Morgan Stanley sees China construction-machinery selloff as sentiment-driven, with fundamentals still resilient

Overview

This update addresses the sharp selloff in China construction-machinery shares. Morgan Stanley attributes the move mainly to several market concerns rather than a deterioration in reported operations, and maintains a positive fundamental outlook while recognizing that VAT-refund and US trade-policy uncertainty may continue to weigh on sentiment.

Core views

The report frames the selloff as driven by four concerns: a possible reduction in export VAT refunds, new US antidumping and countervailing-duty investigations into certain hydraulic cylinders, worries about weakening domestic demand, and concern about further US rate hikes. In the preceding session, Sany, Hengli Hydraulic, Zoomlion and uncovered XCMG fell 6.7%, 6.3%, 3.7% and 2.9%, respectively, while the CSI 300 rose 0.7%. Morgan Stanley says neither it nor the companies contacted were aware of a prospective VAT-refund change, and companies continued to describe operations as steady. It therefore views the concerns as primarily a sentiment overhang rather than a change in its fundamental case. The VAT-refund issue is potentially material if implemented. Construction machinery currently receives a full 13% export VAT refund, while overseas revenue accounted for 64% of Sany's FY25 revenue and 59% of Zoomlion's. Morgan Stanley notes that prior changes in batteries, solar PV, refined oil and non-metallic mineral products were sometimes phased but could also be cut directly to zero; for batteries, the refund moved from 13% to 9% in December 2024, from 9% to 6% in April 2026, and is scheduled to fall from 6% to 0% in January 2027. The firm does not include such a change in its base case, but expects the concern to linger amid broader regulatory tightening. On US AD/CVD investigations initiated by the US Department of Commerce on September 9, Morgan Stanley considers Hengli's risk manageable. Preliminary CVD and AD determinations are due November 12 and January 26, 2027, respectively, subject to extensions. Hengli's management says it competes in higher-end, higher-ASP products rather than low-cost segments; direct US export revenue is below 5%, and estimated indirect sales are also low. Morgan Stanley argues that customers would have limited short-to-medium-term ability to replace Hengli because switching critical hydraulic-cylinder suppliers requires lengthy product testing. It expects any tariff-related margin effect to be limited and believes part of a tariff could be passed through to customers. The report also outlines Hengli's mitigation options. About 40% of its direct US hydraulic-cylinder sales are currently made in Mexico, and management believes this could reach 100% by year-end or in 1Q27 if required. Indonesia, which is outside the investigation scope, could also expand US-oriented production. Hengli says it bore less than half the cost in prior US tariff rounds through customer price increases. Mexico's operating cost is currently 20-30% higher than China's, accompanied by roughly 15% higher ASPs; management aims to reduce the cost gap to below 20% as scale grows, potentially preserving similar gross margins, though the timing is uncertain. Morgan Stanley further notes that tariffs could raise costs for US competitors that import Chinese cylinder parts. Regarding demand, the report attributes weak July-August domestic sales to seasonality, severe weather and slower local-government special-bond issuance in April-May. Companies nevertheless reported steady 3Q conditions, with XCMG expecting stronger growth in September and 4Q than in July-August. Morgan Stanley expects domestic growth to slow in 2H versus 1H, but sees margins improving through less intense competition and price increases. It expects gradual domestic recovery over coming years from replacement demand, national infrastructure projects, urban renewal and electrification; the sector's stronger domestic replacement cycle is expected in 2027. Overseas growth remains the principal fundamental support. Management commentary points to sustained demand in Europe, Southeast Asia and North America, with Africa remaining above 30% growth despite deceleration from a difficult comparison base. Sany expects overseas growth of 15-20% over the next few years, supported by further market-share gains. Zoomlion expects roughly 20% year-on-year overseas growth in 3Q, compared with 21% in 1H, led by Africa, Europe, Southeast Asia and Central America. Morgan Stanley expects overseas margin pressure to ease as price increases materialize and foreign-exchange pressure moderates, helped by a stabilizing USD/CNY and an easier comparison against 2H25. It consequently keeps its positive fundamental sector view, citing overseas share gains, margin expansion and attractive valuations, while retaining an In-Line Asia Pacific industry view because near-term policy and trade concerns could keep sentiment subdued.

Analysis framework

Morgan Stanley combines investor and company-call feedback with revenue-mix data, management operating commentary and an assessment of policy and trade scenarios. It tests the selloff concerns against exposure, supplier substitutability, production-location options, pricing pass-through and the expected domestic and overseas demand trajectory.

