2 November 2017 Manufacturing Construction Machinery
Deutsche Bank Markets Research
Asia Industry Date China 2 November 2017 Industrials Construction Manufacturing Machinery Recommendation Change
Quality growth ahead instead of quantity Fei Sun, CFA Not too late in the cycle; expect quality growth in 2018 Construction machinery sales bottomed out in 3Q16 and have been growing Research Analyst rapidly, driven mainly by demand from infrastructure projects and replacement +852-2203 6130 orders. We identify the key drivers of construction machinery demand and our Vincent Ha, CFA top-down analysis suggests the industry will deliver moderate growth next year. Research Analyst Zoomlion would have relatively greater operating leverage as the sector continues +852-2203 6247 to recover, and we believe the valuation gap between Lonking and Zoomlion will narrow. We upgrade Zoomlion to Buy, as we expect an earnings rebound in Yuki Lu FY18-19 and asset quality to improve (less bad debt provision). We maintain a Research Associate Hold on Lonking as the positives, such as the ability to gain market share and +852-2203 5925 expand margins, are already factored into its share price. Key Changes Better-than-expected demand with balanced supply Company Target Price Rating According to China Construction Machinery Association (CCMA), excavator/ 1157.HK 3.89 to 4.80 Hold to Buy wheel loader/truck crane sales volume surged 100%/45%/122% in 9M17 amid 3339.HK 2.05 to 3.60 - robust replacement and infrastructure demand. Unlike the oversupply in the Source: Deutsche Bank previous down-cycle, construction machinery supply was balanced this time. This Top picks is because, unlike in 2011, fewer individual contractors have entered the industry, Zoomlion (1157.HK),HKD3.81 Buy allowing more rational market competition. Besides this, producers' credit sales Source: Deutsche Bank terms have become much more conservative. Companies featured Zoomlion (1157.HK),HKD3.81 Buy Top-down analysis suggests stable growth ahead 2016A 2017E 2018E Our top-down analysis indicates that downstream demand is likely to remain P/E (x) – 15.5 22.8 robust in 2018E. We expect healthy infrastructure project and mining investment EV/EBITDA (x) 106.8 – 16.1 growth to continue while real estate investment growth will be stable. We forecast Price/book (x) 0.6 0.7 0.6 sales of excavators/wheel loaders/truck cranes to grow 83%/43%/117% YoY in Lonking (3339.HK),HKD3.59 Hold 2017E and 16%/12%/25% in 2018E. 2016A 2017E 2018E P/E (x) 9.9 16.8 13.5 We see a positive earnings outlook for the sector and upgrade Zoomlion to Buy EV/EBITDA (x) 2.5 7.4 5.6 We see a positive earnings outlook for the construction machinery sector in Price/book (x) 0.9 1.8 1.6 FY17-19E, and believe the industry's earnings quality has improved after sector Source: Deutsche Bank consolidation in its worst period from 2012 to 1H16. We upgrade Zoomlion to Buy and increase our target price to HKD4.8 on improving receivables quality and margins. We maintain a Hold on Lonking with a target price of HKD3.6 as its current share price has priced in the strong sales outlook. Our target prices are based on 0.8x/1.6x FY18E P/BV for Zoomlion/Lonking. Upside risks: higher infrastructure/property/mining investment, credit easing and better overseas demand. Downside risks: credit tightening and worse-than-expected demand.
Deutsche Bank AG/Hong Kong Distributed on: 02/11/2017 12:12:09 GMT Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. 0bed7b6cf11c 2 November 2017 Manufacturing Construction Machinery Executive summary
Stable growth driven by infrastructure and replacement Figure 1: Annual sales volumes of excavator and wheel loader in China The dramatic scale and pace of the industry recovery in late 2016 kick-started 300,000 an upgrade and re-rating cycle for the sector. Earnings fundamentals rebounded 250,000 200,000 strongly, based on replacement demand, infrastructure orders and mining 150,000 demand as well as that for real estate. As a result, excavator sales doubled in 100,000 9M17 and wheel loaders increased 45%. Our full-year forecasts are 83%, 43% and 50,000 -
117% YoY growth for excavator, wheel loader and truck crane sales, respectively.
2016
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2019E
2018E 2017E This magnitude will not be repeated and we expect volume demand will moderate Excavator Wheel loader next year to the mid-teens, to be clearly lower but still in positive territory. In order Source: CCMA, Deutsche Bank estimates to estimate the normalized demand level for the industry, we track the fleet sizes of excavators and wheel loaders along with total Fixed Capital Formation (FCF) data. Figure 3 shows that the spike in fleet size or industry capacity in 2009-11, Figure 2: Number of PPP projects in driven by RMB4tr infra investment, was not sustainable. The ratio has declined PPP bank sharply since then and will trend lower, but it provides a basis for estimating future 16,000 40% 14,000 sustainable demand levels. Using this model, we forecast that sales of excavators/ 35% 12,000 wheel loaders/truck cranes will grow 16%/12%/25% in 2018E and in 8%/7%/15% 10,000 30% 8,000 in 2019E. 6,000 25% 4,000 20% 2,000
Leading indicators that support these projections are based on: 0 15%
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Number of PPP projects in PPP bank PPP landing rate ■ Infrastructure FAI: Infrastructure projects have been a major driver of construction machinery sales. Supporting evidence includes a high Source: Wind correlation between excavator sales and the total value of PPP projects among different provinces. We expect infra investment will continue Figure 3: Excavator/wheel loader to support construction machinery demand, especially earth-moving fleet sizes over fixed capital construction machinery like excavators (sales +83% in 2017E, +16% in formation
2018E and +8% in 2019E) and wheel loaders (sales +43% in 2017E, +12% 14
in 2018E and +7% in 2019E). 13
12 ■ FAI for mining: The YTD FAI growth rate for coal mining dressing reached 11
its lowest point of -35% in July 2016 and has been recovering since. 10
The YTD FAI growth rate turned positive in July 2017 for the first time 9
in two years. We attribute the recovery of mining FAI to the rebound in 8
2016
2015
2014
2013
2012
2011
2010
2009
2008
2019E 2018E commodity prices, but note that investment has been constrained by the 2017E
environment controls and mine closures imposed on low-quality miners. Source: Wind, Deutsche Bank estimates Our metals mining analyst, James Kan, estimates that the full-year YoY change in FAI in the coal mining dressing sector will reach 10% in 2017, 2018 and 2019, which would be an important driver of construction Figure 4: Monthly operating machinery sales. hours for Komatsu construction equipment in China ■ GFA starts: YTD GFA starts declined YoY in 2014 and 2015, and have been (hrs/month) 250 40% recovering since. Our property analyst, Jeffery Gao, expects property 30% 200 supply to fall in 2017 and 2018, as developers have recently begun to cut 20% 150 10% capex. Real estate investment growth would likely stay at a high single- 0% digit level with new starts at ~5%. We expect weak real estate demand 100 -10% -20% 50 to provide limited support for construction machinery demand. -30% 0 -40%
■ Replacement demand: we estimate that the life span of excavators
Jan-17
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May-13 May-12 and wheel loaders ranges 5-10 years (with 15,000-20,000 hours of use May-11 on average). Machines purchased during the peak years of 2010-2011 Source: Komatsu
Page 2 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
are starting to be replaced, providing solid demand for construction machinery.
