China Communications Construction (1800 HK):Cheaper than 2011 trough, worth revisiting

Margin declined. China Communications Construction(CCCC) reported FY13 net profit of RMB12.6b, slightly higherthan our estimate of RMB12.2b but 7% below consensus ofRMB13.6b. Revenue was up 12% YoY and net profit was up3% YoY but gross profit margin fell from 11% in 2012 to 10%in 2013 due to the lower profitability of the railway segment.

We cut our 2014F earnings forecasts from RMB14.6b toRMB13.5b on lower-than-expected new contract value in 2013.

More cautious on investment projects. CCCC securedRMB451b in new contracts in 2013, 19% lower than ourestimate of RMB555b. New contracts from investmentprojects (BT/BOT) fell 53% YoY likely due to (1) thecompany's high gearing (net debt-to-equity reached 97% in2013), which made it hard for it to expand projects with higherfinancing requirements; and (2) its more selective approach totaking on investment projects given the potential default risk.

Expanding into property. CCCC will acquire a 45% equityinterest in Phoenix Island Cruise Terminal, a companydeveloping property in Hainan. CCCC seems to be trying todiversify its earnings by entering into the propertydevelopment business. If so, the long cash cycle and cyclicalnature of that industry makes such expansion risky.

Valuation attractive. We lower our target price from HK$8.00to HK$7.20 on the back of the earnings downgrade. Ourtarget price is based on 7x 2014F P/E, the company’saverage P/E for the last three years. We believe the stock isattractive at the current level given it is trading at5.3x 2014F P/E and 0.7x 2014F P/B, lower than its previoustrough valuation in 2011. In the first two months of 2014,China transportation FAI was RMB258b, up 21% YoY (railwayFAI was up 17% YoY), outpacing our FY14F transportationFAI growth forecast of 14%. We expect monthly FAI growth toslow down in 2H14F due to the higher base in 2H13, thoughwe still believe our current forecast for 14% growth in 2014Fis achievable.

Risks to our call. We believe the key risks facing CCCCinclude: (1) Macro risk. Government policy related to FAIcould have a significant detrimental impact on CCCC’searnings in the next few years. (2) Quality managementrisk. As many infrastructure construction projects areoutsourced, project safety and quality is difficult to control andtherefore entails risk. (3) Default risk. Delays in customerpayments could affect CCCC’s working capital and cash flow.

Failure to obtain sufficient funding could also have a bearingon future development.