东方电气(600875)

Earnings seem to have stabilized; upgrading H-share to Hold

Following a 40% underperformance (relative to HSCEI index) over the past oneyear, we are upgrading Dongfang Electric-H to Hold from Sell, as we believethe negatives have been largely priced in. Earnings started to stabilize as 2017turned profitable after a huge net loss in 2016. That said, the stabilization is nota reflection of demand recovery in core operations but driven by better-thanexpected cost reduction. The scope for further cost cuts is limited. We also do notsee support yet for a Buy case for its H-share. Against revised ROE assumptionsof 3-4% for 2018-19E, we believe our target P/B of 0.6x on 2018E is fair.

Power equipment: it seems that the worst is not yet over

Coal-fired (c.50% of total GP): Based on our utility team's projections,annual capacity additions will fall to 30-40GW over 2017-19 (vs. 40-70GWover 2014-16) and drop significantly to 11GW by 2020. Beyond 2020,annual capacity additions will likely continue to fall to a sustained lowlevel of 5-10GW.

Wind power (c.10% of total GP): Annual capacity additions at the industrylevel will likely stay at c.22GW over 2018-20E (vs. 19-21GW in 2016-17).In addition to limited industry growth, Dongfang has been struggling interms of market position (its market share has halved since 2011) andprofitability (only a single-digit GPM).

Nuclear power (c.10% of total GP): Approvals for new nuclear projectsclearly disappointed the market in 2017, against the high hopes. Thislimits Dongfang's ability to convert its revenue in 2018 (under thepercentage-of-completion accounting method). We would prefer to stayon the sidelines until we see concrete signs of a resumption in approvals.

Non-power equipment: not enough to drive a rerating

Overseas EPC: In light of the power equipment downturn and theOBOR initiative, Dongfang clearly puts more emphasis on the overseasEPC business. However, revenue conversion has failed to come throughdespite a high backlog coverage of >5x. Given the uncertaintiesassociated with the execution of overseas projects, visibility of asignificant take-off of the business in 2018 is low. Moreover, Chineseconstructors' subdued valuations (at an average P/B of 0.6-0.7x on 2018E)do not seem to support a rerating case for Dongfang.