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Global Research 14 February 2014

Initiation of Coverage

China Machinery Engineering Corporation Experienced EPC contractor with overseas focus

China's leading global EPC contractor, with a focus on the power sector China Machinery Engineering Corporation (CMEC) is China’s most experienced overseas engineering, procurement and construction (EPC) contractor. We expect its strong track record in EPC contracts outside China to help it win more projects with higher margins than its Chinese peers. We forecast new contract growth of 16%/11% YoY in 2014/2015 to US$3.9bn/US$4.3bn, partly underpinned by US$11.8bn of contracts signed but not yet in effect as at end-H113, and as it is a beneficiary of China's ’Going Global’ policy. Furthermore, we see potential catalysts from: 1) the completion of an asset injection (that it has agreed to complete before 2016), which could increase our 2015E EPS by 5%; and 2) the announcement of major new contracts (such as a US$2bn+ railway EPC contract in Argentina).

Greatest beneficiary of China's ‘Going Global’ policy The Chinese government is providing more financial support to help developing countries with their infrastructure development under the ‘Going Global’ policy, and is encouraging Chinese contractors to undertake more overseas engineering and construction (E&C) projects. We believe CMEC is the greatest beneficiary of this policy, as it derives around 80% of its total revenue (100% of its E&C revenue) from outside China and has more than 30 years’ experience of EPC contracts overseas.

High margin and asset-light model contribute to premium ROE CMEC delivered industry-leading ROE of 25.2% in 2012, far exceeding its major competitors in China. We think this was due to its significantly better gross margin than competitors and high asset turnover because of its asset-light model. However, CMEC's leverage (net cash position) is low compared with peers, which provides potential for acquisitions or ROE improvement from higher gearing.

Valuation: we initiate coverage with a Buy rating and HK$8.10 price target We base our price target of HK$8.10 on 10.0x 2014E EPS of Rmb0.65. We think its valuation is attractive at 6.8x 2014E PE with a 2013-15E EPS CAGR of 15%, and 5.2% dividend yield in 2014E based on our 35% payout assumption.

Equities

China

Heavy Construction

12-month rating Buy Prior: Not Rated12m price target HK$8.10 Prior: -

Price HK$5.65

RIC: 1829.HK BBG: 1829 HK

Trading data and key metrics 52-wk range HK$7.30-3.70

Market cap. HK$23.3bn/US$3.01bn

Shares o/s 4,126m (ORD)

Free float 20%

Avg. daily volume ('000) 4,253

Avg. daily value (m) HK$25.0

Common s/h equity (12/13E) Rmb11.7bn

P/BV (12/13E) 1.6x

Net debt / EBITDA (12/13E) NM

EPS (UBS, diluted) (Rmb) From To % ch Cons.

12/13E - 0.53 - 0.4912/14E - 0.65 - 0.6412/15E - 0.70 - 0.70

Robin XuAnalyst

[email protected]

+86-213-866 8872

Highlights (Rmbm) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17ERevenues 19,077 20,518 21,296 21,487 26,855 29,644 32,757 36,121EBIT (UBS) 1,526 2,138 2,041 2,155 2,778 2,987 3,143 3,369Net earnings (UBS) 1,385 1,851 1,918 2,194 2,688 2,895 3,066 3,293EPS (UBS, diluted) (Rmb) 0.42 0.56 0.58 0.53 0.65 0.70 0.74 0.80DPS (Rmb) 0.21 0.11 0.20 0.17 0.23 0.25 0.26 0.28Net (debt) / cash 3,243 4,785 11,801 11,907 11,090 12,193 13,244 14,333

Profitability/valuation 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EEBIT margin % 8.0 10.4 9.6 10.0 10.3 10.1 9.6 9.3ROIC (EBIT) % 68.0 205.3 <-500 (305.6) 182.6 88.9 73.2 62.9EV/EBITDA (core) x - - - 2.8 2.3 2.1 1.7 1.3P/E (UBS, diluted) x - - - 8.3 6.8 6.3 5.9 5.5Equity FCF (UBS) yield % - - - 2.3 (0.2) 11.7 11.8 12.4Net dividend yield % - - - 3.8 5.2 5.6 5.9 6.3Source: Company accounts, Thomson Reuters, UBS estimates. Metrics marked as (UBS) have had analyst adjustments applied. Valuations: based on an average share price that year, (E): based on a share price of HK$5.65 on 13 Feb 2014 22:41 HKT

Robin Xu, Analyst, S1460511010012, [email protected], +86-213-866 8872

Initiation of Coverage: China Machinery Engineering Corporation 14 February 2014 2

Investment Thesis 12-month rating Buy

CMEC 12m price target HK$8.10

Investment case

We like CMEC for the following reasons: 1) we think it is the greatest beneficiary of China's ‘Going Global’ policy, as it has a successful track record on overseas EPC contracts (especially power); 2) it delivers industry-leading ROE, due to better profitability and an asset-light model; 3) its working capital management is strong, in our view; and 4) a potentially EPS-accretive asset injection from the parent company, as per its IPO prospectus.

Upside scenario

In our upside scenario, we assume revenue grows 35% YoY and that the gross margin expands 80bp in 2014 compared with our current estimates of 25% YoY revenue growth and a 22bp gross margin expansion in 2014. This reflects CMEC taking more market share of international power projects and would increase our valuation to HK$9.10/share.

Downside scenario

In our downside scenario, we assume no revenue growth YoY and that the gross margin deteriorates 50bp YoY in 2014. This reflects CMEC taking less market share of high-margin international power projects and would increase our valuation to HK$6.50/share.

Upcoming catalysts

Announcements on newly effective contracts or the signing of initial MOUs (especially for mega projects) would be one major catalyst. The completion of the agreed asset injection is another major catalyst.

Business description

China Machinery Engineering Corporation (CMEC) is a leading company in the international contracting market, particularly in the international electric power & energy field. CMEC has extended its business to more than 150 countries and territories in the fields of international contracting and general international trade. It operates 26 affiliates in China, 13 affiliates overseas and 26 foreign representative offices.

Industry outlook

We expect strong demand for infrastructure construction globally and that Chinese contractors will have bigger exposure. We attribute this to China’s ‘Going Global’ policy, which encourages Chinese contractors to take more overseas construction projects, some with funding from Chinese banks.

Revenue by region (%)

Source: Company data

Gross profit by product segment

2011 2012 2013E 2014E 2015E

Construction contracts 2,916 2,772 3,198 4,095 4,418

Trading 436 582 312 399 436

Others 308 378 342 383 440

Total 3,659 3,732 3,852 4,877 5,295

Source: Company data, UBS estimates

China11%

Overseas89%


Contents

Investment summary ....................................................................... 4

Risks ............................................................................................................ 5

Valuation and basis for our price target ....................................................... 6

UBS versus consensus .................................................................................. 6

Sensitivity analysis ........................................................................................ 7

Risk analysis ...................................................................................... 8

Industry risks ................................................................................................ 8

Company specific risks ............................................................................... 10

Competitive analysis ...................................................................... 14

Assessment of industry attractiveness ........................................................ 14

Competitive strengths ................................................................................ 19

Management strategy ................................................................................ 24

Financials ........................................................................................ 26

Profit and loss ............................................................................................ 26

Balance sheet............................................................................................. 29

Cash flow .................................................................................................. 30

Return on capital ....................................................................................... 31

Valuation ........................................................................................ 32

Price target derivation ................................................................................ 32

Comparables ............................................................................................. 33

Appendix ........................................................................................ 35

Company background ............................................................................... 35

Projects ...................................................................................................... 36

Regulatory ................................................................................................. 39

Robin XuAnalyst

[email protected]

+86-213-866 8872


Investment summary We initiate coverage of China Machinery Engineering Corporation (CMEC) with a Buy rating and HK$8.10 price target. CMEC is the most experienced Chinese overseas EPC contractor and we expect its good track record abroad to help it win more projects with higher margins than its Chinese peers. We forecast 16%/11% new contract growth YoY in 2014/2015 to US$3.9/US$4.3bn, partly underpinned by US$11.8bn of contracts signed but not yet in effect as at end-H113, and partly as it is a beneficiary of China's ‘Going Global’ policy. Furthermore, we see potential catalysts from: 1) the completion of an asset injection (that its IPO prospectus stated would be completed before 2016), which would increase our 2015E EPS by 5%; and 2) the announcement of major new contracts (such as a US$2bn+ railway EPC contract in Argentina).

Benefitting from China's ‘Going Global’ policy. We see CMEC as the greatest beneficiary of China’s ‘Going Global’ policy, as the government encourages more overseas E&C projects, some with funding support from Chinese banks. Around 80% of CMEC’s revenue (100% of its E&C revenue) comes from overseas, and it has more than 34 years’ experience of overseas EPC contract work.

High margin and asset-light model contributes to premium ROE. CMEC delivered industry leading ROE of 25.2% in 2012, far exceeding its major competitors in China. We attribute this to CMEC’s significantly better gross margin than competitors, and its asset turnover has also been high due to its asset-light model. However, CMEC's leverage (net cash position) is low compared with peers, providing potential for acquisitions or ROE improvement from higher gearing.

Strong working capital management. Unlike most Chinese contractors that have experienced rising receivables problems in China, CMEC maintains significant advance receipts as a result of aggressively using export buyer’s credit. CMEC's advance receipts amounted to Rmb9.1bn as at 30 June 2013, 21% of its backlog on that date. The Chinese government is providing increasing financial support to help developing countries’ infrastructure development under the ‘Going Global’ policy and ‘Supporting Developing Countries’ policy.

Potential EPS accretion from asset injection. CMEC has agreed to acquire a number of assets from its parent company before 2016 (China National Electric Engineering Co. [CNEEC], China National Complete Engineering Corporation [CMCEC] and China National Automation Control System Corporation [CACS]). We believe the CNEEC and CMCEC acquisitions are likely to be completed by end-2014, which would enhance 2015E EPS by 5% (assuming 5.0% funding cost). The parent company also has some other assets, both listed and non-listed, that could be potential acquisition candidates.

Attractive valuation. We believe CMEC’s valuation is attractive at 6.8x PE in 2014E on an estimated EPS CAGR of 15% in 2013-15, and that there is potential EPS accretion if CMEC completes its promised asset injection by end-2014 or early 2015. We see little downside as net cash represents around 103% of current market cap, and CMEC is trading at a 2014E dividend yield of 5.2%.

Initiate with a Buy with price target of HK$8.10

Proven track record working outside China


Risks Uncertainty on global economic recovery. International engineering contracting business is highly correlated with the world economy. An economic slowdown will negatively affect the market size of international engineering contracting business. The top 225 international contractors’ revenue from international engineering contracting business was flat in 2008-10, consistent with the global economic recession in 2009 (world GDP growth was -1% in 2009).

Potential slowdown of public infrastructure investment. International engineering contracting business also depends on the level of public infrastructure spending by relevant governments or governmental agencies in various countries. In other words, a lack of funding from developing countries' governments may slow infrastructure spending.

Renminbi appreciation. International engineering contracts are normally signed in either US dollars or local currency (similarly for revenue recognition), while some of the Chinese contractors’ costs may be incurred in Renminbi (such as equipment and labour). As a result, Chinese contractors may incur forex losses if the Renminbi appreciates against the US dollar or the local currency where a project is located. Furthermore, Renminbi appreciation may reduce the competitiveness of Chinese contractors’ trading business against non-Chinese competitors.

Other risks regarding overseas contracts. International engineering contracting involves dealing with different nations and different project owners, and tends to be much more complicated than similar construction work that most Chinese contractors carry out in China. Furthermore, regulatory, social and political conditions may all affect the ultimate profit margins for international engineering contracting.

