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CSCI-Industrials-China Infrastructure Sector：Bracing for new cycle in China; Overweight - 20171024

Bracing for new cycle in China; Overweight

 

• In spite of a tight funding environment in 1H17, China’s total infrastructure investments continued to grow solidly. Our channel checks suggested a loosening of funding on infrastructure projects, which would help boost the leading infrastructure plays’ earnings and cash flow.
• As a re-cap, China infrastructure players’ 1H17 results remained solid despite the severe funding environment during the period, though CRG’s over 40% YoY growth in earnings surprised on the upside, while the rest of the players saw c. 7-13% YoY improvement. Looking ahead regarding 3Q17 results, we expect the momentum sustain.
• China infrastructure names trade at 7.5x/6.5x FY17/18E PER, looking attractive from a historical perspective. In view of an improving funding environment in 2H17, we are more positive on China’s infrastructure sector and continue to prefer CRCC (1186.HK, BUY, PT: HKD13.9) and CCCC (1800.HK, BUY, PT: HKD11.6).

Expect more room to unlock funding, based on our estimates on each infrastructure-funding source. (Detailed analysis on page 5) Although China’s infrastructure-funding has been stuck in the limbo since 1H17, we still expect China’s total infrastructure investment to gain 15.6% YoY in 2017, mainly on the back of solid budgetary funding growth and expected acceleration in unlocking the replacement-type government bond quota from 2H17.

Key focus on infrastructure names in the new cycle. Total new contract value of the three largest state-owned infrastructure companies in China in 1H17 jumped 43.4% YoY to RMB1,544.7bn (91.6% of their revenue in 2016). In spite of the strong new contract growth, the market appears to be more focused on contract quality. High quality contracts would help the companies to improve balance sheet and cash flow, as market concern over cash flow has been the culprit weighing on the share prices and valuations of these companies, in our view. 

• The projects nature: Toll road and municipal BOT/PPP projects are most welcomed by the market, as these projects could be easily marketed through securitisation.
• Capital investment proportion：The project capital investment proportion determines the payback period of investment and whether the projects could be booked as off-balance sheet items.
• Projects return protection: Government payment, risk subsidy and viability gap funding are favoured by the market.

Our sector top pick: CRCC; least preference: CSCI. We reiterate our positive view on CRCC (1186.HK, BUY, PT:HKD13.9), on the back of: 1) Gross margin is likely to recover from 2H17; 2) CRCC’s mild CAPEX increase in 1H17 bodes well for future earnings growth, as compared to a 15% contraction for CCCC and flat growth for CRG in 1H17. On the contrary, CSCI(3311.HK, HOLD, PT:HKD12.6) is our least preferred play among China infrastructure names, mainly due to: 1) an expected eroding FCF;  2) Margin pressured ahead, and 3) Negative view on China property construction starts floor area growth in the foreseeable future.