Core views:

We expect Zhejiang Communications Technology's revenue to maintain rapid growth during the “14th Five-Year Plan” (FYP) period (2021-25), with vast growth headroom for profit margins. With the accelerated confirmation of physical infrastructure workloads since Sep 2022, alongside the likely acceleration of investments by major shareholders starting next year, the Company's infrastructure engineering revenue growth is likely to gradually pick up. We anticipate more profit elasticity if its profit margins improve due to the low base of the net profit margin (NPM). We arrive at a target price of Rmb6.8 on 9x 2023E PE and initiate coverage with a "BUY" rating.

Abstract:

Company overview: A leading construction company in Zhejiang Province with quality resources backed by provincial and national investment.

Zhejiang Communications Technology covers two major businesses of infrastructure engineering (via its subsidiary Zhejiang Communication Construction Group) and chemical field (divested in Feb 2022). In 2021, the two segments contributed 91% and 9%, respectively, to the total revenue, and the Company has started to focus more on the main business since 2022. The infrastructure engineering business is mainly engaged in the construction projects of roads and bridges in Zhejiang Province, which has become the major driver of the Company's revenue and profit growth in recent years. The actual controller of the Company is the State-owned Assets Supervision and Administration Commission (SASAC) of Zhejiang Province, and the controlling shareholder is Zhejiang Communication Investment Group (the “Group”), which is the main force of communications infrastructure investment and construction in Zhejiang Province and the largest state-owned enterprise (SOE) in this field with operation management at the provincial level.

The triple drivers of revenue growth.

1) Communications infrastructure in Zhejiang has been progressing remarkably during the 14th FYP period: Vertically, compared with that in the 13th FYP period (2016-20), Zhejiang's highway/railway investment is planned to grow by 56%/208% in the 14th FYP period, respectively; Horizontally, the total amount and growth rate of communications infrastructure in Zhejiang Province during the 14th FYP period are taking the lead in China. 2) The major shareholder's communications infrastructure investment during the 14th FYP period is increasing, with more efforts expected in 2023-25: Over 40% of the Company's revenue from infrastructure engineering are related to the Group and its subsidiaries. The major shareholder plans to increase investment by 50% and 80% in highway and railway, respectively, compared with that during the 13th FYP period. We estimate that in 2021 and 2022, it completes only 16.7% and 15.3% of the investment plan, implying stronger investment in the latter three years of the 14th FYP period. 3) Expand the “three outbound markets” + areas beyond roads and bridges, and continue to create a new growth point: In terms of customer group sources, the Company actively expands the “three outbound markets”, i.e., new customers other than its controlling shareholder, projects outside Zhejiang province and markets of foreign countries and regions; In terms of business direction, the Company actively expands areas beyond roads and bridges such as railways, rail transit, underground pipe corridors, ports and navigation.

A dual-driver of excellent operational quality and NPM improvement.

Compared with its peers, the Company's return on equity (ROE) is only lower than that of Sichuan Road & Bridge and Shandong Hi-Speed Road & Bridge. In a breakdown, the Company has a high asset turnover ratio, a low attributable net profit (ANP) and a moderate gearing ratio. The low ANP is mainly due to the low gross profit margin (GPM). In 2021, its GPM (8.4%) was about 3ppts-9ppts lower than Sichuan Road & Bridge (17.0%), Shandong Hi-Speed Road & Bridge (11.4%) and China Communications Construction Company (11.3%) and other peers, but the Company's expense ratio and per capita revenue generation are better than its peers. The low GPM mainly stems from the Company's greater emphasis on project payment returns, higher turnover of receivables, and the more competitive market in Zhejiang. Going forward, the Company's margin improvement is driven by two factors: 1) Continuous quality and efficiency improvement that has been promoted in recent years, and leveraging technological innovation and construction industrialization bases to achieve higher GPM and lower non-R&D expense ratios; 2) strengthening synergies with the resources of the major shareholder's platform, including the Group as the investment platform for transportation and construction and peer companies within the Group engaged in design, resources, highway operations, finance and material supply chain businesses. The listed company's strengthening of synergies with resources within the Group is also conducive to using the capital market well and helping the Group to reduce its debt ratio.

Potential risks: Less-than-expected order growth; disappointing increase in profit margin; affected construction progress due to local Covid flare-ups, weather changes, etc.; less-than-expected M&As; growth constrained by significantly increased liability ratio.

Investment strategy: We expect Zhejiang Communications Technology's revenue to maintain rapid growth during the 14th FYP period, with vast growth headroom for profit margins. With the accelerated confirmation of physical infrastructure workloads since Sep 2022, alongside the likely acceleration of investments by major shareholders starting next year, the Company's infrastructure engineering revenue growth is likely to gradually pick up. We anticipate more profit elasticity if its profit margins improve due to the low base of the NPM. We forecast 2022E/23E/24E ANP to be Rmb1.276bn/1.456bn/1.942bn (+33.7%/+14.1%/+31.6% YoY). If excluding the one-off income of Rmb136mn from the sale of its chemical subsidiaries in 2022, we estimate that the Company's ANP to increase by 24.9% YoY in 2023. Based on the Company's PE/PB valuation center of 9x/1.04x since 2019 and the PE valuation center on 8x per Wind consensus estimates for comparable companies, namely Shandong Hi-Speed Road & Bridge (000498.SZ), Sichuan Road & Bridge (600039.SH), and China Communications Construction Company (CCCC, 601800.SH) since 2019, and considering the obvious growth momentum of Zhejiang's communications constructions and the board headroom for the Company's profit margin, we give a valuation premium and assign 9x 2023E PE to derive a target price of Rmb6.8, and initiate coverage with a “BUY” rating.