Strong earnings rebound with limited bad debt risk
Figure 5: Zoomlion - ROE vs. P/BV Driven by strong construction machinery sales, revenue and margins of major 1.6 25% 1.4 construction machinery producers improved significantly in 1H17. We estimate 20% 1.2 15% 1.0 Zoomlion to record FY17-19 revenue growth of 6.8-13.9% YoY. We expect the Average 0.8 10% company to book RMB1.2-1.6bn net profit in FY17-19 vs. net loss in FY16. 0.6 5% 0.4 For Lonking, we forecast FY17-19 revenue to increase by 9.6-51.9% YoY on 0% 0.2
10.0-38.4% YoY sales volume growth. Together with a stable and improving 0.0 -5%
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Jan-17 Jan-18 margin trend, we estimate net profit to surge 68.0% in FY17 and to expand by Jan-12 16.2-24.3% YoY in FY18-19. P/B (LHS) PB+1SD PB-1SD ROE (RHS) Source: Company data, Deutsche Bank estimates In addition, we believe that the major producers have absorbed most of their historical bad debts and inventory. Zoomlion has c. RMB5bn in second-hand machinery and booked more than RMB2.3bn in provisions, along with another Figure 6: Lonking - ROE vs. P/BV
2.0 14% 1.8 c. RMB6.4bn provision for accounts receivable. In total, Zoomlion booked 12% 1.6 RMB8.7bn in provisions for asset impairment in 1H17, and we believe it is prudent 1.4 PB+1SD 10% 1.2 8% 1.0 Average enough to cover future bad debt expense. Lonking also booked RMB101m 0.8 6% 0.6 4% 0.4 PB -1SD bad debt provision in 1H17, with 98% of receivables to mature within 1 year. 2% 0.2
Therefore, we are confident in the company's future growth and margin trend 0.0 0%
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Aug-12 May-14 from the low base. P/B (LHS) Average P/B PB+1SD PB-1SD ROE (RHS)
Source: Company data, Deutsche Bank estimates Zoomlion upgraded to Buy; Hold on Lonking
We see a positive earnings outlook for FY17-19E, and believe the industry's earnings quality has improved after sector consolidation in the worst period from 2012 to early 2016. Within the sector, we prefer Zoomlion to Lonking, as we believe Zoomlion will enjoy greater operating leverage when the entire industry recovers. We expect the valuation gap between Zoomlion and Lonking will narrow, which would increase Zoomlion's target P/BV from 0.6x to 0.8x. Together with more upside on earnings growth with receivables impairment at the end, we upgrade Zoomlion to Buy and increase our target price to HKD4.8 on improving receivables quality and margins. We maintain Hold on Lonking with a target price of HKD3.6, given that the current share price has priced in a strong sales outlook. Our target prices are based on 0.8x/1.6x FY18E P/BV for Zoomlion/ Lonking.
Risks
Upside risks include policy risks as construction machinery is an investment- driven industry and policy easing should drive up demand.
Downside risks include a worse-than-expected slowdown in infrastructure investment and property investment; and risks associated with volatility in the prices of raw materials, parts and components.
Deutsche Bank AG/Hong Kong Page 3 2 November 2017 Manufacturing Construction Machinery Valuations and ratings
Key target price/earnings changes
As discussed in the previous section, we expect construction machinery sector to remain robust in 2018-19E and forecast excavators/wheel loaders/ truck cranes to grow 16%/12%/25% in 2018E and in 8%/7%/15% in 2019E. Based on 1H17 results, we raised Zoomlion's concrete and crane machinery sales forecast. To elaborate, we expect the company's concrete/crane machinery sales to grow 50%/70% in 2017E and 25%/25% in 2018E.
We estimate Zoomlion to record FY17-19 revenue growth of 6.8-13.9% YoY. We expect the company to book RMB1.2-1.6bn net profit in FY17-19 vs. a net loss in FY16. The reported earnings decline in FY18E is due mainly to the one-off disposal gain in FY17E, partly offset by bad debt provision. To elaborate, Zoomlion disposed of its environmental business in May 2017, and we expect it to record an RMB10.7bn one-off disposal gain in FY17. In addition, RMB8.7bn provision was recognized in 1H17 for receivables impairment and second-hand equipment provision.
Figure 7: Zoomlion - Major assumptions in Deutsche Bank's forecasts 2014 2015 2016 2017E 2018E 2019E Sales volume (units) Concrete machinery 8,425 4,213 3,707 5,561 6,951 7,646 YoY -40.0% -50.0% -12.0% 50.0% 25.0% 10.0% Crane machinery 11,320 6,792 5,773 9,814 12,268 14,108 YoY -40.0% -40.0% -15.0% 70.0% 25.0% 15.0%
Revenue (RMBm) 25,851 20,753 20,023 22,800 24,360 27,350 YoY -32.9% -19.7% -3.5% 13.9% 6.8% 12.3% Operating profit (RMBm) 1,547 1,190 (150) (7,943) 2,248 2,788 YoY -63.9% -23.1% n.a. 5195.2% n.a. 24.0% Net profit (RMBm) 594 89 -929 1,588 1,154 1,590 YoY -84.5% -85.0% n.a. n.a. -27.3% 37.7%
Source: Company data, Deutsche Bank estimates
For Lonking, we forecast FY17 revenue to surge 51.9% on 38.4% YoY sales growth and FY18-19 revenue to increase 9.6-16.2% YoY on 10.0-17.9% YoY sales volume growth. Together with a stable and improving margin trend, we expect net profit to increase 68.0% in FY17 and 16.2-24.3% in FY18-19.
Page 4 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Figure 8: Lonking- Major assumptions in Deutsche Bank's forecasts 2014 2015 2016 2017E 2018E 2019E Sales volume (units) Wheel loader 22,377 13,544 14,258 21,387 24,595 27,055 YoY -13.2% -39.5% 5.3% 50.0% 15.0% 10.0% Forklift 21,448 20,112 26,081 33,905 40,686 44,755 YoY 18.9% -6.2% 29.7% 30.0% 20.0% 10.0% Excavator 2,049 1,522 1,715 2,916 3,353 3,688 YoY -11.5% -25.7% 12.7% 70.0% 15.0% 10.0%
Revenue (RMBm) 7,427 4,829 5,146 7,816 9,086 9,958 YoY -9.0% -35.0% 6.6% 51.9% 16.2% 9.6% Operating profit (RMBm) 768 329 637 1,021 1,249 1,441 YoY -5.1% -57.2% 94.0% 60.2% 22.3% 15.3% Net profit (RMBm) 417 117 462 776 965 1,121 YoY -13.2% -72.0% 296.2% 68.0% 24.3% 16.2%
Source: Company data, Deutsche Bank estimates
Figure 9: Sensitivity analysis - Zoomlion Change in FY18E % change in FY18E % change in FY18E Key variables reported net profit reported net profit net book value (RMBm) 5ppt change in sales volume growth 37 3.2% 0.1% 5ppt change in ASP 45 3.9% 0.1% 5ppt change in gross margin 245 21.2% 0.4%
Source: Deutsche Bank estimates
Figure 10: Sensitivity analysis - Lonking Change in FY18E % change in FY18E % change in FY18E Key variables reported net profit reported net profit net book value (RMBm) 5ppt change in sales volume growth 42 4.4% 0.4% 5ppt change in ASP 48 5.0% 0.4% 5ppt change in gross margin 98 10.2% 0.9%
Source: Deutsche Bank estimates
Our FY17-19 revenue estimates for Zoomlion are in line with consensus and our net profit estimates for Zoomlion are higher than consensus due to higher margin forecasts with bad debt provision and second-hand machinery write-offs towards the end. Our revenue forecasts for Lonking in FY17-19 are slightly higher than consensus on higher sales volume forecast and our net profit forecasts are in line with consensus.
Deutsche Bank AG/Hong Kong Page 5 2 November 2017 Manufacturing Construction Machinery
Figure 11: DBe vs. Bloomberg consensus
Lonking Zoomlion 2017E 2018E 2019E 2017E 2018E 2019E Sales 8,100 9,415 10,319 22,800 24,360 27,350 Yoy chg (%) 51.9% 16.2% 9.6% 13.9% 6.8% 12.3% Consensus 7,574 8,774 9,887 22,681 23,884 27,602 Difference 6.9% 7.3% 4.4% 0.5% 2.0% -0.9%
Gross profit 2,101 2,461 2,723 5,158 5,632 6,588 Gross margin (%) 26.9% 27.1% 27.3% 22.6% 23.1% 24.1% Consensus 2,126 2,459 2,696 5,166 6,000 7,414 Difference -1.2% 0.1% 1.0% -0.1% -6.1% -11.1%
Net profit (RMBm) 776 965 1,121 1,588 1,154 1,590 YoY% 68.0% 24.3% 16.2% n.a. -27.3% 37.7% Consensus 777 944 1,101 1,488 1,058 1,505 Difference -0.1% 2.2% 1.8% 6.7% 9.1% 5.6%
Source: Deutsche Bank estimates, Bloomberg Finance LP
Zoomlion (1157.HK, Buy, target price HK$4.8) We raise our earnings forecasts to reflect a stronger demand recovery for truck cranes, concrete mix machinery and tower cranes. Credit risk is likely to be reduced going forward as the company has abundant RMB8.7bn provision for asset impairment. Going forward, we believe the construction machinery business will likely improve while the agriculture business should continue to be under pressure due to supply side reform. We expect gross profit margin to decline in FY17E (impacted by the sales of second-hand machinery) but to recover in FY18-19E after absorbing second-hand machinery and with operating leverage.
Within the sector, we prefer Zoomlion to Lonking as we believe their valuation gap will narrow and Zoomlion will enjoy more operating leverage when the entire construction machinery industry recovers. We apply a P/BV multiple-based methodology, given Zoomlion's earnings volatility in recent years. We expect Zoomlion's profitability to improve, with its ROEs back to 3-4% in FY18-19E. We thus upgrade Zoomlion to Buy and lift our target price to HK$4.8, based on 0.8x FY18E P/BV (rolling over from 0.7x FY17E P/BV). This discount to book value reflects our concerns about Zoomlion's low ROEs vs. peers.
