CHINA

China CNR Corp The other twin brother We initiate coverage on China CNR with an Outperform rating. China CNR is one of the duopolies in China’s railway equipment market. Our target price is HK$6.95, based on a target PER multiple of 11.4x 2015E PER, translating into a 0.62x PEG and with 36.0% upside potential. We believe the company will benefit from robust railway investment over the next 5 years and demand growth on MUs and locomotives will be steady in the long term, driven by an increase in density. In addition, the company put effort in R&D to localise key components

6199 HK Outperform production, which will help to expand margins. Beneficiary of railway reforms and shifting industry focus Price (at 07:59, 24 Jun 2014 GMT) HK$5.11 China accelerated railway network modernisation and expansion from 2008 to

Valuation HK$ 6.95 2013, with a record level of new railway lines and high-speed railway (HSR) lines - PER to be launched into operation in the next few years. From 2014 onwards, the 12-month target HK$ 6.95 Upside/Downside % +36.0 railway industry’s focus is shifting to improving return on assets and generating 12-month TSR % +38.8 profits to repay the incurred debt. We believe China will continue to deepen its Volatility Index Low railway reform, increasing railways’ competitiveness in the transportation market, GICS sector Capital Goods and continue to increase HSR operating density which will help alleviate capacity Market cap HK$m 67,389 bottleneck issues in the railway network. We expect an additional 30% to 50% of Market cap US$m 8,694 railway freight capacity will be freed up when the major HSR network fully opens Free float % 100 by the end of 2015. Train equipment producers are the key beneficiaries. 30-day avg turnover US$m 13.5 Number shares on issue m 13,188 Favourable industry landscape The entry barrier to China’s railway equipment sector is high. The government Investment fundamentals Year end 31 Dec 2013A 2014E 2015E 2016E has launched localisation initiatives since the early 2000s, and foreign Revenue bn 96.8 107.6 120.9 133.3 companies had to work with local partners to develop products and supply to the EBIT bn 6.0 7.2 8.3 9.4 Ministry of Railways. The localisation policies helped Chinese producers to EBIT growth % 20.1 19.5 15.7 12.5 Reported profit bn 4.1 5.1 6.0 6.8 rapidly develop their own in-house R&D capabilities, manufacturing and supply- Adjusted profit bn 4.1 5.1 6.0 6.8 chain scale. In the HSR railway and locomotive equipment space, China EPS rep Rmb 0.40 0.45 0.49 0.55 EPS rep growth % 17.3 12.5 8.9 12.8 achieved its 80% localisation target rate by the end of 2013. EPS adj Rmb 0.40 0.45 0.49 0.55 EPS adj growth % 17.6 12.3 9.1 12.8 Various drivers to support robust earnings growth PER rep x 10.3 9.1 8.4 7.4 PER adj x 10.3 9.1 8.4 7.4 We forecast CNR’s earnings will see an 18% CAGR from 2014 to 2016. We Total DPS Rmb 0.10 0.11 0.12 0.14 forecast its earnings will grow strongly in 2014, at 23.0% YoY, following a strong Total div yield % 2.4 2.7 3.0 3.4 ROA % 5.3 5.6 5.7 5.9 tender recovery and high-end train order gains from CRC in 3Q2013. We ROE % 11.4 11.6 11.6 12.0 forecast its earnings will grow at 18.3% YoY and 12.8% YoY in 2015 and 2016, EV/EBITDA x 6.6 6.6 5.8 5.2 Net debt/equity % 34.8 14.0 12.6 10.0 respectively, driven by robust railway and urban transit equipment demand in P/BV x 1.1 1.0 0.9 0.9 China and limited competition in the domestic market. CNR is also rapidly

Source: FactSet, Macquarie Research, June 2014 expanding into international markets while its product offerings and technology (all figures in Rmb unless noted, TP in HKD) capabilities are exceeding those of its global peers. The company is also

improving key component production to lift margins and leverage its technology platform to expand into other new product areas. Valuation and risks We use a PER valuation methodology and our target price is based on 11.4x Analyst(s) 2015E PER. Our CNR PER target multiple is at a 19% discount to CSR’s Saiyi He, CFA target multiple of 14.1x 2015E PER, to reflect the 24% lower ROE CNR has +852 3922 3585 [email protected] Kelly Zou over CSR. The stock currently trades at 8.4x 2015E PER; it also offers an +86 21 2412 9068 [email protected] attractive discount to its global peer group, weighted against growth prospects.

Key risks: 1) CRC tender could be slower than expected; 2) CNR might lose 26 June 2014 market share to its competitor; 3) CRC might tender lower grade products Macquarie Capital Securities Limited which would reduce margins.

Please refer to page 50 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures.

Macquarie Research China CNR Corp

Inside China CNR Corp

The other twin brother 3 Company profile Valuation, recommendation, risks 4 . CNR together with CSR dominates the domestic rolling stock market. The company offers a full range of rolling stock products and services, including Business segment overview 13 locomotives, passenger carriages, freight wagons, MUs and RTVs, etc. Other Industry demand outlook 27 than the rolling stock business, it has also diversified its business into general Financial statement analysis 39 mechanical and electric products, modern services and emerging industries. Risk analysis 42 . The history of CNR can be traced back to 1949 when the Factory Affairs Appendices 47 Bureau of the Ministry of Railways was established. Later in 1986, the previous MOR restructured this entity into MOR locomotive and Rolling Stock

Industrial Corporation, from which China National Railways Locomotive and Rolling Stock Industrial Corporation was formed in 1989. Fig 1 6199 HK rel HSI performance . China National Railways Locomotive and Rolling Stock Industrial Corporation were split into CNRG and CSRG in 2002. CNRG is a state-owned enterprise. CNR was established as a joint stock limited company in 2008. CNRG, as its parent company, injected its core businesses and assets into CNR. CNR was listed on Shanghai Stock Exchange in 2009 and HKEX on 22 May 2014. The company’s auditor is KPMG Huazhen. . According to SCI Verkehr, CNR is the world’s largest manufacturer of electric locomotives and metro cars, as well as the world’s 2nd largest and China’s largest manufacturer of freight wagons in terms of aggregate number of units Source: FactSet, Macquarie Research, June 2014 delivered between 2008 and 2012 in each product category. It is the largest (all figures in Rmb unless noted, TP in HKD) rolling stock manufacturer in China in terms of revenue in 2012. According to

CRC, CNR won the bids for 66.0%, 57.3% and 47.8% of the total number of the MUs with a maximum operating speed over 300km/h, locomotives and freight wagons that CRC purchased in 2013, respectively. . The company is also engaged in the manufacturing of mechanical and electrical products and clean energy and environmental protection equipment, trading of raw materials, finance leasing of rolling stock and machines and equipment, and project management contracting services for urban rail and other related projects with the aim of providing future cities with systematic solutions. . CNR currently exports its products to nearly 80 countries and regions in Oceania, Southeast Asia, Latin America, Central Asia, South Asia, Middle East, Africa and North America. Its overseas revenue contribution generated from export of railway equipments and various other products rose from 7% in 2011 to over 10% in 2012. The overseas business has been growing fast at 23.5% CAGR over 2006-2013.

Fig 2 CNR business profile based on 2013 results – revenue breakdown

Emerging industry 4.3% Locomotive 16.3% Modern service 23.6% Passenger carriage 8.3% Mechanical and electric product 1.9%

Railway engineering Freight wagon machinery and 13.7% equipment 1.3% Rapid transit vehicle 6.0% MU 24.7% Source: Company data, Macquarie Research, June 2014

26 June 2014 2

Macquarie Research China CNR Corp

The other twin brother CNR is one of the duopolies in China’s Bright growth prospect for the China rolling stock industry rolling stock industry We initiate on China CNR (6199 HK) with an Outperform rating. The company is one of the duopolies in China’s railway equipment market. We believe the company is a key beneficiary from the robust railway equipment and urban transit network investment in China over the We expect the next five years. railway equipment producers are the In China the railway network upgrade and expansion has happened since 2008, a record late-cycle level of new railway lines and high-speed railway (HSR) lines will be launched into operation beneficiaries from in the next few years. From 2014 onwards, the railway industry’s focus is shifting to improving China’s railway return on assets and generating profits to repay the incurred debt. infrastructure investment Fig 3 China railway industry investment forecasts 2008 2009 2010 2011 2012 2013 2014E 2015E

Total Railway FAI (Rmb 416.8 704.5 842.7 594.7 657.7 663.8 800.0 760.0 bn) yoy growth 61% 69% 20% -29% 11% 1% 21% -5% - Railway construction 337.6 600.4 707.5 460.1 521.5 550.0 655.0 600.0 yoy growth 89% 78% 18% -35% 13% 5% 19% -8% - Railway refurbishment 22.7 25.4 28.5 30.6 31.8 27.0 25.0 25.0 yoy growth 3% 12% 13% 7% 4% -15% -7% 0% - Locomotives & trains 56.6 78.7 106.7 104.0 104.3 86.8 120.0 135.0 yoy growth -1% 39% 35% -2% 0% -17% 38% 13%

Source: CRC, Macquarie Research, June 2014

We believe China will continue to deepen its railway reform, increasing railways’ competitiveness in the transportation market, and continue to increase HSR’s market share in passenger transportation which will help alleviate capacity bottleneck issues in the railway network. We expect an additional 30% to 50% railway freight capacity will be freed up when the major HSR network fully opens by the end of 2015. Train equipment producers are key beneficiaries of the focus on improving operations of the railway network. Based on our density increase assumption and new train demand, we forecast MU demand will grow at a CAGR of 14.5% during the 2013 to 2020 period. Our density increase assumption is conservative – we forecast network train density will only increase from 0.08 MU set/km of HSR at the end of 2013 to 0.094 MU set/km of HSR at the end of 2020. Based on our freight turnover and market share gain assumptions, China’s annual locomotive demand will post an 11.8% CAGR during 2013 to 2020. For details please see our China railway 2020 growth road-map analysis in the long-term demand outlook section. High-entry barriers in domestic market and expansion into overseas CNR and CSR, The Chinese government has helped the railway equipment producers to localise the market control almost 100% over the past 10 years. CNR and its competitor, CSR, control almost 100% market share in domestic market China’s high-speed train, locomotive, freight and passenger wagons and urban transit trains share in the railway markets. China is the world’s largest and fastest growing railway equipment market. CNR and equipment sector, CSR both have world leading technology and production capacity in most of the railway while they are also equipment (except signalling and safety control systems) products categories. Both producers expanding into are expanding into international markets, by opening up production and services centres in overseas markets key international markets. Both producers currently have less than 10% overall revenue exposure to overseas sales; given their cost and quality competitiveness, we do expect they can take market share from the international railway equipment producers. CNR is trading at an attractive valuation comparing to CSR and global peers. CNR is trading at an 8.3x 2015E PER, CNR’s HK listed peers are trading at a 9.7x 2015E PER, and international peers are trading at 14.6x 2015E PER.

26 June 2014 3 Macquarie Research China CNR Corp

Valuation, recommendation, risks CNR is trading at a We value CNR based on the PER and comparable valuation methods. CNR is currently listed discount to its on the China A-share market; we compare CNR’s earnings growth prospects to its China- international peers listed and global peers. Based on Bloomberg consensus forecasts, CNR’s HK listed peers and CSR are trading at a 9.9x 2015E PER, and international peers are trading at a 14.4x 2015E PER. CNR is trading at an 8.4x 2015E PER, at 14.9% discount to the weighted PER of its HK-listed peers. China is the world’s largest and fastest growing railway equipment market, and it is also highly localised by the two domestic train producers. The urban transit vehicle market is also highly localised and demand growth should accelerate over the next few years. Currently the Chinese rolling stock producers have only about 10% revenue exposure to international markets. But we expect the presence in the international market will grow rapidly. CNR can offer a full range of train products, and its product qualities have been verified in the China market as well as in some international markets thereby enabling them to successfully export high-tech content products. Therefore, the Chinese rolling stock industry should grow faster than its global peers. CNR offers attractive discounts to other railway equipment producers in both HK and international markets. Valuation We forecast CNR We forecast CNR’s earnings will grow at an18% CAGR from 2014 to 2016. We forecast its will deliver a similar earnings will grow strongly in 2014, at 23.0% YoY, following a tender recovery from CRC in level of growth as 3Q2013. We forecast its earnings will grow 18.3% YoY and 12.8% YoY in 2015 and 2016, CSR and Zhuzhou respectively. From 2014 to 2016, we forecast Zhuzhou CSR (3898 HK, HK$23.80, Outperform, TP HK$32.60) will deliver the fastest earnings growth, at an 18.2% CAGR; and CNR has ramped up CSR (1766 HK, HK$5.79, Outperform, TP HK$8.0) earnings will grow at a 17.8% CAGR over the technology and the same period. We forecast CNR will deliver a similar level of growth, at an 18% CAGR, as product gaps the company is one of the duopolies in China’s rolling stock sector and the demand outlook is between itself and robust over the next 5 years. CSR CNR has ramped up the technology and product gaps between itself and CSR over the past

few years. From 2014 onwards, we expect CNR and CSR will have equal market share in high-end railway equipment tenders in China. In addition to market share equalisation, rising economies of scale and increasing component localization at CNR will also help to boost the

company’s profitability growth. Our TP of HK$6.95, Given CNR’s earnings growth profile and based on comparable universe valuations, we based on 11.4x derive our target price at HK$6.95, implying a 36.0% upside potential. Our target price is 2015E PER based on an 11.4x 2015E PER and translates into a 0.62x PEG, based on Macquarie’s earnings forecasts. The valuation offers an attractive discount to the global peer group, weighted against growth prospects. CNR’s A-share average forward PER is 13.9x, and its PER 1-std band is 9.6x to 18.11x. CNR is currently trading at an 8.4x 2015E PER. Our PER target multiple is derived from taking into consideration the ROE differential between CNR and its closest domestic peer, CSR. CSR is trading at a 10.3x 2015E PER, and our 12-month target multiple is a 14.1x 2015E PER. CSR has a higher net profit margin and ROE than CNR; we forecast CSR’s ROE will improve from 14.2% in 2014 to 14.4% in 2015. We forecast CNR’s ROE will remain firm at 11.6% in 2014 and 2015, improve to 12% in 2016. Our PER target multiple for CNR, 11.4x 2015E PER, is at a 19% discount to CSR’s target multiple of 14.1 x 2015E PER, to reflect the 24% lower ROE CNR has over CSR. CNR’s target PER multiple is at a 19% discount to CSR’s target multiple. CSR is currently trading at a 10.3x 2015E PER. ZCSR has the highest ROE in the China rolling stock sector, and the stock is trading at a 11.1x 2015E PER. CNR is increasing its market share in high-end components and improving its margins through increasing localisation rates on core components; thus the net profit margin and ROE gap between the two companies is narrowing. We believe CNR has the potential to improve its margins and ROE, as the company continues to improve key core components localisation.

26 June 2014 4 Macquarie Research China CNR Corp

Rolling stock companies’ stock performance underperformed the HSI index year-to-date. CSR outperformed the HSI index between 19 March and 14 April 2014, boosted by the release of new contract wins and CRC new tenders. CRC raised its railway equipment investment in 2014 from Rmb120bn to Rmb143bn, a 19.2% YoY increase. However, railway equipment spending in the first 5M2014 has declined 36.6% YoY. The rolling stock sector has since underperformed on the back of concerns if the investment target will be met. We expect accelerated railway equipment investment in 2H should help support the share price performances in the railway equipment sector. We are confident CRC will continue to roll out equipment tenders, as they continue to deepen railway reform, and recently announced increasing operating density on several high speed railway lines.

Fig 4 China railway industry monthly FAI Fig 5 Year-to-date share price performance

180.0 Rmb bn 10%

160.0 5% 140.0 0% 120.0 -5% 100.0 80.0 -10%

60.0 -15% 40.0 -20% 20.0 -25% 0.0

Jan 14 Jan 14 Jan 14 Feb 14 Feb 14 Mar 14 Mar 14 Apr 14 Apr 14 May 14 May 14 Jun 14 Jun 14

Jul 11 Jul 12 Jul 13 Jul

Oct 11 Oct 12 Apr 12 Oct 13 Apr 13 Oct 14 Apr

Jan 12 Jan 12 Jun 13 Jan 13 Jun 14 Jan

Mar 12 Mar 13 Mar 14 Mar

Feb 12 Feb 13 Feb 14 Feb

Aug 11 Aug 11 Sep 11 Nov 11 Dec 12 Aug 12 Sep 12 Nov 12 Dec 13 Aug 13 Sep 13 Nov 13 Dec

May 12 May 13 May

Railway FAI - monthly - Railway construction FAI 1766 HK 3898 HK 6199 HK HSI Index

Note: CNR-H share price performance since its IPO on 22 May 2014

Source: CRC, Macquarie Research, June 2014 Source: Bloomberg, Macquarie Research, June 2014

Fig 6 CSR-H 12-mth forward PER Fig 7 CSR-A 12-mth forward PER

30 35

30 25

25 20 20 15 15

10 10

5 5

Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14

12-mth forward PER -1 Std +1 Std Average 12-mth forward PER -1 Std +1 Std Average

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Bloomberg, Company data, Macquarie Research, June 2014

26 June 2014 5 Macquarie Research China CNR Corp

Fig 8 ZCSR-H 12-mth forward PER Fig 9 CNR-A 12-mth forward PER

50 25

45 40 20 35

30 15 25

20

15 10 10

5 5

Jul 07 Jul 08 Jul 09 Jul 10 Jul 11 Jul 12 Jul 13 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 12-mth forward PER -1 Std +1 Std Average 12-mth forward PER -1 Std +1 Std Average

Source: Bloomberg, Company data, Macquarie Research, June 2014 Source: Bloomberg, Company data, Macquarie Research, June 2014

Comparison against domestic peer Historically ZCSR and CSR have had higher ROEs than CNR. CSR had a higher ROE than CNR due to the following reasons: 1) CSR historically had higher revenue contribution from higher margin products, such as 350km/hr high-speed train MU products; 2) CSR had a higher components localization rate, therefore, higher product gross profit margins; and 3) CNR had larger business exposure to materials trading, which has lower margins than its normal rolling stock business. In terms of revenue and earnings growth rates, CNR grows at a slightly faster rate than CSR, but at a lower rate than ZCSR. We forecast from 2014 onwards, CSR and CNR will equally share the MU and locomotive market shares, as the two producers reached level-field technology in core products offerings. CNR has higher improvement potential on net profit margin trends and ROE through gaining back market share in high-end locomotive and MU tenders, as well as increasing its components localisation rates. CSR has a higher net profit margin and ROE than CNR. We forecast CSR’s ROE will improve from 14.2% in 2014 to 14.4% in 2015. We forecast CNR’s ROE will remain firm at 11.6% in 2014 and 2015, improve to 12% in 2016. Our PER target multiple for CNR, 11.4x 2015E PER, is at a 19% discount to CSR’s target multiple of 14.1x 2015E PER, to reflect the 24% lower ROE CNR has over CSR. In terms of pecking order in the industry, we prefer ZCSR’s long-term growth potential and favourable shorter product life cycle (components’ life cycle is less than half of rolling stock life cycle). In terms of relative value in the train equipment segment, CSR and CNR both offer similar upside in 12-mont TSR, over 35% upside to our target price. CNR’s target PER multiple is at 19% discount to CSR’s target multiple. CSR is currently trading at a 10.3x 2015E PER. ZCSR has the highest ROE in the China rolling stock sector, and the stock is trading at a 11.1x 2015E PER.

