Introduction

China State Construction (CSCI) is a large construction and infrastructure company in Hong Kong, having rich experience and high reputation. In recent years, drawing on the sound experiences it gained in Hong Kong and Macau, CSCI has been active in extending its reach across regional boundaries and succeeded in spreading the wings of its construction businesses in Mainland China, the United Arab Emirates and India. It has been tireless in building its three major regional business platforms covering Hong Kong-Macau, Mainland China and overseas.

Summary

In 1H2011 new contract value of CSCI kept high growth, especially on infrastructure investment. In the first 6 months of 2011, CSCI recorded new contract value awarded of HK$19.34 Billion, representing a YoY growth of 73.6% and a 69.1% accomplishment of the full year target of 2011 (no less than HK$28 Billion). Infrastructure investment (including affordable housing) business in PRC and construction business in Macau outperformed with a strong YoY growth of 3.6 times and 63.1% respectively. In addition, turnover and net in 2010 rose by 23% and 69% respectively, both exceeding our forecast.

The on-hand contract value amounted over 65billion may ensure profit increase of CSCI, and revenue proportion of infrastructure investment will have positive impact on its gross profit margin. We expect that total turnover in 2011 and 2012 will be 16.54billion and 20.86billion, gross profit margin up to 12%, and net profit will reach 1.38billion and 1.79billion, EPS at 0.413 and 0.498 respectively.

Because shares expanded and revenue from infrastructure was lower than forecast, EPS of CSCI is adjusted to 0.413 and 0.498 respectively, we give the company forecast P/E of 21 times to reflect high degree of prosperity on building affordable house. According to our estimation, 12m TP of CSCI is forecasted to HKD8.67, 14.4% higher than current price. We maintain CSCI “Hold” rating.

Infrastructure investment recorded significant growth in 1H2011

In 1H2011 new contract value of CSCI kept high growth, especially on infrastructure investment. In the first 6 months of 2011, CSCI recorded new contract value awarded of HK$19.34 Billion, representing a YoY growth of 73.6% and a 69.1% accomplishment of the full year target of 2011 (no less than HK$28 Billion). Infrastructure investment (including affordable housing) business in PRC and construction business in Macau outperformed with a strong YoY growth of 3.6 times and 63.1% respectively.

As at 30 June 2011, the on-hand contract value amounted to approximately HK$65.28 billion, among which the backlog was approximately HK$47.96 billion, representing a YoY growth of 65.3%, which meets the Group's works in next three years.

Performance in 2010 exceeded forecast

In 2010 CSCI recorded revenue of HKD 14billion and net profit of 1.036billion, up 23% and 69%, exceeding our forecast, EPS at HKD 34.99, increasing 54.2% YoY.

Construction business continued to dominate the business segment of the Group, which contributed HK$8,480 million, accounting for 70.8%, 14.4 points lower than that in 2009, reflecting soaring growth of infrastructure investment. The revenue from infrastructure investment soared from HKD948million to 2.958billion, growth at 210%.

In 2010 profitability of CSCI was improved, the gross profit margin rose from 7.7% in 2009 to 11.0% in 2010. The major reason for the increase was that the competition and operation environment in Hong Kong were improved in the year as the result of the “Ten Mega Infrastructure Projects” have been in full swing by the Government of HKSAR in the year and the Group continues to execute effective cost-saving system. In addition, the infrastructure related projects with higher profit margin commenced to contribute profit in the year. However, because booked revenue of infrastructure investment was lower than our expectation; total gross profit margin was lower than our previous forecast of 12%.

With increasing scale of company debt, the company's equity increased by 31.6% to 4.619billion. And cash and cash equivalent dropped 2.13billion to 3.728billion due to more investment. It is worth notice that the company's net debt reached 1.621billion, and net debt to equity ratio rose to 35%. In spite of low financial risk, its increasing debt needs to pay attention.

Earning forecast

The on-hand contract value amounted over 65billion may ensure profit increase of CSCI, and revenue proportion of infrastructure investment will have positive impact on its gross profit margin. We expect that total turnover in 2011 and 2012 will be 16.54billion and 20.86billion, gross profit margin up to 12%, and net profit will reach 1.38billion and 1.79billion, EPS at 0.413 and 0.498 respectively.

Risk

Debt may keep rising.

Progress of infrastructure may delay.

Yield of BT business model may drop.

Valuation

Because of upgrading status of affordable houses and leading level in the sector, share price of CSCI in 2H2010 was revalued in short time. See figure2, in the second 6 months of 2010, the forecasted P/E of CSCI rose from 10 times to 18 times, and its share price soared by 185% for soaring P/E and profit forecast. Since 2011, the share price has risen by 9%, fluctuating around HKD 8. In our opinion, CSCI will enjoy high valuation in coming year, P/E between 15times and 22times, and growth of contract value and booked revenue will become more important driving factors.

Because shares expanded and revenue from infrastructure was lower than forecast, EPS of CSCI is adjusted to 0.413 and 0.498 respectively, we give the company forecast P/E of 21 times to reflect high degree of prosperity on building affordable house. According to our estimation, 12m TP of CSCI is forecasted to HKD8.67, 14.4% higher than current price. We maintain CSCI “Hold” rating.

Financials

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