Downside risks: rising raw material costs; a slowdown in the property market; lower margin performance; faster-than-expected RMB depreciation; and weaker- than-expected economic and FAI growth in China.
Figure 12: Zoomlion's revenue breakdown (FY18E) Figure 13: Zoomlion’s ROE vs. P/BV
1.6 25% 1% 3% Concrete machinery 1.4 20% 7% 1.2 15% Crane machinery 1.0 5% Average 0.8 10% Road construction and pile foundation 39% 0.6 machinery 5% 0.4 Earth working machinery 0% 0.2
Financial lease services 0.0 -5%
32%
Jul-16
Jul-15
Jul-14
Jul-13
Jul-12 Jul-17 Jul-18
Oct-16 Oct-17 Oct-18
Apr-16
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Apr-12 Apr-17 Apr-18
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Jan-17 Jan-18 Others Jan-12 P/B (LHS) PB+1SD PB-1SD ROE (RHS)
Source: Deutsche Bank, Company data Source: Deutsche Bank, Company data, Bloomberg Finance LP
Page 6 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Lonking (3339.HK, Hold, target price HK$3.6) We are positive on the demand outlook for Lonking's core products (wheel loaders and excavators) in FY17-19E. A healthy demand recovery would be mainly driven by solid growth in infrastructure investment and replacement demand. We slightly upgrade 2017-2019 earnings, mainly due to a higher wheel loader volume and ASP assumptions, partly offset by higher steel prices.
We forecast China's sales volume for wheel loaders to rise 43% in 2017 and 12% in 2018. We believe Lonking can enjoy higher growth than the industry average, given its healthy balance sheet and cash flow. We forecast Lonking's sales volume for wheel loaders to rise 50%/15% YoY in FY17/18 and its net profit to rise 68.0% to RMB776m in FY17 and to rise 24.3% to RMB965m in FY18. Going forward, we are positive about Lonking's margin as the company had absorbed most poor- quality clients and bad debts by the end of 1H17.
We base our target price on 1.6x FY18E P/BV (rolling over from 1.12x FY17E P/BV), which looks reasonable as a result of 11-13% ROE. We maintain Hold as we believe the current share price has factored in the strong earnings growth. Downside risks: rising raw material costs; slowdown in the infrastructure, property and mining markets; political instability overseas and a lower margin performance. Upside risks: stronger-than-expected construction machinery demand.
Figure 14: Lonking’s revenue breakdown (2018E) Figure 15: Lonking’s ROE vs. P/BV
2.0 14% 0% 1.8 12% 8% 1.6 1.4 PB+1SD 10% Wheel loader 1.2 8% 13% 1.0 Average Road roller 0.8 6% Fork-lifters 0.6 4% 0.4 PB -1SD 2% 55% Excavators 0.2 22% Others 0.0 0%
Finance lease interest Jul-15
Oct-13
Apr-17
Jan-12
Jun-18
Mar-13
Feb-16
Dec-14
Nov-17
Sep-16
Aug-12 May-14 P/B (LHS) Average P/B PB+1SD PB-1SD ROE (RHS)
1%
Source: Deutsche Bank, Company data Source: Deutsche Bank, Company data, Bloomberg Finance LP
Deutsche Bank AG/Hong Kong Page 7 2 November 2017 Manufacturing Construction Machinery (F) 6 11.1 12.7 7.2 5.4 -31.8 0.7 0.6 4.3 3.0 n.a. 16.1 ) 7 1 0 2
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: c r e t u Figure 16: o o 11/1/2017 Zoomlion *Changsha HK 1157 *Lonking Ticker HKD HK 3339 Hold HKD 3.81 Hold 5,053 3.57 7 1,958 15.5 4 22.7 16.4 n.a. 13.2 68.0 24.3 1.8 1. Chinese Manufacturers Chinese LiugongGuangxi CH 000528 Company Name Company Sany Heavy Industry Heavy Sany CH 600031 Xugong ScienceXugong CH 000425 Anhui Heli Co.Heli Anhui CH 600761 Average for Chinese peers for Chinese Average International International Manufacturers Caterpillar* CAT US USD Hold 135.80 80,254 Deere & Company*Deere DE US USD Hold 132.88 42,694 Komatsu * JT 6301 JPY Hold 3,813.00 32,550 Kubota* JT 6326 JPY Buy 2,106.50 22,962 Hitachi Hitachi * JT 6305 JPY Sell 3,930.00 7,425 Doosan Heavy * Heavy Doosan KS 034020 KRW n/a 16,950.00 1,620 Hyundai Heavy*Hyundai KS 009540 KRW n/a 155,500.00 7,912 Volvo-B *Volvo-B VOLVB SS Average for International for International peers Average average Overall N S
Page 8 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery Top-down analysis suggests favorable demand outlook
A strong year in 2017; expect mild growth in 2018
In 9M17, sales volume of excavators/wheel loaders staged strong growth of 100%/45% YoY. The recovery of the construction machinery industry started from 3Q16, led by excavators. In early 2016, the growth rate of FAI in infrastructure accelerated and the growth rate of FAI in mining recovered. We also observed a strong pick-up in PPP projects and a rising PPP landing rate since 2Q16. Since March 2016, utilization hours for Zoomlion's and Komtrax's excavators have increased, and utilization hours of Zoomlion's crane machinery also picked up from July 2016, representing an increase in demand. In our view, rising demand had absorbed in-channel inventory and second-hand machinery, which eventually drove up the demand for new machines. According to an industry expert, one- shift costs increased 10-20% in Central China and Northern China.
Figure 17: Timeline of recovery for construction machinery sector
Jan 2016 Mar 2016 Aug 2016 Utilization hour of Acceleration of infra Zoomlion's excavator Excavator sales concrete machinery in-channel inventory FAI growth / utilization hour increased; volume picked up increased was absorbed recovery of miing Komtrax's machinery
2Q 2016 Jul 2016 Zoomlion's Oct 2016 Wheel One-shift costs crane utilization loader and crane increased 10-20% Acceleration of PPP second-hand hour surged machinery sales in Central China projects; landing machinery was volume picked up and Northern China. rate increasing absorbed
Source: CCMA, Deutsche Bank estimates, Company data
The dramatic scale and pace of the industry recovery in late 2016 kick- started an upgrade and re-rating cycle for the sector. Earnings fundamentals rebounded strongly, based on replacement demand, infrastructure orders and mining demand as well as real estate demand – as a result, excavator sales doubled in 9M17 and wheel loaders increased 45%. Our full-year forecasts are 83%/43%/117% YoY growth for excavators, wheel loaders and truck crane sales, respectively. This magnitude will not be repeated and volume demand should moderate next year to the mid-teens, clearly lower but still in positive territory. In order to estimate the normalized demand level for the industry, we track the fleet sizes of excavators and wheel loaders, along with total Fixed Capital Formation (FCF) data. Figure 3 shows that the spike in fleet size or industry capacity in 2009-11, driven by RMB4tr infra investment, was not sustainable. The ratio has declined sharply since then and will trend lower but it does provide a basis for estimating future sustainable demand levels. Using this model, we forecast
Deutsche Bank AG/Hong Kong Page 9 2 November 2017 Manufacturing Construction Machinery excavators/wheel loaders/ truck cranes will grow 16%/12%/25% in 2018E and by 8%/7%/15% in 2019E.
Leading indicators that support these projections are based on:
■ Infrastructure FAI: Infrastructure projects have been a major driver of construction machinery sales. Supporting evidence includes a high correlation between excavators sales and the total value of PPP projects among different provinces. We expect infra investment will continue to support construction machinery demand, especially earth-moving construction machinery like excavators (83% in 2017E, 16% in 2018E and 8% in 2019E) and wheel loaders (43% in 2017E, 12% in 2018E and 7% in 2019E).
■ FAI for mining: The YTD FAI growth rate for coal mining dressing reached its lowest point of -35% in July 2016, and has been recovering ever since. The YTD FAI growth rate turned positive in July 2017 for the first time in two years. We attribute the recovery of mining FAI to the rebound in commodity prices, but note that investment has been constrained by the environment controls and mine closures imposed on low-quality miners. Our metals mining analyst, James Kan, estimates that the full- year YoY change in FAI in the coal mining dressing sector could reach 10% in 2017, 2018 and 2019, which would be an important driver of construction machinery sales.
