20141231-光大证券-Rail_Equipment_CSR_CNR_Merger_to_Cut_Costs_Increase_Efficiency_and_Improve_Overseas_Margins_12页_192kb

Summary of CSR and CNR Merger and Rail Equipment Sector Update

Core Content

CSR and CNR, two leading Chinese railway equipment manufacturers, announced a merger to form CRRC Corporation Limited on 30 December 2014. The merger aims to reduce costs, increase operational efficiency, and enhance competitiveness in overseas markets. Share trading resumed on 31 December 2014, and the exchange ratio was set at 1:1.1 for both A shares and H shares. This merger is expected to be beneficial for the combined company's profitability and to avoid internal competition that could hurt profit margins.

Main Reasons for the Merger

• Avoiding Price War: The merger helps prevent fierce competition between CSR and CNR, which could negatively impact their profit margins.
• Enhancing Overseas Expansion: By combining their strengths, the merged entity can present a unified symbol of China's advanced high-speed rail technologies, making them more competitive in international tenders.
• Resource Sharing: The merger allows for the sharing of R&D and market resources, leading to cost savings and increased sales. For example, CSR's technological advantage in high-power electronic devices like IGBT can be leveraged across CNR's operations.

Impact on Domestic Business

• The domestic railway market is largely policy-driven due to CRC's dominance.
• Merging CSR and CNR will not significantly change their business landscape within China.
• Their operations will remain largely unaffected, as the market is not competitive.

Long-term Profitability

• The merger is expected to improve long-term profitability by eliminating overlapping investments and enhancing resource utilization.
• Consolidation expenses may occur during the integration phase, but the combined company is anticipated to achieve synergy benefits and exceed the sum of its parts.
• The new company's profitability is projected to grow due to the shared R&D and market resources.

Market Demand and Railway Development

• High Demand for Rail Equipment: With many new lines coming into operation, the demand for railway equipment has surged. In 2014, over 7,000 km of new lines were expected to be launched, the largest in history.
• Railway Investment Plan: The total railway investment (FAI) was projected to exceed Rmb800bn in 2014, with a focus on increasing the railway mileage and improving the railway infrastructure.
• Expected Growth in High-speed Railway Mileage: By 2020, the national operating high-speed railway mileage is expected to double that of 2014, assuming continued progress in the railway construction plan.

Revenue and Earnings Forecast

• CSR Revenue Growth:
  • 2014E: Rmb109,573m
  • 2015E: Rmb122,143m
  • 2016E: Rmb135,283m
• CNR Revenue Growth:
  • 2014E: Rmb98,563m
  • 2015E: Rmb110,195m
  • 2016E: Rmb120,296m
• EPS Forecast:
  • CSR: Rmb0.40 (2014E), Rmb0.47 (2015E), Rmb0.55 (2016E)
  • CNR: Rmb0.45 (2014E), Rmb0.52 (2015E), Rmb0.59 (2016E)
• The merger is considered fair in terms of EPS and is expected to have no dilutive effect on CSR's earnings per share.

Valuation and Rating

• Target Prices (TPs):
  • CSR: HK$10.0, corresponding to a 17x 2015E PE
  • CNR: HK$11.0, corresponding to a 17x 2015E PE
• CRRC (post-merger): The target prices for CRRC and CSR are the same.
• Rating: Both CSR and CNR are given a "Buy" rating.

Valuation Comparison

Code	Name	Close (HK$)	EPS (Rmb)	PE (x)
1766.HK	CSR	7.89	0.30	21.0
			0.40	15.8
			0.47	13.4
			0.55	11.5
6199.HK	CNR	7.66	0.34	18.0
			0.45	13.6
			0.52	11.8
			0.59	10.4

Key Projects in 2014

No.	Project	Mileage (km)	Year of Construction	Year of Completion	Target Speed (km/h)
1	Chengdu-Pengzhou, Pengzhou line	21	2009	2014	200
2	Hangzhou-Changsha railway	933	2009	2014	300
3	Hefei-Fuzhou railway	810	2009	2014	300
4	Lanzhou-Urumqi high-speed railway	1776	2009	2014	250
5	Guiyang-Guangzhou railway	857	2008	2014	250
6	Nanning-Guangzhou railway	577	2008	2014	250
7	Chengdu-Jiangyou-Lechuan	313	2009	2014	250
8	Heilongjiang-Qiqihar	282	2009	2014	250
9	Wuhan-Huangshi inter-city railway	96	2009	2014	250
10	Wuhan-Huanggang inter-city railway	37	2010	2014	200
11	Qingdao-Rongcheng inter-city railway	336	2010	2014	250
12	Zhengzhou-Jiaozuo railway	78	2010	2014	200
13	Zhengzhou-Kaifeng inter-city railway	50	2010	2014	200
14	Datong-Xi'an railway, Taiyuan-Xi'an section	575	2009	2014	250

Risks

1. Unsmooth M&A Process: Potential issues during the merger integration could affect the outcome.
2. Overseas Market Fluctuations: Exposure to changes in international demand may impact the merged company's performance.
3. New Business Development: Unsuccessful expansion into new business areas could pose challenges.

Company Overview

CSR and CNR are major players in the railway equipment market, with a wide range of products including high-speed trains, locomotives, passenger coaches, freight wagons, rapid transit vehicles, and core systems. CSR has strong R&D capabilities and is involved in the manufacturing of mechanical and electrical products, energy conservation equipment, and provides finance leasing and project contracting services.

Income Statement (Consolidated)

Item	2012 (Rmb m)	2013 (Rmb m)	2014E (Rmb m)	2015E (Rmb m)	2016E (Rmb m)
Operating income	89,019	96,525	109,573	122,143	135,283
Operating cost	(73,264)	(79,896)	(89,349)	(99,231)	(109,662)
Gross profit	15,755	16,629	20,224	22,913	25,620
Operating profit	5,816	6,116	7,766	9,097	10,475

Conclusion

The merger of CSR and CNR is a strategic move to consolidate their positions in the domestic market and enhance their global competitiveness. It is expected to lead to cost savings, efficiency improvements, and increased profitability. Despite potential risks, the merger is viewed as a positive step for the Chinese railway equipment sector, with both companies receiving a "Buy" rating and target prices set at HK$10.0 for CSR and HK$11.0 for CNR.