27 Nov 2019

CMB International Securities | Equity Research | Sector Update

China Construction Machinery

Four structural drivers to extend the upcycle to 2020-21E OUTPERFORM (Maintain)

We believe the strict measures on emission control and pro-investment approach China Capital Goods taken by the government will offer earnings visibility to the China construction machinery sector in 2020E. Besides, leading Chinese brands, on the back of the Wayne Fung, CFA rising competitive power, have emerged as potential game changers to challenge (852) 3900 0826 the global giants. Consequently, we see continuous import substitution and [email protected] overseas opportunities as growth drivers over coming years. We initiate coverage on SANY Heavy (600031 CH, TP: RMB19.0, Top pick), Jiangsu Hengli SANY Heavy revenue mix (1H19) (601100 CH, TP: RMB54.0) and Weichai Power-A (000338 CH, TP: RMB15.9) Piling Earth moving Other with BUY rating. machinery machinery machinery 7% 3% 2%  #1: Replacement demand to reach 60% of total sales; driven by emission Concrete regulations. For construction machinery, the National Emission Standard Crane machinery machinery 30% (NES) IV will be implemented in Jul 2020, such pressing timetable should 20% trigger strong replacement demand. For HDT, NES VI(a) will be implemented

in Jul 2021 but we see potential of advanced preparation from local Excavator governments. Besides, some local governments have set deadline for the old 38%

models to fade out on the stage. Our industry model suggests that >60% of Source: Company data, CMBIS the demand will come from replacement in 2020-21E. Jiangsu Hengli revenue mix (1H19)  #2: Structural growth opportunities: Import substitution + market share Completed Component set of 9% gain. Leading Chinese players are gaining market share from the foreign equipment 4% players in the field of excavator and hydraulic components. We see a clear Hydraulic cyclinder Hydraulic trend of further import substitution on the back of rapid enhancement of for pump and excavator valve product quality, marketing strategy and new product development. 44% 20% Specialised  #3: Global market to offer growth potential for Chinese manufacturers. hydraulic cyclinder The world’s top 50 construction machinery manufacturers generated total for heavy revenue of US$184bn (2018). The market share of SANY Heavy (600031 CH, equpment 23% BUY) was <5% among the total revenue of the top 50. We see great potential Source: Company data, CMBIS for Chinese players to gain market share in the global market, given their ongoing overseas investment and increasing global competitive edge. Weichai’s engine sales volume mix 100% Other components  #4: Pro-investment policy + resilient property construction. Since mid- 90% 80% 2019, the Chinese government has gradually loosened rules on local 70% For other non-road infrastructure financing. CMBIS Economic team forecast infrastructure FAI 60% ma chine ry 50% (excluding power) growth to accelerate to 5.5% in 2020E (vs 4.2% in 10M19). 40% For heavy-duty & 30% medium-duty This, together with the strong property construction activities, will lend strong 20% construction machinery support to the construction machinery demand. 10% For HDT 0% 2017 2018 2019E 2020E 2021E  Lifting our machinery demand estimate. We forecast demand for crane Source: Company data, CMBIS estimates machinery /concrete machinery /excavator / HDT to grow 20%/14%/10%/1% in 2020E. We expect leading players will deliver above average growth thanks to market share gain.

Key recommendations Mkt Cap Rating Price TP P/E (x) P/B (x) Name Ticker (US$ mn) (LC) (LC) FY19E FY20E FY19E FY20E SANY 600031 CH 18,252 BUY 14.94 19.00 11.1 9.4 2.8 2.4 Hengli 601100 CH 5,979 BUY 46.70 54.00 32.4 26.2 7.4 6.1 Weichai-A 000338 CH 15,152 BUY 13.38 15.90 11.0 10.4 2.4 2.2 Weichai-H 2338 HK 14,857 BUY 13.86 17.90 10.1 9.5 2.2 2.0 Source: Company data, CMBIS estimates

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Contents

Investment Thesis ...... 3 Is the sector reaching the peak? ...... 3 Key growth drivers ...... 3 Investment ideas ...... 4 #1: Replacement demand driven by emission regulations on off-road machinery and heavy-duty truck ...... 7 Source of emission ...... 7 Implementation of new NES standard ...... 8 Elimination of the old models under operation ...... 9 #2: Import substitution and market share gain to offer structural growth opportunities for leading Chinese players ...... 11 Excavator ...... 11 Hydraulic components for construction machinery ...... 12 Engine for commerical vehicle and off-road application ...... 14 #3: Global market to offer growth potential for Chinese manufacturers ...... 16 Global construction machinery market size >US$184bn ...... 16 Caterpillar remains the largest player but market share on a down trend ...... 16 Leading Chinese players already established presence in overseas ...... 16 #4: Pro-investment policy + Resilient property construction ...... 18 Potential recovery of infrastructure spending growth in 2020 ...... 18 Resilient area under construction positive to concrete and tower crane ...... 19 Demand projection ...... 20 Earth moving machinery ...... 20 Crane machinery ...... 21 Concrete machinery ...... 22 Heavy-duty truck (HDT) ...... 23 SANY Heavy Industry – A (600031 CH) ...... 24 Jiangsu Hengli Hydraulic (601100 CH) ...... 24 Weichai Power- A (000338 CH) ...... 24 Weichai Power-H (2338 HK) ...... 24

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Investment Thesis Is the sector reaching the peak? 2019 marks the third year of China construction machinery upcycle and the market has started to question if it is arriving to the end. Our answer to the question is not yet. In this report, we identify four structural positives factors that will support an extension of the upcycle to 2020-21E. What’s more, leading Chinese machinery and components manufacturers have adopted different approaches and strategies, such as new product launch and overseas expasion, to maintain the growth momentum and reduce the cyclical risk.

Key growth drivers

1) Replacement demand driven by emission regulations on off-road machinery and heavy-duty truck Among the off-road machinery, construction machinery is one of the major sources of emission, accounting for 45%, 34% and 25% of the total emission of hydrocarbons (HC), nitrogen oxide (NOx) and particulate matter (PM) in 2018, respectively. For on-road machinery, the fleet size of HDT (including diesel and other source of energy) was 7.1mn units, representing only 3.1% of the total ownership volume of automobile in China. However, the emission of NOx and PM by HDT contributed to 58% and 66% respectively of the total emission by automobile in China.

The Chinese government has a strong aspiration to address the air pollution issue. Measures include the implementation of more stringent emission control policies. For construction machinery, the National Emission Standard (NES) IV on construction machinery will be implemented in Jul 2020, which is able to trigger strong replacement demand. For HDT, NES VI(a) will be implemented in Jul 2021 but we see potential of advanced preparation from local governments. Besides, local governments have set deadline for the elimination of the old models. Our industry model suggests that >60% of the demand will come from replacement in 2020-21E.

2) Import substitution and market share gain to offer structural growth opportunities for leading Chinese players Chinese players have been gaining market share from the used-to-be dominating foreign brands in the domestic market. For excavator, SANY has clearly become a winner with market share increased substantially from ~12% in 2011 to 25% in 10M19, significantly outpacing all the major competitors. For hydraulic components, an area that had been dominated by foreign brands, Jiangsu Hengli emerged as one of the limited Chinese players that successfully beat its foreign competitors, with current market share in hydraulic cylinder (for excavator) reaching 50%. New product such as hydraulic pump, valve and motor become the new growth drivers. For engine, Weichai has a solid market share of ~33% in the HDT engine field and we see further upside potential. Meanwhile, import substitution on powertrain for excavator and engine for industrial power will bring up incremental value to the Company. Going forward, we see a clear trend of further import substitution on the back of rapid enhancement of product quality, marketing strategy, new product development and management execution.

3) Global market to offer growth potential for Chinese manufacturers According to KHL, the world’s top 50 construction machinery manufacturers generated total revenue of US$184 bn in 2018, up 13.5% YoY. Japan-based firms are the leading players in terms of market share, accounting for 25.3% of the revenue generated by the top 50. Caterpillar (CAT US, NR) remains the largest construction machinery players across the

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 3 27 Nov 2019 globe. From the global perspective, the market share of leading Chinese players such as SANY Heavy and XCMG (000425 CH, NR) were both less than 5% among the top 50 summed revenue. We see great potential for the Chinese players to gain market share in the global market. SANY Heavy has already established production bases and R&D centers in the US, India, Germany and Brazil. For component maker, Jiangsu Hengli established production base in the overseas market also, with a latest plan to build a new production base in India. These players are well prepared to compete in the international market over the upcoming years, which should serve as an important growth driver going forward.

4) Pro-investment policy + resilient property construction. Since mid-2019, the Chinese government has gradually loosened control on local infrastructure financing. CMBIS Economic team forecast infrastructure FAI (excluding power) growth to accelerate to 5.5% in 2020E (vs 4.2% in 10M19). This, together with the strong property construction activities, will lend strong support to the construction machinery demand.

Investment ideas

 SANY Heavy (600031 CH, BUY, TP: RMB19.0) On the back of rapid enhancement in product quality, precise marketing strategy, commitment on R&D spending, solid track record and excellent management execution, SANY is set to emerge as a world class player to compete in the global market, offering earnings upside over the coming years. Near term, we forecast SANY to deliver EPS growth of 70%/18% in 2020E/21E, driven by favourable domestic demand. Initiate with BUY with TP of RMB19.0, based on 12x 2020E PE. SANY is our sector top pick.

 Jiangsu Hengli (601100 CH, BUY, TP: RMB54.0) We initiate on Jiangsu Hengli with a BUY rating and TP of RMB54, based on 30x 2020E P/E on the back of earnings CAGR of 31% in 2019E-21E. We expect Hengli to enter another stage of re-rating, driven by the clear roadmap to achieve import substitution. Besides, the growth is driven more by new product penetration, which should enable Hengli to mitigate the cyclical risk, serving as a risk reduction factor. Key catalysts include better- than-expected growth of pump & valves sales and overseas sales.

 Weichai Power (000338 CH, BUY, TP: RMB15.9) (2338 HK, BUY, TP: HK$17.9) We believe Weichai’s earnings to be more resilient in this cycle than the previous ones as: (1) we expect HDT demand to stay at >1.1mn units in 2019E-21E on the back of solid replacement demand; (2) Weichai’s non-road machinery growth will be a new growth driver, which is overlook by the market. We forecast Weichai to deliver stable earnings growth of 8%/7% in 2020E/21E and our estimates are 8%/14% above consensus. Initiate at BUY with SOPT-based TP of RMB15.9. On the other hand, we maintain our BUY rating on Weichai – H with SOPT-based TP of HK$17.9.

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Focus Charts

Figure 1: CMBI Construction machinery sales Figure 2: CMBI HDT sales projection projection

Sales volume 000' units (units ) 1,400 80% 59% 60% 800,000 80% 53% 1,200 45% 60% 60% 32% 600,000 1,000 30% 40% 40% 18% 22% 20% 800 11% 20% 4% 3% 1% 1% 400,000 -4% 0% 0% 600 -13% 0% -20% -26% 200,000 400 -28% -20% -40% -36% 0 -60% 200 -40% 0 -60%

Earth moving machinery Cra ne Concrete machinery Total growth (YoY) - RHS Replacement demand New demand Growth (YoY) - RHS

Source: CCMA, CMBIS estimates Source: CCMA, Wind, CMBIS estimates

Figure 3: Excavator market share in China Figure 4: Global construction machinery revenue (Top 50 manufacturers)

30% US$ mn 200,000 Others (11-50) 25% 180,000 JCB Doosan 20% 160,000 SANY 140,000 Liebherr 15% Caterpillar 120,000 SANY XCMG 100,000 XCMG 10% Liugong 80,000 Volvo Hitachi 5% SDLG 60,000 40,000 John Deere Komatsu 0% 20,000 Caterpillar 0

2011 2012 2013 2014 2015 2016 2017 2018

2011-07 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 2018-01 2018-07 2019-01 2011-01 Source: CCMA, Wind, CMBIS estimates Source: KHL Yellow Table, CMBIS

Figure 5: Jiangsu Hengli’s market share in China Figure 6: Revenue of major global hydraulic equipment manufacturers

60% US$ mn 4,000 70% 51% 50% 49% 3,500 60% 50% 47% 47% 3,000 50% 2,500 40% 40% 35% 35% 2,000 30% 30% 1,500 30% 20% 24% 1,000 10% 19% 500 20% - 0% 13% 12%

10%

0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2017 2018 Growth (YoY) - RHS

Source: CCMA, Company data, CMBIS estimates Note: The chart includes the hydraulic component and related segment revenue Source: Company Reports, CMBIS

Figure 7: Demand breakdown by application Type of machinery Infrastructure Property Mining Excavator High Low Medium Wheel loader High Low Medium Truck crane High Medium n/a Tower crane Low High n/a Concrete machinery Medium High n/a Mining transport truck n/a n/a High Heavy duty truck (construction) High Low Low Source: CMBIS

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Figure 8: Change in assumptions for key products in China construction machinery market Old New Change (ppt) 2019E 2020E 2021E 2019E 2020E 2021E 2019E 2020E 2021E Sales volume growth (YoY) Earth moving machinery Excavator 15% 0% - 15% 10% 0% 0.0 10.0 - Wheel loader 15% 8% - 4% 0% -5% (10.6) (8.0) - Crane Truck crane 25% 12% - 30% 15% 10% 5.0 3.0 - Tower crane 50% 20% - 50% 30% 20% 0.0 10.0 - Concrete machinery Concrete mixer truck 5% 5% - 30% 15% 8% 25.0 10.0 - Concrete pump truck 15% 5% - 30% 30% 20% 15.0 25.0 - Heavy-duty truck -1% 3% - 1% 1% 0% 2.2 (1.2) - Source: CCMA, Wind, CMBIS estimates

Figure 9: Peer comps Ticker Company Rating Price TP Upside/ Market cap PE (x) PB (x) EV/EBITDA (x) Dividend yield (%) (local (local (downside) (US$ mn) FY19E FY20E FY19E FY20E FY19E FY20E FY19E FY20E currency) currency) HK listed 631 HK Equity SANY INTERNATIONAL BUY 4.15 5.00 20% 1,647 12.7 10.3 1.7 1.5 7.5 6.2 2.4 2.9 3339 HK Equity LONKING HOLD 2.34 1.90 -19% 1,282 6.2 6.9 1.0 1.0 2.9 3.1 10.4 9.3 1157 HK Equity ZOOMLION HEAVY-H BUY 5.62 7.65 36% 6,635 8.6 7.3 1.0 0.9 6.5 5.8 7.0 8.2 2338 HK Equity WEICHAI POWER-H BUY 13.86 17.90 29% 14,857 10.1 9.5 2.2 2.0 5.0 4.7 5.5 5.8 3808 HK Equity SINOTRUK HK LTD BUY 13.52 19.40 43% 4,780 7.2 6.6 1.2 1.0 3.1 2.9 4.8 5.3 564 HK Equity ZHENGZHOU COAL-H NR 3.99 - - 1,409 5.2 4.8 0.6 0.5 4.7 4.3 4.2 4.6 HK listed average 8.3 7.6 1.3 1.1 5.0 4.5 5.7 6.0 A share 000338 CH Equity WEICHAI POWER-A BUY 13.38 15.90 19% 15,152 11.0 10.4 2.4 2.2 5.4 5.2 5.0 5.3 601100 CH Equity JIANGSU HENGLI-A BUY 46.70 54.00 16% 5,979 32.4 26.2 7.4 6.1 25.1 20.8 1.0 1.2 603338 CH Equity ZHEJIANG DINGLI -A BUY 66.20 72.00 9% 3,332 33.3 24.1 6.4 5.2 28.1 19.7 0.5 0.7 600031 CH Equity SANY HEAVY-A BUY 14.94 19.00 27% 18,252 11.1 9.4 2.8 2.4 8.3 7.2 3.6 5.3 000157 CH Equity ZOOMLION HEAVY-A BUY 6.11 7.28 19% 6,766 10.5 9.0 1.2 1.1 8.1 7.2 5.7 6.6 000425 CH Equity XCMG-A NR 4.53 - - 5,151 9.7 7.9 1.1 1.0 8.8 7.8 2.3 2.9 000528 CH Equity GUANGXI LIUGONG-A NR 6.39 - - 1,369 8.6 8.0 0.9 0.8 9.6 8.8 4.1 4.4 603638 CH Equity YANTAI EDDIE P NR 28.20 - - 1,578 32.9 24.3 7.9 6.2 22.9 17.1 0.0 4.4 600761 CH Equity ANHUI HELI CO-A NR 9.05 - - 972 10.6 9.4 1.3 1.2 4.6 4.2 4.1 4.4 603298 CH Equity HANGCHA GROUP-A NR 12.91 - - 1,160 12.7 10.9 1.8 1.6 6.7 5.7 2.9 3.7 000951 CH Equity CNHTC JINAN T-A NR 20.00 - - 1,948 11.6 10.3 2.0 1.7 8.7 8.6 2.9 3.2 601717 CH Equity ZHENGZHOU COAL-A NR 6.06 - - 1,437 9.0 8.3 1.0 0.8 8.1 7.4 2.4 2.7 600582 CH Equity TIAN DI -A NR 2.99 - - 1,796 10.5 8.8 0.7 0.7 6.9 6.1 2.0 2.7 A-share average 12.7 10.6 2.1 1.8 9.3 8.0 3.0 4.0 Overseas CAT US Equity CATERPILLAR INC NR 146.4 - - 80,920 13.4 13.5 5.7 5.7 7.9 8.2 2.6 2.9 DE US Equity DEERE & CO NR 176.6 - - 55,610 17.8 16.0 4.8 4.1 13.2 12.3 1.7 1.9 6305 JP Equity HITACHI CONST NR 2,828.0 - - 5,662 10.5 10.3 1.2 1.1 7.2 7.1 3.3 3.4 6301 JP Equity KOMATSU LTD NR 2,590.0 - - 23,443 11.6 11.3 1.3 1.2 7.3 7.2 4.2 4.3 042670 KS Equity DOOSAN INFRACORE NR 5,500.0 - - 989 4.3 3.8 0.5 0.5 6.1 6.0 0.0 0.0 VOLVB SS Equity VOLVO AB-B NR 148.8 34,062 8.9 12.0 2.2 2.1 6.5 8.0 5.4 0.0 Average 11.1 11.1 2.6 2.4 8.0 8.2 2.9 2.1 Hydraulic components PH US Equity PARKER HANNIFIN NR 202.1 - - 25,960 18.9 17.0 3.9 3.5 12.1 11.0 1.7 1.8 ETN US Equity EATON CORP PLC NR 92.2 - - 38,095 16.1 15.6 2.4 2.3 11.5 11.3 3.1 3.2 7012 JP Equity KAWASAKI HVY IND NR 2,484.0 - - 3,863 14.0 11.1 0.8 0.8 7.4 6.8 2.8 3.0 7242 JP Equity KYB CORP NR 3,330.0 - - 798 6.4 5.8 0.5 0.5 n/a n/a 0.0 0.2 6474 JP Equity NACHI-FUJIKOSHI NR 5,190.0 - - 1,204 15.6 15.0 1.0 1.0 5.9 5.8 1.9 2.0 6268 JP Equity NABTESCO CORP NR 3,390.0 - - 3,948 23.0 19.8 2.2 2.1 11.3 10.3 2.2 2.2 Average 15.7 14.0 1.8 1.7 9.7 9.0 1.9 2.1 Source: Bloomberg, Company data, CMBIS estimates

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#1: Replacement demand driven by emission regulations on off-road machinery and heavy-duty truck Source of emission According to the “China Mobile Source Environmental Management Annual Report (2019)” issued by China Ministry of Ecology and Environmental, construction machinery and agriculture machinery are the two major sources of emission among the off-road machinery, accounted for 34% and 33% of nitrogen oxide (NOx) in 2018.

