EUR 850.00 For Business Accounts Only

Morningstar | Shanghai Electric Group’s 2018 Earnings Missed; Fair Value Estimate Raised

Shanghai Electric Group reported better-than-expected full-year 2018 revenue of CNY 101.2 billion, though net income of CNY 3 billion missed our estimate of CNY 3.4 billion. This is primarily due to a decline in gross margins to 18.2% from 19.9% in 2017 and compared with our estimate of 20.5%. Second-half fiscal-year 2018 gross margins for industrial equipment and modern services came in below our expectations due to pricing pressure for elevators and changes to gross margin structure for the power plant engineering business. Interest expense was also higher than our forecast as additional debt was raised for external investments. Despite the increase in net income, the dividend fell to CNY 0.06 per share in 2018 from CNY 0.09 in 2017, as we believe that Shanghai Electric Group is conserving cash to fund external investments. Our more optimistic medium-term growth outlook for the wind turbine and industrial equipment businesses will more than offset structurally weak demand for coal-fired power equipment. Coupled with a slight appreciation of CNY against HKD, we raise our fair value estimate to HKD 3.18 per share from HKD 2.88 and consider the stock to be modestly undervalued. Our no-moat and stable moat trend ratings remain intact.

During our five-year explicit forecast period, we increased our five-year sales CAGR forecast for the industrial equipment segment to 3.6% compared with 1.4% previously, as robust growth in elevator services and automation should more than offset weak property-led demand for elevator products. However, we expect gross margin pressure in the near term as Shanghai Electric Group adopts a competitive pricing strategy to expand elevator market share. Following a sharp decline in wind turbine demand in 2017 due to regulatory impact, new energy and environmental protection segment growth rebounded strongly to 25.9% in 2018, and we expect strong pulled-forward demand for wind turbine through 2021, before wind tariffs is lowered. We anticipate 12.3% sales CAGR between 2019 and 2021, followed by a decline in 2022 and 2023, resulting in a five-year sales CAGR of 3.9% versus 6.6% previously. Our positive medium-term outlook is underpinned by the division’s 28.9% annual increase in order backlog to CNY 37.9 billion, providing more than two years of estimated visibility.