CAPOL INTERNATIONAL&ASSOCIATES(002949)：EPC BUSINESS SHRINKING;WATCH DEVELOPMENT OF DIGITAL TRANSFORMATION SERVICES

　　3Q22 results in line with our expectations

    　　Capol International & Associates (Capol) announced its 1-3Q22 results: Revenue dropped 29.4% YoY to Rmb1.3bn and attributable net profit rose 2.2% YoY to Rmb144.17mn. In 3Q22, revenue declined 44.5% YoY to Rmb436mn, and attributable net profit edged up 1.2% YoY to Rmb77.04mn. Results are in line with our expectations.

    　　GM rose 14.4ppt YoY to 37.1% in 3Q22, as the proportion of Capol’s low-profit-margin engineering procurement construction (EPC) business dropped. Overall expense ratio in 3Q22 rose 6.2ppt YoY to 17.0%. Specifically, selling, G&A and R&D expense ratios in 3Q22 rose 1.3ppt, 3.3ppt and 1.6ppt YoY, and financial expense ratio remained flat YoY. Total reversal of asset and credit impairment losses equaled Rmb9.23mn in 3Q22, mainly due to the withdrawal of bad debt provision for credit impairment (booked at end-2021). Net margin improved 8.0ppt YoY to 17.7% in 3Q22, and net operating cash inflow increased Rmb43.08mn YoY to Rmb86.61mn thanks to lower cash payment. In 3Q22, net investment cash outflow increased Rmb63.97mn YoY to Rmb134.36mn.

    　　Trends to watch

    　　EPC: Revenue dropped due to shrinkage of business scale; earnings quality improved. In 3Q22, Capol’s revenue dropped 44.5% YoY and GM rose 14.4ppt YoY to 37.1%. Despite the steep decline in revenue, earnings improved as the proportion of low-GM EPC business to total revenue plunged. We expect the proportion of the EPC business to continue narrowing.

    　　Prefabricated building design: Watch marginal improvement in order and revenue growth amid demand recovery. In 1H22, revenue from the prefabricated building design segment rose 1.6% YoY, but the value of new orders dropped 27.1% YoY. According to the CICC Real Estate research team, gross floor area (GFA) of newly started housing projects and net increase of construction area remained low over July-September (both dropped around 45% MoM). We believe this reflects continued reluctance of real estate developers to invest amid weak investment capability. Therefore, we think that order and revenue growth of the firm’s design business came under pressure in 3Q22. Looking ahead, we suggest investors keep an eye on marginal improvement of its order and revenue growth in this segment as demand increases.

    　　Watch development and implementation of orders for digital transformation solutions. In early 2022, the Ministry of Housing and Urban-Rural Development issued the 14th Five-Year Plan for developing the construction industry, proposing to accelerate the application of building information modelling (BIM) technology in engineering projects and to form basic technological framework and standards in 2025. In recent years, Capol has continued to develop BIM technology. Via its cooperation with Vanyitech and ZWSOFT, the firm further enhanced its technological competitiveness in building design. According to the 14th Five-Year Plan of Shenzhen Digital Government and Smart City, the Shenzhen government proposed that the BIM model utilization rate should reach 100% in essential building, municipal infrastructure, and water projects. Given this background, we suggest investors pay attention to Capol’s development and implementation of orders.

    　　Financials and valuation

    　　We keep our 2022 and 2023 earnings forecasts unchanged. The stock is trading at 13.3x 2022e and 11.0x 2023e P/E. We maintain an OUTPERFORM rating and our TP of Rmb18, implying 17.2x 2022e and 14.2x 2023e P/E with 29% upside.

    　　Risks

    　　Recovery of order growth lower than we expect.