14 December 2016 Asia Pacific/Hong Kong Equity Research Construction & Farm Machinery China Construction Machinery Sector Research Analysts INITIATION Amy Ji 852 2101 7735 [email protected] Riding on accelerating replacement cycle Edmond Huang, CFA 852 2101 6701 [email protected] Figure 1: Construction machinery demand forecast 80%
30%
-20%
-70%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2016E 2017E 2018E
Excavator Wheel crane Loader
Source: China Construction Machinery Yearbook, Credit Suisse estimates
■ We initiate coverage on China's construction machinery sector. We expect the overall machinery sector to recover in 2016-18E, on the back of (1) accelerating replacement cycle, and (2) sustainable demand driven by resilient infrastructure investment. By segment, we forecast excavator to register a CAGR of 31%, wheel loader with 20%, crane with 18% and concrete machinery with 9% (lower than other segments due to relatively high correlation with the property sector) in 2017-18. We initiate coverage on Zoomlion (H) (OUTPERFORM, TP HK$4.75), Lonking (OUTPERFORM, TP HK$2.35), Sany (OUTPERFORM, TP Rmb7.80), and Zoomlion (A) (NEUTRAL, TP Rmb4.45). We believe DCF is a better method to capture growth with sustainable FCF improvement during recovery. ■ Accelerating replacement cycle to support new machinery sales. Given the current fleet's usage age, we expect an imminent replacement cycle approaching. According to the channel check with machinery makers and dealers, sales this year mainly came from the existing customers. We expect demand to accelerate in 2017-18E as aging issue will aggravate in the next few years. We believe industry destocking is close to its late stage, with diminishing impact on new machinery sales, while a stricter environmental regulation could serve as a catalyst for further replacement acceleration. ■ Machinery demand driven by resilient infrastructure investment. Given current annual infra FAI >Rmb13 tn, we believe it provides a sustainable demand for construction machinery. Different from 2011-2015, the aging fleet will not be able to fulfill the demand, thus triggering the replacement cycle. In addition, our economics team projects infra FAI to register +20% YoY growth in 2017, which will provide new machinery demand and more than offset the slowdown in the property sector. ■ Pecking order: Zoomlion > Lonking > Sany. We like Zoomlion (H) for its steady revenue/earnings growth, and improving balance sheet as credit risk exposure declines. We believe its current H-share valuation is attractive (trading at 0.65x 2017E P/B, near historical trough and ~35% discount to its peers). We like Lonking for its market leader position in wheel loader industry, strong balance sheet, and quality management. Risks: slower-than-expected industry recovery and replacement cycle.
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
14 December 2016
Focus charts and tables Figure 3: Excavator growth sensitivity test on Figure 2: Ending industry breakdown replacement ratio Infrastructure Property Mining Others Replacement demand growth Replacement ratio in 2017 35% 40% 45% 50% 60% Excavator 40% 30% 20% 10% 130,000 -2% 8% 18% 27% 47% Loader 50% 10% 20% 20% Fleet at end of 148,750 8% 19% 30% 41% 64% Crane 40% 30% 0% 20% expectency in 160,000 14% 26% 38% 50% 74% Concrete 2017 170,000 19% 32% 45% 57% 83% 35% 50% 0% 15% Source: Credit Suisse estimates Source: China Construction Machinery Yearbook, Credit Suisse estimates
Figure 4: FAI infrastructure investment Figure 5: Utilisation hours continue to rise
28 50% 2,000 10.0% 1,800 24
40% 1,600 5.0% Rmb trn Rmb 20 1,400 16 30% 1,200 0.0% 1,000 12 20% 800 -5.0% 8 600 10% 4 400 -10.0% 0 0% 200 2003 2005 2007 2009 2011 2013 2015 2017E - -15.0% Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16
FAI infrastructure investment YoY (RHS) Trailing 12 months operating hours YoY (RHS)
Source: NBS, Credit Suisse estimates Source: Komatsu
Figure 6: Excavator demand mainly driven by Figure 7: Proportion of high-risk credit exposure is replacement due to aging issue declining
250,000 100% 80%
80% 70% 200,000 60% 60% 40% 150,000 50% 20% 40% 100,000 0% 30% -20% 50,000 20% -40%
- -60% 10%
2016E 2017E 2018E
2007 2008 2009 2010 2011 2012 2013 2014 2015
0% 2011 2012 2013 2014 2015 1H16
New demand Replacement demand YoY (RHS) Sany Zoomlion Lonking
Source: China Construction Machinery Yearbook, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Figure 8: Valuation table as of 12 Dec Market Ticker Rating Curr Target priceClose price Upside Cap P/E (x) P/B(x) ROE (%) EV/EBITA Dividend Yield (local) (US$ bn) 2016E 2017E 2018E 2019E 2020E 2016E 2017E 2018E 2019E 2020E 2016E 2017E 2018E 2016E 2017E 2018E 2017E 2018E Lonking 3339.HK O HKD 2.35 1.72 37% 0.9 23.1x 15.0x 11.0x 9.0x 7.9x 1.0x 0.9x 0.9x 0.9x 0.8x 4.2% 6.3% 8.4% 15.6x 13.7x 10.7x 3.5% 5.5% Zoomlion-H 1157.HK O HKD 4.75 3.73 27% 4.7 -50.5x 36.4x 18.2x 13.2x 9.9x 0.6x 0.6x 0.6x 0.6x 0.6x -1.3% 1.8% 3.4% 42.7x 38.9x 20.6x 0.4% 0.8% Sany 600031.SS O CNY 7.80 6.38 22% 7.0 128.2x 39.1x 20.5x 16.3x 13.6x 2.1x 2.0x 1.9x 1.8x 1.6x 1.7% 5.3% 9.6% 18.8x 18.3x 14.6x 0.8% 1.5% Zoomlion-A 000157.SZ N CNY 4.45 4.49 -1% 4.7 -68.3x 49.3x 24.6x 17.8x 13.4x 0.9x 0.9x 0.8x 0.8x 0.8x -1.3% 1.8% 3.4% 42.7x 38.9x 20.6x 0.3% 0.6% Source: Company data, Credit Suisse estimates, Bloomberg
China Construction Machinery Sector 2 14 December 2016
Moderate recovery: Sustainable on the back of replacement cycle and resilient demand Machinery demand driven by resilient infra investment Infrastructure We expect infrastructure investment to support machinery growth in 2017. Given current investment to support annual infra FAI >Rmb13 tn, we believe it provides a sustainable demand for construction machinery demand in machinery. Different from 2011-2015, the aging fleet will not be able to fulfill the demand, 2017 therefore, triggering the replacement cycle. Furthermore, our economics team projects infra FAI to register +20% YoY growth in 2017, which will provide new machinery demand and accelerate the replacement cycle, in our view. Despite recent tightening policy in the property market, we believe it is a correction and not collapse. We believe the resilient infra investment will be able to fully offset the weakening property. Accelerating replacement cycle Accelerating We argue that the current fleet faces an aging issue, and an imminent replacement cycle replacement cycle is fast approaching. According to our channel check with the machinery maker and approaching dealers, the recent rapid growth in construction machinery is mainly driven by replacement demand from the existing customers. Looking forward, we expect the replacement cycle to accelerate in 2017-18, as the aging issue will rapidly grow in the next two years given >40% of current fleet is currently 6-8 years old. Furthermore, the impact of second- hand market is diminishing, given that (1) destocking process has entered the late stage for construction machinery makers, and (2) the availability of quality machinery in second- hand machinery market has significantly declined over the past few years. Balance sheet improvement on the way Improving balance We expect construction machinery companies to further improve the quality of their sheet quality balance sheet by reducing credit exposure. We witness a declining trend of high-risk credit exposure as a percentage of the total. Looking forward, we expect total credit exposure to further shrink, driven by less off-balance sheet items and better receivables repayment. Pecking order: Zoomlion > Lonking > Sany By product, we prefer excavator, thanks to its (1) rising replacement demand, and (2) favourable exposure to infrastructure investment. We believe loader/crane will deliver solid growth. On the other hand, we expect high single-digit growth for concrete machinery, as we believe its growth will be slower than other machineries, due to (1) softening real estate outlook, and (2) nature of late cycle. However, we believe weakening real estate investment has limited downside impact on concrete machineries. As we expect OpCF/FCF to experience stronger recovery than earnings, we believe DCF method is more suitable to capture the medium-term growth. Our forecast for the sector is ahead of consensus, as we factor in higher growth rate driven by sustainable replacement demand. Our top pick is Zoomlion. We like Zoomlion for its steady revenue growth coupled with margin expansion and balance sheet repair as credit risk exposure declines. We believe the current valuation is attractive, trading at 0.65x 2017E P/B (near its historical trough) and ~35% discount to its peer. The recovery in ROE (1.7%/3.4% in 2017/18E) also justifies our valuation, given high correlation between historical P/B and ROE. We also like Lonking for its marker leader position in the wheel loader industry, strong balance sheet, and quality management. Risks: Slower-than-expected industry recovery and replacement cycle.
China Construction Machinery Sector 3 14 December 2016
Machinery demand driven by resilient infrastructure investment Machinery demand We believe resilient infrastructure investment will be a key theme in 2017. While property supported by resilient and infrastructure investment contributed positively to the robust recovery in 2H16, we infrastructure believe a similar theme will not be repeated again in 2017. As the Chinese government investment takes a firm approach to control rising property prices through tightening policies in the property sector, our strategy team believes the government will keep infrastructure investment growth at a fast pace to ensure the completion of its 2017's growth target. Thus, we believe infrastructure investment growth will remain strong going into 2017, and expect it to register +20% YoY growth on the back of PPP projects in both municipal and transportation.
Figure 9: FAI growth rate
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E
Infrastructure Real Estate Total Demand
Source: NBS, Credit Suisse estimates
We believe the impact from a weakening property sector will be largely muted on the construction machinery sector, given the solid infrastructure investment going forward. According to our economics team, despite China's efforts to curb rising property prices, the government will likely ensure the completion of its economic growth. As FAI investment is a vital mediator during economic downturns, we believe the government will at least maintain FAI at its current level, with possible uptick in the long term. As such, the sheer size of the current FAI already provides solid support for machinery demand. Different from 2011-2015, the aging fleet will not be able to fulfill the demand, therefore, triggering the replacement cycle. In addition, as our economics team forecasts a 20% infrastructure investment growth in 2017, we believe it will prompt accelerated short-term machinery demand, mitigating the decline in property investment. As can be seen in Figure 10, while the growth of property investment in projected to slowdown, the faster rise in infrastructure investment makes up for almost half of the demand growth, and will be able to more than offset the fall in property.
China Construction Machinery Sector 4 14 December 2016
Figure 10: Almost half of demand growth comes from infrastructure investment
150 25 (% contribution) (Y-Y%) 20 100 15 50 10 0 5
(50) 0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2016E 2017E
Retail Sales Exports Infrastructure Inv Property Inv Industrial Inv Services Inv Total Demand (RHS)
Source: NBS, Credit Suisse estimates Property market: A correction but not a collapse Healthy correction in Despite recent tightening policy in the property market, we believe it is a healthy correction property market rather than a collapse. The recent tightening policy will inevitably weaken property sales in instead of collapse the coming quarters and depress construction. However, our property analyst believes that it will be to a lesser extent than what happened during the 2014-15 downturns, it is for the following reasons. (1) the drop in sales is likely to be modest and differentiated across different city tiers, given differentiated policies across different tiers of cities, (2) no monetary tightening policy similar to that of 2014, and (3) increasing household income. In addition, the increase in construction new starts has not matched the rise in sales amid the boom as inventory has fallen. Therefore, when sales growth slows due to tightening policy, we expect it to have a limited impact on construction activity, as inventory build-up is not a problem. Our property team expects construction new starts to register 2.3% YoY decline in 2017 (vs 8.2% in 2016), while our economist team forecasts the growth of nominal real estate FAI to moderate to ~2% YoY (vs 6% in 2016).
Bright outlook for infrastructure investment We believe infrastructure investment is well supported going into 2017, thanks to (1) pick up in local government investment on the back of stronger financial capability, (2) accelerating NDRC projects approval, and (3) better execution of PPP projects.
Pick up in local government investment with stronger financial capability We believe infrastructure investment growth could be better than market expectations due to pick up in local government investment. As 96% of the total FAI is from the local government and only 4% from the central government, the role of the local government is crucial for growth in infrastructure investment. As a result, the local government's improving financial capability provides solid fundamental support for infrastructure development by accelerating investment activity which expedites the local government projects.
China Construction Machinery Sector 5 14 December 2016
The improvement in the local government's financial capability can be attributed to (1) debt swap programs, and (2) increasing fiscal income from land transfers. Fiscal income from land transfer started rebounding significantly this year, registering 22% growth in 10M16 to Rmb2.7 tn, up from Rmb2.3 tn in 10M15. We expect the local government's financial capabilities to continue to improve, providing further support for infrastructure investment going into 2017.
Accelerating project approvals ready for next year NDRC approval started NDRC's acceleration in project approval started in September; it approved ~Rmb600 bn to accelerate in 2H16 projects in November alone. We expect the trend to continue, as we believe NDRC is adopting a forward-looking approach to set the stage for stable investment growth in 2017, especially given the moderation in real estate investment growth, following the policy tightening. Breaking down the approved projects, we observe that metro took the lion shares, and we expect it to lead infrastructure investment through the next 3-5 years. In addition, highway and railway (including national railway, HSR, and intercity) will remain as key components. We believe the mix of projects will benefit construction machineries such as excavators and loaders first, followed by road foundation related machineries. While concrete machinery is less sensitive to growth in infrastructure investment, it can nevertheless benefit from the construction of HSR and intercity lines as it involves bridge and abutment. In addition, according to the medium/long-term railway network plan announced by NDRC, there will be a steady shift in focus from traditional developed areas to more rural and remote areas. Thus, we believe concrete machinery can still benefit from continued infrastructure investment given (1) low mobility of concrete machinery's, and (2) small fleet in rural areas.
Figure 11: NRDC approval accelerated in Oct/Nov Figure 12: NRDC projects breakdown YTD
1,000 Pier 0% 900 Airport 800 HSR 5% 10% 700 Metro 600 32% Intercity 500 12% 400 300
200 Railway 17% 100 Highway - 24% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2015 2016
Source: NDRC Source: NDRC
Robust PPP project momentum to drive the infra investment We believe accelerating PPP project execution will also be a key catalyst for infrastructure investment. The strong PPP project growth momentum from the beginning of the year carried through 1H16 and into 3Q16, with a total of 10,471 projects with Rmb 12.4 tn in project value. Transportation/municipal projects not only experienced the highest growth with 21%/34% in 3Q16, but also made up for the lion share of the projects, accounting for 30%/27% of total investment value and 12%/35% of total number of projects.
China Construction Machinery Sector 6 14 December 2016
Figure 13: PPP projects breakdown by total investment value
Travel Others Hydro 5% 13% 3% Transportation Environment 30% protection 5% Affordable housing 6% Area development Municipal 11% 27%
Source: PPP database
Pick up in implementation rate with further room for improvement PPP execution The implementation rate further improved in 3Q16. As shown in the figure below, while momentum continues projects worth a total of 76% of the total investment, are still under examination and preparation phase, the share of projects under the procurement and execution phase have risen significantly, up from 10% at the beginning of the year to 24% as of September. We believe this momentum will sustain going forward given (1) government policy support, (2) easier access to funding, (3) better comprehension of PPP policies, and (4) simplified project application process. We expect more law and regulation regarding PPP to be announced which will further support the PPP project, as it will provide clearer guidance on PPP projects with legal protection and reduced risks.
Figure 14: PPP project phase breakdown by investment value (Rmb bn)
14 30%
12 25%
10 20%
8 15% 6
10% 4
5% 2
0 0% Jan Feb Mar Apr May Jun Jul Aug Sep
Examination Preparation Procurement Execution Implementation rate (RHS)
Source: MOF (implementation stage includes procurement and execution)
China Construction Machinery Sector 7 14 December 2016
Accelerating replacement cycle Replacement cycle We believe the imminent replacement cycle for construction machinery is approaching, approaching driven by and we expect the resulting replacement demand to provide substantial support for new aging stock construction machinery sales. We argue that the current fleet faces eroding aging issue. In addition, we suspect the destocking process has come to the late stage given (1) shrinking second-hand machinery inventory of construction machinery makers, and 2) reduction in quality second-hand machinery in the market. We believe the factors will provide crucial support for new machinery sales, given the ongoing replacement demand. Replacement demand rising due to the aging issue Current market is facing the aging issue According to the China Construction Machinery Yearbook, the fleet size of construction machinery reached 6.6-7.2 mn units by 2015.
Figure 15: Stocking market size estimation by 2015 000 units Low-end High-end Forklift 2,085 2,258 Loader 1,674 1,814 Hydraulic excavator 1,495 1,620 Tower crane 425 460 Truck-mounted concrete mixer 321 328 Wheel crane 217 235 Bulldozer 71 77 Truck-mounted concrete pumps 61 66 Concrete pump 57 62 Concrete mixing plants 50 55 Others 38 40 Total 6,632 7,164 Source: China Construction Machinery Yearbook, Credit Suisse estimates
Despite the large fleet base, we believe the current overall stock is not sufficient to fulfill the end-user demand, given the rising infrastructure investment due to the aging issue. According to our channel check, the normal life span for hydraulic excavator is about 7-8 years while crane and concrete machinery have a slightly longer life span of around 8-10 years. According to our estimation, crane with an age of 8-10 years accounts for 8%, 9% and 7% of the current fleet, respectively. For excavator, over 23% of the total fleet has an usage age of over 8 years.
