Revenue y/y Modern service business -2% 0% -23% 10% -11% -3% Power plant engineering -23% 11% -24% 17% -8% 0% Power plant services 7% 21% -14% 17% -8% 0% Integrated T&D engineering 12% -33% 4% 17% -8% 0% Financial services 14% -9% 27% -14% -12% 0% Others 55% -7% -61% -12% -39% -50% Gross margin breakdown Modern service business 15% 17% 24% 24% 24% 24%
Financial services % cash balance 5.7% 3.8% 4.5% 4.5% 4.5% 4.5%
% of High Efficiency & New Energy revenues Power plant engineering 19% 21% 17% 17% 17% 17% Power plant services 5% 6% 5% 5% 5% 5% Integrated T&D engineering 6% 4% 5% 5% 5% 5% Others 10% 9% 4% 3% 2% 1% Source: Company reports and J.P. Morgan estimates.
Gross profit breakdown by geography 13% of the company’s gross profit in FY17 came from overseas markets such as southeast Asia, south Asia, Middle East, Africa and East Europe. Power plant engineering projects accounted for most of the overseas earnings.
15 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 11: Gross profit by geography, SHE 100% 13% 9% 13% 90% 80% 70% 60% 50% 87% 91% 87% 40% 30% 20% 10% 0% 2015 2016 2017
Mainland China Overseas
Source: Company reports.
Earnings forecast We expect revenue to grow 7-12% p.a. in FY18-20E driven by New Energy Businesses. Revenue from Industrial Equipment should grow at 5-7% p.a. over the same period based on our estimates, driven by automation products.
Table 8: Gross profit forecast by segment, SHE
Segmental breakdown 2015 2016 2017 2018E 2019E 2020E Total revenue 78,009 79,078 79,544 81,533 82,449 84,862 Industrial equipment 23,945 23,769 33,570 35,790 37,544 39,517 High efficiency clear energy 28,697 28,104 26,174 24,783 22,303 20,367 Modern service business 17,824 17,842 13,664 13,139 12,610 12,431 New energy 12,092 13,392 11,018 12,825 15,054 17,756
Revenue y/y 2% 1% 1% 3% 1% 3% Industrial equipment -8% -1% 41% 7% 5% 5% High efficiency clear energy 0% -2% -7% -5% -10% -9% Modern service business -2% 0% -23% -4% -4% -1% New energy 56% 11% -18% 16% 17% 18%
Gross margin (%) 21% 22% 23% 24% 24% 24% Industrial equipment 22% 23% 21% 21% 21% 21% High efficiency clear energy 20% 19% 19% 19% 19% 19% Modern service business 17% 16% 25% 25% 25% 25% New energy 17% 22% 22% 22% 22% 22% Source: Company reports and J.P. Morgan estimates.
We project the company’s EPS to decline by 1% in FY18E driven by increased impairment losses and income tax rate. We think that the company's 9% income tax rate in FY17 was abnormally low and assume 14% for FY18-20E. We expect the company’s EPS to rebound by 3% in FY20 driven by demand for new energy and environment & protection equipment.
16 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 9: Earnings forecast, SHE
RMB mn 2015 2016 2017 2018E 2019E 2020E Total revenue 78,009 79,078 79,544 81,533 82,449 84,862 COGS 78,009 79,078 79,544 81,533 82,449 84,862 Taxes and others (75,186) (75,926) (77,749) (79,520) (80,734) (83,394) Selling expenses (61,322) (61,936) (61,400) (62,004) (62,781) (64,768) Admin expenses (476) (622) (548) (561) (568) (584) Net finance costs (3,127) (3,086) (3,105) (3,183) (3,218) (3,313) Impairment loss (7,802) (7,751) (9,293) (9,526) (9,633) (9,915) Other operating income (191) (182) (510) (661) (710) (755) Operating income 5,012 4,699 5,379 5,594 5,514 5,553 Non-operating income 1,197 784 245 145 45 45 Non-op expenses (77) (39) (96) (96) (96) (96) Earnings before taxes 6,131 5,444 5,529 5,643 5,463 5,502 Income tax expenses (1,288) (1,113) (522) (790) (765) (770) Profit after tax 4,843 4,331 5,006 4,853 4,698 4,732 Minority interest (2,715) (2,271) (2,347) (2,226) (2,108) (2,076) Net profit 2,129 2,060 2,660 2,627 2,590 2,656
EPS (RMB) Basic 0.17 0.16 0.19 0.18 0.18 0.18 Diluted 0.17 0.16 0.19 0.18 0.18 0.18 y/y -17% -6% 22% -6% -1% 3% Source: Company reports and J.P. Morgan estimates.
More than half of the company’s “Operating income” comes from “Other operating income” under the Chinese GAAP. Share of associates and JCEs and financial investment income accounted for most of the “Other operating income” in FY17.
We expect 12-16% growth p.a. in the share of associates and JCEs mainly driven by demand for industrial automation. Shanghai Fanuc is a 50/50% JV between the company and Fanuc (6954 JT, N) engaged in the manufacturing of industrial robots.
Shanghai Fanuc had a net margin of 29% in FY17 and was in net cash. We expect its net profit to grow 30% p.a. in FY18-20E generally in line with our revenue forecasts of other companies in the sector.
17 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 10: Forecast of other operating income, SHE
RMB mn 2015 2016 2017 2018E 2019E 2020E Share of associates & JCEs Ansaldo Energia 28 209 53 53 53 53 Shanghai Fanuc 0 0 485 631 820 1066 Shanghai Fanuc Int'l Trade 0 0 43 43 43 43 Shanghai Mitsubishi Electric 109 87 87 87 87 Shanghai Yileng Carrier Air Conditioning Equipment 136 110 76 66 56 46 Shanghai Schneider Power Distribution 133 112 103 102 101 100 Legend Electric (Shenyang) 19 35 63 73 83 93 Shanghai Siemens Switch 54 39 53 53 53 53 Shanghai Ri Yong-Jea Electric 62 55 45 44 43 42 Shanghai Voith Siemens Hydropower Equipment 15 24 38 39 40 41 Mitsubishi Electric Shanghai Elevator 38 44 32 32 32 32 Other (36) 60 266 287 310 335 Total 449 797 1,342 1,508 1,719 1,989 y/y -16% 77% 69% 12% 14% 16% Other investment income 1,796 751 1,583 1,400 1,400 1,400 Rest of other operating income (56) (2) 659 747 718 709 Other operating income 2,188 1,547 3,585 3,656 3,837 4,098 Source: Company reports and J.P. Morgan estimates.
The company’s EPS was +16% y/y in 1Q18 driven by 20% y/y revenue growth and gains from financial investments under “Other operating income”. 1Q net profit accounted for 23% of our full-year forecast. That is within the historical range of 20- 34% since 1Q08. 1Q on average accounted for 26% of full-year net profit in FY08- 17.
18 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 11: Quarterly income statement
Consolidated annual report 1Q17 restated 1Q18 y/y Total revenue 15,345 18,420 20% Revenue 15,345 18,420 20% Total cost (14,531) (17,532) 21% COGS (11,783) (14,604) 24% Taxes and others (83) (62) -25% Selling expenses (592) (612) 3% Admin expenses (1,764) (1,843) 4% Net finance costs (144) (208) 44% Impairment loss (166) (205) 24% Other operating income 220 343 56% Operating income 1,034 1,231 19% Non-operating income 67 74 10% Non-op expenses (7) (6) -21% Earnings before taxes 1,095 1,299 19% Income tax expenses (197) (176) -11% Profit after tax 897 1,123 25% Minority interest (361) (466) 29% Net profit 536 657 23%
EPS (RMB) Basic 0.04 0.04 16% Diluted 0.04 0.04 16% Source: Company reports.