■ GFA starts: YTD GFA starts declined YoY in 2014 and 2015 and have been recovering ever since. Our property analyst, Jeffery Gao, expects property supply to fall in 2017 and 2018 as developers have recently begun to cut capex. Real estate investment growth would likely stay at a high single-digit level with new starts at ~5%. We expect weak real estate demand to provide limited support for construction machinery demand.
■ Replacement demand: we estimate that the life span of excavator and wheel loader ranges 5-10 years (with 15,000-20,000 hours of use on average). Therefore, machines purchased during the peak years of 2010-2011 are starting to be replaced, providing solid demand for construction machinery.
Page 10 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Figure 18: Demand breakdown for excavators
6% Mixed demand 8% 23%
10% Small-sized demand
13% 18%
Large-sized demand 20%
Medium-sized demand municipal projects new rural construction road construction mining real estate railway construction water conservancy others
Source: China Construction Machinery Market Research Center
Figure 19: Three major FAI drivers of construction machinery sector (RMBm) 2011A 2012A 2013A 2014A 2015A 2016A 2017E 2018E 2019E Infrastructure investment 5,179,695 5,959,269 7,379,189 8,925,800 10,464,500 12,227,500 15,039,825 18,047,790 21,115,914 3% 15% 24% 21% 17% 17% 23% 20% 17% Real estate investment 7,568,483 9,235,713 11,142,385 12,368,978 12,667,425 13,528,369 14,610,639 15,779,490 16,884,054 31% 22% 21% 11% 2% 7% 8% 8% 7% Mining investment 489,686 528,600 526,276 468,200 400,800 303,800 334,180 367,598 404,358 30% 8% 0% -11% -14% -24% 10% 10% 10%
Source: CEIC, Deutsche Bank estimates
Infrastructure investment remains a major demand driver
Infrastructure investment has been a major driver of construction machinery sales. The high correlation between infrastructure FAI and excavator and wheel loader sales is summarized in Figure 20. To elaborate, infrastructure investment was the major driver of the surge in excavator/wheel loader sales from late 2009 to early 2011, and in 1H17. In Figure 21, We also find that the new contract size of the top 4 constructors in China is a leading indicator of construction machinery sales. We believe the increase in size of new contracts for constructors will provide future growth of construction machinery sales.
Deutsche Bank AG/Hong Kong Page 11 2 November 2017 Manufacturing Construction Machinery
Figure 20: FAI for infrastructure YoY vs. excavator/wheel Figure 21: New contracts for major constructors vs. loader sales YoY excavator/wheel loader sales volume
Units RMBm 350% 70% 70,000 1,400,000 300% 60% 60,000 1,200,000 250% 50% 40% 50,000 1,000,000 200% 30% 40,000 800,000 150% 20% 30,000 600,000 100% 10% 20,000 400,000 50% 0% 10,000 200,000 0% -10% - -
-50% -20%
Jul-15
Jul-10
Oct-16
Oct-11
Apr-14
Apr-09
Jun-13
Jan-13
Jun-08
Jan-08
Mar-17
Mar-12
Feb-15
Feb-10
Dec-15 Nov-13
Dec-10 Nov-08
Aug-12
Sep-14
Sep-09 May-16
-100% May-11 -30%
4Q18
3Q18
2Q18
1Q18
4Q17
3Q17
2Q17
1Q17
4Q16
3Q16
2Q16
1Q16
4Q15
3Q15
2Q15
1Q15
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13 1Q13
Excavator YoY Wheel loader YoY FAI for Infrastructure (RHS) Excavator sales Wheel loader sales New contract value (RHS)
Source: Wind, CCMA Source: Company data, CCMA *Four major constructors are CRG, CRCC, CCC and CSCI
The Chinese government published several policies to promote infra projects to be conducted in the PPP format. We have seen a surge in the number of PPP projects and total investment in PPP projects since 2Q16, along with rising landing rates of PPP projects. The FAI target for 23 provinces exceeds RMB45tr in 2017.
According to the Medium and Long-term Railway Network Plan and a three- year action plan for major transportation infrastructure projects, the total number of major infrastructure projects has reached 303, with a total investment of RMB4.7tr. In terms of railway, China Railway plans to complete an investment of RMB800bn, build a 2,100km new railway, a 2,500km double line railway and a 4,000km electrified railway. Meanwhile, the National Transport Network proposed that China's road and water transport projects be completed with RMB1.8tr in fixed asset investment: 5,000km of new expressways, 200,000km of newly renovated rural roads and 7,000 villages in the new poverty-stricken areas. The new contract size of the four constructors is also trending up YTD.
Figure 22: Total investment in PPP projects Figure 23: Number of PPP projects in PPP bank
RMBbn RMBbn 16,000 40% 6,000 300 14,000 35% 5,000 250 12,000 10,000 4,000 200 30% 8,000 3,000 150 6,000 25% 2,000 100 4,000 20% 2,000 1,000 50 0 15%
0 0
Jul-16
Jul-17
Oct-16
Apr-16
Apr-17
Jun-16
Jan-16
Jun-17
Jan-17
Mar-16
Mar-17
Feb-16
Feb-17
Dec-16
Nov-16
Sep-16
Aug-16
Aug-17
May-16
May-17
Jul-16
Jul-17
Apr-16
Oct-16
Apr-17
Jan-16
Jun-16
Jan-17
Jun-17
Mar-16
Mar-17
Feb-16
Feb-17
Dec-16
Nov-16
Sep-16
Aug-16
Aug-17 May-16 May-17 Number of PPP projects in PPP bank PPP landing rate Transportation Municipal Infrastructure
Source: Wind Source: Wind
Our economist, Zhiwei Zhang, expects the growth of infrastructure investment to pick up to 23% in 2017 from 18% in 2016. We believe infra investment will continue to support construction machinery demand, especially earth-moving construction machinery like excavators, wheel loaders and road rollers. As infra
Page 12 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery projects normally take a long time to complete (2-4 years for municipal projects), demand driven by infra projects tends to be stable.
In his latest research report, A change of track - switch from constructors to equipment suppliers, our property analyst, S ky Hong, expects railway construction projects to slow down while rolling stocks pick up.
Figure 24: Total railway investment (RMBbn) 2011A 2012A 2013A 2014A 2015A 2016A 2017E 2018E 2019E Total railway investment 595 658 690 809 824 802 800 750 750 yoy chg% -29% 11% 5% 17% 2% -3% 0% -6% 0% Civil works 460 521 534 628 664 671 661 601 586 yoy chg% -35% 13% 2% 18% 6% 1% -1% -9% -3% % of total 77% 79% 77% 78% 81% 84% 83% 80% 78%
Source: CEIC, Deutsche Bank estimates
Real estate investment to provide limited support
We observe that GFA starts are closely related to construction machinery demand, especially concrete machinery sales. We believe the FAI slump in real estate post 2011 was part of the reason for the decline in construction machinery sales. However, we believe the correlation between construction machinery and real estate has weakened. For example, the recent surge in excavators and wheel loaders is driven by infra and replacement demand, rather than real estate demand.
In his latest research report, The party is not over; buy quality small-caps after correction, our property analyst, Jeffery Gao, expects property supply to fall in 2017 and 2018, as developers have recently begun to cut capex. Real estate investment growth will likely stay at a high single-digit level, with new starts at ~5%. We expect weak real estate demand to provide limited support for construction machinery demand.
Figure 25: GFA starts vs. concrete sales Figure 26: GFA starts vs. excavator/wheel loader sales
2,500,000 70,000 350% 45%
60,000 300% 40% 2,000,000 50,000 250% 35%
1,500,000 40,000 200% 30% 150% 25% 1,000,000 30,000 20,000 100% 20% 500,000 50% 15% 10,000 0% 10% 0 0
-50% 5%
Jul-10
Jul-15
Apr-09
Oct-11
Apr-14
Oct-16
Jun-08
Jan-08
Jun-13
Jan-13
Mar-12
Mar-17
Feb-10
Feb-15
Nov-08
Dec-10
Nov-13
Dec-15
Sep-09
Sep-14
Aug-12
May-11
May-16
2003
2002
2001 2006 2012 2015 2009
2000 2005 2008 2011 2014 2004 2007 2010 2013 1999 -100% 0% GFA started Concrete sales Excavator YoY Wheel loader YoY FAI for real estate (RHS)
Source: d1cm, Wind Source: CCMA, Wind
Mining FAI provides support for machinery sales
Mining is another driver of excavator and wheel loader sales, especially large excavators. We summarize the correlation between mining FAI and excavator/
Deutsche Bank AG/Hong Kong Page 13 2 November 2017 Manufacturing Construction Machinery wheel loader sales in Figure 27. We also notice that large-excavator sales tend to account for a higher percentage of total sales when mining FAI is high.
