Equity Research | Construction Machinery Oct 17, 2017 Lonking (3339 HK) Buy (initiation) Beneficiary of the upcycle in China’s construction machinery industry; Target price: HK$4.30 initiate at Buy Initiate at Buy with TP of HK$4.30 We like Lonking for three main reasons: 1) it stands to benefit from the current upcycle in China’s construction machinery sector; 2) product price Dominic Chan, CFA, FRM increases should spur further business momentum; 3) market share gains demonstrate its SFC CE No. APP609 competiveness. We forecast net profit will rise 81% and 24% respectively in 2017/18, and [email protected] that net profit will see a CAGR of 37% during 2016-19. We initiate our coverage with a Buy +852 3719 1218 rating and target price of HK$4.30, based on 15x 2018E P/E and 2.0x 2018E P/B, its historical averages since 2006, and a 10% discount to the average 2018E P/E of its international peers. GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers Upcycle in China’s construction machinery industry Construction machinery sales 189 Des Voeux Road Central volume in China has been on the rise since 2H16. In 9M17, loader sales volume came in at Hong Kong 67,786 units, up 48% YoY, while excavator sales volume was 101,934units, up a substantial 100% YoY. This strong sales volume has been driven by steady FAI in China’s infrastructure, property and mining sectors, and replacements of machines sold during 2010-2012, after 6-8 years’ use. Meanwhile, the high utilization rate for machines currently being used shows that downstream demand remains robust. The previous upcycle for loaders and excavators lasted for eight years (2004-11), and was followed by a downcycle lasting 4.5 years (2012-1H16). We believe China’s construction machinery industry is now in a period of recovery, and expect the upward trend to last until at least 2020. Product price increases will help strengthen profitability Some loader manufacturers, including Liugong Machinery (000528 CH) and Shantui Construction Machinery (000680 CH), increased their prices on Oct 1. Although Lonking has not officially made a similar announcement, we expect it to follow suit, given strong demand. Lonking is also not ruling out a price hike for its excavators, given solid demand in 9M17. We believe an increase in ASP would help to pass on cost pressure to clients. More importantly, this shows that demand for loaders is solid, and that an increase in volume and product prices would help to strengthen profitability. Ongoing increase in competitiveness The company has seen an ongoing rise in its market shares for its two main products, loaders and excavators. Its share of the loader market increased from 13.7% in 2012 to 24.4% in 1H17, making it the biggest loader manufacturer in China. Its excavator market share is small, but has expanded form 1.9% in 2012 to 2.7% in 1H17. Stock performance New forklift production facility to support volume growth Continued development in China’s logistics industry has spurred demand for forklifts. The company’s forklift production 4 30000 capacity is now operating at full capacity, and the company is building a new forklift facility 25000 3 20000 with capacity of 15,000 units per year (58% of current capacity) in Yixing, and targets to begin 2 15000 operation by the end of 2017. 10000 1 5000 Targeting 20% YoY revenue growth in its overseas business in the next few years The 0 0 company’s proportion of sales from overseas markets is small, accounting for just 7.4% of total revenue in 1H17. But with demand related to the One Belt One Road initiative, management aims to achieve 20% YoY revenue growth in its overseas business in the next 3969 HK HS Index (RHS) few years. Source: Bloomberg Key risks: 1) Reliance on the Chinese economy; 2) Slowdown in China’s FAI; 3) Weaker- than-expected replacement demand; 4) Greater-than-expected cost pressure. Key data Stock valuation Oct 13 close (HK$) 3.55 Shares in issue (m) 4280 Revenue YoY Net profit YoY EPS EPS P/E BPS P/B DPS Dividend ROE (Rmb m) (%) (Rmb m) (%) (Rmb) YoY (Rmb) (Rmb) yield (%) (%) Major shareholder Li San Yam (55.7%) 2015 4,829 -35% 117 -72% 0.03 -72% 110.0 1.55 1.9 0.05 1.7 1.8 Market cap (HK$m) 15,194.35 2016 5,146 7% 462 296% 0.11 296% 27.8 1.57 1.9 0.01 0.5 6.9 3M avg. vol. (m) 40.98 52W high/low 1.11/3.67 2017E 8,560 66% 837 81% 0.20 81% 15.3 1.64 1.8 0.07 2.3 11.9 2018E 11,014 29% 1,040 24% 0.24 24% 12.3 1.77 1.7 0.09 2.8 13.7 Source: Bloomberg 2019E 12,242 11% 1,196 15% 0.28 15% 