Our forecast vs consensus Our EPS forecasts are higher than the Bloomberg consensus for FY18-20E, mainly because we’re more bullish on revenue growth. We think the consensus revenue forecast of 2-4% growth p.a. in FY18-20E is too conservative given the demand for new energy and the company’s market share gain in the elevators market.
Figure 12: Our EPS forecast vs Bloomberg consensus, SHE 0.25
0.2
0.15
0.1
0.05
0 2018 2019 2020
Concensus high Concensus mean Concensus low JPMe
Source: J.P. Morgan estimates, Bloomberg.
19 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Bull/bear case scenario analysis Figure 13: Bull/ bear case scenario, SHE
$3.70
$3.50 $0.81 $3.37 $3.30
$3.10
$2.90
$2.70 $0.05 $0.01
$2.50 $2.50 Share price as of 10/08/2018: $2.58 $(0.04) $2.30 $(0.01)
$2.10
$1.90
$1.70 $1.69 $(0.76) $1.50 BEAR CASE GPM decreased Thermal power Industrial Target price Industrial Thermal power GPM increased by BULL CASE by 1ppt equipment equipment equipment equipment 1ppt revenue revenue revenue increasedrevenue increased decreased by 5% decreased by 5% by 5% by 5%
Source: J.P. Morgan estimates, Company data, Bloomberg. Priced as of 10/08/2018. Assume total cash outflow in investing activities remains constant for all scenarios.
Cash flow forecast The company’s operating cash flow deteriorated significantly in FY17, due to increased inventory and receivables. We expect the operating cash flow to recover to RMB2.7bn p.a. in FY19E with less stress from working capital. We forecast capex of RMB1.2-1.8bn in FY18-20E mainly on manufacturing capacities of wind turbines and testing facilities for high-speed elevators.
The company is negotiating with GCL POLY (3800 HK, NC) on the acquisition of 51% equity stake in Jiangsu Zhongneng mainly engaged in making solar materials. The framework agreement suggests that half of the considerations will be paid in cash and the other half by new A-shares issued by the company.
We estimate that Jiangsu Zhongneng’s net profit will be RMB450-500mn p.a. in FY18-20E. The acquisition valuation is yet to be determined. We have not factored this acquisition in our forecasts.
20 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 12: Cash flow forecast, SHE
RMB mn 2015 2016 2017 2018E 2019E 2020E Net profit 4,843 4,331 5,006 4,853 4,698 4,732 Non-cash adj 1,598 3,062 1,652 3,942 4,579 4,816 Change in working capital 2,063 3,772 (13,230) (4,906) (4,578) (5,420) Other (842) (1,216) (953) (1,904) (1,904) (1,904) Operating cash flow 7,662 9,949 (7,525) 1,986 2,795 2,225
Capex (1,214) (1,506) (3,167) (1,766) (1,388) (1,285) Other (1,674) (9,188) (1,160) (1,210) (1,210) (1,210) Investing cash flow (2,889) (10,694) (4,327) (2,976) (2,598) (2,495)
FCFF 4,773 (745) (11,852) (990) 196 (269) Source: Company reports and J.P. Morgan estimates.
Balance sheet forecast The company has a strong balance sheet, with 24% net cash to equity and 22% debt to capital as of end FY17. We expect the gearing level to remain low at 19% net cash to equity as of end FY20E with generally positive FCFF in FY18-20E.
21 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 13: Balance sheet forecast
RMB mn 2015 2016 2017 2018E 2019E 2020E Current asset Cash 40,248 43,418 37,224 35,486 34,963 33,949 Receivables 33,440 35,632 39,371 41,129 42,394 44,438 Inventory 23,900 24,883 34,474 35,433 36,505 38,308 Other current asset 31,058 29,850 33,289 34,443 35,560 36,681 Total current asset 128,647 133,784 144,357 146,491 149,422 153,376 Non-current asset Fixed assets 11,999 12,990 16,469 17,448 17,913 18,158 Investments 8,644 11,175 12,931 14,031 15,131 16,231 Other non-current asset 12,833 17,685 25,588 26,785 27,767 28,907 Total non-current asset 33,477 41,850 54,989 58,264 60,812 63,296 Total asset 162,124 175,634 199,346 204,755 210,233 216,672 Current liabilities Borrowings & bonds 3,078 3,200 5,725 5,825 5,925 6,025 Payables 39,823 46,530 50,869 52,431 54,140 56,758 Other current liabilities 56,698 53,331 54,725 54,825 54,925 55,025 Total current liabilities 99,599 103,061 111,320 113,082 114,991 117,809 Non-current liabilities Borrowings & bonds 10,917 12,146 14,203 14,303 14,403 14,503 Payables 1,006 1,687 1,577 1,577 1,577 1,577 Other non-current liabilities 972 1,093 1,524 1,543 1,562 1,581 Total non-current liabilities 12,895 14,926 17,304 17,423 17,542 17,661 Total liabilities 112,493 117,987 128,624 130,505 132,533 135,470 Equity Shareholders' equity 37,251 45,093 55,537 56,839 58,181 59,607 Minority interest 12,379 12,554 15,185 17,411 19,519 21,595 Total equity 49,630 57,647 70,722 74,250 77,700 81,202 Total equity and liabilities 162,124 175,634 199,346 204,755 210,233 216,672
Net debt to equity -53% -49% -24% -21% -19% -17% Total debt to capital 22% 21% 22% 21% 21% 20% Receivables % revenue 43% 45% 49% 50% 51% 52% Inventory % COGS 39% 40% 56% 57% 58% 59% Payables % COGS 65% 75% 83% 85% 86% 88% Source: Company reports and J.P. Morgan estimates.
Valuation The stock is usually valued with P/E multiples, in our opinion. We think the stock is reasonably valued at 11x 12-month forward P/E vs historical average of 16x which reflects the flattish EPS in FY19-20E.
22 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 14: 12-month forward P/E, Shanghai Electric - H Figure 15: 12-month forward P/B, Shanghai Electric - H 50.0 2.5 12.0 45.0 40.0 2.0 1.6x 10.0 35.0 8.0 30.0 1.5 21.0x 25.0 6.0 20.0 16.0x 1.0 1.2x 15.0 4.0 10.0 0.5 0.7x 11.0x 2.0 5.0 0.0 0.0 0.0
LT historical P/B Avg P/B LT historical P/B -1 STDEV LT historical P/E Avg P/E LT historical P/E -1 STDEV LT historical P/B +1 STDEV 1yr fwd P/B (x) LT historical P/E +1 STDEV 1yr fwd P/E (x) 1yr fwd ROE (RHS, %)
Source: J.P. Morgan estimates, Bloomberg. Priced as of 10/08/2018. Source: J.P. Morgan estimates, Bloomberg. Priced as of 10/08/2018. Investment Thesis, Valuation and Risks Shanghai Electric Group Company Limited - H (Neutral; Price Target: HK$2.50) Investment Thesis The company is an industrial conglomerate engaged in the manufacturing of elevators, power equipment and electromechanical components. Elevator was the largest earnings contributor in FY17 and accounted for 25% of the gross profit. We expect flattish earnings growth in FY18-20E as growth from elevators, automation products and wind turbines is negated by declines from thermal power equipment. We are cautious on the demand prospects of power generators. We find the H-share fairly valued at 12x FY18E P/E with flattish earnings in FY19-20E.
Valuation We think the stock usually trades on P/E rather than P/B. It looks fairly valued at 11x 12-month forward P/E which is slightly lower than the historical mean of 16x given the flattish earnings prospects. Our Jun-19 PT is based on DCF till FY30E. The discount rate used in our DCF analysis is based on the following assumptions: Risk-free rate: 5% Market risk premium: 6% Beta: 0.9x After-tax cost of debt: 3.5% Terminal g: 2% Target gearing: 17% =>WACC: 9.2%.