According to our metals & mining analyst, James Kan, capital expenditure in the coal industry declined at an accelerating pace in the previous three years; capex (fixed asset investment for Coal Mining & Dressing, announced by the China National Bureau of Statistics) in the coal industry fell 10%, 14.4% and 24.2% YoY in 2014, 2015 and 2016, respectively. He estimates that the full-year YoY change in FAI in the coal mining & dressing sector could reach 10% in 2017, 2018 and 2019, and would be a constant driver of construction machinery sales.
Figure 27: Mining FAI vs. excavator/wheel loader sales Figure 28: Mining FAI vs. % of large excavator sales (3MMA)
350% 60% 30% 60% 300% 40% 25% 40% 250% 20% 20% 200% 20%
150% 15% 0% 0% 100% 10% -20%
50% -20% 5% -40%
0% 0% -60% -40%
-50%
Jul-10
Jul-15
Apr-09
Oct-11
Apr-14
Oct-16
Jul-11
Jul-16
Jun-08
Jan-08
Jun-13
Jan-13
Mar-12
Mar-17
Feb-10
Feb-15
Nov-08
Dec-10
Nov-13
Dec-15
Sep-09
Sep-14
Aug-12
Apr-10
Oct-12
Apr-15
May-11
May-16
Jun-09
Jan-09
Jun-14
Jan-14
Mar-13
Feb-11
Feb-16
Nov-09
Dec-11
Nov-14
Dec-16
Sep-10
Aug-13
Sep-15 May-12 -100% -60% May-17 Large-sized excavator as % of total sales Excavator YoY Wheel loader YoY FAI for coal Mining & Dressing (RHS) FAI for coal Mining & Dressing (RHS), 3MMA
Source: CCMA, Wind Source: CCMA, Wind
Replacement demand to support sales growth
We estimate that the life span of excavator and wheel loader ranges 5-10 years (with 15,000-20,000 hours of use on average). Therefore, machines purchased during the peak years of 2010-2011 are starting to be replaced, providing solid demand for construction machinery.
We think true demand has been increasing as excavator and wheel loader fleet sizes over fixed capital formation (FCF) have been declining to fall below the 2009 level. Considering sales and scrappage, we expect the excavator fleet size to grow 5-6% YoY in 2017-2019E and the wheel loader fleet size to grow 1-2% YoY.
Page 14 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Figure 29: Annual sales volumes of excavators and Figure 30: Excavator/wheel loader fleet sizes over Fixed wheel loaders Capital Formation (FCF)
300,000 14
250,000 13
200,000 12 150,000 11 100,000 10 50,000 9 -
8
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2019E
2018E
2017E
2015
2008 2010 2012 2014 2009 2011 2013 2016
2017E 2019E Excavator Wheel loader 2018E
Source: CCMA Source: Wind, CCMA
Revenue growth and margin trends staying favorable
Driven by strong construction machinery sales, revenue and gross profit margins of major construction machinery producers significantly improved in 1H17. In addition, we believe that major producers have absorbed most of their historical bad debts and inventory. To elaborate, Zoomlion had RMB5bn in second-hand machinery and booked RMB2.3bn in provisions, along with RMB6.4bn provision for accounts receivable. In total, Zoomlion booked RMB8.7bn in provisions for asset impairment in 1H17, and we believe it is prudent enough to cover future bad debt expense. Lonking had also solved its bad debt problem by the end of 1H17, according to management. Therefore, we are confident about the company's future growth and margin trend from the low base in FY16.
Figure 31: Revenue growth comparison (2010-1H17) Figure 32: Gross margin comparison (2010-1H17)
120% 40% 100% 35% 80% 30% 60% 25% 40% 20% 20% 15% 0% 10% 2010 2011 2012 2013 2014 2015 2016 1H17 -20% 5% -40% 0% -60% 2010 2011 2012 2013 2014 2015 2016 1H17
Liugong XGMA Sany Zoomlion Liugong XGMA Sany Zoomlion XCMG Lonking Shantui Sunward XCMG Lonking Shantui Sunward
Source: Company data Source: Company data
Deutsche Bank AG/Hong Kong Page 15 2 November 2017 Manufacturing Construction Machinery Growth likely to continue next year
Excavators
China’s excavator sales volume grew 100% YoY in 9M17, with 109.3% YoY growth in the domestic market and a 22.5% increase in the overseas market. We believe strong growth is mainly due to: 1) replacement demand, 2) a low base effect, 3) strong demand from infra projects (especially municipal projects) and 4) the substitution effect (from wheel loaders to excavators).
We expect excavator demand to remain strong at least until the end of 1H18, but the high growth rate should gradually normalize on the base effect. We forecast excavator sales to grow 83% YoY in 2017E and 16% in 2018E.
Figure 33: Monthly sales of excavators in China Figure 34: Annual sales forecast for excavators YoY Unit 200,000 45,000 400% 180,000 160,000 35,000 300% 140,000 120,000 100,000 25,000 200% 80,000 60,000 15,000 100% 40,000 20,000
5,000 0% -
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2019E 2018E -5,000 -100% 2017E
Excavator
Jun-17
Jun-16
Jun-15
Jun-14
Jun-13
Jun-12
Jun-11
Jun-10
Jun-09
Jun-08
Jun-07
Dec-16
Dec-15
Dec-14
Dec-13
Dec-12
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07 Dec-06
Source: CCMA Source: CCMA, Deutsche Bank estimates
Excavator price is likely to be stable The recent price increase of wheel loaders is unlikely to be passed on to the excavator industry. According to a major excavator producer, only certain hot models will have increased prices while the majority of the models will have flat prices. Excavator prices are unlikely to increase due to 1) overcapacity, and 2) the increase in material costs can be absorbed by implementing a standardized production process and centralized procurement.
Utilization hours have stabilized Equipment utilization hours indicate a genuine demand situation. Komatsu’s machinery average operating hours in China increased 2% YoY and 2% MoM to 137.1hours in September, which implies healthy utilization. Zoomlion's average operating hours for concrete/excavators/truck cranes also grew 6%/14%/6% YoY in September, respectively.
Page 16 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Figure 35: Monthly average operating hours for Figure 36: Monthly average operation hours of Zoomlion KOMTRAX-installed Komatsu construction equipment in machinery in China China (hrs/month) 250 40% (3MMA) 30% 0.6 200 0.5 20% 0.4 150 10% 0.3 0% 0.2 100 -10% 0.1
0
Mar-15
May-15
Jul-15
Sep-15
Nov-15
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Jan-17
Mar-17
May-17 Jul-17 -20% Sep-17 50 -0.1 -30% -0.2 0 -40% -0.3
-0.4
Jan-17
Jan-16
Jan-15
Jan-14
Jan-13
Jan-12
Jan-11
Sep-17
Sep-16
Sep-15
Sep-14
Sep-13
Sep-12
Sep-11
Sep-10
May-17
May-16
May-15
May-14
May-13 May-12 May-11 Concrete machinery Crane Excavator
Source: Komatsu Source: Zoomlion
Wheel loaders
Wheel loader sales volume increased 44.5% YoY in 9M17, with 47.1% growth from the domestic market and 34.4% growth from the export market. We attribute the high growth to replacement demand and solid infrastructure FAI investment.
With the PPP project pipeline staying abundant, we forecast wheel loader sales to grow 43% in 2017 and 12% in 2018. Meanwhile, a decreasing wheel loader fleet size in China in the past three years indicates that second-hand machinery and in-channel inventory were largely absorbed in 2015-2016.
Figure 37: Monthly sales volumes of wheel loader sales Figure 38: Annual sales volume forecast for wheel in China loaders
300,000 Unit YoY 45,000 250% 250,000 40,000 200% 200,000 35,000 150% 150,000 30,000 25,000 100% 100,000 20,000 50% 50,000 15,000 0% -
10,000
2016
2015
2014
2013
2012
2011
2010
2009
2008 2007
-50% 2006
2019E 2018E 5,000 2017E
0 -100% Wheel loader
Feb-07 Feb-10 Feb-13
Feb-08 Feb-11 Feb-14 Feb-17 Feb-06 Feb-09 Feb-12 Feb-15 Feb-16
Aug-06 Aug-09 Aug-12 Aug-15 Aug-07 Aug-10 Aug-13 Aug-17
Aug-08 Aug-11 Aug-14 Aug-16
Source: CCMA Source: CCMA, Deutsche Bank estimates
Going forward, we are confident that the profitability of wheel loader producers will improve, as they are able to pass through the increase in raw material costs to customers. We estimate that direct steel accounts for 13-15% of total cost. Including other components, the use of steel accounts for 30% of total cost. Since the price of medium plate increased 30% in 1H17, total cost of wheel loaders has increased approximately 9-10%, in our view.
