SHANGHAI TUNNEL ENGINEERING(600820)：INVESTMENT INCOME RAMPS UP; REVENUE FROM EASTERN AND SOUTHERN CHINA AND SINGAPORE SOARS

1H23 results in line with our expectations

    Shanghai Tunnel Engineering announced its 1H23 results: Revenue rose 16.0% YoY to Rmb23.38bn, and attributable net profit grew 43.2% YoY to Rmb774mn. In 2Q23, revenue rose 25.7% YoY to Rmb11.94bn, and attributable net profit grew 33.4% YoY to Rmb325mn, in line with our expectations.

    In 1H23, the firm's gross margin fell 2.5ppt YoY to 11.7%. Its R&D expense ratio rose 2.1ppt YoY to 4.0%, financial expense ratio fell 0.9ppt YoY to 3.2%, and the overall expense ratio (including R&D, G&A, selling, and financial expense ratios) grew 1.2ppt to 10.6% in 1H23. Investment income surged to Rmb1.32bn (vs. -Rmb1.76mn in 1H22), mainly due to increased investment income recognized under the equity method. Credit impairment loss increased 184.3% YoY to Rmb324mn. The firm’s attributable net margin rose 0.6ppt YoY to 3.3% in 1H23.

    The firm’s net operating cash outflow shrank 64.4% YoY to Rmb519mn in 1H23, but net investment cash outflow widened 95.4% YoY to Rmb1.27bn.

    Trends to watch Orders from municipal service and energy segments strong; construction revenue from businesses in eastern China, southern

    China, and Singapore high. In 1H23, the firm’s construction revenue rose 21.1% YoY, due to a low base in 1H22. By region, its construction revenue in Shanghai, Fujian, and Guangdong increased 50% or faster YoY, and that in Singapore grew 61.0% YoY in 1H23. Gross margin of its construction business slid 0.3ppt YoY to 8.7% in 1H23.

    The firm's new construction orders grew 6.2% YoY, maintaining the stable growth seen in the past few years. Specifically, orders from municipal service and energy segments grew 64.5% and 199.0% YoY in 1H23, while orders for road construction declined YoY. We believe the firm's construction revenue will maintain stable growth on the back of ample orders on hand.

    Investment and operating income ramping up. In 1H23, the firm’s

    revenue from the infrastructure operation business increased 20.6% YoY to Rmb1.26bn, but its gross margin fell 13.0ppt YoY to 12.1%. Its investment income surged YoY to Rmb1.32bn in 1H23, exceeding the full- year level in 1H22 and driving its earnings growth in 1H23. We believe this reflects the larger scale and higher yields of its investment and operation business.

    At present, the firm mainly participates in domestic infrastructure investment and operation via public-private partnership (PPP). In 1H23, the number of its existing mid- and large-size projects, projects under construction, and projects under operation totals 64. We believe these projects will facilitate the firm’s transformation of its business model, earnings, and cash flow.

    Financials and valuation

    We keep our earnings forecasts unchanged. The stock is trading at 5.8x 2023e and 5.4x 2024e P/E. We maintain an OUTPERFORM rating and our TP of Rmb6.9, implying 6.7x 2023e and 6.2x 2024e P/E with 15% upside.

    Risks

    Disappointing growth in construction orders and/or investment and operating income.