Morningstar | Shanghai Electric’s 1H18 Beat Expectations; Growth Unsustainable; FVE Lowered to HKD 2.80. See Updated Analyst Note from 31 Aug 2018
We have lowered our fair value estimate for Shanghai Electric, or SEG, to HKD 2.80 (from HKD 3.60) after factoring in lower revenue growth assumptions for 2019-22. We expect demand for thermal and nuclear power equipment to remain weak, given China’s focus on renewable energy, and there are environmental and safety concerns regarding nuclear projects. We do not expect the high gross margins achieved in 2016-17 to be sustainable and are lowering our gross margin forecasts for SEG, as the environment of bidding for projects remains competitive, while raw material costs are rising. We have also factored the depreciation of the Chinese yuan into our Hong Kong-dollar-denominated fair value estimate. Our no-moat and negative moat trend ratings on the firm are intact. SEG’s first-half 2018 net profit increased by 12.5% year over year to CNY 1.76 billion from CNY 1.57 billion during the year-ago period on the back of a 24.4% year-over-year increase in revenue. The higher revenue is 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 do not think is sustainable in second-half 2018. In addition, gross margin declined to 17.1% in first-half 2018 from 19.4% during the year-ago period, which in our view could be due to higher raw material costs. We see limited upside for SEG’s share price in the near term, as the macroeconomic environment remains challenging for the company.Order backlog declined slightly to CNY 226.1 billion (around 46% of these orders have not yet come into effect and thus could be canceled) from CNY 231.8 billion in first-quarter 2018. We see a notable decline in order backlog in the high-efficiency and clean energy equipment segment (mainly related to thermal power and nuclear power), offset by an increase in the modern services segment. This supports our view that demand for thermal power equipment should remain weak as China continues to focus on renewable energy.
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