Methodology notes

• Industry AnalysisSupply-demand framework

  Assessment of domestic replacement demand and overseas demand growth

  The report weighs temporary domestic weakness against a projected 2027 replacement cycle and continued overseas growth to judge the sector's operating outlook.

• Industry AnalysisUpstream-Midstream-Downstream Transmission

  Tariff and VAT-policy transmission through hydraulic-cylinder suppliers, machinery makers and customers

  Morgan Stanley evaluates how a VAT-refund change or AD/CVD tariff could affect margins, supplier sourcing, production locations and customer pricing.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Jiangsu Hengli Hydraulic Co. Ltd. (601100.SS)

  Covered hydraulic-cylinder supplier exposed to US AD/CVD concerns but viewed as relatively well protected by high-end positioning, low direct US exposure and mitigation options.

  Strengths

  High-end products, limited alternative suppliers, Mexico and Indonesia production options, and potential tariff pass-through.

  Weaknesses

  Mexico operating costs are currently 20-30% above China, and the timeline for narrowing the gap is uncertain.

  Comparison

  Morgan Stanley views hydraulic cylinders as less readily replaceable than Chinese aerial working platforms in the US market.

  Risks

  Potential AD/CVD tariffs could affect margins.

• Sany Heavy Industry Co., Ltd. (600031.SS)

  Covered construction-machinery company benefiting from overseas expansion and a future domestic replacement cycle.

  Strengths

  FY25 overseas revenue mix was 64%; management maintains an approximately 20% FY26 revenue target and expects overseas growth above 20%.

  Weaknesses

  Domestic growth may decelerate in 2H versus 1H.

  Comparison

  Overseas growth is expected to remain supported by market-share gains relative to the broader sector.

  Risks

  A reduction in export VAT refunds could affect margins given substantial overseas exposure.

• Zoomlion Heavy Industry (1157.HK, 000157.SZ)

  Covered construction-machinery company with significant overseas exposure and improving overseas margin conditions.

  Strengths

  FY25 overseas revenue mix was 59%; management expects around 20% year-on-year overseas growth in 3Q.

  Weaknesses

  3Q domestic growth is expected to be flat to slightly down year on year, although 4Q should grow modestly.

  Comparison

  Morgan Stanley distinguishes the company's hydraulic-cylinder tariff exposure from higher historical AD/CVD tariffs on Chinese aerial working platforms.

  Risks

  Export VAT-refund uncertainty and potential US trade measures may weigh on sentiment.

Key data

• Sany share-price move-6.7%Move in the selloff session, versus CSI 300 +0.7%.
• Hengli Hydraulic share-price move-6.3%Move in the selloff session.
• Zoomlion share-price move-3.7%Move in the selloff session.
• Construction-machinery export VAT refund13%Current full refund; a potential reduction could materially affect margins.
• FY25 overseas revenue mix64% for Sany; 59% for ZoomlionIllustrates the sector's sensitivity to export-related policy.
• Hengli direct US export revenue mix<5%Management-cited factor supporting limited direct AD/CVD exposure.
• Mexico production share of Hengli direct US cylinder sales~40%Management believes this could reach 100% by year-end or 1Q27 if needed.
• Overseas growth outlook15-20% over the next few yearsSany management expectation, supported by market-share gains.

Impact & implications

Morgan Stanley believes the selloff has created a disconnect between sentiment and operating fundamentals. Its sector case rests on overseas growth, future replacement demand, improving pricing and easing FX pressure, while an export VAT-refund change or adverse US trade outcome could delay sentiment recovery and pressure margins.

Risks

• A reduction in the 13% export VAT refund could materially pressure sector margins.
• US AD/CVD duties on hydraulic cylinders could affect Hengli's margins despite mitigation options and possible customer pass-through.
• Domestic demand could remain weak beyond the July-August seasonal slowdown.
• Market sentiment may remain subdued while VAT-refund and US trade-policy uncertainty persists.

What to watch

• Any official indication of a construction-machinery export VAT-refund adjustment.
• US Department of Commerce preliminary CVD determination expected November 12 and preliminary AD determination expected January 26, 2027, subject to extensions.
• Hengli's progress in shifting US-oriented production to Mexico or expanding Indonesia capacity.
• September and 4Q domestic sales momentum after weak July-August conditions.
• Overseas growth, price-hike realization and FX pressure in 2H.