Construction machinery and HDT manufactures generally reported decent results in 1H19. Large construction machinery players such as Zoomlion (1157 HK / 000157 CH, BUY), SANY Heavy (600031 CH, NR) and XCMG (000425 CH, NR) reported significant net profit growth (100-200% YoY). Going forward, we believe the launch of new products, market consolidation, environmental policies driven replacement demand and import substitution will serve as growth drivers. In the near term, the post result remarks by major construction machinery players point to a recovery of order intakes in Sep. We believe a potential pick up of infrastructure spending will boost sales volume in 4Q19E.
- Larger players reported better revenue growth in 1H19. The trend of industry consolidation continued with large players such as SANY Heavy and Zoomlion reported >50% YoY growth of revenue. The growth was driven by strong demand for crane and concrete machinery, as well as market share gains by both players. Smaller players such as Liugong (000528 CH, NR) and Lonking (3339 HK, HOLD) with a focus on wheel loaders reported low single digit revenue growth due to the substitution by excavator.
- Margin expansion. Majority of the players reported margin expansion in 1H19, on the back of operating leverage and product mix enhancement. Zoomlion and SANY Int’l (631 HK, BUY) reported 4.5ppt and 3.6ppt YoY expansion on gross margin. We expect both companies will continue to see margin upside with the launch of more products.
- R&D spending on the rise. Major players raised their R&D expense ratio in 1H19. We believe this is a major trend going forward as the adoption of advanced manufacturing process to reduce cost and the capability to offer intelligent products will become critical factors of success going forward. In 1H19, Weichai (2338 HK, BUY) spent RMB2.4bn on R&D expense, the highest among all players. In terms of growth, SANY Heavy’s R&D expense surged 1.8x YoY. In terms of expense ratio, SANY Int’l raised its R&D expense ratio by 3ppt to 6.9%.
- Operating cash flow surprisingly strong. It is surprising that most of the players reported significant improvement in operating cash flow. This suggested that apart from pursuing volume growth, the machinery manufacturers maintained a prudent approach and put considerable effort on cash collection. The strong cash operating cash flow suggested high earnings quality in general.
- Sector outlook: Major players expect strict environmental policies to eliminate old models and the implementation of strict National Emission Standard (NES) for the new sales will continue to support the replacement demand. On the other hand, import substitution will serves as growth driver for the component makers. For example, Jiangsu Hengli (601100 CH, NR) is on a good track to boost its sales of hydraulic pump & valves. Weichai is targeting the large bore engine for the industrial power segment. Both areas are currently dominated by the overseas players.