Competition from Chinese peers. In the power sector, CMEC faces competition from major Chinese international engineering contractors such as Sinohydro, Shandong Electric Power Construction Corporation III (SEPCOIII), Shanghai Electric and Shandong Electric Power Construction Corporation (SEPCO). In addition, major Chinese transportation infrastructure contractors—including China Communications Construction (CCCC), China Railway Construction (CRCC) and China Railway Group (CRG)—also plan to expand their business overseas.

Competition with China CAMC Engineering (CAMCE). CMEC entered into a non-competition agreement with China National Machinery Industry Corporation (SINOMACH, the parent company that holds a 77.99% stake in CMEC) to the effect that other subsidiaries (excluding CAMCE) of SINOMACH will not compete with CMEC in respect of the core sectors (power, transport and telecommunication). However, this leaves the door open for SINOMACH's 61.22%-owned CAMCE to compete with CMEC in the future.

Concentration of customers and suppliers. CMEC’s main customers are primarily the project owners of its engineering contracting projects for international engineering contracting business. In 2009/2010/2011/2012, its five largest customers in aggregate accounted for 42.3%/34.0%/36.1%/28.0% of its total revenue. Purchases from CMEC’s five largest suppliers (which include subcontractors) accounted for 13.2%/13.0%/13.8%/13.8% of its cost of sales in 2009/2010/2011/2012.

Infrastructure spending relies on a healthy economy

Rmb appreciation may incur forex loss

Competition is more with Chinese peers

CAMCE is a major competitor under the same parent company


Valuation and basis for our price target We derive our 12-month price target of HK$8.10 by applying PE multiples on 2014E EPS. Our target 2014E PE multiple of 10.0x is at a slight discount to listed Korean E&C companies, and at a 33% premium to CMEC's historical average forward PE multiple. Our price target implies 1.9x P/BV (on 21% ROE), and a 3.6% dividend yield in 2014E.

Figure 1: Price target derivation

EPS

2014E EPS (Rmb) 0.65

EPS CAGR (2013-15E) 15%

PE (x)

Target 2014 PE (x) 10.0

Historical PE avg. (x) 7.5

Premium/(discount) 33%

Korean E&C (PT implied) 10.7

Premium/(discount) -7%

Rating/PT

Price target (HK$) 8.10

Current price (HK$) 5.65

Upside/(downside) 43%

Rating Buy

Other financials

New contract CAGR (2013-15E) 13.6%

Net margin 2014E 10.0%

Net gearing 2014E -132%

ROE 2014E 21.3%

Source: UBS estimates

UBS versus consensus Our 2013 reported net profit estimate is 6% below consensus reflecting our lower margin assumptions. However, our reported net profit estimate for 2014 is 1% higher than consensus. According to Bloomberg, CMEC has six Buy ratings and no Neutral or Sell ratings.

Figure 2: UBS estimates versus consensus

2013 2014

(Rmb m) UBS Low High Average Diff UBS Low High Average Diff

Revenue 21,487 20,438 22,166 21,474 0% 26,835 23,152 29,713 26,522 1%

EBIT 2,155 2,304 2,591 2,440 -12% 2,772 2,491 3,373 3,019 -8%

Net profit 1,950 2,062 2,084 2,073 -6% 2,695 2,644 2,707 2,676 1%

Source: Bloomberg, UBS estimates

Initiate with a Buy rating and price target of HK$8.10

Slightly lower than consensus for 2013, but higher in 2014 and 2015


Sensitivity analysis According to our sensitivity analysis, revenue growth rates and changes in the gross margin will have the biggest impact on CMEC’s earnings. Our analysis suggests a 5% change in the revenue growth rate would affect earnings by 5.4%, while a 1ppt change in the gross margin would affect earnings by 7.5%, everything else being equal.

Figure 3: Sensitivity analysis on 2014E EPS

Revenue growth

10% 15% 20% 25% 30% 35% 40%

Gro

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argi

n

16.1% -29% -25% -20% -15% -10% -5% 0%

16.6% -26% -21% -16% -11% -6% -1% 4%

17.1% -23% -18% -13% -7% -2% 3% 8%

17.6% -20% -14% -9% -4% 2% 7% 12%

18.1% -16% -11% -5% 0% 5% 11% 16%

18.6% -13% -7% -2% 4% 9% 15% 20%

19.1% -10% -4% 2% 7% 13% 19% 25%

19.6% -6% -1% 5% 11% 17% 23% 29%

20.1% -3% 3% 9% 15% 21% 27% 33%


Sensitivity on revenue and gross margin


Risk analysis

Industry risks

Uncertainty on global economic recovery

International engineering contracting business is highly correlated with the world economy. According to Engineering News-Record magazine (ENR), the international engineering contracting business revenue of the top 225 international contractors was flat during 2008-10, which is consistent with the global recession in 2009 (world GDP growth was -1% in 2009). The UBS global economics team forecasts global GDP growth to accelerate to 3.3%/3.4% in 2014/2015 from an estimated 2.4% in 2013E, of which developing economies’ GDP growth is expected to be 4.9%/4.8%.

Figure 4: World GDP versus developing economies Figure 5: Total international revenue of the top 225 international contractors

Source: International Monetary Fund, UBS estimates Source: ENR

Potential slowdown of public infrastructure investment

International engineering contracting business also depends on the level of public infrastructure spending by relevant governments or governmental agencies in various countries.

Figure 6: Global fixed asset investment value and infrastructure engineering investment value

Source: World Bank

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Renminbi appreciation

International engineering contracts are normally signed in either US dollars or local currency (similarly for revenue recognition), while some of the costs for Chinese contractors may be incurred in Renminbi (such as equipment and labour). As a result, Chinese contractors may incur forex losses if the Renminbi appreciates against the US dollar or the local currency where a project is located. Furthermore, Renminbi appreciation may reduce the competitiveness of Chinese contractors' trading business versus non-Chinese competitors. UBS China Economist Tao Wang expects a US$:Rmb exchange rate of 6.10/6.10 by the end of 2014/2015. CMEC incurred Rmb332/Rmb505m forex losses in 2010/2011 when the Renminbi appreciated 3.3%/5.0% against the US dollar.

Figure 8: CMEC's forex net loss versus Rmb appreciation Figure 9: CMEC's revenue breakdown by currency

Source: Company data, Bloomberg Source: Company data

Other risks regarding overseas contracts

International engineering contracting involves dealing with different countries and different project owners, and tends to be much more complicated than similar construction work that most Chinese contractors carry out in China. Furthermore, unstable economic, regulatory, social and political conditions may all affect ultimate profit margins for international engineering contracting. There have been several examples of unsuccessful attempts by Chinese contractors in the international engineering market, including CRCC in Saudi Arabia, CRG in Poland and Longking in India.

Figure 10: Past failures overseas by Chinese contractors

Company Time Country Loss

CRCC 2010 Saudi Arabia Rmb4.148bn

CRG 2011 Poland Rmb632m

Longking India NA Source: Company data

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Company specific risks

Competition from other Chinese peers

One of the major concerns of investors on China's ‘Going Global’ policy is that it will lead to more competition among Chinese contractors and squeeze profits for all market participants, similar to the experience of Korean E&C companies. CMEC faces competition from major Chinese international engineering contractors in the power sector such as Sinohydro, Shandong Electric Power Construction Corporation III (SEPCOIII), Shanghai Electric and Shandong Electric Power Construction Corporation (SEPCO). In addition, major Chinese transportation infrastructure contractors (including CCCC, CRCC and CRG) also plan to expand their business overseas. However, we believe CMEC's superior track record will provide it with an advantage when bidding for projects supported by the Chinese government.

Figure 11: Overseas revenue comparison in 2012 Figure 12: International power sector engineering revenue 2007-12

Note: Harbin = Harbin Electric, Dongfang = Dongfang Electric, Shanghai = Shanghai Electric. Source: Company data


Major Chinese competitors in the overseas power sector include Sinohydro, SEPCOIII, Shanghai Electric and SEPCO.

Figure 13: Top Chinese international engineering contractors in the power sector (by revenue from international power projects in US$ m)

Company 2012 2007-12

Sinohydro 2,737 10,473

CMEC 1,592 8,089

SEPCOIII 2,119 7,668

Shanghai Electric 1,632 5,680

SEPCO 1,427 5,227

Source: Company data, ENR

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Competition with CAMCE

CMEC entered into a non-competition agreement with SINOMACH (the parent company, which holds a 77.99% stake in CMEC) to the effect that other subsidiaries of SINOMACH (excluding CAMCE) will not compete with CMEC in respect of the core sectors (power, transport and telecommunication). This leaves the door open for SINOMACH's 61.22%-owned CAMCE to compete with CMEC in the future. However, we are not concerned, as SINOMACH has made it clear that CMEC will be its flagship overseas platform and we expect more resources to be allocated to CMEC in the future.

Figure 14: New contract comparison of CMEC and CAMCE Figure 15: Revenue comparison of CMEC and CAMCE in 2012

Source: Company data Source: Company data

CMEC has a relatively more diversified geographical exposure than CAMCE, with a focus on Asia and Africa, while CAMCE is more concentrated in Asia and South America.

Figure 16: CMEC’s revenue breakdown by region Figure 17: CAMCE’s revenue breakdown by region


In terms of business segments, CMEC focuses on the power segment, with additional exposure in transportation and telecommunications. CAMCE focuses on the agriculture and industrial engineering segments, with exposure in water, power and transportation.

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CMEC focuses on power; CAMCE focuses on industrial and agriculture


Figure 18: CMEC’s construction contracts revenue breakdown


CMEC delivered much higher gross margins (especially in the construction segment) than CAMCE in recent years.

Figure 19: Gross margin comparison of CMEC and CAMCE


CMEC's ROE has been much higher than CAMCE’s, while both have been in a net cash position over the past four years.

Figure 20: ROE comparison of CMEC and CAMCE Figure 21: Net gearing comparison of CMEC and CAMCE


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Concentration of customers and suppliers

CMEC’s main customers for international engineering contracting business are primarily the project owners of its engineering contracting projects. In 2009/2010/2011/2012, its five largest customers in aggregate accounted for 42.3%/34.0%/36.1%/28.0% of its total revenue and its largest customer accounted for 10.1-12.2% of its total revenue in 2009-12. In the same period, purchases from CMEC’s five largest suppliers (which include subcontractors) accounted for 13.2%/13.0%/13.8%/13.8% of its cost of sales. CMEC's largest supplier accounted for approximately 3.3-4.2% of its cost of sales in 2009-12.

Figure 22: Concentration of customers: top 5 customers’ share

Figure 23: Concentration of suppliers: top 5 suppliers’ share


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Competitive analysis

Assessment of industry attractiveness

Solid growth in infrastructure engineering investment in developing countries

The growth rate of infrastructure engineering investment has been higher in developing countries, where CMEC principally operates its business. According to the World Bank, infrastructure engineering investment value in developing countries delivered a CAGR of 10.6%, growing from US$1,214bn in 2001 to US$3,016bn in 2010 while developed countries showed a CAGR of -4.5%. Due to the relatively strong economic growth rate, urbanisation and industrialisation, the World Bank estimates that infrastructure engineering investment in developing countries will continue to increase, at a CAGR of 9.6% from 2010 to US$4,766bn in 2015. In developing countries, power related, transportation and telecommunication infrastructure accounted for over 70% of total infrastructure investment.