26 June 2014 6 Macquarie Research China CNR Corp

Fig 10 Revenue growth: CNR vs. CSR and ZCSR Fig 11 Net profit growth: CNR vs. CSR and ZCSR

24.0% 50.0%

20.0% 40.0%

16.0% 30.0%

12.0% 20.0%

8.0% 10.0%

4.0% 0.0%

0.0% 2011A 2012A 2013A 2014E 2015E 2016E -10.0% 2011A 2012A 2013A 2014E 2015E 2016E

CSR CNR ZCSR CSR CNR ZCSR

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Fig 13 Operating profit margin: CNR vs. CSR and Fig 12 Gross profit margin: CNR vs. CSR and ZCSR ZCSR

20.0% 36.0% 9.0% 21.0%

19.0% 35.5% 20.5% 8.0% 18.0% 35.0% 20.0%

17.0% 7.0% 34.5% 19.5% 16.0% 34.0% 19.0% 6.0% 15.0% 33.5% 18.5% 14.0% 5.0% 13.0% 33.0% 18.0%

12.0% 32.5% 4.0% 17.5% 2011A 2012A 2013A 2014E 2015E 2016E 2011A 2012A 2013A 2014E 2015E 2016E CSR CNR ZCSR (rhs) CSR CNR ZCSR (rhs)

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Fig 14 Net profit margin: CNR vs. CSR and ZCSR Fig 15 ROE: CNR vs. CSR and ZCSR

7.0% 17.4% 20.0% 25.0%

17.2% 24.0%

17.0% 17.0% 23.0% 6.0% 16.8% 22.0%

16.6% 14.0% 21.0% 5.0% 20.0% 16.4% 11.0% 19.0% 16.2% 4.0% 18.0% 16.0% 8.0% 17.0% 15.8% 16.0% 3.0% 15.6% 2011A 2012A 2013A 2014E 2015E 2016E 5.0% 15.0% 2011A 2012A 2013A 2014E 2015E 2016E CSR CNR ZCSR (rhs) CSR CNR ZCSR (rhs)

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

26 June 2014 7 Macquarie Research China CNR Corp

Fig 16 CNR vs. CSR main ratio analysis change table CSR CNR 2011A 2012A 2013A 2014E 2015E 2016E 2011A 2012A 2013A 2014E 2015E 2016E

Gearing Net debt/(Net Cash) Net cash Net cash Net cash Net cash Net cash Net cash 12,529 11,299 13,777 5,707 5,570 4,239 Net debt/equity Net Cash Net Cash Net Cash Net Cash Net Cash Net Cash 48% 31% 35% 11% 10% 7% Total debt 20,424 9,323 11,175 12,500 14,088 15,790 18,424 20,121 22,024 29,621 32,324 35,480

Efficiency AR days 91 124 165 150 124 125 103 111 138 139 130 132 AP days 149 168 194 175 151 150 146 149 158 150 149 151 Inventory turnover days 101 91 83 85 91 91 147 129 99 86 93 94 Cash conversion days 43 47 54 60 64 66 105 91 79 75 74 75

Profitability Gross profit margin 18.7% 17.7% 17.2% 17.7% 17.9% 17.6% 13.2% 14.3% 17.2% 16.6% 16.7% 16.8% Operating profit margin 7.3% 6.5% 6.3% 7.8% 8.0% 8.0% 5.1% 5.5% 6.2% 6.7% 6.9% 7.0% Net profit margin 4.9% 4.5% 4.3% 5.2% 5.4% 5.4% 3.4% 3.7% 4.3% 4.7% 5.0% 5.1%

DuPont analysis Net profit margin 4.9% 4.5% 4.3% 5.2% 5.4% 5.4% 3.4% 3.7% 4.3% 4.7% 5.0% 5.1% Total asset turnover 1.0 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.8 0.8 0.8 Leverage 4.0 3.6 3.3 3.1 2.9 2.9 3.9 3.1 3.1 3.0 2.8 2.8 ROE 18.5% 14.5% 11.9% 14.2% 14.4% 13.9% 12.2% 9.9% 11.4% 11.6% 11.6% 12.0%

ROA 6.9% 5.9% 5.4% 6.7% 7.3% 7.1% 4.7% 4.7% 5.3% 5.6% 5.7% 5.9% Source: Company data, Macquarie Research, June 2014

Fig 17 CNR vs. ZCSR main ratio analysis change table ZCSR CNR 2011A 2012A 2013A 2014E 2015E 2016E 2011A 2012A 2013A 2014E 2015E 2016E

Gearing Net debt/(Net Cash) Net Cash Net Cash Net Cash Net Cash Net Cash Net Cash 12,529 11,299 13,777 5,707 5,570 4,239 Net debt/equity Net Cash Net Cash Net Cash Net Cash Net Cash Net Cash 48% 31% 35% 11% 10% 7% Total debt 696 28 83 1,022 1,150 1,303 18,424 20,121 22,024 29,621 32,324 35,480

Efficiency AR days 99 146 176 217 241 243 103 111 138 139 130 132 AP days 102 127 150 150 143 144 146 149 158 150 149 151 Inventory turnover days 129 106 81 104 120 121 147 129 99 86 93 94 Cash conversion days 127 125 108 170 218 220 105 91 79 75 74 75

Profitability Gross profit margin 35.5% 33.7% 35.7% 35.1% 34.9% 34.7% 13.2% 14.3% 17.2% 16.6% 16.7% 16.8% Operating profit margin 19.1% 18.5% 19.1% 18.9% 19.7% 20.4% 5.1% 5.5% 6.2% 6.7% 6.9% 7.0% Net profit margin 16.6% 16.9% 16.6% 16.2% 16.7% 17.2% 3.4% 3.7% 4.3% 4.7% 5.0% 5.1%

DuPont analysis Net profit margin 16.6% 16.9% 16.6% 16.2% 16.7% 17.2% 3.4% 3.7% 4.3% 4.7% 5.0% 5.1% Total asset turnover 0.9 0.8 0.8 0.7 0.7 0.8 0.9 0.9 0.9 0.8 0.8 0.8 Leverage 1.6 1.6 1.5 1.5 1.5 1.5 3.9 3.1 3.1 3.0 2.8 2.8 ROE 24.2% 21.3% 19.0% 17.2% 18.9% 20.0% 12.2% 9.9% 11.4% 11.6% 11.6% 12.0%

ROA 17.3% 14.7% 14.7% 13.5% 14.7% 15.4% 4.7% 4.7% 5.3% 5.6% 5.7% 5.9% Source: Company data, Macquarie Research, June 2014

26 June 2014 8 Macquarie Research China CNR Corp

Fig 18 Global peers margin comparison Ticker GPM OPM NPM 2010 2011 2012 2013 2010 2011 2012 2013 2010 2011 2012 2013

CSR 1766 HK 17.1% 18.7% 17.7% 17.2% 5.2% 7.3% 6.5% 6.3% 3.9% 4.9% 4.5% 4.3% Zhuzhou CSR 3898 HK 37.0% 35.5% 33.7% 35.7% 16.0% 19.1% 18.5% 19.1% 14.4% 16.6% 16.9% 16.6% CNR 601299 CH 13.0% 13.2% 14.3% 17.2% 3.2% 5.1% 5.5% 6.2% 3.1% 3.4% 3.7% 4.3% Mitsubishi Heavy 7011 JP 15.2% 15.8% 18.5% na 3.5% 4.0% 5.8% 6.1% 1.0% 0.9% 3.5% 4.2% Kawasaki Heavy 7012 JP 15.5% 16.5% 15.8% na 3.5% 4.4% 3.3% 4.7% 2.1% 1.8% 2.4% 2.6% Siemens AG SIE GR 32.2% 29.9% 26.9% 27.4% 10.1% 11.4% 8.8% 7.0% 5.7% 8.4% 5.4% 5.6% Bombardier BBD/A CN 15.0% 12.9% 15.2% 13.7% 5.5% 6.6% 4.0% 4.3% 3.6% 4.6% 2.8% 3.1% Alstom ALO FP 20.3% 18.1% 19.8% 19.5% 9.1% 7.5% 7.1% 7.2% 6.2% 2.2% 3.7% 4.0% ABB Ltd. ABBN VX 36.2% 29.9% 30.5% 28.7% 12.8% 12.4% 10.5% 10.6% 8.1% 8.3% 6.9% 6.7% Schindler Holding SCHP VX na na na na 11.6% 10.4% 11.9% 10.1% 8.3% 7.3% 8.5% 4.9% Source: Bloomberg, Macquarie Research, June 2014

26 June 2014 9

26 June June 26 2014 Research Macquarie

Fig 19 Rolling stock comparable valuation table Company Ticker Market Price Tp(loc) Rec Up/ EBIT margin PER PEG EPS growth P/Bk ROE EV/EBITDA

Cap US$m (loc) Down% CY14E CY15E CY14E CY15E CY15E CY14E CY15E 2013 CY14E CY15E CY15E HK listed railway related companies CSR 1766 HK 9,715 5.79 8.00 Outperform 38% 7.8% 8.0% 11.7 10.3 0.7 32% 14% 1.8 14.2% 14.4% 7.86

CNR 6199 HK 8,547 5.11 6.95 Outperform 36% 6.7% 6.9% 9.1 8.4 0.9 12% 9% 1.1 11.6% 11.6% na Zhuzhou CSR Times 3898 HK 3,700 23.80 32.60 Outperform 37% 18.9% 19.8% 13.4 11.1 0.5 7% 21% 2.6 17.2% 18.9% 9.20 Guangshen Rail 525 HK 2,796 2.80 NR NR NR 11.9% 11.9% 12.4 11.4 1.3 1% 9% 0.6 4.7% 4.4% 5.66 Sector weighted average 11.2 9.9 0.8 1.5

Overseas listed railway related companies Hollysys HOLI US 1,362 23.67 25.00 Outperform 6% 18.0% 18.5% 18.9 15.6 0.8 41% 21% 3.3 15.4% 14.4% 5.61 MIDAS Holdings MIDAS SP 433 0.44 NR NR NR 12.8% 13.6% 20.5 15.0 0.4 173% 36% 0.9 4.3% 5.6% 10.15 Downer EDI DOW AU 2,100 4.41 5.20 Outperform 18% 4.7% 4.8% 9.3 9.2 6.7 -2% 1% 1.1 10.6% 10.0% 3.89 United Group UGL AU 1,195 6.72 7.00 Underperform 4% 4.1% 4.8% 9.8 8.3 0.4 23% 18% 1.0 9.7% 10.5% 6.77 Sector weighted average 12.9 11.2 3.1 1.7

A-share listed railway related companies CNR 601299 CH 8,547 4.40 NR NR NR 6.0% 6.1% 9.4 7.9 0.4 17% 18% 1.2 12.0% 12.5% na CSR 601766 CH 9,715 4.35 NR NR NR 6.3% 6.3% 11.6 9.9 0.6 25% 18% 1.6 12.9% 13.4% 8.39 CRG 601390 CH 9,038 2.58 NR NR NR na na 5.6 5.3 0.9 5% 6% 0.6 11.0% 10.8% 6.82 CRCC 601186 CH 9,329 4.55 NR NR NR na na 5.0 4.7 0.6 8% 7% 0.7 13.0% 12.8% 3.73 China Railway Tielong 600125 CH 997 4.81 NR NR NR 14.6% 14.5% 13.3 11.4 0.7 13% 17% 1.4 10.3% 10.8% 5.04 Sector weighted average 8.1 7.1 0.6 1.0

Japan rail manufacturer Mitsubishi Heavy 7011 JP 20,959 634.00 NR NR NR 6.2% 6.4% 16.2 14.2 1.0 -8% 14% 1.4 8.3% 8.9% 6.53 Nabtesco 6268 JP 2,844 2298.00 NR NR NR 11.0% 11.4% 17.3 15.5 1.3 15% 12% 2.2 11.9% 11.8% 8.10 Kawasaki Heavy 7012 JP 6,432 394.00 NR NR NR 5.1% 5.7% 14.4 12.2 0.7 25% 18% 1.8 12.0% 13.1% 7.26 Sector weighted average 15.9 13.9 1.0 1.5

US/Europe rail manufacturer Siemens AG SIE GR 63,502 98.10 NR NR NR 10.0% 11.1% 14.9 13.0 0.9 31% 15% 3.0 18.4% 19.5% 8.56 Bombardier Inc. BBD/A CN 6,230 3.85 5.25 Outperform 36% 5.3% 5.5% 9.0 8.4 1.2 22% 7% 3.3 27.6% 26.0% 7.38 Alstom ALO FP 6,074 26.78 NR NR NR 5.9% 5.8% 10.7 11.3 na -1% -6% 1.6 13.6% 12.9% 5.55 General Electric GE US 266,538 26.58 NR NR NR 11.8% 12.6% 15.7 14.7 2.1 33% 7% 2.0 12.5% 13.0% 11.10 ABB Ltd. ABBN VX 53,537 20.67 NR NR NR 11.4% 12.5% 16.9 14.7 1.0 13% 15% 2.8 16.3% 17.4% 9.33 Schindler Holding SCHP VX 17,152 137.10 NR NR NR 10.5% 11.0% 22.2 19.8 1.6 65% 12% 6.2 24.7% 23.9% 10.68 Sector weighted average 15.8 14.5 1.7 2.5

International weighted average 15.8 14.4 1.7 2.4 Source: Bloomberg, (Note CNR A-share data is based on Bloomberg consensus), Company data, Macquarie Research, June 2014, Note as at 24 June closing prices; estimates for not rated stocks are based on consensus

China CNR Corp China

10

Macquarie Research China CNR Corp

Sensitivity analysis The rolling stock product segment accounted for over 70% of the company’s total revenue and over 83% of the company‘s gross profit in 2013. In the rolling stock segment, locomotive, MU and RTV products are the three major growth drivers and jointly account for over 50% of the total company’s revenue. We conducted a sales volume and ASP sensitivity analysis on locomotives, MUs and RTVs. CNR’s earnings are Based on our sensitivity analysis, the company’s earnings are more sensitive to ASPs than it the most sensitive is to its sales volumes. For sensitivity analysis on sales volumes, the company’s earnings are to the volume the most sensitive to the volume growth of MUs. According to our analysis, every 2ppt growth of MUs decrease in MUs sales volume growth, with all other variables held constant, would reduce our 2014 base-case earnings forecast by 0.6%. Earnings are less sensitive to locomotives and RTVs compared to MUs. Our analysis shows every 2ppt decrease of locomotive and RTV’s sales volume growth, with all other variables held constant, would reduce our 2014 base-case earnings forecast by 0.4% and 0.2%, respectively.

