• We expect industrial and service sector recovery in March. Another sector expected to enjoy a rebound will be construction materials.
• We are OVERWEIGHT on the China construction materials and infrastructure sectors due to increasing demand for materials and large scale of infrastructure project financing.

Supply-side: Industrial and service sector recovery in March

Industrial Sector：

In the first two months of 2020, the industrial value-added in China decreased by 13.5% YoY, of which the mining industry decreased by 6.5% YoY, manufacturing industry decreased by 15.7% YoY, and utility sectors decreased by 7.1% YoY. (Figure1)

According to the high-frequency data of daily coal consumption in power generation (Figure 2), the resumption of work in March has improved significantly. Coal consumption for power generation in February and March jumped 80% of the same period last year. Considering the high base of industrial value-added in March 2019 (+50.5% MoM, +8.50% YoY), we expect the growth of industrial value-added in March this year will be slower.

In March, the manufacturing PMI (Figure 3) improved greatly, and the production sub item reached the highest since 2018. Combined with the data of coal consumption for power generation, we predict that the decline of industrial value-added in March will be narrowed compared to February (-13.5% YoY), which will drive the growth of industrial value-added in 1Q2020 to pick up.

Service Sector:

In the first two months of 2020, China’s services index dropped by 13.0% YoY (Figure 4), of which the financial industry grew by 4.5% YoY, the IT service industry grew by 3.8% YoY, and other industries declined at varying degrees.

In March, considering the recovery of the economy after the outbreak of the virus and the fact that most of the service industry’s goods are focusing on mainland China, less affected by the overseas outbreak, we expect that the service industry production index in March will pick up to the same level of March 2019.

In general, the industrial growth rate in the first quarter will contract in 1Q2020, but due to the large proportion of service industry in China GDP (more than 50%), we expect the economic decline in the 1Q will be slightly less than 13%.

Demand Side: Construction investment picked up

Consumer:

In the first two months of 2020, the total retail sales of consumer goods in China reached RMB 5.2tn, down 20.5% YoY, the retail sales of consumer goods (excluding automobiles) reached RMB 4.8tn, down 18.9% YoY, auto sales down 37% YoY (Figure 5).

From the high-frequency data of daily average vehicle sales (Figure 6), growth of automobile sales in March remained negative, but the decline was narrowed compared to February.

From the PMI demand sub item (Figure 7), the performance of domestic demand is better than foreign demand, reflecting the gradual recovery of domestic consumption after the epidemic situation. We expect that the decline of China’s automobile consumption and sales of consumer goods in March will be narrower compare to February.

Fixed Assets Investment:

In the first two months of 2020, China’s fixed-asset investment decreased by 24.5% YoY (Figure 8), of which manufacturing investment decreased by 31.5% YoY, infrastructure investment decreased by 26.9% YoY, and real estate investment decreased by 16.3% YoY.

From the high-frequency data, we observed that the steel inventory peaked in mid-March and began to fall back in late March and early April. Refer to the blast furnace operation rate (steel manufacturing) continued to rise from the end of February (Figure 9).  We believe that the decline of steel inventory from the peak is mainly due to the rise of demand, rather than the contraction of production. Also, based on the rebound of PMI of the construction industry and its employees in March, we expect that construction and other sectors with the large demand for steel in March will be improved.

Real estate:

In the first two months of 2020, real estate investment decreased by 16.3% YoY, the construction area increased by 2.9% YoY; the completed area decreased by 22.9% YoY, and the newly started area decreased by 44.9% (Figure 10).

From January to February, the growth rate of land acquisition and price dropped 29.3% YoY and 36.2% YoY respectively. The sales area decreased by 39.9% YoY, and the sales volume decreased by 35.9% YoY (Figure 11).

Infrastructure:

In the first two months of 2020, infrastructure investment (excluding power) decreased by 30.3% YoY.

In March, special debt financing amounted to RMB 154.2 bn (Figure 12). In 1Q2020, the level of special debt financing reached RMB 1104bn, an increase of RMB 386.8bn compared with the same period last year.

We believe that with the gradual implementation of various new infrastructure projects in China, infrastructure financing will be converted into investment expenditure, and we expect that the growth of infrastructure investment will pick up significantly in March.

Investment Actions:

We are OVERWEIGHT on the China Construction Material Sector and Infrastructure Sectors.

Construction Material:

We are positive on construction material sectors due to the rising demand.  Also, based on the rebound of PMI of the construction industry and its employees in March, we expect that construction material sectors’ performance in March will be improved.

The China construction material sector is currently trading at 12.5x P/E for FY20e, lower than 15.9x P/E of total A-share.

Infrastructure:

We believe that with the gradual implementation of various new infrastructure projects in China, infrastructure financing will be converted into investment expenditure, and we expect that the growth of infrastructure investment will pick up significantly in March.