For the construction machinery, national emission standard (NES) I or below accounted for 60%, 51% and 42%, respectively, of the total emission of hydrocarbons (HC), nitrogen oxide (NOx) and particulate matter (PM) in 2018. In terms of the type of construction machinery, wheel loader, excavator and forklift accounted for 95% of the total emission among the construction machinery.

Figure 10: Emission volume breakdown by type of Figure 11: Emission volume breakdown by off-road machinery (2018) construction machinery NES (2018)

100% 0.7% 1.4% 0.6% 100% 1.1% 2.7% 1.1% 10.3% 13.9% 90% 13.7% 90% 17.9%

80% 29.2% 31.5% 80% 26.3% 70% 70% 38.5% 40.0% Aircraft 60% 60% 40.0% Standard III Locomotive 50% 32.5% 50% Standard II 41.6% Vessel 25.8% 40% 40% Standard I Agricultural machinery 24.1% 20.7% Before Standard I 30% Construction machinery 30% 20% 44.5% 20% 34.2% 34.0% 27.1% 10% 25.2% 10% 21.4%

0% 0% HC NOx PM HC NOx PM

Source: Ministry of Ecology and Environmental, CMBIS Source: Ministry of Ecology and Environmental, CMBIS

Figure 12: Emission volume breakdown by type of construction machinery (2018)

100% 3.0% 1.5%2.9% 1.6%2.8% 1.7% 90%

80% 32.1% 32.8% 34.9% Motor grader 70% Pavement machinery 60% Road roller 50% 25.2% 23.1% 29.1% Bull dozer 40% Excavator 30% Forkflift 20% 37.6% 39.1% Wheel loader 30.7% 10%

0% HC NOx PM

Source: Ministry of Ecology and Environmental, CMBIS

The fleet size of HDT (including diesel and other source of energy) was 7.1mn units, accounted for only 3.1% of the total ownership volume of automobile in China. However, the emission of NOx and PM by HDT accounted for 58% and 66% respectively of the total emission by automobile in China.

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Figure 13: China automobile ownership volume Figure 14: Emission volume breakdown by type of breakdown vehicle Automobile ownership volume / fleet size Units (000) % of total Emssion volume (breakdown by vehicle) NOx PM

Passenger vehicle - mini 1,880 0.8% Passenger vehicle - mini 0.6% 0.0% Passenger vehicle - small 201,299 87.1% Passenger vehicle - small 10.9% 1.1% Passenger vehicle - medium 755 0.3% Passenger vehicle - medium 2.7% 0.9% Passenger vehicle - large 1,585 0.7% Passenger vehicle - large 13.2% 13.3% Truck - mini 53 0.0% Truck - mini 0.2% 0.0% Truck - light-duty 17,287 7.5% Truck - light-duty 5.1% 10.6% Truck - medium-duty 1,247 0.5% Truck - medium-duty 9.5% 7.8% Truck - heavy-duty 7,112 3.1% Truck - heavy-duty 57.8% 66.3% Total 231,218 100.0% Total 100.0% 100.0% Source: Ministry of Ecology and Environmental, CMBIS Source: Ministry of Ecology and Environmental, CMBIS

The stringent environmental protection government policies remain the key to reduce the emission. These policies broadly focus on two major areas: (1) National policy: The sale of machines and trucks will be based on new National Emission Standard (NES) which is much more stringent than before; and (2) Local government policies: The elimination of the high polluting models under operation will need to speed up.

Implementation of new NES standard

 For heavy-duty vehicles According to the “Limits and measurement methods for emissions from diesel fueled heavy-duty vehicles (China VI)” [“重型柴油车污染物排放限值及测量方法（中国第六阶 段）], the NES VI standards include two phases, VI(a) and VI(b). China VI-a is largely equivalent to the Euro VI standard, while China VI-b introduces more stringent testing requirements and a remote emission monitoring system. Gas-fueled truck has already started the implementation of NES VI(a) since Jul 2019.

For public transports in cities, NES VI(a) will be implemented starting Jul 2020. NES VI(a) will be applied for all trucks starting Jul 2021. Next, NES VI(b) will be applied on gas-fueled truck and all other remaining trucks on Jan 2021 and Jul 2023 respectively.

Some local governments and municipals already adopted the NES VI(b) standard prior to the timeline stated in the national standard. For example, Beijing started the implementation of NES VI(b) in Jul 2019 for gas-fueled trucks and diesel trucks for public transportation.

According to “Limits and measurement methods for emissions from light-duty vehicles (China VI)” [轻型汽车污染物排放限值及测量方法(中国第六阶段)], sales of all LDTs will have to meet the NES VI starting 1 Jul 2020.

 For off-road machinery According to the latest consultation paper of “The limits and measurement methods for emissions from diesel off-road machinery” (“非道路移动机械用柴油机排气污染物排放限值 及测量方法”), the NES IV will be implemented on the new machinery sales starting Dec 2020.

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Figure 15: Timetable for the implementation of NES Year Type of vehicles 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Heavy duty vehicle Diesel Gasoline Gas fueled Light duty vehicle Diesel Gasoline Gas fueled Off road vehicle Diesel

National emission standard No regulation I II III IV V VI(a) VI(b) Source: Ministry of Ecology and Environmental, CMBIS

Elimination of the old models under operation

 For truck In response to the State Council’s Blue-Sky Initiatives, many local governments launched policies to ban the polluting trucks (including NES II and III, depending on regions) from operation through administrative measures. As of end-2018, NES III and below accounted for 46% of the total fleet size of diesel trucks. We expect these trucks will be phased out over the coming two years.

 For off-road machinery Similarly, we believe the elimination of NES for off road machinery will trigger a new round of replacement cycle. As of end-2017, ~43% of the total construction machinery fleet size in China belonged to Standard I and below. Standard II and III accounted for 41% and 16% of the total fleet size. We believe the elimination of these machines will speed up following the implementation of policies gradually launched by the local governments.

Figure 16: Policies issued by local governments for off-road machinery Province/city NES VI implementation date NES III eliminination date Subsidising policy for NES III elimination Beijing Jul 2019: Public transportation/sanitary To eliminate 100k units by Sep 2019 Max: RMB100k per unit truck/Heavy-duty diesel truck (VI-b) Jan 2020: Gas fueled LDT and other HDT (VI-b) Guangdong (excluding Jul 2019: LDT (VI-b) To accelerate the elimination - Guangzhou & Shenzhen) Guangzhou Jul 2019: Trial for LDT - RMB30k per unit Sep 2019: Official implementation (VI-b) Shenzhen Jul 2019 To eliminate 80k units by in 2019 - Hainan Jul 2019 Banned the sales of gasoline vehicles since RMB7k-25k per unit Mar 2019 Tianjin Jul 2019: LDT (VI-b) End-2020 - Shandong Jul 2019: LDT (VI-b) Jul 2019: To eliminate 34k units RMB40k per unit Henan Jul 2019: LDT (VI-b) End-2020 - Hebei Jul 2019: LDT (VI-b) End-2020 - Hangzhou Jul 2019: LDT (VI-b) End-2019 Max: RMB40k per unit Nanjing Jul 2019: LDT (VI-b) End-2020 Max: RMB40k per unit Shaanxi July 2019: For Guanzhong region (VI-b) End-2020 Max: RMB33k per unit Dalian - Mar 2019- Feb 2020: To ban the operation of 30% of the cost of upgrade (Max: RMB10k per unit) high polluting diesel trucks in certain districts Shanxi Jul 2019: LDT in key districts (VI-b) End-2020 - Chengdu Jul 2019: LDT (VI-b) - - Anhui Jul 2019: LDT (VI-b) - - Jiangsu Jul 2019: LDT (VI-b) - - Zhejiang Jul 2019: LDT (VI-b) - - Chongqing Jul 2019: LDT (VI-b) - - Shanghai Jul 2019: LDT (VI-b) - - Yunnan Jul 2020: LDT (VI-b) End-2020: To eliminate 30k units - Source: Cvworld, local governments, CMBIS

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Figure 17: Policies issued by local governments for HDT and LDT City Location Vehicles banned Effective date Beijing Within the Fifth Ring, Beijing Economic-Technological Development Area Excavators, loaders and 1 Aug 2019 administrative area, and part of Tongzhou forklifts below type III Parts of Haidian, Fengtai, Daxing districts outside the Fifth Ring, and 1 Jan 2020 parts of Mentougou, Shunyi, Changping, Pinggu, Huairou, Miyun and Yanqing districts Shanghai Inside the Outer Ring below type III 1 Oct 2019 Outside Outer Ring below type I 1 Oct 2020 Tianjing 777 sq km of designated area Excavators, loaders and 1 Jan 2019 forklifts below type III Chongqing About 400 sq km of designated area, including 237 towns and streets below type I 1 Nov 2017 Guangzhou Yuexiu, Haizhu, Liwan, Tianhe, Baiyun, Huangpu, Huadu, Panyu, Nansha, below type III 24 Dec 2018 Conghua, Zengcheng districts Chengdu All area inside Fourth Ring and part of area between Fourth and Sixth below type I 1 Feb 2018 Rings Nanjing Designated area below type III 1 Apr 2018 Zhengzhou Within the Third Ring and Zhongzhou, and three development zones below type I 1 Jun 2017 Suzhou Designated area below type I 1 Mar 2018 Yangquan, Shanxi Designated area below type I 15 Oct 2018 Taiyuan, Shanxi Designated area below type I 1 Jan 2018 Shenzhen Futian, Luohu, Yantian, Nanshan districts below type I 1 Nov 2018 below type II 1 Sep 2020 Baoan, Longgang, Longhua, Pingshan, Guangming, Dapeng districts below type I 1 Nov 2018 Xi'an All developed area below type III 1 Jun 2019 All administrative area 1 Oct 2019 Wuhan Area within the Third Ring below type III 1 Sep 2019 Luoyang Designated area below type III 30 Oct 2018 Huizhou Developed area in Huicheng, Huiyang, Dayawan, and Zhongkai districts below type III 27 Dec 2017 Jinan Area within the city beltway, and the developed area in Changqing district below type III 1 Feb 2019 Source: Local governments, CMBIS

Figure 18: China construction machinery fleet size Figure 19: China truck fleet size breakdown by NES breakdown by emission standard (2017) (2018) Standard II or before 1% Standard III, Before Standard I, 15.7% 27.3% Standard V 16%

Standard III 46%

Standard IV Standard II, 37% 41.4% Standard I, 15.6%

Source: Ministry of Ecology and Environmental, CMBIS Source: Ministry of Ecology and Environmental, CMBIS

Figure 20: China truck fleet size breakdown by size Mini truck 0%

HDT 38%

LDT 55%

MDT 7%

Source: Ministry of Ecology and Environmental, CMBIS

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#2: Import substitution and market share gain to offer structural growth opportunities for leading Chinese players Excavator Chinese excavator makers have been gaining market share from the foreign players for years, with market share increased from ~45% in 2015 to 63% in 10M19. The gains by large Chinese excavator makers have been more significant. For instance, on the back of rapid improvement in product quality, precise marketing strategy and excellent management execution, SANY has become a clear winner in the excavator industry with market share increased substantially from ~12% in 2011 to 25% in 10M19, significantly outpacing all the major competitors.

On the contrary, the Japanese brands such as Kobelco, Komatsu (6301 JP) and Hitachi Construction Machinery (6305 JP) are gradually losing market share in China. Komatsu’s market share reduced from >10% in 2011 to only 4% in 10M19. Hitachi’s market share dropped from 10% in early 2011 to 3.4% in 10M19.

Caterpillar (CAT US) market share rapidly increased from 5% in early 2011 to 17% in early 2016. Since then, Caterpillar’s market share has been maintained at 11-16%. Among the foreign manufacturers, Caterpillar is one of the few that is still able to maintain market share in China. We believe the relatively resilient market share is due to Caterpillar’s strategy to focus on large-size excavators and high-end segment. However, Caterpillar is also faced with huge challenge from the Chinese brands. In 10M19, Caterpillar’s market share in China dropped to 9.3%.

In response to the loss of market share in China, Caterpillar and Komatsu plan on launching new products with lower ASP in order to stabilize the declining market share. However, we believe this is less likely for these players to regain the market share without a significant reduction on pricing.

Figure 21: China excavator sales market share Figure 22: China excavator sales breakdown by size breakdown (10M19) (10M19)

Others Large (>30t) 14% SANY Heavy 14% Volvo Industry 3% 25% Hitachi 4% Hyundai Jiangsu 4% Komatsu China Medium (20-30t) 4% 26% XCMG Small (<20t) Liugong 15% 60% 7% Doosan 7% Shandong Caterpillar 9% Lingong 8% Source: CCMA, CMBIS Source: CCMA, CMBIS

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Figure 23: China excavator sales breakdown by Figure 24: Chinese versus foreign manufacturers in countries of the manufacturers China excavator market

100% Korean 11% 90% 80% 70% US & European 60% 13% 50% 40% 30% 20% Japanese 10% Chinese 13% 0%

63%

2015-12 2016-10 2018-10 2015-06 2015-08 2015-10 2016-02 2016-04 2016-06 2016-08 2016-12 2017-02 2017-04 2017-06 2017-08 2017-10 2017-12 2018-02 2018-04 2018-06 2018-08 2018-12 2019-02 2019-04

China Foreign

Source: CCMA, CMBIS Source: Wind, CMBIS

Figure 25: Players gaining market share Figure 26: Players losing market share

30% 18% 16% Kobelco 25% 14%

20% 12% Komatsu SANY 10% 15% Caterpillar 8% Hitachi XCMG 10% 6% Liugong 4% 5% SDLG Hyundai 2% Jiangsu 0% 0%

Volvo

2011-07 2014-07 2017-07 2011-01 2012-01 2012-07 2013-01 2013-07 2014-01 2015-01 2015-07 2016-01 2016-07 2017-01 2018-01 2018-07 2019-01

2011-07 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 2018-01 2018-07 2019-01 2011-01 Source: Wind, CMBIS Source: Wind, CMBIS

Hydraulic components for construction machinery Hydraulic components and control devices are widely used in aerospace, marine equipment, deep sea exploration, energy-saving and environmental protection equipment, new energy equipment, machine tools and tools, heavy machinery, construction machinery, agricultural machinery, and automobiles. Core hydraulic components include hydraulic pumps, valves, motors, cylinders, and systems.

From a global perspective, the US, China, Japan, Germany and France are the top five countries in terms of hydraulic equipment sales. Mobile hydraulic accounts for nearly half of overall sales of hydraulic products.

Figure 27: Hengli’s market share in China Figure 28: Revenue growth in China (Hengli vs KYB)

60% 140% 123% 51% 49% 50% 120% 47% 47% 50% 100% 78% 80% 62% 40% 35% 35% 60% 51% 30% 33% 40% 30% 24% 24% 20% 19% -9% 20% 0% 13% 2015 2016 2017 2018 12% -20% 10% -40% -51% -60% 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E Hengli KYB

Source: Company data, CCMA, CMBIS estimates Source: Company reports, CMBIS

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Figure 29: Hydraulic components for an excavator Figure 30: Hydraulic components for an AWP

Note: A: Hydraulic cylinder, B: Remote control valve, C: Swing Note: A: Hydraulic cylinder, B: Axial Piston Pump, C: Control valve, D: motor, D: Flow sharing mobile valve, E: Single pump, F: Pilot control Motor device Source: Jiangsu Hengli, CMBIS Source: Jiangsu Hengli, CMBIS

Figure 31: Revenue of major global hydraulic Figure 32: Operating profit and margin for selected equipment manufacturers hydraulic manufacturers US$ mn US$ mn 4,000 70% 400 30% 350 3,500 60% 25% 3,000 300 50% 20% 250 2,500 40% 200 15% 2,000 30% 150 1,500 10% 20% 100 1,000 5% 50 500 10% 0 0% - 0%

2017 2018 Growth (YoY) - RHS 2017 2018 Operating margin (2018) - RHS

Note: The chart includes the hydraulic component and related Note: The chart includes the hydraulic component and related segment revenue. segment operating figures. Source: Company reports, CMBIS Source: Company reports, CMBIS

In China, hydraulic component market is fragmented with large number of hydraulic component manufacturers, but most domestically produced products are in the mid-to-low end of the value chain, due to the lack of R&D capacity, brand image, product reliability and durability. High-end products mainly come from imports.

That said, Chinese players such as Jiangsu Hengli (601100 CH, BUY) and Yantai Eddie (603638 CH, NR), on the back of strong R&D capability, rapid enhancement of product quality, proven track record and cost advantage, have emerged to complete with the foreign players on the high-end segment. Jiangsu Hengli currently accounts for ~50% of market share in the hydraulic cylinder segment (for excavator) in China. Apart from hydraulic cylinder, Hengli is also expanding into the manufacturing of hydraulic pump and valve for excavator.

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Engine for commerical vehicle and off-road application According to China Internal Combustion Engine Industry Association (CICEIA), China’s internal combustion engine (ICE) sales were 52mn units in 2018. Diesel engine accounted for 10% (or 5.36mn units) of total sales, while the remaining 90% were gasoline engine mainly for the passenger vehicle and motorcycle. Diesel engine are applied mainly for the commercial vehicles and other off-road machineries. Normally, the larger the size (or displacement), the higher the technological knowhow and the value-added. Weichai Power is the market leader in the multi-cylinder engine market with a market share of ~17% in 10M19, according to CICEIA.

The number of engine manufacturers in China reduced from 644 in late 2015 to 498 in Sep 2019, according to NBS. Meanwhile, the number of loss-making players increased from 99 to 120 during the period, and the loss ratio (number of loss-making company / total number of company) increased from 15% to 24%. We believe with the implementation of strict emission standard going forward, the industry will continue to undergo a consolidation. This offers room for leading players to gain market share.