10.7 1.88 1.6 0.10 3.3 14.9 Sources: Company data, GF Securities (Hong Kong) Company report Oct 17, 2017 Upcycle in construction machinery - Steady FAI growth in infrastructure, property and mining Loaders and excavators are Lonking’s two main products, and are mostly supplied to downstream infrastructure companies (49% of its loaders and 69% of its excavators), while 20% of its loaders and 15% of its excavators are supplied to mining companies, and 10% of its loaders and 11% of its excavators are supplied to property-related companies. Figure 1: Demand for loaders (downstream customers) Figure 2: Demand for excavators (downstream customers) 5% 21% 11% 49% 15% 10% 69% 20% Infrstracture Mining Property Investment Others Infrstracture Mining Property Investment Others Sources: Company data, GF Securities (Hong Kong) estimates Demand for loaders and excavators in China depend on FAI in the infrastructure, mining and property industries. Based on urban FAI in China in 2016, infrastructure investment is the second largest component, accounting for 25% of total urban FAI, while property investment accounted for 17%, and mining investment accounted for 2%. Figure 3: FAI in China by industry (2016) Urban FAI - Property 17% Investment 24% Urban FAI - Manufacturing Urban FAI - Infrastructure 2% Urban FAI - Mining 32% 25% Urban FAI -others Sources: NBSC, Wind, GF Securities (Hong Kong) Urban FAI growth in China has been slowing since 2009, down from 30.4% YoY in 2009 to 8.1% YoY in 2016. However, looking at individual sectors we see that urban infrastructure FAI has maintained steady double-digit growth YoY, buoyed by demand from transportation and hydraulic engineering. In addition, urban FAI in the property and mining sectors has recovered since 2016, as shown in the figures below. 2 Company report Oct 17, 2017 Figure 4: Urban FAI in China (2005-16) (Rmb 100m) Figure 5: Urban FAI - Infrastructure (2005-16) (Rmb 100m) 700,000 35% 160,000 45% 42.2% 600,000 30.4% 30% 140,000 40% 26.6% 35% 500,000 25.8% 25.7% 25% 120,000 24.3% 24.0% 30% 100,000 400,000 20.7%19.4% 20% 25% 80,000 21.3% 22.7% 21.3% 300,000 15.0% 15% 19.8% 20% 60,000 18.5% 17.0% 16.2% 15.3% 15.8%15% 200,000 10.0% 10% 8.1% 40,000 10% 100,000 5% 20,000 5% 3.3% 0 0% 0 0% Urban FAI YoY change Urban FAI - Infrastructure YoY change Sources: NBSC, Wind, GF Securities (Hong Kong) Figure 6: Urban FAI - Property (2005-16) (Rmb 100m) Figure 7: Urban FAI - Mining (2005-16) (Rmb 100m) 120,000 35% 16,000 40% 33.2% 30.2% 30% 14,000 30.3% 30% 100,000 28.1% 28.4%26.6% 25% 12,000 21.2% 20% 80,000 23.4% 19.3%18.7% 22.1% 10,000 13.2% 19.8% 20% 10.2% 10% 60,000 8,000 16.1% 16.2% 15% 0% 6,000 -0.8% 40,000 10.5% 10% 4,000 -10.8% -10% 20,000 6.9% 5% 2,000 -20.4%-20% 0 1.0% 0% 0 -30% Urban FAI - Property Investment YoY change Urban FAI - Mining YoY change Sources: NBSC, Wind, GF Securities (Hong Kong) Figure 8: Monthly Urban FAI (2005-16) (Rmb 100m) Figure 9: Monthly Urban FAI - Infrastructure (2005-16) (Rmb 100m) 25,000 35% 90,000 40% 30% 80,000 35% 20,000 25% 70,000 30% 20% 60,000 25% 15,000 15% 50,000 10% 20% 40,000 10,000 5% 30,000 15% 0% 10% 5,000 -5% 20,000 -10% 5% 10,000 0 -15% 0 0% 2011-05 2015-02 2010-02 2010-07 2010-12 2011-10 2012-03 2012-08 2013-01 2013-06 2013-11 2014-04 2014-09 2015-07 2015-12 2016-05 2016-10 2017-03 2017-08 2015-07 2016-10 2010-07 2010-12 2011-05 2011-10 2012-03 2012-08 2013-01 2013-06 2013-11 2014-04 2014-09 2015-02 2015-12 2016-05 2017-03 2017-08 2010-02 FAI infrastructure -monthly YoY change Urban FAI in China - monthly YoY change Sources: NBSC, Wind, GF Securities (Hong Kong) Figure 10: Monthly Urban FAI - Property (2005-16) (Rmb Figure 11: Monthly Urban FAI - Mining (2005-16) (Rmb 100m) 100m) 2,500 50% 18,000 60% 40% 16,000 50% 2,000 30% 14,000 40% 20% 12,000 1,500 10,000 30% 10% 0% 8,000 20% 1,000 6,000 -10% 10% 4,000 -20% 0% 500 2,000 -30% 0 -10% 0 -40% 2013-01 2010-02 2010-07 2010-12 2011-05 2011-10 2012-03 2012-08 2013-06 2013-11 2014-04 2014-09 2015-02 2015-07 2015-12 2016-05 2016-10 2017-03 2017-08 2011-10 2016-05 2010-02 2010-07 2010-12 2011-05 2012-03 2012-08 2013-01 2013-06 2013-11 2014-04 2014-09 2015-02 2015-07 2015-12 2016-10 2017-03 2017-08 FAI property - monthly YoY change FAI - mining Monthly YoY change Sources: NBSC, Wind, GF Securities (Hong Kong) 3 Company report Oct 17, 2017 Replacement demand to continue apace Demand for construction machinery, including loaders, excavators and road rollers has been rising since 2006 and peaked in 2010-12.