China Construction Machinery Sector 8 14 December 2016
Figure 16: Crane stocking age Figure 17: Excavator stocking age
Aging crane stocks (unit) Aging excavator stocks (unit)
35,000 250,000 18% 18% 17% 18% 30,000 14% 200,000 25,000
150,000 20,000 10% 10% 9% 10% 10% 8% 9% 8% 15,000 7% 7% 8% 100,000 5% 6% 10,000 4% 4% 50,000 5,000
- - 10 9 8 7 6 5 4 3 2 1 10 9 8 7 6 5 4 3 2 1
Source: China Construction Machinery Yearbook, Credit Suisse estimates Source: China Construction Machinery Yearbook, Credit Suisse estimates
Machinery sold during golden period is approaching its replacement cycle The aging ratio will grow rapidly in the next 1-2 years, and will account for ~30-40% of the total stock in 2017, based on our estimates. The rapid rise in aging stock is mainly due to the large number of machineries sold from 2009-2011, which are currently 6-8 years old. Going forward, this portion of machinery will soon approach its normal replacement cycle.
Figure 18: Rapidly growing aging stock (1) Figure 19: Rapidly growing aging stock (2)
250% 60%
50% 200%
40% 150% 30% 100% 20%
50% 10%
0% 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Aged dependency ratio for excavator Excavator Loader Crane
Source: China Construction Machinery Yearbook, Credit Suisse estimates Source: China Construction Machinery Yearbook, Credit Suisse estimates
Note: Aging dependency ratio=(number of machinery aged 8-10)/(number of machinery aged Note: Aging ratio= (number of machinery aged 8-10)/total machinery fleet*100 1-3)*100
We believe this batch of aging machinery will soon approach its replacement cycle while delay in replacement cycle is unlikely, despite relatively low utilisation hour in recent years. The life span of the machinery depends not only on the utilisation hours but also on maintenance and working condition. Through the sluggish demand period from 2012- 2015, users had low incentive to perform regular maintenance. We believe the low revenue generation and high idle rate during the period have led to inadequate maintenance frequency and harsh storage condition, which in turn have led to the
China Construction Machinery Sector 9 14 December 2016
machinery's more rapid quality deterioration. Therefore, we believe the current machinery with an usage age >6 years cannot fulfil the demand of infrastructure projects with higher capability requirement. As the maintenance cost grows as the machinery ages, it would be more economical for users to replace existing old machinery with new one, instead of undergoing costly overhaul.
Figure 20: Sensitivity analysis for sales volume growth on replacement ratio and size of aging fleet Demand growth rate in 2017 Replacement ratio 35% 40% 45% 50% 60% Fleet at end of life 130,000 -2% 8% 18% 27% 47% expectancy in 2017 148,750 8% 19% 30% 41% 64% 160,000 14% 26% 38% 50% 74% 170,000 19% 32% 45% 57% 83% Source: China Construction Machinery Yearbook, Credit Suisse estimates
We believe, given the high aging fleet base and low sales volume in 2015/16, the total replacement volume is very sensitive to replacement ratio. According to our analysis, we estimate ~45% of machinery at the end of life span were replaced by new machinery in 2015, while the rest were mostly replaced by second-hand machinery or disposed with no replacement. Therefore, we use 45% replacement ratio as our base case for 2016-2020 forecast. We believe the downside risk for our estimate is very limited. Given recent high utilisation rate (~80% for Sany and 90% for Komatsu) and limited good quality second- hand machinery, we believe the replacement ratio could be even higher than our assumption, providing potential upside for sales volume growth. Market activities pick-up will spark acceleration in replacement cycle Correlation between We believe operating data serves as a good indicator for correlation between replacement market activity and cycle and market activities, and we observe that the growth in sales volume lags the replacement cycle operating data by approximately one quarter. While it is typical for users to use existing overhauled/repaired machinery that has been used to fulfill short-term demand, we believe when positive market growth appears sustainable, users will start the long-due replacement. For example, according to Komatsu data, excavator operating hours first started to recover in March 2016, with the growth momentum continuing in the following months. Compared to the operating data, sales of excavator started to pick up in July, roughly a quarter later. According to our channel check with dealers and machinery makers, most of customers this year are previous customers who are buying new machineries to fulfill the replacement demands. In addition to excavators, we also witnessed a similar trend for crane and concrete machineries. Thus, we deduce that the continuous improvement in operating data will further provide support for machinery sales, going forward. Given the promising infrastructure investment, we expect market activities to remain at a high level, leading to further acceleration in the replacement cycle.
China Construction Machinery Sector 10 14 December 2016
Figure 21: Excavator sales lags operating data by 2-3 months
4% More sustainable trend given 20% resilient demand and rising 2% aging stock 10% 0% -2% 0% -4% -10% -6% -20% -8%
-10% -30% -12% -40% -14%
-16% -50%
Feb Feb Feb Feb
Apr Aug Apr Aug Dec Aug Dec Apr Aug Dec Apr Aug Dec Apr
Jun Jun Jun Jun Jun
Oct Oct Oct Oct Oct
------
- - - - -
- - - -
- - - -
- - - - -
13 16 12 12 13 14 14 15 15 16
12 13 14 15 16
13 14 15 16
12 13 14 15
16 12 13 14 15
Trailing 12 months operating hous YoY Trailing 12 months excavator sales YoY (RHS)
Source: Wind
Figure 22: Trailing 12 months operating hours by Komatsu Figure 23: Excavator sales (Trailing 12 months)
2,000 10.0% 140 20%
1,800 120 10%
1,600 5.0% Thousands
1,400 100 0%
1,200 0.0% 80 -10% 1,000
800 -5.0% 60 -20%
600 40 -30% 400 -10.0%
200 20 -40%
- -15.0% 0 -50% Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Apr-12 Nov-12 Jun-13 Jan-14 Aug-14 Mar-15 Oct-15 May-16
Trailing 12 months operating hours YoY (RHS) Trailing 12 months sales volume (Unit) YoY (RHS)
Source: Komatsu Source: Wind
Destocking comes to late stage Construction machinery market experienced a prolonged destocking process coupled with rapidly rising second-hand machinery market for two reasons: (1) The aggressive market expansion in 2010-12, which led to high volume of second-hand machinery supply, and (2) Second-hand machinery with lower ASP is much more cost efficient during market downturns. As a result, new machinery sales have been significant depressed over the last three years. Going into 2017, we believe the destocking process has approached late stage with the impact of second-hand market diminishing, going forward. First of all, the clearance of second-hand inventory among construction machinery makers (especially for industry
China Construction Machinery Sector 11 14 December 2016
leaders, such as Zoomlion and Sany) is close to completion. We estimate that the total second-hand machinery accounts for less than 15% of total machinery sold in 2016 as compared to over 40% in the past. We believe this portion will further drop in the coming years as the second-hand machinery inventory continues to decline. Secondly, according to our channel check, the supply of good quality second-hand machinery in the market is falling short. This confirms our view that the current fleet has a serious aging issue, and the destocking process is nearly ending, which opens up the door for new machinery sales. Accelerating of upgrade and replacement cycle after national emission stage III standard A stricter We expect policy-driven replacement to gradually increase. As air pollution becomes one environmental of the biggest rising concerns in China, the central government has paid great attention to regulation can further the environmental issues. We believe given the significant impact national emission accelerate replacement regulation has on construction machinery, there will be an inevitable trend to weed out cycle emissions-unqualified machineries. In order to target emissions, the government has enacted different national emission requirements for different types of engines. For non-road mobile machinery with diesel engines, the national emission stage III policies took effect in April 2016. For road mobile machinery (such as concrete pump truck), national IV standard was implemented in 2015. Furthermore, we expect the emission standard for road mobile machinery to upgrade to National V by the end of 2017.
Figure 24: National emission standard for diesel engines N Product Standard Effective date Further action Non-road mobile machinery Excavator, loader National III Apr-16 Road mobile machinery Truck crane, Truck concrete pump National IV Jan-15 Potential upgrade to National V in 2017 Source: Credit Suisse estimates
With every new national standard, the policy details a new engine emission requirement, and bans the production/sale of any machinery with an engine below the new standard. In the short term, front-loading demand is likely to take place leading up to the implementation of the new standard. As China seems resolved to control air pollution and eliminate low-quality machinery with high pollution, we believe the implementation of stricter environmental policies will continue in the future. From a long-term perspective, we believe this will discourage second-hand sales as well as second-hand imports. Low-quality imports decline with rising replacement demand In a market downturn, we observe a strong downward trend of ASP for imported excavator. We believe it is attributable to (1) change of product mix with rising proportion of excavator <30 t (lower ASP), and (2) higher import volume of low-quality second-hand machinery. When demand is weak, new machinery sales is depressed, especially imported new machinery due to higher ASP. However, imported second-hand machinery appears attractive during this time, thanks to the affordability and ability to fulfill undemanding project. According to CCMA, the average imported excavator ASP in China is only one quarter of that in Korea. We believe the extremely low ASP has implications regarding the quality of imported machinery. We speculate that the unusually low ASP is dragged down by second-hand machinery or old models that do not meet Standard III requirements. We believe if the new environmental standard was strictly implemented, it will effectively reduce these import loophole transactions. Furthermore, those second-hand/low-quality machinery imported during the past few years will be replaced in the coming cycle.
China Construction Machinery Sector 12 14 December 2016
Figure 25: Trending down ASP of imported excavator
120 Trending down ASP since 2012-2014 100 mainly due to changing of product mix
80
60
40 ASP was abnormally low since2015. ASP reached its historical low in Mar 2016, and 20 steady rebounded after National III in Apr 2016
0 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Jun-16
Trailing 12months ASP
Source: Wind, Credit Suisse estimates
National projects and regions with high environment requirement to lead the trend National and municipal By construction type, we believe national and municipal projects are likely to adopt the projects to lead the new type of machineries. These government related projects focus more on the efficiency trend of the machinery to meet project deadline, and want to avoid any compliance issue. By region, we believe tier-one cities and regions with high environmental requirements will likely enforce the use of machineries that comply with National Standard III, as penalty is more severe in these regions. A gradual process of replacement to benefit industry leader in the long run Estimates show that ~2.5 mn existing construction machineries do not meet Standard III requirement, of which ~1.4 mn units are below Standard I requirement and ~1 mn units are under standard II. Although the standard III is not applicable to existing stock, we believe it is an inevitable trend for the over one-third of the existing construction machineries to be ruled out the market in the future, if government starts to penalise the unsatisfying emission issue on the construction site. While we believe the replacement for policy complying machineries will be a gradual process, we nevertheless believe it will accelerate the upgrade and replacement cycle over the long run. Because the introduction and implementation of every new environmental policy will add pressure to a company's sales and existing inventory, we believe industry leaders are better positioned to make the necessary adjustments.
China Construction Machinery Sector 13 14 December 2016
Balance sheet improvement on the way Reduction in credit Back in 2011-13, construction machinery companies adopted an aggressive credit sales exposure strategy in order to gain market share. Both the absolute value of account receivables and turnover days rose dramatically during that period. While all these companies started to tighten credit sales starting in 2014, credit risk remains one of the biggest concerns for this sector. Among peers, we believe Lonking's balance sheet is of the highest quality, thanks to (1) relatively conservative credit sales during 2011-14, and (2) good working capital management. In addition, Sany has reduced its total credit exposure with sufficient impairment booked. However, Zoomlion still faces high credit risk as the total credit exposure remains at historical peak.
Figure 26: Total net credit exposure trending down Figure 27: Credit turnover ratio (Sales/total credit from the peak exposure)
80 450%
70 400% Rmb bn Rmb
60 350%
300% 50 250% 40 200% 30 150% 20 100% 10 50%
0 0% Sany Zoomlion Lonking 2011 2012 2013 2014 2015 1H16
2011 2012 2013 2014 2015 1H16 Sany Zoomlion Lonking
Source: Company data. Note: Net credit exposure = on balance sheet items (account Source: Company data receivables, bill receivables, finance lease)+off balance sheet items (factoring, mortgage guarantee, third party guarantee) – total impairment/provision
Admittedly, accounts receivable level remains high. Sany and Zoomlion both experienced rising account receivables and turnover days in 1H16, compared to 2015. We expect the receivables level to slightly decline, given 4Q is normally the peak repayment season. In terms of overall credit risk, Sany has reduced its total credit exposure from a peak of Rmb53 bn in 2012 to Rmb31 bn in 1H16, mainly driven by shrinking off-balance sheet guarantee (accounting for 14% of the total credit exposure in 1H16 vs 71% in 2011). The progress for Zoomlion appears to be a bit slower than its peers. However, we believe the overall risk is reducing, as a portion of the receivables deduction from construction machinery is offset by the increase in receivables from environment and agriculture business. The overall quality of account receivable has improved in the recent years. Reduction in high risk credit exposure—to be more accurate, we evaluate each class of credit exposure, and we classify those off-balance sheet guarantee or long-term receivables/finance lease as high risk credit exposure. Figure 28 demonstrates a declining trend of high risk credit exposure as % of the total. Looking forward, we expect total credit exposure to further shrink, driven by less off- balance sheet items and better receivables repayment. We believe companies such as Zoomlion and Sany will continue to book impairment loss for these receivables in the following years. As impairment ratio reaches reasonable level, we believe further downside risk will be limited. We believe receivables turnover ratio will also improve along with top-line expansion.
China Construction Machinery Sector 14 14 December 2016
Figure 28: High-risk receivables as % of total credit exposure on a downward trend Figure 29: Lonking has the highest impairment ratio
80% 30%
70% 25%
60% 20% 50%
40% 15%
30% 10%
20% 5% 10%
0% 0% 2011 2012 2013 2014 2015 1H16 2011 2012 2013 2014 2015 1H16
Sany Zoomlion Lonking Sany Zoomlion Lonking
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Note: total impairment booked/ total credit exposure
Figure 30: Zoomlion's total credit exposure is still Figure 31: Zoomlion's risk credit items is lower than relative high (Rmb mn) 2014 but still have room to improve
45,000 80% 80,000
70,000 40,000 70%
35,000 60,000 60%
50,000 30,000 50% 40,000 25,000 40% 30,000 20,000 30% 20,000 15,000
20% 10,000 10,000
- 5,000 10% 2011 2012 2013 2014 2015 1H16 - 0% Trade receivables Bills receivables 2011 2012 2013 2014 2015 1H16 Factored without recourse (off BS) Receivables under finance lease High risky credit exposure (Rmb mn) As % of total (RHS)
Group guarantee Guarantee tp 3rd party
Source: Company data Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 15 14 December 2016
Figure 32: Sany's total credit exposure is reducing, Figure 33: Sany's high risk credit exposure is thanks to less off-balance sheet items (Rmb mn) reducing significantly
60,000 40,000 80%
35,000 70% 50,000
30,000 60% 40,000 25,000 50%
30,000 20,000 40%
20,000 15,000 30%
10,000 20% 10,000
5,000 10% - 2011 2012 2013 2014 2015 1H16 - 0% 2011 2012 2013 2014 2015 1H16 Account receivable Other receivables Mortgage guarantee* Guarantee to 3rd party* High risky credit exposure (Rmb mn) As % of total (RHS)
Source: Company data Source: Company data, Credit Suisse estimates
Figure 34: Lonking's credit exposure well controlled Figure 35: Lonking's high risk credit exposure is (Rmb mn) well controlled
4,500 1,600 40%
4,000 1,400 35% 3,500 1,200 30% 3,000 1,000 25% 2,500
2,000 800 20%
1,500 600 15% 1,000 400 10% 500
- 200 5% 2011 2012 2013 2014 2015 1H16 Trade receivables Bill receivables - 0% 2011 2012 2013 2014 2015 Loan receivables Miscellaneous receivables High risky credit exposure (Rmb mn) As % of total (RHS)
Source: Company data Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 16 14 December 2016
Business expansion is an ongoing theme among machinery companies Ongoing business Due to the strong demand headwind which started back in 2012, machinery companies diversification turned to new businesses as a possible source for future development. As a result, in addition to their traditional equipment businesses, machinery companies have expanded into environmental, agricultural and military defense sectors. While some companies like Zoomlion experienced smooth and successful transition, other companies are still in search of their new golden ticket. Nevertheless, we believe these companies' strategic transformation is warranted and beneficial for the future development, given the positive but moderate recovery in machinery demand and the need for a new growth driver, going forward.
Figure 36: New business expansion Company Sector Progress Zoomlion Environment equipment Acquired Ladurner in 2015; Accounts for >20% of total sales Agricultural machinery Acquired Qirui in 2015; Sany Defense Sep 2015: strategic cooperation agreement signed for "Unmanned equipment"; Joint venture with Poly Defense Investment Prefabrication Kunshan Project; Fire truck Testing Source: Company data
China Construction Machinery Sector 17 14 December 2016
Risks Slower-than-expected infrastructure investment While resilient infrastructure investment proved positive for the construction machinery sector, we acknowledge that investment can be significantly affected by macroeconomic conditions and government policy. If infrastructure investment growth slows down, it will inevitably lead to a decline in machinery demand.
