China State Construction Engineering:Initiate with Hold,Prefer AA/A utilities instead

China State Construction Engineering Corp Ltd (CHCONS) has tapped the USDbond market for the third consecutive year, printing USD1 billion dual-trancheacross 5-year and 10-year. In this note, we initiate on CHCONS 2021s(G+110bp offer), CHCONS 2022s (G+105bp) and CHCONS 2027s (G+135bp)with Hold as valuation appears fair (compared to group comps andconstruction peers). The company is rated A2/A/A by M/S/F, having a 2 notchuplift by S&P, and three by both Moody’s and Fitch from the stand-alone creditprofile due to its strong parental/government support. Just among CHCONSbonds, we prefer the 2027s to 2022s. The curve is relatively steep with 5s/10sg-spread difference at ~30bp (Figure 1), in the context of single-A rates ChinaSOEs that are typically around 20bp. We will be a bit surprised if the 10yrspread underperformance (vs. 5yr) continues in a meaningful way from hereon. 2021s also look relatively more attractive than the 2022s.

    Group comps.

    The spread difference between CHCONS and subsidiary COLI (Baa1/BBB+/A-)has come off YTD tights (Figure 2) and is now around 15-20bps, which weview is fair in the current market context for 2 notch rating differential. CNOOC2022s (A1/A+/A+) is around 35bp tighter than 3-4 notches lower-rated groupcompany COSL 2022s (Baa1/BBB/A)Construction comps.

    We consider China Railway Construction Corp Ltd (A3/A-/NR) and ChinaRailway Group Ltd (NR/BBB+/A-) as the closest peers of CHCONS, given theircentral government ownership, involvement in E&C sector, and strongpositions in their respective market. RLCONS 2023s are now trading at G+123bp offer, while CHRAIL 2023s are at G+115bp and CHRAIL 2026s atG+133bp. Purely on underlying credits, we think CHCONS should trade 5-10bptighter than rail credits for similar maturity, due to its higher ratings, strongerfinancial profile with larger scale, and better EBITDA margin.

    Separately, compared to lower/mid-A rated Chinese names (Figure 3),CHCONS appears broadly at fair value.

    Within the China IG space, we continue to see best value in the AA/A utilitieslike CHGRID 2027s (G+121bp, Buy) and YANTZE 2026s (G+123bp, Buy).

    Key upside risk for CHCONS includes higher-than-expected FAI spending onhousing and infrastructure, while key downside risks are China macroslowdown, reduced SASAC ownership, overly aggressive expansion plans andfailing to execute its real estate projects.