Fig 20 Upside and downside risks to our call and probability Risks to our call Probability Sensitivity Comments

Decrease in locomotive sales volume Low, with high impact A 2ppt decrease of our forecast Our base case assumes locomotive sales in locomotive sales growth could lead to 2014 to grow 18% YoY. Given CRC's intention 0.4% decrease of our forecast 2014 net to further develop railway freight profit transportation; we expect continuously growing locomotive sales in domestic market. Decrease in MU sales volume Low, with high impact A 2ppt decrease of our forecast MU sales Our base case assumes MU sales in 2014 to growth could lead to 0.6% decrease of grow 10% YoY. We expect MU sales to keep our forecast 2014 net profit growing on the back of more new HSR lines put into operation and increasing existing line operation density. Decrease in RTV sales volume Low, with high impact A 2ppt decrease of our forecast RTV Our base case assumes RTV sales in 2014 to sales growth could lead to 0.2% grow 32% YoY. We expect urbanization and decrease of our forecast 2014 net profit the need to reduce traffic congestion and air pollution in cities will bring robust investment in urban rails and RTVs. Decrease in locomotive ASP Low, with high impact A 2ppt decrease of our forecast Our base case assumes locomotive ASP in locomotive ASP growth could lead to 2014 to grow 20% YoY. We expect improving 0.4% decrease of our forecast 2014 net product mix considering CRC is to purchase profit more higher-ASP products to meet rising freight transportation demand. Increase in MU ASP Low, with high impact A 2ppt increase of our forecast MU ASP Our base case assumes MU ASP in 2014 to growth could lead to 0.7% increase of our decline 10% YoY. The increasing proportion of forecast 2014 net profit sales of 250km/h MUs is expected to bring downward pressure on MU ASP. Increase in RTV ASP Low, with high impact A 2ppt increase of our forecast RTV ASP Our base case assumes RTV ASP in 2014 to growth could lead to 0.3% increase of our decline 5% YoY. We expect intensive forecast 2014 net profit competition in RTV segment will put downward pressure on RTV ASP. Source: Macquarie Research, June 2014

26 June 2014 11 Macquarie Research China CNR Corp

Fig 21 Sales volume sensitivity analysis on 2014E earnings Locomotive sales growth rate % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case 18.0% YoY growth 5,079 Base case 4,129 23.0% 28.0% 5,185 2.1% 25.6% 23.0% 5,132 1.0% 24.3% 20.0% 5,101 0.4% 23.5% 18.0% 5,079 0.0% 23.0% 16.0% 5,058 -0.4% 22.5% 13.0% 5,027 -1.0% 21.8% 8.0% 4,974 -2.1% 20.5%

MU sales growth rate % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case 10.0% YoY growth 5,079 Base case 4,129 23.0% 20.0% 5,235 3.1% 26.8% 15.0% 5,157 1.5% 24.9% 12.0% 5,111 0.6% 23.8% 10.0% 5,079 0.0% 23.0% 8.0% 5,048 -0.6% 22.3% 5.0% 5,002 -1.5% 21.1% 0.0% 4,924 -3.1% 19.3%

RTV sales growth rate % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case 32.0% YoY growth 5,079 Base case 4,129 23.0% 42.0% 5,128 0.9% 24.2% 37.0% 5,104 0.5% 23.6% 34.0% 5,089 0.2% 23.3% 32.0% 5,079 0.0% 23.0% 30.0% 5,070 -0.2% 22.8% 27.0% 5,055 -0.5% 22.4% 22.0% 5,031 -0.9% 21.9% Source: Company data, Macquarie Research, June 2014

CNR’s earnings are CNR’s earnings are most sensitive to MU’s ASP. We expect no further increase in MU’s ASP most sensitive to in 2014 considering fewer portions of 380km/h MU in the tender mix. Our analysis shows MU’s ASP every 2ppt decrease in MU’s ASP growth, with all other variables held constant, would reduce our FY2014 base-case earnings forecast by 0.7%. Every 2ppt decrease in locomotive and RTV’s ASP growth, with all other variables held constant, would reduce our FY2014 base- case earnings forecast by 0.4% and 0.3%, respectively. Fig 22 ASP sensitivity analysis on 2014 earnings Locomotive ASP growth % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case 20% YoY growth 5,079 Base case 4,129 23.0% 28.0% 5,163 1.6% 25.0% 25.0% 5,131 1.0% 24.3% 22.0% 5,100 0.4% 23.5% 20.0% 5,079 0.0% 23.0% 18.0% 5,059 -0.4% 22.5% 15.0% 5,028 -1.0% 21.8% 12.0% 4,996 -1.6% 21.0%

MU ASP growth % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case -10.0% YoY growth 5,079 Base case 4,129 23.0% -2.0% 5,231 3.0% 26.7% -5.0% 5,174 1.9% 25.3% -8.0% 5,117 0.7% 24.0% -10.0% 5,079 0.0% 23.0% -12.0% 5,041 -0.7% 22.1% -15.0% 4,984 -1.9% 20.7% -18.0% 4,927 -3.0% 19.4%

RTV ASP growth % 2014E (Rmb) Change from 2013 (Rmb) FY14 YoY growth

Base case -5.0% YoY growth 5,079 Base case 4,129 23.0% 3.0% 5,133 1.1% 24.3% 0.0% 5,113 0.7% 23.8% -3.0% 5,093 0.3% 23.4% -5.0% 5,079 0.0% 23.0% -7.0% 5,066 -0.3% 22.7% -10.0% 5,046 -0.7% 22.2% -13.0% 5,026 -1.1% 21.7% Source: Company data, Macquarie Research, June 2014

26 June 2014 12 Macquarie Research China CNR Corp

Business segment overview CNR business overview CNR’s major business is the manufacturing and refurbishment of rolling stocks including high- speed MUs, locomotives, passenger carriages, freight wagons, rapid transit vehicles, railway engineering machinery & equipment and core system/components of rolling stock. The rolling stock related business accounted for over 70% of its total revenue, and this segment represented 84.0% of total gross profit in 2013.

Fig 23 FY13 CNR revenue breakdown Fig 24 FY13 CNR gross profit breakdown

Emerging Emerging industry, 4.3% Locomotive, Modern industry, 4.3% 16.3% Modern service, 9.8% service, 23.6% Mechanical and Passenger electric product, coach, 8.3% 1.9% Mechanical and electric product, 1.9% Railway engineering Freight wagon, machinery and 13.7% equipment, Rolling stock 1.3% products, Rapid transit 84.0% vehicle, 6.0% High-speed MU, 24.7%

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

We remain positive We remain positive on continued demand growth of its core rolling stock products, namely on continued MUs, locomotives and RTVs. Demand growth is driven by China’s robust investment in demand growth of railway and urban railway networks. We forecast MU and RTV products will have the highest its core rolling stock sales growth rates among its rolling stock product categories, with revenue to grow at a products CAGR of 18% and 22% during 2013-2016E, respectively. We forecast locomotive product revenue will grow at an 18% CAGR over 2013-2016E. We forecast revenue from its rolling stock related business will grow at a CAGR of 9% over 2013- 2016E. The company is also The company is also trying to diversify its business into new areas. CNR has expanded its trying to diversify its business into mechanical and electric products, modern services including trading, project business into new management and lease, clean energy and environmental protection equipment, and IT areas information services. The rest, around 30% and 16% of revenue and gross profit for CNR, is from other new businesses. The revenue contribution from modern services is around 24%, with gross profit contribution at 10% in 2013. We expect revenue from this segment to register a CAGR of 15% over 2013- 2016E driven by further development of the railway and urban rail network, which not only would increase sales for its project management and consulting business and financing leasing business, but also boost its rolling stock product and key component sales. Revenue from emerging industries accounted for 4% of CNR’s total revenue in 2013 with focus on wind power equipment and LNG equipment. Growth drivers are linked to the continued economic growth and rising importance of environment protection. We forecast revenue from emerging industries will post a CAGR of 15% over 2013-2016E. CNR leverages its technology and product expertise into other mechanical and electric product segments. In this business unit, the company is mainly engaged in the production and sales of motors and gearboxes for oil drilling machinery and mining machinery as well as IGBT products. Revenue contribution from this segment is around 1.5-2.5% in 2011-2013. We forecast revenue from this segment to see a CAGR of 23% over 2013-2016E, given the positive demand outlook for both sub-segments.

26 June 2014 13 Macquarie Research China CNR Corp

Fig 25 CNR’s revenue breakdown by business segment 2013-2016E Rmb m 2011 2012 2013 2014E 2015E 2016E CAGR

Locomotive 19,862 16,024 15,774 19,695 22,459 25,925 18% Passenger carriage 4,077 5,471 7,996 5,584 5,738 5,816 -10% Freight wagon 14,099 14,493 13,298 13,348 13,810 14,355 3% MU 24,954 22,130 23,858 23,649 26,429 28,560 6% Rapid transit vehicle 6,370 8,097 5,851 7,689 10,664 12,263 28% Railway engineering machinery and equipment 1,056 252 1,226 1,593 1,912 2,294 23% Rolling stock related subtotal 70,418 66,466 68,004 71,558 81,011 89,214 9% Mechanical and electric products 1,314 2,252 1,794 2,332 2,798 3,357 23% Modern services 14,915 20,241 22,806 28,508 31,358 34,494 15% Emerging industry 2,163 2,839 4,153 5,191 5,710 6,281 15% Total revenue 88,811 91,798 96,756 107,588 120,877 133,346 11% % of total Locomotive 22% 17% 16% 18% 19% 19% Passenger carriage 5% 6% 8% 5% 5% 4% Freight wagon 16% 16% 14% 12% 11% 11% MU 28% 24% 25% 22% 22% 21% Rapid transit vehicle 7% 9% 6% 7% 9% 9% Railway engineering machinery and equipment 1% 0% 1% 1% 2% 2% Rolling stock related subtotal 79% 72% 70% 67% 67% 67% Mechanical and electric products 1% 2% 2% 2% 2% 3% Modern services 17% 22% 24% 26% 26% 26% Emerging industry 2% 3% 4% 5% 5% 5% Total revenue 100% 100% 100% 100% 100% 100% % YoY Locomotive -19.3% -1.6% 24.9% 14.0% 15.4% Passenger carriage 34.2% 46.1% -30.2% 2.8% 1.4% Freight wagon 2.8% -8.2% 0.4% 3.5% 3.9% MU -11.3% 7.8% -0.9% 11.8% 8.1% Rapid transit vehicle 27.1% -27.7% 31.4% 38.7% 15.0% Railway engineering machinery and equipment -76.1% 386.3% 30.0% 20.0% 20.0% Rolling stock related subtotal -5.6% 2.3% 5.2% 13.2% 10.1% Mechanical and electric products 71.3% -20.4% 30.0% 20.0% 20.0% Modern services 35.7% 12.7% 25.0% 10.0% 10.0% Emerging industry 31.2% 46.3% 25.0% 10.0% 10.0% Total revenue 3.4% 5.4% 11.2% 12.4% 10.3% Source: Company data, Macquarie Research, June 2014

Rolling stock products (67% of 2014E revenue) The rolling stock The rolling stock product segment is the core business of the company, which contributed 72% product segment is and 70% of total revenue in 2012 and 2013, respectively. the core business of The company is one of the only two leading rolling stock producers in the domestic market. the company, which Within its rolling stock product segment, the company has five major groups of products, contributed 72% and namely, locomotive, high-speed MU, passenger carriage and freight wagon, rapid transit 70% of total revenue vehicle and other railway engineering machinery and key components of rolling stocks. In in 2012 and 2013 addition to supplying new-make trains, the company generates revenue from jobs undertaken for rolling stock refurbishment.

26 June 2014 14 Macquarie Research China CNR Corp

Fig 26 Revenue forecast of rolling stock business segment 2011 2012 2013 2014E 2015E 2016E 2013-2016 CAGR

Locomotive 19,862 16,024 15,774 19,695 22,459 25,925 18% Passenger carriage 4,077 5,471 7,996 5,584 5,738 5,816 -10% Freight wagon 14,099 14,493 13,298 13,348 13,810 14,355 3% MU 24,954 22,130 23,858 23,649 26,429 28,560 6% Rapid transit vehicle 6,370 8,097 5,851 7,689 10,664 12,263 28% Railway engineering machinery and equipment 1,056 252 1,226 1,593 1,912 2,294 23% Rolling stock related subtotal 70,418 66,466 68,004 71,558 81,011 89,214 9% as % of total 79% 72% 70% 67% 67% 67%

% of total Locomotive 22% 17% 16% 18% 19% 19% Passenger carriage 5% 6% 8% 5% 5% 4% Freight wagon 16% 16% 14% 12% 11% 11% MU 28% 24% 25% 22% 22% 21% Rapid transit vehicle 7% 9% 6% 7% 9% 9% Railway engineering machinery and equipment 1% 0% 1% 1% 2% 2% Rolling stock related subtotal 79% 72% 70% 67% 67% 67%

% YoY Locomotive -19.3% -1.6% 24.9% 14.0% 15.4% Passenger carriage 34.2% 46.1% -30.2% 2.8% 1.4% Freight wagon 2.8% -8.2% 0.4% 3.5% 3.9% MU -11.3% 7.8% -0.9% 11.8% 8.1% Rapid transit vehicle 27.1% -27.7% 31.4% 38.7% 15.0% Railway engineering machinery and equipment -76.1% 386.3% 30.0% 20.0% 20.0% Rolling stock related subtotal -5.6% 2.3% 5.2% 13.2% 10.1% Source: Company data, Macquarie Research, June 2014

1) MU (22% of 2014E revenue) The company offers high-speed MUs with maximum speeds ranging from 200km/h to 380km/h. According to SCI Verkehr, the company is the largest manufacturer of MUs with speeds above 300km/h in the world in terms of the aggregate number of units delivered in 2011 and 2012. CNR won about 59.7% of the total number of MUs with speeds above 300km/h that CRC tendered in 2013. Currently, the company is the only producer in China who is able to mass produce high-speed MUs capable of operating at high altitude and low winter temperatures. In 2012 and 2013 CNR gained all the contracts to supply to the HSR lines operating in the north-eastern part of China. We forecast the level of new HSR line launches will remain robust over the next three years, and CRC has started to progressively increase HSR MU operating densities, following strong growth in ridership and the need to free-up more railway space for freight transportation. We remain positive on CNR’s new MU demand outlook for the next 3 years. Maintenance and refurbishment demand will also start to contribute significantly to revenue from 2017 onwards, which will help to sustain its MU segment’s sales growth momentum. Revenue from MUs High-speed MUs contribute the most to CNR’s revenue within the rolling stock segment. It would increase at a accounted for 25% of the company’s total revenue in 2013. We forecast its new-build MU CAGR of 6% over sales volume would see a CAGR of 15% from 936 units in 2013 to 1,409 units in 2016, while 2013-2016E MU refurbishment volume will register a CAGR of 10% from 1,008 units in 2013 to 1,339 units in 2016. We forecast revenue from MU new-build sales and refurbishment will also increase

at a CAGR of 6% from Rmb23.9bn in 2013 to Rmb28.6bn in 2016.

26 June 2014 15 Macquarie Research China CNR Corp

Fig 27 Sales volume and ASP forecast of MUs 2011 2012 2013 2014E 2015E 2016E 2013-16E CAGR

Sales volume (car) Manufacturing 1,160 936 936 1,030 1,215 1,409 15% Refurbishment 456 592 1,008 1,058 1,164 1,339 10%

ASP (Rmb mn) Manufacturing 19.89 19.83 21.32 19.18 18.23 16.77 -8% Refurbishment 4.12 6.02 3.88 3.68 3.68 3.68 -2%

Revenue (Rmb mn) Manufacturing 23,076 18,564 19,952 19,753 22,143 23,631 6% Refurbishment 1,878 3,566 3,906 3,896 4,286 4,929 8% Total 24,954 22,130 23,858 23,649 26,429 28,560 6% Source: Company data, Macquarie Research, June 2014

2) Locomotive (18% of 2014E revenue) According to SCI Verkehr, CNR is the largest manufacturer of electric locomotives in the world, in terms of aggregate number of units delivered in between 2008 and 2012. In 2013, the company won the bids for 53.2% of the total number of locomotives that CRC tendered. The company produces both DC and AC electric locomotives and diesel locomotives, with electric locomotives covering 4,800 to 10,000KW and diesel locomotives covering 1,000 to 6,000hp. The company also provides refurbishment, upgrades and maintenance services for locomotives. It owns CNR Dalian, the largest manufacturing facility for locomotives in terms of number of locomotives delivered in 2012, and CNR Taiyuan, the largest refurbishment facility for electric locomotives in terms of refurbished electric locomotives delivered in 2012. Locomotives contributed around 16% to total revenue in 2013. We expect continued growth in locomotive demand in the domestic market in light of further development of the railway freight transportation network. Year-to-date, CNR won CRC bids of 499 units of locomotives with market share reaching 50%. Revenue from We forecast both new-build locomotive sales and locomotive refurbishment volume will locomotives to see continue to grow at the company. We expect the company will grow its locomotive sales at a a CAGR of 18% over CAGR of 13% from 634 units in 2013 to 905 units in 2016. We also forecast locomotive 2013-2016E refurbishment volume will increase at a CAGR of 10% from 1,074 units in 2013 to 1,427 units in 2016. We expect revenue from locomotive new-build sales and refurbishment will see a

CAGR of 18% from Rmb15.8bn in 2013 to Rmb25.9bn in 2016.

Fig 28 Sales volume and ASP forecast of locomotives 2011 2012 2013 2014E 2015E 2016E 2013-16E CAGR

Sales volume (unit) Manufacturing 1,089 840 634 748 823 905 13% Refurbishment 634 1,048 1,074 1,128 1,240 1,427 10%

ASP (Rmb mn) Manufacturing 14.62 13.80 16.04 19.24 20.20 21.21 10% Refurbishment 6.22 4.23 5.22 4.70 4.70 4.71 -3%

Revenue (Rmb mn) Manufacturing 15,918 11,590 10,166 14,396 16,627 19,204 24% Refurbishment 3,944 4,434 5,608 5,299 5,832 6,721 6% Total 19,862 16,024 15,774 19,695 22,459 25,925 18% Source: Company data, Macquarie Research, June 2014 3) Passenger carriage and freight wagon (5% and 12% of 2014E revenue) Passenger carriages produced by CNR are used on normal trains. The company has a complete product portfolio of passenger carriages, including a series of 25G, 25K and 25T products with a maximum operating speed under 200km/h.