Pricing pressure from possibly intensifying competition The recent rebound in construction machinery provided the much needed break for the machinery companies. As construction companies, who have been in a downward trend for many years experienced demand recovery, might start to over produce in an attempt to capture the rebounding market. If companies have similar mind set and start to over produce, the market will soon become over supplied and see falling ASPs, which will squeeze the company's profit margins.
Credit risk The high amount of outstanding accounts receivable poses a big risk to the company's financials. While we expect receivables collection to speed up going forward, the possibility of higher receivables and default risk poses as a challenge for the company.
Overseas emerging market's forex fluctuations In addition to domestic markets, some machinery companies have exposure to overseas business. Given the unstable growth in emerging markets, forex fluctuations pose risks to construction companies. Appreciation in RMB will negatively impact export and total sales.
Stronger-than-expected property investment As construction machineries are related to property constructions, pickups in the property investment will have a positive effect on machinery demand. This year, property sales increased by ~50% but property investment only grew by ~6%. As a result, property investment should sustain moderate growth going into 2017.
China Construction Machinery Sector 18 14 December 2016
Valuation
Figure 37: OpCF and FCF shows stronger recovery than net profit
20,000
15,000
10,000
5,000
-
(5,000)
(10,000) 2007 2008 2009 2010 2011 2012 2013 2014 2015 1H16 2016E
Net profit OpCF FCF
Source: Company data, Credit Suisse estimates
We use DCF methodology to value the three companies. We observed that OpCF/FCF experience stronger recovery than earnings, thanks to better working capital management. Construction machinery companies now focus on strengthening cash flow management after 4~5 years of downturn, and profit should be delivered gradually in the coming years. Therefore, we believe DCF method is more suitable to capture the medium-term growth. DCF as the major valuation methodology Figure 38: DCF key assumption Key assumption Lonking Zoomlion Sany Beta 1.20 1.50 1.20 Risk free 3.5% 3.5% 3.0% Equity risk premium 5.0% 5.0% 5.0% Debt/Capital (LT) 25% 50% 50% WACC 8.3% 7.8% 6.4% Terminal growth rate 1.5% 1.5% 1.5% EBIT margin 10.0% 10.0% 10.0% Source: Credit Suisse estimates
Figure 39: DCF valuation DCF Valuation Lonking Zoomlion Sany Present value of explicit years Rmb mn 7,525 28,093 41,644 Terminal value Rmb mn 3,888 30,571 40,790 Total company value Rmb mn 11,414 58,663 82,434 Net debt Rmb mn 1,973 23,883 22,500 Minority Rmb mn 3 680 955 Equity value Rmb mn 9,438 34,101 58,979 No. of shares mn 4,280 7,664 7,617 Fair value Rmb 2.21 4.45 7.75 Fair value local currency 2.35 4.75 7.75 Source: Credit Suisse estimates
China Construction Machinery Sector 19 14 December 2016
Currently, valuation of construction machinery (H) share is still attractive compared to historical. For Lonking, it is currently trading at below 0.5 standard deviation from its historical average. Zoomlion is trading slightly above -1.0 standard deviation from its historical average. While we agree that it's unlikely to repeat its historical peak, we believe the valuation is still relatively attractive, given promising outlook and gradual FCF and earnings improvements. After five years of downward trend, construction machinery sector is now entering into its first replacement cycle. We believe the stock should be re-rated as ROE will reach the level in 2014 and then steadily rise back to normal. We believe valuation should at least moderate back to 2014 average level with more upside, given our upward trend outlook.
Figure 40: Lonking: P/B vs ROE Figure 41: Zoomlion: P/B vs ROE
4.50 40% 3.50 35%
4.00 35% 3.00 30% 3.50 30% 25% 2.50 3.00 25% 20% 2.50 2.00 20% 15% 2.00 1.50 15% 10% 1.50 1.00 10% 5% 1.00 0.50 0.50 5% 0%
- 0% - -5% Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18
[email protected] ROE [email protected] ROE (RHS)
Source: Credit Suisse estimates, Bloomberg Source: Company data, Credit Suisse estimates
Figure 42: CS revenue estimates vs Bloomberg Company Ticker Revenue forecast (CS) Revenue consensus CS vs Cons (Revenue) 2016 2017 2018 2016 2017 2018 2016 2017 2018 Lonking 3339.HK 4,853 5,699 6,715 4,774 5,242 5,691 2% 9% 18% Zoomlion 1157.HK 20,262 22,857 26,259 19,993 22,137 24,654 1% 3% 7% Sany 600031.SS 22,001 25,771 31,051 21,420 24,580 29,901 3% 5% 4% Source: Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service
Figure 43: CS net profit estimates vs Bloomberg Company Ticker Net profit forecast (CS) Net profit consensus CS vs Cons (Net profit) 2016 2017 2018 2016 2017 2018 2016 2017 2018 Lonking 3339.HK 283 435 597 273 368 463 4% 18% 29% Zoomlion 1157.HK (504) 699 1,387 (403) 530 1,051 25% 32% 32% Sany 600031.SS 379 1,242 2,366 263 1,088 2,252 44% 14% 5% Source: Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service
China Construction Machinery Sector 20 14 December 2016
Figure 44: Lonking historical forward P/B Figure 45: Lonking: Consensus 17Y EPS (Rmb)
4.50 0.12
4.00 0.1 3.50
3.00 0.08
2.50 0.06 2.00
1.50 0.04
1.00 0.02 0.50
- 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16
[email protected] PB [email protected] +1 [email protected] -1 [email protected] 2017E EPS consensus forecast trend
Source: Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service Source: the BLOOMBERG PROFESSIONAL™ service
Figure 46: Zoomlion historical forward P/B Figure 47: Zoomlion—Consensus 17Y EPS (Rmb)
3.50 0.16
3.00 0.14
0.12 2.50
0.1 2.00 0.08 1.50 0.06 1.00 0.04 0.50 0.02 - Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 0 1/1/2016 3/1/2016 5/1/2016 7/1/2016 9/1/2016 11/1/2016 [email protected] PB [email protected] +1 [email protected] -1 [email protected] 2017E EPS consensus forecast trend
Source: Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service Source: the BLOOMBERG PROFESSIONAL™ service
China Construction Machinery Sector 21 14 December 2016
Figure 48: Sany historical forward P/B Figure 49: Sany—Consensus 17Y EPS (Rmb)
8.00 0.25
7.00
6.00 0.2
5.00 0.15 4.00
3.00 0.1 2.00
1.00 0.05 - Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16
[email protected] PB [email protected] +1 [email protected] -1 [email protected] 0 1/1/2016 3/1/2016 5/1/2016 7/1/2016 9/1/2016 11/1/2016 2017 EPS consensus forecast trend
Source: Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service Source: the BLOOMBERG PROFESSIONAL™ service
Figure 50: Valuation comparison Market Ticker Rating Curr Target priceClose price Upside Cap P/E (x) P/B(x) ROE (%) EV/EBITA Dividend Yield (local) (US$ bn) 2016E 2017E 2018E 2019E 2020E 2016E 2017E 2018E 2019E 2020E 2016E 2017E 2018E 2016E 2017E 2018E 2017E 2018E Lonking 3339.HK O HKD 2.35 1.72 37% 0.9 23.1x 15.0x 11.0x 9.0x 7.9x 1.0x 0.9x 0.9x 0.9x 0.8x 4.2% 6.3% 8.4% 15.6x 13.7x 10.7x 3.5% 5.5% Zoomlion-H 1157.HK O HKD 4.75 3.73 27% 4.7 -50.5x 36.4x 18.2x 13.2x 9.9x 0.6x 0.6x 0.6x 0.6x 0.6x -1.3% 1.8% 3.4% 42.7x 38.9x 20.6x 0.4% 0.8% Sany 600031.SS O CNY 7.80 6.38 22% 7.0 128.2x 39.1x 20.5x 16.3x 13.6x 2.1x 2.0x 1.9x 1.8x 1.6x 1.7% 5.3% 9.6% 18.8x 18.3x 14.6x 0.8% 1.5% Zoomlion-A 000157.SZ N CNY 4.45 4.49 -1% 4.7 -68.3x 49.3x 24.6x 17.8x 13.4x 0.9x 0.9x 0.8x 0.8x 0.8x -1.3% 1.8% 3.4% 42.7x 38.9x 20.6x 0.3% 0.6% Liugong 000528.SZ NR CNY n.a 7.33 1.19 1.2 133.3x 43.6x 28.7x 0.9x 0.9x 0.9x 0.5% 1.5% 2.9% 55.8x 18.7x 13.0x 1.4% 2.5% XCMG 000425.SZ NR CNY n.a 3.62 3.67 3.7 181.0x 60.3x 40.2x 1.2x 1.2x 1.2x 0.7% 2.2% 2.8% 40.8x 21.5x 17.6x 0.4% 0.3% Global machinery company Caterpillar CAT.N O USD 101 95.08 6% 55.5 29.2x 33.3x 16.7x 11.7x 1.6x 1.6x 1.6x 1.4x 3.9% 3.8% 8.1% 9.6x 10.2x 10.0x 2.5% 2.5% Komatsu 6301.T N JPY 2,150 2,706.50 -21% 22.2 18.6x 26.9x 23.8x 19.6x 1.7x 1.7x 1.7x 1.6x 9.0% 6.4% 7.2% 9.0x 10.3x 10.7x 2.1% 2.1%
Source: Company data, Credit Suisse estimates, the BLOOMBERG PROFESSIONAL™ service
China Construction Machinery Sector 22 14 December 2016
China Construction Machinery in HOLT® Credit Suisse HOLT is not part of Equity Research. The HOLT methodology uses a proprietary performance measure known as Cash Flow Return on Investment (CFROI®). This is an approximation of the economic return, or an estimate of the average real internal rate of return, earned by a firm on the portfolio of projects that constitute its operating assets. A firm's CFROI can be directly compared against its real cost of capital (the investors' real discount rate) to see if the firm is creating economic wealth. By removing accounting and inflations distortions the CFROI allows for global comparability across sectors, regions and time, and is also a more comprehensive metric than the traditional ROIC and ROE.
China Construction Machinery in HOLT – Historical Performance and near-term expectations HOLT provides us with a platform to aggregate economic returns and express value creation or destruction over the last 20 years within the Chinese Construction Machinery industry as a whole.
Figure 51: Historical Performance and Consensus Expectations for Chinese Construction Machinery Industry
Source: Credit Suisse HOLT Lens; weighted aggregate 31 cos; constituents in appendix
Historical Overview Between 2003–2011 the industry experienced on average 35% top line growth year on year, amidst increasing margins. For the first half of this period, asset efficiency increases as sales growth outweighs reinvestment needs. This trend reverses from 2007 as top line tapers down despite continued balance sheet growth. 2011 was a turning point where the Chinese construction industry was confronted with significant structural challenges, mainly the macro economic transformation and rising competition. Returns declined from a peak of 9.6% in 2010 to cost of capital levels, now at 4.2%. Consensus is expecting returns to remain at 4.6% while market expectations are more optimistic at 6.8% in the next five years.
China Construction Machinery Sector 23 14 December 2016
Over the past 6 months, Momentum in this industry has been on the rise, reflecting the positive market sentiment, contributing to the market expectations pricing in the recovery.
Company Specific Analysis Zoomlion Heavy Industry, Sany Heavy Industry and Lonking Holdings are analyzed within the China Construction Machinery. Over the last 5 years, all three companies have experienced declining economic profits with returns now below the cost of capital. The pressures in the industry have been translated into significant decline in top line, margins and asset efficiencies in all three companies.
Sany Heavy Industry Sany Heavy Industry’s returns have declined steeply over the last 5 years, from the highest ever at 24.8% in 2010 to the lowest ever levels at 1.3% in 2015. Near term expectations are of similar levels of 1.5% while market expectations are at optimistic levels of 8% by 2020.
Lonking Holdings Lonking’s returns declined sharply from 20.8% in 2010 to 0.9% in 2015. Near term consensus expectations are for a slight revival in return levels to 2.1%. Market is currently pricing in T+5 return levels at 6.1%.
Zoomlion Heavy Industry Returns at Zoomlion declined from 14.3% in 2011 to 2.0% in 2015. Consensus expectations are for CFROI to remain at subdued levels of 1.8% in the near term. Market implied levels are more optimistic at 4.5% in the next five years.
China Construction Machinery Sector 24 14 December 2016
*Asset growth chart capped to +50% ; Source: Credit Suisse HOLT LensTM
Overlay momentum to current valuations All three companies - Zoomlion Heavy Industry, Sany Heavy Industry and Lonking Holdings have experienced upgrades in price and CFROI over the last three months. Positive revisions will further suppport optimistic expectations in forecasts.
Source: Credit Suisse HOLT LensTM
Driving returns forward to create value Zoomlion, Sany and Lonking are compared across peers to understand the drivers of economic return on a company specific level. This can help assess where further improvements can be expected. The figure below reflects the drivers of returns, in terms of margins and asset efficiency across the companies. The figure positions where the firms are today, defending the levels of CFROI as expressed by the size of the bubbles.
All three companies currently are at the lower end of the peergroup median levels for both parameters of value. Transition of the companies based on CS Analyst estimates is also portrayed below by way of dotted bubbles. Benefits of the structural improvement in the industry is clearly visible through CS Analyst forecast projections. This is translated into improvement in all three companies to above the current peerset median levels. Further progress in gross cash flow margins and asset efficiencies are expected to improve returns and provide further upside.
China Construction Machinery Sector 25 14 December 2016
Figure 52: Asset efficiency vs gross cash flow margin
Source: Credit Suisse HOLT LensTM
Longer term expectations of industry revival Credit Suisse estimates for Zoomlion Heavy Industry, Sany Heavy Industry and Lonking Holdings have been linked to the HOLT framework (refer CS Analyst forecasts through HOLT section for details). CS Estimates suggest a rebound in return levels, given the imminent recovery cycle. The acceleration in demand due to approaching replacement cycle and resilient infrastructure investment should be sustainable growth drivers for these companies. Further upside should be promising if these catalysts are translated well by the companies into higher cash generation along will efficient balance sheet management.
Please contact your HOLT representative for further details.
