27 Nov 2019 CMB International Securities | Equity Research | Sector Update China Construction Machinery Four structural drivers to extend the upcycle to 2020-21E OUTPERFORM (Maintain) We believe the strict measures on emission control and pro-investment approach China Capital Goods taken by the government will offer earnings visibility to the China construction machinery sector in 2020E. Besides, leading Chinese brands, on the back of the Wayne Fung, CFA rising competitive power, have emerged as potential game changers to challenge (852) 3900 0826 the global giants. Consequently, we see continuous import substitution and [email protected] overseas opportunities as growth drivers over coming years. We initiate coverage on SANY Heavy (600031 CH, TP: RMB19.0, Top pick), Jiangsu Hengli SANY Heavy revenue mix (1H19) (601100 CH, TP: RMB54.0) and Weichai Power-A (000338 CH, TP: RMB15.9) Piling Earth moving Other with BUY rating. machinery machinery machinery 7% 3% 2% #1: Replacement demand to reach 60% of total sales; driven by emission Concrete regulations. For construction machinery, the National Emission Standard Crane machinery machinery 30% (NES) IV will be implemented in Jul 2020, such pressing timetable should 20% trigger strong replacement demand. For HDT, NES VI(a) will be implemented in Jul 2021 but we see potential of advanced preparation from local Excavator governments. Besides, some local governments have set deadline for the old 38% models to fade out on the stage. Our industry model suggests that >60% of Source: Company data, CMBIS the demand will come from replacement in 2020-21E. Jiangsu Hengli revenue mix (1H19) #2: Structural growth opportunities: Import substitution + market share Completed Component set of 9% gain. Leading Chinese players are gaining market share from the foreign equipment 4% players in the field of excavator and hydraulic components. We see a clear Hydraulic cyclinder Hydraulic trend of further import substitution on the back of rapid enhancement of for pump and excavator valve product quality, marketing strategy and new product development. 44% 20% Specialised #3: Global market to offer growth potential for Chinese manufacturers. hydraulic cyclinder The world’s top 50 construction machinery manufacturers generated total for heavy revenue of US$184bn (2018). The market share of SANY Heavy (600031 CH, equpment 23% BUY) was <5% among the total revenue of the top 50. We see great potential Source: Company data, CMBIS for Chinese players to gain market share in the global market, given their ongoing overseas investment and increasing global competitive edge. Weichai’s engine sales volume mix 100% Other components #4: Pro-investment policy + resilient property construction. Since mid- 90% 80% 2019, the Chinese government has gradually loosened rules on local 70% For other non-road infrastructure financing. CMBIS Economic team forecast infrastructure FAI 60% ma chine ry 50% (excluding power) growth to accelerate to 5.5% in 2020E (vs 4.2% in 10M19). 40% For heavy-duty & 30% medium-duty This, together with the strong property construction activities, will lend strong 20% construction machinery support to the construction machinery demand. 10% For HDT 0% 2017 2018 2019E 2020E 2021E Lifting our machinery demand estimate. We forecast demand for crane Source: Company data, CMBIS estimates machinery /concrete machinery /excavator / HDT to grow 20%/14%/10%/1% in 2020E. We expect leading players will deliver above average growth thanks to market share gain. Key recommendations Mkt Cap Rating Price TP P/E (x) P/B (x) Name Ticker (US$ mn) (LC) (LC) FY19E FY20E FY19E FY20E SANY 600031 CH 18,252 BUY 14.94 19.00 11.1 9.4 2.8 2.4 Hengli 601100 CH 5,979 BUY 46.70 54.00 32.4 26.2 7.4 6.1 Weichai-A 000338 CH 15,152 BUY 13.38 15.90 11.0 10.4 2.4 2.2 Weichai-H 2338 HK 14,857 BUY 13.86 17.90 10.1 9.5 2.2 2.0 Source: Company data, CMBIS estimates PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 1 ACCESS KEY TO OUR REPORTS ON BLOOMBERG: CMBR 27 Nov 2019 Contents Investment Thesis .................................................................................... 3 Is the sector reaching the peak? ............................................................................. 3 Key growth drivers .................................................................................................... 3 Investment ideas ....................................................................................................... 4 #1: Replacement demand driven by emission regulations on off-road machinery and heavy-duty truck ............................................................ 7 Source of emission ................................................................................................... 7 Implementation of new NES standard ..................................................................... 8 Elimination of the old models under operation ...................................................... 9 #2: Import substitution and market share gain to offer structural growth opportunities for leading Chinese players ............................. 11 Excavator ..................................................................................................................11 Hydraulic components for construction machinery ............................................12 Engine for commerical vehicle and off-road application ....................................14 #3: Global market to offer growth potential for Chinese manufacturers ........................................................................................ 16 Global construction machinery market size >US$184bn ....................................16 Caterpillar remains the largest player but market share on a down trend ........16 Leading Chinese players already established presence in overseas ................16 #4: Pro-investment policy + Resilient property construction ............ 18 Potential recovery of infrastructure spending growth in 2020 ...........................18 Resilient area under construction positive to concrete and tower crane .........19 Demand projection ................................................................................ 20 Earth moving machinery .........................................................................................20 Crane machinery .....................................................................................................21 Concrete machinery ................................................................................................22 Heavy-duty truck (HDT) ...........................................................................................23 SANY Heavy Industry – A (600031 CH) ................................................ 24 Jiangsu Hengli Hydraulic (601100 CH) ................................................. 24 Weichai Power- A (000338 CH) ............................................................. 24 Weichai Power-H (2338 HK) .................................................................. 24 PLEASE READ THE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES ON LAST PAGE 2 27 Nov 2019 Investment Thesis Is the sector reaching the peak? 2019 marks the third year of China construction machinery upcycle and the market has started to question if it is arriving to the end. Our answer to the question is not yet. In this report, we identify four structural positives factors that will support an extension of the upcycle to 2020-21E. What’s more, leading Chinese machinery and components manufacturers have adopted different approaches and strategies, such as new product launch and overseas expasion, to maintain the growth momentum and reduce the cyclical risk. Key growth drivers 1) Replacement demand driven by emission regulations on off-road machinery and heavy-duty truck Among the off-road machinery, construction machinery is one of the major sources of emission, accounting for 45%, 34% and 25% of the total emission of hydrocarbons (HC), nitrogen oxide (NOx) and particulate matter (PM) in 2018, respectively. For on-road machinery, the fleet size of HDT (including diesel and other source of energy) was 7.1mn units, representing only 3.1% of the total ownership volume of automobile in China. However, the emission of NOx and PM by HDT contributed to 58% and 66% respectively of the total emission by automobile in China. The Chinese government has a strong aspiration to address the air pollution issue. Measures include the implementation of more stringent emission control policies. For construction machinery, the National Emission Standard (NES) IV on construction machinery will be implemented in Jul 2020, which is able to trigger strong replacement demand. For HDT, NES VI(a) will be implemented in Jul 2021 but we see potential of advanced preparation from local governments. Besides, local governments have set deadline for the elimination of the old models. Our industry model suggests that >60% of the demand will come from replacement in 2020-21E. 2) Import substitution and market share gain to offer structural growth opportunities for leading Chinese players Chinese players have been gaining market share from the used-to-be dominating foreign brands in the domestic market. For excavator, SANY has clearly become a winner with market share increased substantially from ~12% in 2011 to 25% in 10M19, significantly outpacing all the major competitors. For hydraulic components, an area that had been dominated by foreign brands, Jiangsu Hengli emerged as one of