3Q18 results miss estimates

COMEC’s 1–3Q18 revenue fell 24.1% YoY to Rmb11.76bn. Thecompany recorded a net loss of Rmb577mn （-Rmb0.41/sh） in 1–3Q18, up 208% YoY, and a net loss of Rmb282mn in 3Q18, up 22%YoY. Excluding one-offs, 1–3Q18 losses came in at Rmb574mn.

Revenue and gross margin fell; operational expenses as % ofrevenue slightly improved. Revenue fell about 20% YoY in 1–3Q18and 30% YoY in 3Q18, as the downtrend in the shipbuilding marketdampened new orders and delivery capacity constrained by wharfshortage. Gross margin fell 3.92ppt YoY to 2.82% in 1–3Q18, slowerthan in 1H18 （down 7ppt YoY）。 Selling, G&A and financial expensesdown 53%, 6% and 99% YoY and R&D expenses up 26% YoY.

Forward FX contracts weighed on earnings. With large forward FXcontracts on hand and renminbi depreciation, fair value loss reachedRmb556mn in 1–3Q18 and Rmb334mn in 3Q18. Asset impairmentlosses rose Rmb58mn YoY in 1–3Q18 mainly due to higher contractprovisioning.

Trends to watch

We expect earnings to improve on production capacity expansionand new orders. The company has acquired Wenchong Dockyard toincrease wharf count. Supported by continued production capacityexpansion, we expect the company to turnaround in 2019 withearnings boosted by new orders.

Earnings forecast, Valuation and recommendation

We cut our 2018 earnings to -Rmb173mn to reflect 2018 fair valuecharges and gross margin slump and accordingly cut our 2019earnings by 37% to Rmb116mn. The stock is trading at 0.6x 2018e P/Band 0.6x 2019e P/B. Though 2018 earnings face headwinds fromforward contracts, we remain upbeat on its growth prospect amidthe recovery of the shipbuilding sector. We maintain our BUY ratings,but cut our TPs by 9% and 12% to Rmb11.4 （1.5x 2018e P/B and 1.6x2019e P/B） and HK$6.6 （0.7x 2018e P/B and 0.7x 2019e P/B）。 Our TPsoffer 23% upside for A share and 23% for H share.

Risks

Renminbi depreciation; disappointing civil orders or delivery ofmilitary orders.