A resilient outlook painted during Hong Kong NDR (March 20-22)

We hosted a post-results NDR with Shanghai Electric management in HK onMarch 20-22. The company expects its power equipment business to remainresilient, with rising offshore wind and nuclear equipment offsetting the coalfiredequipment downcycle. For non-power equipment, overseas EPC andbasic parts business (through the upcoming asset injection) will likely be thetwo key drivers. We project an earnings CAGR of 6% over 2017-19. At currentlevels, valuation looks fair for H-shares (hence Hold) but rich for A-shares(hence Sell). In this note, we summarize managements responses to 20 FAQs.

Diminishing impact from coal-fired equipment downcycle

The company sees manageable downside risk to its coal-fired equipment salesduring 2017-18, as most of the projects to be delivered have already gone halfway through their construction cycles, which means substantial losses forproject owners if those projects get suspended. Management expects its coalfiredequipment sales to sustain at c.Rmb10bn toward 2020 (2016: Rmb12bn),which would account for only c.10% of its 2020 sales target of Rmb100bn. Weare more cautious, expecting its coal-fired equipment revenue to drop by8-10% in 2017-19 and account for 10% of its sales by 2019.

Key drivers for power equipment: wind (2017-18) and nuclear (2019-20)

Despite disappointing 2020 development targets for wind power announced bythe government, management believes its unique positioning in offshore windpower equipment (c.50% market share globally in 2016) should allow its windturbine segment to sustain growth at least during 2017-18. Nuclear powerprojects should see concrete resumption this year, and more projects areexpected to kick off construction ahead. This should drive accelerating nuclearrevenue recognition starting in 2019. We project a CAGR of 9% and 15% for itswind and nuclear equipment sales, respectively, over 2017-19.

Key drivers for non-power equipment: overseas EPC and basic parts

Elevator business should remain stable, with rising after-sales and escalatorsales offsetting weakness in new sales for traditional elevators. Managementexpects the injection of SPM to bring immediate accretion (sales of Rmb7-8bn)and to strengthen its strategic positioning in the basic parts business, in lightof the government’s strong push for localization of core components. Foroverseas EPC, it will mainly focus on the countries alongside the “One BeltOne Road” and only undertakes projects that are on Sinosure’s list to managerisks. We project a 2017-19 CAGR of 3% for non-power equipment sales.

Tweaking estimates and target prices while retaining ratings; dividend; risks

Incorporating the 2016 results and guidance, we lowered our earningsestimates by 7% for 2017/18 and introduced our 2019 forecasts. We raised ourtarget prices for H-shares to HKD3.6 and for A-shares to Rmb3.2 as we slightlylift our target P/B to 0.90x (vs. 0.85x previously) to reflect the potential for ROEaccretion from the announced asset injections. We expect Shanghai Electric toresume dividend payout this year after completing its A-share placement. This,along with the distribution of deferred dividends for 2015-16, should lead to a2017 dividend yield of c.4% for H-shares. We maintain Hold for H-shares andreiterate Sell for A-shares. Key risks: faster-/slower-than-expected decline incoal-fired equipment sales and good/poor execution of asset injections.