Figure 33: China engine sales volume breakdown by Figure 34: China engine sales volume breakdown by type of fuel (2018) application (2018) Garden General Power Commercial Diesel machinery equipment generation vehicles 10% Agricultural 6% 1% 3% 6% machinery Vessel 7% 0% Construction machinery 2%

Motorcycle 34%

Passenger Gasoline vehicle 90% 41%

Source: CICEIA, CMBIS Source: CICEIA, CMBIS

Figure 35: China multi-cylinder engine monthly sales Figure 36: Number of engine manufacturers and volume breakdown by company (2019) loss making ratio in China

100% 700 35% 90% 600 30% Othe rs 80% 500 25% Dongfeng Cummins 70% 400 20% Foton Cummins 300 15% 60% Zhejiang Xinchai 200 10% 50% FAW 100 5% 40% J ia ngling 0 0% 30% Yunnei Group

20%

2016-03 2018-05 2019-09 2016-01 2016-05 2016-07 2016-09 2016-11 2017-01 2017-03 2017-05 2017-07 2017-09 2017-11 2018-01 2018-03 2018-07 2018-09 2018-11 2019-01 2019-03 2019-05 2019-07 Yucha i 2015-11 10% Total number of company We icha i 0% Number of losing making company J an Fe b Ma r Apr Ma y J un J ul Aug S e p Oct Ratio of loss making companies - RHS

Source: CICEIA, CMBIS Source: Wind, NBS, CMBIS

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 HDT engine Commercial vehicle engines sales were ~3mn units in 2018, accounting for close to 60% of the total sales of diesel engine. Among the 3mn units of commercial vehicle engine, ~1.1mn units were installed for HDT. Weichai is the largest HDT engine manufacturer with a market share of 31.6%/33.2% in 2018/1H19. We see room for Weichai to further raise market share on the back of further industry consolidation driven by the implementation of NES VI.

 Construction machinery Engines used for construction machinery sales reached 835k units in 2018, representing ~16% of the total diesel engine sales. We combined the data from CCMA and CICEIA to estimate the breakdown of the construction machinery engine demand. We estimate excavator and wheel loader are the two major source of demand, representing ~40% of the total construction machinery engine.

While the wheel loader engine market is dominated by Weichai Power that owns a market share of >80% in China, engine for excavator has long been dominated by the foreign engine manufacturers with almost no Chinese players. Leveraging on the technology from Linde Hydraulic, Weichai has a clear roadmap to enter the excavator engine market by adopting a strategy of “Engine + Hydraulic”. Assuming annual demand of 240k units of excavator with ASP range of RMB50k-80k per unit (depends on the size of excavator), the potential market size will reach RMB12-19bn annually.

Figure 37: China multi-cylinder engine sales volume Figure 38: Weichai Power’s market share on HDT breakdown by application (10M19) engine

Others 40% 17% 35% 35.6% 36.2% 36.2% 36.5% 30% 33.3% 33.2% 32.6% 31.6%

25% 27.0% 20% 21.4% 15% Construction machinery Commercial 10% 18% vehicles 65% 5%

0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19

Engine (for HDT)

Source: CICEIA, CMBIS Source: Company data, CMBIS

 Large bore engine for industrial power Sales of power generation engine in China was 1.6mn units in 2018, with a wide range of price level depending on displacement. Large-bore diesel engine has a wide range of applications such as Uninterruptible Power Supply (UPS), marine power and natural gas power generator.

Currently, the large-bore diesel engine (for industrial power) market is dominated by the overseas manufacturers such as Caterpillar, Cummins, MTU and Liebherr, due to the high technological knowhow. However, Weichai has been actively expanding into the large-bore engine segment, leveraging the technology of Baudouin, a French-based company that acquired by Weichai in 2009.

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#3: Global market to offer growth potential for Chinese manufacturers Global construction machinery market size >US$184bn According to KHL, the world’s top 50 construction machinery manufacturers generated total revenue of US$184 bn in 2018, up 13.5% YoY. Japan-based firms are the leading players in terms of market share in 2018, accounting for 25.3% of the revenue generated by the top 50, followed by US-based firms with 24.6% share. Chinese firms comprised a market share of 16% in 2018, up 2ppt YoY.

Caterpillar remains the largest player but market share on a down trend By company, Caterpillar remains the largest construction machinery players across the globe. However, its market share (in terms of revenue) dropped from 19.4% in 2011 to 12.6% in 2018. Komatsu and Hitachi, the two major Japanese players, have largely maintained the market share over the past few years.

Leading Chinese players already established presence in overseas As discussed in the previous section, Chinese players have gradually gained share from the foreign players in China market, through competitive pricing and product quality enhancement. However, from the global perspective, the market share of leading Chinese players such as SANY Heavy (600031 CH, BUY) and XCMG (000425 CH, NR) were both less than 5% among the top 50. We see large potential for Chinese players to gain market share in the global market. SANY Heavy has already established production bases and R&D centers in the overseas such as the US, India, Germany and Brazil. The Company’s oversea revenue increased 25%/17% in 2017/18.

For component makers, Jiangsu Hengli also established production base in the overseas market. The Company grew its overseas revenue from only RMB12mn in 2010 to RMB947mn in 2018, representing a CAGR of 63%. Hengli continues to further expand its oversea sales with a latest plan of building a new production base in India.

We believe these players are well prepared to compete in the international market over the coming few years, which should serve as an important growth driver going forward.

Figure 39: Global construction machinery revenue Figure 40: Global construction machinery revenue (Top 50 manufacturers) breakdown by the countries of the manufacturers

US$ mn 100% 200,000 Others (11-50) 90%

180,000 JCB 80% 160,000 Doosan 70% Others 140,000 Liebherr 60% Sweden 120,000 SANY 50% Germany XCMG 100,000 China Volvo 40% 80,000 Japan Hitachi 30% 60,000 US 40,000 John Deere 20% Komatsu 20,000 10% Caterpillar 0 0% 2011 2012 2013 2014 2015 2016 2017 2018 2011 2012 2013 2014 2015 2016 2017 2018

Source: KHL Yellow Table, CMBIS Note: based on the countries that the manufacturers belong to Source: Company data, CMBIS

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Figure 41: SANY revenue breakdown by region Figure 42: SANY overseas revenue

100% RMB mn 16,000 180% 155% 160% 80% 14,000 140% 12,000 120% 60% 10,000 100% 8,000 80% 40% 6,000 60% 24% 25% 40% 20% 4,000 17% 2% 20% 2,000 -10% -7% 0% 0% 2011 2012 2013 2014 2015 2016 2017 2018 0 -20% 2011 2012 2013 2014 2015 2016 2017 2018 China Ove rse as Overseas revenue Growth (YoY) RHS

Source: CICEIA, CMBIS Source: Company data, CMBIS

Figure 43: Hengli revenue breakdown by region Figure 44: Hengli overseas revenue

100% RMB mn 90% 1,000 450% 393% 80% 900 400% 70% 800 350% 60% 700 300% 50% 600 250% 40% 500 200% 30% 400 132% 150% 20% 300 60% 100% 10% 200 43% 48% 24% 27% 32% 100 50% 0% 2011 2012 2013 2014 2015 2016 2017 2018 0 0% 2011 2012 2013 2014 2015 2016 2017 2018 China Overseas Overseas Growth (YoY) - RHS

Source: CICEIA, CMBIS Source: Company data, CMBIS

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#4: Pro-investment policy + Resilient property construction Potential recovery of infrastructure spending growth in 2020 In Jun 2019, Chinese government has loosened rules on local infrastructure financing, allowing local governments to use the proceeds of bond sales as well as bank borrowing, rather than local tax revenues, to finance the start of projects. In order to boost government stimulus as the economy continues to decelerate, China still keeps more-local-debt option open.

In Sep 2019, the executive meeting of the State Council confirmed the measures to encourage the speed-up of the issuance of special-purpose bond. The government will allocate, in advance, part of next year's special bonds quota and ensure that funds raised from the bonds be readily available at the start of next year, in an effort to spur effective investment for shoring up weak areas and expanding domestic demand.

In Nov 2019, the State Council decided that the minimum proportion of capital contribution for some infrastructure projects such as port, water transport projects, will be cut from 25% to 20%.

CMBIS Economic team forecast infrastructure FAI (excluding power) growth to accelerate to 5.5% in 2020E, versus 4.2% achieved in 10M19.

Figure 45: Local gov’t debt monthly issue amount Figure 46: Local gov’t debt issue amount (YTD)

RMB bn RMB bn 5,000 1,000

800 4,000

600 3,000

400 2,000 200 1,000 0

0

J ul-18 J ul-19

Oct-18

Apr-18 Apr-19

J un-18 J a n-19 J un-19

Ma r-19 Ma r-18 Fe b-19

Aug-19 Aug-18 S e p-18 Nov-18 De c-18 S e p-19 Ma y-19 Ma y-18 1M 2M 3M 4M 5M 6M 7M 8M 9M 10M 11M 12M Ge nera l Special purpose 2018 2019

Source: Ministry of Finance, CMBIS Source: Ministry of Finance, CMBIS

Figure 47: Infrastructure FAI vs local gov’t spending Figure 48: Infrastructure FAI growth (monthly) RMB bn % 2,000 20% 16.1% 30 1,800 15% 1,600 11.3% 25 10.6% 1,400 10% 20 6.7% 1,200 6.7% 6.3% 4.8% 4.5% 3.7% 4.3% 4.4% 4.4% 15 3.0% 1,000 2.3%2.1% 2.3% 2.0% 5% 10 800 -1.8% -1.8% 0% 600 5 -4.3% 400 -5% 0 200

0 -10%

2014-04 2014-08 2014-12 2015-04 2015-08 2015-12 2016-04 2016-08 2016-12 2017-04 2017-08 2017-12 2018-04 2018-08 2018-12 2019-04 2019-08

2019-02 2019-05 2018-03 2018-04 2018-05 2018-06 2018-07 2018-08 2018-09 2018-10 2018-11 2018-12 2019-01 2019-03 2019-04 2019-06 2019-07 2019-08 2019-09 2019-10 Infrastructure FAI growth YoY (excluding power) 2018-02 Local government expenditure growth (YoY) Infrastructure FAI (exluding power) (RMB bn) Growth (YoY) RHS

Source: Wind, NBS, CMBIS Source: Wind, NBS, CMBIS

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Resilient area under construction positive to concrete and tower crane Historically, concrete machinery and tower crane are correlated with the property area under construction. Area under construction growth reached 9% (YoY) in Oct 2019, the highest growth rate since 2014. Besides, the better-than-expected contract sales reported by major property developers in Sep and Oct should further support the upcoming construction activities.

Figure 49: Zoomlion & SANY revenue vs Area under Figure 50: China tower crane sales volume vs Area construction under construction mn sq m RMB mn Units mn s q m 30,000 1,200 70,000 1,200

25,000 1,000 60,000 1,000 20,000 800 50,000 800 15,000 600 40,000 600 10,000 400 30,000 400 5,000 200 20,000 10,000 200 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 Zoomlion concrete machinery segment revenue (RMB mn) SANY concrete machinery segment revenue (RMB mn) China tower crane sales volume (units) China newly added area under construction (mn sq m) - RHS China newly added area under construction (mn sq m) - RHS

Source: Company data, Wind, NBS, CMBIS Source: Wind, CCMA, NBS, CMBIS

Figure 51: Property start and growth Figure 52: Area under construction (growth)

mn s q m 12% 300 50% 10% 250 30% 200 8% 10% 150 6% -10% 100 4% 50 -30%

0 -50% 2%

0%

2016-02 2017-11 2015-02 2015-05 2015-08 2015-11 2016-05 2016-08 2016-11 2017-02 2017-05 2017-08 2018-02 2018-05 2018-08 2018-11 2019-02 2019-05 2019-08

Property start (mn sq m) Growth (YoY) - RHS

2015-05 2017-02 2018-11 2015-08 2015-11 2016-02 2016-05 2016-08 2016-11 2017-05 2017-08 2017-11 2018-02 2018-05 2018-08 2019-02 2019-05 2019-08 2015-02 Source: Wind, NBS, CMBIS Source: Wind, NBS, CMBIS

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Demand projection Earth moving machinery

 Excavator – Prolonged upcycle China’s excavator sales experienced a down-cycle between 2012 and 2015 but has gradually recovered since 2016, driven mainly by the replacement demand. Sales volume of excavators grew 45% YoY to 210k units in 2018, the highest year in the history.

Based on the useful life of excavator of 5-8 years normally, we calculate that the fleet size of excavators in China remained stable at ~1.1mn units between 2014 and 2016, followed by a moderate increase in 2017 and 2018.

We maintain our sales growth forecast of 15% in 2019E, but revise up the growth forecast in 2020E from 0% to 10% as we expect further increase in fleet size, driven by the favourable government policy to support infrastructure, environmental policy-driven replacement demand, substitution of wheel loader and replacement of labour force. Our analysis assume 50% of the demand will come from replacement demand in 2020E-21E. We expect the fleet size to increase moderately in 2020E-21E.

Figure 53: China monthly excavator sales Figure 54: CMBI excavator sales projection

(Units) (Units) 50,000 300,000 120% 100% 45,000 250,000 40,000 80% 35,000 200,000 60% 30,000 40% 150,000 25,000 20% 20,000 100,000 0% 15,000 -20% 50,000 10,000 -40% 5,000 0 -60% 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2019 2018 2017 2016 Replacement New demand Growth (YoY) - RHS

Source: CCMA, CMBIS Source: CCMA, CMBIS estimates

 Wheel loader – Risk of substitution We revise down our 2019E/20E sales growth forecast from 15%/8% to 4%/0% as the substitution risk by excavator is materializing. We expect the declining trend of the fleet size to continue in 2020E-21E.

Figure 55: China monthly wheel loader sales Figure 56: CMBI wheel loader projection

(Units) (Units ) 20,000 300,000 60% 18,000 250,000 40% 16,000 14,000 200,000 20% 12,000 150,000 0% 10,000 8,000 100,000 -20% 6,000 50,000 -40% 4,000 2,000 0 -60% 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2019 2018 2017 Replacement Ne w demand Growth (YoY)

Source: CCMA, CMBIS Source: CCMA, CMBIS estimates

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Crane machinery Crane machinery broadly divides into truck crane and tower crane. Demand for cranes come mainly from more developed regions. Also they are normally applied in a later stage of the construction cycle.

 Tower crane – Significant potential on structural demand growth Demand for tower crane comes mainly property construction. Historically, the demand for tower crane was correlated with the area under construction. Besides, tower crane is normally applied in a later stage of a construction cycle.

Sales of tower crane reached a peak at ~64k units in 2013 and gradually declined to the lowest level of only 7k units before recovering to 11k units in 2017.

Inventory of tower crane in China reached 1.8k units in 2012 and then gradually declined to only <300 units in 2018, suggesting a significant improvement in demand/supply balance.

Besides, according to Zoomlion (1157 HK / 000157 CH, BUY), the number of tower crane manufacturers reduced from 300 in 2012 to only 70 in 2019, as a result of industry consolidation. That said, we believe large player such as Zoomlion still has room to further gain market share from the small players going forward.

Based on our calculation, the fleet size of tower crane reached a peak of ~305k units in 2014 and has declined since then. We estimate the fleet size was close to 200k units in 2018. We revised up our sales growth forecast in 2020E from 20% to 30%, and we expect another 20% YoY growth in 2021E. We believe our estimate is not excessive as we do not forecast a rebound of fleet size going forward. We expect the sales volume in 2019E-21E will be driven entirely by replacement demand.

While the useful life of a tower crane can reach 10 years, many customers currently tend to upgrade or replace the tower crane in 5-6 years.

We expect large-size tower crane will see above average growth as they are needed for the increasing use of pre-cast concrete. The customers of large-size tower crane are mainly the large construction companies or developers. They only purchase tower crane once they have confirmed projects.

Figure 57: China tower crane inventory level Figure 58: CMBI tower crane sales projection Units Units 2,000 70,000 80%

1,800 60,000 60% 1,600 40% 50,000 1,400 20% 40,000 1,200 0% 1,000 30,000 -20% 800 20,000 -40% 600 10,000 -60% 400 200 0 -80% 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Replacement New demand Growth (YoY)

Source: CCMA, CMBIS Source: CCMA, CMBIS estimates

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 Truck crane – Still in the mid-cycle The annual sales volume of truck crane machinery reached a peak of ~35.5k units in 2011, driven by the economic stimulus policy which boosted the infrastructure demand. After that, there was a multi-year downturn with annual sales volume declined to <10k units in 2015 and 2016. Significant recovery started in 2017 with sales volume doubled to 20k units, and further to 32k units in 2018.

Based on the useful life of around 10 years, we calculate that the fleet size of crane machinery hit a peak of ~190k units in 2013 and then gradually reduced to <170k units as at end-2017 as a result of the decline in sales volume. The fleet size rebounded in 2018 and we expect the trend to continue.

We revise up our truck crane machinery sales growth forecast in 2019E/20E from 25%/12% to 30%/15%. We expect a further growth of 10% in 2021E, on the back of continuous replacement of NES III products.

Figure 59: China monthly truck crane sales Figure 60: CMBI truck crane sales projection

(Units) Units 7,000 60,000 140% 120% 50,000 6,000 100% 80% 5,000 40,000 60% 4,000 30,000 40% 3,000 20% 20,000 0% 2,000 -20% 10,000 1,000 -40% 0 -60% 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2019 2018 2017 Sales volume (units) Growth (YoY) - RHS

Source: CCMA, CMBIS Source: CCMA, CMBIS estimates

Concrete machinery Concrete machinery mainly consists of (1) concrete pump, (2) mixer plant, (3) mixer truck and (4) pump truck. The demand for concrete machinery has been driven by both infrastructure and property construction. We see concrete pump truck and mixer truck having better growth potential, as the elimination of NES III trucks will help boost replacement demand.

Based on our calculation, SANY and Zoomlion are the two major players in the concrete machinery sector with market share of 38% and 14% respectively. In particular, SANY increased its market share significantly from 29% in 2015 to 38% in 2018. We expect both companies will become the beneficiaries of the strong demand in 2020E.

 Concrete pump truck We are in particular positive on concrete pump truck as we expect high sales growth is needed to support the fleet size from significant decline over the coming years. We revised up our concrete pump truck sales growth forecast in 2019E/20E from 15%/5% to 30%/30%.

 Concrete mixer truck We revised up our concrete mixer truck sales growth forecast in 2019E/20E from 5%/5% to 30%/15%.