Deutsche Bank AG/Hong Kong Page 17 2 November 2017 Manufacturing Construction Machinery
We believe the increase in selling prices will offset the raw material price hike and benefit producers' margins. According to our channel checks, from 1 October, the price of wheel loaders under 30t was increased by c.RMB10k and that of wheel loaders of over 50t up by c.RMB20k.
Page 18 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery Comparison between Lonking and Zoomlion
Key summary:
■ Lonking's revenue is concentrated on the wheel loader and excavator businesses and is therefore more exposed to the recovery of the construction machinery industry. Meanwhile, Zoomlion focuses on concrete machinery and cranes.
■ Zoomlion's profit growth and margin trend has been negatively impacted by account receivable provisions since FY12 due to aggressive sales terms to push credit sales in FY10-11.
■ Lonking is non-SOE, more sensitive to market demand and more agile in making adjustments. For example, it is easier for Lonking to lay off idle work force during downturns than for Zoomlion.
■ With a sophisticated risk management system, Lonking began to tighten its credit sales terms in 2012, ahead of competitors, and thus bad debt provision was less of a burden in FY12-16.
Revenue breakdown
As Lonking is more exposed to construction machinery, it benefits more from a sector recovery than Zoomlion. We summarize the key product types of major construction machinery producers in Figure 39. Lonking's products are concentrated in four types of construction machinery: wheel loaders, excavators, forklifts and road rollers, which accounted for c. 98% of its total revenue in 1H17. Zoomlion's products are much more diverse. Apart from construction machinery products (which account for 53% of its revenue in 1H17), Zoomlion also has environmental and agricultural businesses.
Figure 39: Product categories of major construction machinery companies Concrete Concrete Wheel- batching Concrete Concrete trailer Excavator loader Ballgrader Bulldozer Crane plant mixer truck pump truck pump Fork lift Road roller Lonking 3339.HK √ √ √ √ Zoomlion 1157.HK √ √√√√√√√ Liugong 000528.HK √ √ √ √ √ √ √ XGMA 600815.SS √ √ √ √ √ √ Sany 600031.SS √ √ √√√√√ √ XCMG 000425.SS √√√ √√√√√ √ Shantui 000680.SS √ √ √√√√√√ Heli 600761.SS √ √ Sunward 002097.SS √ √
Source: Company data
Deutsche Bank AG/Hong Kong Page 19 2 November 2017 Manufacturing Construction Machinery
Figure 40: 1H17 revenue breakdown for Lonking Figure 41: 1H17 revenue breakdown for Zoomlion
10% 13%
28%
21% 12%
53%
2% 21% 15% 24%
Wheel loaders Excavators Road rollers Forklifts Components Concrete Crane Environmental Argriculture Others
Source: Company data Source: Company data
Margin comparison
During FY10-13, Zoomlion's margin was as good as, if not better than, Lonking's. In FY12, Zoomlion's GPM, OPM and NPM were significantly higher than Lonking's. We attribute the outperformance to the higher margin of its concrete machinery products amid a property construction boom. During that period, Zoomlion's share price significantly outperformed Lonking's.
Since FY12, Lonking's margins have been improving while Zoomlion's have been deteriorating. In FY15-2016, Lonking's margins started to outperform Zoomlion's, which is also reflected in the stock prices.
Zoomlion's operating profit margin was negative in 1H17 as Zoomlion booked an RMB5.5bn provision for doubtful debts. Going forward, credit risk is reduced and we see margin improvement in the next two years.
Figure 42: Gross profit margin Figure 43: Operating profit margin
35% 25%
30% 20%
25% 15%
20% 10%
15% 5%
10% 0% 2010 2011 2012 2013 2014 2015 2016 1H17 5% -5% 0% 2010 2011 2012 2013 2014 2015 2016 1H17 -10% Lonking Zoomlion Lonking Zoomlion
Source: Company data Source: Company data
Lonking is more agile as a non-SOE
We notice that Lonking's revenue rebounds more quickly than Zoomlion's and it has a higher net profit margin partially due to operating leverage. As a non- SOE, Lonking is more sensitive to market demand and is more agile in making adjustments. For example, it is easier for Lonking to lay off idle work force during downturns than for SOEs like Zoomlion. In addition, Lonking's inventory over sales
Page 20 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery ratio has been constant while that of Zoomlion has surged since 2014, due to depressed demand for concrete machinery and a large inventory of second-hand machines in the market after peak sales in 2010-11.
Figure 44: Revenue growth YoY Figure 45: Net profit margin YoY
80% 20%
60% 15%
40% 10% 20% 5% 0% 2010 2011 2012 2013 2014 2015 2016 1H17 0% -20% 2010 2011 2012 2013 2014 2015 2016 1H17
-40% -5%
-60% -10% Lonking Zoomlion Lonking Zoomlion
Source: Company data Source: Company data
Figure 46: Inventory over sales comparison between Figure 47: OCF comparison between Lonking and Lonking and Zoomlion Zoomlion
80% RMBm 4,000 70%
60% 2,000
50% - 2010 2011 2012 2013 2014 2015 2016 40% (2,000) 30% (4,000) 20% (6,000) 10% (8,000) 0% 2010 2011 2012 2013 2014 2015 2016 1H17 (10,000) Lonking Zoomlion Lonking Zoomlion
Source: Company data Source: Company data
Sales terms and risk management
As illustrated in Figure 48, all three companies' sales terms are much stricter in 2017 than in 2010 as the percentage of products sold under financial guarantee and financial lease arrangements is significantly lower. Among them, Lonking began tightening its credit sales terms in 2012, ahead of its peers and thus, had less of a burden from bad debt provision in FY12-16.
Figure 48: Sales terms of three leading construction machinery companies Zoomlion Sany Lonking Payment method 2010 2017 2020E 2010 2017 2020E 2010 2017 2020E Credit 34% 50% 60% 20% 45% 70% 70% 70% 80% Installment payment 15% 15% 20% 20% 20% c.40% c.30% Sales under financial guarantee arrangement 16% 50% 0% 0% 0% 30% 20% Sales under financial lease arrangement 35% <10% <10% 15% 35% <10% <10%
Source: Company data
We notice that Lonking's accounts receivables is dominated by short-term receivables within one year while Zoomlion's accounts receivables is more
Deutsche Bank AG/Hong Kong Page 21 2 November 2017 Manufacturing Construction Machinery
dispersive. The absolute amount of Zoomlion's long-term receivables (1-3 years) has been declining since the 2011 peak.
Figure 49: Lonking - structure of accounts receivables Figure 50: Zoomlion - structure of financial leasing receivables
(Rmbm) (Rmbm) 3,000 16,000 14,000 2,500 12,000 2,000 10,000 1,500 8,000
1,000 6,000 4,000 500 2,000 0 0 2009 2010 2011 2012 2013 2014 2015 2016 1H17 6 6 2009 2010 2011 2012 2013 2014 2015 2016 1H17 Within 1 year Over 1 year but less than 2 years Within 1 year Over 1 year but less than 2 years ars Over 2 years but less than 3 years Over 3 years Over 2 years but less than 3 years Over 3 years
Source: Company data Source: Company data
Page 22 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery Key risks
Upside risks
Policy risk Construction machinery is an investment-driven industry. Infrastructure and real estate investments are major demand sources for construction machinery. Hence, the sector relies heavily on government policies. Policy easing (including a potential stimulus package) would lift demand for construction machinery.
Downside risks
Worse-than-expected slowdown in infrastructure investment Infrastructure is the most important driver of construction machinery demand. If infrastructure investment growth is below our expectation, it could negatively impact demand for construction machinery.
Worse-than-expected slowdown in property investment Property construction is an important driver of construction machinery demand. If property investment growth is below our expectation, it could negatively impact demand for construction machinery.
Risks associated with volatility in the prices of raw materials, parts and components The key raw material of construction machinery is steel, while key components include engines, chassis and driving axles. The cost of raw materials and components represents the majority of construction machinery companies’ cost of sales (over 90% of COGS). Steel is the largest raw material component (around 20% of total COGS). Chinese construction machinery companies normally sign contracts with raw materials suppliers for one year at floating prices. As a result, construction machinery companies are vulnerable to fluctuations in the market prices of steel and other raw materials and components.