Risks to Rating and Price Target Upside risks to our rating and PT include 1) higher-than-expected demand for elevators or thermal power equipment and 2) mergers among the main suppliers of power equipment. Downside risks include 1) lower-than-expected demand for elevators or thermal power equipment and 2) the company overpays for acquisitions.
23 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Shanghai Electric Group Company Limited - H: Summary of Financials Income Statement FY16A FY17A FY18E FY19E FY20E Cash Flow Statement FY16A FY17A FY18E FY19E FY20E Revenue 79,078 79,544 81,533 82,449 84,862 Cash flow from operating activities 9,949 (7,525) 1,986 2,795 2,225 COGS (61,936) (61,400) (62,004) (62,781) (64,768) o/w Depreciation & amortization 2,249 2,708 2,846 2,964 3,051 Gross profit 18,144 19,529 19,668 20,094 20,733 o/w Changes in working capital 3,772 (13,230) (4,906) (4,578) (5,420) SG&A (10,837) (12,398) (12,708) (12,851) (13,227) Adj. EBITDA 6,204 7,555 8,229 8,285 8,443 Cash flow from investing activities (10,694) (4,327) (2,976) (2,598) (2,495) D&A (1,504) (2,175) (2,635) (2,772) (2,890) o/w Capital expenditure (1,506) (3,167) (1,866) (1,488) (1,385) Adj. EBIT 4,699 5,379 5,594 5,514 5,553 as % of sales 1.9% 4.0% 2.3% 1.8% 1.6% Net Interest - - - - - Adj. PBT 5,444 5,529 5,643 5,463 5,502 Cash flow from financing activities (3,163) 3,198 (1,749) (1,719) (1,745) Tax (1,113) (522) (790) (765) (770) o/w Dividends paid (1,803) (1,876) (1,958) (1,928) (1,954) Minority Interest (2,271) (2,347) (2,226) (2,108) (2,076) o/w Shares issued/(repurchased) 363 3,287 0 0 0 Adj. Net Income 2,060 2,660 2,627 2,590 2,656 o/w Net debt issued/(repaid) 1,699 856 200 200 200 . Reported EPS 0.16 0.19 0.18 0.18 0.18 Net change in cash (3,800) (8,727) (2,739) (1,523) (2,014) Adj. EPS 0.16 0.19 0.18 0.18 0.18 Adj. Free cash flow to firm 8,631 (9,710) (990) 196 (269) DPS 0.00 0.09 0.08 0.08 0.09 y/y Growth 26.7% (212.5%) (89.8%) (119.8%) (237.2%) Payout ratio 0.0% 47.5% 47.5% 47.5% 47.5% Shares outstanding 14,725 14,725 14,725 14,725 14,725 . Balance Sheet FY16A FY17A FY18E FY19E FY20E Ratio Analysis FY16A FY17A FY18E FY19E FY20E Cash and cash equivalents 43,418 37,224 35,486 34,963 33,949 Gross margin 22.9% 24.6% 24.1% 24.4% 24.4% Accounts receivable 27,139 27,906 29,419 30,574 32,318 EBITDA margin 7.8% 9.5% 10.1% 10.0% 9.9% Inventories 24,883 34,474 35,433 36,505 38,308 EBIT margin 5.9% 6.8% 6.9% 6.7% 6.5% Other current assets 90,366 107,133 111,006 114,459 119,427 Net profit margin 2.6% 3.3% 3.2% 3.1% 3.1% Current assets 133,784 144,357 146,491 149,422 153,376 PP&E 11,639 13,913 14,392 14,752 14,918 ROE 5.0% 5.3% 4.7% 4.5% 4.5% LT investments - - - - - ROA 1.2% 1.4% 1.3% 1.2% 1.2% Other non current assets 23,591 31,310 33,105 34,293 35,612 ROCE 6.7% 7.2% 6.3% 6.1% 6.0% Total assets 175,634 199,346 204,755 210,233 216,672 SG&A/Sales 13.7% 15.6% 15.6% 15.6% 15.6% Net debt/Equity (48.7%) (24.5%) (20.7%) (18.8%) (16.5%) Short term borrowings 3,200 5,725 5,825 5,925 6,025 Net debt/EBITDA (452.5%) (228.9%) (186.6%) (176.6%) (159.0%) Payables 30,699 33,740 34,692 35,755 37,534 Other short term liabilities 69,161 71,854 72,565 73,311 74,249 Sales/Assets (x) 0.5 0.4 0.4 0.4 0.4 Current liabilities 103,061 111,320 113,082 114,991 117,809 Assets/Equity (x) 4.1 3.7 3.6 3.6 3.6 Long-term debt 12,146 14,203 14,303 14,403 14,503 Interest cover (x) - - - - - Other long term liabilities 14,926 17,304 17,423 17,542 17,661 Operating leverage (455.2%) 2458.5% 159.7% (128.3%) 24.5% Total liabilities 117,987 128,624 130,505 132,533 135,470 Tax rate 20.4% 9.4% 14.0% 14.0% 14.0% . Shareholders' equity 45,093 55,537 56,839 58,181 59,607 Revenue y/y Growth 1.4% 0.6% 2.5% 1.1% 2.9% Minority interests 12,554 15,185 17,411 19,519 21,595 EBITDA y/y Growth (5.6%) 21.8% 8.9% 0.7% 1.9% Total liabilities & equity 175,634 199,346 204,755 210,233 216,672 EPS y/y Growth (6.3%) 21.8% (5.9%) (1.4%) 2.6% . BVPS 3.06 3.77 3.86 3.95 4.05 Valuation FY16A FY17A FY18E FY19E FY20E y/y Growth 10.4% 23.2% 2.3% 2.4% 2.5% P/E (x) 14.5 11.9 12.6 12.8 12.5 P/BV (x) 0.7 0.6 0.6 0.6 0.6 Net debt/(cash) (28,072) (17,295) (15,357) (14,634) (13,420) EV/EBITDA (x) 8.7 8.9 8.7 9.0 9.2 Dividend Yield 0.0% 4.0% 3.8% 3.7% 3.8% . Source: Company reports and J.P. Morgan estimates. Note: Rmb in millions (except per-share data).Fiscal year ends Dec. o/w - out of which
24 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Dongfang Electric Corporation Limited - H Neutral No growth, yet with abundant cash 1072.HK,1072 HK We initiate coverage of Dongfang Electric-H with a Neutral rating and DCF-derived Price: HK$4.76 Jun-19 PT of HK$4.80, implying 1% downside potential. We also initiate coverage Price Target: HK$4.80 of Dongfang Electric-A with an Underweight rating and DCF-derived Aug-19 PT of RMB4.15, implying 45% downside potential. The company is mainly engaged in the China manufacturing of power equipment and the contracting of power plant engineering Infrastructure & Industrial projects. Patrick Xu, CFA AC (852) 2800 8577 Company background: The company was incorporated in 1958 in Sichuan [email protected] Province and consolidated then Dongfang Steam Turbine Factory, Dongfang Bloomberg JPMA PXU
Dongfang Electric Corporation Limited - H (Reuters: 1072.HK, Bloomberg: 1072 HK) Company Data Rmb in mn, year-end Dec FY16A FY17A FY18E FY19E FY20E Shares O/S (mn) 3,091 Revenue (Rmb mn) 33,286 30,830 30,352 26,226 22,025 Market Cap (Rmb mn) 12,832 Net Profit (Rmb mn) (1,784) 673 661 740 791 Market Cap ($ mn) 1,874 EPS (Rmb) (0.76) 0.29 0.24 0.24 0.26 Price (HK$) 4.76 DPS (Rmb) 0.00 0.00 0.03 0.03 0.03 Date Of Price 13-Aug-18 Revenue growth (%) (7.6%) (7.4%) (1.6%) (13.6%) (16.0%) Free Float(%) - EPS growth (%) (500.0%) (138.2%) (16.0%) (1.7%) 6.9% 3M - Avg daily vol (mn) 1.66 ROCE (9.0%) 2.0% 3.2% 3.5% 3.6% 3M - Avg daily val (HK$ mn) 9.13 ROE (8.1%) 3.1% 2.9% 3.1% 3.3% 3M - Avg daily val ($ mn) 1.2 P/E (x) NM 14.3 17.0 17.3 16.2 HSCEI 1,0943.08 P/BV (x) 0.5 0.4 0.6 0.5 0.5 Exchange Rate 7.85 Dividend Yield 0.0% 0.0% 0.6% 0.6% 0.7% Fiscal Year End Dec Source: Company data, Bloomberg, J.P. Morgan estimates. Price Target End Date 30-Jun-19
25 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Key catalysts for the stock price: Upside risks to our view: Downside risks to our view: 1. Greater-than-expected investments in 1. Greater-than-expected market share; 1. Smaller-than-expected market share; power generation; 2. Higher-than-expected dividend payout. 2. Lower-than-expected dividend payout. 2. Introduction of equity incentives to the management; 3. A merger with Shanghai Electric or Harbin Electric.