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Figure 61: China concrete pump truck sales forecast Figure 62: China concrete mixer truck sales forecast

Units Units 14,000 60% 80,000 100% 50% 12,000 70,000 80% 40% 60,000 10,000 30% 60% 50,000 8,000 20% 40% 10% 40,000 6,000 20% 0% 30,000 -10% 4,000 20,000 0% -20% 2,000 10,000 -20% -30% 0 -40% 0 -40%

Sales volume (units) Growth (YoY) Sales volume (units) Growth (YoY)

Source: CCMA, CMBIS Source: CCMA, CMBIS estimates

Figure 63: China concrete pump sales forecast Figure 64: Market share of SANY & Zoomlion in

Units concrete machinery segment 12,000 60% 60%

10,000 40% 50% 14.0% 8,000 20% 17.6% 40% 14.5%

6,000 0% 10.3% 30% 4,000 -20% 20% 34.5% 34.9% 38.1% 2,000 -40% 28.9% 10% 0 -60% 0% 2015 2016 2017 2018

Sales volume (units) Growth (YoY) S ANY Zoomlion

Source: CCMA, CMBIS estimates Source: CCMA, Company, CMBIS

Heavy-duty truck (HDT) We revised up China HDT sales forecast by 4%/3% in 2019E/20E to 1.16mn/1.17mn units, as we expect the replacement demand driven by NES III elimination and the anti- overloading policy to lend support to the HDT demand.

Figure 65: China HDT monthly sales volume Figure 66: CMBI HDT sales projection

(Units) 000' units 1,400 80% 160,000 59% 60% 1,200 53% 60% 140,000 45% 30% 32% 120,000 1,000 40% 18% 22% 100,000 800 11% 20% 4% 3% 1% 1% -4% 0% 80,000 600 -13% 0% -26% 60,000 400 -28% -20% -36% 40,000 200 -40% 20,000 0 -60% 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2016 2017 2018 2019 Replacement demand New demand Growth (YoY) - RHS

Source: Cvworld, CMBIS Source: Wind, NBS, CMBIS estimates

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Figure 67: China HDT fleet size Figure 68: GDP per unit of HDT (in terms of fleet size)

9,000 70% 57% 0.020 8,000 60% 7,000 50% 6,000 40% 0.015 25% 5,000 30% 17% 13% 4,000 9% 12%12% 20% 0.010 7% 8% 6% 6% 7% 7% 6% 6% 4% 3% 3,000 -1% 10% 2,000 -8% 0% 0.005 1,000 -10% 0 -20%

0.000

2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2013 2014 2015 2016 2017 2018 2020E HDT fleet size (000 units) Growth (YoY) RHS GDP (Rmb bn)/ HDT fleet size 2019E

Source: Wind, NBS, CMBIS estimates Source: Wind, NBS, CMBIS

Figure 69: China highway freight transport Figure 70: China highway freight transport turnover turnover (monthly) (yearly)

Bn tonnes km 8,000 20% 800 18.4% 7,000 16.7% 15.9% 700 15% 6,000 13.1% 600 9.3% 10% 5,000 9.5% 500 6.6% 4,000 5.4% 5% 400 3,000 300 0% 2,000 200 -5.0% -5% 100 1,000 -6.4%

0 0 -10% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

2016 2017 2018 2019 Highway freight transport turnover (bn tonne km) Growth (YoY) RHS

Source: Cvworld, CMBIS Source: Wind, CMBIS estimates

Figure 71: Change in assumptions for key products in China construction machinery market Old New Change (ppt) 2019E 2020E 2021E 2019E 2020E 2021E 2019E 2020E 2021E Sales volume growth (YoY) Earth moving machinery Excavator 15% 0% - 15% 10% 0% 0.0 10.0 - Wheel loader 15% 8% - 4% 0% -5% (10.6) (8.0) - Crane Truck crane 25% 12% - 30% 15% 10% 5.0 3.0 - Tower crane 50% 20% - 50% 30% 20% 0.0 10.0 - Concrete machinery Concrete mixer truck 5% 5% - 30% 15% 8% 25.0 10.0 - Concrete pump truck 15% 5% - 30% 30% 20% 15.0 25.0 - Heavy-duty truck -1% 3% - 1% 1% 0% 2.2 (1.2) - Source: CCMA, Wind, CMBIS estimates

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CMB International Securities | Equity Research | Company Update

SANY Heavy Industry – A (600031 CH)

World stage, off we go BUY (Initiation)

Target Price RMB19.00 On the back of rapid enhancement in product quality, precise marketing strategy, Up/Downside +27% commitment on R&D spending, solid track record and excellent management Current Price RMB14.94 execution, SANY is set to emerge as a world class player to compete in the global market, offering earnings upside over the coming years. Near term, we forecast SANY to deliver EPS growth of 70%/18% in 2019E/20E, driven by favourable China Capital Goods domestic demand. Initiate with BUY with TP of RMB19.0, based on 12x 2020E Wayne Fung, CFA P/E. SANY is our sector top pick. (852) 3900 0826 [email protected]  Market share gain on excavator to continue. SANY has clearly become a winner in the excavator industry with market share increased substantially from ~12% in 2011 to 25% in 10M19, outshining all its competitors. SANY Stock Data targets to achieve 30% market share in China going forward, which we believe Mkt Cap (RMB mn) 125,742 is achievable. Avg 3 mths t/o (RMB mn) 942 52w High/Low (RMB) 15.15/7.72  Crane machinery to benefit from structural drivers. We believe crane Total Issued Shares (mn) 8,375.6 Source: Bloomberg machinery will continue to benefit from two structural positive drivers: (1) The wide application of precast concrete in construction will drive the demand for Shareholding Structure large size crane; (2) Stringent environmental policies issued by local SANY Group 30.18% governments will continue to boost the replacement demand for truck cranes. Hong Kong CCASS 7.12% Liang Wengen 3.41%  SANY is the key beneficiary of strong concrete machinery demand. Others 59.28% Source: Shanghai Stock Exchange SANY is the largest player in the concrete machinery with market share rising from 29% in 2015 to 38% in 2018. Favourable competitive landscape is the Share Performance key for SANY to enjoy strong bargaining power amid the current upcycle. Absolute Relative 1-mth +6.0% +6.5% Aside from the NES III truck replacement, the increasing demand for small 3-mth +5.7% +4.1% tank mixer will also drive upcoming demand. 6-mth +23.9% +14.9% Source: Bloomberg  Strong free cash flow & balance sheet. SANY consistently generated positive free cash flow for years, and we forecast the trend will continue in 12-mth Price Performance 2019E-21E, offering room for raising dividend payout ratio. Besides, SANY’s (RMB) 600031 CH 16.0 SHSZ300 (rebased) net debt to equity ratio turned from 81% in 2015 to net cash of RMB4.3bn in 14.0 9M19. The solid balance sheet enables SANY to launch acquisition in 12.0 10.0 overseas. 8.0 6.0  Key risks: (1) Cyclical nature; (2) Risk of overseas business; (3) Increase in 4.0 raw material cost 2.0 0.0 11/2018 2/2019 5/2019 8/2019 11/2019

Earnings Summary Source: Bloomberg (YE 31 Dec) FY17A FY18A FY19E FY20E FY21E Revenue (RMB mn) 38,335 55,822 76,999 88,688 95,481 Auditor: Ruihua CPA YoY growth (%) 65 46 38 15 8 Net income (RMB mn) 2,092 6,116 11,127 13,352 14,473 EPS (RMB) 0.27 0.79 1.35 1.59 1.72 YoY growth (%) 925.0 189.6 70.3 17.8 8.4 EV / EBITDA (x) 21.0 14.1 8.3 7.2 6.8 P/E (x) 54.7 18.9 11.1 9.4 8.7 P/B (x) 4.5 3.7 2.8 2.4 2.1 Yield (%) 1.2 1.9 3.6 5.3 5.8 ROE (%) 8.7 21.5 29.3 27.3 25.3 Net gearing (%) 30.4 Net cash Net cash Net cash Net cash Source: Company data, CMBIS estimates

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Investment case Company overview SANY Heavy Industry manufactures and markets construction and engineering machinery and related parts. The Company produces and sells excavators, concrete pumps, concrete pump vehicles, road rollers, pavers, and other construction machinery products. SANY Heavy Industry markets its products worldwide. After years of development, the Company now has the largest producing capacity of concrete pumps in China and has established itself as one of the biggest manufacturers of concrete pumps in the world.

Market share gain on excavator to continue On the back of rapid enhancement in product quality, precise marketing strategy and excellent management execution, SANY has become a clear winner in the excavator industry with market share increased substantially from ~12% in 2011 to 25% in 10M19, significantly outpacing all the competitors.

SANY’s excavator revenue grew 43% YoY to RMB15.9bn in 1H19, representing 37% of total revenue. Market share of small / medium / large size excavator reached 27.2%/ 20.8% / 22.7%, up 2.1ppt / 2.6 ppt / 9.0 ppt YoY in 1H19. The significant enhancement of large size products and more competitive pricing enabled SANY to gain market share from Caterpillar. We expect SANY to continue to gain share in the large-size segment. For the medium to small size excavator, we expect SANY to continue to gain share from the Japanese players. SANY targets to achieve 30% market share in China going forward, which we believe is achievable.

Figure 72: SANY excavator market share in China Figure 73: SANY’s market share by size of excavator

30% % 30 27.2 25% 25.1 25 22.7 20% 20.8 20 18.2 15% 15 13.7 10% 10 5% 5 0% 0 Large Medium Small

1H18 1H19

2011-07 2012-01 2012-07 2013-01 2013-07 2014-01 2014-07 2015-01 2015-07 2016-01 2016-07 2017-01 2017-07 2018-01 2018-07 2019-01 2011-01 Source: Wind, CMBIS Source: Company data, CMBIS

Crane machinery to benefit from structural drivers SANY’s crane machinery revenue surged 107% YoY to RMB8.5bn in 1H19, representing 20% of total revenue. We believe crane machinery will continue to benefit from two structural positive drivers: First, the wide application of precast concrete in construction will drive the demand for large size crane. Second, the stringent environmental policies issued by local governments will continue to boost the replacement demand for truck cranes. For example, some projects have banned the use of NES II and III in the construction activities.

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Figure 74: SANY truck crane sales growth vs industry Figure 75: SANY’s sales volume breakdown

250% Units Earth moving 160,000 200% machinery 140,000

150% 120,000 Piling machinery 100,000 100% 80,000 Crane machinery 60,000 50% 40,000 Excavator 0% 20,000

0 Concrete machinery

SANY Industry average

Source: Wind, CMBIS Source: Company data, CMBIS estimates

SANY is the key beneficiary of strong concrete machinery demand SANY is the largest player in the concrete machinery sector. In terms of sales volume, SANY raised its market share significantly from 29% in 2015 to 38% in 2018. Zoomlion, the second player, had ~14% share. The favourable competitive landscape enables SANY to enjoy strong bargaining power amid the current upcycle. Aside from the NES III truck replacement, the increasing demand for small tank mixer will also drive upcoming demand.

Overseas expansion the next growth driver Overseas expansion has been SANY’s major strategic focus. SANY has already established R&D centers and production bases across different regions. In China, SANY has three production bases located in Beijing, Hunan and Yangtze River delta. In the overseas, production bases are located in the US, India, Germany and Brazil. The production base in the US is mainly for the assembly of crawler truck crane, excavator and pump truck. In India, the production base is manly for the assembly of concrete and crane machinery. The production base in Brazil is for the production of excavator and crane. Besides, SANY had 150 distributors in the overseas market (as at end-2018).

The Company’s overseas revenue increased from RMB3.4bn in 2011 to RMB13.6bn in 2018. SANY expects huge potential in the overseas market. Overseas revenue accounted for 17% of total revenue in 1H19. SANY plans to speed up the oversea expansion through M&A in the future. SANY expects the overseas contribution to reach 40% in the long run.

Figure 76: SANY’s revenue breakdown by region Figure 77: SANY’s overseas revenue

100% RMB mn 16,000 180% 90% 155% 14,000 160% 80% 140% 12,000 70% 120% 10,000 60% 100%

50% Overseas 8,000 80% 60% 40% China 6,000 24% 25% 40% 30% 4,000 17% 2% 20% 20% -7% 2,000 -10% 0% 10% 0 -20% 2011 2012 2013 2014 2015 2016 2017 2018 0% 2011 2012 2013 2014 2015 2016 2017 2018 Overseas revenue Growth (YoY) RHS

Source: Company data, CMBIS Source: Company data, CMBIS

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Receivable risk significantly reduced SANY’s cash collection in China market can be divided into (1) full payment, (2) installment, and (3) mortgage & finance lease. For the method of full payment, 95% of the total amount will be collected shortly after delivery and installation. For mortgage payment method, SANY has the obligation to repay the remaining balance in case if the customer does not complete the repayment. For finance lease, SANY has cooperated with leasing companies including China KangFu International Leasing Co. (中国康富国际租赁) and Hunan Zhong Hong Finance Leasing (湖南中宏融资租赁). These leasing companies normally discount the receivables from financial institutions. In case if the customers are unable to complete the payment, SANY has the obligation to buy back the machines from the financial institutions.

On the back of stringent cash collection and credit policy, full payment sales as percentage of total sales increased from only 15.2% in 2012 to 30% in 2018. The account receivable days improved from the peak of 338 days in 2015 to 133 days in 2018.

Besides, the financial guarantee (off balance) exposure reduced from a peak of RMB36.7bn in 2012 to only RMB8.7bn in 2017, suggesting continuous improvement in the risk of impairment. The amount increased to RMB17bn in 1H19 due to significant increase in revenue but was still less than half of the peak level.

Figure 78: Sales breakdown by type of payment Figure 79: Customers’ payment schedule

100% Type Payment schedule % of total amount Full payment Prepayment 30% 90% Within 10 days upon delivery 30% 80% Mortgage and Within 10 days upon installation 35% Within 12 months (warranty) 5% finance lease 70% Total 100% 60% Installment Prepayment 30% Installment 50% In 9-18 months 70% Total 100% 40%

30% Mortgage Prepayment 20-30% Full payment In 24-48 months 70-80% 20% 100% 10% Finance lease Prepayment 20-30% 0% In 24-36 months 70-80% 2011 2012 2013 2014 2015 2016 2017 2018 100% Source: Company data, CMBIS Source: Company data, CMBIS

Figure 80: Financial guarantee issued by SANY Figure 81: Write-off due to customers’ default

(RMB mn) (RMB mn) 40,000 8,000

35,000 7,000 30,000 6,000 25,000 5,000 20,000 15,000 4,000

10,000 3,000 5,000 2,000 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 1,000 0 Mortgage Finance lease companies 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19

Source: Company data, CMBIS Source: Company data, CMBIS

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Financial Projection EPS growth of 70%/18%/9% in 2019E/20E/21E

 Revenue growth of 39%/15%/8% in 2019E/20E/21E

1) Excavator We expect the segment revenue growth of 30% in 2019E. We expect SANY to continue to deliver revenue growth of 12%/5% in 2020E/21E, on the back of market share gain and overseas expansion.

2) Concrete machinery We expect concrete machinery to be the highest growth segment due to the strong replacement cycle and resilient property construction. We forecast segment revenue of 50%/20%/10% in 2019E/20E/21E.

3) Crane machinery We expect crane machinery revenue growth to reach 49%/18%/10% in 2019E/20E/21E, on the back strong replacement demand.

 Resilient gross margin We expect the blended gross margin to stay high at >32% in 2019E-21E, as we expect margin expansion on crane and concrete machinery will help offset the potential weakness of excavator margin due to competition. Besides, we expect the capacity automation will help further reduce the production cost.

 Solid net profit growth SANY’s net profit in 9M19 surged 87.5% YoY to RMB9.16bn. We forecast SANY to deliver net profit growth 82%/20%/9% in 2019E/20E/21E. Taking into consideration the dilution effect upon the conversion of CB this year, our projected EPS growth are 70%/18%/8% in 2019E/20E/21E.

 Strong free cash flow and balance sheet SANY consistently generated positive free cash flow over the past few years. We forecast SANY to continue to generate strong free cash flow in 2019E-21E, offering room for raising dividend payout ratio. Besides, SANY’s net debt to equity ratio turned from 81% in 2015 to net cash of ~RMB350mn in 2018. Following the conversion of CB this year, the net cash further increased to RMB4.3bn in 9M19. The strong balance sheet will help SANY to withstand any unexpected cyclical downturn and launch acquisition in the overseas.