Figure 24: Infrastructure engineering investment value and annual growth rate

Figure 25: Infrastructure engineering investment in developing countries, broken down by type

Source: World Bank Source: Ipsos

According to ENR, the total new contract value of infrastructure engineering projects was approximately US$881bn/US$826bn in global markets/developing countries, implying a CAGR of 6.3%/7.5% in 2006-12. Among the various types of projects, power, transportation and telecommunications infrastructure contracts together represented 76% of total new contract value in developing countries in 2012. Power infrastructure has been the main engine of growth as its new contract value increased from US$72bn in 2006 to US$276 in 2012 translating to a CAGR of 25%. Chinese contractors signed new contracts of US$157bn overseas in 2012, among which power/transportation/telecommunications accounted for 14%/23%/11%.

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247 263 304 275 421 505 507 437 459 402 512 608 748 9071,057598

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Power-related infrastructure Transportation infrastructureTelecommunication infrastructure

US$ bn

Fast growing infrastructure spending by developing countries

Power, transportation and telecommunication are the major infrastructure spending overseas


Figure 26: New contract value of infrastructure engineering projects in developing countries breakdown

Figure 27: 2012 new contract value of Chinese contractors in the global market breakdown

Source: Ipsos Source: Ministry of Commerce, China International Contractors Association

Strong demand for power infrastructure in developing countries

We expect a rapid growth period for power related infrastructure in developing countries in coming years for the following reasons: 1) most are experiencing industrialisation and urbanisation, which are two key drivers for electricity consumption growth; and 2) their power infrastructure development is far behind that of developed countries. According to Enerdata, the electricity consumption CAGRs in Asia/the Middle-East/Africa were 7.5%/6.3%/4.4% in 2001-12 while the global growth rate was 3.5%.

Figure 28: Developing countries industrial activity growth Figure 29: Global electricity consumption breakdown

Source: World Bank, UBS estimates Note: CIS= Commonwealth of Independent States. Source: Enerdata

A significant number of countries (especially in Sub-Saharan Africa, South Asia and Southeast Asia) have per capital electricity consumption and production levels well below China’s. For example, India’s electricity production per capita was 720KWH in 2012, which was one fifth of China’s 3,685KWH.

72171 144 167 204 239 276

205142 137

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217221

220197

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2006 2007 2008 2009 2010 2011 2012Power-related Transportation Telecommunication Others

US$ bnPowerUS$21bn14%

Housing constructionUS$32bn20%

TransportationUS$36bn23%

PetrochemicalUS$17bn11%

TelecommunicationsUS$18bn11%

Water and sewageUS$7bn5%

OthersUS$25bn16%

-8%

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Asia North America Europe CISLatinn America Middle-East Africa Pacific

TWh

Rapid growth of power infrastructure needs


Figure 30: China GDP versus power capacity growth Figure 31: Electricity production per capita in 2012

Source: CEIC, UBS estimates Note: ME&NA= Middle East & North Africa, S Africa= Sub-Saharan Africa; Middle East and North Africa and Sub-Saharan Africa data in 2011, others in 2012. Source: World Bank, U.S. Energy Information Administration

According to the Secretariat for Infrastructure of India, India estimated investment of US$514bn/US$1trn during its 11th (2007-12)/12th (2012-17) Five Year Plans to revamp infrastructure. The Asian Development Bank (ADB) estimates Asia’s overall national infrastructure investment needs to be US$8trn over the 2010-20 period (including China’s US$4.4trn), of the total, it estimates Pakistan/Bangladesh/Kazakhstan needs US$179bn/US$145bn/US$70bn. ASEAN nations are estimated to need about US$583.1bn of infrastructure investment by 2020.

Figure 32: 2012- 20F new capacity addition breakdown Figure 33: 2012-20E new capacity addition in Asia

Source: US Energy Information Administration Source: CEIC, UBS estimates

Chinese government helping Chinese contractors

The Chinese government provides policy and financial support to encourage Chinese contractors to seek opportunities in overseas markets, especially in developing countries in Asia, Africa and Latin America. According to the Ministry of Commerce, the revenue of contracted projects overseas rose from US$11.2bn in 2002 to US$137.1bn in 2013, representing a CAGR of 26%, whereas the value of new contracts increased at a 25% CAGR during the same period.

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Potential demand for power is significant

Chinese companies have already expanded overseas


Figure 34: Chinese contractors’ revenue and new contract value from overseas

Source: Ministry of Commerce

Figure 35: Milestones in ‘Going Global’ policy

Regulation / Event Effective date Authority Comment Circular on Approval Authority and Procedure for Establishing Non-trade Joint Ventures Overseas

1st May 1984 MOFTEC A transition from case approval to normative approvals

Provisions Governing Control and Approval Procedures for Opening Non-Trade Enterprises Overseas

1st Feb. 1985 MOFTEC For the first time included all economic entities in official overseas investment provision, as opposed to merely trading companies

Established The Export-Import Bank of China and China Development Bank

1994 Governed by State of Council To provide credit for Chinese companies facilitating their overseas contracting projects and investments

Set up four Industrial investment funds with foreign institutions

From 1998 CDB To provide funding sources and platform

The Tenth Five-Year Plan for National Economic and Social Development of the People's Republic China

15th Mar. 2000 National People's Congress ’Going Global’ strategy explicitly proposed and officially recorded

Established China Export and Credit Insurance Corporation

18th Dec. 2001 Governed by SASAC To offer insurance coverage and export financing for outward foreign investments

Circular on Settling Profit Deposit for Overseas Investments

15th Nov. 2002 SAFE Cancelled the requirement to set aside 5% of the investment as profit wire back guarantee

Circular of the State Administration of Foreign Exchange on the Transitional Policy and Measures

1st Apr. 2003 SAFE Cancelled foreign exchange risk review on domestic institution investments, and simplified source review on foreign investments

Notice of Providing Credit Supports to the Key Overseas Investment Projects Encouraged by the State

27th Oct. 2004 SDRC, The Export-Import Bank of China

Provided discount interest rate for outward foreign investment loan

Circular on the Revision of Certain Foreign Exchange Control Policies Relating to Overseas Investment

1st Jul. 2006 SAFE Removed limitation on currency purchase for outward foreign investments

Several opinions on Encouraging and Guiding Outward Foreign Investment of Non-State-Owned Companies

10th May 2007 MOF, MOC, ACFIC, The People's Bank of China

Encouraging the provision of special funds or loan discount for outward investment projects of non-state-owned companies

Administrative Regulations on Contracting Foreign Projects

1st Sep. 2008 State of Council Indicated the project contracting entities should have the status of a legal person and special grade or grade A qualification certificate

Provisions on the Foreign Exchange Administration of the Overseas Direct Investment of Domestic Institutions

1st Aug. 2009 SAFE Substituted the review policy on the capital source of outward investment with materials recording and registration policy

Established China (Shanghai) Pilot Free Trade Zone 29th Sep. 2013 Approved by State of Council Simplified the outward foreign investment registration procedure for companies within the FTZ

China proposed to set up the Asian Infrastructure Investment Bank

2nd Oct. 2013 President Xi Jinping proposed at a meeting with Indonesian president, Susilo Bambang Yudhoyono

To cooperate with the multilateral development banks to facilitate the development for Asian countries

Notes: MOFTEC = Ministry of Foreign Trade and Economic Cooperation of China, CDB = China Development Bank, SASAC = State-owned Assets Supervision and Administration Commission, SAFE = State Administration of Foreign Exchange, SDRC = National Development and Reform Commission, ACFIC = All-China Federation of Industry and Commerce; Source: Ministry of Commerce, UBS

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The Chinese government is providing increasing financial support to help developing countries with their infrastructure development under the ‘Going Global’ policy and ‘Supporting Developing Countries’ policy. Export-Import Bank of China and China Export & Credit Insurance Corporation are two major parties providing funding for overseas infrastructure construction projects.

Figure 36: Export credit amount from the Export-Import Bank of China

Figure 37: Guarantee amount from the Export-Import Bank of China

Source: Export-Import Bank of China Source: Export-Import Bank of China

Based on Ministry of Commerce statistics and ENR, in 2012, Chinese contractors generated revenue of US$116.6bn in the international infrastructure engineering market, of which 46% came from Asia Pacific and 35% came from Africa. CMEC ranked eighth in terms of revenue derived from overseas.

Figure 38: Chinese contractors 2012 overseas revenue by region

Figure 39: Top Chinese international engineering contractors in the global market in 2012

Company

Revenue from overseas

(US$ m)

China Communications Construction Group 11,187

Sinohydro Corporation 5,473

China State Construction Engineering Corporation 4,988

China Railway Group Ltd. 3,800

CITIC Construction Co., Ltd. 2,636

China Metallurgical Group Corporation 2,296

China Railway Construction Corporation 2,147

CMEC 2,126

SEPCO III 2,099

Gezhouba Group 2,009

Others 77,840

Total 116,600 Source: Ministry of Commerce, China International Contractors Association Source: ENR, company data

1,0281,239 1,300

1,7311,442

1,695 1,754149

174 183

295

326

439 425

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US$ bn

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US$ bn

AsiaUS$54bn46%Africa

US$41bn35%

Latin AmericaUS$11bn10%

EuropeUS$7bn6%

North AmericaUS$1bn1%

OceaniaUS$2bn2%

Financial support by Chinese government

Chinese contractors engaged mainly in Asia and Africa


Competitive strengths CMEC is a leading international engineering contractor, with particular expertise in the power-related infrastructure sector. Its main competitive advantage is premium ROE, a strong cash position, an extensive global network, an experienced team and a rich contract backlog.

High margin & asset-light model contribute to high ROE

CMEC delivered an industry-leading ROE of 25.2% in 2012, far exceeding its major competitors in China. We attribute this to CMEC’s better profitability and asset-light model, which has resulted in leading asset turnover. CMEC's leverage is also low compared with peers, which leaves room for acquisitions or ROE improvement from higher gearing.

Figure 40: ROE decomposition in 2012


CMEC’s gross margin is significantly better than its competitors, which we attribute to its strong presence in the power segment, where the gross margin was 21-27% in 2010-12. The major reasons for its strength in this segment are better pricing and lower costs.

ROE

Net margin Asset turnover Leverage

25.2%

12.5%14.9% 14.1%

18.8%

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CMEC Harbin Electirc Dongfang ElectricSinohydro CAMCE Shanghai Electric

9.1%

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Premium ROE over peers

Highest gross margin among peers


Figure 41: Comparison of overseas construction contracts gross margins

Note: CMEC and Harbin Electric’s gross profit = net revenue – COGS, i.e. net of business tax; Sinohydro, CAMCE, Dongfang Electric and Shanghai Electric’s gross profit = gross revenue – COGS, i.e. before business tax; Source: Company data

From the perspective of project bidding, CMEC has three major bidding processes: tender negotiation; tender invitation; and public bid invitation. CMEC favours tender negotiation which offers higher pricing. The concentration of suppliers for CMEC is relatively low; its top five suppliers accounted for around 13% of corresponding cost of sales during 2009-12, while its largest supplier only accounted for 4% of the total. As a result, CMEC has strong bargaining power over Chinese suppliers to help lower its own costs.

Figure 42: Comparison of three bidding processes

Type Competition Process Terms and conditions as % of track record

Tender negotiation Non-public invitation, no competition one-on-one Based on private negotiations 73.6

Tender invitation Targeted invitations to a defined group of contractors bid on price predetermined 16.0

Public bid invitation Open to public bidding by all contractors bid on price predetermined 10.4 Source: Company data

Strong working capital management

Unlike most Chinese contractors who have experienced rising receivable problems in China, CMEC maintains significant advance receipts as result of aggressively using export buyer’s credit (credit provided to foreign borrowers to finance imports of Chinese products). CMEC has barely used export seller’s credit, instead, using more export buyer’s credit, which has no default risk and thus provides better working capital. CMEC's advance receipts amounted to Rmb9.1bn as at 30 June 2013, which is 21% of the backlog on the same date. CMEC can assist project owners, in particular in developing countries, to obtain financing for infrastructure projects from Chinese financial institutions and development funds in two ways: export buyer’s credit and export seller’s credit. The Chinese government is providing increasing financial support to help developing countries with their infrastructure development under the ‘Going Global’ policy and ‘Supporting Developing Countries’ policy.