Key financial metrics FY17A FY18E FY19E FY20E Valuation and price target basis Revenues (LC) 30,830 30,352 26,226 22,025 The stock trades 18x FY19E P/E vs Chinese peers' average of 18x. Our TP is derived from Revenue growth (%) -7% -2% -14% -16% DCF valuation and implies 17x FY19E P/E. EBITDA (LC) 1,304 1,190 1,200 1,144 EBITDA margin (%) 4% 4% 5% 5% Tax rate (%) -28% 14% 14% 14% Net profit (LC) 673 661 740 791 EPS (LC) 0.29 0.24 0.24 0.26 EPS growth (%) N/A -16% -2% 7% P/B chart DPS (LC) 0.00 0.03 0.03 0.03 BVPS (LC) 9.34 7.52 7.73 7.96 Operating cash flow (LC mn) 450 2,084 4,331 4,377 Free cash flow (LC mn) 406 1,897 4,122 4,061 Interest cover (X) 4.2 2.2 2.1 1.8 Net margin (%) 2.2% 2.2% 2.8% 3.6% Sales/assets (X) 0.38 0.38 0.33 0.28 Debt/equity (%) 11% 7% 3% 3% Net debt/equity (%) -77% -122% -119% -119% ROE (%) 3.1% 2.9% 3.1% 3.3% Key model assumptions FY17A FY18E FY19E FY20E Revenue growth (%) -7.4% -1.6% -13.6% -16.0% Gross profit margin (%) 17.9% 17.8% 18.4% 18.5%
Source: Bloomberg, Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates.
Sensitivity analysis EBITDA EPS JPMe vs. consensus, change in estimates Sensitivity to FY18E FY19E FY18E FY19E EPS FY18E FY19E 1ppt chg in revenue growth -16% -34% -23% -36% 1ppt chg in GPM -16% -34% -23% -36% JPMe 0.24 0.24 % chg N/A N/A Consensus 0.35 0.37 Source: Company and J.P. Morgan estimates. Source: Bloomberg, J.P. Morgan estimates. Comparative metrics CMP Mkt Cap P/E PEG P/BV YTD LC $Mn FY18E FY19E FY18E FY19E FY18E FY19E Stock perf. Dongfang-H 4.8 3,148 17.3 17.6 7.0 0.8 0.6 0.5 -24.6 Nari Technology 15.7 10,468 18.6 16.2 1.3 2.0 3.1 2.8 -14.4 Hongfa Technology 21.4 2,330 18.6 16.2 1.3 2.0 3.1 2.8 -27.4 Shanghai Electric-H 2.6 10,152 12.3 12.8 -10.5 4.1 0.0 0.0 -19.9 TBEA 6.9 3,718 13.2 11.1 0.5 0.8 0.8 0.8 -30.8 General Electric 192.6 57,055 17.3 15.5 13.3 12.2 4.4 3.8 -5.3 Siemens 111 107,909 16.4 14.6 13.5 10.9 1.9 1.8 -4.7 Source: Bloomberg, Company and J.P. Morgan estimates. Prices are as 10/08/2018.
26 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Corporate history and major shareholders The company was founded as Dongfang Motor Factory (DMF) in 1958 in Deyang, Sichuan Province. DMF consolidated Dongfang Steam Turbine Factory, Dongfang Boiler Factory and Dongfeng Motor Factory in 1984. The company was renamed Dongfang Electric in 1992 and made the IPO in HK in 1994.
Figure 16: Company key events Founded as Dongfang Motor Listed in Shanghai Factory (DMF) in Renamed as Stock Exchange 1958 in Deyang, Dongfang Electric through an RTO in Sichuan Province. in 1992 2008
DMF consolidated Listed in Hong Kong Dongfang Steam Stock Exchange in Turbine Factory, 1994 Dongfang Boiler Factory and Dongfeng Motor Factory in 1984
Source: Company data.
The company is an SOE, with Dongfang Electric Corporation as its largest shareholder of the company owning 56% of the shares since mid-Jun 2018. Dongfang Electric Corporation is 100% owned by the State Council SASAC.
Figure 17: Shareholding structure, Dongfang Electric
SASAC
100%
Dongfang Electric Corporation HKSCC Nominees Limited
56% 11%
Dongfang Electric Corporation Limited (1072 HK)
Source: Company data.
27 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Management profile The board chairman, Mr Zuo Lei, spent most of his career with Harbin Electric (1133 HK, NC), another SOE in the same industry based in Harbin, Heilongjiang Province, and joined the company in 2016. The rest of the non-independent board directors have all been with the company for around 30 years.
The company’s previous restricted shares scheme lapsed in Dec 2017 and there’s no equity incentive plan for now. None of the non-independent directors held shares as of end FY17.
Table 14: Management profile, Dongfang Electric
Worth of Remuneration Name Age Title Profile shares (USD) (USD) Mr. Zou Lei is currently the Chairman of the Company, and the Chairman and secretary of the Party Committee of Dongfang Electric Corporation. He has been serving as Chairman and secretary of the Party Committee of Dongfang Electric Zou Lei 51 Chairman Corporation since May 2016, and the Chairman of the Company since Oct 2016. - - Mr. Zhang Xiaolun is currently a Director and the president of the Company, and a director, executive general manager, deputy secretary of the Party Committee of Zhang Xiaolun 53 Director Dongfang Electric Corporation. - - Mr. Huang Wei is currently a Director and senior vice president of the Company, vice general manager and deputy secretary of the Party Committee of Dongfang Electric Huang Wei 52 Director Corporation. - - Mr. Xu Peng currently serves as a Director and senior vice president of the Company. He is also deputy general manager and a member of the Party Committee of Xu Peng 52 Director Dongfang Electric Corporation. - 7,684 Mr. Zhang Jilie serves as a Director and senior vice president of the Company, and deputy general manager, a member of the Party Committee, the chief law consultant Zhang Jilie 54 Director and the director of the general office of Dongfang Electric Corporation. - - Mr. Gong Dan serves as chief accountant, secretary to the Board and chief law consultant of the Company, and concurrently serves as secretary to the board of Chief Accountant, directors of Dongfang Electric Corporation, a director of DEC Dongfang Electric Secretary to the Machinery Co., Ltd. and Dongfang Electric Finance Co., Ltd., and secretary to the Gong Dan 55 Board Party Committee of Sichuan Dongfang Electronic Auto-control Co., Ltd. 2,084 71,496 Mr. Han Zhiqiao is currently a vice president of the Company. He graduated from the faculty of Hydro works of Shanxi college of Technology with a Bachelor’s degree in Han Zhiqiao 59 Vice President engineering and majored in hydroelectric power generating equipment. 2,084 70,973 Source: Company data, Bloomberg, priced as of 31/12/2017.