Figure 82: SANY revenue breakdown Figure 83: SANY gross margin trend

(RMB mn) 50% Other business 45% 100,000 40% 90,000 Others 35% 80,000 30% 70,000 Earth moving 25% 60,000 machinery 20% 50,000 Piling machinery 15% 40,000 10% 30,000 Crane machinery 5% 20,000 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E 10,000 Excavator 0 Concrete machinery Excavator Concrete machinery Crane machinery Piling machinery Earth moving machinery Others

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

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Figure 84: SANY net profit growth Figure 85: SANY ROE

RMB mn % 928% 16,000 1000% 60 55.8 14,000 800% 50 12,000 600% 10,000 40 8,000 400% 29.3 192% 26.6 27.3 6,000 113% 30 25.3 54% 47% 82% 200% 20% 8% 21.5 4,000 -34% -49% -76% -80% 0% 20 2,000 12.4 0 -200% 8.7 10 3.0 0.6 0.9 0 Ne t profit Growth (YoY) 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 86: SANY’s free cash flow Figure 87: SANY’s dividend payout ratio

RMB mn 1.000 66% 70% 18,000 0.900 55% 60% 52% 16,000 0.800 50% 50% 14,000 0.700 50% 40% 38% 12,000 0.600 36% 40% 33% 31% 0.500 10,000 26% 30% 8,000 0.400 6,000 0.300 20% 4,000 0.200 10% 2,000 0.100 0 0.000 0% -2,000 2015 2016 2017 2018 2019E 2020E 2021E -4,000 Operating cash flow Capex Free cash flow DPS (RMB) Dividend payout ratio

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 88: Key operating assumptions (RMB mn) 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenue Concrete machinery 26,509 19,030 16,022 10,474 9,503 12,600 16,964 25,625 30,750 33,825 Excavator 9,499 7,920 6,657 6,118 7,470 13,669 19,247 25,125 28,140 29,547 Crane machinery 5,307 5,036 4,019 3,855 2,710 5,244 9,347 13,914 16,419 18,061 Piling machinery 1,350 2,137 1,251 499 1,187 2,913 4,691 5,876 6,464 6,787 Earth moving machinery 1,543 1,489 1,019 964 875 1,343 2,132 2,673 2,941 3,088 Other machinery 808 729 737 769 1,030 1,887 1,956 2,151 2,259 2,372 Revenue (construction machinery) 45,017 36,340 29,705 22,679 22,773 37,657 54,336 75,365 86,972 93,680 Other business 1,814 987 660 688 507 678 1,485 1,634 1,715 1,801 Total revenue 46,831 37,328 30,365 23,367 23,280 38,335 55,822 76,999 88,688 95,481

Revenue growth Concrete machinery 1.8% -28.2% -15.8% -34.6% -9.3% 32.6% 34.6% 51.1% 20.0% 10.0% Excavator -9.3% -16.6% -15.9% -8.1% 22.1% 83.0% 40.8% 30.5% 12.0% 5.0% Crane machinery -7.7% -5.1% -20.2% -4.1% -29.7% 93.5% 78.3% 48.9% 18.0% 10.0% Piling machinery -39.7% 58.3% -41.5% -60.1% 137.7% 145.5% 61.0% 25.3% 10.0% 5.0% Earth moving machinery -7.8% -3.5% -31.6% -5.4% -9.3% 53.6% 58.7% 25.4% 10.0% 5.0% Other machinery -72.0% -9.8% 1.1% 4.3% 34.0% 83.3% 3.6% 10.0% 5.0% 5.0% Revenue (construction machinery) -8.3% -19.3% -18.3% -23.7% 0.4% 65.4% 44.3% 38.7% 15.4% 7.7% Other business 6.1% -45.6% -33.2% 4.3% -26.4% 33.9% 118.9% 10.0% 5.0% 5.0% Total revenue -7.8% -20.3% -18.7% -23.0% -0.4% 64.7% 45.6% 37.9% 15.2% 7.7%

Gross margin Concrete machinery 35.7% 22.3% 22.1% 22.8% 21.5% 24.2% 25.2% 31.0% 32.0% 32.0% Excavator 27.1% 33.6% 32.6% 27.5% 32.4% 40.6% 38.7% 36.8% 36.0% 35.5% Crane machinery 31.2% 28.0% 27.8% 29.7% 34.0% 23.0% 24.8% 26.5% 27.5% 27.5% Piling machinery 40.8% 38.6% 41.2% 40.1% 25.2% 30.7% 37.3% 44.5% 44.0% 43.0% Earth moving machinery 27.2% 29.6% 24.6% 24.5% 17.4% 18.2% 31.3% 36.5% 36.5% 36.5% Other machinery 9.3% 14.6% 14.3% 7.9% 11.6% 20.9% 22.7% 31.0% 31.0% 31.0% Gross margin (construction machinery) 32.7% 26.7% 25.9% 25.2% 26.1% 30.1% 31.1% 33.4% 33.5% 33.2% Other business 7.0% 8.0% 19.0% 10.3% 28.9% 27.7% 12.5% 11.0% 11.0% 11.0% Blended gross margin 31.7% 26.2% 25.8% 24.8% 26.2% 30.1% 30.6% 32.9% 33.0% 32.7% Source: Company data, CMBIS

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Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E Total revenue 38,335 55,822 76,999 88,688 95,481 Pretax profit 2,869 7,550 13,737 16,485 17,869 Cost of sales (26,806 (38,728 (51,684 (59,396 (64,222 Finance cost 1,271 388 425 329 320 Gross profit 11,529) 17,094) 25,314) 29,292) 31,259) Interest income (72) (344) (687) (1,003) (1,360) Surcharge (279) (326) (462) (532) (573) P rofit or loss of associates (102) (128) (172) (176) (178) S&D expenses (3,832) (4,447) (5,390) (6,119) (6,493) F air value change (383) (276) 0 0 0 Administrative expenses (2,533) (3,800) (5,005) (5,676) (6,111) Provision for assets 903 (8) 0 0 0 Fair value change 403 (362) 0 0 0 Depreciation and amortization 1,913 1,932 1,935 1,950 1,962 Asset impairment (1,189) (1,095) (1,155) (1,330) (1,432) Income tax paid (642) (1,247) (2,267) (2,720) (2,948) EBIT 4,098 7,063 13,303 15,634 16,650 Change in working capital 2,126 1,788 (1,924) (2,190) (325) Net finance income/(cost) (1,319) (136) 263 674 1,040 Others 682 870 0 0 0 Finance income 72 344 687 1,003 1,360 Cash flow from operation 8,565 10,527 11,047 12,674 15,339 Finance expenses (1,391) (479) (425) (329) (320) Net capex on PP&E (34) (1,003) (1,400) (1,000) (1,000) Other gains/(losses) (13) 495 0 0 0 Investment in JV/associates 229 (648) (100) (100) (100) Profit of JV and associates 102 128 172 176 178 Investment in subsidiaries 2,046 311 0 0 0 Pretax profit 2,869 7,550 13,737 16,485 17,869 Dividend received 19 13 17 18 18 Income tax (642) (1,247) (2,267) (2,720) (2,948) Interest received 72 344 687 1,003 1,360 After tax profit 2,227 6,303 11,471 13,765 14,921 Others (1,115) (9,781) (70) (70) (0) MI (135) (187) (344) (413) (448) Cash flow from investing 1,218 (10,765 (865) (149) 278 Net profit 2,092 6,116 11,127 13,352 14,473 E quity financing/(repurchase) 0 0) 0 0 0 Recurring net profit 2,092 6,116 11,127 13,352 14,473 Net bank borrowings (12,158 1,584 (1,000) (300) (200) Dividend paid (229)) (1,233) (2,178) (4,451) (6,676) D&A 1,913 1,932 1,935 1,950 1,962 Interest paid (1,391) (479) (425) (329) (320) EBITDA 6,012 8,995 15,238 17,584 18,612 Others 695 955 0 0 0 Cash flow from financing (13,085 827 (3,602) (5,079) (7,195) Change in cash (3,302)) 589 6,579 7,446 8,421 Cash at beginning of the year 7,442 4,104 11,985 18,564 26,010 Exchange and others (36) 7,293 0 0 0 Cash at the end of the year 4,104 11,985 18,564 26,010 34,431

Balance sheet Key ratios YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec FY17A FY18A FY19E FY20E FY21E Non-current assets 22,030 21,879 21,781 21,176 20,533 Sales mix (%) PP&E 12,805 11,867 11,717 11,157 10,587 Concrete machinery 33% 30% 33% 35% 35% JV/associates 1,404 2,328 2,583 2,842 3,102 Excavator 36% 34% 33% 32% 31% Goodwill 51 51 51 51 51 Crane machinery 14% 17% 18% 19% 19% LT trade receivables 273 366 478 494 552 Piling machinery 8% 8% 8% 7% 7% Intangible assets 4,092 3,880 3,564 3,245 2,853 Earth moving machinery 4% 4% 3% 3% 3% AFS investments 681 1,121 1,121 1,121 1,121 Other machinery 5% 4% 3% 3% 2% Others 1,272 1,115 1,115 1,115 1,115 Other business 2% 3% 2% 2% 2% Deferred tax assets 1,452 1,152 1,152 1,152 1,152 Total 100% 100% 100% 100% 100% Current assets 36,207 51,896 64,704 75,695 86,634 Profit & loss ratio (%) Inventories 7,642 11,595 13,894 15,397 16,274 Gross margin 30.1 30.6 32.9 33.0 32.7 Trade and bills receivables 19,239 20,802 23,499 26,069 26,772 EBIT margin 10.7 12.7 17.3 17.6 17.4 Other receivables 1,789 1,704 2,937 2,408 3,347 Net profit margin 5.8 11.3 14.9 15.5 15.6 Others 2,696 3,272 3,272 3,272 3,272 Growth (%) Cash 4,104 11,985 18,564 26,010 34,431 Revenue 64.7 45.6 37.9 15.2 7.7 Gross profit 89.0 48.3 48.1 15.7 6.7 Current liabilities 22,983 33,935 38,153 39,524 41,876 EBIT n/a n/a 88.3 17.5 6.5 Trade and bills payables 10,938 17,191 21,608 22,979 25,231 Net profit 928.5 192.3 81.9 20.0 8.4 Bank borrowings 5,256 8,336 8,136 8,136 8,236 Balance sheet ratio Tax payable 533 524 524 524 524 Current ratio (x) 1.6 1.5 1.7 1.9 2.1 Others 2,446 3,567 3,567 3,567 3,567 Receivable turnover days 182 133 107 104 103 Non-current liabilities 8,882 7,337 2,504 2,204 1,904 Inventory turnover days 94 91 90 90 90 Bank borrowings 7,577 5,974 1,141 841 541 Payable turnover days 126 133 137 137 137 Deferred tax liabilities 646 650 650 650 650 Net debt / total equity (%) 30.4 Net cash Net cash Net cash Net cash Others 406 471 471 471 471 Profitability (%) Equity 26,373 32,502 45,829 55,143 63,387 ROA 3.5 9.3 13.9 14.6 14.2 Shareholders' equity 25,498 31,485 44,467 53,369 61,166 ROE 8.7 21.5 29.3 27.3 25.3 MI 876 1,017 1,361 1,774 2,222 Per share data EPS (RMB) 0.27 0.79 1.35 1.59 1.72 BVPS (RMB) 3.33 4.04 5.28 6.34 7.27 DPS (RMB) 0.18 0.28 0.54 0.79 0.86 Source: Company data, CMBIS estimates

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Valuation Initiate with BUY SANY traded at an average of >70x forward P/E over the past decade. The key reason for the high earnings multiple was due to the low earnings base during the trough cycle (2014- 16), and thus market shifted to asset base valuation (bottomed out at 1.5x PB three times over the past decade).

SANY’s earnings and valuation bottomed out in 2016 and has entered an upcycle. Since 2017, the forward P/E averaged at 11x, which we believe is more relevant to set a base for our target valuation. Our TP is set at RMB19.0, based on 12x 2020E target P/E, 10% premium to the average P/E to reflect the earnings upcycle.

Figure 89: SANY’s P/E band Figure 90: SANY’s P/B band

RMB RMB 25 35 14x

30 4.7x 20 12x

25 3.9x 15 10x 20 8x 3.1x

15 10 6x 2.3x

10 1.5x 5 5

0 0

Jul-14 Jul-17

Jul-14 Jul-17

Oct-11 Apr-14 Oct-14 Oct-17 Apr-18

Jun-13 Ja n-15 Jun-16 Ja n-18

Oct-11 Apr-14 Oct-14 Oct-17 Apr-18

Ma r-17 Ma r-13

Fe b-12 Fe b-16 Fe b-19

Jun-13 Ja n-15 Jun-16 Ja n-18

Aug-12 Nov-12 S e p-13 De c-13 Aug-15 Nov-15 S e p-16 De c-16 Aug-18 Nov-18 S e p-19

Ma r-17 Ma r-13

Fe b-12 Fe b-16 Fe b-19

Ma y-12 Ma y-15 Ma y-19

Aug-12 Nov-12 S e p-13 De c-13 Aug-15 Nov-15 S e p-16 De c-16 Aug-18 Nov-18 S e p-19

Ma y-12 Ma y-15 Ma y-19

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Risk factors Cyclical nature The demand for construction machinery is driven by infrastructure spending and property construction. Any unfavourable change in these macro parameters will potentially hurt the demand for SANY’s products.

Risk of overseas business Overseas expansion is SANY’s upcoming major strategy. Rising contribution from overseas business will increase the currency risk. Besides, entering new markets may increase the operating risk of the Company.

Increase in raw material cost Unexpected shortage of key components and increase in steel price would put pressure on the Company’s profit margin.

Figure 91: SANY’s production cost breakdown and major suppliers % of total Key suppliers Chassis 5.2 Isuzu, Benz, Volvo Engine and motor 9.4 Deutz, Hino, Weichai Gearbox and hydraulic pump 5.8 Bosch Rexroth, Kawasaki, Brevini Steel 11.3 Wuhan Iron and Steel, Xiangtan Iron & Steel Key body 8.1 Benz, Volvo Others 60.3 100.0 Source: Company data, CMBIS

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 32 27 Nov 2019

CMB International Securities | Equity Research | Company Update

Jiangsu Hengli Hydraulic (601100 CH)

The giant-killer BUY (Initiation)

Target Price: RMB54.0 We initiate on Jiangsu Hengli with a BUY rating and TP of RMB54, based on 30x Up/Downside: +16% 2020E P/E on the back of earnings CAGR of 31% in 2019E-21E. We expect Current Price: RMB46.7 Hengli to enter another stage of re-rating, driven by the clear roadmap to achieve import substitution. Besides, the growth is driven more by new product penetration, which should enable Hengli to mitigate the cyclical risk, serving as a China Capital Goods risk reduction factor. Key catalysts include better-than-expected growth of pump & valves sales and overseas sales. Wayne Fung, CFA (852) 3900 0826  Significant market share gain. Hengli is currently a major hydraulic cylinder [email protected] supplier of the major construction machinery manufacturers, which include

Caterpillar, Hitachi, Kubota, SANY, XCMG etc. Hengli sold 413k units of Stock Data hydraulic cylinder for excavator in 2018, implying ~50% market share in China, Mkt Cap (RMB mn) 41,189 up significantly from 13% in 2008. Hengli has been gaining market share Avg 3 mths t/o (RMB mn) 175 domestically from KYB (7242 JP, NR), the major competitor. And we see 52w High/Low (RMB) 48.30/17.63 Total Issued Shares (mn) 882 further room to increase going forward. Hengli’s success over its competitors Source: Bloomberg is more on product quality instead of pricing, which we believe is a sustainable driver. Shareholding Structure WANG’s family 71.0%  Pump & valve the growth driver. Leveraging the proven track record and CCASS (Hong Kong) 6.5% established customers network, Hengli’s capacity ramp up and sales of pumps Deutsche Bank AG 2.2% Free float 20.3% and valves have been on a good track. The ASP of pump & valve (ranging Source: Company data from RMB5k-25k per unit) is much higher than hydraulic cylinders (~RMB4,800/unit). Therefore, we see potential for Hengli to boost its pump & Share Performance valve revenue to a level similar to that of hydraulic cylinder in a few years’ time, Absolute Relative 1-mth +15.4% +16.0% serving as a key growth driver going forward. We forecast the revenue from 3-mth +56.5% +54.2% pump & valve to grow 110%/50%/40% in 2019E/20E/21E. Besides, we expect 6-mth +51.2% +40.1% the gross margin to further expand driven by operating leverage. Source: Bloomberg

 Overseas another growth driver. Hengli has specialized R&D bases in 12-mth Price Performance Berlin and Chicago, as well as sales network across regions such as Europe, (RMB) 601100 CH 50.0 SHSZ300 (rebased) North America and Japan. Hengli’s overseas revenue reported a CAGR of 63% 45.0 40.0 in 2011-2018. The latest expansion includes setting up two subsidiaries in 35.0 30.0 India in order to serve its local customers there. 25.0 20.0 15.0  Key risks: (1) economic risk; (2) new business risk; (3) risk of overseas 10.0 5.0 expansion; (4) increase in raw materials cost. 0.0 11/2018 2/2019 5/2019 8/2019 11/2019

Earnings Summary Source: Bloomberg

(YE 31 Dec) FY17A FY18A FY19E FY20E FY21E Auditor: RSM Revenue (RMB mn) 2,795 4,211 5,547 6,672 7,790 YoY growth (%) 104.0 50.6 31.7 20.3 16.8

Net income (RMB mn) 382 837 1,270 1,572 1,877 EPS (RMB) 0.43 0.95 1.44 1.78 2.13 YoY growth (%) 442.9 119.1 51.8 23.8 19.4 EV/EBITDA (x) 62.7 37.3 25.1 20.8 17.8 P/E (x) 107.8 49.2 32.4 26.2 21.9 P/B (x) 10.7 9.1 7.4 6.1 5.1 Yield (%) 0.3 0.6 1.0 1.2 1.5 ROE (%) 10.4 19.9 25.2 25.6 25.3 Net debt / equity (%) 5.0 Net cash Net cash Net cash Net cash Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 33 ACCESS KEY TO OUR REPORTS ON BLOOMBERG: CMBR 27 Nov 2019

Company Strength Company Background Jiangsu Hengli was founded in 2005, headquartered in Changzhou, Jiangsu. Hengli has expanded its product line to hydraulic components, precision castings, pneumatic components and hydraulic systems. These hydraulic equipment and systems serve as the core mobility component for large machinery, including excavators, tunnel boring equipment, marine and aerospace machinery, and other specialist vehicles. WANG’s family is the controlling shareholder with ~71% interest in Hengli. The Company has been listed in SSE since 2011.

Strong brand with tier-one and diversifed customer portfolio Following decade of development, Hengli has established a strong brand image and tier- one customer portfolio. Hengli is a key supplier for the major construction machinery manufacturers including Caterpillar, Hitachi, Kubota, SANY, XCMG, Liugong, China Railway Engineering, and CRCC. For example, Hengli has already supplied hydraulic cylinders for >50% of Caterpillar’s excavators. Hengli currently has ~50% market share in hydraulic cylinder for excavator in China. The strong customer portfolio creates strong entry barrier for the potential competitors.

Strong R&D Capability The Company has specialized R&D bases in Berlin, Chicago, Shanghai and Changzhou with more than 500 research personnel. The Company has hired experts in hydraulics from Germany, Japan, the United States, and formed a hydraulic research and development team together with the domestic experts. The Company holds 230 valid patents. With its excellent R&D and manufacturing teams, the Company has developed an advanced manufacturing system that includes high precision hydraulic casting, friction welding, heat treatment, high pressure sealing, product testing and advanced processing.

Extensive marketing network Hengli conducts marketing services through the Technical Service and Marketing Offices covering China, and is able to quickly provide prompt and comprehensive services for the customers. In addition, Hengli has set up overseas offices with marketing personnel and networks in across regions such as Europe, North America, Japan, etc., offering localized services. Exports account for >20% of the Company’s revenue in 2018.

Figure 92: Revenue breakdown (1H19) Figure 93: Major customers Product breakdown by downstream application Customers Component Completed set of 9% Excavator Caterpillar equipment Shengang 4% SANY XCMG Tunnel boring machinery China Railway Engineering Hydraulic CRCC cyclinder for Komatsu excavator Hitachi Hydraulic pump 44% The Robbins Company and valve Marine TTS 20% MacGregor National Oilwell Varco (NOV) New energy Gamesa Vestas Specialised Industrial Haitian hydraulic Yizumi cyclinder for Andritz heavy equpment Special vehicles Manitowoc 23% Terex Source: Company data, CMBIS Source: Company data, CMBIS

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Key growth drivers Further market share gain on hydraulic cylinder for excavator An excavator is typically equipped with four units of hydraulic cylinder and one set of pump & valve. China excavator sales of 203k units in 2018 translated into ~812k units of hydraulic cylinder demand. Hengli sold 413k units of hydraulic cylinder for excavator in 2018, implying ~50% market share in China, up significantly from 13% in 2008. Hengli has been gaining market share from KYB (7242 JP, NR), the major competitor, and we see further room going forward. Hengli’s hydraulic cylinder products are priced higher than its competitors due to its high performance and quality.