26 June 2014 16 Macquarie Research China CNR Corp

CNR also produces freight wagons, and it is the 2nd largest and No 1 freight wagon producer in the world and in China, respectively, in terms of the aggregate number of units delivered between 2008 and 2012. The company won the bids for 47.3% of the total number of freight wagons that CRC purchased in 2013. It also won the bids for 55% and 50% of the total number of passenger carriages and freight wagons that CRC tendered in 5M14. It offers complete types of freight wagon products and is the industry leader in the formulation of technology standards for major railway freight wagons in China. As more new lines are put into operation in the future using high-speed MUs with speed above 200km/h, we see demand for passenger carriages declining. Freight wagons, on the other hand, will continue to see increased demand, considering the freed-up freight transport capacity from HSR lines and also further development of the freight transportation network suggests more freight wagons are needed. We forecast revenue Passenger carriages and freight wagons accounted for 8% and 14% of the company’s total from passenger revenue in 2013. We expect to see new-build passenger carriage sales to decline at a CAGR carriages will of 12% over 2013-2016E, while freight wagon sales to rise at a CAGR of 2% over 2013- decline at a CAGR 2016E. For refurbishment, we expect passenger carriages will see volume decline at a CAGR of 10%, while of 6% over 2013-2016E, while freight wagons should see volume growth at a CAGR of 10% revenue from freight over 2013-2016E. We forecast revenue from passenger carriages will decline at a CAGR of wagons will 10%, while revenue from freight wagons will increase at a CAGR of 3% over 2013-2016E. increase at a CAGR of 3% over 2013- 2016E Fig 29 Sales volume and ASP forecast of passenger carriages and freight wagons 2011 2012 2013 2014E 2015E 2016E 2013-16E CAGR

Passenger carriage: Sales volume (car) Manufacturing 1,030 1,580 1,732 1,126 1,148 1,171 -12% Refurbishment 1,749 1,706 2,182 1,833 1,833 1,833 -6% Freight wagon: Sales volume (car) Manufacturing 28,180 27,466 25,111 25,613 26,125 26,648 2% Refurbishment 27,894 26,941 23,867 26,254 28,879 31,767 10%

Passenger carriage: ASP (Rmb mn) Manufacturing 2.29 2.42 3.22 3.33 3.40 3.40 2% Refurbishment 0.98 0.97 1.11 1.00 1.00 1.00 -3% Freight wagon: ASP (Rmb mn) Manufacturing 0.40 0.41 0.41 0.40 0.40 0.40 -1% Refurbishment 0.11 0.12 0.13 0.12 0.12 0.12 -3%

Revenue (Rmb mn) Passenger carriage Manufacturing 2,356 3,819 5,571 3,750 3,904 3,982 -11% Refurbishment 1,721 1,652 2,426 1,834 1,834 1,834 -9% Total 4,077 5,471 7,996 5,584 5,738 5,816 -10% Freight wagon Manufacturing 11,159 11,338 10,213 10,293 10,450 10,659 1% Refurbishment 2,939 3,155 3,086 3,055 3,360 3,696 6% Total 14,099 14,493 13,298 13,348 13,810 14,355 3% Source: Company data, Macquarie Research, June 2014

4) RTV (7% of 2014E revenue) The company offers complete types of rapid transit vehicles, covering all urban transit needs for metro, light rail, inter-city railcars and trams. It also has the capability to develop and produce maglev trains. The company also develops low-speed MUs with operating speeds ranging from 70km/h to 140km/h for urban rail usage. Two rising factors are driving demand growth for urban transit systems in China – ever- growing urbanised area; and the need to reduce traffic congestion and automobile emission pollution problems. As the rapid transit system is likely to see accelerated investment growth from 2014 to 2020, we expect steady demand growth for RTVs as well. CNR as the market leader, thereby, should benefit the most from rising demand going forward.

26 June 2014 17 Macquarie Research China CNR Corp

We expect RTV RTVs accounted for 6% of the company’s total revenue in 2013. We forecast RTV sales revenue to post a volume will rise at a CAGR of 29% from 1,106 units in 2013 to 2,350 units in 2016. Meanwhile, CAGR of 28% over as existing RTVs under operation will need refurbishment in future, we see RTV 2013-2016E refurbishment will start generating revenue from 2014 with volume ranging between 436-552 units in 2014-2016E. We expect RTV revenue to post a CAGR of 28% from Rmb5.9bn in

2013 to Rmb12.3bn in 2016.

Fig 30 Sales forecast of RTVs 2011 2012 2013 2014E 2015E 2016E 2013-16E CAGR

Sales volume (car) Manufacturing 1,255 1,546 1,106 1,460 2,044 2,350 29% Refurbishment 0 0 0 436 480 552 nm

Revenue (Rmb mn) Manufacturing 6,370 8,097 5,851 7,338 10,278 11,819 26% Refurbishment 0 0 0 351 386 444 nm Total 6,370 8,097 5,851 7,689 10,664 12,263 28% Source: Company data, Macquarie Research, June 2014

5) Railway engineering machinery and key components of rolling stocks (1% of 2014E revenue) The company is also engaged in supplying railway engineering machinery including railway cranes, trackbound maintenance machines, rail grinding trains, ballast shoulder cleaning machines and catenary multi-purpose comprehensive working cars. It is one of China’s major manufacturers of large railway maintenance machinery. It also produces components for its MUs, locomotives, passenger carriages and rapid transit vehicles. It develops key systems for its rolling stock products, including traction systems, control systems and network systems, which will help the company raise its self-supplied capabilities and core competitiveness. Most of the core systems and components of rolling stock manufactured by the company are for internal use or as spare parts for rolling stock products. We forecast revenue Revenue from sales of railway engineering machinery and key components of rolling stocks of railway accounted for 1% of total revenue in 2013. But we see accelerated growth from sales of the engineering key components of rolling stocks. We forecast revenue to increase at a CAGR of 23% over machinery and key 2013-2016E with revenue contribution increasing from 1.3% in 2013 to 1.5-1.7% in 2014- components to 2016E. increase at a CAGR of 23% over 2013- 2016E Fig 31 Revenue from railway engineering machinery and key components of rolling stock sub-segment

2,500 2.0% 1.8% 2,000 1.6% 1.4% 1,500 1.2% 1.0% 1,000 0.8% 0.6% 500 0.4% 0.2% 0 0.0% 2011 2012 2013 2014E 2015E 2016E

Revenue (Rmb mn) % as total (rhs)

Source: Company data, Macquarie Research, June 2014

26 June 2014 18 Macquarie Research China CNR Corp

Mechanical and electric products (2% of 2014E revenue) We forecast revenue CNR leverages its technology and product expertise into other mechanical and electric from mechanical products. In this business unit, the company is mainly engaged in production and sales of and electric motors and gearboxes for oil drilling machinery and mining machinery and also IGBT products to see a products. Revenue contribution from this segment is around 1.5-2.5% in 2011-2013. We CAGR of 23% over forecast revenue from this segment to see a CAGR of 23% over 2013-2016E, given the 2013-2016E positive demand outlook for both sub-segments. Fig 32 Revenue from mechanical and electric product segment

4,000 3.0% 3,500 2.5% 3,000 2.0% 2,500

2,000 1.5%

1,500 1.0% 1,000 0.5% 500

0 0.0% 2011 2012 2013 2014E 2015E 2016E Revenue (Rmb mn) % as total (rhs)

Source: Company data, Macquarie Research, June 2014

Fig 33 Revenue contribution of mechanical and Fig 34 GP contribution of mechanical and electric electric product business product business

2,500 3.0% 450 3.5%

400 3.0% 2.5% 2,000 350 2.5% 2.0% 300 1,500 250 2.0% 1.5%

1,000 200 1.5% 1.0% 150 1.0% 500 0.5% 100 0.5% 50 0 0.0% 2011 2012 2013 0 0.0% Revenue (Rmb m) % of total (rhs) 2011 2012 2013 Gross profit (Rmb m) % of total (rhs)

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Motors and gearboxes for oil drilling machines and mining machinery The company’s DC and AC motors cover power classes ranging from 200KW to 1,600KW. The company has a leading position in the market of oil drilling motors in China in terms of number of units sold in 2013. As of 31 December 2013, its products have been used in 1,000- 12,000m oil rigs running in large oil fields in China, such as Daqing, Shengli, Liaohe, Huabei, Xinjiang and Changqing, and also some overseas oil fields in Russia and Venezuela.

26 June 2014 19 Macquarie Research China CNR Corp

Medium to high-power IGBT modules IGBT is the major revenue driver in this business segment. It is a new generation of semi- conductor core component widely used in smart grids, electric vehicles, clean energy power generation and industrial control for improving electricity use efficiency. For the high-voltage IGBT segment in which CNR specializes, we expect demand growth to remain high above 20% over 2010-2020. MIIT estimates the high-voltage IGBT segment will increase to Rmb9.3bn in 2020. Based on end use, IGBT applications for industry control, electric vehicles, and railway transport is expected to grow at a CAGR of around 20% in terms of total market value, while IGBT applications for new energy should grow the highest by 30-40% between 2010 and 2020.

Fig 35 High-voltage IGBT segment demand growth 2020E market size Area of application (Rmb bn) 2010-2020E CAGR

Industry control Low, medium voltage convertor/inverter 14.2 17-19% High voltage convertor/inverter 2.8 25-30% Electric vehicle 10.2 >20% Railway transport >1 18-22% New energy (wind, solar) 5.1 30-40% Smart grid >0.4 na Source: MIIT, Macquarie Research, June 2014

The IGBT market is dominated by foreign makers from the US, EU and Japan, which controlled more than 95% market share in 2011. But market competition is slightly different among different IGBT sub-segments. The competition is the highest in the mid and low- voltage IGBT segment as almost all the producers have the capability to produce IGBT at the low voltage level. In China, some domestic producers such as BYD, NEC, etc are building up their capability to produce mid-voltage IGBT. In the high-voltage IGBT segment, however, the market is dominated by foreign players like Japan’s Mitsubishi Electric and Fuji Electric, Germany’s Infineon and Dynex, etc. In this area, China has only two domestic players. Zhuzhou CSR has gained IGBT know-how by acquiring UK’s IGBT producer, Dynex; CNR entered this market by independent R&D. CNR is the 1st manufacturer in China to package IGBT modules of 6,500V. It has designed, developed and manufactured high-power IGBT modules with voltage ranging from 1,200- 6,500V and current range from 75-3,600A with advanced technologies.

Fig 36 China IGBT market share breakdown in 2011

Leading foreign company in low -voltage IGBT segment

Leading company in high-voltage IGBT segment New joiner in the low -voltage IGBT segment New joiner in the high-voltage IGBT segment

Source: CCID, June 2014

26 June 2014 20 Macquarie Research China CNR Corp

Modern services (26% of 2014E revenue) The modern service business segment mainly includes trading of raw materials, project management contracting services for urban rail and other related projects and finance lease of rolling stock, machinery and equipment. It is the 2nd largest revenue contributor to the We expect revenue company, accounting for 24% of total revenue in 2013. from modern services We expect revenue from this segment to rise at a CAGR of 15% over 2013-2016E driven by to rise at a CAGR of further development of the railway and urban rail network, which not only would increase 15% over 2013-2016E sales of the project management and consulting business and its financing leasing business but also boost rolling stock product and key components sales.

Fig 37 Revenue contribution of modern services business Fig 38 GP contribution of modern services business

25,000 25.0% 1,800 12.0%

1,600 10.0% 20,000 20.0% 1,400

1,200 8.0% 15,000 15.0% 1,000 6.0% 10,000 10.0% 800

600 4.0%

5,000 5.0% 400 2.0% 200 0 0.0% 0 0.0% 2011 2012 2013 2011 2012 2013 Revenue (Rmb m) % of total (rhs) Gross profit (Rmb m) % of total (rhs)

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Fig 39 Revenue from modern services business segment

40,000 30.0% 35,000 25.0% 30,000 20.0% 25,000

20,000 15.0%

15,000 10.0% 10,000 5.0% 5,000

0 0.0% 2011 2012 2013 2014E 2015E 2016E Revenue (Rmb mn) % as total (rhs)

Source: Company data, Macquarie Research, June 2014

26 June 2014 21 Macquarie Research China CNR Corp

Trading The company is involved in the trading of raw materials. Basically the company purchases steel, coal, ore and chemical products from 3rd party vendors not only to satisfy its own production purpose but also to sell these products to 3rd party customers for trading purposes. Its operating subsidiaries also sell scrap materials from their production processes to 3rd parties. The company’s competitive strength in the raw material trading segment is its close relationship with suppliers and the lower prices through bulk purchase volumes. Its trading business customers mainly include 3rd party local steel trading companies, heavy machinery companies and chemical companies. Project management contracting services for urban rail and other related projects The company is engaged in project management contracting services for urban rail and other related projects. For such projects, the company normally undertakes all or part of the procurement, construction and trial operations of an urban rail and other related project on a turnkey basis. The company is responsible to the project owner for the quality, time progress and cost of project construction. The major customers for this business are usually business entities set up and managed by local governments for the urban rail and other related projects. So far, the company has undertaken one urban rail BT project. It formed a consortium with other third party partners, which undertook the Shenyang Hunnan New District Modern Tram Project on a BT basis in February 2012. The project is the first modern tram project in China. The company is responsible for the financing, management and construction of the project. The Hunnan Modern Transportation Co., Ltd. agreed to purchase the project in three years from the company. Finance lease of rolling stock and machines and equipment The company is engaged in the finance leasing business through its subsidiary CNR Leasing, which has obtained all the necessary licenses from MOFCOM for this business. It provides customers with equipment-based finance leases, which include direct finance leases and sale-leaseback transactions. The ownership of the relevant equipment will generally be transferred from the company to the customer upon expiration of the lease term. The lease term typically ranges from 3 to 5 years. Customers of its lease business primarily comprise 3rd party companies in the chemical, manufacturing, transportation, mining, power and heating, cement, clean energy and urban construction industries. Emerging industries (5% of 2014E revenue) The company also leverages its strong research and development capability and core technologies related to rolling stocks to further diversify its business into emerging industries, such as clean energy, energy conservation and environmental protection and information technology industries. Revenue from emerging industries accounted for 4.3% of CNR’s total revenue in 2013. Fig 40 Revenue contribution of emerging industry Fig 41 GP contribution of emerging industry business business

4,500 5.0% 800 4.4%

4.5% 4,000 700 3,500 4.0% 4.4% 600 3.5% 3,000 500 3.0% 4.3% 2,500 2.5% 400 2,000 2.0% 4.3% 300 1,500 1.5% 1,000 200 1.0% 4.2% 500 0.5% 100

0 0.0% 0 4.2% 2011 2012 2013 2011 2012 2013 Revenue (Rmb m) % of total (rhs) Gross profit (Rmb m) % of total (rhs)

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

26 June 2014 22 Macquarie Research China CNR Corp

The company has three sub-segments under its emerging industry business: . Clean energy: wind turbines and key components: It develops and produces double- fed water cooling and air cooling asynchronous wind generators ranging from 600KW to 5.0MW. . Environmental protection equipment and systems: CNR has a presence in electric buses, waste/sewage recycling systems and other clean energy and environmental protection equipment. . Enterprise resource planning services and other information technology services: The business primarily includes enterprises resource planning services and systematic solutions, energy management services, testing and verification services, and systematic solutions and services for software equipment asset management. We forecast revenue In this segment, the company focuses on two areas: wind power equipment and LNG from emerging equipment. Growth drivers are both linked to the continued economic growth and the rising industries will see a importance of environment protection. We forecast revenue from emerging industries will see CAGR of 15% over a CAGR of 15% over 2013-2016E. 2013-2016E Fig 42 Revenue from emerging industry business segment

7,000 6.0%

6,000 5.0%

5,000 4.0% 4,000 3.0% 3,000 2.0% 2,000

1,000 1.0%

0 0.0% 2011 2012 2013 2014E 2015E 2016E

Revenue (Rmb mn) % as total (rhs)

Source: Company data, Macquarie Research, June 2014 For the wind power equipment sector, first of all, we expect power demand growth will continue, albeit with demand growth shifting from the manufacturing industry to the service industry and residential use. We forecast electricity consumption in China to rise at a 7.8% CAGR from 2010 to 2015. Meanwhile, China is gradually reducing the proportion of fossil energy usage to reduce pollution. It is committed to cut carbon emissions per GDP by 40-45% by 2020 from 2005 levels during the Copenhagen Climate Conference in December 2009. Also the smog problem in metropolitan cities is becoming more serious. Environmental protection is becoming a more urgent issue for the government. One of the key solutions is to reduce coal consumption for power generation. China has set a target to increase the proportion of non-fossil power generation from 7% in 2009 to 15% in 2020. China aims to increase non-fossil energy source supply from 26% of total power capacity in 2009 to 33% in 2015, and 36% in 2020. China government guided wind capacity targets as 100GW and 180GW, solar capacity 2GW and 20GW, and gas capacity 30GW and 40GW in 2015 and 2020, respectively.

26 June 2014 23 Macquarie Research China CNR Corp

Fig 43 China wind power capacity installation and connection forecast MW 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E

New installed capacity 1,334 3,389 6,245 13,803 18,928 17,523 12,960 16,500 18,000 18,000 YoY 154% 84% 121% 37% -7% -26% 27% 9% 0% New grid connections 1,014 2,126 4,741 8,970 13,450 15,470 14,654 16,128 17,843 18,000 YoY 110% 123% 89% 50% 15% -5% 10% 11% 1% Wind turbine delivery 1,334 3,401 6,413 13,832 18,944 17,743 13,390 17,325 18,900 18,900 YoY 155% 89% 116% 37% -6% -25% 29% 9% 0% Source: CWEA, Macquarie Research, June 2014

CNR entered the wind power equipment sector as early as 2009. It formed strategic development agreements with local governments of Harbin in Heilongjiang, Songyuan, Quanzhou in Fujian, Binzhou and Yantai in Shandong and Yinchuan in Ningxia for wind power development. It also formed close relationships with power generator companies like Huaneng, Huadian, Guodian, Guohua, Datang and Luneng. The wind power equipment market is still fragmented, however.

Fig 44 2012 China wind turbine market share Fig 45 1H2013 China wind turbine market share

Sany Elec, 2% Others, 0% Beijing Sany Elec, 2% Beijing Jingcheng, 0% Jingcheng, 2%Others, 1% Windey, 3% CCEW, 2% Windey, 2% CCEW, 2% Goldwind, 21% CSR Wind, 3% CSR Wind, 2% Goldwind, 23% Dongfang Elec, Dongfang Elec, 4% 2% Gamesa, 3% Gamesa, 4% Envision, 5%

Envision, 5% Haizhuang, 6% Haizhuang, 3% United Power, Sinovel, 7% United Power, Sinovel, 10% 17% 15%

Shanghai Shanghai Mingyang, 10% Electric, 9% Mingyang, 10% Electric, 7% XEMC, 8% XEMC, 9%

Source: CWEA, Macquarie Research, June 2014 Source: CWEA, Macquarie Research, June 2014

The company has a leading position in the wind power generator market in China. In 2012, the company sold 1,100 wind power generators, representing 25% of the total installed capacity of wind power generators in China during the same year. It also has a lead in the formulation of national standards for wind power generators and possesses leading technology in China for the development of wind power generators. The company in Oct 2012 acquired an 80% equity interest in Xi’an Golden Wind Technology Co., Ltd. through its subsidiary, Yongji Xinshisu. Xi’an Golden Wind Technology Co., Ltd. used to belong to Xinjiang Golden Wind Technology Co., Ltd, the largest wind turbine maker in China. The new entity after acquisition was named Xi’an Yongdian Goldwind Co., Ltd, which is principally engaged in wind turbine R&D, design, manufacturing and sales. Its acquisition of Xi’an Goldwind reflects its further expansion into the wind turbine market by value chain integration.