0%

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25%

30%

2009 2010 2011 2012

CMEC Harbin Electirc Dongfang Electric Sinohydro CAMCE Shanghai electric

Good pricing and cheaper costs also contribute to higher margins

Buyer’s credit helps working capital


Figure 43: Export credit amount from the Export-Import Bank of China

Figure 44: Advance receipts versus contract backlog

Source: Export-Import Bank of China Source: Export-Import Bank of China

Strong balance sheet and cash flow generating ability

CMEC’s has a strong balance sheet with low debt and rich cash in hand. Its net cash amount was close to its current market cap as at 13 February 2014. Furthermore, we believe CMEC has the ability to generate strong operating cash flow which may be used for potential acquisitions.

Figure 45: CMEC’s net cash Figure 46: Operating cash flow versus capex

Note: 2014/15E market cap represents market cap as at 13 February 2014; Source: Company data


1,0281,239 1,300

1,7311,442

1,695 1,754149

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Extensive global network

CMEC has a long history of EPC contract work and trading around the world, and it currently operates 13 affiliates and 26 foreign representative offices overseas, covering multiple industries including project contracting, trading, engineering design, international bidding, international exhibitions, international logistics and property management.

Figure 47: International coverage

Source: Company data, UBS

Experienced management team and project managers

CMEC's key asset is its experienced management team and project manager team. It has a strong technical team of 1,201 engineers, 704 of whom are designers, 19 certified architects, 20 certified budgeting specialists and 163 international project management professionals (IPMP) which account for 13.5% of the overall team (2 are level A, 7 are level B, 154 are level C). CMEC also has 131 project managers.

Good overseas track record

Key asset is experienced personnel


Figure 48: Experienced senior management team

Role Experience Educational level Certificates

Sun Bai Chairman and Executive

Director

30+ years industry experience and

management experience

Master's degree in

economics

National senior economist

Zhang Chun President and Executive

Director

Over 21 years industry experience Bachelor’s degree in thermal

engineering

National senior engineer

Li Taifang Vice Chairperson and

Executive Director

Over 17 years financial

management experience

Postgraduate Member of Chinese Institution of Certified

Public Accountants, national senior economist

Jiao Hanzhou Vice president, in charge of

trading business

Almost 30 years of experience in

the machinery and equipment

industry, joined CMEC in 1982

Bachelor’s degree in electric

apparatus

Senior engineer

Jin Chunsheng Vice president, in charge of

international engineering

contracting business

Over 30 years of experience in the

machinery and equipment industry,

joined CMEC in 1982

Bachelor’s degree in

hydraulic machinery

Professorial engineer

Zhang Jianguo Vice president, in charge of

trade and other business

Joined CMEC in 1991 Master's degree in history Senior economist

Wang Dingning Vice president, in charge of

the general affairs

Joined CMEC in 2006 Graduated from the Party

School in economic

management

Senior political work specialist

Li Chaoyang Vice president, in charge of

international engineering

contracting business

Over 15 years of experience in the

machinery and equipment industry,

joined CMEC in 2005

Bachelor’s degree in

computer science and

application

Senior engineer

Zhou Yamin CFO Joined CMEC in 2011 Bachelor’s degree in

accounting

Member of Chinese Institution of Certified

Public Accountants, an international certified

practicing accountant and a senior

international finance manager

Chen Minjian Secretary to The Board Joined CMEC in 1978 Graduated from the

University of International

Business and Economics

Senior economist


Rich contract backlog

CMEC’s contract backlog rose rapidly from US$3.7bn to US$7.1bn in 2009-12, implying a CAGR of 25%, while revenue from the construction contracts segment was US$2.1bn in 2012; this had a 3.3x backlog/revenue ratio. Furthermore, as at end-H113 CMEC had another US$11.8bn of contracts which had been signed but had not yet come into effect.

Figure 49: Contract backlog Figure 50: Signed contracts pending as at the end of H113


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Construction contracts revenue New contractBacklog Backlog/revenue

US$ m

PowerUS$4.8bn41%

TransportationUS$3.4bn28%

TelecommunicationsUS$0.1bn1%

Non-core sectorsUS$3.5bn30%

Backlog covers close to 3x of revenue


Management strategy

Focusing on overseas

CMEC's overseas revenue exposure was around 90% in the past, much higher than normal transportation infrastructure contractors (such as CCCC, CRCC and CRG). The remaining around 10% domestic revenue mainly comes from domestic trading business.

Figure 51: Overseas revenue as % of total revenue comparison

Note: Overseas revenue includes all segments. Source: Company data

According to the Ministry of Commerce, CMEC ranked eleventh and twelfth in terms of overseas revenue and new contract revenue, respectively, in 2013. However, it was fourth and third respectively for power related overseas revenue and new contract revenue.

Figure 52: Top Chinese enterprises in contracted projects overseas in 2013

Rank Company

Overseas revenue

(US$ bn) Focusing Sector Company

Overseas new contract (US$ bn) Focusing Sector

1 ZTE 13.0 Telecommunication Huawei 13.9 Telecommunication

2 Huawei 9.2 Telecommunication China State Construction Engineering 11.2 Housing

3 China State Construction Engineering 5.7 Housing ZTE 9.0 Telecommunication

4 Sinohydro 5.3 Power Sinohydro 9.0 Power

5 China Harbour Engineering 3.4 Transportation China Gezhouba 8.2 Power

6 CITIC Construction 2.8 Housing China Harbour Engineering 6.0 Transportation

7 ZPMC 2.7 Manufacturing China Civil Engineering Construction 4.9 Transportation

8 China Gezhouba 2.4 Power CCCC 4.8 Transportation

9 China Road and Bridge 2.2 Transportation ZPMC 3.5 Manufacturing

10 SEPCOIII 2.2 Power Sinopec International 3.5 Petroleum

11 CMEC 2.1 Power China Road and Bridge 2.5 Transportation

12 Shanghai Electric 2.1 Power CMEC 2.3 Power

Source: Ministry of Commerce

Focusing on power

According to ENR’s top 225 international contractors list in 2012, CMEC ranked eighth in terms of revenue from the international power market. And CMEC's power projects delivered much higher gross margins than other projects (such as transporation and telecommunications).

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CMEC CCCC CRCC CRG CSCI Sinohydro CAMCE

Main focus is overseas

47% of revenue in power, with significantly higher margins


Figure 53: Top 10 international contractors in the global power market

2011 2012

Rank Company International revenue in power market

(US$ m) Country Company International revenue in power market

(US$ m) Country

1 Grupo Acs 4,049 Spain Abeinsa Sa 3,918 Spain 2 Abeinsa Sa 3,675 Spain Grupo Acs 3,422 Spain 3 Sinohydro 2,244 China Hyundai E&C 2,891 South Korea 4 VINCI 2,241 France Sinohydro 2,737 China 5 SEPCOIII 2,020 China VINCI 2,210 France 6 SEPCO 1,570 China SEPCOIII 2,099 China 7 Shanghai Electric 1,546 China SEPCO 1,880 China 8 CMEC 1,482 China CMEC 1,592 China 9 Metka 1,157 Greece SAMSUNG C&T 1,549 South Korea 10 Dongfang Electric 1,156 China Grupo Isolux Corsan Sa 1,537 Spain

Others 25,904 28,068 Total 47,043 51,902

Source: ENR, company data

Asset injection

We believe an asset injection from the parent company, SINOMACH, will benefit CMEC. According to CMEC’s IPO prospectus, SINOMACH intended to transfer all of its equity interest in China National Electric Engineering (CNEEC), China National Complete Engineering Corporation (CMCEC) and China National Automation Control System Corporation (CACS) to CMEC within three years after listing (before 2016). We estimate 2015 EPS accretion of 5% if injection of CNEEC and CMCEC can be completed by end of 2014E.

Figure 55: Non-listed SINOMACH subsidiaries under SINOMACH’s intention of injection

Business Geographical focus Revenue in 2011

(Rmb m) Revenue in H112

(Rmb m)

CNEEC Engineering contracting of power projects South-east Asia, China, Middle Asia, Africa 3,754 2,434

CMCEC Civil engineering projects and property development China 1,457 828

CACS Traditional automation technologies and supply of electrical

cables and wires and other related equipment

China 1,526 582


In addition, SINOMACH has several listed assets, which may turn out to be good long-term assets to be acquired by CMEC.

Figure 56: SINOMACH’s listed assets

SINOMACH's listed assets Code Mkt cap (Rmb m) 2012 Net profit (Rmb m) 2012 Net gearing

CMEC 1829.HK 18,223 1,928 -189%

CAMCE 002051.SZ 12,139 635 -177%

YTO 0038.HK 3,179 349 0%

ZYS 002046.SZ 2,354 65 10%

Sinomach Auto 600335.SS 9,408 556 338%

Changlin 600710.SS 1,444 10 -7%

Linhai Power 600099.SS 1,157 0 -55%

Lanpec 601798.SS 4,230 105 4%

Erzhong Heavy 601268.SS 5,298 (2,889) 196%

Note: Above data as at 13 February 2014; YTO = YTO Group Corporation, ZYS = Luoyang Bearing Science & Technology Co.,Ltd., Sinomach Auto = Sinomach Automobile Co.,Ltd., Changlin = Changlin Company Limited, Lanpec = Lanpec Technologies Limited, Erzhong Heavy = China Erzhong Group Heavy Industries Co.,Ltd. Source: Company data, Bloomberg

Figure 54: Scenario analysis on asset injection

Funding cost

4.0% 4.5% 5.0% 5.5% 6.0%

Net

mar

gin

4% 4% 4% 3% 3% 3%

5% 5% 5% 4% 4% 3%

6% 6% 6% 5% 5% 4%

7% 7% 7% 6% 5% 5%

8% 8% 8% 7% 6% 5%


More assets from the parent company


Financials

Profit and loss We expect CMEC to deliver a 15% reported net profit CAGR in 2013-15 on a 12% revenue CAGR.

Figure 57: Profit & loss table

(Rmb m) 2009 2010 2011 2012 2013E 2014E 2015E

Revenues 19,288 19,077 20,518 21,296 21,487 26,855 29,644

Cost of goods sold (17,528) (16,135) (16,859) (17,565) (17,635) (21,978) (24,348)

Gross profit 1,760 2,942 3,659 3,732 3,852 4,877 5,295

SGA (1,051) (1,096) (1,385) (1,565) (1,612) (2,014) (2,223)

EBIT 570 1,526 2,138 2,041 2,155 2,778 2,987

Income from associates 0 0 (0) (0) (0) - -

Finance income 353 412 402 583 791 826 893

Finance expenses (76) (386) (560) (30) (432) (31) (31)

Profit before taxes 835 1,561 1,987 2,616 2,601 3,590 3,866

Taxes (225) (429) (515) (688) (650) (897) (967)

Profit after tax 610 1,132 1,472 1,928 1,950 2,692 2,900

Minorities 3 4 3 (0) (0) (0) (0)

Net profit 614 1,136 1,475 1,928 1,950 2,692 2,899

Pre-x net profit 650 1,385 1,851 1,918 2,194 2,688 2,895

Revenue growth NA -1% 8% 4% 1% 25% 10%

EBIT margin 3% 8% 10% 10% 10% 10% 10%

EBIT growth NA 168% 40% -5% 6% 29% 8%

Net profit growth NA 85% 30% 31% 1% 38% 8%


New effective contracts is the major leading indicator for potential revenue growth. We estimate new effective contracts to grow 16%/11% YoY in 2014/2015 to US$3.9/US$4.3bn after retreating 23% YoY in 2013E, partly underpinned by strong signed contracts pending (US$11.8bn as at 30 June 2013). Power should remain the major new contract contributor, representing 44% of our estimated total effective new contracts in 2015, delivering growth rates of 15%/10% YoY in 2014E/2015E. In terms of regions, we expect traditional markets (Africa and Asia) to remain dominant, with South America becoming another rising star (for example, a potential a new railway project in Argentina). The company’s backlog at the end of H113 was US$7.1bn, which is equivalent to 3.3x 2012 construction revenue of Rmb13.2bn.