Hengli’s hydraulic cylinder (for excavator) capacity is ~450k units annually. That said, the actual production volume can be further increase by adding shift (i.e. two shifts, 24 hours per day). We understand that Hengli started running at two shifts since Oct, thanks to the strong order intakes. We forecast Hengli will deliver segment revenue growth of 15%/10% in 2019E/20E.

Figure 94: Hengli’s market share Figure 95: Revenue growth in China (Hengli vs KYB)

60% 140% 123% 51% 49% 50% 120% 47% 47% 50% 100% 78% 80% 62% 40% 35% 35% 60% 51% 30% 33% 40% 30% 24% 24% 20% 19% -9% 20% 0% 13% 2015 2016 2017 2018 12% -20% 10% -40% -51% -60% 0% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E Hengli KYB

Source: Company data, CCMA, CMBIS estimates Source: Company reports, CMBIS

Pumps, valves and motors the next growth driver Pumps and valves are two key components that are currently dominated by foreign players. Leveraging the solid track record and established customers network, Hengli’s capacity ramp up and sales of pumps and valves have been on a good track. At present, the monthly capacity of pump & valves for small excavator is ~4k units while that for mid-to-large excavator is ~2k units.

The ASP of pump & valve (ranging from RMB5k-25k per unit) is much higher than hydraulic cylinders (~RMB4,800/unit), and therefore we see room for Hengli to boost its pump & valve revenue to a level similar to that of hydraulic cylinder in a few years’ time, serving as a key growth driver going forward. We forecast the revenue from pump & valve to grow 110%/50%/40% in 2019E/20E/21E. Besides, we expect the gross margin to further expand driven by operating leverage.

On the other hand, Hengli is ramping up its motor capacity. Key customers include aerial working platform (AWP) manufacturers such as Lingong, Dingli (603338 CH, BUY) and Sinoboom, as well as excavator makers such as SANY and XCMG.

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Figure 96: Hydraulic components for an excavator Figure 97: Hydraulic components for an AWP

Note: A: Hydraulic cylinder, B: Remote control valve, C: Swing Note: A: Hydraulic cylinder, B: Axial Piston Pump, C: Control valve, D: motor, D: Flow sharing mobile valve, E: Single pump, F: Pilot control Motor device Source: Company, CMBIS Source: Company, CMBIS

Figure 98: Hengli’s revenue of pump & valves Figure 99: Gross margin of pump & valves

RMB mn RMB mn 2,500 300% 900 37% 40% 35% 800 32% 35% 250% 30% 2,000 700 199% 30% 600 200% 25% 1,500 500 19% 20% 150% 400 15% 110% 15% 1,000 92% 300 100% 10% 50% 200 500 40% 50% 100 5% 0 0% 0 0% 2016 2017 2018 2019E 2020E 2021E 2017 2018 2019E 2020E 2021E Hydraulic pump and valve Growth (YoY) - RHS Hydraulic pump and valve Segment gross margin

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 100: Hengli’s piston pumps (InLine brand) Figure 101: Hengli’s control valve products

Source: CMBIS Source: CMBIS

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Non-standardized products for heavy equipment Customized cylinders are mainly supplied for mobile crane machinery, accounting for 50% of the total segment sales, followed by tunnel boring machine and marine engineering. Demand growth are driven by recovery of infrastructure spending. We are positive on mobile crane demand in China as we expect the replacement cycle to boost demand for crane machinery and hydraulic components. We forecast segment revenue CAGR of 20% in 2019E/20E.

Further expansion in the overseas Hengli announced in Sep that it plans to set up two subsidiaries in India, in order to achieve localization in the area of R&D, manufacturing (including hydraulic cylinder, pump & valve, motor, hydraulic parts) and distribution. The registered capital for the two subsidiaries are US$20mn and US$500k respectively (~RMB145mn in total). Given that the major Chinese construction machinery makers (Hengli’s customers) such as SANY Heavy (600031 CH, BUY) and XCMG (000425 CH, NR) have gradually established production bases in India, we believe Hengli’s capacity expansion in India will enable it to better serve its customers there and reduce transportation cost. The Indian government plans to invest 100 trillion Rupees (~US$1.4 trillion) on infrastructure over the coming five years and we believe that it will offer good opportunities for Hengli.

Figure 102: Hengli’s revenue breakdown by region Figure 103: Hengli’s overseas revenue

100% RMB mn 90% 1,000 450% 393% 80% 900 400% 70% 800 350% 700 60% 300% 50% 600 250% 40% 500 200% 30% 400 132% 150% 300 20% 200 60% 100% 10% 43% 48% 24% 27% 32% 100 50% 0% 2011 2012 2013 2014 2015 2016 2017 2018 0 0% 2011 2012 2013 2014 2015 2016 2017 2018 China Overseas Overseas Growth (YoY) - RHS

Source: Company data, CMBIS Source: Company data, CMBIS

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Financial projection Earnings CAGR of 31% in 2019E-21E

 Revenue growth driven by pump & valve We forecast Hengli to deliver revenue growth of 32%/20%/17% in 2019E/20E/21E, driven by the rapid growth of pumps & valves sales and stable growth of cylinders. We forecast such revenue contribution will increase from 11% in 2018 to 27% in 2021E. In the near term, we expect the revenue growth to resume in 4Q19E as Hengi has received strong order intakes since Oct.

 Resilient gross margin We expect the blended gross margin to stay at a resilient range of 37-38% in 2019E-21E, mainly supported by the rising gross profit contribution of pump & valve segment. We expect the gross margin of pump & valve to gradually increase from 29.7% in 2018 to 37% in 2021E. For hydraulic cylinder, we expect the segment gross margin to stay at 40% in 2019E-21E.

 Strong net profit growth with further upside We forecast net profit growth of 52%/24%/19% in 2019E/20E/21E. We have not modelled any potential expansion in overseas market and we see potential upside to our estimates.

 Strong cash flow; Stable dividend payout; Solid balance sheet Strong operating cash flow: Hengli generated strong operating cash flow and achieved positive free cash flow in 2018, due to strong working capital management. In 9M19, the operating cash flow reached RMB1.17bn (+215% YoY), much higher than the net profit of RMB917mn. We forecast Hengli to continue to generate strong free cash flow going forward.

Dividend payout ratio: Historically, Hengli’s payout ratio ranged from 30-40% since 2010 (close to 60% in 2015-16 due to low earnings base). We expect Hengli to maintain a payout ratio of 32% going forward, same as that in 2018.

Balance sheet: Hengli has maintained a solid financial position with net cash of RMB1.2bn as at end-Sep 2019. This provides room for the Company to gear up the balance sheet for further upcoming expansion.

Figure 104: Hengli’s revenue breakdown Figure 105: Gross margin for segment

(RMB mn) 45% Hydraulic Other business cyclinder for 9,000 40% excavator 8,000 Component 35% Specialised 7,000 hydraulic 30% 6,000 cyclinder for Completed set of heavy equpment 5,000 equipment 25% Hydraulic pump and valve 4,000 20% Hydraulic pump and 3,000 valve 15% Completed set 2,000 of equipment Specialised hydraulic 1,000 10% cyclinder for heavy 0 equpment 5% Component Hydraulic cyclinder for excavator 0% 2016 2017 2018 2019E 2020E 2021E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

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Figure 106: Hengli’s net profit growth Figure 107: Hengli’s ROE

RMB mn % 2,000 443% 500% 30 25.6 1,800 25.2 25.3 400% 1,600 25 1,400 19.9 300% 20 1,200 16.6 1,000 200% 119% 15 800 98% 52% 100% 10.4 600 42% 23% 11% 24% 19% 10 400 -15%-20% -31% 6.6 -58% 0% 200 5 2.7 1.8 2.0 0 -100% 0 Net profit Growth (YoY) - RHS 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 108: Hengli’s free cash flow Figure 109: Hengli’s dividend payout ratio

RMB mn RMB 2,000 0.60 70% 59.5%59.1% 60% 1,500 0.50 50% 0.40 1,000 37.0%38.4% 35.0% 36.3% 40% 32.3% 31.6%32.0%32.0% 0.30 30.6% 30% 500 0.20 20% 0 0.10 10% 2,014 2,015 2016 2017 2018 2019E 2020E 2021E (500) 0.00 0% 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E2020E

(1,000) Operating cash flow Ca pex Free cash flow DPS Payout ratio

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 110: Key assumptions on Hengli (RMB mn) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019E 2020E 2021E

Revenue Hydraulic cyclinder for excavator 608 887 728 750 559 407 529 1,154 1,811 2,252 2,478 2,602 Specialised hydraulic cyclinder for heavy equpment 195 236 285 327 415 516 560 1,042 1,144 1,394 1,673 1,924 Hydraulic pump and valve 0 0 0 0 4 3 83 249 479 1,005 1,508 2,111 Completed set of equipment 0 0 18 137 80 81 90 171 201 271 339 424 Component 14 9 12 11 26 67 95 165 537 580 627 677 Revenue (hydraulic business) 817 1,133 1,043 1,226 1,084 1,074 1,358 2,781 4,172 5,504 6,625 7,738 Other business 0 1 2 4 9 14 12 14 39 43 47 52 Total revenue 817 1,133 1,045 1,230 1,093 1,088 1,370 2,795 4,211 5,547 6,672 7,790

Revenue growth Hydraulic cyclinder for excavator 205.8% 45.9% -17.9% 3.0% -25.5% -27.2% 30.0% 118.1% 57.0% 24.4% 10.0% 5.0% Specialised hydraulic cyclinder for heavy equpment -3.9% 21.5% 20.5% 14.7% 27.0% 24.2% 8.6% 86.1% 9.7% 21.9% 20.0% 15.0% Hydraulic pump and valve ------20.8% 2634.7% 198.6% 92.5% 110.0% 50.0% 40.0% Completed set of equipment - - - 658.0% -41.8% 1.1% 12.0% 89.5% 17.2% 35.0% 25.0% 25.0% Component -4.1% -34.4% 28.1% -2.9% 129.0% 158.5% 40.7% 73.8% 226.4% 8.0% 8.0% 8.0% Revenue (hydraulic business) 96.3% 38.7% -7.9% 17.5% -11.6% -0.9% 26.4% 104.8% 50.0% 31.9% 20.4% 16.8% Other business 258.7% 95.0% 177.5% 80.5% 125.7% 46.2% -10.5% 14.6% 175.3% 10.0% 10.0% 10.0% Total revenue 96.4% 38.7% -7.8% 17.7% -11.1% -0.5% 26.0% 104.0% 50.6% 31.7% 20.3% 16.8%

Gross margin Hydraulic cyclinder for excavator 42.9% 43.8% 40.6% 36.7% 28.2% 25.2% 25.3% 38.8% 41.3% 40.0% 40.0% 40.0% Specialised hydraulic cyclinder for heavy equpment 41.2% 42.5% 34.4% 27.7% 19.8% 18.6% 19.2% 31.7% 35.1% 41.0% 40.0% 40.0% Hydraulic pump and valve - - - - 17.8% -182.8% 15.1% 18.6% 29.7% 32.0% 35.0% 37.0% Completed set of equipment - - 35.7% 35.5% 22.7% 16.7% 18.1% 16.8% 21.1% 21.0% 21.0% 21.0% Component 26.6% 27.0% 29.2% 34.4% 22.5% 21.1% 25.4% 35.5% 35.7% 35.0% 35.0% 35.0% Gross margin (hydraulic business) 42.2% 43.4% 38.7% 34.2% 24.4% 20.5% 21.7% 32.8% 36.6% 37.3% 37.4% 37.7% Other business 99.8% 99.9% 95.8% 45.2% 51.5% 74.4% 55.2% 38.5% 35.6% 50.0% 50.0% 50.0% Average gross margin 42.3% 43.4% 38.8% 34.2% 24.6% 21.2% 22.0% 32.8% 36.6% 37.4% 37.5% 37.8% Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 39 27 Nov 2019

Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E Total revenue 2,795 4,211 5,547 6,672 7,790 Pretax profit 447 963 1,475 1,826 2,180 Cost of sales (1,878) (2,671) (3,471) (4,170) (4,846) Finance cost 78 (32) 58 51 44 Gross profit 917 1,540 2,076 2,502 2,943 Profit or loss of associates 0 0 0 0 0 Surcharge (36) (43) (55) (67) (78) Loss/(gain) on disposal (0) 3 0 0 0 S&D expenses (96) (115) (139) (160) (187) DepreciationPP&E/business & amortization 201 232 254 284 309 Administrative expenses (287) (385) (488) (567) (662) Income tax paid (66) (126) (207) (256) (305) Asset impairment (38) (119) 0 0 0 Change in working capital (499) (345) (578) (222) (568) EBIT 460 879 1,394 1,708 2,016 Others 31 122 0 0 0 Net finance income/(cost) (85) 30 15 38 70 Cash flow from operation 154 799 1,003 1,684 1,659 Finance income 23 168 73 89 114 Net capex on PP&E (211) (362) (400) (500) (400) Finance expenses (108) (138) (58) (51) (44) Investment in JV/associates 0 0 0 0 0 Other gains/(losses) 71 54 67 80 93 Investment in subsidiaries 0 (117) 0 0 0 Profit of JV and associates 0 0 0 0 0 Investment in intangibles 0 (19) (10) (10) (10) Pretax profit 447 963 1,475 1,826 2,180 Dividend received 0 0 0 0 0 Income tax (66) (126) (207) (256) (305) OthersJV/associates 126 217 0 0 0 After tax profit 381 837 1,269 1,571 1,875 Cash flow from investing (86) (281) (410) (510) (410) MI 1 (0) 1 2 2 Proceeds from equity 0 0 0 0 0 Net profit 382 837 1,270 1,572 1,877 Netfinancing/(repurchase) bank borrowings 351 (8) (150) (150) (150) Dividend paid (42) (139) (265) (406) (503) D&A 201 232 254 284 309 Interest paid (45) (3) (58) (51) (44) EBITDA 661 1,110 1,648 1,993 2,325 Others (113) (1) 0 0 0 Cash flow from financing 151 (152) (473) (607) (697) Change in cash 220 366 120 567 553 Cash at beginning of the year 870 1,146 1,571 1,691 2,258 Exchange and others 57 59 0 0 0 Cash at the end of the year 1,146 1,571 1,691 2,258 2,810

Balance sheet Key ratios YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec FY17A FY18A FY19E FY20E FY21E Non-current assets 2,862 2,828 2,984 3,210 3,311 Sales mix (%) PP&E 2,063 2,233 2,390 2,617 2,720 Cylinder for excavator 41% 43% 41% 37% 33% JV/associates 0 0 0 0 0 Cylinder for heavy equipment 37% 27% 25% 25% 25% Goodwill 47 0 0 0 0 Hydraulic pump and valve 9% 11% 18% 23% 27% Intangible assets 272 279 278 277 275 Completed set of equipment 6% 5% 5% 5% 5% AFS investments 332 10 10 10 10 Component 6% 13% 10% 9% 9% Others 133 257 257 257 257 Other business 1% 1% 1% 1% 1% Deferred tax assets 15 49 49 49 49 Total revenue 100% 100% 100% 100% 100% Current assets 3,295 4,443 5,319 6,244 7,532 Profit & loss ratio (%) Inventories 821 1,050 1,423 1,547 1,905 Gross margin 32.8 36.6 37.4 37.5 37.8 Trade and bill receivables 990 1,328 1,711 1,945 2,323 EBIT margin 16.5 20.9 25.1 25.6 25.9 Prepayment 141 135 135 135 135 Net profit margin 13.6 19.9 22.9 23.5 24.1 Others 197 358 358 358 358 Growth (%) Pledged deposits 0 0 0 0 0 Revenue 104.0 50.6 31.7 20.3 16.8 Cash 1,146 1,571 1,691 2,258 2,810 Gross profit 204.0 67.9 34.8 20.5 17.6 Current liabilities 1,692 1,981 2,059 2,095 2,163 EBIT n/a 90.9 58.7 22.6 18.0 Trade and bill payables 509 691 868 1,005 1,172 Net profit 442.9 119.1 51.8 23.8 19.4 Bank borrowings 939 905 805 705 605 Balance sheet ratio Tax payable 33 24 24 24 24 Current ratio (x) 1.9 2.2 2.6 3.0 3.5 Advance from customers 97 154 154 154 154 Receivable turnover days 102 100 100 100 100 Others 114 208 208 208 208 Inventory turnover days 137 128 130 130 130 Non-current liabilities 591 715 665 615 565 Payable turnover days 82 82 82 82 82 Bank borrowings 401 353 303 253 203 Net debt / total equity (%) 5.0 Net cash Net cash Net cash Net cash Deferred tax liabilities 9 47 47 47 47 Profitability (%) Deferred income 182 165 165 165 165 ROA 6.7 12.5 16.3 17.7 18.5 Others 0 150 150 150 150 ROE 10.4 19.9 25.2 25.6 25.3 Equity 3,873 4,575 5,579 6,744 8,116 Per share data Shareholders' equity 3,845 4,547 5,552 6,718 8,092 EPS (RMB) 0.43 0.95 1.44 1.78 2.13 MI 28 28 27 25 24 BVPS (RMB) 4.36 5.16 6.30 7.62 9.17 DPS (RMB) 0.16 0.30 0.46 0.57 0.68 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 40 27 Nov 2019

Valuation We see further room of re-rating We initiate coverage on Hengli with a BUY rating and TP of RMB54, based on 30x 2020E P/E on the back of earnings CAGR of 31% in 2019E-21E. We expect Hengli to enter another stage of re-rating, driven by the clear roadmap on the new product development. Besides, the upcoming growth is driven more by new product penetration that should help Hengli mitigate the cyclical risk, serving as a risk reduction factor. Key catalysts include better-than-expected growth of pump & valves sales and overseas sales.

Figure 111: Hengli’s P/E band Figure 112: Hengli’s P/B band

RMB RMB 70 60 7.5x 35x 60 50 30x 6.0x 50 40 25x 40 4.5x 20x 30 30 3.0x 15x 20 20

10 1.5x 10

0 0

Jul-14 Jul-17

Jul-14 Jul-17

Oct-11 Oct-14 Oct-17

Apr-14 Apr-18

Jun-13 Jan-15 Jun-16 Jan-18

Oct-11 Apr-14 Oct-14 Oct-17 Apr-18

Feb-12 Mar-13 Feb-16 Mar-17 Feb-19 Jun-13 Ja n-15 Jun-16 Ja n-18

Dec-16 Nov-12 Dec-13 Nov-15 Nov-18

Aug-12 Sep-13 Aug-15 Sep-16 Aug-18 Sep-19

Ma r-17 Ma r-13

Fe b-12 Fe b-16 Fe b-19

May-12 May-15 May-19 Aug-12 Nov-12 S e p-13 De c-13 Aug-15 Nov-15 S e p-16 De c-16 Aug-18 Nov-18 S e p-19

Ma y-12 Ma y-15 Ma y-19

Source: Bloomberg, Company data, CMBIS estimates Source: Bloomberg, Company data, CMBIS estimates

Risk factors Economic risk The demand for Hengli’s hydraulic components was driven by excavator, marine engineering and port machinery. The end-demand for these machineries is driven by infrastructure spending and the macro economy. Any unfavourable change will potentially hurt the demand for Hengli’s components.

