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Credit Suisse: China's property investment to pick up

KUALA LUMPUR: Credit Suisse says infrastructure investment was the key driver of almost all the sales recovery in construction machines in 2009 in China. But in 2010, it believes infrastructure growth will slow down.

Although the Chinese government introduced a 50% down payment requirement for land purchases, this is not expected to slow property investment growth this year, as land undeveloped at the end of 2009 was three times the land developed in FY09.

"We expect property investment growth to rise in 2010-11E. Mining investment growth should remain strong and could show upside surprise," it said in a report issued on Jan 15.

Below is the report

Credit Suisse said it favoured concrete machines and excavators in 2010. Concrete machines are highly sensitive to property growth and their sales could surprise us. Moreover, the market has over-reacted to the recent property policy and undervalued the key players, in its view.

Excavators should gain from mining and property, while bulldozers may have better-than-expected growth if exports recover more strongly. Loader growth could peak in 1H10.

The research house said Sany and Zoomlion were its top picks, as they still trade below historical average valuations and their income could beat its forecasts.

Shantui is undervalued, given its strong earnings recovery and potential upside from exports. Liugong's earnings growth should remain strong, supported by excavators and cranes.

"We maintain an Outperform rating on these four names. We downgrade Lonking to Neutral from Outperform, based on loaders's expected slow growth and lagging earnings growth in 2010E. Anhui Heli is overvalued, even in a blue-sky scenario; we maintain our Underperform," it said.

Property to show strongest demand for machines

Property investment could replace infrastructure investment in terms of seeing the strongest growth in 2010, supported by stronger investment by developers and the
government’s policy requiring developers to develop the land within two years of acquisition, in order to prevent land hoarding.

Mining investment growth should remain strong, and could surprise on the upside if oil & gas investment improves, because our forecast is based on a conservative assumption of 2% oil & gas investment growth in 2010 versus 25% average growth in 2005-08.

Prefer concrete machines and excavators

We expect concrete machines and excavators to grow the strongest in 2010, while loader growth could peak in 1Q10 after the peak in infrastructure investment growth. Concrete machines have the biggest exposure to property. According to historical data, concrete machine sales growth has high elasticity to the change in property investment growth.

Based on historical data, if property investment growth is strong enough, say above 25%, in 2010, concrete machine growth could easily rise to 50% or more.
Excavators are estimated to see the strongest growth among all the earthmoving machines in 2010. In the infrastructure industry, they should continue, partly, to replace loaders.

In the mining industry, excavators should benefit from a recovery in exploration and development, and capacity expansion in the mining industry, including coal mining, and oil and gas. They are also needed in the property sector. Overall, we expect excavator growth in FY10 to be 25-30% YoY.

Steel cost set to rise again

With economic growth returning, we estimate steel prices will rise in 2010, which would erode machine makers’ margins, since total steel costs (including steel plates and purchased components) account for 80-90% of COGS in the construction machinery industry.

At this point, investing in two kinds of companies would be safer than others: those that have strong pricing power to pass on any cost increase, and those whose
margins are higher and less sensitive to cost increases. Shantui has the strongest pricing power, as it controls nearly a 60% market share in the bulldozer market and has raised its sales price each year when steel price rise to pass on the cost increase.

Zoomlion and Sany have high-margin products: concrete machines and pile driving machines.

Property to show strongest demand for machines in 2010

Thanks to the Chinese government’s investment in infrastructure, almost all construction machines should benefit from it and see their sales recover this year.

However, in 2010, sales growth of these machines is expected to diversify, due to the different trends in downstream demand. Of the three major demand sources for construction machines, we estimate only property investment will definitely speed up. Mining investment growth is also estimated to increase. But infrastructure growth may have peaked in 2009 and largely slow down in 2010.

In the first 11 months of 2009, infrastructure investment had grown 48% YoY, most of the demand increment coming from the transportation sector and water conservancy projects.

In our opinion, such a high growth rate cannot last. Our checks with construction companies show that growth in railway and high-speed road construction in 2010 will slow down. Our infrastructure analyst, Ingrid Wei, estimates railway investment growth in 2010 will fall to 22% from 78% in 2009, while highway investment will stop growing in 2010.

We estimate that mining investment growth will recover in 2010E with the recovery in petroleum and gas investment, and stronger coal mining investment. Among all the subsectors in mining, coal and oil and gas account for 74% of all the investment in 2008.

Mining investment peaked in October 2008 right after the outbreak of the financial crisis, and dropped to around 10% in September 2009. As coal companies did not cut their investment a lot in the past year, this could be the key reason for the reduction in oil and gas investment.