Deutsche Bank AG/Hong Kong Page 23 2 November 2017 Manufacturing Construction Machinery
Model updated: 01 November 2017 Fiscal year end 31-Dec 2014 2015 2016 2017E 2018E 2019E Running the numbers Financial Summary Asia DB EPS (CNY) 0.08 0.01 -0.12 0.21 0.14 0.20 Reported EPS (CNY) 0.08 0.01 -0.12 0.21 0.14 0.20 China DPS (CNY) 0.05 0.15 0.14 0.06 0.04 0.06 Manufacturing BVPS (CNY) 5.3 5.2 4.8 5.0 5.0 5.2 Weighted average shares (m) 7,706 7,686 7,664 7,645 7,797 7,797 Average market cap (CNYm) 31,669 27,098 18,004 24,756 24,756 24,756 Zoomlion Enterprise value (CNYm) 42,149 46,705 39,755 44,028 45,299 47,082 Reuters: 1157.HK Bloomberg: 1157 HK Valuation Metrics P/E (DB) (x) 53.3 304.5 nm 15.5 22.8 16.6 Buy P/E (Reported) (x) 53.3 304.5 nm 15.5 22.8 16.6 P/BV (x) 0.89 0.45 0.61 0.65 0.64 0.63 Price (1 Nov 17) HKD 3.81 FCF Yield (%) nm nm 2.9 18.1 nm nm Target Price HKD 4.80 Dividend Yield (%) 1.2 4.3 5.7 1.9 1.4 1.9 EV/Sales (x) 1.6 2.3 2.0 1.9 1.9 1.7 52 Week range HKD 2.73 - 4.65 EV/EBITDA (x) 22.1 28.7 106.8 nm 16.1 14.0 EV/EBIT (x) 27.2 39.2 nm nm 20.2 16.9 Market cap (m) HKDm 29,200 USDm 3,743.1 Income Statement (CNYm) Sales revenue 25,851 20,753 20,023 22,800 24,360 27,350 Company Profile Gross profit 7,567 6,045 5,300 5,698 6,193 7,169 Zoomlion is the China's second largest construction machinery EBITDA 1,905 1,628 372 -7,403 2,808 3,369 producer in terms of 2015 sales. It has now diversified into the Depreciation 262 288 336 351 369 388 environmental industry, agricultural machinery and financial Amortisation 96 150 186 189 191 194 services businesses. Non-construction machinery sector EBIT 1,547 1,190 -150 -7,943 2,248 2,788 accounted for 40% of its total revenue in 2015. Net interest income(expense) -692 -1,182 -871 -1,026 -962 -1,018 Associates/affiliates 8 31 11 10,738 0 0 Exceptionals/extraordinaries 0 0 0 0 0 0 Other pre-tax income/(expense) 0 0 0 0 0 0 Profit before tax 863 39 -1,010 1,769 1,285 1,770 Price Performance Income tax expense 235 -58 -110 230 167 230 5 Minorities 34 8 29 -50 -36 -50 Other post-tax income/(expense) 0 0 0 0 0 0 4 Net profit 594 89 -929 1,588 1,154 1,590 3 DB adjustments (including dilution) 0 0 0 0 0 0 2 DB Net profit 594 89 -929 1,588 1,154 1,590 1 Jan '16 Jul '16 Jan '17 Jul '17 Cash Flow (CNYm)
Zoomlion HANG SENG INDEX (Rebased) Cash flow from operations -8,825 -5,008 636 -5,924 -174 -1,036 Net Capex -520 722 -121 10,388 -350 -350 Margin Trends Free cash flow -9,345 -4,286 515 4,464 -524 -1,386 Equity raised/(bought back) 0 -128 0 0 393 0 20 Dividends paid -1,156 -378 -1,158 -1,035 -477 -346 Net inc/(dec) in borrowings 1,589 839 -3,586 -2,000 0 -2,000 0 Other investing/financing cash flows 6,738 957 -683 0 0 0 Net cash flow -2,174 -2,996 -4,912 1,429 -607 -3,733 -20 Change in working capital -7,334 -5,354 1,522 1,265 -3,032 -3,746 -40 14 15 16 17E 18E 19E Balance Sheet (CNYm) EBITDA Margin EBIT Margin Cash and other liquid assets 16,374 13,347 8,122 9,551 8,944 5,211 Tangible fixed assets 6,781 8,520 8,069 7,648 7,198 6,718 Growth & Profitibility Goodwill/intangible assets 3,008 4,351 4,758 4,572 4,386 4,200 20 7.5 Associates/investments 5,175 2,873 3,906 2,906 2,206 2,106 Other assets 62,380 64,592 64,246 59,440 65,245 71,747 10 5 Total assets 93,718 93,683 89,101 84,118 87,978 89,982 0 2.5 Interest bearing debt 31,612 35,154 32,797 30,797 30,797 28,797 -10 0 Other liabilities 20,898 17,960 18,549 14,503 17,199 20,139 -20 -2.5 Total liabilities 52,510 53,114 51,346 45,300 47,996 48,936 -30 -5 Shareholders' equity 40,791 39,896 36,773 37,885 39,086 40,199 14 15 16 17E 18E 19E Minorities 417 673 982 932 896 847 Total shareholders' equity 41,208 40,569 37,755 38,817 39,982 41,045 Sales growth (LHS) ROE (RHS) Net debt 15,238 21,807 24,675 21,246 21,853 23,586
Solvency Key Company Metrics 125 3 100 2.5 Sales growth (%) nm -19.7 -3.5 13.9 6.8 12.3 DB EPS growth (%) na -85.0 na na -31.8 37.7 75 2 EBITDA Margin (%) 7.4 7.8 1.9 -32.5 11.5 12.3 50 1.5 EBIT Margin (%) 6.0 5.7 -0.7 -34.8 9.2 10.2 25 1 Payout ratio (%) 64.9 nm nm 30.1 30.0 30.0 0 0.5 ROE (%) 1.4 0.2 -2.4 4.3 3.0 4.0 14 15 16 17E 18E 19E Capex/sales (%) 2.3 3.2 2.1 1.5 1.4 1.3 Capex/depreciation (x) 1.6 1.5 0.8 0.6 0.6 0.6 Net debt/equity (LHS) Net interest cover (RHS) Net debt/equity (%) 37.0 53.8 65.4 54.7 54.7 57.5 Fei Sun, CFA Net interest cover (x) 2.2 1.0 nm nm 2.3 2.7 +852 2203 6130 [email protected] Source: Company data, Deutsche Securities estimates
Page 24 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Model updated: 01 November 2017 Fiscal year end 31-Dec 2014 2015 2016 2017E 2018E 2019E Running the numbers Financial Summary Asia DB EPS (CNY) 0.10 0.03 0.11 0.18 0.23 0.26 Reported EPS (CNY) 0.10 0.03 0.11 0.18 0.23 0.26 China DPS (CNY) 0.05 0.01 0.05 0.05 0.07 0.08 Manufacturing BVPS (CNY) 1.6 1.5 1.6 1.7 1.9 2.0 Weighted average shares (m) 4,280 4,280 4,280 4,280 4,280 4,280 Average market cap (CNYm) 4,935 4,931 4,561 13,027 13,027 13,027 Lonking Enterprise value (CNYm) 5,768 4,400 2,269 9,740 8,733 7,657 Reuters: 3339.HK Bloomberg: 3339 HK Valuation Metrics P/E (DB) (x) 11.8 42.3 9.9 16.8 13.5 11.6 Hold P/E (Reported) (x) 11.8 42.3 9.9 16.8 13.5 11.6 P/BV (x) 0.76 0.59 0.91 1.79 1.64 1.49 Price (1 Nov 17) HKD 3.59 FCF Yield (%) 39.6 39.6 58.6 9.4 10.0 10.8 Target Price HKD 3.60 Dividend Yield (%) 4.5 1.2 5.2 1.8 2.2 2.6 EV/Sales (x) 0.8 0.9 0.4 1.2 1.0 0.8 52 Week range HKD 1.34 - 3.80 EV/EBITDA (x) 5.5 7.5 2.5 7.4 5.6 4.5 EV/EBIT (x) 8.7 22.6 4.2 10.4 7.5 5.8 Market cap (m) HKDm 15,366 USDm 1,969.7 Income Statement (CNYm) Sales revenue 7,427 4,829 5,146 7,816 9,086 9,958 Company Profile Gross profit 2,286 1,489 1,626 2,483 2,848 3,115 Lonking is one of the top five wheel loader producer in China in EBITDA 1,058 585 915 1,315 1,548 1,716 terms of 2015 sales volume. Its major products include wheel Depreciation 392 390 380 382 387 392 loaders, excavators, road rollers and fork-lifts. Amortisation 0 0 0 0 0 0 EBIT 667 195 536 933 1,161 1,324 Net interest income(expense) -64 24 42 57 67 101 Associates/affiliates 0 0 0 0 0 0 Exceptionals/extraordinaries 0 0 0 0 0 0 Other pre-tax income/(expense) -3 -6 -18 -20 -22 -24 Profit before tax 600 212 559 970 1,206 1,401 Price Performance Income tax expense 183 96 97 194 241 280 4 Minorities 0 0 0 0 0 0 Other post-tax income/(expense) 0 0 0 0 0 0 3 Net profit 417 117 462 776 965 1,121 2 DB adjustments (including dilution) 0 0 0 0 0 0 1 DB Net profit 417 117 462 776 965 1,121 0 Jan '16 Jul '16 Jan '17 Jul '17 Cash Flow (CNYm)