China Construction Machinery Sector 26 14 December 2016
Asia Pacific/China Construction & Farm Machinery
Zoomlion Heavy Industry (1157.HK / 1157 HK) Rating OUTPERFORM [V] Price (12-Dec-16, HK$) 3.73 Target price (12-mth, HK$) 4.75 Upside/downside (%) 27.3
Mkt cap (HK$/US$ mn) 36,839 / 4,749 Ongoing recovery with attractive valuation Enterprise value (Rmb mn) 57,399 Number of shares (mn) 7,664 ■ We initiate coverage on Zoomlion with an OUTPERFORM rating and a TP Free float (%) 100.0 of HK$4.75, implying 27% upside. We like Zoomlion as we believe that it will 52-wk price range (HK$) 3.78-2.00 ADTO-6M (US$ mn) 4.1 turn around in 2017 thanks to sector recovery. We expect the steady growth *Stock ratings are relative to the relevant country benchmark. momentum in 2H16 to continue into 2017 driven by a pickup in construction ¹Target price is for 12 months. machinery sales and margin expansion on the back of balance sheet [V] = Stock Considered Volatile (see Disclosure Appendix)
improvement. New business is on the right track to deliver solid growth. Research Analysts ■ Positive earnings ahead with solid revenue growth and margin expansion. Amy Ji 852 2101 7735 We forecast Zoomlion will deliver 14% revenue growth in 2017-18E backed by a [email protected] recovery in the construction machinery industry and solid growth in Edmond Huang, CFA environmental segment. For construction machinery, we expect sales to 852 2101 6701 accelerate from the low base driven by strong infrastructure investment demand [email protected] and faster replacement cycles. Margin should improve given (1) the destocking
process is close to completion, (2) improving margin of the agriculture segment thanks to better product mix, and (3) better cost control on SG&A. ■ Ongoing balance sheet improvement. We expect Zoomlion to gradually reduce its credit risk by (1) shrinking its credit exposure with tightening sales terms and higher down payment, (2) strengthening receivables collection, and (3) rising impairment level to reduce downside risk. Furthermore, we expect the mix of credit exposure to turn better with 20% from new business. The reduction of credit exposure from construction machinery was partially offset by new business expansion. We believe the quality of AR is improving. ■ Valuation appears attractive. Zoomlion currently trades at 0.65x 2017E P/B, 0.75 standard deviation below historical average and 35% discount to its peer. We think the current valuation is attractive given its steady recovery and sequential balance sheet improvement. Our DCF-based TP of HK$4.75 implies 0.85x 2017E P/B. The recovery of ROE (1.7%/3.4% in 2017/18E) also justifies our valuation given high correlation between historical P/B and ROE. Risks to our valuation include worse-than-expected property investment and higher-than-expected credit risk. Share price performance Financial and valuation metrics
Year 12/15A 12/16E 12/17E 12/18E Revenue (Rmb mn) 20,753.0 20,261.8 22,856.8 26,258.9 EBITDA (Rmb mn) 1,343.0 1,476.1 2,779.8 3,744.9 EBIT (Rmb mn) 514.0 584.4 1,864.5 2,805.9 Net profit (Rmb mn) 89.0 (503.9) 698.6 1,397.2 EPS (CS adj.) (Rmb) 0.01 (0.07) 0.09 0.18 Change from previous EPS (%) n.a. - - - Consensus EPS (Rmb) n.a. (0.07) 0.05 0.09 EPS growth (%) (84.9) n.m. n.m. 100.0 The price relative chart measures performance against the P/E (x) 285.9 (50.5) 36.4 18.2 MSCI CHINA F IDX which closed at 6,131.50 on 12/12/16. Dividend yield (%) 4.5 0.0 0.4 0.8 On 12/12/16 the spot exchange rate was HK$7.76/US$1 EV/EBITDA (x) 42.0 38.9 21.0 15.6
Performance 1M 3M 12M P/B (x) 0.64 0.65 0.64 0.62 Absolute (%) 13.0 30.9 30.0 ROE (%) 0.2 (1.3) 1.8 3.4 Relative (%) 13.2 35.1 26.9 Net debt/equity (%) 58.3 61.6 63.0 61.3
Source: Company data, Thomson Reuters, Credit Suisse estimates
China Construction Machinery Sector 27 14 December 2016
Zoomlion Heavy Industry (1157.HK / 1157 HK) Price (12 Dec 2016): HK$3.73; Rating: OUTPERFORM [V]; Target Price: HK$4.75; Analyst: Amy Ji Earnings Drivers 12/15A 12/16E 12/17E 12/18E Per share 12/15A 12/16E 12/17E 12/18E Crane sales volume growth -0.40 -0.17 0.15 0.20 Shares (wtd avg.) (mn) 7,664 7,664 7,664 7,664 - - - - EPS (Credit Suisse) 0.01 (0.07) 0.09 0.18 - - - - (Rmb)DPS (Rmb) 0.15 0.00 0.01 0.03 - - - - BVPS (Rmb) 5.21 5.14 5.22 5.37 - - - - Operating CFPS (Rmb) (0.52) 0.09 0.13 0.28 Income Statement (Rmb mn) 12/15A 12/16E 12/17E 12/18E Valuation (x) 12/15A 12/16E 12/17E 12/18E Sales revenue 20,753 20,262 22,857 26,259 P/E 285.9 (50.5) 36.4 18.2 Cost of goods sold 15,146 14,895 16,513 18,545 P/B 0.64 0.65 0.64 0.62 SG & A 4,773 4,479 4,183 4,566 Dividend yield (%) 4.5 0.0 0.4 0.8 Other operating exp./(inc.) (509) (588) (618) (598) P/CF (6.3) 35.6 26.1 12.0 EBITDA 1,343 1,476 2,780 3,745 EV/sales 2.7 2.8 2.6 2.2 Depreciation & amortisation 829 892 915 939 EV/EBITDA 42.0 38.9 21.0 15.6 EBIT 514 584 1,864 2,806 EV/EBIT 109.8 98.3 31.3 20.8 Net interest expense/(inc.) 736 1,144 958 1,047 Earnings 12/15A 12/16E 12/17E 12/18E Non-operating inc./(exp.) 260 (60) (60) (60) Growth (%) Associates/JV 1 5 5 5 Sales revenue (19.7) (2.4) 12.8 14.9 Recurring PBT 39 (615) 852 1,704 EBIT (62.8) 13.7 219.0 50.5 Exceptionals/extraordinaries 0 0 0 0 Net profit (85.0) (666.2) 238.6 100.0 Taxes (58) (92) 128 256 EPS (84.9) (666.2) 238.6 100.0 Profit after tax 97 (522) 724 1,448 Margins (%) Other after tax income 0 0 0 0 EBITDA 6.5 7.3 12.2 14.3 Minority interests 8 (18) 26 51 EBIT 2.5 2.9 8.2 10.7 Preferred dividends 0 0 0 0 Pre-tax profit 0.2 (3.0) 3.7 6.5 Reported net profit 89 (504) 699 1,397 Net profit 0.4 (2.5) 3.1 5.3 Analyst adjustments 0 0 0 0 Net profit (Credit Suisse) 89 (504) 699 1,397 ROE analysis (%) 12/15A 12/16E 12/17E 12/18E ROE 0.2 (1.3) 1.8 3.4 Balance Sheet (Rmb mn) 12/15A 12/16E 12/17E 12/18E ROIC 2.1 0.8 2.4 3.6 Cash & cash equivalents 11,487 9,886 6,049 5,964 Asset turnover (x) 0.2 0.2 0.3 0.3 Current receivables 43,137 44,616 44,933 46,236 Interest burden (x) 0.1 (1.1) 0.5 0.6 Inventories 14,083 13,874 14,477 14,227 Tax burden (x) 2.5 0.9 0.9 0.8 Other current assets 2,309 2,265 2,498 2,802 Financial leverage (x) 2.3 2.3 2.2 2.2 Current assets 71,016 70,641 67,957 69,229 Credit ratios 12/15A 12/16E 12/17E 12/18E Property, plant & equip. 8,520 8,117 7,696 7,257 Investments 389 394 399 404 Net debt/equity (%) 58.3 61.6 63.0 61.3 Intangibles 4,351 4,242 4,128 4,008 Net debt/EBITDA (x) 17.62 16.71 9.22 6.86 Interest cover (x) 0.70 0.51 1.95 2.68 Other non-current assets 9,407 8,859 9,357 9,835 Total assets 93,683 92,253 89,537 90,733 Accounts payable 16,813 16,516 16,048 15,992 12MF P/E multiple Short-term debt 13,273 15,545 12,667 12,667 Current provisions 0 0 0 0 Other current liabilities 87 85 96 110 Current liabilities 30,173 32,146 28,811 28,768 Long-term debt 21,881 19,000 19,000 19,000 Non-current provisions 439 439 439 439 Other non-current liabilities 621 621 621 621 Total liabilities 53,114 52,206 48,871 48,828 Shareholders' equity 39,896 39,392 39,986 41,173 Minority interests 673 655 680 731 Total liabilities & equity 93,683 92,253 89,537 90,733 Cash Flow (Rmb mn) 12/15A 12/16E 12/17E 12/18E EBIT 514 584 1,864 2,806 Net interest 1,182 1,344 1,158 1,247 Tax paid 0 0 0 0 12MF P/B multiple Working capital (5,354) (1,010) (1,835) (1,527) Other cash & non-cash items (354) (204) (211) (401) Operating cash flow (4,012) 715 977 2,126 Capex (386) (300) (300) (300) Free cash flow to the firm (4,398) 415 677 1,826 Disposals of fixed assets 0 0 0 0 Acquisitions 0 0 0 0 Divestments 37 0 0 0 Associate investments 0 0 0 0 Other investment/(outflows) 3,419 430 61 (172) Investing cash flow 3,070 130 (239) (472) Equity raised 0 0 0 0 Dividends paid (378) 0 (105) (210) Net borrowings 0 0 0 0 Other financing cash flow (1,664) (2,446) (4,469) (1,530) Financing cash flow (2,042) (2,446) (4,574) (1,740) Source: Credit Suisse, Thomson Reuters Total cash flow (2,984) (1,601) (3,836) (86) Adjustments 0 0 0 0 Net change in cash (2,984) (1,601) (3,836) (86)
Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 28 14 December 2016
Construction machinery sales to recover with margin improvement Gradually recovering As the industry is gradually recovering, we expect Zoomlion’s construction machinery construction machinery sales to grow 10% YoY in 2H16 and a 13% CAGR for 2016-18. sales
Figure 53: Zoomlion construction machinery sales recovery Figure 54: Margin to gradually recover
50,000 60.0% 35.0%
45,000 30.0% 40.0% 40,000 25.0% 35,000 20.0% 20.0% 30,000 25,000 0.0% 15.0%
20,000 10.0% -20.0% 15,000 5.0% 10,000 -40.0% 0.0% 5,000 -5.0% - -60.0% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E Gross margin Net margin reported Construction machienry (Rmb mn) YoY (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Crane business to lead the industry We think within the crane segment, wheel crane will lead the growth thanks to its high correlation with infrastructure investment. Zoomlion’s wheel crane business started to recover in 3Q16 while the industry was still struggling. We think Zoomlion will continue to dominate the wheel crane market. According to our channel check, the utilisation ratio improved to >70% from 60% at its trough. Monthly operating hours registered nine consecutive double-digit YoY growth and the average monthly operating hours reached over 170 hours per month, which is at historical peak. We believe the good operational data indicates solid demand for wheel crane which will lead to new machinery sales in the coming months. As for tower crane, we believe large size tower crane will have better growth opportunity thanks to infrastructure projects, in-line with Zoomlion's strategic outlook. Sales of large size tower crane also recovered in 3Q. While unit sales may be down, revenue and margin are expected to be higher. Furthermore, due to the change in its sales team, Zoomlion has lost market share in small-medium size cranes in 2016. We expect it to regain the share next year which will further support crane sales.
China Construction Machinery Sector 29 14 December 2016
Figure 55: Zoomlion crane machinery sales Figure 56: Zoomlion concrete machinery sales
18,000 50.0% 25,000 120.0%
16,000 40.0% 100.0%
14,000 30.0% 20,000 80.0% 20.0% 12,000 60.0% 10.0% 15,000 10,000 40.0% 0.0% 8,000 20.0% -10.0% 10,000 6,000 0.0% -20.0% 4,000 -30.0% 5,000 -20.0% 2,000 -40.0% -40.0% - -50.0% - -60.0% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Crane (Rmb mn) YoY (RHS) Concrete machinery (Rmb mn) YoY (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Moderate recovery of concrete machinery Gradual recovery in We expect concrete machinery to deliver high single-digit growth in 2017, slightly slower concrete machinery than other types of machinery due to our conservative view on the property market. However, we expect the growth to accelerate to 10% in 2018 thanks to rising replacement demand. We think the recovery of concrete machinery YTD is weaker than that of excavator, which can be mainly attributed to: (1) its late cycle nature, (2) its relatively high correlation with property construction, and (3) slightly longer life span compared to excavator. Normal life span of concrete machinery is about 10 years compared to 7-8 years for excavator. However, we think any further decline in concrete machinery is unlikely and a mild recovery is on the way. According to our channel check, monthly operation hours registered seven consecutive months of YoY growth starting in May, and the trend is likely to continue. As we mentioned above, operating data is a good reflection of market activities and a leading indicator for potential sales. We estimate that Zoomlion's concrete machinery has registered its last sales decline in 3Q16 and we expect a high single-digit growth in 4Q16. We are confident that the growth momentum will continue as infrastructure investment can more than offset the weakening property market. Within infrastructure investment, construction of high speed rail, intercity line, and large scale projects also support demand for concrete machinery. In addition, according to the medium/long term railway network plan announced by the NDRC, there will be a steady shift in focus from developed areas to more rural and remote areas. The mobility of concrete machinery such as concrete mixer is relatively low and can only serve within a 30-kilometer radius. Given the relatively small fleet in rural areas, we expect demand on new concrete machinery from these areas to grow. According to our channel check, western and central China led the recent recovery of sales.
Room for margin expansion We expect gross margin to expand driven by higher contribution from new machinery sales and agricultural segment's margin improvement. In addition to gross margin expansion, we also expect the earnings of Zoomlion to improve significantly, thanks to lower operating cost and a reduction in one-off expense.
China Construction Machinery Sector 30 14 December 2016
Figure 57: Gross margin trend for key segment Figure 58: Gross margin and net margin trend
40.0% 35.0%
35.0% 30.0%
30.0% 25.0%
25.0% 20.0%
20.0% 15.0%
15.0% 10.0%
10.0% 5.0%
5.0% 0.0%
0.0% -5.0% 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Concrete Crane Construction machinery Gross margin Net margin reported
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Diminishing impact from ongoing destocking process Destocking Gross margin of construction machinery was largely dragged down by clearance of approaching late stage second-hand machines inventory. Second-hand machinery normally comes from defaulted receivables. Clearance of second-hand machinery generates almost zero margin as the main purpose is to collect cash. While we acknowledge that clearance of second-hand machinery is still ongoing, we think the destocking process is close to completion. The negative impact from the destocking process will reduce gradually. The size of second-hand machinery inventory is shrinking. For example, concrete machinery was one of the most oversold machinery with high second-hand machinery inventory. According to our estimates, the proportion of second hand concrete machinery accounted for ~20% sales in 1H16, down from its 35% peak in 1H15. In terms of overall construction machinery sales, we estimate that second-hand machinery only accounted for ~5% of total sales in 2016 YTD. We expect a sequential decline in this proportion going forward. Thus, as sales contribution from higher-margin new machinery rises, it will help raise the overall gross margin level. Figure 59: We estimate that the proportion of second-hand machinery accounts for ~20% in 1H16 compared to 35% in the peak back in 1H15
40%
35%
30%
25%
20%
15%
10%
5%
0% 1H14 2H14 1H15 2H15 1H16
Second hand machinery as % of total concrete sales Gross margin
Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 31 14 December 2016
Furthermore, as the market recovers, Zoomlion is likely to make more efforts to sell new machinery, which reduces the urgency to sell second-hand machinery. During the downturn, the priority of the company is to get rid of second-hand machinery as fast as possible to reduce inventory and increase cash collection. Looking forward, we think the company will strike a balance between clearance of second-hand machinery and sale of new machinery to provide steady margin growth. Meanwhile, Zoomlion also initiated its leasing business. By leasing, Zoomlion can convert second-hand machinery inventory into fixed asset which will generate stable cash inflow for the company without depressing the margin.
Agriculture product: margin improvement in long term Better product mix Gross margin of the agricultural segment came in at 15.8% in 2015, much lower than the company's overall gross margin. We expect gross margin of agriculture to improve on the back of (1) economies of scales, (2) penetration into high-end market, and (3) government support. The agricultural machinery industry is undergoing product upgrade and structural adjustment. Zoomlion, as the second largest wheat harvester producer, should maintain its leading position and gain more market share from small competitors who do not have sufficient R&D for technology upgrades. With less competition and higher technology barrier, we expect gross margin to further improve.
Profitability improvement with better cost control Zoomlion started its staff optimisation program since 2013. The number of employees has declined from its peak of 31,707 in 2013 to only 15,714 in 1H6. It let go ~4000 staff in 1H16 alone. As a result, overall expense was up in the short term due to staff severance payment, which is reflected in 1H16 results. However, the effectiveness of cost saving is evident in 3Q16 as SG&A cost declined by 10%. We think the cost reduction trend will continue in 2017.
Figure 60: SG&A YoY and as % of sales Figure 61: No. of employees
40% 35,000
30% 30,000 20% 25,000 10%
0% 20,000
-10% 15,000 -20% 10,000 -30% 5,000 -40%
-50% - 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 2009 2010 2011 2012 2013 2014 2015 1H16
SG&A YoY SG&A as % of sales No. of employee
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 32 14 December 2016
Ongoing balance sheet improvement Improving balance We expect Zoomlion to gradually reduce its credit risk by (1) shrinking credit exposure with sheet tightening sales term and higher down payment, (2) enhancing receivable collection and (3) rising impairment level to reduce downside risk.
Figure 62: Zoomlion's credit exposure remain Figure 63: We expect the impairment ratio to reach relatively high (Rmb mn) 9% in 2018
80,000 80,000 10.0% 9.0% 70,000 70,000
60,000 8.0% 60,000 50,000 7.0% 50,000 6.0% 40,000 40,000 5.0% 30,000 4.0% 20,000 30,000 3.0% 10,000 20,000 2.0% - 10,000 2011 2012 2013 2014 2015 1H16 1.0%
Trade receivables Bills receivables - 0.0% 2011 2012 2013 2014 2015 2016E 2017E 2018E Factored without recourse (off BS) Receivables under finance lease Group guarantee Guarantee tp 3rd party Net credit exposure Total impairment Impariment ratio
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
We agree that Zoomlion's total credit exposure remains high with total amount of Rmb56 bn, including both on/off balance sheet credit exposure. Nevertheless, we believe that the risk for receivables aged 1-2 years is under control. Zoomlion has tightened its credit policy since 2014 and most of its machinery is sold to existing good quality customers. Therefore, the default risk has declined significantly in the recent two years. The risky receivables are those over two years of duration and off-balance sheet items. We have seen that the high risk credit exposure is reducing. We think the situation will be gradually improved over the next few years. We think that the mix of credit exposure turned better as ~20% of accounts receivable came from new environmental business. We think this part of credit risk is relatively low as target customers are usually government related parties. The reduction of credit exposure from construction machinery has been partially offset by new business expansion. We believe the quality of accounts receivable is improving and we expect operating cash flow to strengthen in the next few years.