With resurging oil prices, our energy team expects China’s three major oil and gas exploitation companies will raise their investment in exploration and development again. One construction machinery dealer which focuses on the coal industry told us there would be more new coal mine construction projects emerging, especially from the private sector, with macro economy’s recovery. If actual investment growth in oil and gas is higher than our conservative forecast, mining investment could surprise us.

Property is expected to bottom out and have the strongest growth increase among all three major downstream drivers of construction machinery in 2010. On the demand side, the strong sales of second-hand houses last year has shown residential purchasing intentions in China. Office and commercial building demand should also increase with the economy warming up.

Both would trigger property developers’ intentions to develop new projects. The central government also targets to raise investment in the public housing
system. For instance, it plans to build 6 million public homes versus around 3 million in 2009E.

We estimate property investment in 2010 will rise to 27% from an estimated 20% in 2009.

On the land supply side, in order to have more supply to stabilise property prices, the government is expected to strictly implement a policy requiring developers to develop land within two years of acquiring it on order to prevent land hoarding. At the end of 2009, the government released a new policy requiring a 50% down payment for land purchases and a one year payment period.

We think it could decrease new property development project growth in the future. But it would not have much impact on property investment and related
concrete machine demand growth in the next two years, because there is still a huge land inventory in the market that is enough to meet demand, even without considering new land purchased in 2010. B

By the end of 2009, total land to be developed is estimated at 1,037 mn sq metres, equal to three times the land developed in 2009E.

Based on our prospects for infrastructure, mining and property investment, we expect concrete machines and excavators to grow the most in 2010, while loader growth could peak in 1Q10 after the peak in infrastructure investment growth.

Among all the major machines, concrete machines have the biggest exposure to property.

From historical data, concrete machine sales growth has high elasticity to the change in property investment growth. Based on historical data, if property investment growth is strong enough, say above 25%, in 2010E, concrete machine growth could easily rise to 50% or more.

Although it has big exposure to infrastructure, excavators are estimated to have strongest growth among all earthmoving machines in 2010E. In the infrastructure industry, they should continue partly replacing loaders.

In the mining industry, excavators would benefit from a recovery in exploration and development, and capacity expansion in the mining industry, including coal mining, and oil and gas.

While loaders are mainly needed by coal mines and steel plants to dump coal, their demand is connected to coal production the growth of which is estimated to be around 10% in 2010. They are also needed in the property sector. Overall, we expect excavator YoY growth in FY10 to be 25-30%.

We expect bulldozer demand in China will be strong, too. The whole sector’s sales growth could probably be as strong as excavators’ if exports recover, as export sales accounted for 40% of bulldozer total sales in 2008. We estimate bulldozer growth in 2010 will be around 15-20% given a 30% increase in export sales.

Loaders, we believe, will be the loser versus other machines in the next year. They have the biggest exposure to the infrastructure industry (Figure 18), the growth of which is expected to drop a lot in 2010.

We do not expect the mining industry to benefit from capex increases in coal, and oil and gas. Therefore, we expect loader growth to peak in 1H10, as
infrastructure investment growth peaked in September 2009, with its YoY growth in FY10 possible being 5-10%.

As a mature product and a widely used machine, truck-mounted cranes are not so cyclical as others. In 2009, they were largely used in railway and road construction, which sped up crane sales so they had better growth than the others. In 2010, we estimate their growth will keep stable, supported by transportation projects.

Because this product is needed in the late stages of railway construction and with more projects starting, more new cranes would be purchased.

In addition, forklift demand should return with the warming up of the logistics and transportation industries. However, being a late-cycle product, its growth would be lower than that for most other machines. We estimate the forklift industry will have 10-15% sales growth in 2010E. If developed countries’ economies turn out to be much healthier, industry sales growth could be stronger, driven by exports.

Among all the players, we believe that Sany (and Zoomlion) will be the biggest winners in 2010. Although these two stocks’ valuations do not look far from their historical average (our target price), their earnings forecasts could quite possibly be higher than expected, since our concrete machine sales assumption is quite conservative compared with historical experience. Furthermore, the possible negative impact from the new land purchase policy has been digested by the market.


Steel cost set to rise again

With economic growth returning, China is likely to enter an inflationary cycle again. We estimate steel prices will rise in 2010E. Since almost all the components of construction machines are manufactured by steel, except some special parts like tyres, a steel price increase would erode undoubtedly machine makers’ margins. Including steel plate and purchased components, total steel cost accounts for 80-90% of COGS in the construction machinery industry.

At this point, investing in two kinds of companies would be safer than others: those who have strong pricing power to pass through cost increase, and those
whose margins are higher and less sensitive to cost increase.

Shantui has the strongest pricing power, as it controls nearly 60% market share in bulldozer market and had raised its sales price every year when steel price went up to pass through cost increase. Zoomlion and Sany have high margin products: concrete machine and pile driving machine.

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