Lonking HANG SENG INDEX (Rebased) Cash flow from operations 1,785 1,604 1,878 1,277 1,348 1,462 Net Capex 170 350 794 -51 -51 -51 Margin Trends Free cash flow 1,955 1,954 2,671 1,227 1,297 1,412 Equity raised/(bought back) 0 0 0 0 0 0 20 Dividends paid -220 -220 -61 -233 -289 -336 15 Net inc/(dec) in borrowings 1,676 -211 -2,433 -445 -151 -135 Other investing/financing cash flows -3,317 -1,465 -196 -362 0 0 10 Net cash flow 93 57 -18 187 858 940 5 Change in working capital 822 990 1,119 121 -2 -48 0 14 15 16 17E 18E 19E Balance Sheet (CNYm) EBITDA Margin EBIT Margin Cash and other liquid assets 3,447 3,571 3,598 2,879 3,737 4,677 Tangible fixed assets 3,264 2,829 2,465 2,133 1,797 1,456 Growth & Profitibility Goodwill/intangible assets 0 0 0 0 0 0 75 25 Associates/investments 5 1,328 848 2,115 2,115 2,115 Other assets 6,454 4,788 4,296 5,285 5,791 6,178 50 20 Total assets 13,169 12,516 11,207 12,413 13,440 14,426 25 15 Interest bearing debt 4,281 4,365 2,150 1,705 1,555 1,419 0 10 Other liabilities 1,859 1,526 2,337 3,445 3,947 4,283 -25 5 Total liabilities 6,140 5,891 4,487 5,150 5,501 5,703 -50 0 Shareholders' equity 7,027 6,621 6,717 7,260 7,935 8,720 14 15 16 17E 18E 19E Minorities 3 3 3 3 3 4 Total shareholders' equity 7,029 6,624 6,720 7,263 7,939 8,724 Sales growth (LHS) ROE (RHS) Net debt 834 795 -1,448 -1,174 -2,182 -3,258
Solvency Key Company Metrics 20 13.375830881552 Sales growth (%) nm -35.0 6.6 51.9 16.2 9.6 0 12.375830881552 DB EPS growth (%) na -72.1 296.2 68.0 24.3 16.2 EBITDA Margin (%) 14.2 12.1 17.8 16.8 17.0 17.2 -20 11.375830881552 EBIT Margin (%) 9.0 4.0 10.4 11.9 12.8 13.3 Payout ratio (%) 52.8 52.5 50.9 30.0 30.0 30.0 -40 10.375830881551705 ROE (%) 6.0 1.7 6.9 11.1 12.7 13.5 14 15 16 17E 18E 19E Capex/sales (%) 1.4 1.4 0.5 0.6 0.6 0.5 Capex/depreciation (x) 0.3 0.2 0.1 0.1 0.1 0.1 Net debt/equity (LHS) Net interest cover (RHS) Net debt/equity (%) 11.9 12.0 -21.5 -16.2 -27.5 -37.3 Fei Sun, CFA Net interest cover (x) 10.4 nm nm nm nm nm +852 2203 6130 [email protected] Source: Company data, Deutsche Securities estimates
Deutsche Bank AG/Hong Kong Page 25 2 November 2017 Manufacturing Construction Machinery Appendix 1
Important Disclosures *Other information available upon request
Disclosure checklist Company Ticker Recent price* Disclosure Lonking 3339.HK 3.56 (HKD) 2 Nov 2017 13 Zoomlion 1157.HK 3.75 (HKD) 2 Nov 2017 14 *Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced from local exchanges via Reuters, Bloomberg, and other vendors. Other information is sourced from Deutsche Bank, subject companies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/ DisclosureDirectory.eqsr. Aside from within this report, important conflict disclosures can also be found at https://gm/db.com/equities under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. Important Disclosures Required by U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes. 14. Deutsche Bank and/or its affiliate(s) has received non-investment banking related compensation from this company within the past year. Important Disclosures Required by Non-U.S. Regulators Disclosures marked with an asterisk may also be required by at least one jurisdiction in addition to the United States. See Important Disclosures Required by Non-US Regulators and Explanatory Notes. 13. As of the end of the preceding week, Deutsche Bank and/or its affiliate(s) owns one percent or more of a class of common equity securities of this company. For disclosures pertaining to recommendations or estimates made on securities other than the primary subject of this research, please see the most recently published company report or visit our global disclosure look-up page on our website at http://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr Analyst Certification The views expressed in this report accurately reflect the personal views of the undersigned lead analyst about the subject issuers and the securities of those issuers. In addition, the undersigned lead analyst has not and will not receive any compensation for providing a specific recommendation or view in this report. Fei Sun
Page 26 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
Historical recommendations and target price. Lonking (3339.HK)
(as of 11/02/2017) 5.00 Current Recommendations Buy Hold 4.00 Sell Not Rated Suspended Rating
3.00 ** Analyst is no longer at Deutsche Bank
4 2.00 Security price 1 2 3 1.00
0.00 Jan '16 May '16 Sep '16 Jan '17 May '17 Sep '17 Date
1. 11/13/2015 Hold, Target Price Change HKD 1,20 Phyllis Wang** 3. 10/12/2016 Upgraded to Hold, Target Price Change HKD 1,07 Phyllis Wang** 2. 04/28/2016 Downgraded to Sell, Target Price Change HKD 1,04 4. 01/25/2017 Hold, Target Price Change HKD 2,05 Phyllis Wang** Phyllis Wang**
§§§§$$$$$§§§§§
Historical recommendations and target price. Zoomlion (1157.HK) (as of 11/02/2017) 6.00 Current Recommendations Buy Hold 5.00 Sell Not Rated Suspended Rating 4 4.00 ** Analyst is no longer at 1 3 Deutsche Bank 3.00 2
Security price 2.00
1.00
0.00 Jan '16 May '16 Sep '16 Jan '17 May '17 Sep '17 Date
1. 11/13/2015 Hold, Target Price Change HKD 2,86 Phyllis Wang** 3. 10/12/2016 Hold, Target Price Change HKD 2,73 Phyllis Wang** 2. 04/28/2016 Hold, Target Price Change HKD 2,81 Phyllis Wang** 4. 01/25/2017 Hold, Target Price Change HKD 3,89 Phyllis Wang**
§§§§$$$$$§§§§§
Deutsche Bank AG/Hong Kong Page 27 2 November 2017 Manufacturing Construction Machinery
Equity Rating Key Equity rating dispersion and banking relationships Buy: Based on a current 12- month view of total share-holder return (TSR = percentage change in share price from current price to projected target price plus pro-jected dividend yield ) , we recommend that investors buy the stock. Sell: Based on a current 12-month view of total share-holder return, we recommend that investors sell the stock. Hold: We take a neutral view on the stock 12-months out and, based on this time horizon, do not recommend either a Buy or Sell. Newly issued research recommendations and target prices supersede previously published research.
Page 28 Deutsche Bank AG/Hong Kong 2 November 2017 Manufacturing Construction Machinery
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Deutsche Bank AG/Hong Kong Page 29 2 November 2017 Manufacturing Construction Machinery
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Page 32 Deutsche Bank AG/Hong Kong David Folkerts-Landau Group Chief Economist and Global Head of Research
Raj Hindocha Michael Spencer Steve Pollard Global Chief Operating Officer Head of APAC Research Head of Americas Research Research Global Head of Economics Global Head of Equity Research
Anthony Klarman Paul Reynolds Dave Clark Pam Finelli Global Head of Head of EMEA Head of APAC Global Head of Debt Research Equity Research Equity Research Equity Derivatives Research
Andreas Neubauer Spyros Mesomeris Head of Research - Germany Global Head of Quantitative and QIS Research
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