7 March 2017 Asia Pacific/China Equity Research Construction & Farm Machinery China Construction Machinery Sector Research Analysts SECTOR REVIEW Amy Ji 852 2101 7735 [email protected] Strength in excavator/crane continues with Edmond Huang, CFA 852 2101 6701 concrete machinery catching up [email protected] Figure 1: Excavator sales tripled in Feb; concrete machinery catching up 50,000 350.0% 2000 25% 45,000 300.0% 1800 20% 40,000 250.0% 1600 15% 35,000 1400 200.0% 10% 30,000 1200 150.0% 5% 25,000 1000 100.0% 0% 20,000 800 50.0% -5% 15,000 600 0.0% 10,000 400 -10% 5,000 -50.0% 200 -15% 0 -100.0% 0 -20% Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13 Jul-14 Jun-15 May-16 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Excavator sales volume YoY (RHS) Operating hours (trailing 12 months) YoY(RHS) Source: Company data, Credit Suisse estimates ■ Strong February excavator sales with sufficient new orders. Official excavator sales volumes tripled in February, led by small/large-sized excavators (+317%/+345% YoY), beating market expectations. January- February volumes grew 189% YoY. Sany’s market share further expanded to 25% from 22% last month. We estimate that major machinery makers have already secured sufficient orders to fulfil their production in March- April. For truck cranes, the production pipeline has already reached May. ■ Concrete machinery is catching up. We turn more positive on concrete machinery, and expect their sales to register 15-20% growth in 2017 on a low base, vs our previous estimate of high single-digit growth. We expect Sany's concrete machinery sales to rise 180% YoY in January-February. The resilient infrastructure spending and rising replacement cycle are sufficient to offset a softening property market, in our view. Moreover, environment regulation has become a key growth driver. About 50% of mixing plants are sold for relocation demand due to environment issues. National V emission standards (from 17 July) could also help machinery companies improve margins by ~1%, based on their new product launch. ■ Disciplined supply with healthy financing terms. Utilisation of production capacity of key machinery makers is approaching 100% compared to less than 50% during the downturn. We expect profitability for Zoomlion and Sany to improve, thanks to their high operating leverage. We observe no price competition, and all financing terms remain healthy or even tighter. We expect accounts receivables (AR) quality to improve with better operating cash flow (OpCF). ■ Maintain OVERWEIGHT on construction machinery. We raise our construction machinery sector forecasts by 10-20% in 2017E, factoring in better-than-expected sales growth and lower costs. Our top pick is Zoomlion (H), as we expect it to register a stronger-than-industry average rebound with better margins and a healthier balance sheet. We like Sany for its exposure to excavator sales and high sensitivity to a concrete machinery rebound. 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. 7 March 2017 Focus charts and table Figure 2: Excavator sales tripled in February Figure 3: Growth of truck cranes is catching up 50,000 350.0% 8,000 200% 45,000 300.0% 7,000 150% 40,000 250.0% 6,000 35,000 200.0% 100% 5,000 30,000 150.0% 25,000 4,000 50% 100.0% 20,000 3,000 50.0% 0% 15,000 2,000 10,000 0.0% -50% 1,000 5,000 -50.0% 0 -100.0% 0 -100% Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13 Jul-14 Jun-15 May-16 Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13 Jul-14 Jun-15 May-16 Excavator sales volume YoY (RHS) Truck crane sales YoY(RHS) Source: CCMA Source: CCMA Figure 5: Truck crane operating hours have reached Figure 4: Expect Jan-Feb loader sales to double a historical peak 45,000 250% 2000 25% 40,000 1800 20% 200% 35,000 1600 15% 150% 1400 30,000 10% 1200 25,000 100% 5% 1000 20,000 0% 50% 800 15,000 -5% 0% 600 10,000 400 -10% -50% 5,000 200 -15% 0 -100% 0 -20% Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13 Jul-14 Jun-15 May-16 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Loader sales YoY(RHS) Operating hours (trailing 12 months) YoY(RHS) Source: CCMA Source: Company data, Credit Suisse estimates Figure 6: Valuation