Risk of new business expansion Pump, valve and motor are Hengli’s new products and source of growth. There exists risk of rising competition and potential change in competitors’ pricing strategies, which may create uncertainties to Hengli’s expansion.

Risk of overseas business Overseas expansion is Hengli’s major strategy. Rising contribution from overseas business will increase the currency risk. Besides, entering new markets (such as India) may increase the operating risk of the Company.

Raw material cost Steel is the major production cost item. While strong pricing power enables the Company to mitigate the volatile raw material cost, substantial increase in steel price would put pressure on the Company’s profit margin.

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 41 27 Nov 2019

CMB International Securities | Equity Research | Company Update

Weichai Power- A (000338 CH)

Resilient HDT engine; Non-road segment the next growth driver BUY (Initiation)

Target Price RMB15.90 We believe Weichai’s earnings to be more resilient in this cycle than the previous Up/Downside +19% ones as: (1) we expect HDT demand to stay at >1.1mn units in 2019E-21E on Current Price HK$13.38 the back of solid replacement demand; (2) Weichai’s non-road machinery growth will be a new growth driver, which is overlook by the market. We forecast Weichai to deliver stable earnings growth of 8%/7% in 2020E/21E and our estimates are China Capital Goods 8/14% above consensus. Initiate at BUY with SOTP-based TP of RMB15.9. Wayne Fung, CFA (852) 3900 0826  Higher forecast on HDT engine sales. In our projection, China HDT annual [email protected] demand to stay at 1.17mn units in 2020E-21E. We forecast Weichai’s HDT engines sales volume to be 402k/410k units in 2020E/21E, based on 34%/35% Stock Data market share. Meanwhile, we expect higher market share assumptions for Mkt Cap (RMB mn) 119,843 Weichai due to: (1) the rising contribution from LNG engine where Weichai Avg 3 mths t/o (RMB mn) 597 52w High/Low (RMB) 14.59/7.41 has a strong presence in; (2) potential industry consolidation driven by the Total Issued Shares (mn) 5,991 (A) implementation of NES VI; (3) increase in engine sales to Sinotruk (3808 HK, 1,943 (H) BUY). Source: Bloomberg

 Engines for non-road machinery to become the growth drivers over the Shareholding Structure coming years. The application of non-road machinery engine includes Weichai Holdings Group 16.8% Weifang Investment Group 3.7% construction machinery, industrial power generation, agricultural machinery Free float (H-share) 24.2% etc. In particular, we see huge potential for Weichai to achieve import Free float (A-share) 55.3% substitution in the area of excavator powertrain and industrial power engine. Source: HKEx

Revenue from non-road machinery engine contribution already increased Share Performance from 24% in 2017 to 29% in 1H19. We forecast the non-road segment revenue Absolute Relative growth to reach 16%/13% in 2020E/21E, taking the revenue contribution to 1-mth +11.2% +11.8% >35% by 2021E. 3-mth +19.7% +17.9% 6-mth +16.3% +7.8%  Valuation and key catalysts. We apply target multiple of 6x 2020E Source: Bloomberg

EV/EBITDA for Weichai’s core business. Our SOTP-based TP is RMB15.9. 12-mth Price Performance

Key catalysts: (1) better than expected HDT demand in 4Q19E and 1Q20E; (RMB) 000338 CH (2) speed up of the implementation of NES VI. 16.0 SHSZ300 (rebased) 14.0  Risk factors: (1) weakness in HDT and engine demand; (2) technology risk. 12.0 10.0 8.0 Earnings Summary 6.0 4.0 (YE 31 Dec) FY17A FY18A FY19E FY20E FY21E 2.0 0.0 Revenue (RMB mn) 151,569 159,256 170,540 179,391 187,155 11/2018 2/2019 5/2019 8/2019 11/2019 YoY growth (%) 62.7 5.1 7.1 5.2 4.3 Source: Bloomberg Net income (RMB mn) 6,808 8,658 9,733 10,519 11,205 EPS (RMB) 0.85 1.08 1.23 1.33 1.41 Auditor: Ernst & Young YoY growth (%) 178.9 27.2 13.3 8.1 6.5 P/E (x) 15.0 12.0 10.9 10.3 9.6 Related Reports EV / EBITDA (x) 6.7 5.9 5.3 5.0 4.8 1. China HDT Sector – HDT sales P/B (x) 2.9 2.6 2.3 2.1 1.9 growth of 12% YoY in Oct reaffirms Yield (%) 2.6 3.5 5.0 5.4 5.7 our bullish view – 4 Nov 2019 ROE (%) 20.3 23.2 23.0 21.9 21.0 2. Weichai Power (2338 HK, BUY) – Net gearing (%) 1.2 Net cash Net cash Net cash Net cash 3Q19 profit +10% YoY in line; Expect further demand growth in Source: Company data, CMBIS estimates 4Q19E – 31 Oct 2019 3. China HDT Sector - 3Q19 HDT sales +2% YoY; better than expectations – 5 Aug 2019 4. China HDT Sector – Three catalysts in 3Q19; Opportunity emerges – 8 Jul 2019

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 42 ACCESS KEY TO OUR REPORTS ON BLOOMBERG: CMBR 27 Nov 2019

Figure 113: Key assumptions on Weichai 2017 2018 2019E 2020E 2021E Sales volume (unit) Engine sales volume breakdow n For HDT 363,000 363,000 390,000 401,700 409,734 For non-road machinery 149,215 194,000 231,600 268,120 303,592 For heavy-duty & medium-duty construction machinery 96,674 125,000 140,000 158,200 177,184 For other non-road machinery 52,540 69,000 91,600 109,920 126,408 Other components 104,375 112,000 117,600 121,128 123,551 Engine total 616,590 669,000 739,200 790,948 836,877 HDT 149,000 153,000 157,000 165,000 165,000 Gear box 835,000 909,000 1,000,000 1,030,000 1,050,000

Grow th (YoY) Engine sales volume grow th (YoY) For HDT 83.3% 0.0% 7.4% 3.0% 2.0% For non-road machinery - 30.0% 19.4% 15.8% 13.2% For heavy-duty & medium-duty construction machinery - 29.3% 12.0% 13.0% 12.0% For other non-road machinery - 31.3% 32.8% 20.0% 15.0% Other components - 7.3% 5.0% 3.0% 2.0% Engine total 61.2% 8.5% 10.5% 7.0% 5.8% HDT 81.7% 2.7% 2.6% 5.1% 0.0% Gear box 66.7% 8.9% 10.0% 3.0% 1.9%

2017 2018 2019E 2020E 2021E (RMB mn) Revenue Diesel engines 43,802 44,858 49,600 53,073 56,154 Automobiles and major components 59,300 63,200 65,949 68,115 69,255 Other components 3,635 3,397 4,000 4,700 5,500 Import & export services 152 251 260 260 250 Forklift trucks & supply chain solution 58,493 60,540 63,567 66,745 70,083 Intersegment sales (13,813) (12,990) (12,836) (13,503) (14,087) Total revenue 151,569 159,256 170,540 179,391 187,155

Growth (YoY) Diesel engines 76.5% 2.4% 10.6% 7.0% 5.8% Automobiles and major components 88.0% 6.6% 4.3% 3.3% 1.7% Other components 18.1% -6.5% 17.8% 17.5% 17.0% Import & export services 7.2% 64.7% 3.8% 0.0% -3.8% Forklift trucks & supply chain solution 42.4% 3.5% 5.0% 5.0% 5.0% Intersegment sales 85.0% -6.0% -1.2% 5.2% 4.3% Average 62.7% 5.1% 7.1% 5.2% 4.3%

Segment profit Diesel engines 6,731 7,310 8,482 9,075 9,546 Automobiles and major components 1,431 1,821 2,440 2,452 2,493 Other components 187 131 192 244 275 Import & export services (37) 11 13 13 13 Forklift trucks & supply chain solution 2,866 3,636 3,814 4,005 4,205 Intersegment sales (456) 128 (128) (135) (141) Total segment profit 10,721 13,037 14,812 15,655 16,391

Segment margin Diesel engines 15.4% 16.3% 17.1% 17.1% 17.0% Automobiles and major components 2.4% 2.9% 3.7% 3.6% 3.6% Other components 5.1% 3.9% 4.8% 5.2% 5.0% Import & export services -24.5% 4.3% 5.0% 5.0% 5.0% Forklift trucks & supply chain solution 4.9% 6.0% 6.0% 6.0% 6.0% Average 7.1% 8.2% 8.7% 8.7% 8.8% Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 43 27 Nov 2019

Figure 114: Weichai’s HDT engine market share Figure 115: Shaanxi Heavy Duty Motor’s market share

40% 14%

35% 36.5% 13% 35.6% 36.2% 36.2% 13.3% 13.3% 13.3% 30% 33.3% 33.2% 32.6% 31.6% 12% 12.7% 12.3% 25% 27.0% 11% 20% 11.1% 11.2% 21.4% 10% 15% 10.2% 9% 10% 8% 5%

0% 7% 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 6% Engine (for HDT) 2012 2013 2014 2015 2016 2017 2018 1H19

Source: Company data, CMBIS Source: Company data, Wind, CMBIS

Figure 116: Weichai’s engine sales breakdown Figure 117: Weichai ROE

100% % Other 90% 25.0 23.2 23.0 components 21.9 80% 20.3 21.0 70% 20.0 For other non- 16.6 60% road machinery 15.0 50% For heavy-duty 40% & medium-duty 10.0 7.7 30% construction machinery 4.4 20% For HDT 5.0 10% 0% 0.0 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 118: Weichai-A P/E band Figure 119: Weichai-A P/B band

RMB RMB 25 20 3.7x

18 14x 20 3.0x 16 12x 14 10x 12 15 2.3x

10 8x 10 8 1.6x 6x 6

4 5 0.9x

2

0 0

Jul-15 Jul-12 Jul-18

Oct-09 Apr-12 Oct-12 Apr-15 Oct-15 Oct-18 Apr-19

Jun-11 Jan-13 Jun-14 Jan-16 Jun-17 Jan-19

J ul-18 J ul-12 J ul-15

Feb-10 Mar-11 Mar-14 Feb-17 Mar-18

Nov-13 Aug-10 Nov-10 Sep-11 Dec-11 Aug-13 Sep-14 Dec-14 Aug-16 Nov-16 Sep-17 Dec-17 Aug-19 Nov-19

May-10 May-13 May-16

Oct-09 Apr-12 Oct-12 Apr-15 Oct-15 Oct-18 Apr-19

J un-11 J an-13 J un-14 J an-16 J un-17 J an-19

Ma r-11 Ma r-14 Ma r-18

Fe b-10 Fe b-17

Nov-16 Nov-10 De c-11 Nov-13 De c-14 De c-17 Nov-19

Aug-10 S e p-11 Aug-13 S e p-14 Aug-16 S e p-17 Aug-19

Ma y-10 Ma y-13 Ma y-16

Source: Bloomberg, Company data, CMBIS Source: Bloomberg, Company data, Wind, CMBIS

Figure 120: SOTP valuation SOTP valuation Valuation methodology Target EBITDA Estimated EV Net cash / Equity value multiple (Net debt) (x) 2020E (RMB mn) (RMB mn) (RMB mn) Weichai core business EV/EBITDA 6 13,799 82,793 21,565 104,358 KION Group Proportionate market value - - - 25,232 Share of JV/associates PB 1.5 - - - 6,695 Minority interest (Weichai core business) (9,741) Total NAV 126,545 NAV per share (RMB) 15.9 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 44 27 Nov 2019

Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E Revenue 151,569 159,256 170,540 179,391 187,155 Pretax profit 10,522 13,858 15,548 16,805 17,900 Cost of sales (118,468) (123,686) (132,339) (139,207) (145,232) Finance cost 1,548 1,135 1,285 1,160 1,163 Gross profit 33,102 35,569 38,201 40,183 41,923 Interest income (957) (1,060) (1,275) (1,575) (1,946) Operating expenses (21,912) (21,757) (22,664) (23,809) (24,816) Share of profit or loss of associates (85) (174) (225) (230) (235) EBIT 11,189 13,812 15,537 16,375 17,106 Depreciation 5,088 5,321 5,670 6,055 6,440 Other expenses (161) (52) (205) (215) (225) Amortization of intangible assets 2,185 2,016 2,267 2,267 2,267 Net finance cost (591) (75) (10) 415 783 Income tax paid (1,344) (2,233) (2,519) (2,722) (2,900) Finance income and others 957 1,060 1,275 1,575 1,946 Change in working capital (2,887) 2,363 366 (654) 401 Finance expenses (1,548) (1,135) (1,285) (1,160) (1,163) Others 2,188 1,035 1,275 1,575 1,946 profit of JV & associates 85 174 225 230 235 Cash flow from operation 16,258 22,262 22,392 22,680 25,036 Pretax profit 10,522 13,858 15,548 16,805 17,900 Net capex on PP&E (2,775) (16,665) (5,000) (5,000) (5,000) Income tax (1,344) (2,233) (2,519) (2,722) (2,900) Investment in JV/associates (1,038) (1,655) 0 0 0 After tax profit 9,178 11,626 13,029 14,082 15,000 Investment in subsidiaries (34) 0 0 0 0 MI (2,370) (2,968) (3,296) (3,563) (3,795) Dividend received 51 181 135 138 141 Net profit 6,808 8,658 9,733 10,519 11,205 Others (1,241) 10,958 0 0 0 Cash flow from investing (5,037) (7,181) (4,865) (4,862) (4,859) D&A 7,365 7,404 7,937 8,322 8,707 Proceeds from equity financing 0 0 0 0 0 EBITDA 18,554 21,216 23,474 24,697 25,813 Net bank borrowings (7,459) 635 (4,000) 100 100 Dividend paid (1,599) (4,039) (3,661) (5,353) (5,786) Interest paid 0 0 (1,285) (1,160) (1,163) Others 2,461 (3,577) 0 0 0 Cash flow from financing (6,598) (6,980) (8,946) (6,413) (6,848) Change in cash 4,623 8,100 8,581 11,405 13,329 Cash at beginning of the year 27,123 34,222 38,210 46,791 58,196 Exchange gains/(losses) and others 2,475 (4,112) 0 0 0 Cash at the end of the year 34,222 38,210 46,791 58,196 71,525

Balance sheet Key ratios YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec FY17A FY18A FY19E FY20E FY21E Non-current assets 89,298 97,171 94,324 91,094 87,481 Sales mix (%) PP&E 27,067 29,453 28,783 27,727 26,287 Diesel engines 28.9 28.2 29.1 29.6 30.0 Investment in JV/associates 2,639 4,464 4,554 4,646 4,740 Automobiles and major components 39.1 39.7 38.7 38.0 37.0 Goodwill 22,583 23,037 23,037 23,037 23,037 Other components 2.4 2.1 2.3 2.6 2.9 Long term receivables 5,198 6,483 6,483 6,483 6,483 Import & export services 0.1 0.2 0.2 0.1 0.1 Intangible assets 23,840 23,299 21,033 18,766 16,499 Forklift trucks & supply chain solution 38.6 38.0 37.3 37.2 37.4 Others 7,971 10,434 10,434 10,434 10,434 Intersegment sales (9.1) (8.2) (7.5) (7.5) (7.5) Current assets 100,340 108,105 120,570 131,804 148,561 Total 100.0 100.0 100.0 100.0 100.0 Prepayments 560 1,109 1,109 1,109 1,109 Profit & loss ratio (%) Inventories 19,851 20,674 22,834 22,932 24,815 Gross margin 21.8 22.3 22.4 22.4 22.4 Trade receivables 13,573 13,155 14,879 14,610 16,155 EBIT margin 7.4 8.7 9.1 9.1 9.1 Notes receivables 25,291 24,993 24,993 24,993 24,993 After tax profit margin 6.1 7.3 7.6 7.9 8.0 Others 6,844 9,964 9,964 9,964 9,964 Growth (%) Cash 34,222 38,210 46,791 58,196 71,525 Revenue 62.7 5.1 7.1 5.2 4.3 Gross profit 57.0 7.5 7.4 5.2 4.3 Current liabilities 78,474 88,617 90,867 90,142 94,071 EBIT 128.3 23.4 12.5 5.4 4.5 Trade and bills payables 30,655 30,869 35,119 34,294 38,123 Net profit 178.9 27.2 12.4 8.1 6.5 Notes payable 12,361 15,925 15,925 15,925 15,925 Balance sheet ratio Bank borrowings 8,771 12,371 10,371 10,471 10,571 Current ratio (x) 1.3 1.2 1.3 1.5 1.6 Others 26,686 29,451 29,451 29,451 29,451 Receivable turnover days 30 31 30 30 30 Non-current liabilities 54,810 54,400 52,400 52,400 52,400 Inventory turnover days 55 60 60 60 60 Bank borrowings 26,138 23,174 21,174 21,174 21,174 Payable turnover days 81 91 91 91 91 Long term payables 18,455 19,475 19,475 19,475 19,475 Net debt / total equity (%) 1.2 Net cash Net cash Net cash Net cash Others 10,216 11,751 11,751 11,751 11,751 Profitability (%) Equity 56,355 62,259 71,627 80,357 89,571 ROA 5.2 5.9 6.2 6.4 6.5 Shareholders' equity 35,240 39,314 45,385 50,552 55,971 ROE 20.3 23.2 23.0 21.9 21.0 MI 21,115 22,946 26,242 29,805 33,600 Per share data EPS (RMB) 0.85 1.08 1.23 1.33 1.41 BVPS (RMB) 4.41 4.96 5.72 6.37 7.05 DPS (RMB) 0.33 0.46 0.67 0.73 0.78 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 45 27 Nov 2019

CMB International Securities | Equity Research | Company Update

Weichai Power-H (2338 HK)

Resilient HDT engine; Non-road segment the next growth driver BUY (Maintain)