Fig 46 CNR’s wind power equipment related sales contracts Contract date Subsidiary Counterparty Detail Contract amount

13-Jul-10 Yongji Xinshisu Sinovel sales contract of 1.5kw wind power generators Rmb1.155bn 7-Apr-10 Yongji Xinshisu Xinjiang Goldwind sales contract of YJ127A wind power generator Rmb2.7bn 28-Nov-11 CNR Jinan Beijing Guorui Funding Investment sales contract of 1.5MW Wind power generator Rmb187mn 2-Nov-12 CNR Lanzhou Huaneng Xinjiang Energy sales contract of wind vane tower barrel Rmb124.98mn 2-Nov-12 CNR Lanzhou Huadian Heavy Industries sales contract of wind vane tower barrel Rmb105.73mn 2-Nov-12 CNR Wind Yantai Zhulong Wind Power sales contract of Wind power generator Rmb185.63mn 3-May-13 Yongji Xinshisu & Xi’an Xinjiang Goldwind sales contract of power generator and generator Rmb2.1bn Yongdian Goldwind stator 3-May-13 CNR Lanzhou Xinjiang Hami Yandun Tianrun Wind sales contract of wind vane tower barrel Rmb81mn Power 18-Oct-13 Yongji Xinshisu Xinjiang Goldwind sales contract of wind turbine Rmb639mn Source: Company data, Macquarie Research, June 2014

26 June 2014 24 Macquarie Research China CNR Corp

LNG CNR also aims to expand its sales into the LNG equipment sector. China has already become the largest consumer of energy globally, but its primary energy consumption is poised for further growth as its GDP/capita catches up with global peers. But the challenges in meeting China’s energy demand in an environmentally sustainable manner are also growing significantly.

To reduce CO2 emission and resolve the air pollution problem, gas will be increasingly used for energy consumption in China. Gas demand has grown nearly 6x since 2000, and China is now the fourth largest gas consumer in the world. Nonetheless, gas still accounts for only 5% of China‘s primary energy needs (versus Russia 54%, US 30%, Japan 22%, Korea 17%, India 9%), setting the scene for strong demand growth in the coming decade. China targets its gas consumption to rise to 230/380bcm or 7.5%/10% of its forecast primary energy mix by 2015/20E, representing a CAGR of 16% in 2012-15E and 13% in 2012-20E. Based on our granular bottom-up work by sub-segment and assuming 7% sustainable growth in China GDP in the long run, we think the government targets for gas demand are reasonable, with longer-term risks skewed to the upside.

Fig 47 Global gas demand (2012) Fig 48 China gas demand

(bcm) bcm 800 0.18 400 12.0% 350 700 0.15 10.0% 600 300 0.12 8.0% 500 250 0.09 400 200 6.0% 0.06 150 300 4.0% 0.03 100 200 2.0% 50 100 0 0 0.0% 0 -0.03 2002 2004 2006 2008 2010 2012 2014E 2016E 2018E 2020E

US UK Iran Italy UAE China Saudi India Egypt Residential Power Generation Russia Japan Mexico Canada ThailandS. Korea Germany Industrial Transport (NGVs) Gas Demand 2000-12A CAGR (RHS) Other Gas as % total energy (RHS)

Source: BP Stat review, Macquarie Research, June 2014 Source: China NDRC, WMAC, CEMC, Macquarie Research, June 2014 The rising demand for natural gas also boosted the need for infrastructure development and gas transportation. CNR has accumulated technology and product knowledge in railway tank car design and manufacturing. It also has experience in developing cryogenic liquid containers for military use. CNR formed a strategic alliance with Shanqi Group and Shanxi Gas Group to develop an LNG equipment production base in the Shaanxi province. Shaanxi is among the provinces slated to develop their local LNG markets given their excess local gas supply. The three parties will cooperate in areas of LNG railway and road transport equipment development and LNG transport services offerings. Within the framework of this strategic alliance, CNR is in charge of research and development of the LNG railway and road tank cars and also other kinds of LNG transport and storage equipment. Shanqi specializes in development of LNG truck products, while Shanxi GAS Group can rely on CNR and Shanqi for transport equipment procurement and gas delivery services.

26 June 2014 25 Macquarie Research China CNR Corp

Fig 49 China LNG retail station distribution (2012) Fig 50 Excess gas capacity vs. gas demand (2012)

Zhejiang, 5% Shandong, 20 Gas demand Hubei, 5% 19% (bcm) Sichuan Sichuan, 6% 16

Jiangsu, 6% 12

Guangdong Hebei, 6% 8 Xinjiang Guangdong, Shaanxi 18% 4 Inner Gansu, 9% ShandongShanxi Mongolia 0 Inner Mongolia, -15 -10 -5 0 5 10 15 20 25 9% Xinjiang, 17% Implied Provincial Gas Excess Capacity (bcm)

Source: C1 Energy, Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014

26 June 2014 26 Macquarie Research China CNR Corp

Industry demand outlook China started to modernise its ailing railway network from 2008; after some setbacks in 2011 and 2012, Ministry of Railway was transformed into China Railway Corporation (CRC) in June 2013. The total railway network length grew from 70,000 km at the end of 2001 to about 106,000 km by the end of 2013. The national four-vertical and four-horizontal major high- speed railway network started operation from 2008, and total operating length reached about 13,000 km by the end of 2013. Railway equipment Railway equipment producers are late-cycle beneficiaries; we forecast railway construction producers are late- FAI will gradually trend down in the final two years of the 12th five-year plan (2011-2015). As cycle beneficiaries railway construction projects are coming towards the last-mile stage, construction costs are also coming down. The deepening of The railway reform is aimed at improving the industry’s operating efficiency and profitability, railway reform and generating sustainable profits to refinance debt borrowed for construction capex brings further investment from 2008 to 2015. From 2014 onwards, CRC will focus on further deepening demand upside on industry reform to transform both railway passenger and freight transportation services. railway equipment The Chinese rolling stock producers are the world’s largest scale train producers in terms of revenue. CNR and CSR currently only generate about 10% of revenue from overseas markets; both producers are looking to expand into international markets.

Fig 51 Top 10 rolling stock makers globally in terms of 2012 revenue

9.0 US$ bn 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0

Source: SCI Verkehr, Macquarie Research, June 2014

Railway FAI forecast Under the 12th Five-Year-Plan (2011-2015), China plans to invest a total RMB3.3 trillion on railway investment, RMB1.1 trillion more than RMB2.2 trillion planned during the 11th Five- Year-Plan. Total railway investment is comprised of construction, railway refurbishment and rolling stock procurement. We expect railway We expect railway investment in 2014 to be 8% higher than 2013, and railway investment investment to growth in 2015 to decline by 6% YoY. Although the construction phase is coming towards the increase 8% and 6% tail-end, we forecast railway construction FAI will grow by 9% YoY in 2014, and railway YoY in 2014 and equipment investment will grow 9% YoY. In 2015 we forecast railway equipment investment 2015 will grow 11% YoY. In terms of new high-speed railway (HSR) lines launching into operation in 2014, we expect 22% YoY growth in 2014. Due to strong growth in demand for HSR passenger travel, CRC started to increase HSR train operating density at the beginning of 2014; some of the HSR lines have only been operating for about two years.

26 June 2014 27 Macquarie Research China CNR Corp

We expect CRC to We expect CRC will continue to increase HSR operating density to relieve the capacity continuously increase bottleneck on the normal railway network and allow more capacity to be used for running HSR operating density commercial freight services, which is the main profit generating avenue for the industry.

Fig 52 China railway industry investment forecasts 2008 2009 2010 2011 2012 2013 2014E 2015E

Total Railway FAI (Rmb bn) 416.8 704.5 842.7 594.7 657.7 663.8 800.0 760.0 yoy growth 61% 69% 20% -29% 11% 1% 21% -5% - Railway construction 337.6 600.4 707.5 460.1 521.5 550.0 655.0 600.0 yoy growth 89% 78% 18% -35% 13% 5% 19% -8% - Railway refurbishment 22.7 25.4 28.5 30.6 31.8 27.0 25.0 25.0 yoy growth 3% 12% 13% 7% 4% -15% -7% 0% - Locomotives & trains 56.6 78.7 106.7 104.0 104.3 86.8 120.0 135.0 yoy growth -1% 39% 35% -2% 0% -17% 38% 13%

Total railway length (km) 79,687 85,518 91,178 93,250 98,000 105,959 112,959 120,000 Incremental 1,721 5,831 5,661 2,071 4,750 7,959 7,000 7,041 yoy growth 95% 239% -3% -63% 129% 68% -12% 1% Dual track length 29,000 33,000 37,000 39,013 44,000 49,907 56,497 63,848 Increment 1,900 4,000 4,000 2,013 4,987 5,907 6,590 7,351 yoy growth 171% 111% 0% -50% 148% 18% 12% 12% Electrified railway 28,000 36,000 42,000 45,600 51,000 58,316 66,560 75,850 Increment 2,500 8,000 6,000 3,600 5,400 7,316 8,244 9,290 yoy growth 127% 220% -25% -40% 50% 35% 13% 13% High speed railway 1,207 3,459 5,013 6,434 9,356 12,947 17,334 21,377 Increment 2,252 1,554 1,421 2,922 3,591 4,387 4,043 yoy growth -9% 106% 23% 22% -8% Source: CRC, Macquarie Research, June 2014

The need for railway transportation in China The railway While freight and passenger transportation volume have experienced rapid growth over the networks still suffer last three decades, the railway network has suffered from severe capacity constraints. The from severe government only started to more aggressively expand the railway network and build a new capacity constraints high-speed railway network since 2008. Passenger and freight traffic on the China railway network grew at 6.4% and 5.1% CAGR, respectively, during 1980-2013. The operating mileage of China’s railway network saw a CAGR of 2.0% during 1980 and 2013. China’s highway system length registered a 4.9% CAGR during the same period. While railway remains an important transportation mode in China, in terms of both passenger and freight, the capacity constraint has led to a decline of its market share.

Fig 53 China railway annual passenger traffic Fig 54 China railway annual freight traffic

Source: CEIC, Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014 Railway ranks second in terms of passenger volume handled in China, and ranks third in freight tonnage-km in China.

26 June 2014 28 Macquarie Research China CNR Corp

Fig 55 China railway market share in passenger Fig 56 China railway market share in freight transportation transportation

100% 100%

90% 90%

80% 80%

70% 70%

60% 60%

50% 50%

40% 40%

30% 30%

20% 20%

10% 10%

0% 0%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Railway Road Water Airline Railway Road Water Airline

Source: CEIC, Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014

Fig 57 Operating length of China’s railways Fig 58 Operating length of China’s highways

120,000.0 5,000,000.0 km km 4,500,000.0 100,000.0 CAGR of 4.9% CAGR of 2.0% 4,000,000.0 3,500,000.0 80,000.0 3,000,000.0

60,000.0 2,500,000.0

2,000,000.0 40,000.0 1,500,000.0

1,000,000.0 20,000.0 500,000.0

0.0 0.0

1980 1982 1984 1986 1990 1992 1994 1996 2002 2004 2006 2008 1988 1998 2000 2010 2012

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 1980 1982 2006 2008 2010 2012

Source: CEIC, Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014

Relatively low penetration of railway network in China China still has When compared to other developed and emerging countries, China still has relatively low relatively low railway coverage density, both in terms of railway length over population density and length railway coverage over country size. The Chinese government plans to continue to expand its railway network density post the 12th five-year plan period, and continue to build the railway network in the mid and western parts of China. Given China’s expansive geographical landscape and dense population, passenger and heavy freight transportation will have to heavily rely on railways. We believe China Railway Corporation will continue to improve railway network utilisation; they have been investing in building dual-tracks and electrifying the railway lines. The opening of the HSR network will also relieve capacity bottlenecks on the normal railway network, which still handles about 70% of total railway passengers.

26 June 2014 29 Macquarie Research China CNR Corp

Fig 59 Railway density comparison in 2012 Fig 60 Railway density comparison in 2012

20.00 19.27 18.86 12.00 11.40 km/10k people 18.00 km/100 sqkm 10.00 16.00

14.00 8.00 12.00

8.92 6.00 5.53 10.00 8.35 7.80 8.00 4.00 6.00 4.97 4.64 2.54 2.18 4.00 2.00 1.23 1.52 1.02 0.75 0.56 2.00 0.72 0.53 0.35 0.31 0.00 0.00

Source: SCI Verkehr, Macquarie Research, June 2014 Source: SCI Verkehr, Macquarie Research, June 2014

Fig 61 HSR density in 2012 (km/mn people) Fig 62 HSR density in 2012 (km/000 sqm)

60.0 10.0 9.6 53.5 9.0 50.0 8.0 7.0 6.8 7.0 40.0 6.0 31.0 5.0 30.0 5.0 4.1 3.7 20.9 4.0 18.8 3.2 3.1 20.0 16.6 2.9 15.3 15.0 3.0 11.0 8.2 9.6 2.0 1.3 10.0 7.3 1.1 5.6 4.4 0.8 1.0 0.6 0.5 1.8 1.2 0.0 0.0 0.0

Source: UIC, World Bank, Macquarie Research, June 2014 Source: UIC, World Bank, Macquarie Research, June 2014

On the passenger transport side, China railway network’s market share is only 29%, below 70-90% market share of EU countries’ railway network. As for freight transport, China’s railway network only has 17% market share, below 40% of market share of the US railway network. China’s economic growth, rising domestic consumption and rapid urbanization all demand more adequate railway services and coverage. The government sees railway infrastructure as a strategic investment in helping to balance economic growth between in-land and coastal regions. Railway transportation can also help to improve logistics efficiency and reduce pollution, compared with trucking and air transportation. The uptake on HSR The major four-vertical and four-horizontal high-speed railway (HSR) network will be services has been completed by the end of 2015. The uptake on HSR services has been much better than much better than expected; during the 2014 Chinese New Year (CNY) period, 35% of railway passengers were expected; CRC is handled by HSR services, up from 28% in 2013 and only 12% in 2012. CRC also increased increasing operation operating density on 5 HSR lines at the beginning of 2014, due to increasing demand; most of density of some these HSR lines have only been in operation for 2 years. We believe CRC will continue to HSR lines increase HSR operating density in the future, as the HSR density in China is significantly below other countries with HSR networks, and the demand for HSR in China is also rapidly rising given its convenience and efficiency.

26 June 2014 30 Macquarie Research China CNR Corp

Fig 63 Operating length of electrified railways (km) Fig 64 Operating length of HSR (km)

70,000 14,000

60,000 12,000

50,000 10,000

40,000 8,000

30,000 6,000

20,000 4,000

10,000 2,000

0 0 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013

Source: CRC, Macquarie Research, June 2014 Source: CRC, Macquarie Research, June 2014

Long-term demand outlook for high-speed trains By the end of 2013 we estimate the high-speed railway (HSR) network reached 12,947 km, and CRC targets to grow the network to over 21,000 km by the end of 2015 and about 40,000 km by the end of 2020, growing at a CAGR of 17.5% during the 2013 to 2020 period. Operating density of At the end of 2013, China’s HSR network train density was about 0.077 sets of MU trains per HSR lines is kilometre of HSR. The density rate is significantly below the rates in Japan, Germany and significantly below France. For instance, the high-speed train density of Japan Shinkansen is around 0.172 the rates of those sets/km. developed countries Before 2013, almost all CRC’s MU tenders were for new HSR lines opening in the following year. We expect the increased demand for network density will translate to 50% of total annual MU tenders by 2018. The demand from a density increase would also support MU demand growth until the end of the 13th five-year-plan period. CRC increased operating density on 5 HSR lines at the beginning of 2014, and tendered about 100 sets of MU trains in 2013 to increase usage density. The 5 HSR lines have been in operation less than 3 years, but demand already has far exceeded train capacity. As the HSR network continues to extend and the network nodes will be increasingly connected, we expect the network impact will increase travel demand on the HSR network. We forecast MU Based on our density increase assumption and new train demand, we forecast MU demand demand will grow at will grow at a CAGR of 14.5% during the 2013 to 2020 period. Our density increase a CAGR of 14.5% assumption is conservative – we forecast network train density will only increase from 0.08 over 2013-2020 MU set/km of HSR at the end of 2013 to 0.094 MU set/km of HSR at the end of 2020. We estimate the major MU maintenance cycle is around 7 years; based on the historical MU delivery schedule, we estimate the MU maintenance cycle will kick start in 2016, with about 480 sets of MUs entering level 5 maintenance state and the volume will grow 35.8% YoY to 652 sets in 2017. We expect the strong growth in maintenance demand will help to improve the margin mix of train makers from 2016 onwards. The increase in ridership on China’s HSR network has been significant within the 4 years of operation. According to World Bank data, it took China’s HSR network only 4 years to have its passenger traffic reach 420m in 2011, about 23% of total railway passenger traffic. In 2011 the total length of HSR lines was only about 6,434km, about half of the length at the end of 2013. HSRs have changed the dynamics of passenger transportation in China. For instance, the launch of Guangzhou-Wuhan HSR line in 2009 reduced air traffic on the same route by 2/3rd within 2 years. Similarly, the launch of Changchun-Jilin HSR in 2012 brought additional 6mn passenger traffic into the railway network, of which 2m passenger traffic was taken out from highway travel.

26 June 2014 31 Macquarie Research China CNR Corp

We estimate HSR handled about 35% of total passenger volume in 1Q2014, which is still low compared to the 57% market share in some developed countries. We believe HSRs in China still have substantial growth potential. Apart from incremental passenger traffic from more new HSR lines put into operation, the network effect formed between new lines and existing lines will further boost ridership growth on the HSR network. From the experiences of developed countries like Japan, France and Italy, HSR passenger traffic grew at a CAGR of over 40% during the initial 5-10 years of operation. For instance, passenger traffic at Japan’s Shinkansen has grown by 26.3 times over the past 40 years, as the network effect played out. Its passenger traffic registered a CAGR of 43% for the initial 5 years and a CAGR of 28% for the initial 10 years. The HSRs in France saw passenger traffic increasing by 15.2 times with a CAGR of 87% for the initial 4 years. Therefore we maintain our positive view on sustainable growth of MU demand in China within the 12th and 13th five-year plan periods.