comparison—as of 6 March Market EPS Ticker Rating Target priceClose price Cap P/E (x) P/B(x) ROE (%) EV/EBITA Dividend Yield CAGR (local) (US$ bn) 2017E 2018E 2017E 2018E 2017E 2018E 2017E 2018E 2017E 2018E 2017-18 Zoomlion -H 1157.HK O 5.10 4.06 5.1 34.4x 17.5x 0.7x 0.7x 2.0% 3.9% 21.2x 15.6x 0.4% 0.9% n/a Lonking 3339.HK O 2.60 2.17 1.2 17.1x 13.2x 1.2x 1.1x 7.0% 8.8% 12.1x 10.0x 3.1% 4.6% 41% Sany 600031.SS O 9.00 7.29 8.1 38.0x 21.0x 2.3x 2.2x 6.2% 10.6% 15.1x 11.4x 0.8% 1.4% 197% Zoomlion -A 000157.SZ N 4.65 4.82 5.1 45.9x 23.4x 0.9x 0.9x 2.0% 3.9% 21.2x 15.6x 0.3% 0.6% n/a Source: Company data, Credit Suisse estimates, The BLOOMBERG PROFESSIONAL™ service China Construction Machinery Sector 2 7 March 2017 Strong February excavator sales China Construction Machinery Associate (CCMA) announced official excavator sales volume data: up 298% YoY in February. Monthly sales volume reached 14,540 units in February, 50,000 back to the same level350.0% as in 2012. January-February sales volume grew 189% YoY. 45,000 300.0% By product type, small-sized excavators (0-13 tonne) and large-sized excavators (>30 40,000 tonne) continued to250.0% show strong growth momentum, +317% and +345% YoY in 35,000 February, respectively200.0%. Mid-sized excavators also caught up with +252% YoY. The 30,000 trend was similar to 2H16's and we believe the growth reflects (1) resilient 150.0% 25,000 infrastructure demand, especially driven by municipal PPP projects (mainly using 100.0% 20,000 small-sizes excavators), and (2) continuous active mining activities. Rural 50.0% 15,000 development has also become a key driver for small-sized excavator sales. 10,000 As expected, Sany continue0.0% d to exceed industry average and registered 369% YoY 5,000 growth, with its market-50.0% share expanding from 22% in January to 25% in February. We 0 believe Sany will continue-100.0% to gradually gain market share on the back of its high Jan-09 Dec-09 Nov-10 Oct-11 Sep-12 Aug-13qualityJul-14 productJun-15 May-16s and strong sales and service teams. Excavator sales volume YoY (RHS) Figure 7: Excavator sales tripled in February Figure 8: Sany further expanded market share 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2012-12 2013-06 2013-12 2014-06 2014-12 2015-06 2015-12 2016-06 2016-12 Sany CAT XCMG Komatsu Liugong Source: CCMA Source: CCMA, Credit Suisse estimates Strong sales led to low inventory levels with sufficient new orders Machinery makers now have relatively low inventory levels due to stronger-than-expected machinery demand, especially for new machinery. Based on feedback from dealers, several types of machinery are even in shortage. One of the major machinery makers currently holds only a half month's shipments compared to its normal level of two months. On the other hand, new orders remain strong. Currently, major machinery makers have already secured sufficient orders to fulfil their production in March-April. For truck cranes, the production pipeline has already reached May. Concrete machinery is catching up Based on our recent channel checks, we turn more positive on concrete machinery and expect concrete machinery to register 15-20% growth in 2017 on a low base, vs our previous estimate of high single-digit growth. We observe that concrete machinery sales are largely muted due to a weakening property market, and we attribute the growth to (1) infrastructure demand, (2) replacement demand, and (3) environment regulations. We China Construction Machinery Sector 3 7 March 2017 estimate Sany’s concrete machinery sales to register ~180% YoY growth in January- February. We expect the trend to continue, as there are sufficient orders that are able to cover production until April/May. Infrastructure investment and replacement to offset the weak property market We reiterate our view that infrastructure investment and replacement demand should be able to offset the weakening property market. We estimate that the impact from the property market on concrete machinery is declining while infrastructure investment now accounts for ~50% of the demand. Pump truck sales almost tripled in February and we attribute the growth to infrastructure demand and replacement cycle.