Rating: OUTPERFORM (maintain) 

We expect reform initiatives at centrally managed infrastructure companies to continue in the areas of 「construction + industry」, 「construction + twin carbon targets」 and others to bring significant improvements in financial positions. After local SOEs straighten out their incentive mechanisms, we expect their internal growth momentum to increase and lead to higher revenue and profit flexibility. 

Undervalued SOE blue chips present investment potential  

We believe construction sector investors would do well to monitor undervalued blue-chips’ price/performance ratios at this time. Overall, we believe that fundamentals of blue-chip centrally managed SOEs and local SOEs that are currently undervalued in the post-pandemic market will continue to improve. We see their lead market shares continuing to increase while traditional construction companies are undergoing restructure and upgrades. Along with a 「green building」 trend, traditional business methods will continue to change. We believe that the new era of 「construction plus」 demand would consist of industry reforms in three main areas: 「construction plus industry」, 「construction plus twin carbon targets」 and 「construction plus endogenous efficiency improvements」. 

Construction + industry: twin drivers provide performance and flexibility 

「Construction + industry」 reforms would mainly develop along two paths: chemical supply chain and mineral resources. Chemical engineering companies such as China National Chemical and East China Engineering use their traditional chemical advantages to switch over to new-era industry. The subsidiary of China Railway has a quality mineral resources business. We believe centrally managed construction companies hold advantages in production line design and process optimization, as well as bearing lower initial investments and lower capital costs. Thus, their transformation would optimize the quality of their financial positions, improve fundamentals and enhance profit sustainability. 

Construction + twin carbon targets: operations/maintenance; model revamp 

In view of China’s twin carbon peak and neutrality goals, traditional engineering skills in production lines are used to revamp operations and maintenance structures. Sinoma International and Sinosteel International, for instance, are using their traditional project experience and tech prowess to upgrade old production lines and enter the operations and maintenance market, expanding their incremental market potential. They have visible traditional main business and competitive advantages. With their channel advantages, engineering companies would do well in market segments that require intelligent transformation, and operational and maintenance revamp. In addition to providing construction companies with an incremental market for technological transformation and engineering services, they could also collect stable operational and management fees, reshaping their business model. 

Construction + endogenous efficiency improvement: local infrastructure buildup  

This represents the reform of the incentive mechanism, where traditional local SOEs stimulate internal growth potential and improve quality and efficiency. Local infrastructure SOEs in Shandong and other places continued to improve their fundamentals in 1H21. Sufficient orders on hand also laid a good foundation for the development of the 14th FYP. These companies also have the ability to move from traditional road and bridge construction to rail transit and municipal administration. We believe that after the incentive mechanism is straightened out from top to bottom, local SOEs would achieve significant improvements in profit and reporting quality through cost reduction and efficiency improvements. With a multi-category expansion to other industries such as environmental protection and environmental protection, regional infrastructure demand is high and the 14th Five-Year Plan period would drive higher growth. Thus, in addition to a rise in major shareholders’ stakes, we also see increases in their share of provincial markets. 

Valuation and risks 

We expect the trend of centrally managed infrastructure companies to continue, 「construction + industry」, 「construction + twin carbon targets」 and other growth paths would bring significant improvements in financial positions. After local SOEs straighten out their incentives, internal growth momentum would increase and lead to higher revenue and profit flexibility. We recommend Shandong Hi-Speed Road & Bridge Group (000498 CH, BUY), China National Chemical Engineering (601117 CH, BUY), China State Construction Engineering Corporation (601668 CH, BUY), China Communications Construction Company (601800 CH, BUY), China Railway Group (601390 CH, BUY), China Railway Construction Corporation (601186 CH, BUY), China State Construction International Holdings (3311 HK, BUY; initiation). We would also monitor activity at Sinosteel Engineering & Technology (000928 CH, ACCUMULATE). Other stocks related: Metallurgical Corporation of China, Sinoma International Engineering, East China Engineering Science and Technology, Shandong Sunway Chemical Group. Risks include: pandemic duration exceeds expectations; growth rates of infrastructure investment not rebounding as expected; and net margins of construction companies rising less than expected. 

免责声明(DISCLAIMER): 

此文件仅发给指定收件人或机构。其内容可能包含某种享有法律特权或者需要保密的信息。对于任何未经本公司授权而对本文件所载内容进行使用、披露、分发、变更之行为及由此产生的后果，天风国际证券集团有限公司及其联属公司和附属公司（「天风集团」）概不承担任何责任。如您并非此文件的指定收件人或机构，请立即通知天风集团，并立即销毁此文件。谢谢合作。 

This message is intended only for the individual or entity to which it is addressed. It may contain legally privileged and/or confidential information. TF International Securities Group Limited and its affiliates and subsidiaries (「TF Group」) does not accept liability for the unauthorized use, disclosure, distribution and/or alteration of any information it contains or the consequences thereof. If you are not an intended recipient, please inform TF Group and destroy this message immediately. Thank you.