Fig 65 Macquarie MU new-build and refurbishment demand forecast 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E

High speed railway (km) 5,013 6,434 9,356 12,947 17,334 21,377 25,102 28,826 32,551 36,275 40,000 Increment (km) 1,554 1,421 2,922 3,591 4,387 4,043 3,725 3,725 3,725 3,725 3,725

MU installation (sets) 480 652 825 1,040 1,326 1,611 1,940 2,289 2,664 3,068 3,502

Assuming density increase 2.0% 5.0% 6.0% 6.0% 6.0% 6.0% 6.0% Existing density 0.082 0.080 0.080 0.082 0.084 0.087 0.090 Increment density 0.060 0.065 0.068 0.070 0.071 0.074 0.076 Density (set/km) 0.096 0.101 0.088 0.080 0.076 0.075 0.077 0.079 0.082 0.085 0.088 Density increase % 16% 6% -13% -9% -5% -1% 3% 3% 3% 3% 4%

Existing HSR lines 21 66 97 116 137 160 184 New HSR lines 264 263 253 259 266 274 284 Total procurement (sets) 195 172 173 227 285 329 349 375 404 434 468

Existing HSR lines 166 530 773 931 1,099 1,279 1,473 New HSR lines 2,115 2,102 2,021 2,072 2,129 2,195 2,268 Total procurement (cars) 1,560 1,376 1,384 1,816 2,281 2,633 2,794 3,003 3,228 3,474 3,741 % YoY growth 78.9% -11.8% 0.6% 31.2% 25.6% 15.4% 6.1% 7.5% 7.5% 7.6% 7.7%

Maintenance (sets) 176 285 480 652 825 1,040 1,326 Maintenance (cars) 1,408 2,280 3,840 5,216 6,600 8,323 10,604 % YoY growth 61.9% 68.4% 35.8% 26.5% 26.1% 27.4% Source: CRC, Macquarie Research, June 2014

Railway freight reform – Shifting focus to improve industry operations As soon as Ministry of Railway was transformed into China Railway Corporation (CRC) in June 2013, CRC carried out major railway freight reform. Including streamlining the operating rights onto designated freight transportation railway lines, SOE logistics companies would have to compete with all logistics companies to bid for the operating rights of these lines. The railway freight pricing was simplified from 7 layers of charges into one straightforward pricing system. The local railway bureaus are encouraged to provide a full solution and door-to-door services to long-term customers. CRC will continue to We believe CRC will continue to deepen railway freight reform and improve its services. Over deepen railway the past two years, CRC has increased railway freight rates by about 22%. The increased freight reform and rates will help to improve industry profitability, but the key priority is to increase freight volume improve its services transported on the railway network. Railway offers significant cost and time savings for heavy loads that need to be transported over long distances. Freight The main bottleneck restricting the railway’s development in China’s freight transportation transportation is the market has been its restricted capacity. Railways used to control more than 20% freight key area CRC wants turnover volume share in China’s freight transportation market before 2000, but it gradually to grow for lost market share to trucking and waterways. The railway network had to prioritise passenger profitability and bulk material transportation; it has very limited capacity to capture the significant demand improvement growth in China’s non-bulk material freight transportation market.

26 June 2014 32 Macquarie Research China CNR Corp

Fig 66 Railway passenger transport market share Fig 67 Railway freight transport market share comparison (2012) comparison (2012)

100% 93% 45% 89% 88% 40% 90% 40% 80% 73% 35% 70% 30% 60%

50% 25%

40% 20% 17% 29% 30% 21% 15% 11% 20% 11% <10% 10% 7% 10% 5% <10% 5% 0% Germany France UK Japan China Korea US 0% Germany France UK Japan China Korea US US China Korea Germany UK Japan France

Source: MLIT, Eurostat, Macquarie Research, June 2014 Source: MLIT, Eurostat, Macquarie Research, June 2014

The gradual shift of Railway freight transportation is the main revenue generation business for CRC, and its passenger travel capacity has been constrained by passenger train services over the past decade. The gradual onto HSR will help shift of passenger travel onto HSR will help to relieve freight transportation capacity constraints, to relieve freight and help the railways to take on bigger market share in the overall freight transportation market. transportation Railway ranks second in terms of passenger volume handled in China and third in freight capacity constraints tonnage-volume in China. In developed countries, logistics transportation comprise of various combinations of transportation modes – waterways, trucking, airways and railway. For instance, in the US, where the inter-modal transportation method is often used in the logistics transportation industry, railway’s freight transportation market share is significantly higher than China’s level, 40% vs. 17%.

Fig 68 China railway market share in passenger Fig 69 China railway market share in freight transportation transportation (changed as requested)

100% 100%

90% 90%

80% 80%

70% 70%

60% 60%

50% 50%

40% 40%

30% 30%

20% 20%

10% 10%

0% 0%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Railway Road Water Airline Railway Road Water Airline

Source: CEIC, Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014

CRC aims to We estimate China’s total logistics market will grow at the same rate as GDP from 2014 to increase its market 2020. CRC targets to increase its market share in the logistics transportation market from 16% share in the in 2013 to about 20% by the end of 2020. We assume it will gradually increase its market logistics sector from share to 17% by the end of 2020 through railway freight reform initiatives implemented since 16% in 2013 to June 2013. about 20% by the end of 2020

26 June 2014 33 Macquarie Research China CNR Corp

CRC plans to CRC plans to achieve market share gain by tendering for non-bulk material-related goods achieve market transportation. We expect freight turnover on the railway network will grow at a 7.7% CAGR share gain by from 2013 to 2020. CRC is also increasing the proportion of electrical locomotives in the tendering for non- current locomotive fleet, and the target is to increase the ratio from 55% in 2013 to 60% by bulk material-related 2015. Due to industry changes, electrical locomotive procurement has fallen behind target, goods and we have stretched the target to 2018. Based on our assumption, China’s annual transportation locomotive demand will post an 11.8% CAGR during 2013 to 2020. At the end of 2012, about 70% of China’s locomotive fleet was more than 10 years old. We estimate the annual replacement demand will be around 800 to 1000 units, making up more than 60% of total annual demand before 2016.

Fig 70 Macquarie locomotive new-build and refurbishment demand forecast 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Real GDP growth 10.4% 9.2% 7.8% 7.7% 7.7% 7.0% 6.8% 6.6% 6.4% 6.2% 6.1% Total freight turnover (bn, ton-km) 13,964 15,643 17,059 18,298 19,707 21,086 22,520 24,006 25,543 27,127 28,781 % YoY 16.3% 12.0% 9.0% 7.3% 7.7% 7.0% 6.8% 6.6% 6.4% 6.2% 6.1%

Railway freight turnover (bn ton-km) 2,733 2,913 2,889 2,917 2,956 3,226 3,513 3,817 4,163 4,503 4,893 % YoY 9.6% 6.6% -0.8% 1.0% 1.3% 9.1% 8.9% 8.7% 9.1% 8.2% 8.7% % of total freight turnover 19.6% 18.6% 16.9% 15.9% 15.0% 15.3% 15.6% 15.9% 16.3% 16.6% 17.0%

Locomotive installation (unit) 19,431 19,590 19,600 19,791 20,053 20,459 21,033 21,792 22,658 23,677 24,846 % YoY 2.7% 0.8% 0.1% 1.0% 1.3% 2.0% 2.8% 3.6% 4.0% 4.5% 4.9% Electrical locomotive installation (unit) 8,369 9,090 9,604 10,885 11,230 11,661 12,199 12,857 13,595 14,206 14,908 % YoY 5.6% 1.4% 5.7% 13.3% 3.2% 3.8% 4.6% 5.4% 5.7% 4.5% 4.9% % of total 43% 46% 49% 55% 56% 57% 58% 59% 60% 60% 60%

Replacement 1,200 1,200 1,000 800 800 800 850 850 900 950 1,000 New addition 509 159 10 191 262 405 574 760 866 1,019 1,169 Total annual procurement (unit) 1,709 1,359 1,010 991 1,062 1,205 1,424 1,610 1,766 1,969 2,169 % YoY 15.1% -20.5% -25.7% -1.9% 7.1% 13.5% 18.1% 13.1% 9.7% 11.5% 10.2% Source: CEIC, CRC, Macquarie Research, June 2014

CRC is developing 18 logistics centres around the major railway network hubs, such as Beijing, Shanghai, Chongqing, Chengdu, Qingdao, etc. Currently, there are 9 major terminals, namely Kunming, Shanghai, Chongqing, Chengdu, Zhengzhou, Qingdao, Dalian, Wuhan, Xi'an Terminals are already under operation. We believe the railway freight reform and the modernisation services around railway networks will support the acceleration of railway’s market share gain in China’s freight handling market. This trend will support demand growth for freight locomotives and wagons in the long run. Fig 71 18 railway logistics centres

Shaanxi

Source: CRintermodal, Macquarie Research, January 2014

26 June 2014 34 Macquarie Research China CNR Corp

Urban transit development in China Rapid urbanisation Rapid urbanisation in China is driving the accelerated development of the urban transit in China is driving system. China needs a diversified range of urban transport solutions, such as metro trains, the accelerated over-ground light rail, tram, maglev trains and inter-city lines high-speed trains. With the ever- development of the growing urban population, area and traffic, local governments are under immense pressure to urban transit system increase urban transit infrastructure. China is currently undergoing rapid construction growth in subway systems in top tier cities, and intercity railway network development is about to start over the next ten years. We expect the rapid transit system will see accelerated investment growth from 2014 to 2020. China’s urban rail transit system is still in the early stage of development. Large tier 1 cities like Shanghai, Beijing, Guangzhou and Shenzhen with more developed urban rail systems still have lower urban rail density, as compared to London, New York and Tokyo.

Fig 72 Urban rail density comparison (2012) Fig 73 Urban rail density comparison (2012)

0.90 km/sqkm 4.50 0.79 km/10k people 0.76 3.84 0.80 0.74 4.00 0.70 3.50

0.60 3.00

0.50 2.50 0.41 0.40 2.00 1.42 0.30 1.50

0.20 1.00 0.69 0.09 0.09 0.40 0.40 0.29 0.37 0.10 0.03 0.03 0.50 0.25 0.00 0.00

Paris Tokyo Paris Tokyo Beijing London Beijing London Shanghai Shenzhen New York Shanghai Shenzhen New York Guangzhou Guangzhou Source: CEIC Macquarie Research, June 2014 Source: CEIC, Macquarie Research, June 2014 The total length of China’s 12th FYP targets to invest RMB1,200bn on developing the urban railway system, the urban rail transit which is twice more than the investment amount in the 11th FYP period. The total length of the system in China is urban rail transit system in China has grown from 621km in 2006 to over 2,500km in 2013 expected to grow and is expected to reach 3,000km by 2015, according to NDRC approval plans. According to from over 2,500km the China Association of Metros, the total length of urban rail tracks completed in China is in 2013 to 3,000km expected to reach 7,000km in 2020, implying an 18.5% CAGR in 2015-2020. by 2015 and Urban transit vehicles are one of the key growth segments for train makers; CNR is planning 7,000km by 2020 to capture the accelerated growth in this market by providing full solution services, apart from supplying train vehicles. The company plans to tender for subway contracts by selectively offering BT (build and transfer) contracts.

Fig 74 Operating length of urban rail rapid transit systems in China (km)

8,000

7,000

6,000

5,000 CAGR of 22.3% for 2006-2013

4,000

3,000

2,000

1,000

0 2006 2007 2008 2009 2010 2011 2012 2013 2015E 2020E

Source: NBS, MOT, China Association of Metros, Macquarie Research, June 2014

26 June 2014 35 Macquarie Research China CNR Corp

The development of The development of the urban rail rapid transit system will spur demand for rapid transit the urban rail rapid vehicles. The number of rapid transit vehicles in operation also experienced substantially high transit system will growth over 2006-2012. According to the National Bureau of Statistics (NBS), the number of spur demand for rapid transit vehicles has seen a CAGR of 28.8% over 2006-2012. rapid transit vehicles Fig 75 Number of rapid transit vehicles in operation (units)

14,000

12,000 CAGR of 28.8% for 2006-2012 10,000

8,000

6,000

4,000

2,000

0 2006 2007 2008 2009 2010 2011 2012

Source: China Association of Metros, Macquarie Research, June 2014

Rise of Chinese high-end equipment producers in overseas market Chinese rolling Chinese rolling stock producers have world-leading technology and production capacity. China is stock producers now the world’s largest market for high-speed trains, locomotives, urban transit trains and wagons. have world-leading The Chinese government supported the localisation of core technologies in the rolling stock technology and industry by developing national standards and setting up joint-venture requirements with leading production capacity international suppliers. For instance, CNR has developed 350km/hr high-speed trains for operating in low temperatures as well as the 9,600kW heavy duty locomotives, which are high- performance products specifically developed for the China market. Entry barriers in the Among the capital goods sector in China, we think the rolling stock sector has the best market domestic railway dynamics. Due to high entry barriers and high required standards of supply quality, there are equipment market no over-capacity issues in the sector. The train makers focus on improving localisation rates are high; the train of core components, improving production economies of scale, as well as developing new makers focus on products. There is no destructive price competition between the two rolling stock producers. improving China Railway Corporation (CRC)’s tender pricing has been stable over the past 5 years. The localisation rates of mature products usually will have 5% to 10% price reductions, but CRC continues to require core components improvements in the performance of high-speed train and locomotives, and the producers and developing new also continue to improve on products to sustain product ASPs. For instance, when the new products 9,600 KW locomotives are launched into operation, the negotiated price is about 20% more than the 7,200KW locomotives. The favourable The favourable market dynamics, technology and production scale can help CNR to expand market dynamics, into overseas markets. Over the past 5 years, CNR has been setting up assembly plants in technology and several key international markets, such as Africa, Australia, South America, Middle East and production scale ASEAN regions. The company received US$800m of locomotive orders from South Africa can help CNR to Transnet Corporation. This is a major breakthrough for Chinese capital goods companies, expand into exporting high-tech and high-ticket price products. overseas markets CNR currently exports its products to nearly 80 countries and regions in Oceania, Southeast Asia, Latin America, Central Asia, South Asia, Middle East, Africa and North America. Its overseas revenue contribution generated from exports of MUs, rapid transit vehicles, diesel locomotives, electric locomotives, passenger coaches, freight wagons and various other products rose from around 7% in 2011 to over 10% in 2012. The overseas business has been growing fast at a 23.5% CAGR over 2006-2013. In terms of product offerings, CNR can offer a much wider range of products than foreign train makers.

26 June 2014 36 Macquarie Research China CNR Corp

Fig 76 Global rolling stock market competition landscape Rolling stock Light- Commuter and High-speed and Freight System Company Region rail Metros regional trains intercity trains Locomotives Monorail wagon integration Signalling

Bombardier Germany ▲ ▲ ▲ ▲ ▲ ▲ ▲ ▲ Alstom France ▲ ▲ ▲ ▲ ▲ ▲ ▲ Ansaldo STS Italy ▲ ▲ CAF Spain ▲ ▲ ▲ ▲ CNR China ▲ ▲ ▲ ▲ ▲ ▲ CSR China ▲ ▲ ▲ ▲ ▲ ▲ GE US ▲ ▲ Hitachi Japan ▲ ▲ ▲ ▲ ▲ Invensys UK ▲ Kawasaki Japan ▲ ▲ ▲ Rotem Korea ▲ ▲ ▲ ▲ ▲ Siemens Germany ▲ ▲ ▲ ▲ ▲ ▲ ▲ Stadler Switzerland ▲ ▲ ▲ Thales France ▲ Vossloh Germany ▲ ▲ ▲ ▲ ▲ ▲ Trinity Industries US ▲ Source: Company data, Macquarie Research, June 2014

CNR has two overseas research and development centres. It also has built cooperative relationships with research institutes overseas like Czech Technology University Prague and University of Michigan. It has established 16 after-sales service stations in overseas markets like Australia and Brazil.

Fig 77 CNR overseas revenue contribution Fig 78 CNR overseas revenue progression

100.0% 4.1% 5.7% 5.6% 12,000 120.0% 8.3% 7.0% 7.1% 10.5% 7.8% 90.0% 100.0% 10,000 80.0% 80.0% 70.0% 8,000 60.0% 60.0% 40.0% 50.0% 6,000 95.9% 94.3% 94.4% 20.0% 91.7% 93.0% 92.9% 89.5% 92.2% 40.0% 4,000 0.0% 30.0% -20.0% 20.0% 2,000 -40.0% 10.0% 0 -60.0% 0.0% 2006 2007 2008 2009 2010 2011 2012 2013 2006 2007 2008 2009 2010 2011 2012 2013 Overseas revenue (Rmb m) % YoY chg (rhs) Domestic Overseas

Note: FY2006-2010 is based on PRC GAAP Note: FY2006-2010 is based on PRC GAAP Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

CNR is also CNR is also leveraging off its existing technology platform to expand into other high-end leveraging off its product categories, such as IGBT and power inverters, as well as developing urban transit- existing technology related systems and products. We expect these new products could help CNR to expand platform to expand outside the train transportation industry as well as further improve potential for exports. into other high-end The company plans to further increase its overseas market share to become a world-class product categories multinational company with leading technologies and proprietary brands. It intends to further explore the global market by serving its rapid transit vehicle, passenger coach and freight wagon products to the global market, marketing its diesel locomotive products, promoting its electric locomotives and high-speed MUs and increasing its export of rolling stock components and mechanical and electric products.

26 June 2014 37 Macquarie Research China CNR Corp

It plans to further widen its customer base in Oceania, South America, Commonwealth of Independent States, South Asia, the Middle East and Africa. To do this, it aims to establish R&D, manufacturing, supply and refurbishment bases and broaden its international sales network to enhance its global existence, improving service coverage on site for its international customers.

