EUR 850.00 For Business Accounts Only

Morningstar | Shanghai Electric Group’s 3Q 2018 Results Trending Largely in Line With Our Full-Year Forecasts. See Updated Analyst Note from 31 Oct 2018

Shanghai Electric Group's third-quarter 2018 results are tracking largely in line with our full-year estimates. We maintain our fair value estimate at HKD 2.80 as longer-term secular headwinds persist. Our no-moat and negative moat trend ratings remain intact. During the quarter, revenue grew by 7.2% year over year, though this came at the expense of gross margin, which contracted 90 basis points to 21.4% from the same period a year ago, driven by a competitive bidding environment as well as higher raw material costs. On a quarter-over-quarter basis, revenue fell by 43.3% to CNY 18.63 billion, which is in line with our expectation. The higher revenue in first half 2018 was due to revenue recognition of completed environment protection engineering projects and peak season for production and delivery for coal-fired power generation projects, which we believe is unsustainable for the remainder of the year. In the near term, we see limited upside for the share price given the challenging macroeconomic environment and the potential spillover effect from the ongoing U.S. and China trade war.

Over the longer term, we continue to expect demand for thermal and nuclear power equipment to remain soft, given China’s focus on renewable energy, as well as environmental and safety concerns regarding nuclear projects. The company is attempting to pivot toward the faster-growing wind power segment (across the entire value chain from equipment maker to service provider) and to improve its margins by focusing on higher-end nuclear equipment. We think that its transition toward the faster-growing wind power segment should help to mitigate the slowdown from its declining core thermal power business. In addition, it has been trying to grow its overseas business, given the secular headwinds in the domestic market. However, given that overseas business only made up around 13% of its revenue in 2017, we do not expect it to have a big impact on its profitability in the near term.

Order backlog increased slightly to CNY 228.4 billion (around 47% of these orders have not yet come into effect and thus could be canceled) from CNY 226.1 billion in first-half 2018. It is worth noting that around 8% of the company's order backlog (around CNY 17.9 billion) are related to wind power equipment, where it saw a 17.7% increase from 2017. This supports our view that Shanghai Electric's move to focus on wind power segment is on the right track as China continues to focus on renewable energy.