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China Infrastructure Sector China / Hong Kong Industry Focus China Infrastructure Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 21 Jan 2021 Recovering from the trough HSI: 29,962 • Current valuation of 2-3x P/E factors in lower infrastructure investments and US sanctions ANALYST • Expect investments in railway and urban rail Manyi LU +852 36684186 [email protected] transit to surprise on the upside Dennis LAM +852 36684177 [email protected] • Sector recovery ahead, expect 10-17% earnings CAGR for FY20-22F • Top pick is CRG (390 HK) for strong growth in Recommendation & valuation new contracts and improving cash flow Target Mkt PE Company Name Currency Price PriceR ecom Cap 21F Expect upside surprise in transportation FAI. The Ministry of Local$ Local$ US$m x Transportation (MoT) of China announced that total China Railway Con.'H' transportation FAI was Rmb 3.4tr in 2020, which exceeded HKD 5.15 7.50 BUY 15,778 2.4 (1186 HK) the target of Rmb2.6tr for the year. The target for 2021 is China Railway Con.'A' lower at Rmb 2.4tr. We expect this target to be exceeded CNY 8.11 9.00 HOLD 15,778 4.5 (601186 CH) with railway FAI growth anticipated to be strong at c.Rmb China Railway Group 'H' 810bn, up from Rmb 780bn in 2020, driven by strong HKD 3.98 5.30 BUY 19,918 3.1 demand for highspeed railways and large investment in the (390 HK) China Railway Group 'A' Tibet-Sichuan Railway project. CNY 5.65 6.20 HOLD 19,918 5.3 (601390 CH) Valuations yet to reflect solid growth in new contract flows. China Comm. Cons. 'H' HKD 4.00 4.00 HOLD 15,552 2.7 Besides the steady growth in railway projects, we see good (1800 HK) growth potential in municipal construction projects such as China Comm. Cons. 'A' CNY 7.32 7.50 HOLD 15,552 6.0 (a) urban railway transit – we expect c.Rmb 800bn (601800 CH) investments per year in 2020-22 from c.Rmb 600bn in 2019; and (b) housing construction - CRCC and CRG to benefit Source: Thomson Reuters, DBS Bank (Hong Kong) Limited (“DBS HK”) from improving market share. We expect the value of new Closing price as at 20 Jan 2021 construction contracts to rise 10-25% y-o-y in FY20-22F, recovering from the downtrend in FY18-19. These positives have yet to be reflected in sector share prices. Top pick is CRG. We believe the negatives in 2020 such as uncertainties due to the COVID-19 outbreak, and the US’ ban on American investors buying shares in selected China construction companies are largely digested by now. We expect sector valuations to recover from the current level of 2-3x FY21F PE. Potential catalysts are: 1) higher-than- expected infrastructure investment; and 2) issuance of C- REITs to unlock project values and enhance financing capability. Our top pick is China Railway Group (390 HK) on its strong deal flow and improving cash flow. ed-JS/ sa-CS / AH Industry Focus China Infrastructure Sector Why is the sector trading at historical low valuations? The aim to stabilise house prices and keep debt under control has prevented the government from implementing China infrastructure sector continued to trend down in large-scale monetary and fiscal easing policies. 2020, following a weak 2019. Railway construction companies’ share prices fell by c.30-50% during the year Sector performance vs infrastructure FAI growth while the HSI declined by 3.4%. The sector is now trading at a historical low valuation at 2-3x FY21F P/E, or 0.2-0.3x (Jan 1, 2015 = 1) % FY21F P/B. We believe the current valuation factors in most 2.00 40 of the negatives and we expect valuations to recover 30 supported by improving sector fundamentals. 1.50 20 10 Weak share performance in 2020 1.00 0 -10 0.50 -20 -30 HSI 0.00 -40 CRG Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 (390 HK) Jan-21 Sector relative performance to HSI (LHS) CCCC Infrastructure FAI yoy (%, RHS) (1800 HK) CRCC Source: CEIC, DBS HK (1186 HK) 2) US sanctions affecting market sentiment CRRC China-US tensions has negatively affected construction (1766 HK) SOEs in 2020. We believe the impact should be limited as their operations and technology do not have material 0% -20% -40% -60% exposure to the US. However, their share prices have come Source: Bloomberg Finance L.P., DBS HK under short-term pressure given that US investors are banned from buying these stocks from Jan 2021. The following factors led to the sector’s underperformance in 2020: Impact of US sanctions 1) “New normal” of lower infrastructure investment growth