Fig 79 Per capita rail length of the top 10 ten countries in terms of total rail length in 2012 (km/million people)

2,500

1,926.6 2,000 1,886.8

1,500

891.8 1,000 834.8 780.5

497.0 464.3 500 152.0 72.6 52.5 0

US Brazil China India Canada Russia France Australia Argentina Germany

Source: SCI, Verkehr, World Bank, Macquarie Research, June 2014

Fig 80 Global annual railway investment market by Fig 81 Annual railway investment market by region segment (US$ bn) (US$ bn)

120 120 CAGR 2.8% CAGR 2.8%

100 100 42.5 53.8 80 80 37.9 48.2

60 60 24.0 24.6 40 40 40.7 19.6 34.7 16.4 20 20 26.3 15.1 17.9 19.1 0 0 2010-2012 2015-2017 2010-2012 2015-2017 System and signalling Services Rolling stock Rest of world North America Asia-Pacific Europe

Source: UNIFE, Macquarie Research, June 2014 Source: UNIFE, Macquarie Research, June 2014

26 June 2014 38 Macquarie Research China CNR Corp

Financial statement analysis Income statement We forecast revenue to post a CAGR of 11% over 2013-2016E. We expect gross profit margin to stay stable at around 16.6%-16.8% in 2014-2016E mainly due to a better product mix and increasing domestic content of the key components going forward. We expect financing costs to remain stable. We expect bottom-line profit will register a CAGR of 15.5% over 2014-2016E. Net profit margin should rise from 4.4% in 2013 to 5.2% in 2016E.

Fig 82 Consolidated income statement Rmb mn 2011 2012 2013 2014E 2015E 2016E

Sales Revenue 88,811 91,798 96,756 107,588 120,877 133,346 % YoY growth 3.4% 5.4% 11.2% 12.4% 10.3% COGS -77,091 -78,707 -80,103 -89,719 -100,698 -111,003 Gross Profit 11,720 13,091 16,653 17,869 20,179 22,344 Gross profit margin 13.2% 14.3% 17.2% 16.6% 16.7% 16.8%

Depreciation 1,457 1,723 2,201 2,243 2,430 2,600 EBITDA 6,016 6,738 8,226 9,441 10,756 11,965 EBITDA margin 6.8% 7.3% 8.5% 8.8% 8.9% 9.0%

Other revenue 512 583 405 357 356 356 Selling and distribution costs -1,469 -1,723 -2,018 -2,152 -2,418 -2,667 Administrative expenses -6,075 -6,876 -8,784 -8,607 -9,428 -10,268 Other net loss (gain) -129 -61 -231 -269 -363 -400 Total EBIT 4,559 5,015 6,025 7,198 8,326 9,365 % YoY growth 10.0% 20.1% 19.5% 15.7% 12.5% EBIT margin 5.1% 5.5% 6.2% 6.7% 6.9% 7.0%

Net Interest Expense -1,149 -1,066 -1,216 -1,393 -1,395 -1,510 Share of Associate Profit (loss) 245 239 291 345 300 300 Pre-Tax Profit 3,655 4,187 5,099 6,150 7,231 8,155 Tax Expense -510 -603 -873 -953 -1,085 -1,223 Net profit 3,145 3,584 4,226 5,197 6,146 6,932 Minority Interest -120 -154 -97 -118 -138 -156

Net profit to common shareholders 3,025 3,431 4,129 5,079 6,008 6,776 % YoY growth 13.4% 20.3% 23.0% 18.3% 12.8% Net profit margin 3.5% 3.9% 4.4% 4.8% 5.1% 5.2%

EPS (rep) 0.34 0.34 0.40 0.45 0.49 0.55 EPS (adj) 0.34 0.34 0.40 0.45 0.49 0.55 Source: Company data, Macquarie Research, June 2014

Fig 83 CNR GPM progression Fig 84 CNR OPM and NPM progression

18.0% 8.0% 7.0% 17.0% 6.0% 16.0% 5.0% 4.0% 15.0% 3.0% 14.0% 2.0% 1.0% 13.0% 0.0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 12.0% OPM NPM 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

Note: 2006-2010 data based on A-share company filing Note: 2006-2010 data based on A-share company filing Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

26 June 2014 39 Macquarie Research China CNR Corp

Balance sheet The company had net gearing of 34.8% as of end-2013. We forecast the company to remain in a net debt position in 2014-2016E after factoring in capital expenditure with the net debt/equity ratio reduced to 10.0% in 2016E. We forecast cash conversion days to remain largely stable in 2014-2016E. ROE and ROA should both see steady improvement from 2013 to 2016E due to margin improvement.

Fig 85 Consolidated balance sheet Rmb mn 2011 2012 2013 2014E 2015E 2016E

Cash 5,895 8,821 8,247 20,055 22,604 26,315 Receivables 25,125 30,499 42,751 40,725 45,756 50,476 Inventories 31,119 24,714 18,637 24,277 27,248 30,037 Investment 1,754 1,788 1,984 2,329 2,629 2,929 Fixed Assets 22,062 25,295 27,997 30,137 32,145 34,028 Lease prepayments 8,699 9,127 9,967 10,757 11,532 12,291 Intangibles 343 348 640 819 961 1,072 Goodwill 0 14 14 14 14 14 Other 2,368 5,975 9,923 9,923 9,923 9,923 Total Assets 97,366 106,582 120,159 139,037 152,812 167,084

Trade Payables 46,147 44,155 52,089 53,899 60,494 66,685 Short term Debt 18,198 20,095 20,609 24,504 25,235 27,595 Long Term Debt 225 26 1,415 2,723 4,453 4,870 Provisions 483 472 536 596 670 739 Other Liabilities 6,147 5,586 5,944 5,944 5,944 5,944 Total Liabilities 71,201 70,333 80,593 87,665 96,796 105,831

Shareholders Fund 24,842 34,671 37,780 49,469 53,975 59,056 Minority Interest 1,323 1,577 1,785 1,903 2,041 2,197 Total S/H Equity 26,165 36,249 39,566 51,372 56,016 61,253

Total Liab & S/H Fund 97,366 106,582 120,159 139,037 152,812 167,084 Source: Company data, Macquarie Research, June 2014

Fig 86 Gearing, efficiency and DuPont analysis Rmb mn 2011 2012 2013 2014E 2015E 2016E

Gearing Total debt 18,424 20,121 22,024 27,227 29,688 32,464 Net debt/(Net Cash) 12,529 11,299 13,777 7,172 7,084 6,149 Net Debt/Equity 47.9% 31.2% 34.8% 14.0% 12.6% 10.0%

Efficiency AR days 103 111 138 142 131 132 AP days 146 149 158 152 149 151 Inventory turnover days 147 129 99 87 93 94 Cash conversion days 105 91 79 77 75 75

Dupont analysis Net profit margin 3.4% 3.7% 4.3% 4.7% 5.0% 5.1% Total asset turnover 0.9 0.9 0.9 0.8 0.8 0.8 Leverage 3.9 3.1 3.1 3.0 2.8 2.8 ROE 12.2% 9.9% 11.4% 11.6% 11.6% 12.0%

ROA 4.7% 4.7% 5.3% 5.6% 5.7% 5.9% Source: Company data, Macquarie Research, June 2014

26 June 2014 40 Macquarie Research China CNR Corp

Cash flow Cash flows have been strong with operating cash flow changing from negative cash flow of Rmb3.4bn in 2011 to positive cash flow of Rmb3.7bn in 2013. We forecast operating cash flow to remain positive in 2014-2016E. We forecast capex to remain stable at Rmb5.4bn each year in 2014/2015/2016. We believe operating cash flow could largely satisfy the funding needs of investment, and thereby forecast free cash flow to also increase in 2014-2016E.

Fig 87 Consolidated cash flow Rmb mn 2011 2012 2013 2014E 2015E 2016E

EBITDA 6,016 6,738 8,226 9,441 10,756 11,965 Net Interest Paid -843 -1,197 -1,195 -1,393 -1,395 -1,510 Tax Paid -545 -571 -771 -953 -1,085 -1,223 Change in Working Cap -7,994 -4,552 -3,674 -1,745 -1,332 -1,249 Others 6 181 1,106 0 0 0 Operating Cash Flow -3,361 599 3,692 5,350 6,944 7,983

Acquisitions -454 -75 -40 0 0 0 Capex -7,569 -6,119 -5,327 -5,354 -5,354 -5,354 Asset Sales 46 45 49 0 0 0 Others 210 163 -398 0 0 0 Investing Cash flow -7,767 -5,986 -5,716 -5,354 -5,354 -5,354

Dividend (ordinary) -495 -681 -1,088 -1,270 -1,503 -1,695 Equity Raised 0 6,874 0 7,880 0 0 Debt Movements 12,444 1,477 2 5,203 2,461 2,776 Others -140 200 1,865 Financing Cash flow 11,808 7,869 779 11,812 958 1,081

Exchange difference -28 2 -21 Net Chg in Cash/debt 680 2,483 -1,245 11,808 2,549 3,711 FCF -11,128 -5,387 -2,024 -4 1,591 2,630 Source: Company data, Macquarie Research, June 2014

26 June 2014 41 Macquarie Research China CNR Corp

Risk analysis Product quality risk CNR is subject to possible product liabilities due to defects in its products. Meanwhile, it could also likely incur liability under PRC laws or other jurisdictions if its products prove to be defective and results in personal injuries, property damage or other losses to its customers. The high-speed train crash in 23 July 2011 was due to malfunction of the signalling system and failure of the traffic control centre carrying out appropriate procedures, according to the government investigation. The train makers were not named in the investigation report. But CNR had one voluntary product withdrawal in 2011. After the company found a potential flaw in the automatic safety alarm system in its CRH380BL high-speed MU products, it reported to the Ministry of Railway and voluntarily withdrew 54 CRH380BL high-speed MUs in use on the Beijing-Shanghai high-speed railway. The company rectified the flaw and the MUs in question have resumed operation since November 2011. The company didn’t incur any administrative penalties as a result of this product return. From 2013 onwards, CNR has resolved all functional issues on its high-speed MUs, and gained back most of the 350km/hr MU market share in the 2013 tenders. This was also because it was the exclusive supplier of the CRH380BMU of the Harbin-Dalian high-speed railway line and supplied the anti-freeze MU trains. In March this year, KiwiRail withdrew 40 locomotives made by CNR from the service as asbestos was suspected to exist in the sound proofing compound and packing material which is used in the engine bay of the locomotives. Laboratory testing of samples indicates that no airborne asbestos fibres or asbestos dust had been found to be present in 33 of the 40 locomotives. But to be completely sure these locomotives are safe for its staff to use, the company agreed to have a further round of testing. All locomotives will not be returned to service until all the degraded material is removed and the company is absolutely certain the locomotives were safe. CNR is working with KiwiRail over the removal of the degraded materials over the short-to-medium term. It also will carry out necessary rectification on future products. On the back of these domestic and overseas incidents, CNR needs to exercise extreme caution to be protected from potential product quality risk. Customer concentration risk CNR has a relatively concentrated customer base. The company relies on a limited number of customers to generate a majority of its revenue. Historically revenue from its top five customers contributed 50-65% to its total revenue. CRC and its affiliated enterprises are its largest group of customers, which contributed 45-60% to its total revenue in 2011, 2012 and 2013.

Fig 88 Revenue contribution from top 5 customers Fig 89 Revenue contribution from CRC

63.0% 62.4% 70.0%

62.0% 58.1% 60.0% 61.0% 47.7% 48.5% 60.0% 50.0% 58.9% 59.0% 40.0% 58.0% 30.0% 57.0% 56.3%

56.0% 20.0% 55.0% 10.0% 54.0%

53.0% 0.0% 2011 2012 2013 2011 2012 2013

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

26 June 2014 42 Macquarie Research China CNR Corp

As a result, any reduction, revision, delay or cancellation of orders from CRC would have a material adverse effect on the company. So far, the company has not experienced any cancellation of orders from CRC or any of its affiliated enterprises, and neither has it experienced any default on contract payments by CRC. CRC is a government entity. We believe CRC is unlikely to default on payments in the future either. The central government fully supports railway development, and it should help secure financing for railway investment from not only public sources but also by encouraging private investment. We also believe CNR can mitigate the risk through expansion into other product segments, such as urban rail rapid transit vehicles which are related to urban rail development plans of local governments. Also the company is targeting the export market and currently sells to nearly 80 countries and regions throughout the world. Its overseas revenue contribution generated from the export of MUs, rapid transit vehicles, diesel locomotives, electric locomotives, passenger coaches, freight wagons and various other products rose from around 7% in 2011 to over 8% in 2013. In addition, the company is diversifying its product portfolio by utilising its core rolling stock technology to develop wind power generators, electric buses, waste/sewage recycling systems and other clean energy and environmental protection equipment. Raw material price volatility risk CNR is subject to price fluctuations in raw materials, components and spare parts purchased from third parties. Historically, these costs accounted for 85-90% of its total COGS for rolling stock products before consolidation. The major raw materials used in the rolling stock industry are aluminium, steel and copper. These raw materials are commodities, and their availability and prices depend on local and global market conditions and their relationships with suppliers. Among its products, MUs and freight wagons are relatively more sensitive to changes in prices of these major raw materials. Based on COGS sensitivity analysis 1) with an increase of 1% in the price of aluminium, with all other variables held constant, the cost of sales for manufacturing a unit of MU would increase by approximately RMB3,300; and 2) an increase of 1% in the price of steel, with all other variables held constant, the cost of sales for manufacturing a unit of freight wagons would increased by approximately RMB1,900. We have included Macquarie’s Commodities team forecast for the raw materials. Overall our commodity team forecasts a soft commodity market. Copper price is expected to decline in 2014 and 2015. Aluminium price is expected to decline in 2014, and steel HR coil (HRC) price is expected to rise in 2014, but decline in 2015 and going forward.

Fig 90 Copper price forecast Fig 91 Aluminium and steel HRC price forecast

8,500 2,200 660

2,100 640 8,000 2,000 620

7,500 1,900 600

1,800 580 7,000 1,700 560

6,500 1,600 540

1,500 520 2012 2013 2014E 2015E 2016E 2017E 2018E 6,000 2012 2013 2014E 2015E 2016E 2017E 2018E Aluminium(lhs) Steel (average HRC)

Source: CRU, LME, Macquarie Research, June 2014 Source: CRU, LME, Metal Bulletin, Macquarie Research, June 2014

26 June 2014 43 Macquarie Research China CNR Corp

Meanwhile, fluctuations in prices of raw materials generally won’t have a material impact on its cost of sales. The company uses a combination of centralized procurement and separate procurement which enables it to procure raw materials from reliable suppliers and leverage its collective bargaining power to receive discounts in procurement prices. Through this procurement process and improving product mix, gross profit margin should continue to improve.

Fig 92 CNR gross profit margin Fig 93 FY2013 CNR revenue mix

18.0% Emerging industry 4.3% Locomotive 17.0% Modern 16.3% service 23.6% 16.0% Passenger coach Mechanical 8.3% 15.0% and electric product 1.9% 14.0% Railway engineering Freight wagon machinery and 13.7% equipment 13.0% 1.3% Rapid transit High-speed vehicle 12.0% MU 6.0% 2006 2007 2008 2009 2010 2011 2012 2013 24.7%

Note: 2006-2010 GPM based on China GAAP Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Competition risk China’s railway vehicle equipment market is effectively a duopoly, namely CSR and CNR, which are the two biggest suppliers with all the necessary licenses to operate. But if the relevant authorities change the industry entry barriers and regulations, the company may face more intense competition from current and new entrants in the long term. Overall we believe the domestic market is likely to remain a duopoly in the near-to-medium term dominated by CSR and CNRG. The current hurdles for foreign competitors in China’s market are the necessary commercial licenses and a higher cost structure relative to the domestic manufacturers.

Fig 94 CSR and CNR market share in MU and locomotive market 2005 2006 2007 2008 2009 2010 2011 2012 2013

MU CSR 100% 93% 73% 54% 57% 55% 45% 51% 48% CNR 0% 7% 27% 46% 43% 45% 55% 49% 52% Total 100% 100% 100% 100% 100% 100% 100% 100% 100%

Locomotive CSR 100% 53% 43% 36% 52% 50% 47% 40% 51% CNR 0% 47% 57% 64% 48% 50% 53% 60% 49% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% Source: Company data, Macquarie Research, June 2014

Overseas business risk The company generated 10% of total revenue in exports in 2012 and it aims to grow its overseas business to over 15% of total revenue in the future. Although CNR enjoys a cost advantage relative to its international peers, the company does not have a strong brand name in the international market and this may prove a hindrance in terms of winning contracts.

26 June 2014 44 Macquarie Research China CNR Corp

Fig 95 CNR domestic and overseas revenue breakdown

100.0% 4.1% 5.7% 5.6% 8.3% 7.0% 7.1% 10.5% 7.8% 90.0%

80.0%

70.0%

60.0%

50.0% 95.9% 94.3% 94.4% 91.7% 93.0% 92.9% 89.5% 92.2% 40.0%

30.0%

20.0%

10.0%

0.0% 2006 2007 2008 2009 2010 2011 2012 2013

Domestic Overseas

Note: 2006-2010 data based on company filings and under China GAAP Source: Company data, Macquarie Research, June 2014

CNR faces various business risks in the overseas market, including compliance with foreign laws and regulations, exposure to litigation risks outside China, political and economic instabilities, foreign exchange rate exposure, unfamiliarity with local operating and market conditions, etc. As its targeted overseas markets are mostly emerging countries like those in Southeast Asia, Latin America, Central Asia, South Asia, Middle East and Africa, political risk thereby has become the largest risk it faces for its overseas expansion. Overseas markets often have higher product quality standards, and hence the company may incur product liabilities due to defective products. The recent asbestos incident in NZ shows that the overseas market can be difficult sometimes because of higher environment standards and safety issues. The company is also exposed to foreign currency fluctuations as CNR’s cost base is in Rmb but it receives revenue in foreign currencies which have been mostly depreciating against the Rmb over the past few years. We think the risks are two-fold. First, the company cannot fully hedge its foreign exchange rate risk in the procurement of overseas contracts and could suffer a decline in profit margin. Second, the company may eventually lose its cost advantage if the Rmb experiences rapid appreciation. Supplier risk CNR’s successful operation relies on its ability to obtain from suppliers sufficient quantities of raw materials, key components and energy at acceptable prices and quality in a timely manner. As the company doesn’t maintain significant inventories of raw materials and components, and does not have exclusive contracts with suppliers, it may not be able to obtain necessary key components in a timely manner to assure smooth operation. The company has more than 8,000 suppliers. Purchase from its five largest suppliers accounted for 17.7%, 16.6% and 11.3% of its total purchase cost in 2011, 2012 and 2013. Meanwhile, purchase from its largest supplier accounted for around 8.1%, 7.4% and 4.0% of its total purchase cost in 2011, 2012 and 2013. But we believe it should be able to mitigate operational risk from any likely supply disruption as 1) it has been working with the major suppliers for more than 10-20 years and has established long-term relationships with them; and 2) it has carefully selected suppliers based on various criteria, including supply quality, price, product nature and specification, production capacity, credit history and after-sales services.