28 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Main businesses Coal-fired power generators in the Clean and Efficient Power Generation Equipment segment was the largest earnings contributor in FY17 and accounted for 47% of the gross profit. We expect its contribution to decline in FY18-20E and yet still to be the largest among the segments accounting for 36% of the total gross profit in FY20E.
Figure 18: Gross profit mix by product 100% Clean and efficient power generation 80% equipment New energy
60% Engineering and service 40% Hydropower and 20% environmental protection equipment Other business 0%
Businesses acquired in -20% Jun 2018 2012 2013 2014 2015 2016 2017 2018E 2019E 2020E
Source: Company data, J.P. Morgan estimates.
The company acquired equities and assets of eight companies from the parent in Jun 2018. The target equities generated net profit of RMB314mn in FY17, -31% y/y, mainly from financial services and overseas projects. The consideration is RMB6.8bn in the form of 754mn new A-shares (32% dilution). We’ve factored the acquisition in our earnings forecast.
29 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 15: Companies acquired in Jun 2018, Dongfang Electric
Equity stake Acquired assets 2015 2016 2017 Revenue 95% Dongfang Electric Group Finance Co Ltd 388 257 358 100% Dongfang Electric Group International Cooperation Co Ltd 1,637 1,534 1,006 100% Sichuan Dongfang Electric Automatic Control Engineering Co Ltd 845 610 488 41% Dongfang Rili (Chengdu) Electric Control Equipment Co Ltd 247 152 132 100% Dongfang Electric (Sichuan) Supplies Co Ltd 501 376 489 100% Dongfang Electric Group Project Cargo Logistics Co Ltd 331 252 312 100% Dongfang Electric Chengdu Clean Energy Technology Co Ltd - 1 0 100% Dongfang Electric Chengdu Intelligent Technology Co Ltd - 2 6 Total 3,949 3,183 2,791
Revenue y/y 95% Dongfang Electric Group Finance Co Ltd -34% 39% 100% Dongfang Electric Group International Cooperation Co Ltd -6% -34% 100% Sichuan Dongfang Electric Automatic Control Engineering Co Ltd -28% -20% 41% Dongfang Rili (Chengdu) Electric Control Equipment Co Ltd -39% -13% 100% Dongfang Electric (Sichuan) Supplies Co Ltd -25% 30% 100% Dongfang Electric Group Project Cargo Logistics Co Ltd -24% 24% 100% Dongfang Electric Chengdu Clean Energy Technology Co Ltd -100% 100% Dongfang Electric Chengdu Intelligent Technology Co Ltd 276% Total -19% -12%
Net profit 95% Dongfang Electric Group Finance Co Ltd 208 286 191 100% Dongfang Electric Group International Cooperation Co Ltd 80 118 94 100% Sichuan Dongfang Electric Automatic Control Engineering Co Ltd 19 61 3 41% Dongfang Rili (Chengdu) Electric Control Equipment Co Ltd 2 (23) 7 100% Dongfang Electric (Sichuan) Supplies Co Ltd 16 14 8 100% Dongfang Electric Group Project Cargo Logistics Co Ltd 6 0 10 100% Dongfang Electric Chengdu Clean Energy Technology Co Ltd (0) 0 0 100% Dongfang Electric Chengdu Intelligent Technology Co Ltd (0) 0 1 Total 331 457 314
Net margin 95% Dongfang Electric Group Finance Co Ltd 54% 111% 53% 100% Dongfang Electric Group International Cooperation Co Ltd 5% 8% 9% 100% Sichuan Dongfang Electric Automatic Control Engineering Co Ltd 2% 10% 1% 41% Dongfang Rili (Chengdu) Electric Control Equipment Co Ltd 1% -15% 6% 100% Dongfang Electric (Sichuan) Supplies Co Ltd 3% 4% 2% 100% Dongfang Electric Group Project Cargo Logistics Co Ltd 2% 0% 3% 100% Dongfang Electric Chengdu Clean Energy Technology Co Ltd 18% 594% 100% Dongfang Electric Chengdu Intelligent Technology Co Ltd 27% 12% Overall 9% 16% 12% Source: Company reports.
30 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
High-efficient cleaning power generation equipment The segment is mainly engaged in the manufacturing of thermal power equipment, gas turbines and conventional island of nuclear power plant. The company is one of the three major suppliers of thermal power equipment in China and accounted for 35% of the market share in FY17 based on our estimate.
Figure 19: High-efficient cleaning power generation equipment, Dongfang Electric t n e m p i u q e Gas turbine generator n o i t a r e n e g
r e Power station steam w
o turbines p
g n i n a e l c
t n
e Power station boilers i c i f f e - h g i H
Source: Company data.
We expect the segment’s revenue to slide 10-25% p.a. in FY18-20E driven by the shrinking demand for thermal power equipment. Gross profit contribution from thermal power equipment should decline to 36% in FY20E from 47% in FY17 based on our estimates.
31 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 16: Gross profit forecast, Clean and efficient power generation equipment, DFE
2015 2016 2017 2018E 2019E 2020E Revenue (RMB mn) Clean and efficient power generation equipment 23,032 19,674 20,774 18,649 14,204 10,678 Thermal power 17,311 15,769 16,241 14,022 10,595 7,603 Nuclear power conventional island 1,182 1,043 1,633 2,123 1,718 1,718 Gas turbine 4,539 2,862 2,900 2,503 1,891 1,357
Revenue y/y Clean and efficient power generation equipment -5% -15% 6% -10% -24% -25% Thermal power -2% -9% 3% -14% -24% -28% Nuclear power conventional island -29% -12% 57% 30% -19% 0% Gas turbine -7% -37% 1% -14% -24% -28%
GPM Clean and efficient power generation equipment Thermal power 14% 15% 16% 17% 18% 19% Nuclear power conventional island 43% 22% 21% 21% 21% 21% Gas turbine 17% 17% 24% 24% 24% 24%
China market size (RMB bn) Thermal power investment 116 112 74 64 48 35 Nuclear power investment 57 50 40 51 42 42
Revenue % market size Thermal power 15% 14% 22% 22% 22% 22% Nuclear power conventional island 2.1% 2.1% 4.1% 4.1% 4.1% 4.1% Gas turbine 3.9% 2.6% 3.9% 3.9% 3.9% 3.9% Source: Company reports and J.P. Morgan estimates.
New energy The segment is mainly engaged in the manufacturing of wind turbines and nuclear island equipment. The company has a track record of over 16 years in the nuclear sector and is capable of manufacturing the 3rd-generation nuclear power equipment.
32 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 20: New energy, Dongfang Electric
Wind power y g r e n E
w e
N Nuclear power island
Source: Company data.
We expect 4-12% revenue growth p.a. of the segment in FY18-20E driven by demand for wind turbines. We think the 18% gross margin for wind turbine in FY17 was one-off due to project mix changes and assume it to be 9% in FY18-20E based on the average of FY14-17.
