2016 results in line with expectations

Xinjiang Machinery Research Institute announced its 2016 results: revenue was Rmb1.791bn (+27.86% YoY)and net profit attributable to shareholders was Rmb251mn (-16.56% YoY) or Rmb0.17/share. Income statement:gross margin dipped due to weak sales of agricultural machinery; G&A and financial expenses both increased due to thefull-year consolidation of Future Aerospace. Balance sheet: account receivables’ share of total assets rose 3.06% aspayment collection weakened due to the sluggish agricultural machinery sector. Cash flow statement: cash outflowfrom financing activities surged 270.34% YoY due to payment of loans and interest.

Trends to watch

Agricultural machinery business likely to continue shrinking. Due to upgrading emission standards andadjustments to the subsidy scheme in 2016, the company sold its agricultural machinery products at a discount, hurtinggross margin. Looking ahead, sales of agricultural machinery may fall further in 2017 amid supply-side reform in cornplanting. However, its profit margin may rise, given efforts to organize production based on sales.

Defense business likely to maintain rapid growth: 1) the capacity expansion of its traditional defense businessadvanced steadily and it may outperform its earnings promise in 2017. 2) It has started deploying in civil business andbegan negotiation with international aircraft manufacturers, such as Airbus; international business may become a newgrowth engine going forwards. And, 3) satellite business is advancing smoothly, and its commercial satellite businessmay take off.

Earnings forecast

We lower our 2017 EPS forecast by 5% from Rmb0.32 to Rmb0.31.

Valuation and recommendation

The stock is trading at 47.7x/31.2x 2017/18 P/E. We maintain our BUY rating and target price of Rmb17.00(60x 2017e P/E for defense business and 20x for agricultural machinery).

Risks

Intensifying competition in agricultural machinery sector; defense business misses expectations.