20140505-DBS_Group-China_Construction___Material_Sector_Gaining_rail_momentum_17页_366kb

Gaining Rail Momentum Summary

Core Content

The document outlines the positive outlook for the Chinese railway sector, emphasizing that the first-quarter performance does not fully reflect the strong investment momentum expected for the rest of the year. The Chinese government has increased the 2014 railway investment budget to over Rmb700bn, up from Rmb630bn, indicating a significant upward revision. This is expected to drive more contract flows in the coming quarters, especially in the 2nd to 4th quarters, as the project bidding process accelerates.

The sector's earnings growth in 1Q14 is largely attributed to high backlog orders from 2013, with railway companies holding Rmb1.8tn in backlog at the end of March 2014. This backlog is significantly higher than in 2008, providing a strong foundation for future earnings. Despite a slight compression in gross profit (GP) margins in 1Q14, this is expected to stabilize as the railway segment's contributions increase.

Main Points

• Investment Momentum: The 2014 investment budget is set at Rmb720bn, an increase of 11% from the previous year. About 80% of the budget is allocated to infrastructure, which will boost order books.
• Backlog Orders: Railway companies have a substantial backlog of Rmb1.8tn, which supports future earnings and is about 4 times higher than in 2008.
• Earnings Performance: Railway companies reported a 23% y-o-y increase in 1Q14 earnings, driven by backlog orders. However, this is not yet reflected in the investment pace, which is expected to pick up in the second half of the year.
• Valuation Impact: The announcement of through-train trading affected valuations, especially for H-listed railway stocks, due to the valuation premium over A-shares. The current average PE of 5.5x is considered attractive.
• Government Support: The government is actively supporting railway investments through a development fund and additional funding for the central-western region. China Railway Corporation is also raising funds via bonds and private financial institutions.
• Company Performance:
  • CRCC (1186 HK): Earnings grew by 23%, with a GP margin of 10.3%. The company has a lower gearing level (40%) compared to CRG (107%).
  • CSR (1766 HK): Expected to benefit from infrastructure spending, with a GP margin improvement to 18.3% despite a 5% decline in 1Q14 earnings.
• Market Cap and Valuation:
  • CRCC and CSR are recommended as "Buy" with target prices of HK$8.8 and HK$7.7 respectively.
  • The H-A share valuation gap is significant, with CSR at 17%, CRCC at 12%, China Railway Group at 21%, and China Rail Construction at 27%.

Key Information

• Government Actions:
  • Railway development fund set up in April 2014.
  • Rmb400bn-600bn planned for central-western region railway network rollout.
  • Sale of Rmb150bn in railway bonds to widen funding sources.
• Investment Trends:
  • 1Q14 investment accounted for only 10% of the revised budget.
  • Expected increase in deal flows for the rest of the year.
• Valuation Trends:
  • H-listed railway stocks have retreated due to the valuation premium over A-shares.
  • Current average PE of 5.5x is seen as attractive.
• Company Performance Highlights:
  • CRCC (1186 HK): Maintained a "Buy" rating with a target price of HK$8.8.
  • CSR (1766 HK): Maintained a "Buy" rating with a target price of HK$7.7.
  • China Communications Construction (1800 HK): Earnings grew by 23%, with a GP margin of 12.3%.
  • China Railway Group (390 HK): Maintained a "Hold" rating with a target price of HK$3.9.
• Earnings and Margins:
  • Railway companies' GP margins are expected to remain stable compared to 2013.
  • Cost pressures are low due to oversupply of building materials, allowing revenue growth to directly impact profits.
• Financial Health:
  • Companies have high backlog orders, which provide stability and growth potential.
  • CRCC and CSR have better financial positions with lower gearing and higher GP margins.

Conclusion

The Chinese railway sector is poised for growth as the government increases its investment budget and accelerates project funding. Despite a weaker 1Q performance, the strong backlog and expected increase in new contracts suggest a positive outlook for the rest of the year. CRCC and CSR are highlighted as preferred picks due to their strong fundamentals and favorable valuations. The valuation gap between H and A shares is a key factor influencing stock performance, and the current low PE ratios are seen as an opportunity for investors.