Table 17: Gross profit forecast, New Energy, DFE
2015 2016 2017 2018E 2019E 2020E Revenue New energy 4,585 7,937 3,932 4,404 4,577 4,998 Wind 3,214 6,905 2,831 2,973 3,419 3,840 Nuclear power island 1,371 1,032 1,101 1,431 1,158 1,158
Revenue y/y New energy -6% 73% -50% 12% 4% 9% Wind -8% 115% -59% 5% 15% 12% Nuclear power island -2% -25% 7% 30% -19% 0%
GPM New energy Wind 7% 6% 18% 9% 9% 9% Nuclear power island 26% 32% 27% 27% 27% 27%
China market size (RMB bn) Nuclear power investment 57 50 40 51 42 42 Wind power investment 120 93 64 68 78 87
Market share Wind 2.7% 7.5% 4.4% 4.4% 4.4% 4.4% Nuclear power island 2.4% 2.0% 2.8% 2.8% 2.8% 2.8% Source: Company reports and J.P. Morgan estimates.
33 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Hydropower and environmental protection equipment The segment is mainly engaged in the manufacturing of hydro power generators and environmental protection equipment such as gas desulfurization systems and de-NOx systems for power plants.
Figure 21: Hydropower and environmental protection equipment, Dongfang Electric
Francis
Kaplan
l Bulb a
t Hydropower n e t n m e
n Pelton m o r p i i v u n q e
e Pump storage
& n
r o i e t c w Sea water e o t desulfurization p o r o r p
d Environmental
y Deaminase protection H station equipment
Limestone water desulfurization
Source: Company data.
We expect the segment’s revenue to decline 9%/19% in FY19E/20E driven by declining investments in hydro power. We expect the revenue from environment protection equipment to be a percentage of the revenue from power plant engineering and services because we think the sales of environment protection equipment is probably driven by the sales of these services, given that the environment protection equipment is mainly for reducing sulfur and NOx from the exhaust gas emitted by thermal power plants.
34 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 18: Gross profit forecast, Hydropower and environmental protection equipment, DFE
2015 2016 2017 2018E 2019E 2020E Revenue Hydropower and environmental protection equipment 2,629 1,604 1,999 2,160 1,968 1,586 Hydro power 1,392 688 1,154 1,371 1,319 1,046 Environment protection equipment 1,237 916 845 788 649 540
Revenue y/y Hydropower and environmental protection equipment -39% -39% 25% 8% -9% -19% Hydro power -41% -51% 68% 19% -4% -21% Environment protection equipment -37% -26% -8% -7% -18% -17%
GPM Hydropower and environmental protection equipment Hydro power 16% -31% 0% 0% 0% 0% Environment protection equipment 30% 16% 39% 27% 27% 27%
China market size (RMB bn) Hydro 79 62 62 73 71 56
Market share Hydro 1.8% 1.1% 1.9% 1.9% 1.9% 1.9%
Environment protection equipment % to thermal power equipment sales 7% 6% 5% 6% 6% 7% Source: Company reports and J.P. Morgan estimates.
Engineering and services The segment is mainly engaged in the engineering contracting of power station projects and the provision of power plant services such as upgrade & optimization, inspection, and installation & commissioning.
Figure 22: Engineering and services, Dongfang Electric
& Power plant engineering
g s n i e r c i e v e r n e i S g n
E Power plant services
Source: Company data.
We expect the segment’s revenue to be driven by power equipment sales, and hence forecast it to decline by 6-18% p.a. in FY18-20E due to reduced sales of power equipment.
35 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 19: Gross profit forecast, Engineering & Services, DFE
2015 2016 2017 2018E 2019E 2020E Revenue Engineering and service 5,523 3,893 3,847 3,601 2,964 2,466 Power plant engineering 3,663 2,045 2,249 2,124 1,748 1,454 Power plant services 1,447 1,298 1,339 1,225 1,008 838 Other business 413 550 259 252 208 173
Revenue y/y Engineering and service 4% -30% -1% -6% -18% -17% Power plant engineering 1% -44% 10% -6% -18% -17% Power plant services 20% -10% 3% -9% -18% -17% Other business -14% 33% -53% -3% -18% -17%
GPM Engineering and service 20% 4% 17% 17% 17% 17% Power plant engineering 16% -20% 8% 8% 8% 8% Power plant services 38% 32% 35% 35% 35% 35% Other business -11% 24% 5% 5% 5% 5%
% to power equipment sales Engineering and service 18% 13% 14% 14% 14% 14% Power plant engineering 12% 7% 8% 8% 8% 8% Power plant services 5% 4% 5% 5% 5% 5% Other business 1% 2% 1% 1% 1% 1% Source: Company reports and J.P. Morgan estimates.
Gross profit breakdown by geography 14% of the company’s gross profit in FY17came from overseas markets, mainly power plant engineering projects in southeast Asia and Belt & Road countries. Most of the projects were thermal power and hydro power plants using the company's equipment. Figure 23: Gross profit by geography, DFE 100% 15% 17% 14% 12% 14% 90% 24% 23% 80% 70% 60% 50% 85% 83% 86% 88% 86% 40% 76% 77% 30% 20% 10% 0% 2011 2012 2013 2014 2015 2016 2017 China Overseas
Source: Company reports.
36 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Earnings forecast We expect the company’s revenue to decline 2-16% p.a. in FY18-20E driven by reduced sales of Clean & Efficient Power Generation Equipment (mainly thermal power) and the related revenues from Engineering & Services.
Table 20: Gross profit by segment, DFE
Segmental breakdown 2015 2016 2017 2018E 2019E 2020E Total revenue 36,018 33,286 30,830 30,352 26,226 22,025 Clean and efficient power generation equipment 23,032 19,674 20,774 18,649 14,204 10,678 New energy 4,585 7,937 3,932 4,404 4,577 4,998 Engineering and service 5,523 3,893 3,847 3,601 2,964 2,466 Hydropower and environmental protection equipment 2,629 1,604 1,999 2,160 1,968 1,586 Other business 248 177 279 263 216 180 Businesses acquired in Jun 2018 1,276 2,297 2,117
Revenue y/y -8% -8% -7% -2% -14% -16% Clean and efficient power generation equipment -5% -15% 6% -10% -24% -25% New energy -6% 73% -50% 12% 4% 9% Engineering and service 4% -30% -1% -6% -18% -17% Hydropower and environmental protection equipment -39% -39% 25% 8% -9% -19% Other business -31% -29% 57% -6% -18% -17%
Gross margin 17% 12% 18% 18% 18% 19% Clean and efficient power generation equipment 16% 16% 18% 18% 19% 20% New energy 13% 10% 21% 15% 13% 13% Engineering and service 20% 4% 17% 17% 17% 17% Hydropower and environmental protection equipment 23% -4% 17% 10% 9% 10% Other business 33% 36% 25% 25% 25% 25% Businesses acquired in Jun 2018 32% 32% 32% Source: Company reports and J.P. Morgan estimates.
We expect the EPS to decline 16%/2% in FY18E/19E mainly driven by reduced sales of thermal power equipment before stabilizing in FY20E driven by tighter control of admin expenses.
37 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 21: Earnings forecast, DFE
RMB mn 2015 2016 2017 2018E 2019E 2020E Total revenue 36,018 33,286 30,830 30,352 26,226 22,025 COGS (29,960) (29,278) (25,303) (24,956) (21,405) (17,939) Taxes and others (330) (378) (309) (304) (263) (221) Selling expenses (965) (1,447) (854) (841) (726) (610) Admin expenses (3,362) (3,563) (3,610) (3,584) (3,123) (2,645) Net finance costs 477 641 310 539 572 649 Impairment loss (1,665) (1,498) (742) (627) (585) (478) Other operating income 171 240 298 297 283 269 Operating income 384 (1,996) 620 877 980 1,050 Non-operating income 228 219 216 216 216 216 Non-op expenses (79) (168) (303) (313) (323) (333) Earnings before taxes 533 (1,944) 533 780 873 933 Income tax expenses (73) 185 150 (109) (122) (131) NPAT 459 (1,759) 683 671 751 802 Minority interest (20) (25) (10) (10) (11) (12) Net profit 439 (1,784) 673 661 740 791
EPS (RMB) Basic 0.19 (0.76) 0.29 0.24 0.24 0.26 Diluted 0.19 (0.76) 0.29 0.24 0.24 0.26 y/y -68% -500% -138% -16% -2% 7% Source: Company reports and J.P. Morgan estimates.
