September 2, 2016 ACTION Removed from Asia Pacific Conviction Buy List Lonking Holdings (3339.HK) Equity Research Off CL on faster loader-excavator substitution; maintain Buy What happened Investment Profile We remove Lonking from the Conviction List as we see faster-than-expected Low High loader-to-excavator substitution driving a slower recovery of loaders (53% of Growth Growth Returns * Returns * 2015 revenue) vs. excavators (11% 2015 revenue). However, we stay Buy- Multiple Multiple rated as we still expect robust infrastructure construction activities and cost Volatility Volatility control to drive top/bottom line growth and effective cash flow management Percentile 20th 40th 60th 80th 100th /sufficient provisions to provide strong earnings protection against further Lonking Holdings (3339.HK) impairment. Since adding Lonking to the CL on Apr 7, 2016, the stock is -7%, Asia Pacific Industrials Peer Group Average * Returns = Return on Capital For a complete description of the investment vs. the HSCEI Index up 11%; we attribute the underperformance to limited profile measures please refer to the liquidity / concern over the sustainability of construction machinery demand. disclosure section of this document. Key data Current Current view Price (HK$) 1.25 1) We remain positive on construction machinery thanks to improving 12 month price target (HK$) 1.50 Market cap (HK$ mn / US$ mn) 5,350.1 / 689.7 activity and faster replacement. However, we believe accelerating loader-to- Foreign ownership (%) -- excavator substitution is hampering the loader recovery (Jan-Jul 2016 sales 12/15 12/16E 12/17E 12/18E -16%) as buyers switch from cheaper loaders to pricier but more efficient EPS (Rmb) New 0.03 0.05 0.07 0.08 excavators (Jan-Jul sales +6%) given the improving business outlook. While EPS revision (%) 0.0 (22.2) (20.5) (12.4) EPS growth (%) (72.0) 72.4 39.6 16.4 we maintain our excavator forecasts, we expect a slower recovery for EPS (dil) (Rmb) New 0.03 0.05 0.07 0.08 P/E (X) 42.2 22.9 16.4 14.1 loaders and cut 2016/17/18E loader yoy sales growth to -11%/ +5%/+8%. P/B (X) 0.7 0.7 0.7 0.7 Thus we trim Lonking’s loader 2015-18E sales CAGR from +7% to +4%. EV/EBITDA (X) 17.2 12.9 9.2 7.8 Dividend yield (%) 1.2 2.3 3.2 3.7 ROE (%) 1.7 3.0 4.1 4.7 2) In our Construction Machinery coverage, we continue to favor Lonking for CROCI (%) 4.6 7.3 8.3 8.8 its strong cost and cash flow control, giving it the best operating leverage to revenue growth and a clean balance sheet with limited credit risk exposure Price performance chart 1.5 13,500 (effective provision rate of 21% vs. Liugong/Zoomlion of 6.9%/ 5.2%). Buy. 1.4 12,500 Valuation: After factoring in updated loader sales forecasts, we cut Lonking 1.3 11,500 2016-18E EPS by 22%/21%/12.4%. We cut our 2017E EV/GCI vs. CROCI/WACC 1.2 10,500 based 12m target price to 1.50HKD from 1.80HKD (cash return multiple/EV/ 1.1 9,500 GCI premium applied unchanged at 0.90x/10%). 1.0 8,500 0.9 7,500 Risks: 1) Lower-than-expected China infrastructure/property FAI growth; 2) Sep-15 Dec-15 Mar-16 Jun-16 worse-than-expected loader sales; and 3) weaker-than-expected cost control. Lonking Holdings (L) Hang Seng China Ent. Index (R) INVESTMENT LIST MEMBERSHIP Share price performance (%) 3 month 6 month 12 month Absolute 8.7 17.9 22.5 Asia Pacific Buy List Rel. to Hang Seng China Ent. Index (1.7) 1.9 17.7 Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 9/02/2016 close. Coverage View: Neutral Tian Lu, CFA +852-2978-0748 [email protected] Goldman Sachs (Asia) L.L.C. Goldman Sachs does and seeks to do business with companies Jacqueline Du covered in its research reports. As a result, investors should be +86(10)6627-3147 [email protected] Beijing Gao Hua Securities Company Limited aware that the firm may have a conflict of interest that could Frank Shi affect the objectivity of this report. Investors should consider +852-2978-0108 [email protected] Goldman Sachs (Asia) L.L.C. this report as only a single factor in making their investment Diana Zhao +65-6654-5191 [email protected] Goldman Sachs (Singapore) Pte decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non- US affiliates are not registered/qualified as research analysts