China State Construction (3311, $11.96) announced solid full-year 2013 results. Comment: Benefiting from a surge in build-transfer (BT) projects, China State Construction's revenue grew 247.1% year on year to RMB 27.1 billion, while net profit rose 30.1% year on year to RMB 2.7 billion (earnings per share of RMB 0.71, up 30.1% year on year), a record high since its listing in 2005. Operating performance exceeded the annual targets in two respects: (1) net profit growth reached 30.1% year on year, surpassing the annual target of 20%; (2) new contract value reached RMB 45.5 billion, slightly above the annual target of RMB 43 billion. The solid results were mainly due to an increased contribution from high-margin BT projects in mainland China. The 2013 gross margin increased by 1.3 percentage points year on year to 13.7%.

　　Looking ahead, management expects new contract value in 2014 to reach at least RMB 55 billion. In the first two months of this year, the company had already secured RMB 21.15 billion of new contracts, accounting for 38.5% of the annual target. Affordable housing construction in mainland China has become the focus of the company's business development. Management aims to capture a 5% market share of affordable housing projects over the next five years. China State Construction's target for new BT project contracts this year is RMB 22 billion, up 47% year on year. This target is quite aggressive, as it implies that BT projects will account for 50% of this year's total new contract target excluding MGM, whereas BT projects accounted for only about 35% last year.

 

　　BT projects carry higher gross margins than cash works, but their longer payment periods entail higher credit risk. Management said the company is quite selective when choosing BT projects and has sufficient information on hand to assess collection risk. In fact, since China State Construction began its BT project business, all receivables have been collected on time with no defaults. We believe this reflects the company's effective control of the risk of recovering payments on BT projects.

 

　　As of the end of January 2014, the unfinished order backlog was approximately RMB 91.7 billion, up 40.9% year on year. Based on 2013 revenue, the order backlog-to-revenue ratio is about 3.3 times. We expect the company's revenue to continue growing rapidly in 2014 and 2015. We forecast a compound annual growth rate of 25% for revenue and, benefiting from a 0.5 percentage point increase in gross margin and unit fixed cost savings from economies of scale, a compound annual growth rate of 28% for net profit. We expect investment activity to accelerate after the Two Sessions and the company's operating environment to improve. At the current price, the stock trades at 13.3 times 2013 earnings, with EPS growth of 28%, which is an attractive valuation. We maintain our Buy rating on China State Construction with a six-month target price of HK$15.5, equivalent to 17 times 2014 earnings. The company's main risk is problems with project payment collection.