China Construction Machinery Sector 33 14 December 2016
Figure 64: Account receivables >2yrs accounts for only 21% of total receivables Figure 65: Declining high risk credit exposure
45,000 80% <1Y 1-2Y 2-3Y 3-5Y 40,000 70%
4% 35,000 60%
30,000 50% 25,000 17% 40% 20,000 30% 49% 15,000 20% 10,000
5,000 10% 30% - 0% 2011 2012 2013 2014 2015 1H16
High risky credit exposure (Rmb mn) As % of total (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Figure 66: OpCF will strengthen in the following years Figure 67: Gearing ratio
4,000 25,000 70.0% 60.0% 2,000 20,000 50.0% 15,000 - 40.0% 30.0% 10,000 (2,000) 20.0% 5,000 10.0% (4,000) - 0.0% (6,000) -10.0% (5,000) -20.0% (8,000) (10,000) -30.0% 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
(10,000)
2016E 2017E 2018E
2007 2008 2009 2010 2011 2012 2013 2014 2015 Net debt (Rmb mn ) Net debt to common equity
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 34 14 December 2016
Financials and valuation Attractive valuation Zoomlion currently trades at 0.65x 2017E P/B, 0.75 standard deviation below historical average. We think current valuation is attractive given its steady recovery and sequential balance sheet improvement. Our DCF-based TP of HK$4.75 implies 0.85x 2017E P/B. Figure 68: DCF valuation summary Key assumption DCF valuation Terminal growth 1.5% Present value of explicit years Rmb mn 28,093 Terminal EBIT margin 10.0% Terminal value Rmb mn 30,571 Terminal tax rate 25.0% Total company value Rmb mn 58,663 Target debt/capital 50.0% Net debt Rmb mn 23,883 Pre-tax cost of debt 6.0% Minority Rmb mn 680 Beta 1.50 Equity value Rmb mn 34,101 Risk-free rate 3.5% Number of shares mn 7,664 Equity risk premium 5.0% Fair value Rmb 4.45 Fair value HKD 4.75
Source: Company data, Credit Suisse estimates
Figure 68 shows that its historical P/B and ROE is highly correlated. The recovery of ROE (1.7%/3.4% in 2017/18E) justifies our valuation at 0.85x 2017E P/B. We think valuation should at least moderate back to 2014 average level, with more upside given our upward trend outlook. Figure 69: Zoomlion historical forward P/B
3.50
3.00
2.50
2.00
1.50
1.00
0.50
- Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16
[email protected] PB [email protected] +1 [email protected] -1 [email protected]
Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 35 14 December 2016
Figure 70: Historical P/B and ROE is highly correlated Figure 71: Forward P/B vs ROE trend
2.5 3.50 35%
3.00 30%
2.0 25% 2.50 20% 1.5 2.00 15% 1.50 1.0 10% 1.00
5% Historical Historical average P/B 0.5 0.50 0%
- -5% 0.0 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 -5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% [email protected] ROE (RHS) Historical ROE
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Risks Worse-than-expected decline in property investment Due to the relationship between Zoomlion's concrete and crane segments and property investment, a worse-than-expected fall in property investment will lead to a slowdown in property and in turn, a slowdown in concrete and crane demand.
Intensifying competition The rebound in investment might cause producers to over produce and thus create an oversupplied market which suppresses machinery ASP and company margin.
Credit risk While we believe receivables collection will improve going forward, worse-than-expected receivables collection could weigh down on the company's balance sheet. In addition, a portion of new business's contribution to account receivables could be lower than expected. Forex risk As Zoomlion has operations across the world, many being in developing countries, a change in currency could hurt Zoomlion's sales.
China Construction Machinery Sector 36 14 December 2016
Company background Changsha Zoomlion Heavy Industry Science & Technology Development Co., Ltd (Zoomlion) is a Chinese manufacturer which mainly engages in developing and manufacturing high-tech equipment in engineering, agricultural, and environmental sectors. Zoomlion has multiple industrial and technological parks across the world. In addition, with subsidiaries in more than 40 countries around the world, Zoomlion has comprehensive sales and services system with worldwide coverage.
Currently, Zoomlion has ~20% market share in crane and ~40% in concrete, making it one of the biggest players in the two sectors. Nevertheless, Zoomlion continues its efforts to diversify business through expansion in both environmental and agricultural segments. The company was founded in 1992, and became listed on both the Shenzhen and Hong Kong stock exchanges in 2000 and 2010, respectively. Management profile Dr. Zhan Chunxin, aged 61, is the chairman and CEO. Mr Zhan has been the company's chairman since 2001 and previously served as a director of the company since its establishment in 1999. Mr Zhan is a researcher-level senior engineer recognised by the Ministry of Construction. Mr. Shen Ku, aged 45, is the secretary of the board of directors and the company secretary. Mr. Shen is currently the head of the office of the secretary of the board of directors and the head of the investment and financing management division. He held the role of deputy head of the investment and financing management division from 2008-2010. Mr. Yin Zhengfu, aged 60, is the vice president of the construction machinery group and the general manager of the eastern China branch of Zoomlion, a director of both Hunan Teli Hydraulic Co., Ltd., and Chairman of the board of directors of Hunan Zoomlion Axle Co., Ltd. He previously held multiple roles in Hunan Puyuan Machinery Factory and Changsha Heavy Equipment Factor. Dr. Zhang Jianguo, aged 57, is vice present of the environmental industry group and general manager of the environmental industry company and the head of supervisor board of Hunan Teli Hydraulic Co., Ltd. Mr. Zhang is a senior engineer who has held the roles of deputy general manager, secretary to the Board of Directors, and executive president before he became a senior president in 2007. Shareholding structure
Figure 72: Shareholding structure
State-owned Assets Supervision and Administration Commission Public of Hunan Province People’s Government 16.35% 83.65%
Zoomlion Heavy Industry Science & Technology Development Co., Ltd. (000157.SZ/1157.HK)
Source: Company data, Credit Suisse
China Construction Machinery Sector 37 14 December 2016
Asia Pacific/China Construction & Farm Machinery
Lonking Holdings Limited (3339.HK / 3339 HK) Rating OUTPERFORM Price (12-Dec-16, HK$) 1.72 Target price (12-mth, HK$) 2.35 Upside/downside (%) 36.6
Mkt cap (HK$/US$ mn) 7,362 / 948.98 Quality player with solid growth outlook Enterprise value (Rmb mn) 9,112 Number of shares (mn) 4,280 ■ We initiate coverage on Lonking Group with an OUTPERFORM rating Free float (%) 44.2 and a TP of HK$2.35, implying 37% potential upside. Lonking announced 52-wk price range (HK$) 1.85-0.93 positive profit alert for 2016 in early December and expects substantial net ADTO-6M (US$ mn) 1.3 profit increase thanks to revenue growth, better cost control and FX gain. *Stock ratings are relative to the relevant country benchmark. We think the growth momentum is sustainable and expect net profit to ¹Target price is for 12 months.
deliver 45% CAGR in 2016-18E given positive outlook for loader, steady Research Analysts forklift business and continuous cost improvement on top of healthy balance
Amy Ji sheet. 852 2101 7735 [email protected] ■ Promising outlook for loader recovery. Being the market leader of the industry (~20% market share), Lonking garnered much of the benefit from Edmond Huang, CFA the recent sector rebound thanks to recent acceleration in mining activities 852 2101 6701 [email protected] and infrastructure investment. We believe loader growth will sustain going forward on the back of resilient infra investment and replacement demand. We forecast wheel loader to register 20% CAGR in 2016-18E with stable margin as we expect its core product, ZL50, to register solid growth. ■ Steady forklift outlook. We expect Lonking’s forklift segment to deliver solid growth on the back of rise in domestic logistic companies as well as a shift in demographics and occupational preference. While Lonking's forklift has pricing advantage over peers, its margin has improved noticeably from ~13% in 2013 to ~18% in 2016 thanks to better economies of scale. We believe with continuing economies of scale and pricing advantage, Lonking should experience solid growth with potential market expansion. ■ Strong balance sheet with solid management. Among the peers, we believe Lonking has the highest quality balance sheet thanks to (1) more disciplined credit sales during the golden period and (2) strong working capital management. Lonking is solely focused on its core products. We see this as a positive sign under the machinery recovery theme as opportunities are best captured by those who are ready. Our DCF-based TP of HK$2.35 implies 1.35x PB, in line with historical average. Risks to our TP: (1) slower- than-expected replacement cycle, (2) worse-than-expected industry growth. Share price performance Financial and valuation metrics
Year 12/15A 12/16E 12/17E 12/18E Revenue (Rmb mn) 4,829.3 4,852.9 5,698.7 6,714.9 EBITDA (Rmb mn) 585.0 665.0 854.4 1,036.0 EBIT (Rmb mn) 188.5 285.2 463.4 618.9 Net profit (Rmb mn) 116.6 283.2 435.5 597.4 EPS (CS adj.) (Rmb) 0.03 0.07 0.10 0.14 Change from previous EPS (%) n.a. - - - Consensus EPS (Rmb) n.a. 0.06 0.08 0.11 EPS growth (%) (72.0) 143.0 53.8 37.2 The price relative chart measures performance against the P/E (x) 56.2 23.1 15.0 11.0 MSCI CHINA F IDX which closed at 6,131.50 on 12/12/16. Dividend yield (%) 0.9 2.3 3.5 5.5 On 12/12/16 the spot exchange rate was HK$7.76/US$1 EV/EBITDA (x) 16.7 13.7 10.0 7.5
Performance 1M 3M 12M P/B (x) 0.99 0.97 0.94 0.91 Absolute (%) 14.7 38.7 38.7 ROE (%) 1.7 4.2 6.3 8.4 Relative (%) 14.8 43.0 35.6 Net debt/equity (%) 48.7 37.4 28.4 17.5
Source: Company data, Thomson Reuters, Credit Suisse estimates
China Construction Machinery Sector 38 14 December 2016
Lonking Holdings Limited (3339.HK / 3339 HK) Price (12 Dec 2016): HK$1.72; Rating: OUTPERFORM; Target Price: HK$2.35; Analyst: Amy Ji Earnings Drivers 12/15A 12/16E 12/17E 12/18E Per share 12/15A 12/16E 12/17E 12/18E - - - - Shares (wtd avg.) (mn) 4,280 4,280 4,280 4,280 - - - - EPS (Credit Suisse) 0.03 0.07 0.10 0.14 - - - - (Rmb)DPS (Rmb) 0.01 0.03 0.05 0.08 - - - - BVPS (Rmb) 1.55 1.58 1.63 1.68 - - - - Operating CFPS (Rmb) 0.40 0.39 0.40 0.43 Income Statement (Rmb mn) 12/15A 12/16E 12/17E 12/18E Valuation (x) 12/15A 12/16E 12/17E 12/18E Sales revenue 4,829 4,853 5,699 6,715 P/E 56.2 23.1 15.0 11.0 Cost of goods sold 3,730 3,732 4,369 5,142 P/B 0.99 0.97 0.94 0.91 SG & A 589 551 582 654 Dividend yield (%) 0.9 2.3 3.5 5.5 Other operating exp./(inc.) (75) (95) (106) (117) P/CF 3.8 3.9 3.8 3.6 EBITDA 585 665 854 1,036 EV/sales 2.0 1.9 1.5 1.2 Depreciation & amortisation 396 380 391 417 EV/EBITDA 16.7 13.7 10.0 7.5 EBIT 189 285 463 619 EV/EBIT 51.9 31.8 18.4 12.6 Net interest expense/(inc.) (24) (60) (68) (110) Earnings 12/15A 12/16E 12/17E 12/18E Non-operating inc./(exp.) 0 0 0 0 Growth (%) Associates/JV 0 0 0 0 Sales revenue (35.0) 0.5 17.4 17.8 Recurring PBT 212 346 531 729 EBIT (71.6) 51.3 62.5 33.5 Exceptionals/extraordinaries 0 0 0 0 Net profit (72.0) 143.0 53.8 37.2 Taxes 96 62 96 131 EPS (72.0) 143.0 53.8 37.2 Profit after tax 117 283 436 598 Margins (%) Other after tax income 0 0 0 0 EBITDA 12.1 13.7 15.0 15.4 Minority interests 0 0 0 0 EBIT 3.9 5.9 8.1 9.2 Preferred dividends 0 0 0 0 Pre-tax profit 4.4 7.1 9.3 10.9 Reported net profit 117 283 435 597 Net profit 2.4 5.8 7.6 8.9 Analyst adjustments 0 0 0 0 Net profit (Credit Suisse) 117 283 435 597 ROE analysis (%) 12/15A 12/16E 12/17E 12/18E ROE 1.7 4.2 6.3 8.4 Balance Sheet (Rmb mn) 12/15A 12/16E 12/17E 12/18E ROIC 1.0 2.4 4.2 5.8 Cash & cash equivalents 1,146 1,480 2,527 3,242 Asset turnover (x) 0.4 0.4 0.4 0.5 Current receivables 2,002 1,582 1,305 1,109 Interest burden (x) 1.1 1.2 1.1 1.2 Inventories 1,281 1,329 1,077 986 Tax burden (x) 0.5 0.8 0.8 0.8 Other current assets 2,222 2,927 3,453 3,381 Financial leverage (x) 1.9 1.9 2.0 2.0 Current assets 6,651 7,318 8,363 8,718 Credit ratios 12/15A 12/16E 12/17E 12/18E Property, plant & equip. 2,829 2,554 2,367 2,453 Investments 3 3 3 3 Net debt/equity (%) 48.7 37.4 28.4 17.5 Intangibles 0 1 2 3 Net debt/EBITDA (x) 5.51 3.80 2.32 1.22 Interest cover (x) n.a. n.a. n.a. n.a. Other non-current assets 3,032 2,833 2,950 3,071 Total assets 12,516 12,711 13,686 14,248 Accounts payable 684 1,125 1,317 1,550 12MF P/E multiple Short-term debt 292 2,000 2,000 2,000 Current provisions 62 47 29 8 Other current liabilities 659 659 756 872 Current liabilities 1,697 3,831 4,101 4,430 Long-term debt 4,078 2,005 2,505 2,505 Non-current provisions 5 4 3 1 Other non-current liabilities 111 111 111 111 Total liabilities 5,891 5,951 6,720 7,046 Shareholders' equity 6,621 6,756 6,961 7,196 Minority interests 3 3 3 3 Total liabilities & equity 12,516 12,710 13,684 14,245 Cash Flow (Rmb mn) 12/15A 12/16E 12/17E 12/18E EBIT 189 285 463 619 Net interest 0 0 0 0 Tax paid 0 0 0 0 12MF P/B multiple Working capital 946 890 771 687 Other cash & non-cash items 588 490 477 517 Operating cash flow 1,722 1,665 1,712 1,822 Capex (70) (100) (200) (500) Free cash flow to the firm 1,652 1,565 1,512 1,322 Disposals of fixed assets 0 0 0 0 Acquisitions 0 0 0 0 Divestments 112 0 0 0 Associate investments 0 0 0 0 Other investment/(outflows) (1,199) (605) (620) (124) Investing cash flow (1,157) (705) (820) (624) Equity raised 0 0 0 0 Dividends paid (220) (149) (231) (362) Net borrowings (211) (365) 500 0 Other financing cash flow (76) (112) (114) (121) Financing cash flow (508) (626) 155 (483) Source: Credit Suisse, Thomson Reuters Total cash flow 57 334 1,047 715 Adjustments 1 0 0 0 Net change in cash 58 334 1,047 715
Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 39 14 December 2016
Promising outlook for loader recovery Sustainable wheel Lonking is well positioned as the market leader in the loader sector with ~20% market loader recovery share. Lonking garnered much of the benefit from the recent sector rebound thanks to recent acceleration in mining activities and infrastructure investment. We believe loader growth will sustain going forward on the back of resilient infra investment and replacement demand. We expect loader to register 17% CAGR in 2017-2018E. The decline in loader sales has reduced significantly in recent months, even registering +19% YoY growth in Oct. According to channel check with loader dealers, the recovery in loader sales is mainly driven by (1) recent acceleration in mining activities, and (2) improvement in infrastructure demand. Inner Mongolia, Shanxi and Shaanxi led the rise in demand growth, evident from coal output activities trends shown in Figure 72. In addition, customers for wheel loaders are mostly previous customers who have experienced higher replacement need as activities picked up.
Figure 73: Coal inventory—Bohai Rim 6 ports Figure 74: Coal output—key mining regions
10 days output- key mining provinces (mnt Bohai rim 6 ports inventory (mnt) ) Others 35 25.0 Shanxi Shaanxi 30 Ningxia/Gansu 20.0 Erdos 25 15.0 20
15 10.0
10 5.0
5 0.0
0
10-Jul-16 20-Jul-15 30-Jul-16
20-Oct-15 20-Apr-15 20-Apr-16 20-Oct-16
10-Jan-15 20-Jun-15 20-Jan-16 20-Jun-16
20-Mar-16 20-Mar-15
10-Feb-15 20-Feb-16
20-Aug-15 20-Sep-15 20-Nov-15 20-Dec-15 20-Aug-16 10-Sep-16 30-Sep-16 10-Nov-16 30-Nov-16 20-Dec-16
20-May-15 10-May-16 30-May-16
Jul-15 Jul-16
Apr-15 Oct-15 Apr-16 Oct-16
Jan-15 Jun-15 Jan-16 Jun-16
Feb-15 Mar-15 Feb-16 Mar-16
Aug-15 Sep-15 Nov-15 Dec-15 Aug-16 Sep-16 Nov-16 Dec-16 May-16 May-15
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Looking forward, we believe the trend is likely to continue. We like loader for its favourable ending industries mix even though demand from property market is largely muted. We believe the improving market activities will trigger a replacement demand for loader. Furthermore, infrastructure and mining projects will increase demand for Z50, the key product of Lonking with relatively high margin.
