CRCC (1186.HK) Railway Sector 6 March 2013

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1 INSTITUTIONAL RESEARCH CRCC (1186.HK, Buy) Thoughts on MOR Reforms and Earnings Preview 6 March 2013 CRCC (1186.HK) Railway Sector 6 March 2013 Thoughts on MOR Reforms and Earnings Preview CRCC s share price has fallen 16% from its recent peak on the back of weak market sentiment, negative sector news, and China s 2013 railway-investment target coming in below expectations. We think investors have yet to factor in the potential positives from Ministry of Railway (MOR) reforms and are forgetting that the Ministry is already behind in its rollout of new projects. We maintain our Buy rating on CRCC and suggest accumulating on the recent pullback. Target Price 12m Rating Price Chart (HK$) HK$10.40 Buy (27% upside) MOR reform coming soon. According to local media, the Ministry of Railways (MOR) will be split into a national railway company and a railway bureau. The national railway company will be responsible for railway operation while the bureau will supervise railway and network planning. Our take. MOR reforms have been under discussion for many years. One possible model for MOR reform could be the reforms undergone at China s aviation authority, the Civil Aviation Administration of China (CAAC), which was previously both operator and supervisor of the nation s airlines and airports. If the MOR follows the same track, it could end up transferring the construction of new railway networks to local governments or combine them into regional networks. If local governments are allowed to participate in projects, they may be able to accelerate capex since they can provide fresh funding. That suggests upside for railway investment in 13 th Five Year Plan, which should benefit related companies such as CRCC, CRG (390.HK), CSR (1766.HK) and Zhuzhou CSR (3898.HK). In the sector, we continue to prefer CRCC and expect a pickup in railway investment to improve earnings visibility. Earnings preview. CRCC and its peers are scheduled to announce results at the end of the month. We expect unexciting FY12 numbers for CRCC given the drop in railway infrastructure spending in the first 10 months of the year amid a lack of funding. We estimate the top line to grow 6.5% y/y, led by non-railway and overseas projects, and the bottom line to decline 3% y/y. Our EPS is at the low end of market though there may be some upside if the company received additional compensation from the MOR for previous railway contracts. What to look for: 1) Account-receivable levels. 2) Order backlog and new contracts signed. 3) We also expect further updates on MOR budget guidance and impact on its property business with tough measures issued last Friday. Figure 1: CRCC Earnings Preview Actual Actual SHKF Consensus FY11 3Q12 FY12E FY12E High Low Revenue RMB bn Gross margin % EBIT margin % Net profit RMB m 7,854 1,904. 7,605 8,180 8,760 7,605 Net-profit growth % (3.2) 4.1 EPS RMB fen EPS growth % (3.2) 4.5 Sources: Bloomberg and Sun Hung Kai Financial Feb 12 May 12 Aug 12 Nov 12 Feb 13 Stock price Eva Yip, CFA eva.yip@shkf.com HSI perf. rebased to sh. price Price (HK$) W high/low (HK$) 9.54/4.81 Mkt cap (A+ H share) HK$m (US$m) Reports available at: Bloomberg Code: <shkr> 88,319.9 (11,387) Shares in issue (H share) millions 2, Free float (H share) % M avg. t/o HK$m (US$m) (20.1) Major shareholder (%) CRCCG Sources: Bloomberg and Sun Hung Kai Financial Recent report On the Fast Track 1 Nov 2012 Sun Hung Kai Financial Institutional Research 1