26 June 2014 45 Macquarie Research China CNR Corp

Fig 96 Top 5 suppliers’ contribution to COGS Fig 97 Biggest supplier’s contribution to COGS

20.0% 9.0% 17.7% 8.1% 18.0% 16.6% 8.0% 7.4%

16.0% 7.0% 14.0% 6.0% 12.0% 11.3% 5.0% 10.0% 4.0% 4.0% 8.0% 3.0% 6.0%

4.0% 2.0%

2.0% 1.0%

0.0% 0.0% 2011 2012 2013 2011 2012 2013

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

Receivable risk The company incurs certain credit risk attributable to its trade and bills receivables. The company has a credit policy in place and its exposure to receivable risks is monitored on an ongoing basis. Total trade and bill receivables account for 45.1% and 26.6% of total current assets and total assets as at the end of 2013. The trade receivables from the five largest debtors as at the end of 2013 make up for 60.0% of the total trade receivables, while 47.0% of the total trade receivables were due from the largest single debtor respectively. As we highlighted in previously, CRC and its affiliated enterprises are its largest group of customers, which contributed 45-60% to its total revenue in 2011, 2012 and 2013. CRC is a government entity. We believe CRC is unlikely to default on payments in the future either. The central government fully supports railway development, and it should help secure financing for railway investment from not only public sources but also by encouraging private investment. But an increasing proportion of sales made to non-CRC customers could lead to increasing credit risks on trade receivables, given a relatively longer payment cycle of these non-CRC customers. The allowance of doubtful debt the company made on its balance sheet was Rmb1, 095.2mn as at the end of 2013, representing 3.5% of total trade receivables.

Fig 98 Top 5 debts’ contribution to trade receivables Fig 99 Total trade and bill receivables

62.0% 35% 33% 60.0% 60.0% 30% 27% 25% 58.0% 25% 21% 55.7% 56.0% 20% 19% 17% 54.0% 15%

52.0% 50.7% 10% 50.0% 5% 48.0% 0% 46.0% 2011 2012 2013 2011 2012 2013 as % of sales as % of total assets

Source: Company data, Macquarie Research, June 2014 Source: Company data, Macquarie Research, June 2014

26 June 2014 46 Macquarie Research China CNR Corp

Appendices History and key events of CNR CNR, along with CSR, dominates the domestic rolling stock market. The history of these two companies can be traced back to October 1949 when the Factory Affairs Bureau of the Ministry of Railways was established, from which, CNRG and CSRG, both the companies’ promoters were reorganized. In February 1986, MOR Locomotive and Rolling Stock Industrial Corporation was established by the previous MOR, which took over the role of Factory Affairs Bureau of the Ministry of Railways. Later in 1989, the MOR Locomotive and Rolling Stock Industrial Corporation was renamed as China National Railways Locomotive and Rolling Stock Industrial Corporation, which then split into CNRG and CSRG in 2002. CNRG and CSRG are the controlling shareholders of CNR and CSR, respectively. They are both SOE companies under the control and supervision of the SASAC. CNR was established as a joint stock limited company in June 2008. CNRG, as its parent company, injected its core businesses and assets into CNR. The company was listed in Shanghai Stock Exchange in 2009.

Fig 100 CNR - key development events Date Event 1949 Establishment of company's predecessor, Factory Affairs Bureau of the Ministry of Railways. 1958 Started to produce the Dongfeng diesel locomotive. 1964 "Qianjin" steam locomotive produced by the company became the most commonly used locomotive in China. 1986 Factory Affairs Bureau of the Ministry of Railways was reformed into MOR Locomotive and Rolling Stock Industrial Corporation. 1989 MOR Locomotive and Rolling Stock Industrial Corporation was renamed to China National Railways Locomotive and Rolling Stock Industrial Corporation. 2002 CNRG (controlling shareholder of the company) and CSRG (controlling shareholder of CSR) was split from China National Railways Locomotive and Rolling Stock Industrial Corporation. Company manufactured the 1st passenger coach with an aluminum alloy body using its own IP rights. 2007 Company assembled the 1st HXD2 locomotive jointly with Alstom. 2008 CNR established as a joint stock limited company. Company manufactured the 1st world-leading domestically made HXN3 high-power AC diesel locomotive. Company manufactured the HXD23B high-power AC freight locomotive with the highest power per unit. Company manufactured the 1st domestically made Hexie CRH3 high-speed MU with a speed of 350km/h. CNR Changchun entered into sales agreement with Hong Kong MTR to supply 10 rapid transit vehicles. 2009 Company was listed in Shanghai Stock Exchange. 2010 Company developed the fastest MU in the world, CRH380BL with a continuous speed up to 350km/h and a maximum running speed of 380km/h. Company acquired a 100% stake of CNR Shenyang from CNRG. 2012 Company produced the world's 1st alpine locomotive CRH380BMU with a speed of 350km/h operating at high altitudes and low temperature was exclusively used on Harbin-Dalian HRS line. Company with its parent company CNRG established CNR Financial. Company acquired a 38.44% equity interest in CNR Yingtai for the information technology service business. Company acquired an 80% equity stake in Xi'an Gold Wind Technology Co., Ltd for its wind power generator business. Company made an A share right issue adding 2,020,056,303 new shares Company undertook the Shenyang Hunnan New District Modern Tram BT project. Source: Company data, Macquarie Research, June 2014

26 June 2014 47 Macquarie Research China CNR Corp

Shareholding structure and management profile

Fig 101 CNR shareholding structure post IPO

SASAC

100%

CNRG

Beijing CNR Investment NSSF Other Shareholders of A shares Other Shareholders of H shares

52.34% 2.94% 4.92% 24.80% 15.00%

Note: NSSF stands for National Council for Social Security Fund of the PRC Source: Company data, Macquarie Research, June 2014

Management profile

. Mr. Cui Dianguo, aged 59, is the chairman of the board and non-executive director. He is in charge of the board, formulates corporate and business strategies and gives advice on nomination of directors and senior management. He has been the general manager of CNRG since September 2000. Mr. Cui has over 30 years of experience in the rolling stock manufacturing industry. . Mr. Xi Guohua, aged 50, was appointed as an executive Director and president of the company on 25 June 2008. Mr. Xi joined the company on 25 June 2008 and has over 25 years of experience in the rolling stock manufacturing industry. . Mr. Gao Zhi, aged 49, joined the company and was appointed as chief financial officer in June 2008, following he was appointed as vice president in August 2008. He has over 25 years of experience in the financial field. He previously worked for Changchun Passenger Coaches Factory, CNR Changchun, CNRG, CNR Financial and Beijing CNR Investment. . Mr. Xie Jilong, aged 47, joined the company and was appointed as secretary to the Board in August 2008. He has over 20 years of experience in management. He previously worked for Changchun Locomotive Factory, Changchun Locomotive and Rolling Stock Company Limited and CNR Tianjin. . Mr. Wang Yongzhi, aged 50, was appointed as chief engineer on 8 April 2011. He joined the group on 9 March 2009. He has over 25 years of experience in the rolling stock industry. He previously worked for CNRG, Yongji Electrical Machine Plant, Yongji Xinshisu and Shanghai CNR Yongdian Electronic Technology Company Ltd.

26 June 2014 48 Macquarie Research China CNR Corp

China CNR Corp (6199 HK, Outperform, Target Price: HK$6.95) Interim Results 2H/13A 1H/14E 2H/14E 1H/15E Profit & Loss 2013A 2014E 2015E 2016E

Revenue m 59,989 48,414 59,173 54,395 Revenue m 96,756 107,588 120,877 133,346 Gross Profit m 10,325 8,041 9,828 9,081 Gross Profit m 16,653 17,869 20,179 22,344 Cost of Goods Sold m 49,664 40,373 49,345 45,314 Cost of Goods Sold m 80,103 89,719 100,698 111,003 EBITDA m 5,100 4,248 5,193 4,840 EBITDA m 8,226 9,441 10,756 11,965 Depreciation m 1,365 1,009 1,234 1,093 Depreciation m 2,201 2,243 2,430 2,600 Amortisation of Goodwill m 0 0 0 0 Amortisation of Goodwill m 0 0 0 0 Other Amortisation m 0 0 0 0 Other Amortisation m 0 0 0 0 EBIT m 3,735 3,239 3,959 3,747 EBIT m 6,025 7,198 8,326 9,365 Net Interest Income m -754 -627 -766 -628 Net Interest Income m -1,216 -1,393 -1,395 -1,510 Associates m 180 155 190 135 Associates m 291 345 300 300 Exceptionals m 0 0 0 0 Exceptionals m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Forex Gains / Losses m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Other Pre-Tax Income m 0 0 0 0 Pre-Tax Profit m 3,161 2,768 3,383 3,254 Pre-Tax Profit m 5,099 6,150 7,231 8,155 Tax Expense m -541 -429 -524 -488 Tax Expense m -873 -953 -1,085 -1,223 Net Profit m 2,620 2,339 2,858 2,766 Net Profit m 4,226 5,197 6,146 6,932 Minority Interests m -60 -53 -65 -62 Minority Interests m -97 -118 -138 -156

Reported Earnings m 2,560 2,286 2,794 2,704 Reported Earnings m 4,129 5,079 6,008 6,776 Adjusted Earnings m 2,560 2,286 2,794 2,704 Adjusted Earnings m 4,129 5,079 6,008 6,776

EPS (rep) 0.25 0.22 0.23 0.22 EPS (rep) 0.40 0.45 0.49 0.55 EPS (adj) 0.25 0.22 0.23 0.22 EPS (adj) 0.40 0.45 0.49 0.55 EPS Growth yoy (adj) % 35.7 45.7 -8.1 -0.4 EPS Growth (adj) % 17.6 12.3 9.1 12.8 PE (rep) x 10.3 9.1 8.4 7.4 PE (adj) x 10.3 9.1 8.4 7.4

EBITDA Margin % 8.5 8.8 8.8 8.9 Total DPS 0.10 0.11 0.12 0.14 EBIT Margin % 6.2 6.7 6.7 6.9 Total Div Yield % 2.4 2.7 3.0 3.4 Earnings Split % 62.0 45.0 55.0 45.0 Weighted Average Shares m 10,320 11,290 12,260 12,260 Revenue Growth % 18.8 31.7 -1.4 12.4 Period End Shares m 10,320 12,260 12,260 12,260 EBIT Growth % 35.4 41.5 6.0 15.7

Profit and Loss Ratios 2013A 2014E 2015E 2016E Cashflow Analysis 2013A 2014E 2015E 2016E

Revenue Growth % 5.4 11.2 12.4 10.3 EBITDA m 8,226 9,441 10,756 11,965 EBITDA Growth % 22.1 14.8 13.9 11.2 Tax Paid m -771 -953 -1,085 -1,223 EBIT Growth % 20.1 19.5 15.7 12.5 Chgs in Working Cap m -3,674 -1,745 -1,332 -1,249 Gross Profit Margin % 17.2 16.6 16.7 16.8 Net Interest Paid m -1,195 -1,393 -1,395 -1,510 EBITDA Margin % 8.5 8.8 8.9 9.0 Other m 1,106 0 0 0 EBIT Margin % 6.2 6.7 6.9 7.0 Operating Cashflow m 3,692 5,350 6,944 7,983 Net Profit Margin % 4.3 4.7 5.0 5.1 Acquisitions m -40 0 0 0 Payout Ratio % 25.0 25.0 25.0 25.0 Capex m -5,327 -5,354 -5,354 -5,354 EV/EBITDA x 6.6 6.6 5.8 5.2 Asset Sales m 62 0 0 0 EV/EBIT x 8.9 8.5 7.4 6.6 Other m -411 0 0 0 Investing Cashflow m -5,716 -5,354 -5,354 -5,354 Balance Sheet Ratios Dividend (Ordinary) m -1,088 -1,270 -1,503 -1,695 ROE % 11.4 11.6 11.6 12.0 Equity Raised m 0 7,880 0 0 ROA % 5.3 5.6 5.7 5.9 Debt Movements m 2 5,203 2,461 2,776 ROIC % 10.5 11.4 12.1 12.6 Other m 1,865 0 0 0 Net Debt/Equity % 34.8 14.0 12.6 10.0 Financing Cashflow m 779 11,812 958 1,081 Interest Cover x 5.0 5.2 6.0 6.2 Price/Book x 1.1 1.0 0.9 0.9 Net Chg in Cash/Debt m -1,265 11,808 2,549 3,711 Book Value per Share 3.7 4.0 4.4 4.8 Free Cashflow m -1,635 -4 1,591 2,630

Balance Sheet 2013A 2014E 2015E 2016E

Cash m 8,247 20,055 22,604 26,315 Receivables m 42,751 40,725 45,756 50,476 Inventories m 18,637 24,277 27,248 30,037 Investments m 0 0 0 0 Fixed Assets m 27,997 30,137 32,145 34,028 Intangibles m 653 833 974 1,086 Other Assets m 21,873 23,009 24,084 25,143 Total Assets m 120,159 139,037 152,812 167,084 Payables m 52,089 53,899 60,494 66,685 Short Term Debt m 20,609 24,504 25,235 27,595 Long Term Debt m 1,415 2,723 4,453 4,870 Provisions m 536 596 670 739 Other Liabilities m 5,944 5,944 5,944 5,944 Total Liabilities m 80,593 87,665 96,796 105,831 Shareholders' Funds m 37,780 49,469 53,975 59,056 Minority Interests m 1,785 1,903 2,041 2,197 Other m 0 0 0 0 Total S/H Equity m 39,566 51,372 56,016 61,253 Total Liab & S/H Funds m 120,159 139,037 152,812 167,084

All figures in Rmb unless noted. Source: Company data, Macquarie Research, June 2014

26 June 2014 49 Macquarie Research China CNR Corp

Important disclosures: Recommendation definitions Volatility index definition* Financial definitions Macquarie - Australia/New Zealand This is calculated from the volatility of historical All "Adjusted" data items have had the following Outperform – return >3% in excess of benchmark return price movements. adjustments made: Neutral – return within 3% of benchmark return Added back: goodwill amortisation, provision for Underperform – return >3% below benchmark return Very high–highest risk – Stock should be catastrophe reserves, IFRS derivatives & hedging, expected to move up or down 60–100% in a year IFRS impairments & IFRS interest expense Benchmark return is determined by long term nominal – investors should be aware this stock is highly Excluded: non recurring items, asset revals, property GDP growth plus 12 month forward market dividend speculative. revals, appraisal value uplift, preference dividends & yield minority interests Macquarie – Asia/Europe High – stock should be expected to move up or Outperform – expected return >+10% down at least 40–60% in a year – investors should EPS = adjusted net profit / efpowa* Neutral – expected return from -10% to +10% be aware this stock could be speculative. ROA = adjusted ebit / average total assets Underperform – expected return <-10% ROA Banks/Insurance = adjusted net profit /average Medium – stock should be expected to move up total assets Macquarie First South - South Africa or down at least 30–40% in a year. ROE = adjusted net profit / average shareholders funds Outperform – expected return >+10% Gross cashflow = adjusted net profit + depreciation Neutral – expected return from -10% to +10% Low–medium – stock should be expected to *equivalent fully paid ordinary weighted average Underperform – expected return <-10% move up or down at least 25–30% in a year. number of shares Macquarie - Canada Outperform – return >5% in excess of benchmark return Low – stock should be expected to move up or All Reported numbers for Australian/NZ listed stocks Neutral – return within 5% of benchmark return down at least 15–25% in a year. are modelled under IFRS (International Financial Underperform – return >5% below benchmark return * Applicable to Asia/Australian/NZ/Canada stocks Reporting Standards). only Macquarie - USA Outperform (Buy) – return >5% in excess of Russell Recommendations – 12 months 3000 index return Note: Quant recommendations may differ from Neutral (Hold) – return within 5% of Russell 3000 index Fundamental Analyst recommendations return Underperform (Sell)– return >5% below Russell 3000 index return

Recommendation proportions – For quarter ending 31 March 2014 AU/NZ Asia RSA USA CA EUR Outperform 51.32% 60.23% 41.25% 40.21% 58.52% 48.74% (for US coverage by MCUSA, 8.21% of stocks followed are investment banking clients) Neutral 34.54% 24.97% 40.00% 53.19% 35.56% 32.77% (for US coverage by MCUSA, 6.67% of stocks followed are investment banking clients) Underperform 14.14% 14.80% 18.75% 6.60% 5.92% 18.49% (for US coverage by MCUSA, 0.00% of stocks followed are investment banking clients)

6199 HK rel HSI performance

(all figures in Rmb unless noted, TP in HKD)

Source: FactSet, Macquarie Capital (USA), June 2014

12-month target price methodology 6199 HK: Target price: HK$6.95.We use a PER valuation methodology and our target price is based on 11.4x 2015E PER.

Company-specific disclosures: 6199 HK: MACQUARIE CAPITAL SECURITIES LIMITED or one of its affiliates is currently managing or co-managing a public offering of securities of China CNR Corp Ltd. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures.

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26 June 2014 51

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