15% net profit CAGR in 2013-15E

New contracts to grow 16%/11% YoY in 2014E/2015E


Figure 58: Newly effective contracts by segment Figure 59: Newly effective contracts growth rate

(US$ m) 2009 2010 2011 2012 2013E 2014E 2015E

Power 789 2,515 1,583 4,127 1,512 1,739 1,913

Transportation - 112 407 9 706 811 893

Telecommunications - - 209 11 370 425 468

Non-core sectors 312 328 28 218 773 927 1,066

Total 1,100 2,955 2,227 4,365 3,360 3,903 4,339



Looking into different business segments, we expect international engineering construction contracts to be the major revenue growth driver as we believe demand for power infrastructure in developing countries will grow quickly in the next few years.

Figure 60: Revenue breakdown Figure 61: Revenue growth for different segments

Source: Company data, UBS estimates Source: Company data, UBS estimates

The power segment, as the largest gross profit contributor, benefitted from high gross margins of 20.7%-27.2% in 2010-12. We estimate power’s premium gross margin to continue in 2014-15 at 22.1-22.4%. Unlike some Chinese peers, the performance matrix for CMEC management is profit and return, and we expect the gross margin of construction contracts to be slightly lower in 2014-15 and gradually decline later due to increasing competition among Chinese peers in overseas markets.

0%

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2009 2010 2011 2012 2013E 2014E 2015E

Power Transportation Telecommunications Non-core sectors

71%63% 59% 62%

72% 74% 74%

26%33% 37% 34%

23% 22% 22%

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2010 2011 2012 2013E 2014E 2015E

Overall Construction contractsTrading Others

International engineering contracting to be the major revenue growth driver

Power gross margin to stay high


Figure 62: Gross margin of different segments Figure 63: Gross margin of construction contacts in different sectors


We estimate that SG&A as a percentage of revenue will stabilise around 7.5% of revenue in 2013-15 and that the EBIT margin will be around 10%.

Figure 64: Selling expenses and administrative expenses Figure 65: EBIT and EBITDA margin


We forecast finance income (from interest income and finance income on receivables from customers) of Rmb826m/Rmb893m in 2014/2015, representing 30.7%/30.8% of reported net profit. We expect the forex loss to shrink to zero in 2014/2015 as we expect no Renminbi appreciation in 2014/2015, after a Rmb400m forex loss in 2013E.

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2009 2010 2011 2012 2013E 2014E 2015E

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2009 2010 2011 2012 2013E 2014E 2015E

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2009 2010 2011 2012 2013E 2014E 2015E

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2009 2010 2011 2012 2013E 2014E 2015E

EBIT margin EBITDA margin

EBIT margin to stabilise

Finance income still significant, forex loss to ease


Figure 66: Finance income breakdown Figure 67: Forex loss against Renminbi appreciation


Balance sheet We estimate the balance sheet will remain strong and the company’s net cash position will continue in 2013-15, as we have not factored in the asset injection of CNEEC, CMCEC and CACS.

Figure 68: Total cash versus total debt Figure 69: Net gearing


Figure 70: Balance sheet

(Rmb m) 2010 2011 2012 2013E 2014E 2015E

Net tangible fixed assets 345 392 444 478 503 517 Net intangible fixed assets 112 1,668 1,851 1,912 1,973 2,034 Net working capital -5,329 -6,177 -8,290 -6,884 -5,954 -6,034 Other long-term liabilities -324 -132 -62 -62 -62 -62 Total invested capital -5,196 -4,249 -6,057 -4,556 -3,541 -3,544 Investments/other assets 6,311 5,218 4,539 4,664 6,475 7,334 Total capital employed 1,115 968 -1,518 108 2,934 3,789 Net (cash)/debt -3,243 -4,785 -11,801 -11,907 -11,090 -12,193 Provisions 393 380 366 366 366 366 Minority Interests -4 -6 -3 -2 -2 -1 Shareholders’ Funds 3,969 5,380 9,920 11,652 13,661 15,618 Total capital employed 1,115 968 -1,518 108 2,934 3,789 Fixed asset growth NA 13% 13% 8% 5% 3% Capital employed growth NA -13% NA NA 2609% 29%


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2009 2010 2011 2012 2013E 2014E 2015E

Interest incomeFinance income on receivables from customers% of avg. receivable% of avg. cash

Rmb m

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2009 2010 2011 2012 2013E 2014E 2015E

Net cash position to continue in 2013-15E, without taking into account of acquisitions


Advance receipts amounted to Rmb12.7bn at the end of 2012, and declined to Rmb9.2bn at the end of H113. We expect advance receipts to remain at high levels during 2013-15 as the company increasingly uses export buyer’s credit.

Figure 71: Advance receipts versus backlog Figure 72: Construction contracts and as % of revenue



Figure 73: Net working capital

(Rmb m) 2010 2011 2012 2013E 2014E 2015E

Accounts receivable 4,919 6,427 5,510 5,560 6,958 7,685

Inventory 175 212 226 227 282 313

Other current assets 8,447 7,521 10,111 9,473 9,524 9,576

Accounts payable (9,605) (9,671) (10,943) (11,492) (12,068) (12,673)

Other short term liabilities (9,265) (10,666) (13,193) (10,651) (10,651) (10,936)

Net working capital (5,329) (6,177) (8,290) (6,884) (5,954) (6,034)

Days of receivables 94 114 94 94 95 95

Days of Inventory 3 4 4 4 4 4

Days of payables 217 209 227 238 200 190

Days of NWC (102) (110) (142) (117) (81) (74)


Cash flow We estimate operating cash to improve significantly from 2015 as more new contracts are signed in terms of export buyer’s credit, hence significant advance receipts.

20%

27%

31%29%

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2009 2010 2011 2012 2013E 2014E 2015E

Construction contracts as % of revenue

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Advance receipts to remain high

OpCF to turn strong in 2015E


Figure 74: Cash flow

Rmb m 2010 2011 2012 2013E 2014E 2015E

EBIT 1,526 2,138 2,041 2,155 2,778 2,987

Depreciation 41 72 99 107 116 126

Change in working cap 4,291 1,434 5,037 (1,531) (2,741) (779)

Other operating (139) (306) 110 (324) 7 7

Operating cash flow 5,718 3,338 7,287 407 161 2,341

Interest 358 348 550 760 795 862

Taxes paid (445) (683) (603) (650) (897) (967)

Capex (21) (925) (309) (202) (202) (202)

Free cash flow 5,610 2,079 6,925 314 (144) 2,035

Net acquisitions / disposals 3 1 5 0 0 0

Dividends (common) (273) (698) (354) (675) (682) (942)

Dividends (preferred) 0 0 0 0 0 0

Share issues / buybacks 0 0 3,012 457 0 0

Other NA (168) (2,633) (305) 26 26

Cash flow (inc)/dec in net debt NA 1,214 6,955 (208) (800) 1,119

Capex/sales 0.1% 4.5% 1.4% 0.9% 0.8% 0.7%

Net debt to equity -81.7% -88.9% -119.0% -102.2% -81.2% -78.1%


Return on capital We estimate ROE to be around 20% during 2013-15.

Figure 75: ROCE/ROE decomposition

2010 2011 2012 2013E 2014E 2015E

Asset turnover -367.2% -434.5% -413.3% -404.9% -663.4% -836.8%

EBIT margin 8.0% 10.4% 9.6% 10.0% 10.3% 10.1%

EBIT ROIC -29.4% -45.3% -39.6% -40.6% -68.6% -84.3%

Taxes 72.5% 74.1% 73.7% 75.0% 75.0% 75.0%

Returns on invested capital -21.3% -33.5% -29.2% -30.5% -51.5% -63.2%

IC as % of Capital employed -466.0% -453.4% 1875.6% 752.9% -266.1% -105.4%

Returns on other invested capital -3.7% -6.4% 0.4% -5.1% 0.2% 0.2%

Other assets/CE 566.0% 553.4% -1775.6% -652.9% 366.1% 205.4%

Returns on capital employed 78.3% 116.6% -554.1% -195.9% 137.8% 67.0%

Leverage 33.3% 25.0% -4.3% -8.9% 15.0% 28.8%

Minorities 109.8% 108.2% 104.8% 103.4% 102.9% 102.5%

Exceptional 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

ROE 28.6% 31.6% 25.2% 18.1% 21.3% 19.8%

ROE (adjusted) 34.9% 39.6% 25.1% 20.3% 21.2% 19.8% Source: Company data, UBS estimates


Valuation

Price target derivation We initiate coverage of CMEC with a Buy rating and price target of HK$8.10, which implies 10.0x/9.2x 2014E/2015E PE. We derive our 12-month price target by applying PE multiples on 2014E EPS. We apply a 7% PE multiple discount on listed Korean E&C companies to arrive at our target multiple of 10.0x as we believe Korean E&C companies are the closest peers. The discount to the price target implied PE for Korean E&C companies is to reflect CMEC being strong on projects backed by the Chinese government, while it is still weaker than Korean peers in commercial markets.

Figure 76: Price target derivation

EPS

2014E EPS (Rmb) 0.65

EPS CAGR (2013-15E) 15%

PE (x)

Target 2014 PE (x) 10.0

Historical PE avg. (x) 7.5

Premium/(discount) 33%

Korean E&C (PT implied) 10.7

Premium/(discount) -7%

Rating/PT

Price target (HK$) 8.10

Current price (HK$) 5.65

Upside/(downside) 43%

Rating Buy

Other financials

New contract CAGR (2013-15E) 13.6%

Net margin 2014E 10.0%

Net gearing 2014E -132%

ROE 2014E 21.3% Source: UBS estimates

CMEC is now trading slightly below its historical mean in terms of both forward PE and forward P/BV. We expect a re-rating as we believe growth will resume in 2014-15 after a weak 2013.

Figure 77: 12-month forward PE Figure 78: 12-month forward P/BV


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Initiate with a Buy rating and price target of HK$8.10


Comparables Our price target of HK$8.10 implies 2014E/2015E PE of 10.0x/9.2x, which is at a premium to most Hong Kong-listed Chinese construction companies (CCCC, CRCC and CRG), although at a discount to CSCI. We think this is reasonable as CMEC benefits more from its high overseas exposure and proven track record.

Korea-listed E&C companies

Korean E&C companies include Hyundai E&C (000720.KS), Daelim Industrial (000210.KS), Samsung Engineering (028050.KS), Hyundai Development (012630.KS) and GS E&C (006360.KS). According to UBS estimates, Korean E&C companies are trading at 2014/2015 PE of 23.4x/9.5x on abnormal earnings growth given some were loss making in 2012-13.

HK-listed construction companies

Chinese construction companies listed in Hong Kong include CCCC (1800.HK), CRCC (1186.HK), CRG (0390.HK), CSCI (3311.HK) and MCC (1618.HK). According to Bloomberg and UBS estimates, Hong Kong listed Chinese construction companies are trading at average 2014E/2015E PE of 7.3x/6.5x, on an average earnings CAGR of 15% over 2013-15E.

