Dongfang Electric reported 3Q16 net loss of RMB723m on lowrevenue and assets impairment
   
Management expects flat overall GPM for FY16e; looking forrecovery from hydro/wind
   
Maintain Hold/Reduce for H/A shares, with unchanged TPs ofHKD5.6/RMB5.0
   
Investment thesis: As a major Chinese traditional power equipment player,Dongfang Electric is facing significant growth challenges amid the over-suppliedpower market. We did not expect power equipment stocks to rally so strongly, asearnings are no longer falling, but they are not rising either. We think earnings havenow bottomed but see no sign of a cyclical rerating. Our H-share TP price impliesFY17e PB of 0.5x, which we believe fairly reflects a RoE contraction to 1% in2017-18e. We keep the H shares rated Hold and maintain our Reduce rating on theA share due to their expensive valuation.
   
3Q16 result: Dongfang reported 3Q16 net loss of RMB723m due to 1) low revenueof RMB5,420m, down 30% yoy; and 2) assets impairment of RMB452m related toprovision on aging receivables and inventory reduction in 3Q16, compared toRMB325m in 3Q15; GP margin maintained at 11.5% in 3Q16 vs 11% for 1H16. Neworder inflow experienced a sharp decline to RMB5,570m in 3Q16 by 43.7% yoy, vsRMB1,480m in 2Q16. The company has cash on hand of RMB25bn by end of 3Q16vs market cap of HKD24bn.
   
Key highlights from conference call: Management sees the uncertainty of FY16assets impairment and expects no more impairment related to inventory reduction;Production output is largely scheduled for 2017, including thermal and cleanenergy; Expects overall GP margin to bottom out at this level and expects FY16e GPmargin of 11-12%; Expects 8-10 nuclear projects for public tender over 2016-2020e(accounts for 10%-15% of company’s annual revenue); Looking for GP marginrecovery from hydro (to the normal level at 15% helped by large scale projects, i.e.
   
Baihetan).and wind. DEC signed a USD2bn Egypt projects contract in 1H16 (notincluded in 9M16 new orders as not received prepayment), which still in the progress.
   
Valuation: We use the PB valuation approach, as the company has flagged potentialloss for FY16. We apply a PB multiple of 0.5x to reflect RoE of 1% in 2016-18e.
   
Upside risks for H and A shares: Better order inflows for the thermal power, fasterdevelopment in nuclear power projects, and higher GPM from a recovery in ASP.
   
Downside risks for H shares: Cancellation or suspension of thermal backlogorders; lower-than expected GPM recovery.