China Construction Machinery Sector 40 14 December 2016
Figure 75: 50% of loader is for infrastructure use Figure 76: 50% of loader is for infrastructure use
250,000 60%
40% 200,000 Others 20% 20% 150,000 0%
100,000 -20% Infrastructure -40% Mining 50% 50,000 20% -60%
- -80%
2016E 2017E 2018E
2014 2008 2009 2010 2011 2012 2013 2015 Property 2007 10%
New demand Replacement demand YoY (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Steady forklift outlook Forklift to continue While wheel loader makes up 50+% of Lonking's revenue, its forklift segment has become solid growth an increasingly important part, accounting for 21% of total revenue in 2015. Looking into momentum 2017 and beyond, we think the forklift industry will continue to rise thanks to (1) rising demand from storage factory expansion/construction by logistic companies, and (2) China's continued industrialisation and urbanisation. In addition, the ongoing changes in China's demographic and occupational preferences also provide support for the industry. Although Lonking only has 8% market share in this industry, we believe forklift sector's continuing growth momentum with a forecast CAGR of 15% from 2016-18E will nevertheless benefit the company. With Lonking's pricing advantage over peers, we think the company can further benefit from economies of scale with possible market share gain. From our discussion with management, the rise of domestic express delivery companies provided a new source of demand thanks to their demand of storage facilities. As the growth of domestic express delivery market slowed down, delivery companies have shifted their attention to providing better service in an attempt to gain market share. As can be seen from Figure 75 below, prospectus across express delivery companies have listed sorting hub (centers to sort and ship parcels) upgrade/construction as the most heavily invested segment.
China Construction Machinery Sector 41 14 December 2016
Figure 77: Sorting hub capex
100% 90% 80% 550 4078 4524 1352 70% 60% 50% 40% 30% 800 5656 5033 1463 20% 10% 0% SF ZTO (USD mn) YTO STO
Sorting hub upgrade Others
Source: Company data Competitive pricing with margin improvement Economies of scale to We think given Lonking's competitive pricing among peers, it will be the first to benefit. increase margin From our discussion with management, Lonking's forklift, while similar in quality, relies on pricing competitiveness. Nevertheless, Lonking's forklift segment experienced gross margin expansion through the years, from 13% back in 2013 to 18% in 2016. We think the rise in margin can be mainly attributed to economies of scale it experienced as production passed the threshold. As a result, given the solid outlook for the industry going forward, we think Lonking can continue to benefit from economies of scale with rising margin. In addition, its competitive pricing can support the company for further market share gain. Figure 78: Gross margin gradually expands thanks to economies of scale Figure 79: Estimated ASP comparison
21.0% 63,000
19.0% 62,000
61,000 17.0% 60,000 15.0% 59,000 13.0% 58,000 11.0% 57,000 9.0% 56,000 7.0% 55,000 2015 5.0% 2013 2014 2015 2016E 2017E 2018E Lonking Heli
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 42 14 December 2016
Diesel forklifts continues to dominate domestic market Currently, ~80% of the domestic forklifts demand comes from internal-combustion (diesel) forklifts and only 20% comes from electric forklifts. We believe the demand landscape is beneficial to Lonking because diesel forklifts making up 95% of total production. We believe Lonking's dedication and brand recognition in the diesel forklift industry will respond well to the growing domestic market. Figure 80: Domestic forklift sales breakdown
100% 90% 18% 22% 19% 18% 22% 20% 18% 20% 24% 20% 80% 70% 60% 50% 40% 82% 78% 81% 82% 78% 80% 82% 80% 76% 80% 30% 20% 10% 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E
Diesel Electric
Source: Company data, Credit Suisse estimates,
China Construction Machinery Sector 43 14 December 2016
Strong balance sheet with solid management Good management We believe Lonking has the highest quality balance sheet among peers thanks to (1) more quality disciplined credit sales during the golden period, and (2) strong working capital management. We think its current impairment ratio of 24% is sufficient to cover its credit risk. Lonking has always been able to maintain strong OpCF and has successfully maintained an OpCF of over Rmb1 bn every year over the last four years while its peers experienced weakening cash flow and difficulties in receivable collection. We believe this trend will likely continue in the next few years thanks to its strong working capital management and disciplined credit exposure.
Figure 81: Total credit exposure is well under Figure 82: Disciplined credit sales with limited risky controlled credit exposure
1,600 40% 4,500
4,000 1,400 35%
3,500 1,200 30% 3,000 1,000 25% 2,500
2,000 800 20%
1,500 600 15%
1,000 400 10% 500 200 5% - 2011 2012 2013 2014 2015 1H16 - 0% Trade receivables Bill receivables 2011 2012 2013 2014 2015 Loan receivables Miscellaneous receivables High risky credit exposure (Rmb mn) As % of total (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Notes: High risky credit exposure includes overdue receivables and loan receivables
Figure 83: Lonking has more sufficient impairment ratio than its peers Figure 84: Strong OpCF to continue
30% 2,500
25% 2,000
20% 1,500 15%
1,000 10%
5% 500
0% - 2011 2012 2013 2014 2015 1H16 2011 2012 2013 2014 2015 2016E 2017E 2018E Sany Zoomlion Lonking Operating cash flow (Rmb mn)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 44 14 December 2016
Valuation Potential upside driven Lonking is currently trading at 0.94x 2017E P/B, ~0.5 standard deviation below its by promising business historical average. Lonking is trading at a premium over Zoomlion. We think the outlook premium over its peers is likely to sustain, justified by its strong balance sheet and solid and resilient earnings growth. Our DCF-based TP of HK$2.35 implies 1.35x 2017E P/B, justified by ROE improvement, high quality balance sheet and strong cash flow. Our earnings forecast for 2017-18E is ahead of consensus as we factor in sustainable growth momentum driven by replacement demand. Figure 85: DCF valuation summary Key assumption DCF valuation Terminal growth 1.5% Present value of explicit years Rmb mn 7,525 Terminal EBIT margin 10.0% Terminal value Rmb mn 3,888 Terminal tax rate 25.0% Total company value Rmb mn 11,414 Target debt/capital 25.0% Net debt Rmb mn 1,973 Pre-tax cost of debt 6.0% Minority Rmb mn 3 Beta 1.20 Equity value Rmb mn 9,438 Risk-free rate 3.5% Number of shares mn 4,280 Equity risk premium 5.0% Fair value Rmb 2.21 Fair value HKD 2.35
Source: Company data, Credit Suisse estimates
Figure 86: Lonking historical forward P/B Figure 87: Lonking historical forward P/E
4.50 70.00
4.00 60.00 3.50 50.00 3.00
2.50 40.00
2.00 30.00 1.50 20.00 1.00
0.50 10.00
- - Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
[email protected] PB [email protected] +1 [email protected] -1 [email protected] [email protected] PE [email protected] +1 [email protected] -1 [email protected]
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Risks Weaker-than-expected forklift growth: While the forklift industry has experienced robust in recent years, the slowdown in China's economy might put downward pressure on forklift growth.
Slower-than-expected receivables collection: Lonking's balance sheet has always been relatively solid compared to peers. However, a slowdown in receivables collection will nevertheless hurt the company's financial condition.
Weak commodity prices: A decline in commodity prices will lead to reduced mining activity. Given wheel loader's relation to mining activity, a fall in commodity prices will in turn lead to less demand for wheel loaders, putting more pressure on wheel loader sales.
China Construction Machinery Sector 45 14 December 2016
Company background Lonking Holdings Limited (Lonking) is one of the largest construction and logistic machinery manufacturers in China. Lonking manufactures wheel loaders, hydraulic excavators, road rollers, forklifts, motor graders and skit steer loaders with wheel loader (53% of total revenue in 2015) and forklift (21% of total revenue in 2015) making up the biggest components. In addition to machinery, Lonking also develops and produces core components, including gearboxes, torque converters, axle, hydraulic components, gear pipes and drive shaft. The company has 19 wholly owned subsidiaries and four production bases located in Fujian, Shanghai, Jiangxi and He'nan, respectively, covering over 3 million square meters.
Lonking was founded in 1993 and listed on the Hong Kong Stock Exchange in November 2005, becoming the first overseas listing in the Chinese construction machinery sector. Since its issuance of 1,037mn H shares at IPO, Lonking had two other major shares issuance, one in June 2009 for 1,070 mn shares and another in October 2010 for 2,140 mn shares. Currently, the company has a total of 4,280 mn shares outstanding with the Chairman and his wife, Mr. Li San Yim and Ms. Ngai Ngan Ying, jointly holding a combined 55.73%.
Management profile Mr. Li Sanyim, aged 65, is the Chairman of the Board and one of the founders of the company. He was appointed as a deputy of the 11th National People’s Congress, member of the Executive Committee of the All-China Federation of Industry and Commerce, vice-chairman of the Fujian Province Federation of Industry and Commerce.
Mr. Yin Kunlun, aged 48, is an Executive Director and the chief financial officer of the company. He previously worked as auditing director under China Petroleum Jilin Chemical Group, chief financial officer of BASF JCIC NPG Company Ltd and Putzmeister Machinery (Shanghai) Company Ltd. and chief financial officer of Mahle Technology (China) Holding Ltd.
Mr. Chen Chao, aged 41, is an Executive Director and currently the vice-president of the company in charge of supply chain management. Mr. Chao joined the Group in 1997 and previously served as a deputy chief of the product development department at Shanghai Longgong Machinery, manager of the research and development centre and deputy general manager of Shanghai Longgong Machinery.
Mr. Luo Jianru, aged 69, joined the company in 1998 and currently holds the role of vice president. Mr. Luo has held various senior positions including the deputy general manager of Fujian Longyan Construction Machinery, general manager of Longgong (Shanghai) Axle & Transmission Co., Limited and deputy general manager of the company. He has over 25 years of experience in corporate management and the infrastructure machinery industry.
China Construction Machinery Sector 46 14 December 2016
Shareholding structure
Figure 88: Shareholder structure and company structure
Li San Yim Ngai Ngan Ying
55% 45%
China Longgong Group Public Holdings Limited
30.65% 25.03% 44.32%
Lonking Holdings Limited (3339.HK)
Source: Company data, Credit Suisse
China Construction Machinery Sector 47 14 December 2016
Asia Pacific/China Construction & Farm Machinery
Sany Heavy Industry Co (600031.SS / 600031 CH) Rating OUTPERFORM [V] Price (12-Dec-16, Rmb) 6.38 Target price (12-mth, Rmb) 7.80 Upside/downside (%) 22.3
Mkt cap (Rmb/US$ mn) 48,557 / 7,033 Market share taker in excavator business Enterprise value (Rmb mn) 67,213 Number of shares (mn) 7,611 ■ We initiate coverage on Sany with an OUTPERFORM rating and TP of Free float (%) 42.7 Rmb 7.80, implying 22% upside. We like the company for its strong position 52-wk price range (Rmb) 6.89-4.63 ADTO-6M (US$ mn) 29.8 in excavator with further market share gain, and steady overseas outlook on *Stock ratings are relative to the relevant country benchmark. the back of more disciplined sales. We believe that its solid sales growth is ¹Target price is for 12 months. sustainable in the coming two to three years. [V] = Stock Considered Volatile (see Disclosure Appendix)
■ Sany is in the sweet spot as the market leader in excavator business. Research Analysts Sany has the highest excavator exposure with a market share of ~20%. Amy Ji 852 2101 7735 Sany’s market share has gradually expanded from 13% in 2009 to 20% in [email protected] 2016 thanks to quality improvement and good sales network. We expect its Edmond Huang, CFA excavator business to deliver a growth rate of 33% in 2017-18E, faster than 852 2101 6701 the industry thanks to further market share expansion on the back of good [email protected] product quality and strong sales and service team.
■ Overseas business on the right track but new business still at early stage. Overseas business now accounts for over 40% of Sany’s total sales. We believe Sany’s overseas business will continue to expand thanks to (1) well-established overseas sales and production network (2) favourable presence in US and (3) one belt one road program. On the other hand, Sany extends its business into prefabrication and defense sector. While we have witnessed that Sany made progress, we think it is still too early to quantify the earnings impact. We believe it will still take some time for Sany's defense equipment to have material earnings impact. ■ Valuation and risk. Our target price of Rmb7.80 is based on DCF valuation, implying 2.4x 2017E P/B, in line with historical average. Risks to our valuation: worse-than-expected property investment and rising competition. Share price performance Financial and valuation metrics
Year 12/15A 12/16E 12/17E 12/18E Revenue (Rmb mn) 23,245.7 22,001.1 25,771.0 31,051.2 EBITDA (Rmb mn) 3,566.9 3,674.7 4,619.4 6,046.4 EBIT (Rmb mn) 1,726.9 1,852.5 2,734.0 4,083.8 Net profit (Rmb mn) 19.4 378.7 1,241.8 2,366.0 EPS (CS adj.) (Rmb) 0.00 0.05 0.16 0.31 Change from previous EPS (%) n.a. - - - Consensus EPS (Rmb) n.a. 0.04 0.14 0.27 EPS growth (%) (94.6) 1850.5 227.9 90.5 The price relative chart measures performance against the P/E (x) 2501.0 128.2 39.1 20.5 Shanghai Shenzhen CSI300 index which closed at Dividend yield (%) 0.2 0.2 0.8 1.5 3,408.58 on 12/12/16. On 12/12/16 the spot exchange rate EV/EBITDA (x) 19.3 18.3 14.3 10.8 was Rmb6.9/US$1 P/B (x) 2.14 2.12 2.04 1.91
Performance 1M 3M 12M ROE (%) 0.1 1.7 5.3 9.6 Absolute (%) -2.1 16.0 -0.5 Net debt/equity (%) 85.2 77.8 71.5 63.5
Relative (%) -1.9 11.5 5.1 Source: Company data, Thomson Reuters, Credit Suisse estimates
China Construction Machinery Sector 48 14 December 2016
Sany Heavy Industry Co (600031.SS / 600031 CH) Price (12 Dec 2016): Rmb6.38; Rating: OUTPERFORM [V]; Target Price: Rmb7.80; Analyst: Amy Ji Earnings Drivers 12/15A 12/16E 12/17E 12/18E Per share 12/15A 12/16E 12/17E 12/18E Excavator sales growth -0.08 0.13 0.32 0.35 Shares (wtd avg.) (mn) 7,617 7,611 7,611 7,611 - - - - EPS (Credit Suisse) 0.00 0.05 0.16 0.31 - - - - (Rmb)DPS (Rmb) 0.01 0.01 0.05 0.09 - - - - BVPS (Rmb) 2.98 3.01 3.13 3.35 - - - - Operating CFPS (Rmb) 0.28 0.44 0.42 0.49 Income Statement (Rmb mn) 12/15A 12/16E 12/17E 12/18E Valuation (x) 12/15A 12/16E 12/17E 12/18E Sales revenue 23,246 22,001 25,771 31,051 P/E 2501.0 128.2 39.1 20.5 Cost of goods sold 17,577 16,326 18,912 22,491 P/B 2.14 2.12 2.04 1.91 SG & A 3,942 3,823 4,125 4,477 Dividend yield (%) 0.2 0.2 0.8 1.5 Other operating exp./(inc.) (1,840) (1,822) (1,885) (1,963) P/CF 22.7 14.4 15.4 13.0 EBITDA 3,567 3,675 4,619 6,046 EV/sales 3.0 3.1 2.6 2.1 Depreciation & amortisation 1,840 1,822 1,885 1,963 EV/EBITDA 19.3 18.3 14.3 10.8 EBIT 1,727 1,852 2,734 4,084 EV/EBIT 39.8 36.2 24.2 16.0 Net interest expense/(inc.) 852 819 752 724 Earnings 12/15A 12/16E 12/17E 12/18E Non-operating inc./(exp.) (327) (145) 5 5 Growth (%) Associates/JV 62 62 62 62 Sales revenue (23.0) (5.4) 17.1 20.5 Recurring PBT 610 950 2,049 3,427 EBIT (22.8) 7.3 47.6 49.4 Exceptionals/extraordinaries (491) (506) (593) (652) Net profit (94.6) 1849.0 227.9 90.5 Taxes (18) 67 218 416 EPS (94.6) 1850.5 227.9 90.5 Profit after tax 138 377 1,238 2,359 Margins (%) Other after tax income 0 0 0 0 EBITDA 15.3 16.7 17.9 19.5 Minority interests (0) (1) (4) (7) EBIT 7.4 8.4 10.6 13.2 Preferred dividends 0 0 0 0 Pre-tax profit 2.6 4.3 8.0 11.0 Reported net profit 139 379 1,242 2,366 Net profit 0.1 1.7 4.8 7.6 Analyst adjustments (119) 0 0 0 Net profit (Credit Suisse) 19 379 1,242 2,366 ROE analysis (%) 12/15A 12/16E 12/17E 12/18E ROE 0.1 1.7 5.3 9.6 Balance Sheet (Rmb mn) 12/15A 12/16E 12/17E 12/18E ROIC 4.1 4.0 5.8 8.4 Cash & cash equivalents 6,841 4,922 4,794 5,241 Asset turnover (x) 0.4 0.4 0.4 0.5 Current receivables 23,768 23,971 24,161 24,457 Interest burden (x) 0.4 0.5 0.7 0.8 Inventories 5,521 5,367 6,218 7,394 Tax burden (x) 1.2 0.8 0.9 0.9 Other current assets 1,199 831 868 919 Financial leverage (x) 2.6 2.4 2.4 2.3 Current assets 37,329 35,091 36,041 38,012 Credit ratios 12/15A 12/16E 12/17E 12/18E Property, plant & equip. 15,226 14,232 13,389 12,684 Investments 1,026 1,088 1,150 1,213 Net debt/equity (%) 85.2 77.8 71.5 63.5 Intangibles 4,436 4,570 4,689 4,794 Net debt/EBITDA (x) 5.65 5.06 3.83 2.77 Interest cover (x) 2.03 2.26 3.64 5.64 Other non-current assets 3,211 3,414 3,414 3,414 Total assets 61,228 58,396 58,684 60,117 Accounts payable 6,229 6,665 6,943 7,024 12MF P/E multiple Short-term debt 17,785 11,000 11,000 11,000 Current provisions 0 0 0 0 Other current liabilities 3,790 3,742 3,887 4,090 Current liabilities 27,804 21,407 21,830 22,114 Long-term debt 9,199 12,500 11,500 11,000 Non-current provisions 431 431 431 431 Other non-current liabilities 163 163 163 163 Total liabilities 37,597 34,501 33,924 33,708 Shareholders' equity 22,671 22,936 23,805 25,461 Minority interests 960 959 955 947 Total liabilities & equity 61,228 58,396 58,684 60,117 Cash Flow (Rmb mn) 12/15A 12/16E 12/17E 12/18E EBIT 1,727 1,852 2,734 4,084 Net interest 0 0 0 0 Tax paid 18 (67) (218) (416) 12MF P/B multiple Working capital (2,794) (303) (396) (715) Other cash & non-cash items 3,185 1,881 1,040 791 Operating cash flow 2,136 3,364 3,159 3,743 Capex (1,570) (962) (1,162) (1,362) Free cash flow to the firm 1,774 3,002 2,797 3,381 Disposals of fixed assets 385 0 0 0 Acquisitions 0 0 0 0 Divestments 0 0 0 0 Associate investments 0 0 0 0 Other investment/(outflows) 900 596 0 0 Investing cash flow (285) (366) (1,162) (1,362) Equity raised 0 0 0 0 Dividends paid (1,246) (1,433) (1,124) (1,434) Net borrowings 1,042 (3,484) (1,000) (500) Other financing cash flow 0 0 0 0 Financing cash flow (204) (4,917) (2,124) (1,934) Source: Credit Suisse, Thomson Reuters Total cash flow 1,647 (1,919) (128) 447 Adjustments 0 0 0 0 Net change in cash 1,647 (1,919) (128) 447
Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 49 14 December 2016
Excavator business to drive the growth Market share taker in To recap from the discussion on sector, we believe excavator will lead the recovery in the excavator segment construction machinery sector driven by (1) its early cycle nature, (2) wide application, and (3) approaching replacement cycle. We expect the industry to witness a 30% CAGR from 2016-18E. We believe given Sany's leading position, it will be a key beneficiary amid the rise in excavator market. We estimate Sany will deliver higher growth rate than the excavator industry with ~32% CAGR in 2016-18E driven by market share gain on the back of its brand recognition and strong sales and service team.
