Factories in China, except Hubei, are scheduled to resume operation today. We evaluate the companies under our coverage from several dimensions, including location of factories, capacity utilization, downstream demand and cash flow management. Our base case scenario suggests that the overall earnings impact for the full year should be limited, as the sales volume in 1Q (the traditional peak season) will potentially be shifted to 2Q or 3Q (low seasons) when the construction activities pick up when the epidemic is under control. We believe potential share price volatility in the near term will serve as opportunities to accumulate quality names such as SANY Heavy (600031 CH, BUY, TP: RMB19.0), Jiangsu Hengli (601100 CH, BUY, TP: RMB54.0) and Weichai Power (2338 HK, BUY, TP: HK$17.9 / 000338 CH, BUY, TP: RMB15.9).
- Utilization rate to gradually increase. For the companies under our coverage, no production base is located in Hubei province (figure 1). Some companies such as Weichai, SANY Heavy and Zoomlion have already resumed production since last week while others will restart today. That said, we do expect most of them will only ramp up its production gradually due to the potential labour shortage in the near term. Companies are trying their best to ramp up production to fulfil the existing orders, based on our check.
- Expect mild delay on downstream demand. Demand for construction machinery are mainly driven by infrastructure, property and mining activities. Delay of the construction activities will affect the demand for the construction machinery in the near term. For mining equipment, however, the impact is relatively smaller as major coal miner such as Shenhua (1088 HK, NR) has already resumed operation, as the government has ordered for the security of energy supply. We therefore believe that SANYI (631 HK, BUY, TP: HK$5.6) is relatively resilient.
- Prudent cash flow management. Most companies have maintained strong balance sheet with net cash position. What’s more, we understand that some companies have started asking their suppliers to extend the credit term in order to protect the cash flow. We see little risk for big companies to encounter financial difficulties.
- Base case scenario - The epidemic to come under control by the end of 1Q. Under this assumption, we expect the procurement of construction machinery will pick up in 2Q and the capacity utilization rate to return to normal level in 1-2 months. In particular, we expect infrastructure spending will serve as important measure to stabilize the economy going forward. Machinery sales volume in 2Q will likely see strong YoY and QoQ growth, while the full year sales will be little affected under this scenario.
- Bear case scenario - The epidemic will only be contained until the end of Jun. In such case, we project the construction machinery demand (including earth moving, crane and concrete) will see no growth this year, and HDT sales will see 10% YoY decline (due to weak demand for logistic trucks). We calculate that earnings downside for major players in 2020E will be 7-21%, with largest impact on Sinotruk (3808 HK, BUY, TP: HK$19.4).