Affected China’s infrastructure FAI growth was slower in 2019, companies US sanctions Potential impact* CCCC In Aug 2020, US Dredging business dropping to low single digit from double digit before 2018. restricted 5 of CCCC's makes up 6% of total Infrastructure FAI declined by 30.3% y-o-y in Jan-Feb 20 due dredging subsidiaries revenue; small overseas to COVID-19 impact, and recovered during the rest of the from using technology exposure; not using US year. In Jan-Nov 2020, infrastructure FAI increased by 1% y- or products of US technology in core o-y, lower than overall FAI growth of 2.6% y-o-y, and much suppliers equipment lower than consensus expectations of high-single digit to CCCC From Nov 2020, US US shareholding on H- double digit growth. investors banned shares is 10.9% from investing in In fact, China has entered a “new normal” against the “flood- CCCC like” easing seen during the previous stimulus rounds. The CRCC From Nov 2020, US US shareholding on H- investors banned shares is 13.6% Chinese government is now more tolerant towards slower from investing in economic growth. In the Central Economics Work CRCC Conference in Dec 2020, the government put forward 2021 CRRC From Nov 2020, US US shareholding on H- fiscal policy as “improving quality and efficiency, more investors banned shares is 15% sustainable, maintaining reasonable expenditure”. Efficiency from investing in and quality are now more important factor than simply CRRC having larger scale projects. Source: DBS HK * Shareholding information as of 7 Jan 2021 Page 2 Industry Focus China Infrastructure Sector After US President Trump issued the executive order PPP projects during the COVID-19 outbreak placed higher barring Americans from investing in a list of Chinese pressure on operating cash flows. companies in Nov 2020, US investors’ shareholdings in the infrastructure sector fell. In the past, 25-30% of H-shares of Secondly, more cost was incurred as a result of COVID-19 infrastructure stocks were held by US shareholders. The outbreak. The gross margins of CRCC, CCCC and CRG fell by shareholding ratio has dropped to 10-15% in Jan 2021. 0.1-0.9ppts y-o-y in 1H20. In 9M20, CRCC and CRG’s gross margins are still lower than the same period in 2019. 3) Pressure on operations from COVID-19 Firstly, operating cash outflow was high in 9M20 vs 9M19. Finally, there is more uncertainty on the outlook of overseas Compared with the sector peak in 2014-15, there is now projects. The impact is larger on CCCC, which has c.15-20% higher pressure on construction companies’ cash flow and of its revenue from overseas projects. In 1H20, overseas balance sheet. This is due to the higher portion of public- revenue dropped 16.2% y-o-y to c.Rmb 38bn, accounting for private partnership (PPP) projects after 2016/17, which have 15.5% of total revenue. CRCC and CRG only have c.5% of higher financing requirements for contractors. revenue coming from overseas, hence the negative impact is less compared to CCCC. Despite efforts to enhance cash collection, longer account receivable days and suspension of collection of tolls from US ownership in H-shares Operating cash outflow in 9M20 % RMB bn 40 45 35 40 30 35 25 30 25 20 20 15 15 10 10 5 5 0 0 CCCC CRCC CRRC CRCC CCCC CRG Nov-20 Jan-21 9M19 9M20 Gross margin in 9M20 14% 12% 10% 8% 6% 4% 2% 0% CRCC CCCC CRG 9M19 9M20 Source: Companies, DBS HK Page 3 Industry Focus China Infrastructure Sector Strong new growth potential for other sections should be called in the next two to three years; and 2) HSR: the government’s HSR target is 2021 transportation investment target is lower than 2020. c.70,000km by 2035 vs c.39,000km as of the end of 2020. Despite a challenging 1Q20, transportation investment in With more than 15,000km of new length under construction 2020 had increased by 6.6% y-o-y to Rmb 3.4tr, exceeding or in the planning stage, we expect c.2,500km p.a. to be 2020’s target of Rmb 2.6tr. Meanwhile, the MoT has set a completed in 2021/22. lower target for 2021 at Rmb 2.4tr. This raised concerns that infrastructure construction growth may slow after years of Highway: stable investment ahead. Highway FAI has high investments. recovered strongly after 1Q20. In 11M20, highway FAI was 11% y-o-y higher at Rmb 2.25tr, exceeding the original 2020 Target and actual transportation investment target of Rmb 1.8tr. Looking ahead, we expect stable investment in this segment despite the high base.
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