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DBS Group Research Summary - Railway Equipment and Construction Sector (June 12, 2014)

Core Content Overview

This report from DBS Group Research focuses on the railway equipment and construction sector in China, highlighting the positive impact of increased fast speed train adoption and service enhancements on train manufacturers and railway construction companies. The report outlines the expected growth in infrastructure investment, the recent contract wins, and the valuation outlook for key players in the sector.

Main Points and Key Information

Positive Trends in the Railway Sector

• Service Enhancements: Starting from July, there will be an increase in the frequency and speed of train services for both passenger and freight markets.
• Carrying Capacity: The increased service will drive the need for higher carrying capacity, leading to more train procurements.
• New Rail Tracks: The commissioning of 7,000km of new rail tracks this year is expected to further boost train procurement.
• Government Initiatives: The government's accelerated railway network expansion program is driving increased investment in the sector.

Major Contract Wins

• China Railway Corporation (CRC) has awarded large contracts to CSR Corp and China CNR, each worth up to RMB16-17bn in the first two weeks of June.
• CRG has secured more new railway construction contracts by value year-to-date (YTD), while CRCC is expected to catch up in the coming months.

Investment Outlook

• Total Railway Spending Budget: The 2014 railway spending budget is reportedly to be revised upward to RMB800bn from the original RMB720bn.
• Infrastructure Investment: From January to April 2014, railway infrastructure investment reached RMB94.3bn, a 5% increase compared to the same period in 2013.
• Investment Growth: The investment trend is expected to continue with the annual railway investment likely to reach higher levels.

Valuation and Earnings Prospects

• Undemanding Valuation: Despite the recent dip in share prices due to the government's proposed through-train scheme, valuations for these companies are considered undemanding.
• Earnings Growth: The increasing order flow and new contracts are expected to improve earnings prospects for the companies.
• CSR as Top Pick: CSR is highlighted as the top pick due to its strong backlog of orders and earnings fundamentals. It is currently trading at 1 SD below the mean PE, indicating it is undervalued.

Market Reaction and Concerns

• Share Price Depressed: The proposed through-train scheme has led to a decline in share prices for railway companies.
• Working Capital Pressure: The increasing business flow may lead to higher trade receivables and pressure on working capital, which has affected share price performance.

Investment Recommendations

Company	Price (HK$)	Target Price (HK$)	Recommendation	Market Cap (US$m)	FY14F PE (x)
China Communications Construction (1800 HK)	5.48	6.8	Buy	11,435	4.8
China Railway Group (390 HK)	3.79	3.9	Hold	10,414	6.2
China Railway Construction (1186 HK)	6.74	8.8	Buy	10,727	5.6
CSR (1766 HK)	6.01	7.7	Buy	10,702	12.8
China CNR (6199 HK)	5.24	n.a.	NR	8,207	13.4

Segmental Breakdown and Key Assumptions

China Communications Construction (1800 HK)

• Backlog: RMB700.5bn (FY14)
• New Contracts: RMB514.9bn (FY14)
• Segmental Revenues:
  • Construction: RMB286.3bn (FY14)
  • Design: RMB20.1bn (FY14)
  • Dredging: RMB34.4bn (FY14)
  • Port Machinery: RMB24.2bn (FY14)
  • Others: RMB4.1bn (FY14)
• Gross Profit Margins:
  • Construction: 9.0%
  • Design: 24.0%
  • Dredging: 14.0%
  • Port Machinery: 7.0%
  • Others: 9.0%
• Total Gross Profit: RMB38.9bn (FY14)

China Railway Group (390 HK)

• Backlog: RMB1,302.0bn (FY14)
• New Contracts: RMB1,757.1bn (FY14)
• Segmental Revenues:
  • Infrastructure Construction: RMB479.1bn (FY14)
  • Survey, Design, and Consulting Services: RMB10.1bn (FY14)
  • Engineering Equipment & Component Manufacturing: RMB12.3bn (FY14)
  • Property & Others: RMB107.6bn (FY14)
• Gross Profit Margins:
  • Infrastructure Construction: 5.8%
  • Survey, Design, and Consulting Services: 18.0%
  • Engineering Equipment & Component Manufacturing: 16.0%
  • Property Development: 10.0%
  • Other Business: 7.6%
• Total Gross Profit: RMB43.6bn (FY14)

China Railway Construction (1186 HK)

• Backlog: RMB942.3bn (FY14)
• New Contracts: RMB586.7bn (FY14)
• Segmental Revenues:
  • Construction: RMB286.3bn (FY14)
  • Design: RMB15.4bn (FY14)
  • Dredging: RMB30.3bn (FY14)
  • Port Machinery: RMB16.9bn (FY14)
  • Others: RMB6.5bn (FY14)
• Gross Profit Margins:
  • Construction: 9.7%
  • Design: 25.7%
  • Dredging: 14.2%
  • Port Machinery: 5.0%
  • Others: 9.0%
• Total Gross Profit: RMB32.6bn (FY14)

Summary of Key Growth Areas

• Railway Operational Length: Expected to increase from 103,000km in 2013 to 123,000km in 2015, with a CAGR of 9.3%.
• High-Speed Rail: Projected to grow from 11,028km in 2013 to 19,000km in 2015, with a CAGR of 31.3%.
• Passenger Turnover: Anticipated to rise from 1,060bn people/km in 2013 to 1,600bn people/km in 2015, with a CAGR of 22.9%.
• Freight Turnover: Expected to increase from 2,903bn tonnes/km in 2013 to 4,290bn tonnes/km in 2015, with a CAGR of 21.6%.

Conclusion

The report suggests that the railway equipment and construction sector in China is poised for growth due to increased service frequency and higher adoption rates of fast speed trains. The sector is experiencing a surge in new contracts and is expected to benefit from the increased railway infrastructure spending. While valuations are currently undemanding, the strong backlog and earnings fundamentals make companies like CSR attractive investment opportunities. The overall outlook is positive, with the potential for improved earnings and share price performance as the spending cycle gains momentum.