Shenwan Hongyuan Group: Short-term enterprise valuation repair rebound maintains a "positive" rating on the construction and decoration industry.

Shenwan Hongyuan Group released a research report stating that profit recovery is supported by investment, maintaining a "positive" rating for the construction and decoration industry. The bank believes that after undergoing industry restructuring in recent years, companies have made relatively sufficient provisions for bad debt, and some operating indicators have begun to improve in 2023-2025. With the combined catalyzing factors of stable infrastructure growth policies, relaxation of real estate policies, SOE reforms, and the Belt and Road Initiative, companies in the medium to long term are expected to benefit from improvements in industry data, resulting in increased revenue, profit, and cash flow, while in the short term this will be more reflected in valuation recovery and rebound. Shenwan Hongyuan Group's main points are as follows: Long process and large scale of real estate investment, deep involvement of construction companies, gradual completion of risk mitigation By 2025, the total amount of national real estate development investment completion is expected to reach 8.28 trillion yuan, accounting for 17.1% of fixed asset investment. In the breakdown, construction engineering, installation engineering, equipment purchase, and other expenses including survey and design all fall under the scope of general contracting in construction, accounting for about 60% of the total real estate development investment completion. Construction companies are deeply involved in providing services. In the backdrop of continued weakness in real estate investment, companies are facing challenges, reducing leverage internally, streamlining personnel to control costs, optimizing customer and business structures externally, embracing state-owned enterprises, and increasing the proportion of non-residential business. The bank believes that the diversification of company operations has shown some results, with some key operating indicators of sample companies bottoming out in 2023-2025, and risk mitigation gradually completed. Urban renewal taps into existing markets to support investment volume The "15th Five-Year Plan for Urban Renewal" quantitatively sets goals for urban renewal construction, with projects such as renovation of old areas and villages within cities expected to tap into existing markets. Due to the involvement of multiple sectors and intricate processes involved, the expectations on contracting and construction companies are higher. Inspection and testing, prefabricated building constructions are also expected to see growing demand. At the same time, the underground city pipe network is not only an important component of the plan but also a key point in the "Six Network" construction. Under the encouragement of multiple policies, the construction of underground city pipe networks is expected to enter the fast lane in the "15th Five-Year" period, supporting investment volume in the municipal sector. Review of real estate chain cycles: Valuation catalyzed by strong policies in 2008 and 2014, fundamental recovery and profit realization in 2011 1) 2008-2010: The fundamental recovery was V-shaped, market expectations improved under the stimulus of the "4 trillion yuan" package, leading to rapid increase in sector valuations, while company revenue and profits lagged due to the nature of business, with real estate and construction decoration PEs rising by 113% and 71%, and profit increases of 31% and 16% respectively. 2) 2011-2013: Mild expectations on real estate policies, heating up of infrastructure stimulus policies, leading to valuation increase of the sector, as well as benefitting from the lagged response to the 2008 "4 trillion yuan" investment and rapid increase in urbanization rate, profits of the sector were released in this current cycle, with real estate and construction decoration PE ratios increasing by 17% and 12%, and profit increasing by 25% and 18% respectively. 3) 2014-2017: Comprehensive relaxation of real estate policies, start of monetizing shantytown redevelopment, "Belt and Road" initiatives, PPP, etc., strong support for real estate and infrastructure policies led to a significant increase in sector valuations, but as industry investment data continued to weaken, company revenue and profits were unable to be released, with real estate and construction decoration PEs increasing by 211% and 270%, and profit growth of 0% and 5%. Cycle review suggestions: Strong expectation for policy relaxation in this cycle, improvement in medium to long term data, short term reflects valuation increase Compared to previous real estate cycles, there are several differences in this current cycle. 1) The beta of the sector in this cycle is less noticeable compared to previous cycles due to the suppression from multiple troubled real estate companies; 2) The level of supply-side restructuring in this cycle has surpassed the decrease in demand, leading to an oversupply in the market; 3) The willingness of companies in the industry chain to expand their operations is lower than in previous cycles; 4) Both the real estate and construction industry have passed the rapid development stage and entered the mature stage. Considering these factors, this current cycle, under the combined catalyzing factors of stable infrastructure growth policies, expectations of real estate policy relaxation, SOE reforms, and the Belt and Road Initiative, companies are expected to benefit from improvements in industry data in the medium to long term, leading to increased revenue, profit realization, and cash flow improvement. In the short term, this will be more reflected in valuation recovery and rebound. Risk warning: Economic recovery falls short of expectations, real estate recovery falls short of expectations.