Zoomlion:Headwinds Continue; Maintain Neutral China Machinery Sector

Conclusion:Zoomlion’s bottom-line results were disappointing, largely due to higher expenses and provisions for impairment alongside weaker gross margins. The most interesting tidbit was Zoomlion’s disclosure that it had paid Rmb 673 mil to banks to repurchase repossessed equipment for ‘non-recourse’ factored receivables. We have long argued that Zoomlion would be on the hook for these ‘non-recourse’ factored receivables and FY13 results underpin our thesis on this matter. This adds another level of uncertainty to earnings forecasts in addition to a much slower than expected recovery in the company’s key business segments. Risks remain despite management taking steps to stabilize the business, but we maintain our Neutral rating on the stock given its inexpensive valuation (6.4x 2014E). At current levels, we think the bad news/uncertain outlook is more than adequately baked into the stock price. Maintain Neutral.

FY13 Results:Reported EPS was Rmb 0.50versus Rmb 0.95in FY12, Rmb 0.12 below our estimates and Rmb 0.10 below consensus. Sales were Rmb38,542mil (-19.8%), +0.9% above our estimates and +1.7% above consensus. Strength in Environmental & Sanitation Machinery(+8.2% Y/Y)and Road Construction & Pile Foundation Machinery(+11.1%Y/Y) were more than offset by weaker than expected sales for Concrete Machinery(-27.1% Y/Y), Crane Machinery (-11.7% Y/Y),Earth Working Machinery(-66.0% Y/Y), Financial Lease Interest Income(-8.7% Y/Y) and Other(-13.6% Y/Y). Relative to our estimated P&L, lower than expected sales, lower gross profit, higher sales & distribution expenses, higher administrative expenses and higher R&D were partly offset by higher net finance costs, higher other income and a lowerthan expected tax rate to deliver EPS of Rmb 0.50, well below our forecasts. Gross margins of 29.2% were -310 bps below FY12 and -140 bps below our estimates and consensus. See Figures 4 & 5 for details.

A/R & Factoring: Total current accounts receivables increased to Rmb 36.8billion, up from Rmb 29.1 billion a year ago. The company also increased its impairment provision for trade receivables by +67% Y/Y and its impairment for receivables under finance lease by a whopping +144% Y/Y. Factoring slowed in 2013 with Rmb 2,021 mil of trade receivables factored to banks without recourse vs. Rmb 4,830 mil in FY12. Similarly, factoring for receivables under finance lease fell by -59% Y/Y to Rmb 6,759 mil from Rmb 16,518 mil. Interestingly enough, the company disclosed that it paid Rmb 673 mil (2012: Rmb 0) to banks to repurchase repossessed equipment from banks to which Zoomlion had factored its receivables.

Deteriorating Operating Cash Flows: Cash flow from operations clocked in at Rmb 43million compared to Rmb 2,611million a year ago.

Investment Recommendation:We rate Zoomlion a Neutral with a target price of HK$5.25 (previously HK$6.25), based on 6.5x (unchanged) P/Emultiple on our projected 2015 EPS of Rmb 0.64 (previously Rmb 0.78).

Risks To Our Price Target: (1) Stronger than expected industry growth; (2) Stronger than expected market share gains; (3) Faster than expected inventory destocking; (4) Faster than expected rebound in concrete machinery sales; and (5) Better than expected FAI spend.