The company’s net profit was +40% y/y in 1Q18 driven by revenue growth, project mix change and lower income tax rate. 1Q net profit accounted for 32% of our full- year forecast, which is in line with the historical range of 0-241% (average at 30%) since FY08.
38 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 22: Quarterly income statement, DFE
RMB mn 1Q17 2Q17 3Q17 4Q17 1Q18 y/y Total revenue 5,586 8,992 6,336 9,917 6,594 18% COGS (4,745) (7,332) (5,303) (7,924) (5,494) 16% Taxes and others (47) (123) (38) (101) (75) 61% Selling expenses (198) (340) (132) (184) (167) -16% Admin expenses (613) (851) (726) (1,420) (629) 3% Net finance costs 50 169 92 (1) 43 -13% Impairment loss 14 (216) (237) (304) (110) -876% Other operating income 14 18 (2) 269 65 370% Operating income 61 318 (11) 252 228 272% Non-operating income 171 32 33 (19) 4 -98% Non-op expenses (10) (139) 7 (162) (0) -98% Earnings before taxes 223 211 29 71 231 4% Income tax expenses (46) 36 24 136 (11) -75% NPAT 176 247 53 207 220 25% Minority interest (23) (23) 1 35 (6) -73% Net profit 153 224 54 242 214 40%
EPS (RMB) Basic 0.07 0.09 0.02 0.11 0.09 Diluted 0.07 0.09 0.02 0.11 0.09 Source: Company reports and J.P. Morgan estimates.
Our forecast vs consensus Our EPS forecasts are lower than the Bloomberg consensus, mainly because we have relatively lower revenue forecasts. We think the consensus is aggressive forecasting 12% revenue growth for FY18E given that 53% of the company’s revenue in FY17 came from thermal power equipment where demand is falling.
Figure 24: Our EPS forecast vs Bloomberg consensus, DFE 0.60
0.50
0.40
0.30
0.20
0.10
- 2018 2019 2020
Concensus high Concensus mean Concensus low JPMe
Source: J.P. Morgan estimates, Bloomberg.
39 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Bull/bear case scenario analysis Figure 25: Bull/ bear case scenario, DFE $6.00 $1.00 $5.90
$5.50
$5.00 Share price as of 10/08/2018: HKD$4.83 $0.01 $0.06
$(0.06) $4.80 $(0.00) $4.50
$4.00
$(1.06) $3.50 3.65 BEAR CASE GPM decreased New energy High-efficient Target price High-efficient New energy GPM increased by BULL CASE by 1ppt revenue cleaning power cleaning power revenue increased 1ppt decreased by 5% generation generation by 5% equipment equipment revenue revenue increased decreased by 5% by 5%
Source: J.P. Morgan estimates, Company data, Bloomberg. Priced as of 10/08/2018. Assume total cash outflow in investing activities remains constant for all scenarios.
Cash flow forecast The company has the strongest cash flow generation in the sector and consistently had positive FCFF in FY15-17. We expect the company to generate RMB1.9-4.1bn positive FCFF p.a. in FY18-20E with less than RMB400mn capex p.a.
Table 23: Cash flow forecast, DFE
RMB mn 2015 2016 2017 2018E 2019E 2020E Net profit 460 (1,759) 683 671 751 802 Non-cash adj 2,135 1,825 1,423 1,448 1,362 1,241 Change in working capital 1,561 8,900 (1,656) (221) 2,033 2,148 Other - - (0) 185 185 185 Operating cash flow 4,156 8,965 450 2,084 4,331 4,377
Capex (385) (274) (206) (176) (200) (306) Other 128 (169) 162 (10) (10) (10) Investing cash flow (258) (443) (44) (186) (210) (316)
FCFF 3,898 8,522 406 1,897 4,122 4,061 Source: Company reports and J.P. Morgan estimates.
Balance Sheet forecast The company has the strongest balance sheet in the sector, with 119% net cash to equity and only 3% debt to capital as of end FY17. We expect the balance sheet to remain the strongest in the sector by end FY20E underpinned by positive FCFF.
40 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Table 24: Balance sheet forecast, DFE
RMB mn 2015 2016 2017 2018E 2019E 2020E Current asset Cash 21,088 28,409 27,884 29,510 33,263 36,921 Receivables 22,295 21,491 18,558 18,273 15,873 13,461 Inventory 26,900 19,871 18,581 18,326 15,718 13,173 Other current asset 3,671 2,867 2,679 2,579 2,479 2,379 Total current asset 73,953 72,637 67,703 68,689 67,333 65,934 Non-current asset Fixed assets 8,547 7,725 6,712 6,232 5,835 5,594 Investments 1,140 1,562 1,542 1,552 1,562 1,572 Other non-current asset 2,494 2,778 2,964 3,808 3,898 3,988 Total non-current asset 12,181 12,066 11,218 11,592 11,295 11,155 Total asset 86,134 84,703 78,921 80,281 78,628 77,089 Current liabilities Borrowings & bonds 1,996 1,016 730 720 710 700 Payables 22,531 22,620 20,723 20,588 18,198 15,867 Other current liabilities 34,956 35,654 31,521 31,511 31,501 31,491 Total current liabilities 59,483 59,290 52,974 52,819 50,409 48,059 Non-current liabilities Borrowings & bonds 719 537 42 32 22 12 Payables 201 537 752 752 752 752 Other non-current liabilities 1,754 2,253 2,385 2,485 2,585 2,685 Total non-current liabilities 2,673 3,327 3,179 3,269 3,359 3,449 Total liabilities 62,157 62,617 56,153 56,088 53,768 51,507 Equity Shareholders' equity 23,052 21,144 21,821 23,236 23,893 24,602 Minority interest 926 941 947 956 967 979 Total equity 23,978 22,086 22,768 24,193 24,861 25,582 Total equity and liabilities 86,134 84,703 78,921 80,281 78,628 77,089
Net debt to equity -77% -122% -119% -119% -131% -142% Total debt to capital 10% 7% 3% 3% 3% 3% Receivables % revenue 62% 65% 60% 60% 61% 61% Inventory % COGS 90% 68% 73% 73% 73% 73% Payables % COGS 75% 77% 82% 82% 85% 88% Source: Company reports and J.P. Morgan estimates.
Valuation The H-share is usually valued by P/E multiple, in our opinion. The company’s EPS was negative in FY16. The average 12-month forward P/E before 2015 was 17x. The stock is trading at 17x 12-month forward P/E, in line with the historical mean level.
41 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Figure 26: 12-month forward P/E, Dongfang Electric – H Figure 27: 12-month forward P/B, Dongfang Electric - H 70.0 4.0 35.0 3.5 3.3x 30.0 25.0 60.0 3.0 20.0 2.5 50.0 1.8x 15.0 2.0 10.0 40.0 1.5 5.0 0.0 1.0 -5.0 30.0 0.5 -10.0 0.0 0.3x -15.0 20.0
10.0 LT historical P/B Avg P/B LT historical P/B -1 STDEV LT historical P/B +1 STDEV 1yr fwd P/B (x) 0.0 1yr fwd ROE (RHS, %)
Source: J.P. Morgan estimates, Bloomberg, priced as of 10/08/2018. Source: J.P. Morgan estimates, Bloomberg, priced as of 31/12/2014.