A-share listed construction companies

Major A-share listed construction companies with overseas exposure include Sinohydro (601669.SS), CREC (600528.SS), CAMCE (002051.SZ), Shenzhen Tagen (000090.SZ), Zhejiang Southeast Space Frame (002135.SZ) and China Haisum (002116.SZ). According to Wind, this group of companies trades at average 2014E/2015E PE of 10.7x/8.6x, on an average earnings CAGR of 21% in 2013-15E. The closest comparable with CMEC in the A-share market is CAMCE, which is trading at 13.0x/10.7x PE in 2014E/2015E.

Global construction companies

Major global listed construction companies with exposure in the power segment include Acs (ACS.SM), Jacobs Engineering Group (JEC.N), WorleyParsons (WOR.AX) and Abengoa (ABG.A). According to Bloomberg and UBS estimates, this group of companies trades at average 2014E/2015E PE of 15.4x/12.2x, on an average earnings CAGR of 8% over 2013-15E.

Figure 79: Implied multiples

2014E 2015E

Implied PE (x) 10.0 9.2

Implied P/BV (x) 1.9 1.7

Implied dividend yield 3.6% 3.9%

ROE 21% 20%

Implied EV/EBITDA (x) 5.3 4.6


HK listed peers

A-share peers

Global peers


Figure 80: Valuation

Name Ric code Mkt cap Price PE (x) P/BV (x) Div. Yld (%) ROE (%) EPS CAGR

(US$ bn) (LC) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013-15E

HK-listed

CMEC 1829.HK 3.0 5.65 8.4 6.8 6.3 1.6 1.3 1.2 3.7 5.2 5.6 20.3 21.2 19.8 15%

CCCC 1800.HK 12.0 5.76 5.8 4.9 4.5 0.9 0.7 0.6 3.6 5.0 5.4 13.8 14.3 13.9 13%

CRCC 1186.HK 10.7 6.75 6.3 5.7 5.2 0.8 0.7 0.6 2.6 2.9 3.1 13.7 13.4 13.0 9%

CRG 0390.HK 9.5 3.47 6.9 5.9 5.4 0.7 0.6 0.6 2.3 2.6 2.8 10.4 10.9 10.8 12%

CSCI 3311.HK 7.1 14.12 20.7 15.6 13.3 3.6 3.1 2.6 1.5 1.9 2.3 18.4 21.1 21.4 25%

Sinopec Engineering 2386.HK 5.6 9.78 8.3 6.8 5.8 1.5 1.3 1.1 3.6 4.4 5.2 28.5 21.0 20.9 19%

MCC* 1618.HK 5.0 1.35 7.0 5.6 5.3 0.5 0.4 0.4 1.1 1.7 4.0 6.8 7.7 7.8 15%

Average 9.1 7.3 6.5 1.4 1.2 1.0 2.6 3.4 4.1 16.0 15.7 15.4 15%Weighted average 8.6 7.0 6.3 1.3 1.1 0.9 2.7 3.4 3.9 15.0 14.9 14.7 14%A-share

Sinohydro** 601669.SS 4.4 2.82 5.8 5.1 4.5 0.8 0.7 0.7 4.3 4.8 5.2 14.1 14.5 14.6 14%

CAMCE** 002051.SZ 2.0 19.05 14.7 13.0 10.7 2.4 2.2 1.9 1.8 2.0 2.4 16.5 16.8 17.6 18%

Shenzhen Tagen** 000090.SZ 0.6 6.64 12.4 10.6 8.1 1.1 1.0 0.9 NA NA 0.0 8.9 9.4 11.0 24%

China Haisum** 002116.SZ 0.5 14.58 18.7 14.3 11.4 4.3 3.5 2.8 1.5 1.9 2.2 23.3 24.4 24.6 28%

Average 12.9 10.7 8.6 2.2 1.9 1.6 2.5 2.9 2.5 15.7 16.3 17.0 21%Weighted average 9.5 8.2 6.8 1.5 1.3 1.1 3.1 3.5 3.9 14.9 15.3 15.8 17%Global

Hyundai E&C 000720.KS 5.8 56500.00 12.5 11.2 8.9 1.3 1.2 1.1 0.9 1.2 1.6 10.5 10.7 12.3 19%

Daelim Industrial 000210.KS 2.8 85600.00 -120.1 15.4 6.7 0.6 0.7 0.6 0.1 0.6 1.2 -0.5 4.5 9.6 NA

Samsung Engineering 028050.KS 2.8 75100.00 -3.9 30.8 12.2 2.1 2.8 2.4 0.3 0.8 2.0 -54.5 9.1 19.6 NA

Hyundai Development 012630.KS 1.8 25800.00 -9.1 29.8 11.7 0.8 0.9 0.9 0.8 1.6 1.6 -9.3 3.0 7.3 NA

GS E&C 006360.KS 1.4 30100.00 -2.2 30.1 8.1 0.4 0.5 0.5 0.0 0.3 1.3 -19.7 1.6 5.9 NA

Acs ACS SM 11.5 26.70 12.5 10.9 11.0 3.0 2.7 2.4 4.3 4.9 4.9 23.9 24.5 21.9 7%

Jacobs Engineering JEC.N 7.8 60.25 15.5 16.3 13.9 1.6 1.8 1.6 0.0 0.0 0.0 10.7 10.8 11.3 15%

WorleyParsons WOR.AX 3.4 15.57 18.7 14.3 12.9 2.9 1.8 1.8 3.8 4.9 5.4 15.6 12.4 13.7 -4%

Abengoa* ABG.A 3.4 3.45 26.3 20.0 11.1 1.5 1.6 1.3 2.2 2.3 2.0 5.8 8.1 11.9 12%

Average -5.5 19.9 10.7 1.6 1.5 1.4 1.4 1.8 2.2 -1.9 9.4 12.6 10%Weighted average 3.0 16.2 11.1 2.0 1.8 1.7 1.9 2.3 2.6 7.2 13.4 14.8 8%Overall

Median 8.3 10.9 8.1 1.1 1.0 0.9 2.0 2.2 2.4 10.7 10.9 12.3 14%

Average 3.8 12.8 8.6 1.5 1.4 1.2 2.1 2.6 2.9 8.1 12.4 13.7 13%

Weighted average 6.6 10.6 8.3 1.5 1.3 1.2 2.4 3.0 3.3 11.7 13.8 14.2 12%

Above data as at 13 February 2014. Source: *Bloomberg, **Wind, UBS estimates


Appendix

Company background Figure 81: Shareholder structure


SINOMACH NSSF H share

China Machinery Engineering Corporation(CMEC, 1829.HK)

Trading Business

International Engineering Contracting Business

Other Businesses

CMEC Engineering C.A. (Venezuela)

China Machinery Engineering

Argentina S.A.

CMEC Nigeria Development

Zhongnan

CMEC International Engineering

China Machinery R&D

CMEC Senegal S.A.

2.18%77.99% 19.83%

100%

100%

50%

100%

100%

99.9%

100%

China National Electric Engineering

(CNEEC)

China National Automation

Control System(CACS)

China National Complete

Engineering(CMCEC)

100%

100%

100%

Unlisted SINOMACH subsidiaries under SINOMACH’s intention of injection to CMEC

China CAMC Engineering

(CAMCE, 002051.SZ)

YTO Group(00038.HK,

601038.SS)

ZYS (002046.SZ)

SINOMACH Automobile (600335.SS)

Changlin (600710.SS)

Linhai Power (600099.SS)

Lanpec (601798.SS)

Erzhong Heavy (601268.SS)


Projects Figure 82: Representative completed power projects

Project

Completion

date Brief description

Contract value

(US$ m)

Thermal Power

Thermal power stations in Turkey Dec-11 CMEC contracted with a private Turkish conglomerate for two EPC projects in relation to two

thermal power stations with an installed capacity of 1 x 600 MW each in the power plant situated

in Catalagzi, Turkey. These two EPC projects were the largest thermal power projects undertaken

by a PRC contractor outside China at the time and represented the first export from China of a 600

MW supercritical thermal power unit.

613

Thermal power station in Pakistan Jul-10 CMEC contracted with a leading industrial conglomerate in Pakistan for an EPC project in relation

to a thermal power station with an installed capacity of 200+ MW in Sahiwal, Pakistan.

161

Thermal power station in Malaysia Sep-10 CMEC contracted with a Kuala Lumpur-listed enterprise for an EPC project in relation to a thermal

power station with an installed capacity of 2 x 135 MW in Sarawak, Malaysia. Prior to this project,

it had completed two projects in Kuching, Sarawak, Malaysia in relation to the construction of two

thermal power stations with an installed capacity of 2 x 50 MW and 2 x 55 MW, respectively.

201

Thermal power station in Indonesia Nov-09 CMEC contracted with the Indonesian government for an EPC project in relation to a thermal

power station with an installed capacity of 2 x 115 MW in Sumatera, Indonesia.

224

Expansion project for turbo-gas

power plant in Malabo, the

Republic of Equatorial Guinea

2012 CMEC contracted with the government of the Republic of Equatorial Guinea for an EPC expansion

project in relation to a turbo-gas power plant in Malabo, the Republic of Equatorial Guinea. The

project involved the installation of three single cycle turbo-gas generators with a total installed

capacity of 126MW. At the time, the total installed capacity of the operating power plant in the

European region of Malabo was only 28MW. The design and construction involved in the

expansion work under the project will complement the electric grid and city network to be

completed, to provide power supply for the whole of Malabo City.

124

Hydropower

Hydropower station in India Jul-11 CMEC contracted with a stated-owned electricity company in India for an EPC project in relation to

a hydropower station in India which includes 6x39 MW turbine hydrogenerator units and other

auxiliary machinery.

65

Hydropower station in the Republic

of Congo

Nov-10 CMEC contracted with the government of the Republic of Congo for an EPC project in relation to a

hydropower station with an installed capacity of 120 MW in Brazzaville, the Republic of Congo. It

was the largest engineering project undertaken by a Chinese contractor in the Republic of Congo at

the time and the largest hydropower station in the Republic of Congo built.

307

Power transformation stations and transmission lines

Power infrastructure in the Republic

of Angola

Oct-10 CMEC contracted with an Angolan state-owned enterprise for two EPC projects in relation to

two15kV power transformation stations and 60kV transmission lines as well as the household

electricity lines in Luanda, the capital of Angola.

39

Power transformation station in the

Republic of Equatorial Guinea

May-11 CMEC contracted with the government of the Republic of Equatorial Guinea for an EPC project in

relation to a 66kV power transformation station in Malabo, Equatorial Guinea.

81

Transmission lines and power

transformation project in Sudan

Jun-11 CMEC contracted with the government of Sudan for an EPC project in relation to 220kV

transmission lines and three 220/33/11kV power transformation substations respectively.

220

Power transmission and

transformation engineering project

in the Republic of Congo

2012 CMEC contracted with the government of the Republic of Congo for the construction work of a

power transmission and transformation EPC project. The project was a follow-up of the Imboulou

hydropower station project and involved connecting the Imboulou hydropower station, a completed

project in which it also acted as the contractor, with several small power stations to construct the

“major power channel” between Ponite-Noire, Brazzaville and Ouesso in the Republic of Congo.

This project is designed to supply power for the capital and surrounding areas, to greatly reduce

power shortages in the Republic of Congo. The scope of works for this project included: design,

construction, equipment procurement, installation, testing, staff training, guidance on commercial

operation and spare parts provision.