Figure 89: Market share breakdown Figure 90: Growth rate faster than industry
40%
30% Sany 19% 20%
Others 10% 40% 0%
-10% CAT 14% -20%
-30%
-40% Hitachi XGXM -50% 6% Doosan 7% 7% 2012 2013 2014 2015 2016E 2017E 2018E Komatsu 7% Market growth YoY Sany's excavator growth YoY
Source: Wind Source: Company data, Credit Suisse estimates
Figure 91: Excavator demand forecast Figure 92: Rising contribution from excavator
250,000 100% 14,000 45.0%
40.0% 80% 12,000 200,000 60% 35.0% 10,000 30.0% 150,000 40% 8,000 25.0% 20% 20.0% 100,000 0% 6,000 15.0% -20% 4,000 50,000 10.0% -40% 2,000 5.0%
- -60%
2016E 2017E 2018E
2007 2008 2009 2010 2011 2012 2013 2014 2015 - 0.0% 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E
Excavators sales(Rmb mn) As % of total sales (RHS) New demand Replacement demand YoY (RHS)
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
China Construction Machinery Sector 50 14 December 2016
Market share expansion Sany expanded its market share from 7% in 2012 to 19.5% in 9M16. We believe its market share expansion is sustainable and has further upside as its expansion is based on quality products and not on aggressive credit sales, which is more viable Quality products with over the long run. good brand recognition
Figure 93: Sany's market share continues to expand Figure 94: Market share comparison (2009 vs 2016)
25% 25%
20% 20%
15% 15%
10% 10%
5% 5%
0% 2009 2010 2011 2012 2013 2014 2015 2016YTD 0% Sany CAT XGXM Komatsu Doosan Sany CAT Komatsu 2009 2016YTD Doosan XGXM
Source: Wind Source: Wind
■ Strong brand recognition and quality improvement: Figure 93 shows the survey conducted by Construction Machinery Online which shows that Sany's brand recognition ranks No.1. According to our channel check, market feedback on the quality of Sany’s product is very positive as the quality gap between Sany and overseas brand narrows thanks to improvement in functionality and durability in Sany's machinery. We think this is the main reason behind its recent market share expansion whereas XCGM has mainly gained market share through aggressive credit sales. We believe the organic market share expansion of Sany is more sustainable in the long run and we think Sany has room for further market share gain. According to the user survey conducted by CCMA, users pay most attention to functionality, efficiency and energy saving capability of the machinery. We expect Sany, with strong brand recognition and quality products, to stand out and experience further market share expansion.
China Construction Machinery Sector 51 14 December 2016
Figure 95: Brand survey—Sany ranks No.1 Figure 96: End-user preference survey
Sany Efficienty Caterpillar
Komatsu Energy saving
Doosan Functionality Volvo
Kobelco Stablity Hitachi
Liugong Flexibility
Lovol Life span Hyundai
0 50000 100000 150000 200000 250000 300000 350000 400000 450000 0% 20% 40% 60% 80% 100%
Source: Construction Machinery Online Source: China Construction Machinery Association
■ Strong customer profile. Sany has always maintained good relations with large constructors, such as CRCC, CRG, and CCCC. According to our channel check, 30- 40% of concrete machinery is sold to large SOE construction companies. We like these high quality customers for their low credit risk and high volume demand. Furthermore, we think Sany's market share is highly secured as the barrier for new competitors is relatively high. Construction companies (CRCC, CRG and CCCC) have high exposure to Chinese infrastructure investment. Through 9M16, these constructors registered ~40% YoY new order growth thanks to rise in infrastructure investment and PPP program. We have seen acceleration in project execution and believe that momentum will continue. The acceleration in execution rate indicates a strong machinery demand. Sany is in the sweet spot to register higher sales being the key supplier for these constructors companies.
■ Good reputation in its after-sales service. We think it will support its business in two ways: (1) leveraging its after sales service to attract new customers. Timely after-sales service is highly valued by customers as many of them have tight project timelines (2) After-sales service alone can be a revenue contributor. In western construction firms, after sales service fee and parts replacement are two main sources of total revenue. The situation in China is different as end-users utilised local repair factory for parts replacement given their lower cost. However, as customer base transitions from individual customers to large construction firms, they are more likely to utilise Sany's direct after sales replacement service as they are more concerned about quality than price. Sany’s concrete machinery is a good demonstration for after-sales service. We estimate that over Rmb1 bn revenue is from selling parts each year and we believe the proportion of after service will rise as the after-service market becomes more regulated.
China Construction Machinery Sector 52 14 December 2016
Overseas expansion Strong overseas Sany’s overseas presence is also the strongest among peers. Currently with presence with well- manufacturing facilities in Brazil, business will continue to expand thanks to (1) its established sales overseas sales and production network in India, US, Germany, and Indonesia. Along with network sales network in more than 70 countries, Sany is in a good position to take advantage of international infrastructure increase, (2) China's continued one belt one road program. Figure 97: Milestone for overseas expansion Year Key progress 2006 Signed investment memorandum with the government of Maharashtra in India for construction of production facility in Pune First overseas industrial park commenced operation in Pune, India 2007 Signed investment memorandum with state of Georgia to construct R&D facility 2009 Signed investment agreement with Germany's North Rhine-Westphalia state for construction of R&D facility 2010 Signed Letter of Intent with Brazil's Saint Paul government to construct production facility 2012 Austrian company Palfinger AG and Sany formed two joint ventures: Sany Palfinger to produce and sell Palfinger products in China and Palfinger Sany to distribute Sany mobile cranes outside China Acquired 90% equity stake in German concrete pump company, Putzmeister 2013 Signed Frame Agreement with major shareholders of Palfinger to acquire 10% equity stake with cash and Palfinger to acquire 10% stake in Sany Heavy Industry Acquired an additional 10% equity stake in Putzmeister for a total 100% 2014 Formally completed equity transaction with Palfinger in May 2015 Intent to invest and construct in Phase One of Brazil's manufacture park construction 2016 Sany established strategic partnership with Cevital, the largest private firm in Algeria, to explore Algeria's construction machinery and prefabrication markets Source: Company data, Credit Suisse
Good exposure to U.S: US market seems poised to register solid demand going forward. With moderate job growth, a healthy real estate market, continued low interest rates, and US president-elect Donald Trump's aim for higher infrastructure investment, US is on its way to register moderate gains through 2017 and beyond, in our view. We believe Sany will be able to benefit from rising US demand thanks to its US local production team and technology support from Palfinger. To benefit from One Belt One Road: As mentioned above, Sany has always maintained good relationship with large Chinese constructors such as CRG, CRCC, and CCCC. The benefits from these relationships are not just limited to domestic sales. Under China's continued push for One Belt One Road, constructors rapidly expanded their overseas operations across the globe. Co-operating with these constructors, Sany also expanded its international footprint by setting up operations and selling products in various countries. Further expansion in Brazil: Furthermore, Brazil's recent plan to invest US$4.4 bn into roads, railways, ports and airports construction along with India's continuing infrastructure spending in order to create better investment environment is also beneficial to the company. According to Sany, the Indian market is one of the fastest growing markets even though the current size is still small. We see great potential from these developing countries and we believe they will be long-term growth drivers given their low current fleet and potential sizable infrastructure investment demand.
China Construction Machinery Sector 53 14 December 2016
Valuation ROE to gradually Sany is now trading at 2.1x 2017E P/B, below its historical average. We expect Sany to improve deliver solid revenue growth and earnings improvement in the next few years as the industry enters into replacement cycle. Our DCF-based target price of Rmb7.95 implies a 2.4x 2017E P/B, in line with historical average. We expect its ROE to gradually improve in the next few years.
Figure 98: DCF valuation summary Key assumption DCF valuation Terminal growth 1.5% Present value of explicit years Rmb mn 41,644 Terminal EBIT margin 10.0% Terminal value Rmb mn 40,790 Terminal tax rate 25.0% Total company value Rmb mn 82,434 Target debt/capital 50.0% Net debt Rmb mn 22,500 Pre-tax cost of debt 5.0% Minority Rmb mn 955 Beta 1.20 Equity value Rmb mn 58,979 Risk-free rate 3.0% Number of shares mn 7,611 Equity risk premium 5.0% Fair value Rmb 7.75
Source: Company data, Credit Suisse estimates
Figure 99: Sany historical forward P/B band Figure 100: P/B vs ROE
8.00 8.00 50%
45% 7.00 7.00 40% 6.00 6.00 35% 5.00 5.00 30%
4.00 4.00 25%
20% 3.00 3.00 15% 2.00 2.00 10% 1.00 1.00 5%
- - 0% Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18
[email protected] PB [email protected] +1 [email protected] -1 [email protected] [email protected] -1 [email protected]
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Risks Worse-than-expected decline in property investment: Due to the relationship between Sany's concrete and crane segment and property investment, a worse-than-expected fall in property investment will lead to a slowdown in property and in turn, a slowdown in concrete and crane demand. Intensifying competition: The rebound in investment might cause producers to over produce and thus create an oversupplied market which suppresses machinery ASP and company margin. Overseas expansion: As Sany's tries to establish its footprint overseas, political uncertainty and sluggish economic activity can hinder Sany's overseas expansion progress.
China Construction Machinery Sector 54 14 December 2016
Company background Sany Heavy Industry Co Ltd (Sany) was founded in 1994 as a subsidiary of Sany Group. Sany went public on the Shanghai Stock Exchange in 2003 and is one of the largest heavy equipment manufacturers in the world. Sany is mainly involved in the R&D, manufacturing and sales of engineering machinery. Sany is the No.1 domestic market leader in trailer mounted concrete pumps, concrete pumps, and full hydraulic compactors. It also has a substantial market share in products such as excavator, truck cranes, crawler cranes, pile driving machinery, and road construction machinery. As of 2015, concrete, excavator and hosting segments make up 45%/26%/17% of the company's total revenue in 2015. Currently, Sany has over 7,500 service engineers throughout the world with 169 sales centres and over 2,000 service stations around the world. In addition, Sany has built both R&D and manufacturing plants including in India, the US, Germany, Brazil. Sany received the License for Scientific Research and Production of Weapons and Equipment earlier this year, and is qualified to carry specified research and manufacturing of military equipment in China. Management profile Mr. Liang Wengen, aged 60, is the founder and current chairman of the board of Sany Heavy Industry and director of Sany Group. Prior to that, he served as chairman of Sany Group from 1991-1998 and held various positions in manufacturing related companies. He has over 33 years of experience in the construction machinery industry. Mr. Tang Xiuguo, aged 53, is currently the director of Sany Heavy Industry and director and chairman of Sany Group. He is responsible for Sany Group's operation and strategic planning. He is also one of the founders of the company and has over 29 years of experience in the machinery industry. Mr. Xiang Wenbo, aged 54, is the vice director and president of Sany Heavy Industry and director of Sany Group. He joined Sany in 1991 and has over 20 years of experience in the machinery industry. Shareholding structure Figure 101: Shareholding structure
Liang Wen Gen
56.42%
Sany Group Public
3.75% 46.17% 50.08%
Sany Heavy Industry Co. Ltd (600031.SS)
Source: Company data, Credit Suisse
China Construction Machinery Sector 55 14 December 2016
Asia Pacific/China Construction & Farm Machinery
Zoomlion Heavy Industry (000157.SZ) Rating NEUTRAL Price (12-Dec-16, Rmb) 4.49 Target price (12-mth, Rmb) 4.45 Upside/downside (%) -0.9
Mkt cap (Rmb/US$ mn) 32,787 / 4,749 Ongoing recovery Enterprise value (Rmb mn) 57,399 Number of shares (mn) 7,664 ■ We initiate coverage on Zoomlion (A) with a NEUTRAL rating and a TP Free float (%) 62.5 of Rmb4.45, implying -1% upside. We like Zoomlion as we believe that it will 52-wk price range (Rmb) 5.61-4.01 turn around in 2017 thanks to sector recovery. We expect steady growth ADTO-6M (US$ mn) 4.1 momentum in 2H16 to continue into 2017 driven by pickup in construction *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. machinery sales and margin expansion on the back of balance sheet Research Analysts improvement. New business is on the right track to deliver solid growth. Amy Ji ■ Positive earnings ahead with solid revenue growth and margin expansion. 852 2101 7735 [email protected] We forecast Zoomlion will deliver 14% revenue growth in 2017-18E backed by a Edmond Huang, CFA recovery in construction machinery industry and solid growth in its environmental 852 2101 6701 segment. For construction machinery, we expect sales to accelerate from the low [email protected] base driven by strong infrastructure investment demand and faster replacement
cycles. Margin will improve given (1) the destocking process is close to completion, (2) improving margin of the agricultural segment thanks to better product mix, and (3) better cost control on SG&A. ■ Ongoing balance sheet improvement. We expect Zoomlion to gradually reduce its credit risk by (1) shrinking credit exposure with tightening sales term and higher down payment, (2) strengthening receivables collection, and (3) rising impairment level to reduce downside risk. Furthermore, we expect the mix of credit exposure to turn better with 20% from new business. The reduction of credit exposure from construction machinery was partially offset by new business expansion. We believe the quality of AR is improving. ■ Valuation appears fair. Zoomlion currently trades at 0.85x 2017E P/B. We believe the current valuation is fair given its steady recovery and sequential balance sheet improvement. Our DCF-based TP of Rmb4.45 implies 0.85x 2017E P/B. The recovery of ROE (1.7%/3.4% in 2017/18E) also justifies our valuation given high correlation between historical P/B and ROE. Risks to our valuation include worse-than-expected property investment and higher- than-expected credit risk. Share price performance Financial and valuation metrics
Year 12/15A 12/16E 12/17E 12/18E Revenue (Rmb mn) 20,753.0 20,261.8 22,856.8 26,258.9 EBITDA (Rmb mn) 1,343.0 1,476.1 2,779.8 3,744.9 EBIT (Rmb mn) 514.0 584.4 1,864.5 2,805.9 Net profit (Rmb mn) 89.0 (503.9) 698.6 1,397.2 EPS (CS adj.) (Rmb) 0.01 (0.07) 0.09 0.18 Change from previous EPS (%) n.a. - - - Consensus EPS (Rmb) n.a. (0.01) 0.08 0.18 EPS growth (%) (84.9) n.m. n.m. 100.0 P/E (x) 386.7 (68.3) 49.3 24.6 The price relative chart measures performance against the Dividend yield (%) 3.3 0.0 0.3 0.6 Shanghai Shenzhen CSI300 index which closed at 3,408.58 on EV/EBITDA (x) 42.0 38.9 21.0 15.6 12/12/16. On 12/12/16 the spot exchange rate was P/B (x) 0.86 0.87 0.86 0.84 Rmb6.9/US$1 ROE (%) 0.2 (1.3) 1.8 3.4 Performance 1M 3M 12M Net debt/equity (%) 58.3 61.6 63.0 61.3 Absolute (%) -7.0 -0.2 -15.0 Source: Company data, Thomson Reuters, Credit Suisse estimates
Relative (%) -6.8 -4.8 -9.4
China Construction Machinery Sector 56 14 December 2016
Sany Heavy Industry – CS Analyst Forecasts through HOLT® Credit Suisse HOLT is not part of Equity Research. Figure below reflects CS Forecasts for Sales, Margins and Returns. Based on CS assumptions, HOLT calculates returns to revive to 7.0% by 2020, driven by 15.1% top line CAGR, coupled with 336bps margin expansion and improvement in asset efficiencies from 0.35x to 0.53x. The default fade window of 5 years is extended to 10 years to factor in the full revival cycle within the business and delay the long term mean reversion. Beyond the explicit forecast window, HOLT assumes the CFROI and discount rate fade to 6% over a long term period, while asset growth fades to 2.5% - incorporating the economic reality of competition which causes CFROI and growth rate to regress to mean. The above assumptions suggest a HOLT warranted value of CNY 7.84, or 23% upside to the current market price.
