CHINA INDUSTRIAL AUTOMATION：3Q17 - GROWTH LIKELY BEATS EXPECTATION AGAIN
Preliminary datapoints from Gongkong show that China's IA new order growthfurther accelerated in 3Q （+14% YoY vs. +11%/12% in 1Q/2Q）。 The marketpreviously had anticipated that on a higher base, the growth would taper offprobably towards the high-single digit level. Our conversations with Gongkongsuggest the final growth rate may come even higher and such strong growthwas largely driven by better-than-expected demand from small-to-medium-sizeenterprises （SMEs） as they are increasingly willing to invest in automationupgrades to strengthen their competitiveness against the backdrop of improvingprofitability. Strong government support also helped to accelerate this trend, inour view.
Hollysys and Inovance may deliver better-than-expected order growth in 3Q
For servo and low-voltage inverter （Inovance's key products）， YoY growth rates（preliminary data） for new orders further accelerated to 30%+ and c.15%respectively in 3Q, from 14%/27% and 11%/10% respectively in 1Q/2Q. This,along with accelerating import substitutions, may drive stronger-than-expected IAnew order growth for Inovance in 3Q. For DCS （Hollysys' key product）， preliminarynew order growth further ticked up to 7% from 5% in 1H. Hollysys managedto deliver 36% IA new order growth in FY17 against flattish industry growth.Continued market recovery, together with rising after-sales services, likely led tofurther acceleration in Hollysys' IA new order growth over the past quarter.
We retain bullish view on the sector; buy Hollysys and Inovance
We are seeing more evidence that this ongoing IA demand recovery in China isstructural in nature rather than cyclical, and therefore strong growth could besustained going forward. This evidence includes 1） SMEs' increasing willingnessto invest in automation, and 2） accelerating manufacturing upgrades in traditionalverticals （e.g. textile machinery, machine tools, metallurgy, etc.） where newexpansion capex has not been a driving force of automation demand. Forindividual companies, we look for better-than-expected 3Q IA new orders to serveas a strong catalyst. On top of this, we believe the non-IA business （rail forHollysys and NEV for Inovance） will likely see a strong turnaround in 2H as NEVsales continue to recover while rail equipment procurement speeds up. We useDCF to value the two companies. Key risks: slower-than-expected IA and importsubstitution.
□ .S.k.y. .H.o.n.g./.N.i.c.k. .Z.h.e.n.g .德.意.志.银.行.股.份.有.限.公.司