Target Price HK$17.90 We believe Weichai’s earnings will be more resilient in this cycle than the (Previous TP HK$16.2) Up/Downside +29% previous ones as: (1) we expect HDT demand to stay at >1.1mn units in 2019E- Current Price HK$13.86 21E on the back of solid replacement demand; (2) Weichai’s non-road machinery growth will be a new growth driver, which is overlook by the market. We are raising our 2020E/21E earnings forecast by 2%/9% following our revision on HDT China Capital Goods demand projection and higher contribution from non-road machinery engine. Our Wayne Fung, CFA 2020E-21E earnings estimates are 8-14% above consensus. Reiterate BUY with (852) 3900 0826 new SOPT-based TP of HK$17.9. [email protected]

 Higher forecast on HDT engine sales. In our projection, China HDT annual Stock Data demand to stay at 1.17mn units in 2020E-21E. We revised up Weichai’s HDT Mkt Cap (HK$ mn) 110,842 engines sales volume forecast by 3%/9% to 402k/410k units in 2020E/21E, Avg 3 mths t/o (HK$ mn) 88 52w High/Low (HK$) 15.1/8.2 based on 34%/35% market share. We expect higher market share Total Issued Shares (mn) 5,991 (A) assumptions for Weichai due to: (1) the rising contribution from LNG engine 1,943 (H) where Weichai has a strong presence in; (2) potential industry consolidation Source: Bloomberg driven by the implementation of NES VI; (3) increase in engine sales to Shareholding Structure Sinotruk (3808 HK, BUY). Weichai Holdings Group 16.8% Weifang Investment Group 3.7%  Engines for non-road machinery to become the growth drivers over the Free float (H-share) 24.2% coming years. The application of non-road machinery engine includes Free float (A-share) 55.3% construction machinery, industrial power generation, agricultural machinery Source: HKEx

etc. In particular, we see huge potential for Weichai to achieve import Share Performance substitution in the area of excavator powertrain and industrial power engine. Absolute Relative Revenue from non-road machinery engine contribution already increased 1-mth +12.0% +10.6% from 24% in 2017 to 29% in 1H19. We forecast the non-road segment revenue 3-mth +22.2% +18.5% 6-mth +23.3% +24.9% growth to reach 16%/13% in 2020E/21E, taking the revenue contribution to Source: Bloomberg >35% by 2021E. 12-mth Price Performance  Valuation and key catalysts. We rolled over our valuation base to 2020E (HK$) 2338 HK HSI (rebased) with 6x EV/EBITDA target multiple. Our SOTP-based TP is raised to HK$17.9. 16.0 14.0 Key catalysts: (1) better than expected HDT demand in 4Q19E and 1Q20E; 12.0 (2) speed up of the implementation of NES VI. 10.0 8.0  Risk factors: (1) weakness in HDT and engine demand; (2) technology risk. 6.0 4.0 2.0 Earnings Summary 0.0 11/2018 2/2019 5/2019 8/2019 11/2019

(YE 31 Dec) FY17A FY18A FY19E FY20E FY21E Source: Bloomberg Revenue (RMB mn) 151,569 159,256 170,540 179,391 187,155 YoY growth (%) 62.7 5.1 7.1 5.2 4.3 Auditor: Ernst & Young Net income (RMB mn) 6,808 8,658 9,733 10,519 11,205 EPS (RMB) 0.85 1.08 1.23 1.33 1.41 Related Reports YoY growth (%) 178.9 27.2 13.3 8.1 6.5 1. China HDT Sector – HDT sales P/E (x) 13.8 11.1 10.1 9.5 8.9 growth of 12% YoY in Oct reaffirms EV / EBITDA (x) 6.3 5.5 5.0 4.7 4.5 our bullish view – 4 Nov 2019 2. Weichai Power (2338 HK, BUY) – P/B (x) 2.7 2.4 2.2 2.0 1.8 3Q19 profit +10% YoY in line; Yield (%) 2.8 3.8 5.5 5.8 6.2 Expect further demand growth in ROE (%) 20.3 23.2 23.0 21.9 21.0 4Q19E – 31 Oct 2019 Net gearing (%) 1.2 Net cash Net cash Net cash Net cash 3. China HDT Sector - 3Q19 HDT Source: Company data, CMBIS estimates sales +2% YoY; better than expectations – 5 Aug 2019 4. China HDT Sector – Three catalysts in 3Q19; Opportunity emerges – 8 Jul 2019

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 46 ACCESS KEY TO OUR REPORTS ON BLOOMBERG: CMBR 27 Nov 2019

Figure 121: Change in key assumptions Change in key assumptions 2019E 2020E 2021E Sales volume (unit) Old New Change Old New Change Old New Change Engine sales volume breakdow n For HDT 390,000 390,000 0.0% 389,000 401,700 3.3% 375,000 409,734 9.3% Non-road machinery 231,600 231,600 0.0% 253,072 268,120 5.9% 244,661 303,592 24.1% For heavy-duty & medium-duty construction machinery 140,000 140,000 0.0% 145,000 158,200 9.1% 140,000 177,184 26.6% For other non-road machinery 91,600 91,600 0.0% 108,072 109,920 1.7% 104,661 126,408 20.8% Other components 117,600 117,600 0.0% 121,128 121,128 0.0% 122,339 123,551 1.0% Engine total 739,200 739,200 0.0% 763,200 790,948 3.6% 742,000 836,877 12.8% HDT (Shaanxi Heavy-duty Motor) 176,000 157,000 -10.8% 177,000 165,000 -6.8% 165,000 165,000 0.0% Gear box (Shaanxi Fast Gear Company) 1,000,000 1,000,000 0.0% 990,000 1,030,000 4.0% 950,000 1,050,000 10.5%

(RMB mn) Revenue Diesel engines 49,600 49,600 0.0% 51,211 53,073 3.6% 49,788 56,154 12.8% Automobiles and major components 70,090 65,949 -5.9% 69,553 68,115 -2.1% 66,454 69,255 4.2% Other components 4,000 4,000 0.0% 4,700 4,700 0.0% 5,500 5,500 0.0% Import & export services 260 260 0.0% 260 260 0.0% 250 250 0.0% Forklift trucks & supply chain solution 63,567 63,567 0.0% 66,745 66,745 0.0% 70,083 70,083 0.0% Intersegment sales (13,126) (12,836) -2.2% (13,473) (13,503) 0.2% (13,445) (14,087) 4.8% Total revenue 174,391 170,540 -2.2% 178,997 179,391 0.2% 178,630 187,155 4.8%

Segment profit Diesel engines 8,482 8,482 0.0% 8,757 9,075 3.6% 8,215 9,546 16.2% Automobiles and major components 2,593 2,440 -5.9% 2,504 2,452 -2.1% 2,326 2,493 7.2% Other components 192 192 0.0% 244 244 0.0% 275 275 0.0% Import & export services 13 13 0.0% 13 13 0.0% 13 13 0.0% Forklift trucks & supply chain solution 3,814 3,814 0.0% 4,005 4,005 0.0% 4,205 4,205 0.0% Intersegment sales (131) (128) -2.2% (135) (135) 0.2% (134) (141) 4.8% Total segment profit 14,963 14,812 -1.0% 15,388 15,655 1.7% 14,899 16,391 10.0%

Segment margin Change (ppt) Change (ppt) Change (ppt) Diesel engines 17.1% 17.1% 0.0 17.1% 17.1% 0.0 16.5% 17.0% 0.5 Automobiles and major components 3.7% 3.7% 0.0 3.6% 3.6% 0.0 3.5% 3.6% 0.1 Other components 4.8% 4.8% 0.0 5.2% 5.2% 0.0 5.0% 5.0% 0.0 Import & export services 5.0% 5.0% 0.0 5.0% 5.0% 0.0 5.0% 5.0% 0.0 Forklift trucks & supply chain solution 6.0% 6.0% 0.0 6.0% 6.0% 0.0 6.0% 6.0% 0.0 Average 8.6% 8.7% 0.1 8.6% 8.7% 0.1 8.3% 8.8% 0.4 Source: Company data, CMBIS estimates

Figure 122: Weichai’s HDT engine market share Figure 123: Shaanxi Heavy Duty Motor’s market share

40% 14%

35% 13% 36.2% 36.5% 35.6% 36.2% 13.3% 13.3% 13.3% 30% 33.3% 33.2% 32.6% 31.6% 12% 12.7% 12.3% 25% 27.0% 11% 20% 11.1% 11.2% 21.4% 10% 15% 10.2% 9% 10% 8% 5%

0% 7% 2010 2011 2012 2013 2014 2015 2016 2017 2018 1H19 6% Engine (for HDT) 2012 2013 2014 2015 2016 2017 2018 1H19

Source: Company data, CMBIS Source: Company data, Wind, CMBIS

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 47 27 Nov 2019

Figure 124: Weichai’s engine sales breakdown Figure 125: Weichai ROE

100% % Other 90% 25.0 23.2 23.0 components 21.9 80% 20.3 21.0 70% 20.0 For other non- 16.6 60% road machinery 15.0 50% For heavy-duty 40% & medium-duty 10.0 7.7 30% construction machinery 4.4 20% For HDT 5.0 10% 0% 0.0 2017 2018 2019E 2020E 2021E 2014 2015 2016 2017 2018 2019E 2020E 2021E

Source: Company data, CMBIS estimates Source: Company data, CMBIS estimates

Figure 126: Weichai’s P/E band Figure 127: Weichai P/B band

HKD HKD 25 3.5x 25

14x 20 20 2.8x 12x

15 10x 15 2.1x

8x 10 10 1.4x 6x

5 5 0.7x

0 0

Jul-18 Jul-12 Jul-15

Oct-09 Apr-12 Oct-12 Apr-15 Oct-15 Oct-18 Apr-19

Jun-11 Jan-13 Jun-14 Jan-16 Jun-17 Jan-19

Feb-10 Mar-11 Mar-14 Feb-17 Mar-18

J ul-12 J ul-15 J ul-18

Aug-13 Aug-10 Nov-10 Sep-11 Dec-11 Nov-13 Sep-14 Dec-14 Aug-16 Nov-16 Sep-17 Dec-17 Aug-19 Nov-19

May-10 May-13 May-16

Apr-12 Oct-15 Oct-09 Oct-12 Apr-15 Oct-18 Apr-19

J un-11 J an-13 J un-14 J an-16 J un-17 J an-19

Ma r-11 Ma r-14 Ma r-18

Fe b-10 Fe b-17

Nov-10 De c-11 Nov-13 De c-14 Nov-16 De c-17 Nov-19

Aug-10 S e p-11 Aug-13 S e p-14 Aug-16 S e p-17 Aug-19

Ma y-10 Ma y-13 Ma y-16

Source: Bloomberg, Company data, CMBIS Source: Bloomberg, Company data, CMBIS

Figure 128: SOTP valuation SOTP valuation Valuation methodology Target EBITDA Estimated EV Net cash / Equity value multiple (Net debt) (x) 2020E (RMB mn) (RMB mn) (RMB mn) Weichai core business EV/EBITDA 6 13,799 82,793 21,565 104,358 KION Group Proportionate market value - - - 25,232 Share of JV/associates PB 1.5 - - - 6,695 Minority interest (Weichai core business) (9,741) Total NAV 126,545 NAV per share (RMB) 15.9 NAV per share (HK$) 17.9 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 48 27 Nov 2019

Financial Summary

Income statement Cash flow summary YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E Revenue 151,569 159,256 170,540 179,391 187,155 Pretax profit 10,522 13,858 15,548 16,805 17,900 Cost of sales (118,468) (123,686) (132,339) (139,207) (145,232) Finance cost 1,548 1,135 1,285 1,160 1,163 Gross profit 33,102 35,569 38,201 40,183 41,923 Interest income (957) (1,060) (1,275) (1,575) (1,946) Operating expenses (21,912) (21,757) (22,664) (23,809) (24,816) Share of profit or loss of associates (85) (174) (225) (230) (235) EBIT 11,189 13,812 15,537 16,375 17,106 Depreciation 5,088 5,321 5,670 6,055 6,440 Other expenses (161) (52) (205) (215) (225) Amortization of intangible assets 2,185 2,016 2,267 2,267 2,267 Net finance cost (591) (75) (10) 415 783 Income tax paid (1,344) (2,233) (2,519) (2,722) (2,900) Finance income and others 957 1,060 1,275 1,575 1,946 Change in working capital (2,887) 2,363 366 (654) 401 Finance expenses (1,548) (1,135) (1,285) (1,160) (1,163) Others 2,188 1,035 1,275 1,575 1,946 profit of JV & associates 85 174 225 230 235 Cash flow from operation 16,258 22,262 22,392 22,680 25,036 Pretax profit 10,522 13,858 15,548 16,805 17,900 Net capex on PP&E (2,775) (16,665) (5,000) (5,000) (5,000) Income tax (1,344) (2,233) (2,519) (2,722) (2,900) Investment in JV/associates (1,038) (1,655) 0 0 0 After tax profit 9,178 11,626 13,029 14,082 15,000 Investment in subsidiaries (34) 0 0 0 0 MI (2,370) (2,968) (3,296) (3,563) (3,795) Dividend received 51 181 135 138 141 Net profit 6,808 8,658 9,733 10,519 11,205 Others (1,241) 10,958 0 0 0 Cash flow from investing (5,037) (7,181) (4,865) (4,862) (4,859) D&A 7,365 7,404 7,937 8,322 8,707 Proceeds from equity financing 0 0 0 0 0 EBITDA 18,554 21,216 23,474 24,697 25,813 Net bank borrowings (7,459) 635 (4,000) 100 100 Dividend paid (1,599) (4,039) (3,661) (5,353) (5,786) Interest paid 0 0 (1,285) (1,160) (1,163) Others 2,461 (3,577) 0 0 0 Cash flow from financing (6,598) (6,980) (8,946) (6,413) (6,848) Change in cash 4,623 8,100 8,581 11,405 13,329 Cash at beginning of the year 27,123 34,222 38,210 46,791 58,196 Exchange gains/(losses) and others 2,475 (4,112) 0 0 0 Cash at the end of the year 34,222 38,210 46,791 58,196 71,525

Balance sheet Key ratios YE 31 Dec (RMB mn) FY17A FY18A FY19E FY20E FY21E YE 31 Dec FY17A FY18A FY19E FY20E FY21E Non-current assets 89,298 97,171 94,324 91,094 87,481 Sales mix (%) PP&E 27,067 29,453 28,783 27,727 26,287 Diesel engines 28.9 28.2 29.1 29.6 30.0 Investment in JV/associates 2,639 4,464 4,554 4,646 4,740 Automobiles and major components 39.1 39.7 38.7 38.0 37.0 Goodwill 22,583 23,037 23,037 23,037 23,037 Other components 2.4 2.1 2.3 2.6 2.9 Long term receivables 5,198 6,483 6,483 6,483 6,483 Import & export services 0.1 0.2 0.2 0.1 0.1 Intangible assets 23,840 23,299 21,033 18,766 16,499 Forklift trucks & supply chain solution 38.6 38.0 37.3 37.2 37.4 Others 7,971 10,434 10,434 10,434 10,434 Intersegment sales (9.1) (8.2) (7.5) (7.5) (7.5) Current assets 100,340 108,105 120,570 131,804 148,561 Total 100.0 100.0 100.0 100.0 100.0 Prepayments 560 1,109 1,109 1,109 1,109 Profit & loss ratio (%) Inventories 19,851 20,674 22,834 22,932 24,815 Gross margin 21.8 22.3 22.4 22.4 22.4 Trade receivables 13,573 13,155 14,879 14,610 16,155 EBIT margin 7.4 8.7 9.1 9.1 9.1 Notes receivables 25,291 24,993 24,993 24,993 24,993 After tax profit margin 6.1 7.3 7.6 7.9 8.0 Others 6,844 9,964 9,964 9,964 9,964 Growth (%) Cash 34,222 38,210 46,791 58,196 71,525 Revenue 62.7 5.1 7.1 5.2 4.3 Gross profit 57.0 7.5 7.4 5.2 4.3 Current liabilities 78,474 88,617 90,867 90,142 94,071 EBIT 128.3 23.4 12.5 5.4 4.5 Trade and bills payables 30,655 30,869 35,119 34,294 38,123 Net profit 178.9 27.2 12.4 8.1 6.5 Notes payable 12,361 15,925 15,925 15,925 15,925 Balance sheet ratio Bank borrowings 8,771 12,371 10,371 10,471 10,571 Current ratio (x) 1.3 1.2 1.3 1.5 1.6 Others 26,686 29,451 29,451 29,451 29,451 Receivable turnover days 30 31 30 30 30 Non-current liabilities 54,810 54,400 52,400 52,400 52,400 Inventory turnover days 55 60 60 60 60 Bank borrowings 26,138 23,174 21,174 21,174 21,174 Payable turnover days 81 91 91 91 91 Long term payables 18,455 19,475 19,475 19,475 19,475 Net debt / total equity (%) 1.2 Net cash Net cash Net cash Net cash Others 10,216 11,751 11,751 11,751 11,751 Profitability (%) Equity 56,355 62,259 71,627 80,357 89,571 ROA 5.2 5.9 6.2 6.4 6.5 Shareholders' equity 35,240 39,314 45,385 50,552 55,971 ROE 20.3 23.2 23.0 21.9 21.0 MI 21,115 22,946 26,242 29,805 33,600 Per share data EPS (RMB) 0.85 1.08 1.23 1.33 1.41 BVPS (RMB) 4.41 4.96 5.72 6.37 7.05 DPS (RMB) 0.33 0.46 0.67 0.73 0.78 Source: Company data, CMBIS estimates

PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 49 27 Nov 2019

Disclosures & Disclaimers Analyst Certification The research analyst who is primary responsible for the content of this research report, in whole or in part, certifies that with respect to the securities or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about the subject securities or issuer; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific views expressed by that analyst in this report. Besides, the analyst confirms that neither the analyst nor his/her associates (as defined in the code of conduct issued by The Hong Kong Securities and Futures Commission) (1) have dealt in or traded in the stock(s) covered in this research report within 30 calendar days prior to the date of issue of this report; (2) will deal in or trade in the stock(s) covered in this research report 3 business days after the date of issue of this report; (3) serve as an officer of any of the Hong Kong listed companies covered in this report; and (4) have any financial interests in the Hong Kong listed companies covered in this report.

CMBIS Ratings BUY : Stock with potential return of over 15% over next 12 months HOLD : Stock with potential return of +15% to -10% over next 12 months SELL : Stock with potential loss of over 10% over next 12 months NOT RATED : Stock is not rated by CMBIS

OUTPERFORM : Industry expected to outperform the relevant broad market benchmark over next 12 months MARKET-PERFORM : Industry expected to perform in-line with the relevant broad market benchmark over next 12 months UNDERPERFORM : Industry expected to underperform the relevant broad market benchmark over next 12 months

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CMB International Securities Limited (“CMBIS”) is a wholly owned subsidiary of CMB International Capital Corporation Limited (a wholly owned subsidiary of China Merchants Bank)

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