According to the preliminary data of China Construction Machinery Association, excavator sales of 25 major manufacturers reached 16,027 units in December, an increase of 14% over the previous year. Domestic sales increased 12% to 14,278 vehicles (89% of total sales) and exports increased 38% to 1,749 vehicles (11% of total sales). The 14% growth rate in December was similar to that in November. Annual sales in 2018 increased by 45% to 203,420 vehicles (a record high), in line with our expectations. The Association will release December data for other machinery products later this month, and we expect other construction machinery sales growth to improve as well.

      The rising cycle lasts until 2019. We do not expect the high base in 2018 to affect the growth rate of excavators. We are still optimistic that the excavator industry will achieve 15% sales growth in 2019. We believe that the growth momentum comes from three aspects: (1) the Chinese government will shift its focus on investment to support economic growth, and infrastructure investment will continue to increase; (2) the growth of natural demand for renewal and replacement will remain stable with less downside risk; (3) in response to the Central Government launched the "Three-year Action Plan for Winning the Blue Sky Defense War" in mid-2018, including Tianjin, Chengdu, Jinan, Beijing, Guangzhou and Shenzhen. Local governments in Shenzhen and other places have banned the operation of heavily polluted off-road vehicles (construction machinery and forklifts). According to the data of China's Ministry of Ecology and Environment, more than 80% of China's construction machinery in 2017 belongs to Guo II or previous models. Opportunities for these construction machinery are further constrained. We believe that strict local government restrictions on old-fashioned machinery will drive demand for alternatives.

      Investment Suggestion: We believe that Sany Heavy Industry (600031CH, not rated) has benefited most from its large share of the sales of excavators (about 40%). China Longgong (3339 HK, Buy, Target Price: HK$3.60) valuation is attractive, with a price-earnings ratio of only three times after cash in 2019 and a dividend yield of more than 9%. In addition, we anticipate that Jiangsu Hengli (601100CH, unrated), China's largest manufacturer of excavator hydraulic cylinders, will benefit from increased demand for excavators and increased market share. The main catalysts for the future include: (1) better-than-expected monthly sales data for the first quarter of 2019; (2) more policies to eliminate old machinery will be introduced by local governments.