SANY HEAVY INDUSTRY CO LTD (600031) Current Price: CNY 6.38 Warranted Price: CNY 7.84 Valuation date: 13-Dec-16
Sales Growth (parallel % point change to forecasts) Dec 14A Dec 15A Dec 16E Dec 17E Dec 18E
CNY -2.0% -1.0% 0.0% 1.0% 2.0% Sales Growth, % -18.7 -23.0 -5.8 17.1 20.5 EBITDA Mgn, % 11.7 13.9 16.7 17.9 19.5 -2.0% -32% -20% -5% 12% 30% Asset Turns, x 0.47 0.4 0.3 0.4 0.5
-1.0% -21% -7% 9% 27% 47% CFROI®, % 3.2 1.3 2.3 3.6 5.4 Disc Rate, % 4.7 3.8 4.5 4.5 4.5 0.0% -9% 6% 23% 42% 64%
Asset Grth, % 4.5 0.7 -4.2 -0.5 0.7 to to forecasts) 1.0% 3% 18% 37% 58% 81% Value/Cost, x 1.9 1.4 1.4 1.3 1.3
Economic PE, x 57.4 105.3 61.0 36.8 23.9 2.0% 14% 31% 51% 73% 98%
EBITDA MarginEBITDA (parallel % point change Leverage, % 31.9 27.3 35.6 34.7 34.3
More than Sales Growth (%) More than 10% Within 10% 60 10% upside downside 50 40 30 CFROI & Discount Rate (in %) 20 10 25 0 -10 20 -20 -30 15 2011 2013 2015 2017 2019 2021 2023 2025
10 EBITDA Margin 25 5 20
0 15 2011 2013 2015 2017 2019 2021 2023 2025 Historical CFROI Historical Transaction CFROI Forecast CFROI Forecast CFROI 10
CFROI Discount Rate HOLT HOLT - Credit Analyst Data Suisse Scenario 5 Asset Growth (in %) 0 80 2011 2013 2015 2017 2019 2021 2023 2025 70 60 Asset Turns (x) 50 1.2 40 30 1.0 20 0.8 10 0 0.6 -10 0.4 2011 2013 2015 2017 2019 2021 2023 2025 0.2 Historical Asset Growth Rate Forecast Growth Forecast Growth RAGR Normalised Growth Rate 0.0 2011 2013 2015 2017 2019 2021 2023 2025
Source: Credit Suisse HOLT®. CFROI and HOLTare trademarks or registered trademarks of Credit Suisse Group AG or its affiliates in the United States and other countries.
China Construction Machinery Sector 57 14 December 2016
Lonking Holdings – CS Analyst Forecasts through HOLT® Figure below reflects CS Forecasts for Sales, Margins and Returns. Based on CS assumptions, HOLT calculates returns to revive to 5.6% by 2020, driven by 15.1% top line CAGR, coupled with 205bps margin expansion and improvement in asset efficiencies from 0.32x to 0.48x. The default fade window of 5 years is extended to 10 years to factor in the full revival cycle within the business and delay the long term mean reversion. Beyond the explicit forecast window, HOLT assumes the CFROI and discount rate fade to 6% over a long term period, while asset growth fades to 2.5% - incorporating the economic reality of competition which causes CFROI and growth rate to regress to mean. The above assumptions suggest a HOLT warranted value of CNY 2.19, or 43% upside to the current market price.
LONKING HOLDINGS LIMITED (3339) Current Price: CNY 1.53 Warranted Price: CNY 2.19 Valuation date: 13-Dec-16
Sales Growth (parallel % point change to forecasts) Dec 14A Dec 15A Dec 16E Dec 17E Dec 18E
CNY -2.0% -1.0% 0.0% 1.0% 2.0% Sales Growth, % -9.0 -35.0 0.5 17.4 17.8 EBITDA Mgn, % 14.9 11.0 13.7 15.0 15.4 -2.0% -23% -10% 4% 21% 39% Asset Turns, x 0.48 0.3 0.3 0.4 0.4
-1.0% -7% 7% 24% 42% 62% CFROI®, % 5.0 1.0 2.0 2.8 3.9
Disc Rate, % 7.2 7.0 6.6 6.6 6.6 0.0% 9% 25% 43% 63% 85%
Asset Grth, % 5.1 -1.5 -1.6 4.7 0.3 to to forecasts) 1.0% 26% 43% 62% 84% 109% Value/Cost, x 0.7 0.6 0.8 0.8 0.8
Economic PE, x 14.6 67.9 40.3 28.1 19.8 2.0% 42% 60% 82% 106% 132%
EBITDA MarginEBITDA (parallel % point change Leverage, % 46.4 44.0 43.8 46.7 46.7
More than Sales Growth (%) More than 10% Within 10% 30 10% upside downside 20 10 0 CFROI & Discount Rate (in %) -10 16 -20 14 -30 -40 12 -50 10 2011 2013 2015 2017 2019 2021 2023 2025 8 6 EBITDA Margin 20 4 18 2 16 14 0 12 2011 2013 2015 2017 2019 2021 2023 2025 Historical CFROI Historical Transaction CFROI 10 Forecast CFROI Forecast CFROI 8 CFROI Discount Rate
HOLT HOLT - Credit Analyst Data Suisse Scenario 6 4 Asset Growth (in %) 2 0 30 2011 2013 2015 2017 2019 2021 2023 2025 25 20 Asset Turns (x) 15 1.0 0.9 10 0.8 5 0.7 0 0.6 -5 0.5 0.4 -10 2011 2013 2015 2017 2019 2021 2023 2025 0.3 0.2 Historical Asset Growth Rate Forecast Growth 0.1 Forecast Growth RAGR Normalised Growth Rate 0.0 2011 2013 2015 2017 2019 2021 2023 2025
Source: Credit Suisse HOLT®. CFROI and HOLTare trademarks or registered trademarks of Credit Suisse Group AG or its affiliates in the United States and other countries .
China Construction Machinery Sector 58 14 December 2016
Zoomlion Heavy Industry – CS Analyst Forecasts through HOLT® Figure below reflects CS Forecasts for Sales, Margins and Returns. Based on CS assumptions, HOLT calculates returns to revive to 4.1% by 2020, driven by 14.2% top line CAGR, coupled with 789bps margin expansion and improvement in asset efficiencies from 0.25x to 0.39x. The default fade window of 5 years is extended to 10 years to factor in the full revival cycle within the business and delay the long term mean reversion. Beyond the explicit forecast window, HOLT assumes the CFROI and discount rate fade to 6% over a long term period, while asset growth fades to 2.5% - incorporating the economic reality of competition which causes CFROI and growth rate to regress to mean. The above assumptions suggest a HOLT warranted value of CNY 5.86, or 30% upside to the current market price.
ZOOMLION HEAVY INDUSTRY SCIENCE AND TECHNOLOGY CO Current Price: CNY 4.49 Warranted Price: CNY 5.86 Valuation date: 13-Dec-16
Sales Growth (parallel % point change to forecasts) Dec 14A Dec 15A Dec 16E Dec 17E Dec 18E
CNY -2.0% -1.0% 0.0% 1.0% 2.0% Sales Growth, % -32.9 -19.7 -2.4 12.8 14.9 EBITDA Mgn, % 8.5 9.2 7.3 12.2 14.3 -2.0% -34% -22% -9% 7% 25% Asset Turns, x 0.33 0.3 0.2 0.3 0.3
-1.0% -18% -4% 11% 28% 49% CFROI®, % 2.8 2.0 1.2 1.9 2.7 Disc Rate, % 5.1 4.6 5.3 5.3 5.3 0.0% -1% 13% 30% 50% 73%
Asset Grth, % 13.6 3.1 -1.4 -3.1 0.1 to to forecasts) 1.0% 15% 31% 50% 71% 96% Value/Cost, x 1.2 1.0 0.9 0.9 0.9
Economic PE, x 42.6 52.0 81.2 49.5 33.2 2.0% 31% 49% 69% 93% 120%
EBITDA MarginEBITDA (parallel % point change Leverage, % 42.7 37.8 50.2 48.3 48.4
More than Sales Growth (%) More than 10% Within 10% 50 10% upside downside 40 30 20 CFROI & Discount Rate (in %) 10 0 16 -10 14 -20 12 -30 -40 10 2011 2013 2015 2017 2019 2021 2023 2025 8 6 EBITDA Margin 25 4
2 20
0 15 2011 2013 2015 2017 2019 2021 2023 2025 Historical CFROI Historical Transaction CFROI Forecast CFROI Forecast CFROI 10
CFROI Discount Rate HOLT HOLT - Credit Analyst Data Suisse Scenario 5 Asset Growth (in %) 0 30 2011 2013 2015 2017 2019 2021 2023 2025 25 20 Asset Turns (x) 1.0 15 0.9 10 0.8 0.7 5 0.6 0 0.5 0.4 -5 2011 2013 2015 2017 2019 2021 2023 2025 0.3 0.2 Historical Asset Growth Rate Forecast Growth 0.1 Forecast Growth RAGR Normalised Growth Rate 0.0 2011 2013 2015 2017 2019 2021 2023 2025
Source: Credit Suisse HOLT®. CFROI and HOLTare trademarks or registered trademarks of Credit Suisse Group AG or its affiliates in the United States and other countries .
Please contact your HOLT representative for further details.
China Construction Machinery Sector 59 14 December 2016
Companies Mentioned (Price as of 12-Dec-2016) Caterpillar Inc. (CAT.N, $95.08) China Communications Construction Co Ltd (1800.HK, HK$8.88) China Railway Construction Corporation Limited (1186.HK, HK$10.22) China Railway Group Limited (0390.HK, HK$6.48) Komatsu (6301.T, ¥2,706) Lonking Holdings Limited (3339.HK, HK$1.72, OUTPERFORM, TP HK$2.35) Sany Heavy Industry Co (600031.SS, Rmb6.38, OUTPERFORM[V], TP Rmb7.8) XCMG Construction Machinery Co., Ltd (000425.SZ, Rmb3.62) Zoomlion Heavy Industry (1157.HK, HK$3.73, OUTPERFORM[V], TP HK$4.75) Zoomlion Heavy Industry (000157.SZ, Rmb4.49, NEUTRAL, TP Rmb4.45)
Disclosure Appendix Analyst Certification Amy Ji and Edmond Huang, CFA, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cove r multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 44% (64% banking clients) Neutral/Hold* 38% (59% banking clients) Underperform/Sell* 15% (54% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors. Important Global Disclosures Credit Suisse’s research reports are made available to clients through our proprietary research portal on CS PLUS. Credit Suisse research products may also be made available through third-party vendors or alternate electronic means as a convenience. Certain research products are only made available through CS PLUS. The services provided by Credit Suisse’s analysts to clients may depend on a specific client’s preferences regarding the frequency and manner of receiving communications, the client’s risk profile and investment, the size and scope of the overall client relationship with
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Target Price and Rating Valuation Methodology and Risks: (12 months) for Lonking Holdings Limited (3339.HK) Method: Our DCF (discounted cash flow)-backed price target of HK$2.35 for Lonking Holdings Limited is based on 1.5% terminal growth and 8.3% WACC (weighted average cost of capital). We assume 9.5% cost of equity and 4.5% after-tax cost of debt. Our price target implies 1.35x 2016E P/B (price-to-book). We give Lonking an OUTPERFORM rating for its solid outlook given resilient infrastructure investment and replacement cycle. Risk: Risks that could impede achievement of our HK$2.35 target price and OUTPERFORM rating for Lonking Holdings Limited include: (1) Weaker than expected forklift growth: While the forklift industry has experienced robust in recent years, the slowdown in China's economy might put downward pressure on forklift growth. (2) Slower than expected receivables collection: Lonking's balance sheet has always been relatively solid compared to peers. However, a slowdown in receivables collection will nevertheless hurt the company's financial condition. (3) Weak commodity prices: A decline in commodity prices will lead to reduced mining activity. Given wheel loader's relation to mining activity, a fall in commodity prices will in turn lead to less demand for wheel loaders, putting more pressure on wheel loader sales. Target Price and Rating Valuation Methodology and Risks: (12 months) for Sany Heavy Industry Co (600031.SS) Method: Our target price of Rmb7.80 for Sany Heavy Industry Co is based on a DCF (discounted cash flow) model which we believe can better capture the mid-term growth. We assume 9% cost of equity, 50% target leverage, 1.5% terminal growth and 10% terminal EBIT margin. Our target price implies 2.4x P2017 P/B. We have an OUTPERFORM rating on Sany thanks to its strong position in excavator with further market share gain. Risk: Risks to our Rmb7.80 target price and OUTPERFORM rating for Sany Heavy Industry Co include: 1) Worse than expected decline in property investment: Due to the relationship between Sany's concrete and crane segment and property investment, a worse than expected fall in property investment will lead to slowdown in property and in turn, slowdown in concrete and crane demand. 2) Intensifying competition: The rebound in investment might cause producers to over producer and thus creating an oversupplied market which suppress machinery ASP and company margin. 3) Overseas expansion: As Sany's tries to establish its footprint overseas, political uncertainty and sluggish economic activity can hinder Sany's overseas expansion progress. Target Price and Rating Valuation Methodology and Risks: (12 months) for Zoomlion Heavy Industry (1157.HK) Method: Our HK$4.75 target price for Zoomlion Heavy Industry (H) is based on DCF (discounted cash flow) model which we think can better capture the mid-term growth. We assume 11% cost of equity, 50% target leverage, 1.5% terminal growth and 10% terminal EBIT margin. The target price implies 0.85 2016E P/B. We have an OUTPERFORM rating on Zoomlion H share, given its recovery with reducing credit risk and better OpCF. We think the recovery of construction machinery is sustainable thanks to resilient infra demand and accelerating replacement cycle Risk: Risks to our HK$4.75 target price and OUTPERFORM rating for Zoomlion Heavy Industry (H) include 1) Worse-than-expected decline in property investment: Due to the relationship between Zoomlion's concrete and crane segment and property investment, a worse than expected fall in property investment will lead to slowdown in property and in turn, slowdown in concrete and crane demand. 2) Intensifying competition: The rebound in investment might cause producers to over producer and thus creating an oversupplied market which suppress machinery ASP and company margin. 3) Credit risk: While we believe receivables collection will improve going forward, worse than expected receivables collection could weight down on company's balance sheet. In addition, portion of new business's contribution to account receivable could be lower than expected. 4) FX risk: As Zoomlion has operations across the world, many being in developing countries, a change in currency could hurt Zoomlion's sales. Target Price and Rating Valuation Methodology and Risks: (12 months) for Zoomlion Heavy Industry (000157.SZ) Method: Our Rmb4.45 target price for Zoomlion Heavy Industry (A) is based on a DCF (discounted cash flow) model which we think can better capture the mid-term growth. We assume 11% cost of equity, 50% target leverage, 1.5% terminal growth and 10% terminal EBIT margin. The target price implies 0.85 2016E P/B (price-to-book). We have a NEUTRAL rating on Zoomlion A share given its recovery with reducing credit risk and better OpCF. we think the recovery of construction machinery is sustainable thanks to resilient infra demand and accelerating replacement cycle
China Construction Machinery Sector 61 14 December 2016
Risk: Risks to our Rmb4.45 target price and NEUTRAL rating for Zoomlion Heavy Industry (A) include 1)Worse-than-expected decline in property investment: Due to the relationship between Zoomlion's concrete and crane segment and property investment, a worse than expected fall in property investment will lead to slowdown in property and in turn, slowdown in concrete and crane demand. 2 )Intensifying competition: The rebound in investment might cause producers to over producer and thus creating an oversupplied market which suppress machinery ASP and company margin. 3) Credit risk: While we believe receivables collection will improve going forward, worse than expected receivables collection could weight down on company's balance sheet. In addition, portion of new business's contribution to account receivable could be lower than expected. 4) FX risk: As Zoomlion has operations across the world, many being in developing countries, a change in currency could hurt Zoomlion's sales
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China Construction Machinery Sector 62 14 December 2016
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China Construction Machinery Sector 63 14 December 2016
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