with FINRA in the U.S. The Goldman Sachs Group, Inc. Global Investment Research September 2, 2016 Lonking Holdings (3339.HK) Lonking Holdings: Summary Financials Profit model (Rmb mn) 12/15 12/16E 12/17E 12/18E Balance sheet (Rmb mn) 12/15 12/16E 12/17E 12/18E Total revenue 4,829.3 4,573.5 5,166.1 5,698.8 Cash & equivalents 1,146.3 1,988.1 2,451.9 2,744.8 Cost of goods sold (3,730.5) (3,548.8) (3,944.6) (4,327.8) Accounts receivable 2,693.7 2,443.4 2,618.5 2,888.4 SG&A (477.8) (413.7) (480.4) (560.8) Inventory 1,280.9 1,118.1 1,188.8 1,304.3 R&D (300.0) (300.0) (300.0) (300.0) Other current assets 1,529.8 1,529.8 1,529.8 1,529.8 Other operating profit/(expense) (250.6) (184.8) (154.3) (141.7) Total current assets 6,650.7 7,079.4 7,788.9 8,467.3 EBITDA 474.1 541.8 711.9 801.2 Net PP&E 2,829.3 2,503.7 2,158.7 1,795.9 Depreciation & amortization (403.6) (415.6) (425.1) (432.8) Net intangibles 0.0 0.0 0.0 0.0 EBIT 70.5 126.1 286.9 368.4 Total investments 210.5 210.5 210.5 210.5 Interest income 140.0 135.1 175.4 159.4 Other long-term assets 2,825.0 2,825.0 2,825.0 2,825.0 Interest expense (116.1) (109.1) (113.5) (117.9) Total assets 12,515.6 12,618.7 12,983.2 13,298.8 Income/(loss) from uncons. subs. (0.7) 0.0 0.0 0.0 Others 118.8 95.0 25.1 25.1 Accounts payable 1,252.1 1,215.3 1,404.9 1,541.4 Pretax profits 212.5 247.1 373.9 435.0 Short-term debt 292.2 292.2 292.2 292.2 Income tax (95.9) (46.1) (93.5) (108.8) Other current liabilities 152.8 197.0 238.8 262.9 Minorities (0.1) (0.1) 0.0 0.0 Total current liabilities 1,697.1 1,704.6 1,935.9 2,096.5 Long-term debt 4,073.1 4,073.1 4,073.1 4,073.1 Net income pre-preferred dividends 116.5 200.9 280.4 326.3 Other long-term liabilities 121.3 121.3 121.3 121.3 Preferred dividends 0.0 0.0 0.0 0.0 Total long-term liabilities 4,194.4 4,194.4 4,194.4 4,194.4 Net income (pre-exceptionals) 116.5 200.9 280.4 326.3 Total liabilities 5,891.5 5,899.0 6,130.3 6,290.9 Post-tax exceptionals 0.0 0.0 0.0 0.0 Net income 116.5 200.9 280.4 326.3 Preferred shares 0.0 0.0 0.0 0.0 Total common equity 6,621.3 6,716.8 6,850.0 7,005.0 EPS (basic, pre-except) (Rmb) 0.03 0.05 0.07 0.08 Minority interest 2.8 2.9 2.9 2.9 EPS (basic, post-except) (Rmb) 0.03 0.05 0.07 0.08 EPS (diluted, post-except) (Rmb) 0.03 0.05 0.07 0.08 Total liabilities & equity 12,515.6 12,618.7 12,983.2 13,298.8 DPS (Rmb) 0.010.020.030.04 Dividend payout ratio (%) 52.5 52.5 52.5 52.5 BVPS (Rmb) 1.55 1.57 1.60 1.64 Free cash flow yield (%) 32.9 19.6 12.3 9.5 Growth & margins (%) 12/15 12/16E 12/17E 12/18E Ratios 12/15 12/16E 12/17E 12/18E Sales growth (35.0) (5.3) 13.0 10.3 CROCI (%) 4.6 7.3 8.3 8.8 EBITDA growth (55.1) 14.3 31.4 12.5 ROE (%) 1.7 3.0 4.1 4.7 EBIT growth (89.4) 78.9 127.4 28.4 ROA (%) 0.9 1.6 2.2 2.5 Net income growth (72.0) 72.4 39.6 16.4 ROACE (%) 1.0 1.9 2.6 3.4 EPS growth (72.0) 72.4 39.6 16.4 Inventory days 150.5 123.4 106.7 105.1 Gross margin 22.8 22.4 23.6 24.1 Receivables days 242.1 205.0 178.8 176.4 EBITDA margin 9.8 11.8 13.8 14.1 Payable days 133.1 126.9 121.2 124.2 EBIT margin 1.5 2.8 5.6 6.5 Net debt/equity (%) 48.6 35.4 27.9 23.1 Interest cover - EBIT (X) NM NM NM NM Cash flow statement (Rmb mn) 12/15 12/16E 12/17E 12/18E Valuation 12/15 12/16E 12/17E 12/18E Net income pre-preferred dividends 116.5 200.9 280.4 326.3 D&A add-back 403.6 415.6 425.1 432.8 P/E (analyst) (X) 42.2 22.9 16.4 14.1 Minorities interests add-back 0.1 0.1 0.0 0.0 P/B (X) 0.7 0.7 0.7 0.7 Net (inc)/dec working capital 1,319.0 376.3 (56.2) (249.0) EV/EBITDA (X) 17.2 12.9 9.2 7.8 Other operating cash flow (117.2) 0.0 0.0 0.0 EV/GCI (X) 0.9 0.8 0.7 0.7 Cash flow from operations 1,722.0 992.9 649.3 510.1 Dividend yield (%) 1.2 2.3 3.2 3.7 Capital expenditures (100.0) (90.0) (80.0) (70.0) Acquisitions 0.0 0.0 0.0 0.0 Divestitures 0.0 0.0 0.0 0.0 Others (1,057.0) 0.0 0.0 0.0 Cash flow from investments (1,157.0) (90.0) (80.0) (70.0) Dividends paid (common & pref) (220.3) (61.2) (105.5) (147.2) Inc/(dec) in debt 0.0 0.0 0.0 0.0 Common stock issuance (repurchase) 0.0 0.0 0.0 0.0 Other financing cash flows (286.8) 0.0 0.0 0.0 Cash flow from financing (507.1) (61.2) (105.5) (147.2) Total cash flow 57.9 841.7 463.8 292.9 Note: Last actual year may include reported and estimated data.