514



Figure 83: Representative ongoing power projects

Project

Commencement

date

Expected

completion date Brief description

Contract value

(US$ m)

Thermal Power

Thermal power stations in Turkey Feb-11 Jun-14 CMEC contracted with a private Turkish enterprise for an EPC project in

relation to a thermal power station with an installed capacity of 2 x

135 MW.

245

Thermal power stations in Sri Lanka

(Phases I and II)

Jul-07 Apr-14 CMEC contracted with the government of Sri Lanka for two EPC

projects in relation to a thermal power plant on Kalpitiya Peninsula, Sri

Lanka in two phases. Phase I involved the construction of one thermal

power station with an installed capacity of 1 x 300 MW, and phase II

involved the construction of two thermal power stations each with an

installed capacity of 2 x 300 MW. It was the largest cooperative project

between China and Sri Lanka and the largest government infrastructure

project in Sri Lanka at the time.

1,346

Thermal power station in Brest and

Vitebsk, the Republic of Belarus

Feb-11 Jan-14 CMEC contracted with two state-owned power enterprises for two EPC

projects in relation to two thermal power stations, each with an

installed capacity of 427 MW, in Brest and Vitebsk.

746

Power plant project in Salah Al-din, Iraq May-17 CMEC contracted with the government of Iraq for an EPC project in

relation to a power plant in Salah AL-din, Iraq, which was situated 16

km from the southeast of Samarra, Salah AL-din, Iraq and north of

Tigris River. CMEC was responsible for the construction of two gas

turbine generators with capacity of 630MW each. The scope of work

involved all construction works, including, but not limited to, land

levelling, surveying, design, provision of parts for the formation of a

complete set of generator (including gas turbines, boilers, generators

and ancillary equipment) with an installed capacity of 2×630MW,

construction, installation and testing, as well as the construction and

installation of ancillary buildings and facilities. It is the largest

generator in terms of installed capacity to be built in Iraq at present.

1,299

Hydropower

Hydropower station in Pakistan Apr-08 Jun-16 CMEC formed a consortium with Chinese state-owned enterprise

specialised in hydropower infrastructure construction, and contracted

with the Pakistani government for an EPC project in relation to a

hydropower station with an installed capacity of 972 MW in

Muzaffarabad, Pakistan. Its consortium partner was responsible for the

construction of civil engineering works at Nauseri, Thotha and Agar

Nullah while CMEC was responsible for the procurement and

installation of the machinery and electrical equipment as well as the

design of the metallic structure of the hydropower station.

497

Hydropower station in Myanmar Oct-10 Dec-13 CMEC contracted with the government of Myanmar for an engineering

contracting project in relation to a hydropower station with an installed

capacity of 3x40 MW in Myanmar.

51

Power transformation stations and

transmission lines

Power transmission and transformation

station in the Republic of Chad

Oct-11 Jan-14 CMEC contracted with the government of the Republic of Chad for an

EPC project in relation to a 90kV loop transmission line, four sets of

90/15kV power substations and a distribution network.

130

Reconstruction and expansion of

electricity grid in the Republic of Angola

(Phases I and II)

Nov-08 Mar-13 CMEC contracted with an Angolan state-owned enterprise for an EPC

project in relation to the restructuring and expansion of the electricity

grid in Luanda in two phases. The restructuring and expansion work

involved eight power transformation stations, 60kV transmission lines

in a total distance of 37.5 km, 125 substations with capacity of 1,000

KVA each and other residential electricity supply systems.

177



Figure 84: Representative completed transportation and telecommunications projects

Project Completion date Brief description

Contract value

(US$ m)

Transportation

Shipbuilding projects in Germany Jan-10 CMEC contracted with a German company for two projects in relation to the design and

construction of two 4,250 TEU (twenty-foot equivalent unit) container vessels respectively.

These vessels were approximately 261 meters’ long and weighed approximately 50,000

tonnes.

124

Railway project in the Republic of

Angola

May-09 CMEC contracted with an Angolan railway company for two EPC projects in relation to the

redevelopment and reconstruction of three railroads spanning from Bongo-Baia, Luanda

Harbor Area and Viana-Baia.

116

Shipbuilding projects in the

Republic of Angola

Dec-10 CMEC contracted with the government of the Republic of Angola for three projects in

relation to the design and procurement of 3,000 canoes.

118

Highway reconstruction and

asphalt paving in the Republic of

Congo

Oct-11 CMEC contracted with the government of the Republic of Congo for an EPC project in

relation to a highway reconstruction and asphalt paving construction. The highway was 125

km long and situated in North Congo running across Obouya, Boundji and Okoya and linked

the Republic of Congo with the Republic of Gabon. CMEC was responsible for site clearance,

earthworks, road construction, bridge construction, drainage structures, the incorporation of

signal transmission facilities, the construction of schools and medical centres in the suburban

area extending from the highway and the placement of gas stations every 100 km along the

highway.

124

Telecommunications

Telecommunications projects in

the Republic of Angola

Mar-11 CMEC contracted with an Angolan telecommunications enterprise for four EPC projects of

the Next Generation Network (NGN) in Angola; this was a packet-based network that

offered telecommunications services. The NGN project covered 15 states of Angola.

275


Figure 85: Representative ongoing transportation and telecommunications projects

Project

Commencement

date

Expected


Contract value

(US$ m)

Transportation

Highway construction in the

Republic of Cote d’Ivoire

Nov-11 Dec-15 CMEC contracted with the government of the Republic of Cote d’Ivoire

for an EPC project in relation to the construction of a 23km highway.

CMEC was responsible for site clearance, earthworks, road construction,

bridge construction, drainage structures, tollbooths construction, the

incorporation of signal transmission facilities, etc.

135

Reconstruction of the Naypyidaw

Airport in Myanmar

Jan-11 Jul-14 CMEC contracted with the government of Myanmar for an EPC project

in relation to the expansion of the Naypyidaw Airport of Myanmar to

handle 3.5 million passengers annually. CMEC was responsible for: (i)

the procurement of building materials for the construction of the

terminals; (ii) the procurement, installation, examination, adjustment

and transfer of part of the mechanical and electrical equipment of the

terminals; and (iii) the construction of the terminals, walkways, elevated

highway and approach road.

95

Highway reconstruction and asphalt

paving in the Republic of Congo

Dec-11 Mar-15 CMEC contracted with the government of the Republic of Congo for an

EPC project in relation to a highway reconstruction. The highway is 87

km long and ran across Okoyo, Lekety and the Gabonese border and

links the Republic of Congo with the Republic of Gabon.

91

Telecommunications

2.5G network expansion and

3G network project in Bangladesh

Jan-12 Jan-14 CMEC contracted with a Bangladeshi telecommunications enterprise for

an EPC project in relation to the expansion of a 2.5G network and the

construction of a 3G network in Bangladesh.

211



Figure 86: Representative completed other projects

Project

Completion

date Brief description

Contract value

(US$ m)

Reinforcement of water supply

network in the Republic of Angola

(Phase I)

Oct-10 CMEC contracted with the government of the Republic of Angola for phase I of an EPC project in

relation to the reinforcement of the water supply system in Huambo, Angola which involved the

construction of 20 water stations, water supply pipes and connecting pipelines to individual

households.

10

Expansion of alkali mine in Turkey

(Phase III)

Aug-11 CMEC formed a consortium with a PRC enterprise and contracted with a Turkish enterprise for

phase III of an EPC project as a follow-up project in relation to the expansion of an alkali mine in

Beypazari, Turkey with 16 vertical wells and 16 horizontal wells. CMEC completed the first two

phases of the project which involved the construction of 30 pits.

16

Construction of 1,000 residential

units in Hulhumale, Maldives

2012 CMEC contracted with the government of the Republic of Maldives for the construction of 1,000

residential units in Hulhumale. 76


Figure 87: Representative ongoing other projects

Project

Commencement

Date

Expected


Contract value

(US$ m)

Water supply system enhancement in

the Republic of Congo

Nov-08 Apr-14 CMEC contracted with the government of the Republic of Congo for an

EPC project in relation to the enhancement of the water supply system

of Brazzaville, capital of the Republic of Congo. CMEC was responsible

for the repairs of the old water plant and the construction of a new

water plant to increase production capacity.

305

Reconstruction of water supply

network in the Republic of Angola

(Phase II)

Oct-09 Jun-13 CMEC contracted with the government of the Republic of Angola for

phase II of an EPC project as a follow-up project in relation to a water

supply network in Luanda, the Republic of Angola.

70

Cement plant in the Republic of

Yemen

May-09 Dec-14 CMEC contracted with the government of the Republic of Yemen for an

EPC project in relation to the expansion of a cement factory by setting

up a clinker production line with a daily clinker capacity of 2,500

tonnes as well as a 32 MW power station.

134


Regulatory Figure 88: Critical process of international engineering contracting business


Achieved intention

Signed memorandum of understanding

Signed formal contract

Signed and pending to be

effective

Newly effective contract/Backlog

Commencement of project

Received advance payment from project

owner

Effective

Revenue recognized to completion

As at Jun 30 2013, signed contracts pending to be

effective was USD11.8bn

Newly effective contract value was USD1.2bn in H113.

As at Jun 30 2013, the backlog value was USD7.1bn

As at Jun 30 2013, receipt in advance was

Rmb9.2bn


Figure 89: Engineering contracting industry chain


Planning

• Positioning the local industry development of the project, and planning for the industrial structure, spatial layout, impact of economic and social environment etc.

Consulting

• Providing consulting service of engineering construction project decisions and management to government departments, project owners and other types of customers, including early project proposal consultation, survey and design consultation, issuing investment project feasibility study report etc.

Design

• Comprehensive analysis of the conditions of technology and resources required for the construction of the project, prepare the project design documents, and provide related services which includes schematic design and technical design etc.

Procurement

• Engagement of subcontractor and selection of suitable suppliers• Collecting and procuring construction materials, production facilities and equipments required

for the construction of the project• Following up on the entire procurement process

Construction

• Depending on specific project, carrying out new-build, expansion or alteration, which involve road paving, port reinforcing, infrastructure construction, installation of equipment and other related construction work

Maintenance/Operation

• Engineering maintenance includes testing and repairing for the completed projects and periodic maintenance

• Engineering operation includes the models of BOT, PFI, PPP etc., taking BOT as an example, this model means” Build-Operate-Transfer”, represents a concept of complete project financing, also called “Concessional financing”

EPC

CMEC

Sinohydro

CCCC/CRCC/CRG/CSCI



China Machinery Engineering Corporation (1829.HK)

Income statement (Rmbm) 12/10 12/11 12/12 12/13E % ch 12/14E % ch 12/15E 12/16E 12/17ERevenues 19,077 20,518 21,296 21,487 0.9 26,855 25.0 29,644 32,757 36,121Gross profit 2,942 3,659 3,732 3,852 3.2 4,877 26.6 5,295 5,684 6,164EBITDA (UBS) 1,567 2,210 2,140 2,262 5.7 2,894 27.9 3,113 3,278 3,514Depreciation & amortisation (41) (72) (99) (107) 8.1 (116) 8.9 (126) (135) (145)EBIT (UBS) 1,526 2,138 2,041 2,155 5.6 2,778 28.9 2,987 3,143 3,369Associates & investment income 0 0 0 0 0.0 0 - 0 0 0Other non-operating income 19 10 12 12 0.0 12 0.0 12 12 12Net interest 358 348 550 760 38.0 795 4.6 862 934 1,010Exceptionals (incl goodwill) (342) (508) 12 (326) - 5 - 5 5 5Profit before tax 1,561 1,987 2,616 2,601 -0.6 3,590 38.0 3,866 4,094 4,397Tax (429) (515) (688) (650) 5.5 (897) -38.0 (967) (1,023) (1,099)Profit after tax 1,132 1,472 1,928 1,950 1.2 2,692 38.0 2,900 3,070 3,298Preference dividends and Minorities 4 3 0 0 0.0 0 0.0 0 0 0Extraordinary items 0 0 0 0 - 0 - 0 0 0Net earnings (local GAAP) 1,136 1,475 1,928 1,950 1.2 2,692 38.0 2,899 3,070 3,297Net earnings (UBS) 1,385 1,851 1,918 2,194 14.4 2,688 22.5 2,895 3,066 3,293Tax rate (%) 27.5 25.9 26.3 25.0 -4.9 25.0 0.0 25.0 25.0 25.0