2 MOR reform may be similar to CAAC reform According to local media, the Ministry of Railways (MOR) will be split into two entities: 1) a national railway company under the State-owned Assets Supervision and. Administration Commission; and 2) a railway bureau that will be merged with the Ministry of Transport. The national railway company will be responsible for railway operations while the railway bureau will supervise railway and network planning. The MOR did not respond to media queries about the restructuring and there has been no indication which unit will be responsible for construction. MOR reforms have been under discussion for many years. The Ministry s dual role as railway operator and supervisor is seen by some as the cause of its corruption scandals and rapidly expanding balance sheet. One possible model for MOR reform could be the reforms undergone at China s aviation authority, the Civil Aviation Administration of China (CAAC), which was previously both operator and supervisor of the nation s airlines and airports. If the MOR follows the same track, it could end up transferring the construction of new railway networks to local governments or combine them into regional networks. Aviation authority reforms followed by surge in related FAI The CAAC was formerly known as the General Administration of Civil Aviation of China. The body was split into two units in 1987, one to operate airlines and the other to operate airports. This was followed by a series of restructurings, with the General Administration of Civil Aviation eventually renamed the CAAC. In March 2002, major airport reforms were carried out. The CAAC transferred related assets, liabilities, staff and administrative rights for civil airports to provincial/municipal governments. The reforms were finally completed in 2004 and local governments are now responsible for the construction and operation of civil airports. As illustrated in the chart on the left below, new-airport construction was somewhat limited in the years leading up to China s airport reform. Indeed, in 1997, 1999, 2000 and especially 2003, the number of civil airports dropped, likely owing to the merger of some airports. But subsequently new-airport construction has risen significantly. Civil-aviation FAI has also risen steadily in recent years unlike railway FAI, which has come down in the past couple of years. Figure 2: Post reforms, China has added a substantial number of airports (L) and civil-aviation FAI has risen steadily 15 (RMBbn) (5) (10) 10 (15) No. of civil-sector airports - net adds Sources: WIND and Sun Hung Ka Financial Sun Hung Kai Financial Institutional Research 2

3 Figure 3: China railway FAI and railway infrastructure spending (RMBbn) Railway FAI Railway infrastructure spending Sources: WIND and Sun Hung Ka Financial Don t expect further delays in railway spending It is too early to tell whether splitting the MOR s administration and operations will improve overall efficiency. We believe, however, that allowing local government participation in railway projects would broaden funding channels. Railway construction spending is now solely dependent on the MOR and given its stretched balance sheet, it could be difficult to deploy more new projects. Figure 4: MOR is stretching its balance sheet (L) and assets are increasingly underutilized (R) (X) Q12 Debt/Equity ratio % ROA (0.760) ROE (1.377) Sources: MOR and Sun Hung Ka Financial If local governments are allowed to participate in projects they may be able to accelerate capex since they can provide fresh funding. Local governments will likely attract more private enterprises to invest, which have a wider range of financing channels. More importantly, local governments will assume some of the investment risk, reducing the chances of overinvestment and making it more likely that network expansion will match the local economy and market demand. As such, we expect railway investment to become more rational post reforms. Could be positive in the long run for railway construction companies The expected reforms should improve the MOR s profitability and overall railway investment in China. Taking the CAAC s reforms as a base case, it could take around two years to complete the split of the MOR s supervisory Sun Hung Kai Financial Institutional Research 3

4 and operational responsibilities, which would bring us to the end of 12 th Five Year Plan. That suggests upside for railway investment in 13 th Five Year Plan, which should benefit related companies such as CRCC, CRG (390.HK), CSR (1766.HK) and Zhuzhou CSR (3898.HK). With reference to the CAAC s reforms, airport construction picked up following the restructuring, with 33 airports built in the first Five Year Plan post reforms and 52 airports targeted for the next Five Year Plan. We expect a similar outcome for railway works once the MOR has undergone a similar process. In the sector, we continue to prefer CRCC and expect a pickup in railway investment to improve earnings visibility. The share price has fallen 16% from its recent peak on the back of weak market sentiment, negative sector news, and China s 2013 railway-investment target coming in below expectations. We think investors have yet to factor in the potential positives from possible Ministry of Railway (MOR) reform and are forgetting that the Ministry is already behind in its rollout of new projects. We also see room for upward revisions to China s railway investment numbers throughout the year, as happened in 2012 when the MOR revised up its figures three times to address funding bottlenecks. This is especially so given the lackluster 2013 investment target. We maintain our Buy rating on CRCC and suggest accumulating on the recent pullback. Earnings preview for CRCC CRCC and its peers are scheduled to announce results at the end of the month. We expect unexciting FY12 numbers for CRCC given the drop in railway infrastructure spending in the first 10 months of the year amid a lack of funding. We estimate the top line to grow 6.5% y/y, led by non-railway and overseas projects, and the bottom line to decline 3% y/y. Our EPS is at the low end of market though there may be some upside if the company received additional compensation from the MOR for previous railway contracts. What to look for: Account-receivable levels. A decline could indicate that the MOR s repayment capability has improved and that it is more able to continue works. Order backlog and new contracts signed. A strong order backlog would provide strong earnings visibility. We also expect further updates on MOR budget guidance and impact on its property business from tough measures issued last Friday. Figure 5: CRCC Earnings Preview Actual Actual SHKF Consensus FY11 3Q12 FY12E FY12E High Low Revenue RMB bn Gross margin % EBIT margin % Net profit RMB m 7,854 1,904. 7,605 8,180 8,760 7,605 Net-profit growth % (3.2) 4.1 EPS RMB fen EPS growth % (3.2) 4.5 Sources: Bloomberg and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 4