Investment Thesis, Valuation and Risks Dongfang Electric Corporation Limited - H (Neutral; Price Target: HK$4.80) Investment Thesis Dongfang Electric is one of the largest power generation equipment producers in China, with high efficiency and clean energy as well as new energy equipment, which represent its core business segments. Our Neutral view on Dongfang rests on the offsetting effects of: (1) expected weak demand on coal-fired equipment as China relies less and less on coal due to pollution concerns; and (2) reasonable valuation on the back of strong cash flow generation.
Valuation We think the stock usually trades on P/E rather than P/B. It looks fairly valued at 17x 12-month forward P/E which is in line with the historical mean. Our Jun-19 PT is based on DCF till FY30E. The discount rate used in our DCF analysis is based on the following assumptions:
Risk-free rate: 5%
Market risk premium: 6%
Beta: 1.2x
After-tax cost of debt: 2.5%
Terminal g: 2%
Target gearing: 2%
=>WACC: 12%.
42 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Risks to Rating and Price Target Downside risks to our Neutral rating and PT include 1) greater-than-expected write- offs of receivables if clients decide to default on their payments for fear of declining returns from coal-fired power plants and 2) lower-than-expected gross margin due to lack of scale.
Upside risks to our Neutral rating and PT include 1) greater-than-expected demand for power generation capacities that would result in higher-than-expected revenue growth and 2) mergers among the main suppliers of power equipment.
43 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
Dongfang Electric Corporation Limited - H: Summary of Financials Income Statement FY16A FY17A FY18E FY19E FY20E Cash Flow Statement FY16A FY17A FY18E FY19E FY20E Revenue 33,286 30,830 30,352 26,226 22,025 Cash flow from operating activities 8,965 450 2,084 4,331 4,377 COGS (29,278) (25,303) (24,956) (21,405) (17,939) o/w Depreciation & amortization 1,088 994 852 792 743 Gross profit 4,008 5,527 5,396 4,821 4,086 o/w Changes in working capital 8,900 (1,656) (221) 2,033 2,148 SG&A (5,010) (4,464) (4,425) (3,850) (3,255) Adj. EBITDA (908) 1,614 848 819 791 Cash flow from investing activities (443) (44) (186) (210) (316) D&A (1,088) (994) (852) (792) (743) o/w Capital expenditure (274) (206) (186) (210) (316) Adj. EBIT (1,996) 620 877 980 1,050 as % of sales 0.8% 0.7% 0.6% 0.8% 1.4% Net Interest - - - - - Adj. PBT (1,944) 533 780 873 933 Cash flow from financing activities (1,374) (818) (270) (368) (402) Tax 185 150 (109) (122) (131) o/w Dividends paid (211) (39) (250) (348) (382) Minority Interest (25) (10) (10) (11) (12) o/w Shares issued/(repurchased) 0 0 0 0 0 Adj. Net Income (1,784) 673 661 740 791 o/w Net debt issued/(repaid) (1,161) (775) (20) (20) (20) . Reported EPS (0.76) 0.29 0.24 0.24 0.26 Net change in cash 7,328 (523) 1,627 3,754 3,659 Adj. EPS (0.76) 0.29 0.24 0.24 0.26 Adj. Free cash flow to firm 8,699 276 1,897 4,122 4,061 DPS 0.00 0.00 0.03 0.03 0.03 y/y Growth 128.7% (96.8%) 586.8% 117.2% (1.5%) Payout ratio 0.0% 0.0% 11.0% 11.0% 11.0% Shares outstanding 2,337 2,337 3,091 3,091 3,091 . Balance Sheet FY16A FY17A FY18E FY19E FY20E Ratio Analysis FY16A FY17A FY18E FY19E FY20E Cash and cash equivalents 28,409 27,884 29,510 33,263 36,921 Gross margin 12.0% 17.9% 17.8% 18.4% 18.5% Accounts receivable 20,872 17,931 17,653 15,253 12,810 EBITDA margin (2.7%) 5.2% 2.8% 3.1% 3.6% Inventories 19,871 18,581 18,326 15,718 13,173 EBIT margin (6.0%) 2.0% 2.9% 3.7% 4.8% Other current assets 44,169 39,785 39,144 34,036 28,979 Net profit margin (5.4%) 2.2% 2.2% 2.8% 3.6% Current assets 72,637 67,703 68,689 67,333 65,934 PP&E 7,617 6,506 6,026 5,629 5,388 ROE (8.1%) 3.1% 2.9% 3.1% 3.3% LT investments 1,447 1,405 1,405 1,405 1,405 ROA (2.1%) 0.8% 0.8% 0.9% 1.0% Other non current assets 3,537 3,874 4,738 4,848 4,958 ROCE (9.0%) 2.0% 3.2% 3.5% 3.6% Total assets 84,703 78,921 80,281 78,628 77,089 SG&A/Sales 15.1% 14.5% 14.6% 14.7% 14.8% Net debt/Equity (121.6%) (119.1%) (118.9%) (130.9%) (141.5%) Short term borrowings 1,016 730 720 710 700 Net debt/EBITDA 2956.3% (1680.0%) (3389.5%) (3970.8%) (4579.2%) Payables 14,380 14,235 14,040 12,042 10,092 Other short term liabilities 43,894 38,009 38,059 37,657 37,266 Sales/Assets (x) 0.4 0.4 0.4 0.3 0.3 Current liabilities 59,290 52,974 52,819 50,409 48,059 Assets/Equity (x) 3.9 3.8 3.5 3.4 3.2 Long-term debt 537 42 32 22 12 Interest cover (x) - - - - - Other long term liabilities 3,327 3,179 3,269 3,359 3,449 Operating leverage 8170.5% 1776.8% (2668.6%) (86.3%) (44.5%) Total liabilities 62,617 56,153 56,088 53,768 51,507 Tax rate (9.5%) 28.1% 14.0% 14.0% 14.0% . Shareholders' equity 21,144 21,821 23,236 23,893 24,602 Revenue y/y Growth (7.6%) (7.4%) (1.6%) (13.6%) (16.0%) Minority interests 941 947 956 967 979 EBITDA y/y Growth (159.6%) (277.6%) (47.4%) (3.4%) (3.5%) Total liabilities & equity 84,703 78,921 80,281 78,628 77,089 EPS y/y Growth (500.0%) (138.2%) (16.0%) (1.7%) 6.9% . BVPS 9.05 9.34 7.52 7.73 7.96 Valuation FY16A FY17A FY18E FY19E FY20E y/y Growth (8.3%) 3.2% (19.5%) 2.8% 3.0% P/E (x) NM 14.3 17.0 17.3 16.2 P/BV (x) 0.5 0.4 0.6 0.5 0.5 Net debt/(cash) (26,856) (27,112) (28,758) (32,531) (36,209) EV/EBITDA (x) 4.9 NM NM NM NM Dividend Yield 0.0% 0.0% 0.6% 0.6% 0.7% . Source: Company reports and J.P. Morgan estimates. Note: Rmb in millions (except per-share data).Fiscal year ends Dec. o/w - out of which
44 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
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J.P. Morgan Equity Research Ratings Distribution, as of July 02, 2018 Overweight Neutral Underweight (buy) (hold) (sell) J.P. Morgan Global Equity Research Coverage 47% 41% 13% IB clients* 54% 48% 40% JPMS Equity Research Coverage 45% 42% 13% IB clients* 74% 66% 58% *Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. Please note that stocks with an NR designation are not included in the table above.
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45 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
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46 Patrick Xu, CFA Asia Pacific Equity Research (852) 2800 8577 13 August 2018 [email protected]
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47 Completed 13 Aug 2018 06:37 PM HKT Disseminated 13 Aug 2018 07:01 PM HKT