Per share (Rmb) 12/10 12/11 12/12 12/13E % ch 12/14E % ch 12/15E 12/16E 12/17EEPS (UBS, diluted) 0.42 0.56 0.58 0.53 -7.9 0.65 22.5 0.70 0.74 0.80EPS (local GAAP, diluted) 0.34 0.45 0.58 0.47 -18.6 0.65 38.0 0.70 0.74 0.80EPS (UBS, basic) 0.42 0.56 0.58 0.53 -7.9 0.65 22.5 0.70 0.74 0.80Net DPS (Rmb) 0.21 0.11 0.20 0.17 -18.6 0.23 38.0 0.25 0.26 0.28Book value per share 1.20 1.63 2.47 2.82 14.4 3.31 17.2 3.79 4.28 4.82Average shares (diluted) 3,300.00 3,300.00 3,321.64 4,125.40 24.2 4,125.70 0.0 4,125.70 4,125.70 4,125.70

Balance sheet (Rmbm) 12/10 12/11 12/12 12/13E % ch 12/14E % ch 12/15E 12/16E 12/17ECash and equivalents 5,079 5,171 12,089 12,145 0.5 11,329 -6.7 12,431 13,483 14,571Other current assets 13,541 14,160 15,847 15,259 -3.7 16,765 9.9 17,574 18,473 19,441Total current assets 18,620 19,331 27,936 27,404 -1.9 28,094 2.5 30,005 31,956 34,012Net tangible fixed assets 345 392 444 478 7.6 503 5.1 517 523 519Net intangible fixed assets 112 1,668 1,851 1,912 3.3 1,973 3.2 2,034 2,096 2,157Investments / other assets 6,311 5,218 4,539 4,664 2.8 6,475 38.8 7,334 8,300 9,338Total assets 25,388 26,608 34,770 34,459 -0.9 37,044 7.5 39,891 42,875 46,026Trade payables & other ST liabilities 18,870 20,337 24,137 22,143 -8.3 22,719 2.6 23,608 24,537 25,464Short term debt 576 160 134 134 0.00 134 0.00 134 134 134Total current liabilities 19,446 20,497 24,271 22,277 -8.2 22,853 2.6 23,742 24,670 25,598Long term debt 1,260 226 155 105 -32.3 105 0.0 105 105 105Other long term liabilities 717 512 427 427 0.0 427 0.0 427 427 427Preferred shares 0 0 0 0 - 0 - 0 0 0Total liabilities (incl pref shares) 21,423 21,234 24,852 22,809 -8.2 23,385 2.5 24,274 25,202 26,130Common s/h equity 3,969 5,380 9,920 11,652 17.5 13,661 17.2 15,618 17,673 19,896Minority interests (4) (6) (3) (2) 16.2 (2) 19.3 (1) (1) (1)Total liabilities & equity 25,388 26,608 34,770 34,459 -0.9 37,044 7.5 39,891 42,875 46,026

Cash flow (Rmbm) 12/10 12/11 12/12 12/13E % ch 12/14E % ch 12/15E 12/16E 12/17ENet income (before pref divs) 1,136 1,475 1,928 1,950 1.2 2,692 38.0 2,899 3,070 3,297Depreciation & amortisation 41 72 99 107 8.1 116 8.9 126 135 145Net change in working capital 4,291 1,434 5,037 (1,531) - (2,741) -79.0 (779) (937) (1,078)Other operating 163 23 170 (9) - (9) -0.9 (9) (9) (9)Operating cash flow 5,631 3,003 7,234 516 -92.9 58 -88.7 2,237 2,259 2,355Tangible capital expenditure (16) (50) (98) (100) -2.5 (100) 0.0 (100) (100) (100)Intangible capital expenditure (6) (874) (211) (102) 51.7 (102) 0.0 (102) (102) (102)Net (acquisitions) / disposals 3 1 5 0 - 0 - 0 0 0Other investing (2,259) 195 (2,566) 10 - 10 - 10 10 10Investing cash flow (2,277) (728) (2,870) (192) 93.3 (192) 0.0 (192) (192) (192)Equity dividends paid (273) (698) (354) (675) -90.5 (682) -1.1 (942) (1,015) (1,074)Share issues / (buybacks) 0 0 3,012 457 -84.8 0 - 0 0 0Other financing 100 20 0 0 - 0 - 0 0 0Change in debt & pref shares (411) (1,432) (98) (50) 48.98 0 - 0 0 0Financing cash flow (583) (2,110) 2,560 (268) - (682) -154.5 (942) (1,015) (1,074)Cash flow inc/(dec) in cash 2,770 165 6,924 56 -99.2 (817) - 1,102 1,052 1,088FX / non cash items (45) (73) (5) 0 100.0 0 - 0 0 0Balance sheet inc/(dec) in cash 2,726 92 6,919 56 -99.2 (817) - 1,102 1,052 1,088Source: Company accounts, UBS estimates. (UBS) metrics use reported figures which have been adjusted by UBS analysts.


China Machinery Engineering Corporation (1829.HK)

Valuation (x) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EP/E (local GAAP, diluted) - - - 9.3 6.8 6.3 5.9 5.5P/E (UBS, diluted) - - - 8.3 6.8 6.3 5.9 5.5P/CEPS - - - 7.9 6.5 6.0 5.7 5.3Equity FCF (UBS) yield % - - - 2.3 (0.2) 11.7 11.8 12.4Net dividend yield (%) - - - 3.8 5.2 5.6 5.9 6.3P/BV x - - - 1.6 1.3 1.2 1.0 0.9EV/revenues (core) - - - 0.3 0.3 0.2 0.2 0.1EV/EBITDA (core) - - - 2.8 2.3 2.1 1.7 1.3EV/EBIT (core) - - - 2.9 2.4 2.2 1.8 1.3EV/OpFCF (core) - - - 2.9 2.4 2.2 1.7 1.3EV/op. invested capital - - - NM 4.4 2.0 1.3 0.8

Enterprise value (Rmbm) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EMarket cap. - - - 18,199 18,224 18,224 18,224 18,224Net debt (cash) (1,667) (4,014) (8,293) (11,854) (11,499) (11,642) (12,719) (13,789)Buy out of minorities - - 4 3 2 2 1 1Pension provisions/other - - 0 0 0 0 0 0Total enterprise value - - - 6,348 6,728 6,584 5,507 4,436Non core assets (1) 0 0 0 0 0 0 0Core enterprise value - - - 6,348 6,727 6,584 5,507 4,436

Growth (%) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17ERevenue -1.1 7.6 3.8 0.9 25.0 10.4 10.5 10.3EBITDA (UBS) 158.1 41.0 -3.2 5.7 27.9 7.6 5.3 7.2EBIT (UBS) 167.7 40.1 -4.5 5.6 28.9 7.5 5.2 7.2EPS (UBS, diluted) 112.9 33.7 2.9 -7.9 22.5 7.7 5.9 7.4Net DPS 156.2 -49.3 89.3 -18.6 38.0 7.7 5.9 7.4

Margins & Profitability (%) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EGross profit margin 15.4 17.8 17.5 17.9 18.2 17.9 17.4 17.1EBITDA margin 8.2 10.8 10.0 10.5 10.8 10.5 10.0 9.7EBIT margin 8.0 10.4 9.6 10.0 10.3 10.1 9.6 9.3Net earnings (UBS) margin 7.3 9.0 9.0 10.2 10.0 9.8 9.4 9.1ROIC (EBIT) 68.0 205.3 <-500 (305.6) 182.6 88.9 73.2 62.9ROIC post tax 49.3 NM NM NM NM 66.6 54.9 47.1ROE (UBS) 39.6 39.6 25.1 20.3 21.2 19.8 18.4 17.5

Capital structure & Coverage (x) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17ENet debt / EBITDA NM NM NM NM NM NM NM NMNet debt / total equity (81.8) (89.0) NM NM (81.2) (78.1) (74.9) (72.0)Net debt / (net debt + total equity) NM NM NM NM NM NM NM NMNet debt/EV - - - NM NM NM NM NMCapex / depreciation % 43.0 99.8 161.5 146.2 128.4 114.4 103.2 94.0Capex / revenue % 0.1 0.2 0.5 0.5 0.4 0.3 0.3 0.3EBIT / net interest NM NM NM NM NM NM NM NMDividend cover (UBS) 2.0 5.2 2.8 3.2 2.9 2.9 2.9 2.9Div. payout ratio (UBS) % 50.4 19.1 35.2 31.1 35.1 35.0 35.0 35.0

Revenues by division (Rmbm) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EOthers 19,077 20,518 21,296 21,487 26,855 29,644 32,757 36,121Total 19,077 20,518 21,296 21,487 26,855 29,644 32,757 36,121

EBIT (UBS) by division (Rmbm) 12/10 12/11 12/12 12/13E 12/14E 12/15E 12/16E 12/17EOthers 1,526 2,138 2,041 2,155 2,778 2,987 3,143 3,369Total 1,526 2,138 2,041 2,155 2,778 2,987 3,143 3,369Source: Company accounts, UBS estimates. (UBS) metrics use reported figures which have been adjusted by UBS analysts.


Forecast returns

Forecast price appreciation +43.4%

Forecast dividend yield 5.2%

Forecast stock return +48.6%

Market return assumption 9.6%

Forecast excess return +39.0%

Statement of Risk

We see major industry related risk being slow down of global infrastructure spending, Renminbi appreciation and overseas regulatory risks. Key company specific risk is competition from Chinese peers (especially sister company CAMEC).


Required Disclosures

This report has been prepared by UBS Securities Co. Limited, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission.

Analyst Certification: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.

UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating

Definition Coverage1IB Services2

Buy FSR is > 6% above the MRA. 44% 36% Neutral FSR is between -6% and 6% of the MRA. 45% 35% Sell FSR is > 6% below the MRA. 11% 23% UBS Short-Term Rating

Definition Coverage3IB Services4

Buy Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event.

less than 1%

less than 1%

Sell Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event.

less than 1%

less than 1%

Source: UBS. Rating allocations are as of 31 December 2013. 1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months.

KEY DEFINITIONS: Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.

EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows.

UBS Securities Co. Limited: Robin Xu.


Company Disclosures

Company Name Reuters 12-month rating Short-term rating Price Price date

China Machinery Engineering Corporation 1829.HK Not Rated N/A HK$5.65 13 Feb 2014

Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date

Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.

China Machinery Engineering Corporation (HK$)

01

-Jan

-09

01

-Ap

r-0

9

01

-Ju

l-0

9

01

-Oct

-09

01

-Jan

-10

01

-Ap

r-1

0

01

-Ju

l-1

0

01

-Oct

-10

01

-Jan

-11

01

-Ap

r-1

1

01

-Ju

l-1

1

01

-Oct

-11

01

-Jan

-12

01

-Ap

r-1

2

01

-Ju

l-1

2

01

-Oct

-12

01

-Jan

-13

01

-Ap

r-1

3

01

-Ju

l-1

3

01

-Oct

-13

01

-Jan

-14

0.00

2.00

4.00

6.00

8.00

Price Target (HK$) Stock Price (HK$)

No Rating

Source: UBS; as of 13 Feb 2014


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