Global Markets Research ANCHOR REPORT ANCHOR China construction machinery: Benefit from favorable policies China’s easing measures and policy- 20 June 2019 driven upgrade demand the key drivers Research analysts China Industrials We expect the demand for China construction machinery to grow Jamie Wang - NIHK continuously in 2019-20F, as we believe: 1) escalating US-China trade [email protected] tensions will prompt the China government to roll out more easing policies +852 2252 2195 with better financial support; and 2) the overloading ban and diesel Japan machinery standard upgrade will drive continuous upgrade demand. Katsushi Saito - NSC While China excavator shipment growth turned negative in May-19, we [email protected] expect the trend to stabilize in 2H19F given China’s easing policies. We +81 3 6703 1160 also expect Sany to gain more market share in the coming years given its Boqiong Wang - NSC good product quality and better aftermarket service. [email protected] +81 3 6703 1217 We prefer Zoomlion (1157 HK, Buy) over Sany (600031 CH, Neutral) given Zoomlion’s cheaper valuation and more attractive dividend yield. Key themes and analysis in this Anchor Report include: China’s easing policies and stricter environmental regulations will be key demand drivers for China construction machinery In-depth analysis of excavator density and size trend in China Highlights of strong cashflow and improving receivables quality for Zoomlion and Sany Production Complete: 2019-06-20 10:52 UTC See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. China construction machinery EQUITY: CAPITAL GOODS Benefit from favorable policies Global Markets Research 20 June 2019 China’s easing measures and policy-driven upgrade demand the key drivers Anchor themes We hold a positive view on China Demand growth to continue in 2019-20F driven by supportive policies machinery sector as we see After two consecutive years of strong growth, we expect demand growth for continuous demand growth in China construction machinery to continue in 2019-20F, as we believe that: 2019/20F driven by China's Escalating US-China trade tensions will prompt the China government to easing policies and stricter come up with more easing/stimulus policies with better financial support to environmental regulations. We stabilize GDP growth. China FAI grew by 6.1% y-y in 4M19 (vs. 5.9% y-y in prefer Zoomlion (1157 HK) over 2018); however, our China economics team forecasts it to reach 7.9% y-y in Sany (600031 CH) given 2019F, suggesting accelerating FAI growth during the rest of 2019F. Zoomlion's cheaper valuation and higher dividend yield. Stricter environmental regulations will lead to further upgrade demand. Since 2016, the overloading ban (GB1589-2016) and the upgrade of China’s Nomura vs consensus diesel standard have been two key replacement drivers for construction While market expects China machinery, and we believe that the China government’s attempt: 1) to excavator shipment to decline y-y eliminate 2.0mn China III diesel trucks; and 2) to potentially ban NRMM in 2H19, we expect the trend to (Non-road Mobile Machinery) by the end of 2020F are likely to lead to pre- be flat. buying/purchases and hence boost machinery demand (see the chapter on environmental regulations). Research analysts Excavator: Demand to stabilize in 2H19F given China’s easing measures; Chinese makers continue to gain market share China Industrials Although China excavator shipment growth turned negative (-6% y-y) in May- Jamie Wang - NIHK 19, we expect flattish y-y growth in 2H19F, given China’s easing policies. We [email protected] +852 2252 2195 also believe that Chinese makers, particularly Sany, will continue to gain market share in China given their improving product quality and better Japan machinery aftermarket services. We expect Sany’s market share to increase to 26%/28% Katsushi Saito - NSC in 2019F/20F, from 22% in 2018. (see case study – hydraulic excavators) [email protected] Action: Assuming coverage of Zoomlion at Buy and Sany at Neutral +81 3 6703 1160 Zoomlion (1157 HK, Buy): We forecast Zoomlion to deliver 35%/18% y-y Boqiong Wang - NSC earnings growth in 2019F/20F given strong growth of crane and concrete [email protected] +81 3 6703 1217 business. We believe that continuous earnings growth and improving A/R quality should trigger a further re-rating. Korea Machinery Sany (600031 CH, Neutral): Although we expect Sany to gain more excavator market share in the next few years, we believe that its current Jaehyung Choi - NFIK [email protected] share price has already factored in most of the upside. An upside risk could +82 2 3783 2318 be a potential dividend payout hike given its strong cashflow, in our view. We prefer Zoomlion over Sany given Zoomlion’s 1) higher exposure to crane and concrete machinery, both showing stronger growth than that for excavators, 2) cheaper valuation at 0.9x P/BV, 3) attractive dividend yield. Fig. 1: Stocks for action Mkt Cap. Avg. daily TO Company Code Rating (USD mn) (USD mn) Target Price Closing price Upside (%) Zoomlion Heavy 1157 HK Buy 5,178 6.9 6.0 5.2 15.6% Sany Heavy 600031 CH Neutral 14,575 213.0 14.4 12.9 11.6% Source: Bloomberg, Nomura estimates. Prices as of 19 June 2019 See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | China construction machinery 20 June 2019 Contents Executive summary ................................................................................ 3 Growth to continue in 2019-20F due to favorable policies .............................. 3 Excavators: Demand to stabilize in 2H19F thanks to China’s easing measures; Chinese makers continue to gain market share ............................ 3 Assuming coverage of Zoomlion/Sany at Buy/Neutral .................................... 3 Key figures and charts ............................................................................ 4 A supportive policy environment ............................................................. 7 Stabilizing infrastructure investment the main policy pivot .............................. 7 Issuing special local government bonds to fund infrastructure ........................ 7 Beijing can’t afford to stop easing yet… .......................................................... 8 The effect of easing policies has appeared ..................................................... 9 Stricter environmental regulations to drive upgrade demand ................ 10 Overloading ban and diesel emission upgrades to become future demand drivers ............................................................................................................ 10 Further diesel emission upgrades to spur upgrade demand ......................... 11 Road machinery could see better upgrade demand...................................... 12 Case study – Hydraulic excavators ....................................................... 13 A clear sign of a slump in shipments? ........................................................... 13 Chinese makers have consistently gained market share .............................. 14 2019-21F demand forecast ................................................................... 17 Our forecasting methodology ......................................................................... 17 Crane machinery ........................................................................................... 17 Concrete machinery ........................................................................................ 18 Excavators ..................................................................................................... 19 Zoomlion Heavy Industry ...................................................................... 21 Sany Heavy Industry ............................................................................ 40 Appendix A-1 ........................................................................................ 60 2 Nomura | China construction machinery 20 June 2019 Executive summary Growth to continue in 2019-20F due to favorable policies We hold a positive view on the China construction machinery sector, as we believe that 1) escalating US-China trade tensions will prompt the China government to come up with more easing/stimulus policies with better financial support to stabilize GDP growth; and 2) the stricter overloading ban and China government’s attempt to terminate the production and sale of China III standard diesel engines will drive further upgrade demand. In a supportive policy environment, we expect demand growth for overall construction machinery to continue in 2019-20F, even though the sector has seen two consecutive years of strong growth in 2017-18. We think that the China government’s easing policies have shown some effectiveness, as total y-y FAI (fixed asset investment) growth increased slightly to 6.1% in 4M19 from 5.9% in 2018. Our China economics team forecasts that total FAI will grow by 7.9% y-y in 2019F, implying more infrastructure projects will be seen in 2H19F (Fig. 2). (see A supportive policy environment) Since 2016, the overloading ban (GB1589-2016) and the upgraded diesel standard have been two key replacement drivers for construction machinery, and we believe that the China government’s attempt to eliminate 2.0mn China III diesel trucks and potentially ban NRMM (Non-road Mobile Machinery) by the end of 2020F are likely to lead to pre- buy/purchase and hence