5 Figure 6: CRCC- Financial statements Year end Dec. As at end Dec. P/L RMB m FY10 FY11 FY12E FY13E B/S RMB m FY10 FY11 FY12E FY13E Revenue 470, , , ,791 PPE 35,172 38,507 40,496 41,967 COGS (428,647) (409,327) (434,676) (504,917) Others LT assets 23,097 24,151 26,890 29,513 GP 41,512 48,039 52,211 59,873 Total non-current assets 58,269 62,659 67,385 71,480 Other income Inventories 59,598 76,006 92, ,958 EBIT 6,850 12,395 15,029 16,743 A/R 49,533 62,919 72,916 77,715 Finance costs (511) (1,982) (4,528) (5,083) Cash & Equivalents 65,207 83,058 88,380 91,646 Profit before tax 6,089 10,056 10,670 11,828 Total current assets 291, , , ,789 Tax (1,772) (2,174) (2,987) (3,312) Total assets 350, , , ,269 Net profit 4,317 7,882 7,682 8,516 A/P 127, , , ,475 Net profit to owners 4,246 7,854 7,605 8,431 Short-term debt 16,243 41,665 58,180 60,180 Total current liabilities 262, , , ,243 EPS RMB fen Long-term debt 22,415 30,611 29,393 29,393 DPS RMB fen Total liabilities 292, , , ,900 Owner s equity 57,403 64,748 71,120 78,317 Minority Interests ,009 1,051 Ratios - % FY10 FY11 FY12E FY13E Cash Flow RMB m FY10 FY11 FY12E FY13E Revenue growth 36.3 (2.7) Pre-tax profit 6,089 10,056 10,670 11,828 Op. profit growth (29.7) Depn. & amortization 7,807 9,391 10,184 10,701 EPS growth (35.7) 85.0 (3.2) 10.9 Δ WC (6,128) (23,784) (11,700) (11,167) GPM Operating cash flow 6,253 (12,576) 12,188 14,789 EBIT margin Capex (16,727) (14,800) (12,000) (12,000) NPM Investing cash flow (15,525) (10,603) (12,000) (12,000) Net Debt/Equity Net cash Net cash Net cash Net cash Δ in borrowings 13,930 33,618 15,296 2,000 ROA Issued share ROE Dividend (1,974) (1,234) (1,234) (1,481) A/R T/O days Financing cash flow 10,359 41,649 14, Inventory T/O - days Net cash flow ,244 14,212 3,266 A/P T/O - days End cash 55,923 74,168 88,380 91,646 Sources: The Company and Sun Hung Kai Financial Sun Hung Kai Financial Institutional Research 5

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Institutional Equities Contacts Address: 42/F, The Lee Gardens, 33 Hysan Avenue, Causeway Bay, Hong Kong Phone: Research (852) Fax: (852) Sales (852) Web: Research Stephen Yang, CFA stephen.yang@shkf.com (852) Nicholas Studholme nicholas.studholme@shkf.com (852) Vik Chopra vik.chopra@shkf.com (852) Eva Yip, CFA eva.yip@shkf.com (852) Stuwart Chen stuwart.chen@shkf.com (852) Edward Chung edward.chung@shkf.com (852) Doris Ma doris.ma@shkf.com (852) Sales Richard Seaward richard.seaward@shkf.com (852) Jack Li, CFA jack.li@shkf.com (852) Andrew Scott andrew.scott@shkf.com (852) Charles Streeter charles.streeter@shkf.com (852) Craig Hodge craig.hodge@shkf.com (852) Katina Wong katina.wong@shkf.com (852) Cherain Wong cherain.wong@shkf.com (852) Sun Hung Kai Financial Institutional Research 6